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  1. 1. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeking ... Page 1 of 14Get email alerts on EXTRNew: Get email alerts with breaking news and articles on EXTRExtreme Networks CEO Discusses Q4 2011Results - Earnings Call TranscriptExecutivesOscar Rodriguez - Chief Executive Officer, President and DirectorJames Judson - Interim Chief Financial OfficerAnalystsJonathan Kees - Capstone InvestmentsSanjit Singh - Wedbush Securities Inc.Unknown Analyst -William John NasgovitzExtreme Networks (EXTR) Q4 2011 Earnings Call August 1, 2011 5:00 PM ETOperatorWelcome 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 JudsonThank 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, InterimCFO. As a reminder this conference is being recorded today, August 1, 2011.This afternoon, Extreme Networks issued a press release announcing the companys fiscal results for the fourth quarterof 2011. A copy of this release and a slide presentation of the supporting financial materials are available in the InvestorRelations section of the companys website at www.extremenetworks.com. This call is being broadcast live over theInternet, 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 risksand uncertainties, including statements regarding the companys expectations regarding its financial performance,strategies, growth of customer bandwidth demand, development of new products, customer acceptance of thecompanys products -- excuse me, customer acceptance of the companys products, customer buying and spendingpatterns, overall trends and economic conditions in the companys markets.Actual results could differ materially from those projected in the forward-looking statements as a result of certain riskfactors including, but not limited to, a challenging macroeconomic environment worldwide, fluctuations in demand forthe companys products and services, a highly competitive business environment for network switching equipment, thecompanys effectiveness in controlling expenses, the possibility that the company might experience delays in thedevelopment of the new technologies and products, customer response to its new technology and products, the timingof any recovery in the global economy, risks related to pending or future litigation, and the dependency on third partieshttp://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  2. 2. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeking ... Page 2 of 14for certain components and for the manufacturing of the companys products.The company undertakes no obligation to update this information on the conference call. More information aboutpotential factors that affect our business and financial results is included in the companys filings with the Securities andExchange Commission.Throughout the conference call, the company will reference both GAAP and non-GAAP financial results. The companyhas provided a reconciliation table of GAAP to non-GAAP, and information in the tables that accompany the pressrelease on its website. Please go to the Investor Relations section of the companys website atwww.extremenetworks.com. In addition, all announced results are preliminary and may be subject to change when thereview 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 weannounced on July 12. Ill then turn the call over to Oscar for more clarity on the actions we have taken under thisrestructuring plan, along with comments on the quarter and progress the company is making with its transformation.After Oscars comments, I will provide guidance for our fiscal 2012 first quarter and full year. We will then open up forQ&A.As in previous periods, we have posted a slide presentation on our website at www.extremenetworks.com under theInvestor Relations Section, that I hope you will find useful. As a reminder, all of my comments will be non-GAAP exceptfor revenue and the number of common shares. Non-GAAP results excludes stock-based compensation, restructuringcharges and litigation settlements. Theres a reconciliation of GAAP to non-GAAP financial results in the slidepresentation 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 reviewingcertain 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 EPSnumber, 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. Q4revenue totaled $89.8 million, up $14.1 million or 19% from Q3, and up 5% from Q4 FY 10. This also exceeded ourguidance 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 $2.8million 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 ouroperating results.In connection with the end-of-sale announcements of our BD 10, 12 and 20K products, we recognized $3.1 million ofrevenue with customers purchasing the end-of-sale and replacement products. We had discussed order delayssurrounding these products and customers on our Q3 call, and are pleased that we were able to work with thesecustomers to sell them additional Extreme products.Geographically, the growth in revenue from Q3 to Q4 came largely from the recovery in North America, with revenuetotaling $40 million, up 53% quarter-over-quarter. Our EMEA geo grew 7% quarter-over-quarter to $34.9 million, whilethe Asia Pac geo declined slightly to $14.9 million after a strong Q3. On an annual basis, the strong Q4 North Americaenabled them to close the year with revenue of $123.6 million, flat year-over-year despite the organizational changesduring 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 byour 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 ofproduct 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 obsoleteinventory for the end of sale of some of our Metro/Carrier products in Q3, the gross margin declined 1.3 points from Q3.http://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  3. 3. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeking ... Page 3 of 14The decline in gross margin was primarily due to decreased product margins. This was due to deeper discounts onseveral large transactions with customers affected by the end of sale of some of our Metro/Carrier products. Thiscontributed just over half of the decline in margin quarter-over-quarter. We believe these are one-time transactions, andare 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 aggressivelypriced deals that had been won in prior quarters, but had not shipped due to credit issues, which were resolved in Q4.Additionally, were 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 tonon-OEM revenue. In addition, OEM revenue will vary on a quarterly basis as we develop this business. And as aresult, 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 fromthe reversal of $1.5 million of accruals for bonuses. The primary increase in expenses during Q4 was variable salescommissions and year-end accelerators, which kicked in as a result of the higher revenue, especially in North Americaand Asia Pacific. Also contributing were increased expenses associated with engineering prototypes and NREs, as wecomplete the development of products announced in Q4, and increased marketing costs related to trade shows andpartner conferences.Estimated EPS for Q4 is expected to be $0.02 per share, compared to our guidance at the start of the quarter of $0.03to $0.05 and a loss of $0.05 per share in Q3. The lower margins on large customer and OEM deals, in addition to theincreased 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 tothe 53-week year is complete.Turning to the balance sheet. Total cash and investments for the quarter remained unchanged at $147 million driven bystrong collections and a DSO of 38 days, versus 42 a quarter ago. Inventory increased $2.8 million to $21.6 million fromQ3, 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 planfor the company. Weve successfully worked through the end-of-sale issues with many of our customers who wereimpacted. We completed several larger strategic deals in the quarter, we kept the company focused on deliveringproducts and results in Q4 after a 5% reduction in staffing in Q3, and we have implemented the changes we believe areneeded to right-size the companys cost structure to position the company for double-digit operating income growthgoing forward.As announced previously, our Q4 fiscal 11 GAAP results include a restructuring charge for reducing our employee baseby 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. Allcosts from this action are employee severance costs, associated with downsizing the company and reducing our fixedcosts.The total cost of restructuring will result in a charge to the P&L of approximately $3.5 million, on a GAAP basis, whencomplete. The restructuring charge in Q4 FY 11 is $3.2 million on a GAAP basis, which when netted against earliercharges, resulted in a $2.8 million charge to the P&L in the quarter. Approximately 300k, on a GAAP basis, of additionalrestructuring charges will occur over Q1 and Q2.At this point, Ill 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 andsigns of traction we are seeing with the implementation of our strategy. I will be back after his comments to discussguidance moving forward. Oscar?Oscar RodriguezThank you, Jim, and I want to thank all of our investors for joining this call.http://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  4. 4. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeking ... Page 4 of 14As 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 requiredto reach consistent double-digit operating income. We believe that with a focus on driving efficient operations, coupledwith a clear strategy for continuous product and services cost reductions, we will be able to provide sustainablecustomer 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 reachconsistent operating income without the need for additional revenue growth, and will position us to further improvefinancial performance as we grow revenue.As weve mentioned in our last earnings call, in Q3, we took to the initial steps in our strategy to sustainably reduceengineering costs by focusing our technology investments to leverage product development efforts across all of ourproduct lines, and by eliminating specific underperforming products from our portfolio. This transition effort is nowlargely behind us, and we have stopped the associated cost for select Metro Ethernet products. This has had the effectof lowering committed R&D and operations costs, while increasing available resources to focus product development forour strategic vertical markets.In Q4, we began to take the next steps to further lower our operating costs as follows: First, we are focusing softwaredevelopment 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 innovationcapabilities 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 whileexpanding R&D headcount.Next, by consolidating and aligning sales management more effectively across our geographies, we are lowering oursales cost structure while focusing resources on higher-performing regions. As of Q4, we completed our work to realignand staff North America sales management with positive results. In Q1, we are focused on the managementrealignment in selected portions of EMEA and Latin America. And we believe these changes will also serve to enhanceperformance while lowering overall sales costs.Next, by reducing corporate marketing spend and shifting those resources to field marketing, we expect to expandcustomer awareness for our solutions, thereby enhancing brand awareness and lead generation in our targeted verticalmarkets to enable revenue growth.Finally, by moving to simplify our processes, systems and infrastructure, we expect to lower the cost of G&A andstreamline our operations. Beyond these changes to lower operating costs, we are also taking specific steps to alsolower 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 fiscal2012. And by consistently and continually redesigning products for lower cost, we expect to be better positioned tomaintain product gross margins in the competitive pricing environment were working in.By more effectively balancing the location and skills of our global service and support workforce, we expect to lowercost 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 todrive more efficient logistics in product delivery, we expect a lower overhead -- operating overhead while enhancing ouroperations productivity.We have already begun to execute on these specific transformative actions, and we expect to complete these actions inthe first half of 2012. Once completed, we believe these changes will enable us to drive a consistent double-digitoperating income at sustainable revenue levels. While we believe these operational changes position us well in terms ofoverall cost structure, I want to reiterate that a key focus is also on driving revenue growth, with both our new andexisting products.In a difficult year with the -- in the networking industry, where total revenue declined from $4.8 billion in Q1 2010 to $4.4billion in Q1 2011 despite the healthy increase in port sales overall, we are pleased to have grown fiscal year productrevenues by 10% year-over-year. We were helped in the market by a shift to a more favorable mix, as customersmoved to upgrade their networks to install higher-performance tech, 1-gig and 10-gig networks, with high-value networkintelligence, and by increased traction in our select market verticals.http://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  5. 5. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeking ... Page 5 of 14I am pleased to report that we continue to make progress in our vertical strategy by increasing revenue from ourtargeted verticals, with 27% of our product revenue already coming from these verticals as measured over a rollingfourth quarters.Extremes transformation to focus on select market verticals is key to driving our revenue growth and to our strategy toexpand operating margins. Over the new fiscal year, we will place additional emphasis on building brand identity in ourselect vertical markets by focusing marketing and sales investments in high-growth regions and in our targetedverticals.By increasing investments in our select verticals, we believe we can provide the focused vertical customer valueneeded to drive revenue growth and margin stability. And while our strategy includes initiatives to continue to see lowerproduct costs to effectively complete -- compete in an increasingly competitive market, our long term focus will remainon 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 andeducation vertical customers. In January, we articulated of 5-phase strategy to address the data infrastructure needs ofcustomer networks, spanning from 3G and 4G LTE mobility networks through campus, core and edge networks, andthe new fabric architectures for cloud services. The strategy leverages the feature-rich ExtremeXOS network operatingsystem to provide intelligence and automation across network boundaries, and to enable a seamless user quality ofexperience for people and machines. This new vertical solution focus has been well received our customers, ourpartners, industry analysts as well. And our new product announcements over the past few months reflect this newvertical solutions focus.In Q3, we announced the E4G Cell Site Router family designed to address the mobile service provider vertical, and thespecific performance and connectivity needs for the next-generation 3G, 4G, and LTE mobile backhaul market. TheE4G family is a next-generation mobile backhaul platform that provides -- that supports 2G, 3G deployments whilescaling 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 withexisting products through multiple OEM partners. In Q4 and FY 11, we had deployments in tier 1 mobile operators inmultiple 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 largecloud scale service networks, designed to address the needs of emerging cloud service providers. At the Interop tradeshow trade show in Las Vegas this past May, we announced 2 new products, the new BlackDiamond X8 aggregationand core fabric switch and the new Summit X670 top-of-rack switch. These products are designed to offer newindependent, best-of-breed solutions choices for customers who need to drive high-value cloud services with lower totalcost 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 privatecloud data centers.The new Summit X670 top-of-rack switch complements the BD X8 by offering leading-edge features and low latencyneeded to address the needs of high-performance 10-gig and 40-gig cloud scale solutions. We were honored to haveNetwork World add both the BD X8 and the Summit X670 to the list of top new products at the Interop trade show inMay. 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 X670top-of-rack switch, and our already established BD 8000 Series products for smaller scale data centers, Extreme offerscost-effective price performance, network virtualization intelligence and a low total cost of operations that is necessaryfor 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] inFinland expanded their deployments for Extreme switches in support of their fourth data center in Helsinki. Keypurchasing 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, andother 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 revenuemomentum for existing products in complement to our new family of next-generation cloud services networkingproducts.http://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  6. 6. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeking ... Page 6 of 14Beyond these mobility in cloud services products, we also released key intelligence features to address the complexnetwork deployment problems facing education customers in competitive campus deployments. ID managementfunctionality is now available across our ExtremeXOS portfolio and enables automated role-based policy control ofaccess-to-network resources. Extreme Network virtualization, or XNV enables the automated management of virtualmachine mobility in increasingly complex data centers. These features enable automatic and dynamic networkconfigurations, enabled -- enabling a customer to manage networks with less human intervention, avoiding human errorand lowering the need for staff.For education and competitive campus customer deployments, we have also expanded our portfolio to -- with acomplete and comprehensive switching solution, with the announcement of the Extreme Ethernet access switch familyof 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 tocompete more effectively in the wider campus market, and provide competitive offer -- and drive the competitiveofferings 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 ourglobal install base of colleges, universities and schools. Customers in Q4 included the Jeju International English Villagein 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 Ethernetand 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 regionsfrom more and larger deals and in our major geographies including North America, as a result of the completion of ourmanagement changes.In summary, we believe that the markets we serve are strong, and our innovation is real -- is adding real value to ourcustomers. We are now executing on the next steps in our strategy, and I believe our strategy is on track. We arefocusing our work to both lower fixed and variable costs and thereby, enable more consistent levels of operatingincome, without the need for revenue growth. However, revenue growth is a significant focus for our business, and weare taking the first critical steps to drive the customer awareness and focus in our product portfolio investments toexecute a clear vertical market strategy. We look forward to having a continuing and active and engaged dialogue withall of our investors.And now Ill turn the call back over to Jim, who will share some details regarding our guidance for Q1 and FY 12. Jim?James JudsonThank 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 andlonger 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 ashare.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 byapproximately $20 million during FY 12 from our Q3 FY 11 cost structure, which we used as a baseline to build ourplan for FY 12.When fully implemented at the end of Q2, we expect a breakeven point below $70 million revenue per quarter, and ourgoal is to have in place a cost structure for double-digit operating income on a revenue level in the low-$80 million rangein 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 financialmodel. 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 dont believe we can grow revenue, we believethat the new products that we have announced, which will begin shipping at different points throughout the fiscal year,http://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  7. 7. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeking ... Page 7 of 14and 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 arebuilding our plan, assuming low revenue growth in the overall market. At this time, we expect revenue for FY 12 to be inthe range of $320 million to $340 million, and EPS of $0.28 to $0.35 per diluted share.With that, well open the call for questions. Matthew, if you could start the polling.Question-and-Answer SessionOperator[Operator Instructions] Our first question comes from Jonathan Kees of Capstone Investments.Jonathan Kees - Capstone InvestmentsI wanted to ask, I guess, trying to make sure I understand this new restructuring program thats been announced. Backin January, there was one that was announced in which there is -- youll be taking $2 million out of the OpEx on aquarterly basis. And now, we were talking about this new restructuring program. This is including that or is this separatefrom that?Oscar RodriguezNo. This is all incremental, Jonathan.Jonathan Kees - Capstone InvestmentsOkay. All right. So this is in addition to that. So, okay. All right. And all right, thats a lot of savings to be taken out, allright. Then, let me also ask about the OpEx for Q4, obviously, that was a substantial increase, and I can understandthat theres a lot of one-time, a lot of seasonal charges, sales commissions and that kind of stuff. But it seems liketheres still some increase, sequential increase more so than normal seasonality. I guess, Im just trying to understand,is most of this still just more of that one-time, and that were going to have to sharp drop-off for beginning of next fiscalyear? Is there -- is it going to be more tapered off going forward? How should I think of that?James JudsonI think, Jonathan, when you get a chance to do some modeling based upon the guidance that weve given you, and a lotof the color around the restructuring, youll find that we expect our operating expenses to drop pretty significantly fromQ4 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 thatdriven by the variable compensation within the field organization. Yet, we commented on how strong the Americas wasafter a pretty soft Q3. Some of that surprised us, as you might expect, and we saw a lot more accelerators kick in for ahandful of the reps there, and likewise, throughout Asia, they over-performed their plan quite a bit, and we sawaccelerators kick in there as well. The other place where there was a pretty significant increase was around the newproduct introductions that weve talked about. And just trying to really be aggressive in moving forward there with ourprototypes and NREs, and keep those projects on course for introduction here in the first half and early second half ofFY 12.Oscar RodriguezYes, Jonathan. This is Oscar. Let me also add to what Jim said. We also -- in our movement to the new verticals, weneed -- 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 someactivities in the field, while still having the corporate marketing expense on line that effectively allowed us to, or forcedus to, spend a little more marketing in that quarter than we would going forward.Jonathan Kees - Capstone InvestmentsOkay. And you did mention that the corporate stuff is dropping off, and so you can find more money, or more focus onthe 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 --http://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  8. 8. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeking ... Page 8 of 14most of it was back-end loaded? Or was -- I mean, or was it pretty linear throughout the quarter?James JudsonYes. I wouldnt say it was linear, Jonathan. But in terms of linearity, we tracked at or ahead of what a normal linearitywould look like, historical bookings during the quarter. And we didnt see a significant pickup in month 3 as a result ofthe 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.Jonathan Kees - Capstone InvestmentsOkay. All right. So a last, a last minute rush. Did you guys mention book-to-bill, by the way, for the quarter?James JudsonWe did not. It was slightly negative. I did mention in the script, that there were a couple of deals that had been on thebooks for quite a while, because we had the customers that had not obtained financing for the purchases, and thathappened in Q4, and we were able to go ahead and ship those products. So it was a slightly negative book-to-bill, but agood result in terms of those deals thats actually being able to turn to revenue.Jonathan Kees - Capstone InvestmentsOkay, all right. Just a couple of more questions, and then Ill stand -- get out of the line here. The -- it looks like yourbalance sheet metrics have improved -- DSOs, especially. I guess, should we look for, in the new fiscal year, for moreof this improvement for DSOs? And I can understand for inventory days, the buildup for materials because of Japan, inanticipation of any shortage in Japan. But that should come down since that did not become a problem. So are youguys have a -- Im assuming that theres going to be some more improvement in the metrics. Is that the right way tothink of that?James JudsonI think that in the short term, I wouldnt expect a significant improvement in the DSO. Thats a low number. 38 days ofsales outstanding is a low number from like the last 2 years, so I wouldnt expect that, that would get lower. From aninventory standpoint, we did build the inventories, as I said, in anticipation of some product constraints. It didntmaterialize, but the one shift that will be happening throughout Q1 and into Q2 is that, Oscar mentioned that we arechanging our logistics model a little bit. We have opened a distribution center in Hong Kong, which will significantlylower our cost of distribution for product throughout Asia, but as well, will also help in terms of positioning product for theAmericas as well. So we will see a little bit of -- well see an increase in overall inventories offsetting that decrease in theadditional material that we put in the pipeline. So it wont come down significantly in the Q1, in early Q2 timeframe, butthere is potential for us, at least, either maintain or drawdown the absolute dollars as we go through the year, dependingon what happens on the top line.Jonathan Kees - Capstone InvestmentsOkay, got you. All right. And last question, if I may. I guess in terms of the guidance for the fiscal year, the midpointthere is -- looking at around flat with fiscal year 2011. I hear what youre talking about in terms of competitive dynamicsthere and even for this last period here, the dollars went down, even the port revenues go -- number of ports shippedwent up. I guess, this is incorporating a continued dynamics like that? Are you seeing a more -- competitive dynamicsgetting more fierce? Worse than before? Is it still the same, I guess, how would you characterize that? And how was itrelative to the guidance that youve given?Oscar RodriguezOkay. This is Oscar, let me take that one. I think it varies, Jonathan, from region to region, is what weve found. And sowe see some competitors more aggressive in some regions than others. I think also this quarter is the first quarter wevehad a fully staffed management team in North America. You can see some of the results are in on that. So Im pleasedwith the work that the North America team has really done. And that management team now is getting things settled intoplace. So as a result of that, I think that were in a much better position now to be competitive than maybe we were inthe last few quarters in that market. So when I look at North America, it -- we didnt see as much pricing pressure inNorth America this time. However, I want to be ready for it going forward. And I want to be ready for those campushttp://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  9. 9. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeking ... Page 9 of 14deployments because campus deployments are the places that are much more hostile in terms of pricing. And ofcourse, our goal is to focus on the verticals that will not only allow us to be able to sell high-value solutions, but also willenable us to have some level of competitiveness against the other would-be competitors that are selling more PlainJane products out there.Jonathan Kees - Capstone InvestmentsSo it sounds like youre expecting the worst there in terms of the competitors in North America. And now that you have afully staffed team in North America, youre being cautious, youre being conservative in terms of your guidance at leastfor North America for the fiscal year.Oscar RodriguezIm being cautiously optimistic in all the markets because I want to be sure that as we give guidance here, were givingguidance based on what we believe is a proactive set of steps to make sure that people understand, our investorsunderstand that port sales are up in the industry, and revenues are down in the industry. And that means that therespricing pressure thats out there. However, it doesnt mean its in every vertical. Its not in every market segment. And sotherefore, our goal is to grow in the select verticals, that we believe that not only can we offer value to maintain pricingwherever possible, but also were preparing our cost structures for those places where we need to have a competitiveset of offerings, we can certainly offer that. And on top of that, whenever we get competitive attacks, we can certainlyfend that off as well. So I believe that the marketplace is about -- today, is about those vendors that are going to beproactive with their cost structures. And thats what we want to do. We want to prepare for that.James JudsonAnd Jonathan, I would just add that Extreme is a 1%, 1.5% kind of market share player in the overall marketplace. Sofor 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 thecompetitors that are out there, theyve been pretty cautious in terms of what the market looks like going forward. And wewanted to make sure that we were sizing the company properly, that we could return a good EPS, good operatingincome, and bottom line cash flow, the whole thing to the shareholders in a market where the overall market may not begrowing that rapidly. Having said that, were feeling pretty good about where we are in terms of positioning the companyand the products that we have coming out. And as the market is growing, we fully hope to and expect to grow with it.But were just not big enough, I dont think, really, to gauge whats happening in the overall marketplace.Oscar RodriguezI think thats also.OperatorOur next question comes from Rohit Chopra of Wedbush.Sanjit Singh - Wedbush Securities Inc.This is Sanjit Singh for Rohit Chopra. A couple of quick data questions. Do you guys have the ratio between stackularand modular, as well as the split between enterprise and service provider?Oscar RodriguezSo we have not released that this quarter. Honestly, I dont believe that, thats not a good way to gauge our businessgoing 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 ofoverall revenue, is a good way to gauge it. And I think that when you look at the technology side of the deployments, Ithink there were going to see a difference in how customers buy, because we continue to see increasingly, stackablesbeing bought in the industry, if you look at the overall industry versus chassis, although there are customers that do buychassis-stackable combinations, and there are some customers that we have, that buy only chassis, and prefer to haveonly chassis, even all the way to the edge. So were happy to put that on the website and give you the information. Jim,I dont know if you have the split for this quarter?http://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  10. 10. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeki... Page 10 of 14James JudsonI didnt bring it with me.Oscar RodriguezOkay. Were beginning to see that, not be as an important metric going forward. So thats what we can put it out there,Sanjit.Sanjit Singh - Wedbush Securities Inc.Okay. On the restructuring, just to make sure that Im clear. We are -- the restructuring efforts will be completed by Q2and from Q3 to Q4, thats 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 JudsonWe will see continued improvement from Q4 to Q1, to Q2 to Q3. We will not have implemented the full savings that weexpect to see from the actions that weve taken here in July until the end of Q2. So our comments around sort of hittinga double-digit operating income at revenue in the low-80s would not be effective until we get to that Q3 time frame.Sanjit Singh - Wedbush Securities Inc.Okay, but not until Q3. On the gross margin side, splitting up the product and service gross margin, I understand theresgoing to be some improvements on the supply chain side? What levels of gross margin, both on the product andservice, do you think is sustainable?James JudsonSo we have said all along that we would like to be -- the financial model of the company has put out there, for grossmargin, total gross margins in the 57% to 59% range. Weve tracked below that most of this year. But we do believe thatwith the actions that weve taken to date in terms of lowering our fixed cost structure, as well as the actions that Oscarreferred to around some product redesigns that well see hit the market in the second half of the year, as well as someof the supply chain activities. I mentioned the Hong Kong distribution center, we believe that we will get back into thatrange this fiscal year.Sanjit Singh - Wedbush Securities Inc.Okay, this fiscal year, okay. And on the competitive environment, so I think Dell is looking to buy Force10. Wheres thecompetitive pressure sourcing from? Is it the guy with a 70% market share? Is it all players? Is it in fluctuation? Where isthe pricing aggressiveness coming from?Oscar RodriguezThats a good question. So it really depends. Since we were serving different parts of the market. It really depends onwhat part were talking about. If we look at the campus environments, we definitely see increased pressure from thosethat are trying to gain market share, Hewlett-Packard and Juniper, I think are good examples. Those that are trying togain market share in the marketplace. I dont 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 thateither were targeting or accounts that are looking at some of our solution sets. So thats where I -- we see the mostamount of competitive price pressure, really is in the campus environments. And as we focus more on the educationalenvironments -- and the interesting aspect of educational environments is they have a self-generating awareness in thatthey talk a lot, they dont see each other as a competitive, so they talk a lot to each other. So we have a lot of word ofmouth that goes our way as well. The key value we offer there is that we offer not only great CapEx and good OpExgoing forward, but the OpEx is also augmented by more automation, which means that customers need to have fewerpeople to manage their networks. Educational systems, typically, cannot afford to have lots of deep experts becausetheyre $100,0000 and above folks, and its difficult for different educational systems around the country or around theworld to maintain that level of expertise. So the more automation, the better. And thats really our focus is driving, thatlevel of automation for educational customers. So we shop the value versus the -- just working on price, but we do knowhttp://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  11. 11. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeki... Page 11 of 14that when we see competitive pressures from the other competitors, that has a tendency to have an effect on price.Sanjit Singh - Wedbush Securities Inc.Wonderful. And this is my last question regarding the restructuring. Other companies in this industry, over the lastdecade or so, have announced similar restructuring plans to improve the operating margin, and therell be a temporarybenefit, and oftentimes, either due to a fall of company morale, or maybe not enough feed on the street on the salesand marketing side, the operating margin never -- targets never materialize. What have you -- is there any risk to thathere in terms of maybe, cutting too deep? What have you -- how have you gone about trying to mitigate those risksgoing forward.Oscar RodriguezYes, thats a great question. First, lets talk about the changes weve actually made. So because in looking at thechanges we actually made, hopefully this will give you some comfort that while theres risk, Im not going to say theresno risk here. Theres always risk and weve cited all of our risk factors upfront. We believe weve made the appropriatechanges to really focus the company in the right direction. So the first thing weve done is weve actually made adecision to move software engineering out of California and into the lower cost venues where we have already hadcritical mass people and also where we have the most of the -- one of the venues we have the most amount of longevityin software engineering where the majority of our architects sit. So between Raleigh, North Carolina here in the U.S.and Chennai, India, thats where the bulk of our software engineering resources are sit today, between those 2 sites.And so what were 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 sothe result of that, I think thats a good move that actually enhances our ability to drive future velocity, and be able toeffectively also, expand headcount because by moving into lower cost venues, we can actually afford more heads. So Ithink thats a good move for us. So thats lowering costs while still, not only maintaining, but also expanding yourinnovation capability. In operations, weve chosen to move people closer to the factory as youre aware, in reading ourKs, and youve followed the company for a while. We have outsourced manufacturing and an ODM relationship withAlpha Networks. By moving people closer to that, to where the factory really is, rather than maintaining them here inCalifornia, some of those positions will enable us to lower costs while, I believe, increasing productivity and increasingour ability to have a better relationship with that vendor as well. In services, what were doing is, were actually movingsome 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, thatsgoing to lower costs without letting go of the skill set and the intimacy that weve developed over the years. One of thethings that has allowed us to maintain our market share as it is, in spite of the fact that were a small player, is that ourcustomers value our customer service capability and our customer intimacy very highly. And so as a result of that, wewanted to be sure that we did not, while making adjustments and lowering costs, take inordinate risk with that. So I thinkthat those 3 areas are areas where I see an appropriate level of risk, relative to the lower cost structures that weregoing to go into. And I think that well actually get better lift in R&D. I think well get better, our productivity out of theoperation side of the factory side, and I believe we will actually able to balance our skill sets between tier 1 and tier 2support, et cetera, around the world. When it comes to sales, what weve done is weve taken very clear steps toactually simplify some of the management structures that weve had. So some of the costs that were taking out of salesis simplification. And Im a big believer that simplification often leads to better productivity and also, just easier ways ofdoing business with the company. So by being able to do a similar thing that weve done in North America, which is justbasically simplify the sales structure that I believe that in parts of Latin America -- in Latin America and in parts ofEMEA, I think that were going to get a little better lift there as well. Now we have made moves from investing incorporate marketing to investing in field marketing. I think that, that shift enables us to put more marketing activitiescloser to the customer, and to enable us to drive better awareness, geo by geo, so that the customers who are dealingwith -- that we want -- that were targeting with our target market verticals, will actually then be able to build awarenessthat begets consideration, that should invite us in the deals and grow our sales pipeline. So I think that the steps thatwere taking are appropriate. I think that they have appropriate risk and they are not risk-free, nothing is risk free. But Ido believe that we have taken the appropriate steps to make sure it executes well.James JudsonSanjit, before you go, you had asked about the stackables and modular. Just so you have the information this quarter incase its key to what youre doing. This quarter, it was 71% stackables and 29% modules, modular.Operator[Operator Instructions] Our next question comes from Bill Nasgovitz from Heartland Funds.http://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  12. 12. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeki... Page 12 of 14William John NasgovitzWhat do you think R&D will run as a percent of sales in the new year, the new year were in.James JudsonYes. Were looking something in the 12% to 13% range, as a percent of revenue.William John NasgovitzOkay. And CapEx, Im sorry, I might have missed that.James JudsonWe didnt talk about that, but historically, its around somewhere between $1 million to the $1.5 million per quarter.William John NasgovitzOkay, all right. And could you outline, again, your -- the company as the Boards buyback policy?Oscar RodriguezSo 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.William John NasgovitzWell, I wish you would, as a long-term patient shareholder, whats our cash earning these days?James JudsonAbout 1%, yes.William John NasgovitzAbout 1%. Well, were building cash. I mean, our hats are off to, thats good to see in a tough environment. You seem tobe thrifty and wise, and why not buy back a little of the shares, too?Oscar RodriguezBill, well certainly take that into consideration. One of things that we certainly consider every quarter and every year is,whether or not were driving the best value for our shareholders, thats paramount. And so as we look at theenvironment, and some of the variability thats out there in the global economic environment, we want to be sure thatwhile were driving value for our shareholders, were not creating undue risk for the company as well.William John NasgovitzWell, with cash at $150 million or something like that, it wouldnt seem to -- just a modest buyback would seem to makesense, would seem to be prudent. Do you have an authorization now, is there an active authorization?Oscar RodriguezNo, theres not.William John Nasgovitzhttp://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
  13. 13. Extreme Networks CEO Discusses Q4 2011 Results - Earnings Call Transcript - Seeki... Page 13 of 14Okay. In these volatile times, I think it makes sense to have that flexibility.OperatorOur next question comes from Ryan Mardiman [ph] of VALogic.Unknown Analyst -Id like to echo the last callers desire to see some share repurchases at this seemingly high, sort of ROE level. Butanyway -- so Dell announced their intention to purchase Force10. Some wire reports suggest it may be close to $700million, which is about 3.5x revenue. It looks like from their S-1, their gross margins are significantly worst than ours andtheir revenues are about 2/3 of ours. What do they "have that we dont have?" And what do you say about theseemingly outrageous disparity between the valuation that was reportedly realized by F10, or Force10 and the impliedvalue of our stock. Its been less than at 0.5x enterprise value to sales and expected profitability?Oscar RodriguezYouve 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, theyre clearly focused in one specific space, and it appears thatthey fit the deal when it came to Dells wants and needs. So clearly, the question for how they fit Dell, I think its moreappropriately ask the Dell folks and how they see that. In terms of valuation, I stopped trying to guess on valuations along time ago. Im not an investment banker. It does -- it is interesting that, that value is there, because Im hoping that,that also signals the level of value that maybe Extreme should have as well because we are clearly, delivering productsin those specific spaces in addition to other high-growth spaces like mobile, backhaul and mobility. So Im hopeful thatthe 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 ourown IP? And what have been the results? And it seems that we spent over $400 million in R&D in the last 7 years, inthe -- weve continued our -- continuing to have patents issued to us. It seems like there should be significant valuethere, and what do you reckon its worth? And what steps, if any, are going to be taken to realize that value, besides, Iguess, hopeful incremental sales associated with that?Oscar RodriguezYes. Its a good question. We have not done a formal valuation of our IP at this point in time. I can tell you that our IPportfolio is significantly smaller than a Nortel portfolio, also significantly smaller than some of the other very super largeportfolios that have been discussed out in the industry to date. We may not be able to get value thats anywhere nearwhat we might expect, and it really comes down to whos buying and why are they buying.OperatorAnd gentlemen, I would now like to turn the program back to you for any closing remarks.Oscar RodriguezAll right, very good. I want to thank all of our investors for, once again, joining us on the call, and for the analysts whocontinue to follow us. We certainly are doing the hard work of making sure that we have the right plans and the rightexecution 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, andactually next week, also in Boston, and I look forward to meeting any investors, should you happen to be at either oneof those conferences. So thank you very much. And we look forward to our next engagements.OperatorLadies and gentlemen, thank you for joining todays conference. This does conclude the program, and you may nowdisconnect.http://seekingalpha.com/article/283717-extreme-networks-ceo-discusses-q4-2011-results-ea... 2/9/2012
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