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Extreme Networks' CEO Discusses Q4 2011
Results - Earnings Call Transcript
Executives

Oscar Rodriguez - Chief Executive Officer, President and Director

James Judson - Interim Chief Financial Officer

Analysts

Jonathan Kees - Capstone Investments

Sanjit Singh - Wedbush Securities Inc.

Unknown Analyst -

William John Nasgovitz

Extreme Networks (EXTR) Q4 2011 Earnings Call August 1, 2011 5:00 PM ET

Operator

Welcome to the Extreme Networks' 2011 Fourth Quarter Conference Call. I would now like to turn the call over to Mr.
Jim Judson, Interim CFO of Extreme Networks.

James Judson

Thank you, Matthew. Welcome to the Extreme Networks' 2011 Fourth Quarter Conference Call. [Operator Instructions]
On the call today from Extreme Networks are Oscar Rodriguez, President and CEO; and myself, Jim Judson, Interim
CFO. As a reminder this conference is being recorded today, August 1, 2011.

This afternoon, Extreme Networks issued a press release announcing the company's fiscal results for the fourth quarter
of 2011. A copy of this release and a slide presentation of the supporting financial materials are available in the Investor
Relations section of the company's website at www.extremenetworks.com. This call is being broadcast live over the
Internet, and will be posted on the Extreme Networks' website for a replay shortly after the conclusion of the call.

Extreme Networks wants to remind you that this conference call contains forward-looking statements that involve risks
and uncertainties, including statements regarding the company's expectations regarding its financial performance,
strategies, growth of customer bandwidth demand, development of new products, customer acceptance of the
company's products -- excuse me, customer acceptance of the company's products, customer buying and spending
patterns, overall trends and economic conditions in the company's markets.

Actual results could differ materially from those projected in the forward-looking statements as a result of certain risk
factors including, but not limited to, a challenging macroeconomic environment worldwide, fluctuations in demand for
the company's products and services, a highly competitive business environment for network switching equipment, the
company's effectiveness in controlling expenses, the possibility that the company might experience delays in the
development of the new technologies and products, customer response to its new technology and products, the timing
of any recovery in the global economy, risks related to pending or future litigation, and the dependency on third parties

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for certain components and for the manufacturing of the company's products.

The company undertakes no obligation to update this information on the conference call. More information about
potential factors that affect our business and financial results is included in the company's filings with the Securities and
Exchange Commission.

Throughout the conference call, the company will reference both GAAP and non-GAAP financial results. The company
has provided a reconciliation table of GAAP to non-GAAP, and information in the tables that accompany the press
release on its website. Please go to the Investor Relations section of the company's website at
www.extremenetworks.com. In addition, all announced results are preliminary and may be subject to change when the
review of the fiscal quarter is concluded and/or a Form 10-K is filed.

I will review our fiscal Q4 and full year 2011 results, followed by a brief discussion of the restructuring plan we
announced on July 12. I'll then turn the call over to Oscar for more clarity on the actions we have taken under this
restructuring plan, along with comments on the quarter and progress the company is making with its transformation.
After Oscar's comments, I will provide guidance for our fiscal 2012 first quarter and full year. We will then open up for
Q&A.

As in previous periods, we have posted a slide presentation on our website at www.extremenetworks.com under the
Investor Relations Section, that I hope you will find useful. As a reminder, all of my comments will be non-GAAP except
for revenue and the number of common shares. Non-GAAP results excludes stock-based compensation, restructuring
charges and litigation settlements. There's a reconciliation of GAAP to non-GAAP financial results in the slide
presentation under Investor Relations on our website that I mentioned previously.

In addition, our 2011 fiscal year contains 53 weeks instead of the usual 52 weeks. As a result, we are still reviewing
certain expense accruals that could impact our earnings per share number by reducing it. If a reduction were to occur,
the company believes -- with most likely be by $0.01 per share for both the fourth quarter, as well as the full year.
Rather than delay the announcement of earnings until we can complete this review, we have elected to release our EPS
number, which may be revised depending on the outcome of our review.

Fourth quarter FY '11 showed a significant rebound in revenue from a soft Q3, especially in our Americas geo. Q4
revenue totaled $89.8 million, up $14.1 million or 19% from Q3, and up 5% from Q4 FY '10. This also exceeded our
guidance for Q4 of revenue between $80 million to $85 million during our Q3 earnings call.

The revenue deferral of a large customer win we discussed in our Q3 results was recognized in Q4, contributing $2.8
million of revenue. In addition, Q4 was a 14-week quarter, and we believe that this extra week may have had an impact,
a positive impact on our sales. However, we are not able to quantify the effect of the slightly longer quarter on our
operating results.

In connection with the end-of-sale announcements of our BD 10, 12 and 20K products, we recognized $3.1 million of
revenue with customers purchasing the end-of-sale and replacement products. We had discussed order delays
surrounding these products and customers on our Q3 call, and are pleased that we were able to work with these
customers to sell them additional Extreme products.

Geographically, the growth in revenue from Q3 to Q4 came largely from the recovery in North America, with revenue
totaling $40 million, up 53% quarter-over-quarter. Our EMEA geo grew 7% quarter-over-quarter to $34.9 million, while
the Asia Pac geo declined slightly to $14.9 million after a strong Q3. On an annual basis, the strong Q4 North America
enabled them to close the year with revenue of $123.6 million, flat year-over-year despite the organizational changes
during the year and a very competitive market in the Enterprise Campus space they have traditionally relied on.

The EMEA geo finished the year at $144.1 million, which represents an 8% revenue growth year-over-year, aided by
our relationship with Ericsson, which grew to an 11% revenue customer in fiscal year 2011.

In Asia Pac, revenue grew 27% year-over-year to $66.7 million, led by growth in China, Korea and Southeast Asia.

For the full year, revenue totaled $334.4 million, up 8% over fiscal 2010. That was comprised of $274.4 million of
product revenue, up 10% versus 2010, and $60 million of service revenue, which was flat when compared to 2010.

Gross margin in Q4 increased by 5.8 points versus Q3 to 54.3%. Excluding the write-off of excess and obsolete
inventory for the end of sale of some of our Metro/Carrier products in Q3, the gross margin declined 1.3 points from Q3.



The decline in gross margin was primarily due to decreased product margins. This was due to deeper discounts on
several large transactions with customers affected by the end of sale of some of our Metro/Carrier products. This
contributed just over half of the decline in margin quarter-over-quarter. We believe these are one-time transactions, and
are not expected to have an ongoing impact on margins.

We also won more large competitive deals in the quarter. And were able to recognize revenue on several aggressively
priced deals that had been won in prior quarters, but had not shipped due to credit issues, which were resolved in Q4.

Additionally, we're starting to see increased revenue from our OEM relationships, which may tend to have lower gross --
product gross margins due to our partners bearing most of the cost of sales and marketing expenses.

As the overall portion of OEM revenues increases, quarterly gross margins may vary based on the mix of the OEM to
non-OEM revenue. In addition, OEM revenue will vary on a quarterly basis as we develop this business. And as a
result, the margin impact could vary from quarter-to-quarter.

Operating expenses in Q4 increased $5.3 million to $46.3 million from Q3 levels. You may recall that Q3 benefited from
the reversal of $1.5 million of accruals for bonuses. The primary increase in expenses during Q4 was variable sales
commissions and year-end accelerators, which kicked in as a result of the higher revenue, especially in North America
and Asia Pacific. Also contributing were increased expenses associated with engineering prototypes and NREs, as we
complete the development of products announced in Q4, and increased marketing costs related to trade shows and
partner conferences.

Estimated EPS for Q4 is expected to be $0.02 per share, compared to our guidance at the start of the quarter of $0.03
to $0.05 and a loss of $0.05 per share in Q3. The lower margins on large customer and OEM deals, in addition to the
increased operating expenses I just described, resulted in the lower EPS.

For the full year, the company expects to earn $0.08 per share, which is a decrease of $0.05 per share versus FY '10.
Final EPS numbers for both the fourth quarter and full year will be made available after our financial review related to
the 53-week year is complete.

Turning to the balance sheet. Total cash and investments for the quarter remained unchanged at $147 million driven by
strong collections and a DSO of 38 days, versus 42 a quarter ago. Inventory increased $2.8 million to $21.6 million from
Q3, as we position material to minimize supply disruptions after the Japan tsunami, which did not materialize.

Overall, we are pleased with the revenue results for Q4, as we continue to move forward with our transformation plan
for the company. We've successfully worked through the end-of-sale issues with many of our customers who were
impacted. We completed several larger strategic deals in the quarter, we kept the company focused on delivering
products and results in Q4 after a 5% reduction in staffing in Q3, and we have implemented the changes we believe are
needed to right-size the company's cost structure to position the company for double-digit operating income growth
going forward.

As announced previously, our Q4 fiscal '11 GAAP results include a restructuring charge for reducing our employee base
by approximately 110 people, or 16% of the worldwide workforce. Affected employees were notified week of July 11,
with approximately 70 leaving the company immediately, and the remainder transitioning out through Q1 and Q2. All
costs from this action are employee severance costs, associated with downsizing the company and reducing our fixed
costs.

The total cost of restructuring will result in a charge to the P&L of approximately $3.5 million, on a GAAP basis, when
complete. The restructuring charge in Q4 FY '11 is $3.2 million on a GAAP basis, which when netted against earlier
charges, resulted in a $2.8 million charge to the P&L in the quarter. Approximately 300k, on a GAAP basis, of additional
restructuring charges will occur over Q1 and Q2.

At this point, I'll turn the call over to Oscar to discuss the progress we are making with the transformation of Extreme,
including some more color on the restructuring plan we have implemented, as well as some key customer wins and
signs of traction we are seeing with the implementation of our strategy. I will be back after his comments to discuss
guidance moving forward. Oscar?

Oscar Rodriguez

Thank you, Jim, and I want to thank all of our investors for joining this call.



As we discussed in our last call, we are in the process of transforming Extreme by focusing our resources on select,
high-growth market verticals to drive revenue growth, while making the transformative changes we believe are required
to reach consistent double-digit operating income. We believe that with a focus on driving efficient operations, coupled
with a clear strategy for continuous product and services cost reductions, we will be able to provide sustainable
customer value in an increasingly competitive market.

We also believe that the new cost structure from the restructurings implemented in Q3 and Q4 will enable us to reach
consistent operating income without the need for additional revenue growth, and will position us to further improve
financial performance as we grow revenue.

As we've mentioned in our last earnings call, in Q3, we took to the initial steps in our strategy to sustainably reduce
engineering costs by focusing our technology investments to leverage product development efforts across all of our
product lines, and by eliminating specific underperforming products from our portfolio. This transition effort is now
largely behind us, and we have stopped the associated cost for select Metro Ethernet products. This has had the effect
of lowering committed R&D and operations costs, while increasing available resources to focus product development for
our strategic vertical markets.

In Q4, we began to take the next steps to further lower our operating costs as follows: First, we are focusing software
development work into our 2 established lower cost venues in Research Triangle Park, North Carolina and Chennai,
India. As a result, we will expand the resources in these existing locations to leverage our high-value innovation
capabilities and existing infrastructure. We believe this will allow us to realize greater productivity in economies of scale,
decrease time-to-market for products, and increase feature velocity and will allow us to lower overall R&D costs while
expanding R&D headcount.

Next, by consolidating and aligning sales management more effectively across our geographies, we are lowering our
sales cost structure while focusing resources on higher-performing regions. As of Q4, we completed our work to realign
and staff North America sales management with positive results. In Q1, we are focused on the management
realignment in selected portions of EMEA and Latin America. And we believe these changes will also serve to enhance
performance while lowering overall sales costs.

Next, by reducing corporate marketing spend and shifting those resources to field marketing, we expect to expand
customer awareness for our solutions, thereby enhancing brand awareness and lead generation in our targeted vertical
markets to enable revenue growth.

Finally, by moving to simplify our processes, systems and infrastructure, we expect to lower the cost of G&A and
streamline our operations. Beyond these changes to lower operating costs, we are also taking specific steps to also
lower both product and service cost structures proactively. First, we initiated cost reduction activities for key high-
volume products. As a result, we expect to realize lower standard costs for select products over the course of fiscal
2012. And by consistently and continually redesigning products for lower cost, we expect to be better positioned to
maintain product gross margins in the competitive pricing environment we're working in.

By more effectively balancing the location and skills of our global service and support workforce, we expect to lower
cost and expand service margins while continuing to provide world-class customer service to all our valued customers.

Finally, by moving select manufacturing operations' staff closer to our factories in Asia, and by completing our plans to
drive more efficient logistics in product delivery, we expect a lower overhead -- operating overhead while enhancing our
operations productivity.

We have already begun to execute on these specific transformative actions, and we expect to complete these actions in
the first half of 2012. Once completed, we believe these changes will enable us to drive a consistent double-digit
operating income at sustainable revenue levels. While we believe these operational changes position us well in terms of
overall cost structure, I want to reiterate that a key focus is also on driving revenue growth, with both our new and
existing products.

In a difficult year with the -- in the networking industry, where total revenue declined from $4.8 billion in Q1 2010 to $4.4
billion in Q1 2011 despite the healthy increase in port sales overall, we are pleased to have grown fiscal year product
revenues by 10% year-over-year. We were helped in the market by a shift to a more favorable mix, as customers
moved to upgrade their networks to install higher-performance tech, 1-gig and 10-gig networks, with high-value network
intelligence, and by increased traction in our select market verticals.



I am pleased to report that we continue to make progress in our vertical strategy by increasing revenue from our
targeted verticals, with 27% of our product revenue already coming from these verticals as measured over a rolling
fourth quarters.

Extreme's transformation to focus on select market verticals is key to driving our revenue growth and to our strategy to
expand operating margins. Over the new fiscal year, we will place additional emphasis on building brand identity in our
select vertical markets by focusing marketing and sales investments in high-growth regions and in our targeted
verticals.

By increasing investments in our select verticals, we believe we can provide the focused vertical customer value
needed to drive revenue growth and margin stability. And while our strategy includes initiatives to continue to see lower
product costs to effectively complete -- compete in an increasingly competitive market, our long term focus will remain
on driving high-value solutions for select market verticals to drive revenue growth and operating income.

To drive new revenue growth, we are focused on creating solutions for mobile operators, cloud service providers and
education vertical customers. In January, we articulated of 5-phase strategy to address the data infrastructure needs of
customer networks, spanning from 3G and 4G LTE mobility networks through campus, core and edge networks, and
the new fabric architectures for cloud services. The strategy leverages the feature-rich ExtremeXOS network operating
system to provide intelligence and automation across network boundaries, and to enable a seamless user quality of
experience for people and machines. This new vertical solution focus has been well received our customers, our
partners, industry analysts as well. And our new product announcements over the past few months reflect this new
vertical solutions focus.

In Q3, we announced the E4G Cell Site Router family designed to address the mobile service provider vertical, and the
specific performance and connectivity needs for the next-generation 3G, 4G, and LTE mobile backhaul market. The
E4G family is a next-generation mobile backhaul platform that provides -- that supports 2G, 3G deployments while
scaling for the high-bandwidth needs of 4G and LTE services including mobile video.

In advance of the new E4G product family, we continue to build traction in the mobile service provided vertical with
existing products through multiple OEM partners. In Q4 and FY '11, we had deployments in tier 1 mobile operators in
multiple geographies and one mobile OEM partner with a greater than 10% customer, both in Q4 and in FY '11.

In Q4, we announced the expansion of our data center product portfolio and our Open Fabric architecture for large
cloud scale service networks, designed to address the needs of emerging cloud service providers. At the Interop trade
show trade show in Las Vegas this past May, we announced 2 new products, the new BlackDiamond X8 aggregation
and core fabric switch and the new Summit X670 top-of-rack switch. These products are designed to offer new
independent, best-of-breed solutions choices for customers who need to drive high-value cloud services with lower total
cost of operations. The new BlackDiamond X8 offers industry-leading cloud scale networks port capacity, low latency,
low power consumption and virtual network automation for next-generation cloud service providers and large private
cloud data centers.

The new Summit X670 top-of-rack switch complements the BD X8 by offering leading-edge features and low latency
needed to address the needs of high-performance 10-gig and 40-gig cloud scale solutions. We were honored to have
Network World add both the BD X8 and the Summit X670 to the list of top new products at the Interop trade show in
May. The X670 is now generally available, and we have already begun to receive initial product orders.

By providing network automation at the network operating system level for the BD X8 core fabric switch, and the X670
top-of-rack switch, and our already established BD 8000 Series products for smaller scale data centers, Extreme offers
cost-effective price performance, network virtualization intelligence and a low total cost of operations that is necessary
for the new generation of cloud service operators.

When the cloud -- within the cloud service provider vertical, we continue to win deals. Recently, Alisa Links[ph] in
Finland expanded their deployments for Extreme switches in support of their fourth data center in Helsinki. Key
purchasing criteria included scalability, open flexibility and automation support for virtualization.

In Q4, we also added private data center wins that included Sierra Trading Post, and Vericrest in North America, and
other data center wins from major customers including Lockheed Martin, FellaBella [ph] and Wellcome Sanger Trust
(sic) [Wellcome Trust Sanger]. These data center wins provide key customer deployments and enable revenue
momentum for existing products in complement to our new family of next-generation cloud services networking
products.



Beyond these mobility in cloud services products, we also released key intelligence features to address the complex
network deployment problems facing education customers in competitive campus deployments. ID management
functionality is now available across our ExtremeXOS portfolio and enables automated role-based policy control of
access-to-network resources. Extreme Network virtualization, or XNV enables the automated management of virtual
machine mobility in increasingly complex data centers. These features enable automatic and dynamic network
configurations, enabled -- enabling a customer to manage networks with less human intervention, avoiding human error
and lowering the need for staff.

For education and competitive campus customer deployments, we have also expanded our portfolio to -- with a
complete and comprehensive switching solution, with the announcement of the Extreme Ethernet access switch family
of products. These products enable us to provide more cost-effective end-to-end campus, Ethernet switching bundle --
solution bundles to address the needs of educational vertical customers. These portfolio expansions allow us to
compete more effectively in the wider campus market, and provide competitive offer -- and drive the competitive
offerings in the face of recent price pressure from some of our major competitors.

In the mobile, student and vertical education vertical -- and education vertical, we had 44 new wins in Q4, adding to our
global install base of colleges, universities and schools. Customers in Q4 included the Jeju International English Village
in Korea, who selected our BD 8K core switches and Summit switches at the edge, while Shanghai, YK Pao School,
selected our BD 8K, Summit products and our Altitude wireless LAN products. We continue to see campus Ethernet
and wireless LAN bundles, as well as core network upgrades as drivers for educational customer wins.

In FY '11, we added over 230 new customers, including Kingston College in Europe, Texas A&M University,
Northwestern College, and Bay County schools in the U.S. and a major medical research institute in Paris.

Beyond the business from our select market verticals, we also saw increased customer traction across all our regions
from more and larger deals and in our major geographies including North America, as a result of the completion of our
management changes.

In summary, we believe that the markets we serve are strong, and our innovation is real -- is adding real value to our
customers. We are now executing on the next steps in our strategy, and I believe our strategy is on track. We are
focusing our work to both lower fixed and variable costs and thereby, enable more consistent levels of operating
income, without the need for revenue growth. However, revenue growth is a significant focus for our business, and we
are taking the first critical steps to drive the customer awareness and focus in our product portfolio investments to
execute a clear vertical market strategy. We look forward to having a continuing and active and engaged dialogue with
all of our investors.

And now I'll turn the call back over to Jim, who will share some details regarding our guidance for Q1 and FY '12. Jim?

James Judson

Thank you, Oscar. As discussed earlier, the company has implemented a significant restructuring plan at the end of Q4,
which will not be fully implemented until the end of Q2 FY '12, and we continue to see a very competitive landscape and
longer customer purchasing cycles. As a result, we believe there is a greater level of uncertainty surrounding Q1.

For the quarter, we expect revenue in the range of $74 million to $80 million, and EPS in the range of $0.02 to $0.05 a
share.

Turning to full-year guidance, we expect to see continued progress in our cost structure as we complete the transitions.
When completed, we anticipate that as a result of these actions, we will have lowered our operating costs by
approximately $20 million during FY '12 from our Q3 FY '11 cost structure, which we used as a baseline to build our
plan for FY '12.

When fully implemented at the end of Q2, we expect a breakeven point below $70 million revenue per quarter, and our
goal is to have in place a cost structure for double-digit operating income on a revenue level in the low-$80 million range
in the latter half of FY '12.

FY '12 will be a transition year for the company, as we move to a lower structure aimed at achieving our stated financial
model. We have built our FY -- full year plan to return increasing earnings and operating cash flow to our shareholders,
without the requirement to grow revenue. That does not mean that we don't believe we can grow revenue, we believe
that the new products that we have announced, which will begin shipping at different points throughout the fiscal year,



and our customer-focused strategy present opportunity for the company to grow.

However, given the uncertainty we see in the global economies and the competitive and pricing pressure, we are
building our plan, assuming low revenue growth in the overall market. At this time, we expect revenue for FY '12 to be in
the range of $320 million to $340 million, and EPS of $0.28 to $0.35 per diluted share.

With that, we'll open the call for questions. Matthew, if you could start the polling.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jonathan Kees of Capstone Investments.


I wanted to ask, I guess, trying to make sure I understand this new restructuring program that's been announced. Back
in January, there was one that was announced in which there is -- you'll be taking $2 million out of the OpEx on a
quarterly basis. And now, we were talking about this new restructuring program. This is including that or is this separate
from that?

Oscar Rodriguez

No. This is all incremental, Jonathan.


Okay. All right. So this is in addition to that. So, okay. All right. And all right, that's a lot of savings to be taken out, all
right. Then, let me also ask about the OpEx for Q4, obviously, that was a substantial increase, and I can understand
that there's a lot of one-time, a lot of seasonal charges, sales commissions and that kind of stuff. But it seems like
there's still some increase, sequential increase more so than normal seasonality. I guess, I'm just trying to understand,
is most of this still just more of that one-time, and that we're going to have to sharp drop-off for beginning of next fiscal
year? Is there -- is it going to be more tapered off going forward? How should I think of that?

James Judson

I think, Jonathan, when you get a chance to do some modeling based upon the guidance that we've given you, and a lot
of the color around the restructuring, you'll find that we expect our operating expenses to drop pretty significantly from
Q4 to Q1. But also, it will continue to drop into Q2 and into Q3 as well. Q4 was higher than we anticipated. A lot of that
driven by the variable compensation within the field organization. Yet, we commented on how strong the Americas was
after a pretty soft Q3. Some of that surprised us, as you might expect, and we saw a lot more accelerators kick in for a
handful of the reps there, and likewise, throughout Asia, they over-performed their plan quite a bit, and we saw
accelerators kick in there as well. The other place where there was a pretty significant increase was around the new
product introductions that we've talked about. And just trying to really be aggressive in moving forward there with our
prototypes and NREs, and keep those projects on course for introduction here in the first half and early second half of
FY '12.

Oscar Rodriguez

Yes, Jonathan. This is Oscar. Let me also add to what Jim said. We also -- in our movement to the new verticals, we
need -- we knew we had to get our awareness, and begin to generate our awareness in the field as much as we could.
So we also conducted not only trade shows, but also partner conferences in 2 different geos. So that created some
activities in the field, while still having the corporate marketing expense on line that effectively allowed us to, or forced
us to, spend a little more marketing in that quarter than we would going forward.


Okay. And you did mention that the corporate stuff is dropping off, and so you can find more money, or more focus on
the fields stuff. So all right, that helps with that. And then let me also as ask in terms of linearity for the quarter. Was it --



most of it was back-end loaded? Or was -- I mean, or was it pretty linear throughout the quarter?

James Judson

Yes. I wouldn't say it was linear, Jonathan. But in terms of linearity, we tracked at or ahead of what a normal linearity
would look like, historical bookings during the quarter. And we didn't see a significant pickup in month 3 as a result of
the 14th week, so that the percent of the business we got in month 1, 2 and 3 was actually even a little bit more front-
end loaded in Q4 than historical patterns would indicate. So definitely more linear during the quarter.


Okay. All right. So a last, a last minute rush. Did you guys mention book-to-bill, by the way, for the quarter?

James Judson

We did not. It was slightly negative. I did mention in the script, that there were a couple of deals that had been on the
books for quite a while, because we had the customers that had not obtained financing for the purchases, and that
happened in Q4, and we were able to go ahead and ship those products. So it was a slightly negative book-to-bill, but a
good result in terms of those deals that's actually being able to turn to revenue.


Okay, all right. Just a couple of more questions, and then I'll stand -- get out of the line here. The -- it looks like your
balance sheet metrics have improved -- DSOs, especially. I guess, should we look for, in the new fiscal year, for more
of this improvement for DSOs? And I can understand for inventory days, the buildup for materials because of Japan, in
anticipation of any shortage in Japan. But that should come down since that did not become a problem. So are you
guys have a -- I'm assuming that there's going to be some more improvement in the metrics. Is that the right way to
think of that?

James Judson

I think that in the short term, I wouldn't expect a significant improvement in the DSO. That's a low number. 38 days of
sales outstanding is a low number from like the last 2 years, so I wouldn't expect that, that would get lower. From an
inventory standpoint, we did build the inventories, as I said, in anticipation of some product constraints. It didn't
materialize, but the one shift that will be happening throughout Q1 and into Q2 is that, Oscar mentioned that we are
changing our logistics model a little bit. We have opened a distribution center in Hong Kong, which will significantly
lower our cost of distribution for product throughout Asia, but as well, will also help in terms of positioning product for the
Americas as well. So we will see a little bit of -- we'll see an increase in overall inventories offsetting that decrease in the
additional material that we put in the pipeline. So it won't come down significantly in the Q1, in early Q2 timeframe, but
there is potential for us, at least, either maintain or drawdown the absolute dollars as we go through the year, depending
on what happens on the top line.


Okay, got you. All right. And last question, if I may. I guess in terms of the guidance for the fiscal year, the midpoint
there is -- looking at around flat with fiscal year 2011. I hear what you're talking about in terms of competitive dynamics
there and even for this last period here, the dollars went down, even the port revenues go -- number of ports shipped
went up. I guess, this is incorporating a continued dynamics like that? Are you seeing a more -- competitive dynamics
getting more fierce? Worse than before? Is it still the same, I guess, how would you characterize that? And how was it
relative to the guidance that you've given?

Oscar Rodriguez

Okay. This is Oscar, let me take that one. I think it varies, Jonathan, from region to region, is what we've found. And so
we see some competitors more aggressive in some regions than others. I think also this quarter is the first quarter we've
had a fully staffed management team in North America. You can see some of the results are in on that. So I'm pleased
with the work that the North America team has really done. And that management team now is getting things settled into
place. So as a result of that, I think that we're in a much better position now to be competitive than maybe we were in
the last few quarters in that market. So when I look at North America, it -- we didn't see as much pricing pressure in
North America this time. However, I want to be ready for it going forward. And I want to be ready for those campus



deployments because campus deployments are the places that are much more hostile in terms of pricing. And of
course, our goal is to focus on the verticals that will not only allow us to be able to sell high-value solutions, but also will
enable us to have some level of competitiveness against the other would-be competitors that are selling more Plain
Jane products out there.


So it sounds like you're expecting the worst there in terms of the competitors in North America. And now that you have a
fully staffed team in North America, you're being cautious, you're being conservative in terms of your guidance at least
for North America for the fiscal year.

Oscar Rodriguez

I'm being cautiously optimistic in all the markets because I want to be sure that as we give guidance here, we're giving
guidance based on what we believe is a proactive set of steps to make sure that people understand, our investors
understand that port sales are up in the industry, and revenues are down in the industry. And that means that there's
pricing pressure that's out there. However, it doesn't mean it's in every vertical. It's not in every market segment. And so
therefore, our goal is to grow in the select verticals, that we believe that not only can we offer value to maintain pricing
wherever possible, but also we're preparing our cost structures for those places where we need to have a competitive
set of offerings, we can certainly offer that. And on top of that, whenever we get competitive attacks, we can certainly
fend that off as well. So I believe that the marketplace is about -- today, is about those vendors that are going to be
proactive with their cost structures. And that's what we want to do. We want to prepare for that.

James Judson

And Jonathan, I would just add that Extreme is a 1%, 1.5% kind of market share player in the overall marketplace. So
for us to try and judge where overall market is going is a little bit difficult. If we -- you look at some of the results from the
competitors that are out there, they've been pretty cautious in terms of what the market looks like going forward. And we
wanted to make sure that we were sizing the company properly, that we could return a good EPS, good operating
income, and bottom line cash flow, the whole thing to the shareholders in a market where the overall market may not be
growing that rapidly. Having said that, we're feeling pretty good about where we are in terms of positioning the company
and the products that we have coming out. And as the market is growing, we fully hope to and expect to grow with it.
But we're just not big enough, I don't think, really, to gauge what's happening in the overall marketplace.

Oscar Rodriguez

I think that's also.

Operator

Our next question comes from Rohit Chopra of Wedbush.


This is Sanjit Singh for Rohit Chopra. A couple of quick data questions. Do you guys have the ratio between stackular
and modular, as well as the split between enterprise and service provider?

Oscar Rodriguez

So we have not released that this quarter. Honestly, I don't believe that, that's not a good way to gauge our business
going forward. Yes, we can certainly put that back on the website, if you feel that this is a statistic you want to maintain.
But I think that going forward, the percentage of revenue at -- or let me say, the vertical revenue, as a percentage of
overall revenue, is a good way to gauge it. And I think that when you look at the technology side of the deployments, I
think there we're going to see a difference in how customers buy, because we continue to see increasingly, stackables
being bought in the industry, if you look at the overall industry versus chassis, although there are customers that do buy
chassis-stackable combinations, and there are some customers that we have, that buy only chassis, and prefer to have
only chassis, even all the way to the edge. So we're happy to put that on the website and give you the information. Jim,
I don't know if you have the split for this quarter?


Extreme Networks' CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeki... Page 10 of 14

James Judson

I didn't bring it with me.

Oscar Rodriguez

Okay. We're beginning to see that, not be as an important metric going forward. So that's what we can put it out there,
Sanjit.


Okay. On the restructuring, just to make sure that I'm clear. We are -- the restructuring efforts will be completed by Q2
and from Q3 to Q4, that's when we should expect progress on the operating margin? Or is it more approved in Q1,
approved in Q2, more of a linear stressed up all the way to Q4? Like how you would expect...

James Judson

We will see continued improvement from Q4 to Q1, to Q2 to Q3. We will not have implemented the full savings that we
expect to see from the actions that we've taken here in July until the end of Q2. So our comments around sort of hitting
a double-digit operating income at revenue in the low-80s would not be effective until we get to that Q3 time frame.


Okay, but not until Q3. On the gross margin side, splitting up the product and service gross margin, I understand there's
going to be some improvements on the supply chain side? What levels of gross margin, both on the product and
service, do you think is sustainable?

James Judson

So we have said all along that we would like to be -- the financial model of the company has put out there, for gross
margin, total gross margins in the 57% to 59% range. We've tracked below that most of this year. But we do believe that
with the actions that we've taken to date in terms of lowering our fixed cost structure, as well as the actions that Oscar
referred to around some product redesigns that we'll see hit the market in the second half of the year, as well as some
of the supply chain activities. I mentioned the Hong Kong distribution center, we believe that we will get back into that
range this fiscal year.


Okay, this fiscal year, okay. And on the competitive environment, so I think Dell is looking to buy Force10. Where's the
competitive pressure sourcing from? Is it the guy with a 70% market share? Is it all players? Is it in fluctuation? Where is
the pricing aggressiveness coming from?

Oscar Rodriguez

That's a good question. So it really depends. Since we were serving different parts of the market. It really depends on
what part we're talking about. If we look at the campus environments, we definitely see increased pressure from those
that are trying to gain market share, Hewlett-Packard and Juniper, I think are good examples. Those that are trying to
gain market share in the marketplace. I don't think we are the target. I think they have their sights set on bigger game.
But I think that we see the collateral damage when they attempt to bid using that same tactics into the accounts that
either we're targeting or accounts that are looking at some of our solution sets. So that's where I -- we see the most
amount of competitive price pressure, really is in the campus environments. And as we focus more on the educational
environments -- and the interesting aspect of educational environments is they have a self-generating awareness in that
they talk a lot, they don't see each other as a competitive, so they talk a lot to each other. So we have a lot of word of
mouth that goes our way as well. The key value we offer there is that we offer not only great CapEx and good OpEx
going forward, but the OpEx is also augmented by more automation, which means that customers need to have fewer
people to manage their networks. Educational systems, typically, cannot afford to have lots of deep experts because
they're $100,0000 and above folks, and it's difficult for different educational systems around the country or around the
world to maintain that level of expertise. So the more automation, the better. And that's really our focus is driving, that
level of automation for educational customers. So we shop the value versus the -- just working on price, but we do know



that when we see competitive pressures from the other competitors, that has a tendency to have an effect on price.


Wonderful. And this is my last question regarding the restructuring. Other companies in this industry, over the last
decade or so, have announced similar restructuring plans to improve the operating margin, and there'll be a temporary
benefit, and oftentimes, either due to a fall of company morale, or maybe not enough feed on the street on the sales
and marketing side, the operating margin never -- targets never materialize. What have you -- is there any risk to that
here in terms of maybe, cutting too deep? What have you -- how have you gone about trying to mitigate those risks
going forward.

Oscar Rodriguez

Yes, that's a great question. First, let's talk about the changes we've actually made. So because in looking at the
changes we actually made, hopefully this will give you some comfort that while there's risk, I'm not going to say there's
no risk here. There's always risk and we've cited all of our risk factors upfront. We believe we've made the appropriate
changes to really focus the company in the right direction. So the first thing we've done is we've actually made a
decision to move software engineering out of California and into the lower cost venues where we have already had
critical mass people and also where we have the most of the -- one of the venues we have the most amount of longevity
in software engineering where the majority of our architects sit. So between Raleigh, North Carolina here in the U.S.
and Chennai, India, that's where the bulk of our software engineering resources are sit today, between those 2 sites.
And so what we're really doing is expanding and enhancing those 2 sites. So the leaders in those sites are absorbing,
able to absorb the work effectively. We have more junior people or less experienced people here in California. And so
the result of that, I think that's a good move that actually enhances our ability to drive future velocity, and be able to
effectively also, expand headcount because by moving into lower cost venues, we can actually afford more heads. So I
think that's a good move for us. So that's lowering costs while still, not only maintaining, but also expanding your
innovation capability. In operations, we've chosen to move people closer to the factory as you're aware, in reading our
K's, and you've followed the company for a while. We have outsourced manufacturing and an ODM relationship with
Alpha Networks. By moving people closer to that, to where the factory really is, rather than maintaining them here in
California, some of those positions will enable us to lower costs while, I believe, increasing productivity and increasing
our ability to have a better relationship with that vendor as well. In services, what we're doing is, we're actually moving
some of our heads around, and our skills around, to the extent that we are actually going to be able to serve customers,
I think, the better. And at the same time, be able to balance the skills across different venues. So I think that, that's
going to lower costs without letting go of the skill set and the intimacy that we've developed over the years. One of the
things that has allowed us to maintain our market share as it is, in spite of the fact that we're a small player, is that our
customers value our customer service capability and our customer intimacy very highly. And so as a result of that, we
wanted to be sure that we did not, while making adjustments and lowering costs, take inordinate risk with that. So I think
that those 3 areas are areas where I see an appropriate level of risk, relative to the lower cost structures that we're
going to go into. And I think that we'll actually get better lift in R&D. I think we'll get better, our productivity out of the
operation side of the factory side, and I believe we will actually able to balance our skill sets between tier 1 and tier 2
support, et cetera, around the world. When it comes to sales, what we've done is we've taken very clear steps to
actually simplify some of the management structures that we've had. So some of the costs that we're taking out of sales
is simplification. And I'm a big believer that simplification often leads to better productivity and also, just easier ways of
doing business with the company. So by being able to do a similar thing that we've done in North America, which is just
basically simplify the sales structure that I believe that in parts of Latin America -- in Latin America and in parts of
EMEA, I think that we're going to get a little better lift there as well. Now we have made moves from investing in
corporate marketing to investing in field marketing. I think that, that shift enables us to put more marketing activities
closer to the customer, and to enable us to drive better awareness, geo by geo, so that the customers who are dealing
with -- that we want -- that we're targeting with our target market verticals, will actually then be able to build awareness
that begets consideration, that should invite us in the deals and grow our sales pipeline. So I think that the steps that
we're taking are appropriate. I think that they have appropriate risk and they are not risk-free, nothing is risk free. But I
do believe that we have taken the appropriate steps to make sure it executes well.

James Judson

Sanjit, before you go, you had asked about the stackables and modular. Just so you have the information this quarter in
case it's key to what you're doing. This quarter, it was 71% stackables and 29% modules, modular.

Operator

[Operator Instructions] Our next question comes from Bill Nasgovitz from Heartland Funds.




What do you think R&D will run as a percent of sales in the new year, the new year we're in.

James Judson

Yes. We're looking something in the 12% to 13% range, as a percent of revenue.


Okay. And CapEx, I'm sorry, I might have missed that.

James Judson

We didn't talk about that, but historically, it's around somewhere between $1 million to the $1.5 million per quarter.


Okay, all right. And could you outline, again, your -- the company as the Board's buyback policy?

Oscar Rodriguez

So we have not set a buyback policy. We -- I think we may have talked last time, we did a buyback about 2.5 years ago.
And we have not set a specific buyback policy at this point.


Well, I wish you would, as a long-term patient shareholder, what's our cash earning these days?

James Judson

About 1%, yes.


About 1%. Well, we're building cash. I mean, our hats are off to, that's good to see in a tough environment. You seem to
be thrifty and wise, and why not buy back a little of the shares, too?

Oscar Rodriguez

Bill, we'll certainly take that into consideration. One of things that we certainly consider every quarter and every year is,
whether or not we're driving the best value for our shareholders, that's paramount. And so as we look at the
environment, and some of the variability that's out there in the global economic environment, we want to be sure that
while we're driving value for our shareholders, we're not creating undue risk for the company as well.


Well, with cash at $150 million or something like that, it wouldn't seem to -- just a modest buyback would seem to make
sense, would seem to be prudent. Do you have an authorization now, is there an active authorization?

Oscar Rodriguez

No, there's not.




Okay. In these volatile times, I think it makes sense to have that flexibility.

Operator

Our next question comes from Ryan Mardiman [ph] of VALogic.

Unknown Analyst -

I'd like to echo the last caller's desire to see some share repurchases at this seemingly high, sort of ROE level. But
anyway -- so Dell announced their intention to purchase Force10. Some wire reports suggest it may be close to $700
million, which is about 3.5x revenue. It looks like from their S-1, their gross margins are significantly worst than ours and
their revenues are about 2/3 of ours. What do they "have that we don't have?" And what do you say about the
seemingly outrageous disparity between the valuation that was reportedly realized by F10, or Force10 and the implied
value of our stock. It's been less than at 0.5x enterprise value to sales and expected profitability?

Oscar Rodriguez

You've asked a lot of questions there, a lot of them are subjective, a lot of the answers are probably subjective. Well,
first and foremost, I think that when I look at Force10, they're clearly focused in one specific space, and it appears that
they fit the deal when it came to Dell's wants and needs. So clearly, the question for how they fit Dell, I think it's more
appropriately ask the Dell folks and how they see that. In terms of valuation, I stopped trying to guess on valuations a
long time ago. I'm not an investment banker. It does -- it is interesting that, that value is there, because I'm hoping that,
that also signals the level of value that maybe Extreme should have as well because we are clearly, delivering products
in those specific spaces in addition to other high-growth spaces like mobile, backhaul and mobility. So I'm hopeful that
the valuation that is -- the comparables that are set in the industry, also will have an effect on our valuation as well.

Unknown Analyst -

Okay. And then, second question with the spirited auction of the Nortel IP, what have we done to attempt to value our
own IP? And what have been the results? And it seems that we spent over $400 million in R&D in the last 7 years, in
the -- we've continued our -- continuing to have patents issued to us. It seems like there should be significant value
there, and what do you reckon it's worth? And what steps, if any, are going to be taken to realize that value, besides, I
guess, hopeful incremental sales associated with that?

Oscar Rodriguez

Yes. It's a good question. We have not done a formal valuation of our IP at this point in time. I can tell you that our IP
portfolio is significantly smaller than a Nortel portfolio, also significantly smaller than some of the other very super large
portfolios that have been discussed out in the industry to date. We may not be able to get value that's anywhere near
what we might expect, and it really comes down to who's buying and why are they buying.

Operator

And gentlemen, I would now like to turn the program back to you for any closing remarks.

Oscar Rodriguez

All right, very good. I want to thank all of our investors for, once again, joining us on the call, and for the analysts who
continue to follow us. We certainly are doing the hard work of making sure that we have the right plans and the right
execution steps in place as we move forward.

I look forward to speaking with all of the investors wherever possible. We will be in New York City later this month, and
actually next week, also in Boston, and I look forward to meeting any investors, should you happen to be at either one
of those conferences. So thank you very much. And we look forward to our next engagements.

Operator

Ladies and gentlemen, thank you for joining today's conference. This does conclude the program, and you may now
disconnect.



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