United States District Court, N.D. California, San Jose Division
ORDER GRANTING DEFENDANTS' MOTION TO DISMISS WITH
LEAVE TO AMEND [Re: ECF 89]
LAB SON FREEMAN United States District Judge.
case arises from allegations that certain officers of Extreme
Networks, Inc. engaged in securities fraud. Plaintiffs bring
this action against Charles W. Berger, Kenneth B. Arola, and
John T. Kurtzweil (collectively, “Individual
Defendants”), and Extreme Networks, Inc. (collectively
with the Individual Defendants, “Defendants”)
under Section 10(b) of the Securities Exchange Act of 1934
(“Exchange Act”), 15 U.S.C. § 78j(b), and
Rule 10b-5, 17 C.F.R. § 240.10b-5. Plaintiffs also
assert claims against the Individual Defendants as
“control persons” pursuant to Section 20(a) of
the Exchange Act, 15 U.S.C. § 78t(a).
the Court is Defendants' motion to dismiss. Mot., ECF 89.
The Court heard oral argument on February 9, 2017. For the
reasons set forth herein, the motion to dismiss is GRANTED
WITH LEAVE TO AMEND. Defendants have also filed a request for
judicial notice, which the Court GRANTS. Mot. 4 n.1.
Extreme Networks, Inc. (“Extreme” or
“Company”) is a Delaware corporation that
develops and sells network infrastructure equipment and
related service contracts for warranty and maintenance of its
equipment. Consolidated Compl. (“Compl.”)
¶¶ 2, 29, ECF 87. Defendant Charles W. Berger was
the Company's President and Chief Executive Officer
(“CEO”) and a member of Extreme's Board of
Directors from April 2013 until April 19, 2015. Id.
¶ 31. Defendant John T. Kurtzweil was Extreme's
Chief Financial Officer (“CFO”) and Senior Vice
President from June 29, 2012 through June 1, 2014.
Id. ¶ 32. From June 2, 2014 until September 30,
2014, Kurtzweil served as “Special Assistant to the
CEO.” Id. Defendant Kenneth B. Arola was the
Company's CFO and Senior Vice President from June 2, 2014
through May 2016. Id. ¶ 33.
Plaintiff Arkansas Teacher Retirement System
(“Plaintiffs”) filed a class action complaint on
behalf of all investors who purchased the publicly traded
common stock of Extreme and/or exchange-traded options on
such common stock between September 12, 2013, and April 9,
2015, (the “class period”). Id. ¶
1. Plaintiffs allege that during the class period, Defendants
falsely assured investors regarding the status of
Extreme's acquisition of Enterasys Networks, Inc.
(“Enterasys”), misrepresented the potential
impact of the Company's partnership with Lenovo Group
Ltd. (“Lenovo”), and falsely promised that the
Company would achieve 10 percent revenue growth and 10
percent operating margin by the end of its fiscal year
(“FY”) 2015. Id. ¶¶ 12-14.
Plaintiffs further allege that these misrepresentations and
omissions led Extreme's stock to trade at artificially
inflated prices during the class period. Id. ¶
16. Plaintiffs offer statements by seven confidential
witnesses (“CWs”) to suggest that the Individual
Defendants knew of or deliberately disregarded the falsity of
their statements at the time they were made.
The Enterasys Integration
September 12, 2013, Extreme issued a press release announcing
an agreement to acquire Enterasys, a similarly-sized company
based in New Hampshire, for $180 million in cash.
Id. ¶ 4; Ex. 7 to Austin Decl., ECF 89-9 (Sept.
12, 2013 press release). The acquisition roughly doubled the
size of the Company, and the Company described it as a
“merger of equals.” Id. The market
reacted favorably to statements regarding the immediate value
that the acquisition would add to Enterasys. Id.
¶ 174. As a result, Extreme's stock price increased
seven percent by $0.30 per share, from $4.03 per share at the
close of trading on September 11, 2013, to $4.33 per share at
the close of trading on September 12, 2013. The merger closed
on October 31, 2013, during Extreme's Second Quarter
(“Q2”) 2014. Id. ¶ 53.
November 4, 2013, Extreme issued a press release announcing
its financial results for Extreme's First Quarter
(“Q1”) 2014 and its Q2 2014 guidance.
Id. ¶ 177. Among other things, the press
release stated that Chris Crowell, the former CEO of
Enterasys, had been retained as the Chief Operating Officer
(“COO”) of Extreme, with direct responsibility
for “sales and marketing.” Id. In the
press release, Berger touted Extreme's
“considerable progress” in the integration of
Enterasys. Id. On a conference call that same day,
Berger reiterated that the integration was progressing well.
Id. ¶ 178. After this announcement, the
Company's stock price increased from $5.38 per share to
$6.30 per share. Id. ¶ 182.
the market opened on February 5, 2014, Extreme issued a press
release announcing its Q2 2014 financial results and its Q3
2014 guidance. Id. ¶ 188. Extreme reported
revenues toward the low end of the guidance announced in its
November 4, 2013, press release for Q2 2014, and expected
reserves for Extreme's Third Quarter (“Q3”)
2014 below the consensus estimates of $154 million.
Id. During a conference call with investors to
discuss this announcement, Berger acknowledged that the
Company had “not seen significant evidence of revenue
[due] to synergies.” Id. After this disclosure, the
Company's stock declined from $7.04 per share to $5.92
per share. Id. ¶ 189.
close of Q3 2014, Extreme released two press releases after
trading hours. Id. ¶ 199. These announcements
reported financial results for the first full quarter since
the acquisition was complete. Id. The first
announced Company revenues for Q3 2015 that were again on the
low end of the guidance given at the end of the prior
quarter. Id. The press release also announced the
transition of Kurtzweil from CFO to “Special Assistant
to the CEO” and the hiring of Arola as CFO.
Id. ¶ 200. The second press release on May 6,
2014, announced the departure of Chris Crowell, COO of
Extreme and former CEO of Enterasys. Id. On an
earnings call that same day, Berger disclosed that Extreme
“ha[d] experienced some integration issues, ” and
announced that the field organizations and corporate
marketing would report to him effective immediately.
Id. ¶ 201. Following these announcements, the
Company's stock declined $1.38 per share. Id.
¶ 202 (share price was $3.95 per share at the close of
trading the next day).
21, 2014, two weeks before Extreme released its official
Fourth Quarter (“Q4”) 2014 financial results, the
Company issued a press release announcing higher guidance for
Q4 2014. Id. ¶ 213. In the press release,
Berger stated that “[o]ur integration remains ahead of
plan as we continue to execute against key Company and
operational and financial milestones, including successfully
completing our ERP integration in early July[.]”
Id. Berger and Arola continued to tout the successes
of the integration through October 2014, when Extreme
preannounced disappointing Q1 financial results. Id.
October 2014, Extreme issued a press release announcing that
Extreme's reported revenues were approximately $15
million below the Company's prior guidance and its
Non-GAAP Net Income per Diluted Share would be break-even
despite prior announcements that it would be between $0.06
and $0.08. Id. ¶ 227. Berger attributed the
results to “significant delays in closing deals”
in North America, but reassured investors that Extreme had
“made dramatic progress” with the Enterasys
integration, including hiring Jeff White as Chief Revenue
Officer (“CRO”). Id. ¶¶
227-28. The day after these disclosures, Extreme's stock
fell by approximately 18 percent, declining from $3.76 per
share to $3.06 per share. Id. ¶ 228.
that same month, Extreme issued a press release announcing
its financial results for Q1 2015 and its Q2 2015 guidance.
Id. ¶ 223. Extreme's reported revenue for
Q1 2015 was slightly above the Company's preannounced
results. Id. In the press release, Berger reassured
investors that Extreme was “on track to realize the
full $30 to $40 million in cost synergies expected from the
acquisition, ” and that the Company had “made
significant progress towards finalizing the
integration.” Id. Later that day, Berger and
Arola hosted an earnings call with analysts to discuss the Q1
2015 financial results. Id. ¶ 234. During that
call, Berger acknowledged that the low revenue and top-line
growth were caused by “significant”
“disruptions” resulting from the ongoing
Enterasys integration efforts. Id. Berger, however,
assured investors that “these disruptions are now fully
behind us.” Id.
January 2015, while Arola touted the success of the
integration, its customers, and quality of its products and
services, he also suggested that Extreme would not be able to
deliver on its commitment of 10 percent growth by the end of
FY 2015. Id. ¶ 249. After making this
disclosure, Extreme's stock declined from $3.36 per share
to $3.20 per share, and continued to decline for two weeks.
Id. ¶ 250. Later that month, Extreme announced
its Q2 2015 financial results and its guidance for Q3 2015.
Id. ¶ 254. Extreme's revenue was in line
with the original guidance, and its expected revenue was
slightly lower than analysts' expectations. Id.
During a January 28, 2015, earnings call, Berger stated that
the Company would not be able to deliver the 10 percent
year-over-year growth that he and the other Defendants had
projected from the beginning of the Enterasys acquisition.
Alleged False Statements
allege that Defendants made a number of false and misleading
statements related to the acquisition during the class
period. Primarily, these statements fall into the following
categories: (1) statements touting the success of the
integration without disclosing the “failures”;
(2) claims that the integration was “on track”;
and (3) statements announcing the financial expectations of
the acquisition despite having no reasonable basis for such
identify numerous statements falling into each category. The
Court offers the following as examples:
• The acquisition “is expected to be immediately
accretive.” Id. ¶¶ 168 (Sept. 12,
2013), 170 (would produce “significant value” for
shareholders) (same date).
• The revenue of the combined companies “will be
approximately double that of either company alone.”
Id. ¶¶ 169 (Sept. 12, 2013), 172 (same
• “[W]e plan to reduce product costs and operating
expenses between $30 million to $40 million . . . over a 12
to 24-month period.” Id. ¶¶ 169
(Sept. 12, 2013), 180 (Nov. 4, 2013), 194 (Feb. 5, 2014), 220
(Aug. 14, 2014), 228 (Oct. 15, 2014).
• “There will be no disruption in customers'
ability to grow and operate their networks.”
Id. ¶¶ 170 (Sept. 12, 2013), 192 (Feb. 5,
• “We have already made considerable progress
towards integrating the two companies including establishing
the executive leadership team.” Id.
¶¶ 177-78 (Nov. 4, 2013).
• “[O]ur integration efforts are on track.”
Id. ¶¶ 178 (Nov. 4, 2013), 190 (Feb. 5,
• “The senior management team for the combined
Company has been established and we continue to make steady
progress towards a complete integration.” Id.
¶ 190 (Feb. 5, 2014).
• “We see [the integration] getting dramatically
better with a couple of things, the combination of sales
forces under the leadership of our now head of North American
sales John Fabiaschi, who came from Enterasys with strong
performance there.” Id. (Feb. 5, 2014).
• “[W]e have started to make significant cuts,
particularly in removing duplicative and very expensive
senior management in the sales organization. We've got a
similar move already in the marketing organization. I think
you will see more of those synergies in this quarter and
certainly next.” Id. ¶ 195 (Feb. 5,
• “We expect to have [the integration of the sales
teams] complete late summer early fall .”
Id. ¶ 192 (Feb. 5, 2014), 220 (“[T]he two
companies are now fully integrated . . . .”) (Aug. 14,
• “[O]ur sales force integration is
complete.” Id. ¶ 217 (Aug. 14, 2014).
• “[T]he combined company is in a better position
than ever to seamlessly deliver value to the customer.”
Id. (Aug. 14, 2014).
• “On the whole, the integration has significantly
exceeded my expectations.” Id. ¶ 218
(Aug. 14, 2014).
• “Overall, we are exactly where we planned to be
in [the] integration process and the realization of the
related financial synergies . . . . We completed major
elements of the integration of Enterasys and are on track to
realize the synergies we have committed to.”
Id. (Aug. 14, 2014).
• “[W]e expect to achieve a 10% non-GAAP operating
margin in Q4 and beyond.” Id. (Aug. 14, 2014)
claim that these statements were false because: (1)
Extreme's acquisition of Enterasys “wasn't a
very good deal”; (2) Extreme lacked an appropriate
integration plan or product roadmap for the combined Company;
(3) they incorrectly implied that the combined Company would
achieve over $600 million in annual revenues due to its lack
of overlap in revenue sources while failing to mention the
substantial overlap between the two companies'
salesforce, region, and products/services; (4) they
incorrectly implied that the lack of customer overlap would
help the joint Company achieve annual revenues in line with
their separate trailing revenues; (5) Extreme's revenue
and ability to create cost-saving synergies depended on
successfully integrating Enterasys, but the Company was
experiencing substantial integration problems that were not
disclosed; (6) Defendants lacked a reasonable basis to expect
to achieve $30 to $40 million in cost savings within the
promised time frame; (7) Defendants touted positive aspects
of the integration without disclosing the negative aspects,
such as significant cuts of duplicative senior positions
without disclosing the fact that numerous redundancies
remained; and/or (8) gave the false impression that
Extreme's cost cutting measures would materialize in
increased profit margins in the near future, without
disclosing that these cost cuts would not be sufficient to
offset the loss of customers and business due to the
integration problems. Id. ¶¶ 171, 173,
179, 181, 191, 193, 196, 214, 219, 221.
further allege that even after CEO Berger disclosed that
Extreme had “experienced some integration issues,
” Defendants continued to mislead the market:
• Defendants represented that despite these issues, the
integration was “ahead of plan, ” “ahead of
schedule, ” “going very well, ” and would
soon deliver the positive revenue impacts that had been
predicted. Id. ¶¶ 203-05 (May 6, 2014),
223 (“I am confident . . . that virtually all of the[
integration challenges in the North American sales and
partner organization] are behind us.”) (Aug. 14, 2014),
228 (Oct. 15, 2014), 233 (“During the quarter, we made
significant progress towards finalizing the integration of
the acquisition of Enterasys.”) (Oct. 28, 2014), 256
(Jan. 28, 2015).
• Defendants “reemphasize[d their] plan and [ ]
commitment to attain double digit revenue growth by the
second half of 2015” and a “10% operating margin
on a non-GAAP basis.” Id. ¶¶ 204
(May 6, 2014), 223 (“[W]e expect to achieve a 10%
non-GAAP operating margin in Q4 . . . .”) (Aug. 14,
2014), 235 (Oct. 28, 2014).
• “[T]he[ ] disruptions [to the integration
efforts] are now fully behind us.” Id. ¶
234 (Oct. 28, 2014).
• “We continue to [be on] track to realize the
full $30 million to $40 million of synergies expected from
the Enterasys acquisition.” Id. ¶ 235
(Oct. 28, 2014).
• “Although many deals were pushed out of the
quarter, they remain in the pipeline, and we are confident in
our ability to compete for these deals that were delayed from
Q1.” Id. ¶¶ 238 (referring to
“deal slippage”) (Oct. 28, 2014), 247 (Dec. 17,
2014). Additionally, in December 2014, Defendants first
claimed that the integration was complete in some respects.
Id. ¶ 245 (conversion to one ERP system and
integration of sales team completed). Plaintiffs claim that
these statements were false and misleading for many of the
reasons stated above and because: (1) Defendants lacked any
reasonable basis to expect to achieve double-digit revenue
growth and 10 percent profit margin by June of 2015, and in
fact failed to achieve such results; (2) the integration was
a “failure”; (3) Extreme's revenue shortfalls
could not be fully explained by “deal slippage”
because numerous deals were lost due to undisclosed
integration problems Id. ¶¶ 206, 219, 224,
The Partnership with Lenovo
allege that during the class period, Extreme's business
model depended primarily on selling its products and services
through other companies it called “channel
partners.” Id. ¶ 6. One such partnership
was with Lenovo, a global technology company. Id.
Extreme first announced this partnership on July 17, 2013.
Id. Throughout the class period, Defendants claimed
that Lenovo was one of the Company's “key
partnerships” as well as a key “growth
driver” due to its expanding server business.
Id. ¶¶ 7, 77. Defendants predicted that
Extreme would begin to see “a lot of business”
from Lenovo beginning in March 2014. Id. ¶ 75.
January 23, 2014, Lenovo announced that it would be expanding
its server business by acquiring IBM's “x86”
server business. Id. ¶ 76. After this
announcement, Extreme adjusted its assessment of when it
would begin to reap the benefits of the partnership. For
example, on May 6, 2014, Berger stated that the Company
expected the relationship “to have meaningful revenue
impact in the second half of fiscal 2015.” Id.
¶ 81. Berger continued to tout the “key
partnership” with Lenovo throughout 2014. In early Fall
2014, Berger announced that he had “met with the Lenovo
executive team in China” and it was clear to him that
“they are strongly committed to the alliance.”
Id. ¶ 83. He also stated that Extreme expected
“to attain year-over-year double-digit revenue growth
in the fourth fiscal quarter, driven by our expected ramp of
the Lenovo business.” Id. On October 28, 2014,
Berger stated that the two companies “continue to make
progress each day towards realizing the potential of this
agreement, ” and anticipated “significant results
by the fourth quarter.” Id. ¶ 89. He
further stated that “there [was] no longer any doubt
that this will happen, ” and that he expected to
achieve double-digit revenue growth as a result of the
partnership by the end of 2015. Id. After the
October 28 announcements, Extreme's stock increased from
$3.30 per share to $3.79 overnight. Id. ¶ 292.
mid-January 2015, CFO Arola touted the success of the
Enterasys integration and Extreme's customers, products,
and services during a public presentation at the Needham
Growth Conference. Id. ¶ 294. After the
presentation, however, Plaintiffs allege that Arola implied
that Extreme would not be able to deliver on its commitment
of 10 percent growth by the end of FY 2015. Id.
Arola was also more ambiguous about the potential impact of
the Lenovo partnership:
[We are] evaluating where we are with things like our Lenovo
relationship, how much business we'll get in our
quarter-four timeframe in relation to that business . . . . I
don't want to make a comment about the 10% and the 10%,
but our long-term view of the business if you ask me should
be running this business at ¶ 10% operating margin
pretty consistently over time.
Id. After this disclosure, Extreme's stock
declined from $3.36 per share to $3.20 per share overnight.
Id. ¶ 295. Two days after the disclosure,
Extreme's stock declined further. Id.
the Company's January 28, 2015, earnings call to discuss
financial results for its 2Q 2015, Berger revealed that the
revenue impact the Company anticipated as a result of the
partnership with Lenovo would not be achieved by June 2015,
and perhaps not for another year. Id. ¶ 92.
Nevertheless, he expressed confidence in the relationship
between the two companies, claiming that the
“partnership with Lenovo strengthened during the
quarter on many fronts, ” with “continued
productive discussions at all levels with Lenovo.”
Id. ¶¶ 92, 298. After these disclosures,
the Company's stock price increased from $2.78 per share
to $3.04. Id. ¶ 301.
Alleged False Statements
allege that Defendants made a number of false or misleading
statements in connection with Extreme's partnership with
Lenovo. The Court offers the following as illustrative of the
types of statements Plaintiffs claims were false or
• “[T]he Lenovo agreement, which we announced [in
July 2013], will start to go into full swing this
month.” Id. ¶ 265 (Nov. 4, 2013).
• Given Lenovo's business plans, Extreme
“should see a pick up [in business] coming into the
March quarter.” Id. (Nov. 4, 2013).
• “We continue to be [Lenovo's] only
networking partner, and we will be now included in a price
list shared by 1200 more sales people they are getting as
part of the acquisition [of IBM's server business],
assuming it stays on track and closes in 6 to 9 months and we
just see this as tremendously positive.” Id.
¶ 272 (Feb. 5, 2014).
• “I want to again reemphasize our plan and
commitment to attain double digit revenue growth by the
second half of 2015 as we . . . realize the benefits of our
key partnerships like Lenovo and Ericsson . . . .”
Id. ¶¶ ...