Extreme Networks Inc (EXTR) 2002 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Extreme Networks (Company: Extreme Networks Inc.; Ticker: EXTR; URL: http://www.extremenetworks.com/) second quarter fiscal 2002 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. At that time, if you have a question, you will need to press the numbers one, followed by four on your telephone.

As a reminder, this conference call is being recorded today, Wednesday, January 16, 2002.

I would now like to turn the call over to Mr. John Carvell, Director of Investors Relations. Please go ahead, sir.

Thank you. Good afternoon, and welcome to Extreme Networks second quarter earnings call. On the call today are Gordon Stitt, President, CEO and Chairman of Extreme Networks; and Hal Covert, Vice President and CFO.

Earlier this afternoon we issued our second quarter fiscal 2002 earnings press release. A copy of this release is available on our Web site at www.extremenetworks.com.

As a reminder, this call is being recorded and broadcast live over the Internet. The recording will be posted on our Web site and will be available for replay shortly after the conclusion of the call.

Some of the remarks made may include forward-looking statements as governed by the Private Securities Reform Act of 1995. Any statements about future events and trends, including steps the company plans to take to improve the financial result or financial condition, should be considered as forward-looking statements. These forward-looking statements may differ from actual results and are subject to risks, uncertainties as detailed in our filings with the SEC and in our press release today.

I would now like to turn the call over to Gordon Stitt.

Thank you, John. Good afternoon, everyone, and thank you for joining us.

I'll begin today's call with a review of our quarterly activities and a discussion of our strategy for moving forward. I'll then turn the call over to Hal for a detailed review of our financials.

This is the first full quarter for Hal at Extreme, and I'm very pleased with the impact that he's having on the company. Hal has been a key factor in defining the steps we are taking to optimize our business processes and position Extreme for long-term growth and profitability.

In the December quarter we achieved financial results that were in line with expectations. Revenue was slightly over 109 million, and pro forma earnings were two cents per share. The programs that we've initiated to strengthen our operating model have led to significant improvements in both gross margins and expenses, and have allowed us to achieve profitability at the operating income line. Hal will expand on our financials later in the call.

Let me make a few comments about our business from a regional perspective. We are cautiously optimistic that the economy and business environment has stabilized in North America. Although Q2 was not a strong quarter in this region, we are now seeing indications that the market is beginning to recover. We think there's reason to believe that the worst is now behind us in this region, and we can look forward to a more stable North American market in upcoming quarters.

Despite regional seasonality, we've continued to see strength in the EMEA region, and Asia continues to be strong. Our success in Asia is a direct result of our widely accepted Ethernet everywhere vision and the investments in the region that we've made over the past year.

These investments, combined with the development of effective business partnerships, have resulted in continuing strong demand. We're very pleased with the traction we've achieved in the important and rapidly growing Asian marketplace.

The value proposition we offer to customers is compelling, and it's enabled us to continue performing well during the difficult business conditions of the last few quarters. Extreme offers its customers the most effective applications and services infrastructure in keeping with our founding vision of a simpler, faster, and more cost-effective network environment based upon Ethernet technology. This clear, focused approach has continued to win new business for Extreme in the markets we are engaged in.

We continue to focus on two of the largest networking markets, the two with the greatest opportunities for growth and success for Extreme; that is large enterprise and Ethernet Metro. Throughout our history we've maintained a clear strategic direction and a consistent technical vision. Our participation in these two key markets is a reflection of those strong core principles. Since the beginning, we've had a strong presence in the enterprise market and have played an important role in the continuing evolution of enterprise networking.

When we pioneered the Ethernet Metro market two years ago, we leveraged our Ethernet everywhere vision and our vast experience in the enterprise to successfully establish a position in Metro market. Today we are seeing the two markets converge with both enterprises and Metro service providers, seeking technology that can help create a unified global network architecture.

Extreme could not be in a better position to capitalize on this convergence. With unmatched experience and a solution set that is second to none, Extreme is poised for great success in the years ahead.

Our continuously expanding base of satisfied customers provides the best validation of our market strategy. Extreme's strong, clear vision, combined with our unequaled portfolio of best of breed solutions, is continuing to attract new customers around the world.

Although this quarter was a difficult time for the world economy, we won many significant new accounts and achieved a very significant milestone. During this past quarter, Extreme Networks shipped its five-millionth Layer 3 Ethernet port. This major milestone was achieved within five years of our initial shipments. This achievement is a tribute to our customers' commitment to us and to our visions of a simplified network based upon Ethernet technology.

I want to take this time to congratulate the dedicated team at Extreme for the continued hard work and effort in helping us reach this very important milestone.

Now, let's spend a few minutes to talk about some of the wins during this past quarter. Throughout the quarter we made significant progress within our two primary markets. In the enterprise market, Ace is a new place for Extreme. Ace Hardware, the nation's largest co-op retailer, has upgraded its network at their corporate headquarters in Illinois. Ace has successfully migrated from a legacy Token

infrastructure to Extreme's Ethernet-based platforms, which are delivering 100 megabit per second switch connections to employees desktops.

Extreme technology gives Ace a superior network infrastructure, supporting mission-critical software applications that are increasing the productivity and effectiveness of their corporate operations which support over 5,000 locations throughout the U.S.

In Germany, a leading automaker of Volkswagen has implemented Extreme at its Wolfsburg plant to improve production operations and office communications. VW found our best of breed technology, competitive pricing, and service and support package to be a winning combination.

One of our focus points within the enterprise space is on major educational institutions. Now, during Q2 we continued our success in this target market. For example, the Suffolk Law School in Boston has created a remarkable campus with a future with Extreme Networking solutions. Suffolk connects thousands of students through our switches to an optical Metro network provided by our partner,

.

It's an amazing learning environment where every student can plug into a big

to access daily course work via mock trials, via IP video, and to connect with the Internet from the dormitories. Ethernet has even found its way into the cafeteria at Suffolk.

Another key area for Extreme is helping municipalities manage their complex and growing network requirements. As such, we've also made significant progress in the federal and local government segment.

The State of New York and Albany has adopted Extreme to improve their IT infrastructure, partly in response to the events of 9/11. The new Ethernet network, upgraded from a legacy ATM infrastructure, allows agencies scattered throughout the State to quickly access DMV records, social services data, state infrastructure information, and financial records, from a central database.

The city of Seoul in Korea is sponsoring a city hall data superhighway project and recently completed a network utilizing multiple Extreme switches. The network connects city hall with several district offices over a pure IP backbone.

The Toronto Convention Center in Canada has selected Extreme to deliver high balanced connections for both visiting exhibitors and its regular service vendors. They first experienced Extreme's remarkable networking performance during a

Canada trade show last summer and decided that our simplified network solution would be the right choice for events all year around.

So, as you can see, our success in enterprise spans government, education, large industrial companies, and retail and service industries.

Turning to the Metro service provider arena, Extreme continued to make significant progress and to secure new business in this important emerging market. Let's talk about a few of the wins here.

Now

, Europe's largest independent Internet traffic exchange in London, continues to deploy our core switching solutions, and recently upgraded their network to include our proprietary 10 gigabit Ethernet solution.

continually fortifies their network to meet traffic growth, a growth which has surpassed 10 gigabits for the 120 ISPs that connect to their exchange.

We're also pleased to announce that we delivered our first products to Cincinnati Bell during December quarter. Cincinnati Bell has chosen Extreme as the infrastructure for their new Metro area Ethernet offering.

Our success to date has been truly dependent upon our long-term commitment to innovation and technology leadership. Today, we continue to make significant investments in research and development. During this past quarter, we have expanded the breadth of our product portfolio with enhancements to each of the platforms. We even added important new functionality to the BlackDiamond. We have built

a

compliant Alpine product line with a new 3802 chassis which is designed for branch office productivity, and we've begun the process of refreshing our industry leading Summit line of fixed configuration switches.

In December, we introduced the new Summit

and the Summit

. These low-cost Summit platforms enable us to expand our market base to include network applications that require very low-cost enterprise access technology versus our existing customers who rely on the high functionality of our award-winning Summit 48 enterprise desktop switch. We will continue to invest in delivering advanced technology in our industry-leading Summit series.

Our new software release completed this past quarter brings extensive new functionality to the Extreme product line. We are particularly excited about

.

is Ethernet Automatic Protection Switching. Now, in the Ethernet Metro, we have long endorsed the use of Ethernet over Ring

, allowing the use of existing Sonnet fiber optic plant.

Some of our largest customers deploy our switches utilizing Ring

. Now we are very supportive of industry standardization efforts in the Ethernet Ring arena, and of technology, such as

. But we are a little frustrated with the lack of timely progress.

, which is being delivered in production environments, has proven an excellent solution. We have built Rings with an excess of 50 nodes, and we've achieved resiliency of less than 250

. Now, this is with production software. In the labs, our new generation

solution is achieving resiliency of close to 50

. Now, as you know, 50

is what it takes Sonnet to recover.

As we deliver this new version of

, we'll be well down the path of providing Sonnet-like resiliency in an Ethernet environment, all with no hardware changes to our existing installed base.

Our strong commitment to R&D has also brought Extreme unprecedented industry recognition this quarter. In October, our recently introduced Summit PX

application switch was awarded the networking industry's most prestigious honor, the Networld plus

show award. Extreme has now won this important award for five straight years, the industry's longest winning streak.

This remarkable record demonstrates our continuing progress in pioneering new technologies and innovative new products. Staying ahead of market trends is what keeps Extreme ahead of the pack and drives our market position for the future.

To ensure that we will carry that success well into the future, we are maintaining a strong R&D effort. We will continue to add products to our portfolio of switching solutions that provide higher performance and a greater return on investments than the competition.

In the coming months, you will see new high-performance interfaces based upon our 10 gigabit Ethernet technology, significant new management features for Ethernet bandwidth provisioning that will be extremely valuable in the Metro marketplace, and you will see more competitive enhancements to our Summit family of access products.

I'd like to expand a little bit on our course strategy, which I believe places Extreme in a very strong position versus many of our competitors.

First of all, in the swirl of market activity over the last several years, Extreme has had a consistent strategic direction. We have always believed in large enterprise as a business, and we believe that the same technologies that we have developed apply to the new emerging Metro Ethernet market.

The value proposition that has made Extreme a major player in the enterprise is simple, yet critically important to businesses in the Internet age. We provide a network environment that delivers top performance, is simpler to implement and manage, and offers a better return on investment than other solutions.

Thousands of customers have chosen us over our competitors for many specific reasons; for raw speed, for better design

implemented products, for lower cost, and simplicity of operation. But ultimately, it comes down to providing superior network infrastructure that can support the rapidly increasing load of mission-critical applications that are the life blood of so many companies today.

In the Internet age, companies are now building corporate campus' that are not concentrated in a small geographic area. Extreme has made large enterprise customers for whom corporate campus means hundreds of buildings spread over a city-sized area.

In the very near future, the corporate campus will have essentially no geographic limits at all. Companies now must build an extended network infrastructure to support a whole world of inner-connected customers, partner companies, and other resources.

To help companies achieve this goal, Extreme Networks is extending the Ethernet LAN experience beyond the walls of the corporation into a global business network, what we call the campus of the future. We are uniquely positioned to do this because of the advanced technologies we have developed in our work for the Metro service provider market. Our work in both markets provides great advantages to our customers in each of these markets.

Now in the Ethernet Metro space we have historically focused on new

network opportunities, and we've been extremely successful in building some of the largest pure Ethernet networks in the world.

Now, two years ago we began a program to address the needs of the incumbent carriers and to help them migrate from their legacy voice-centered technology base, and to achieve the benefits of the Ethernet everywhere vision. We called this program Legacy to Leading Edge.

There are five phases to this plan which include the delivery of legacy access and aggregation, service provision, and

support. We are well down the path of completing our five stage plan and in providing the very best migration support for existing incumbent carriers.

For example, based upon the technology that we delivered as part of the Legacy to Leading Edge program, Cincinnati Bell selected Extreme for their Metro area product.

We will continue to drive our Legacy to Leading Edge initiative, as well as our campus of the future initiative. By focusing on the technical sweet spots that encompasses both markets, we are able to offer our customers a consistent, easily managed, highly scalable network environment that will ultimately be available everywhere from the corporate headquarters to the farthest reaches of the company's global presence.

We also enable seamless integration with new services that will be offered by Metro service providers. Many of our customers are already relying on a combination of company-owned infrastructure and service provider products today, and many more will do so in the near future.

With core technologies that are relevant and compelling in both enterprise and Ethernet Metro markets, and distribution and selling strategies that have already achieved success in both markets, we can grow our company faster by providing the most effective network infrastructure to both large enterprise and Ethernet Metro service provider markets. This synergy is the key reason why I believe that Extreme will emerge as one of the most significant and important companies in our industry.

Also this quarter, we expanded our team with the addition of Kenneth Levy to the Board of Directors. As the founder of KLA-Tencor more than 25 years ago, Ken has led that company to its present position as a multi-billion dollar company, and the world leader in yield management and process control solutions for semi-conductor manufacturing and related industries.

Ken is widely recognizing we're building high-performance teams that consistently deliver excellent financial performance. With Ken as a member of our Board, we can leverage his in-depth management knowledge and his direct personal experience in growing companies to multi-billion dollar status. We are truly delighted to welcome Ken to Extreme and look forward to a long and successful relationship with him.

Before turning the call over to Hal, I would like to reiterate, while the forward visibility is still uncertain given the macro-economic environment, we are optimistic that the worst of the industry downturn is behind us.

We remain committed to our strategy of providing the most effective applications and services infrastructure for companies around the world. We will continue to leverage our channel and industry partners to extend our reach into growing regional and vertical markets.

Thank you, Gordon.

Before I discuss our financial performance for the quarter, I'd like to highlight several key aspects of our financial and operational strategy.

First, over the next 18 to 24 months, our goal is to achieve the following financial targets for our long-term operating model expressed as a percent of revenue: Gross margin, 53 to 55; R&D, 12 to 13; Selling and marketing, 18 to 20; G&A, 4 to 5; and, operating profit, 15 to 20.

Key programs to achieve our operating model goals include monitoring and controlling all key aspects of our supply chain, including closely working with related partners to insure that we effectively manage materials.

Materials represent more than 80 percent of our cost-to-goods sold, thereby providing a major opportunity for cross-containment and improvement.

Streamlining our global business processes, implementation of a new global

system, and enhancements to our global CRM system, successful implementation of these back office systems will enable us to drive the majority of our customer and operational transactions through an e-business platform, and thereby increase customer satisfaction and operational productivity.

And finally, utilizing key performance indicators and benchmarking to insure that all members of our management team are aware of Best-of-

practices for each key activity performed by the company, and that we have necessary action programs in place to achieve continuous improvement as we pursue world-class performance.

Over the next 18 to 24 months, our operating plans include continuous improvement for each key element of our income statement and balance sheet.

Turning to our financial results for Q2 FY 2002, we had three goals as we entered the quarter. First, no decline in sequential revenue. Next, to be profitable at the operating profit level. And finally, to exit the quarter with momentum, or in other words, with a good backlog.

I'm happy to say that we achieved each of these goals. As we discuss our income statement performance and balance sheet position for Q2, this will be apparent. Please note that my comments regarding margins and expenses do not include amortization expenses related to goodwill and intangible assets and deferred compensation, which totaled $15.2 million for Q2 FY 2002.

Revenue for Q2 FY 2002 was 109.1 million versus 108.3 million in Q1 FY 2002, and 144.7 million in Q2 FY 2001. Our book to bill ratio was greater than one for Q2 FY 2002.

On a geographic basis, the Americas represented 34 percent of all revenue for Q2 - FY 2002 - versus 31 percent in Q1 FY 2002, and 45 percent in Q2 FY 2001.

Europe represented 21 percent of our revenue for Q2 FY 2002 versus 23 percent in Q1 FY 2002, and 27 percent in Q2 FY 2001.

And Asia represented 45 percent of our revenue for Q2 FY 2002 versus 46 percent in Q1 FY 2002, and 28 percent in Q2 FY 2001.

As we have indicated, it will take several quarters for the Americas to return to its historical level of approximately 45 to 50 percent of total revenue.

For Q2 FY 2002, we have one customer that accounted for more than 10 percent of our revenue on an individual basis. Tech Data, a large distributor, focused on our U.S. customers, accounted for 15 percent of our revenue for the quarter.

I would like to point out that we had three resellers in Asia during the quarter that accounted for review in the high single digits as a percent of total revenue.

The revenue split between enterprise and service provider segments for Q2 FY 2002 was in line with the historical trend, approximately two-third's enterprise, and one-third service provider. Enterprise includes government and educational customers.

Product mix consisted of 54 percent modular and 46 percent

for Q2 FY 2002 versus 56 percent modular and 44 percent

in Q1 FY 2002, and 47 percent modular and 53 percent

in Q2 FY 2001.

Although there is some variation in product mix from quarter to quarter, w do not anticipate a consistent shift in product mixed in the near term.

Q2 FY 2002 gross margin was 52.9 percent, compared to 52.1 percent in Q1 FY 2002, and 51.8 percent in Q2 FY 2001.

While at the micro-level there is competitive pressure for specific deals from a pricing standpoint, we did not experience a major change in pricing in the macro-pricing environment.

ASPs for Q2 FY 2002 were consistent with recent historical trends. Based on this experience, our focus on operational excellence, and our new product roll-out plans, we expect gross margins to be slightly higher over the next few quarters.

Operating expenses were 56.4 million in Q2 FY 2002, 58.8 million in Q1 FY 2002, and 58.3 million in Q2 FY 2001.

For Q2 FY 2002 R&D expense represented 13.4 percent of revenue, selling and marketing 32.8 percent, and G&A 5.5.

Moving forward we plan to leverage our current operating infrastructure and thereby increase expenses at a slower rate than the expected increase in revenue.

Operating profit for Q2 FY 2002 was $1.3 million versus a loss of 2.4 million in Q1 FY 2002, and a $16.6 million profit for Q2 FY 2001.

The improvement in sequential operating profit is a result of our focus on improving operational performance, while the unfavorable comparison to Q2 FY 2001 is due to the increase in comparable revenue.

Other income and expense for Q1 FY 2002 was 1.7 million. This is .4 million less than Q1 FY 2002, primarily due to lower interest rates and a drop in other non-operating income.

Pro forma net income for Q2 FY 2002 was $2 million, compared to break-even performance in Q1 FY 2002, and a $12.6 million profit for Q2 FY 2001.

Pro forma earnings per share were two cents for Q2 FY 2002, and 11 cents for Q2 FY 2001.

Our long-term pro forma tax rate remains at approximately 35 percent.

Turning to the balance sheet, I'd like to highlight several items.

First, our cash equivalents and investments balance on December 31, 2001 was 385 million, compared to 205 million on September 30, 2001, and 192 million on June 30, 2001. These balances do not include $80 million of long-term restricted investments. Restricted investments relate to the financing of our corporate campus.

The increase in cash, cash equivalents, and investments balance as of December 31, 2001 is due to the issuance of convertible debt in November. Net

fees, we raised approximately $194 million.

The bonds earn 3.5 percent annual interest and are convertible into Extreme's common stock and its

price of just under $21 per share.

While on the topic of the dead offering, let me take a moment to explain why we did this financing. First, it was not done to fund operations, as we believe that we will be cash neutral to positive going forward in this regard. We wanted to strengthen our balance sheet from a marketplace and customer standpoint, as well as to be in a solid position to make strategic investments in technology if and when an appropriate opportunity arises.

In addition, the current economic environment enabled us to raise cash at a very reasonable cost.

During Q2 FY 2002 we achieve our goal in achieving positive cash-flow from operations. Accounts receivable were $54 million on December 31, 2001, which equates to a DSO of 45 days. DSO for Q1 FY 2002 was 43 days, and DSO for Q2 FY 2001 was 63 days.

Net

inventory on December 31, 2001 was $48 million, or a reduction of $4 million when compared to the $52 million reported on September 30, 2001. Over the next several quarters, our plans include actions to reduce the level of net inventory that we carry on an ongoing basis.

Channel inventory was within targeted levels at the end of Q2 FY 2002. Keep in mind that we have always recognized revenue based on

. Therefore, the shipment of inventory into the channel does not impact reported revenue.

Staff, including temporary personnel, as of December 31, 2001 was 1,054 versus 1,080 as of the -- as of September 30, 2001. As of December 31, 2001, the company had 117.4 million shares of common stock outstanding on a fully diluted basis.

Now I'd like to address financial guidance going forward. As a result of the uncertain global macroeconomic environment that the business community is facing in general, and in particular the technology sector, we will not provide any specific financial guidance at this time. However, we would like to offer a number of comments.

From an addressed market and overall product offering standpoint, we believe that we are well positioned strategically and have a very competitive value proposition to offer our current and prospective customers. We are optimistic that we will experience some degree of sequential revenue growth in Q3 FY 2002 and have plans to achieve continuous improvement in our operating margins for the quarter.

We are currently operating at a cash neutral level, taking operating and capital expenditure requirements into consideration. If and when the global economic environment returns to a more predictable mode, we will consider providing additional directional comments or financial guidance.

Next I would like to reiterate our ongoing communication plans for our shareholders and the investment community. We will continue to have an active and broadbased program that will include participation by Gordon, John, and me, as well as other members of our senior management team.

Key elements include -- attendance at major investment banking conferences throughout the year, at least one or two road trips each quarter to visit current and prospective shareholders, an analyst day each year, investor bus tours at our corporate facility on a requested basis, and active communications with shareholders and analysts during the quarter from the date of our earnings call until the beginning of the third month of each quarter.

From the beginning of the third month of each quarter until our earnings call we will be in our quiet period. During this time, there will be no communications with our investors or the investment community regarding information related to the current quarter, unless a formal announcement or a press release is made.

Now I'd like to turn the call back over to Gordon.

Thank you, Hal. All things considered, it was a positive quarter for Extreme. Companies must continue to invest in networking solutions to stay competitive, efficient, and profitable. Our approach to helping companies build the most effective applications and services infrastructure, based on our technology vision of Ethernet everywhere, uniquely positions us as a networking vendor of choice.

In considering our long-term potential, I think it's important to place our company in the proper economic context. Extreme's a relatively small player in a very large market, a market that is brimming with opportunities. As such, we are much less dependent on the macroeconomic situation than our larger competitors. We do not need rapid growth in the broad economy in order to grow ourselves. We have the right strategy and the right value propositions, and we have many opportunities to grow our share of the market, even when the market itself is flat or growing at a very slow pace.

As long as we continue to execute well and optimize our business operations, we can achieve meaningful growth and success during less than perfect economic times.

Extreme's a truly exciting company that has made a real difference for companies all over the world. Everyday we worth with customers who look to us for help in deploying high performance networks that can optimize the many business-critical applications they depend on to maintain a competitive edge and to increase their own profitability. We are working hard to ensure that more and more companies will discover the unique advantages of our solutions in the months and years ahead.

We'd now like to open up the call for questions.

Thank you, sir. The floor is now open for questions. If you do have a question or comment, please press the numbers one, followed by four on your touch-tone telephone at this time.

Our first question is coming from Sam Wilson of Merrill Lynch. Please pose your question.

Good afternoon, gentlemen. Kind of a couple part question for you. Gordon, can you -- you've launched a number of new products over the last several quarters -- 16

Diamond, legacy interfaces from the

, the app switch. Can you just kind of run us through how some of those -- how they're going? Are they going as expected, a little bit better than expected? Just kind of take us through that a little bit?

Sure, Sam. First of all, we don't break out, you know, specific, you know, products on numbers on any specific product, but I can provide some color across those product categories.

First of all, the application switch, the Sonnet TX-1, which we had first volume shipments of the December quarter, you know, continues to meet and exceed our expectations. It's a product that once customers put into their network and particularly into their data centers, they never give them back. So we had good conversion of demo units and we've seen excellent take up on that product.

The Black Diamond 6816, which is our highest density product. Originally we thought that that product would be used primarily in Internet exchanges, for instance, where there's just a huge number of gigabit ports to be aggregated, but we've seen take up on that product from enterprise customers as well, who just -- who need to have a very large scale switch for data center and aggregation opportunities.

On a lot of the -- we'll call it the legacy interfaces that came from

, which included a T-1, E-1, DS-3, as well as our internally developed interfaces, which include our packet over Sonnet series of products, those are also seeing good traction in the marketplace and are really part of our overall solution set in our legacy to leading edge migration. And as we've proposed that story to potential customers and showing how we can bring them from a legacy environment into a pure Ethernet environment and provide all the migration tools, those products that we've introduced have been a significant factor and has helped us when a number of new accounts, as I mentioned in the prepared comments.

Thank you. Your next question is coming from Michael Weintraub of UBS Warburg.

Thank you. I have a question on a guidance, or a lack of such. If I understand correctly, you exited the quarter with sufficient backlog that was planned. And I believe that the beginning of January,

they didn't comment on it, is tracking OK.

So the lack of guidance, is it based on possibility of future deterioration in particular markets in Asia or Europe, for example, or is it based on the competitive positioning and competitive

going to come from elsewhere?

Well, you know, I think we did give some indication. You know, for example, when we entered our quarter two, Michael, we wanted to have sequential revenue growth or no decline. We wanted to increase our operating profit. We wanted to be cash positive, and we wanted to have a good backlog exiting the quarter.

And I think we have the same set of goals heading into quarter three. So we are planning on continuous improvements and moving forward.

Thank you, sir. And our next question is coming from Lisa Bogaty of Credit Suisse First Boston.

I would like to just make a brief announcement though, to limit all questions to one at a time. Thank you.

OK. I was actually going to ask three, but I'll try to limit it to one. Can you give us a little bit of color -- I apologize for the connection -- a little bit of color on comments about North America that -- I think you said that you thought that there was a little bit of improvement there in the outlook. Is this something that you're seeing in actual very recent sales or in orders, or is it just activity levels?

And then, if so, what's the driver? Is this postponements from last year? Do you think 9/11 perhaps, you know, created some demand? Or is it share gains or just some new -- you know, new projects? Thanks.

Yeah, I'll start, Lisa, and then I'll let Gordon pick up.

In quarter one of this fiscal year, we had 31 percent of our revenue coming from the Americas. And our quarter two, as we indicated, we had 34 percent. So we have seen some pick up. I don't believe it's related to September 11th. I think it's just, in general, companies starting to look at how they can increase productivity -- Gordon.

Yeah, a couple things to add there, Lisa. You know, we did not see, you know, the end of December, I've got to spend all my budget money in a factor that, you know, certainly we've seen in past years. And I think that's a good sign and that people are, you know, are, I guess, returning to very rational decision-making regarding capital expenditures and that we've consistent delays over the course of the last year of people delaying projects that they had committed to.

And, you know -- yet, you know, as we move through December, we just saw a lot of consistency in that. And that's given us, you know, generally positive feeling with a slight uptick. You know, we're hopeful that that will continue out over the next couple quarters.

Next question, please.

Thank you. Your next question is coming from Chris Stix of Morgan Stanley.

Hi. I wanted to get a feel for what percentage of the business you think could be layer two over time? I noticed that you'd released -- announced on our Web site a layer two switch, the E-2. And I wanted to, as you look forward, maybe a year, what do you think the layer two market opportunity is?

Sure. I think -- Chris, that's a good question. It's difficult to give you a precise answer. And really, the way we look at that market is -- what we do is we provide a large enterprise solution set. And, you know, in all cases, we sell a combination of products. You know, it's pretty rare for us just to sell, you know, a stackable series of products, for instance, to a customer.

So really, what we excel at is in putting together a solution that includes core aggregation and access. And the reason that we introduce the Summit

and the

, which is a low cost layer three product, is really to expand the market and to capture some of that segment of people who were really buying low cost access products.

So if they were buying Extreme at the core and maybe a very low-cost commodity product on the edge, we want to be able to capture some of that, and also to provide clear differentiation between the low cost edge product and our enterprise desktop switch series, which provides a very high functionality and security functions that are becoming increasingly important.

So we probably won't break that out in the future in terms of on a product by product basis, but certainly as we report

, we will report our layer three on the revenues and our layer two revenues. I do expect the bulk of our revenue, the vast majority of our revenue, will continue to be in layer three.

Thank you. Your next question is coming from Alex Henderson of Salomon Smith Barney.

Thank you very much. I was wondering if I could ask a question on the new product front. You've obviously had a very strong flow of new products, not just over the last quarter but, you know, really, across the last four or five months, you've had a pretty good flow.

What I would like to know, though, is as we go into N+I and get into the spring timeframe, how do you see your new product flow going forward? Will we see the pace of introductions accelerate, flow, stay about the same?

And then if I might, just I wanted to clarify off of the question that was asked about the North American condition. You'd indicated up at our conference first week of the month -- appreciated you coming out there -- but you'd indicated that you hadn't seen much change in the U.S. And I was wondering if you'd seen a change subsequent to the beginning of the new year. And had there been some pickup in January, specifically, to cause some of that and

? Just a clarification on that point.

Let me answer the first part -- the second part of your question, first of all, on North America. You know, I think in general, we're cautious about North America because we want to make sure that there's real signs before we indicate that. And, you know, as we said, we did increase a couple percentage points, and we're seeing pretty good activity. So we think, heading into the new quarter, that we're hopeful as we've indicated that we're going to see momentum going forward.

Yeah, on the new product front -- this is Gordon -- on the new product front, as you know, you followed us for a while. We've maintained a continual investment in our technology. And we've always very much believed that that's the lifeblood of our business. So I don't think you should expect to see anything change.

We did introduce a large number of new products in the past 12 months. But also, if you look from, you know, roughly a year ago December, we also almost doubled our engineering team at Extreme. So, you know, we continue the high investment. And you can expect to see, as we move into the middle of this year and throughout this year, I think you should expect to see the continual flow of new products.

Next question, please?

Your next question is coming from William Necklean of Commerce Capital Markets.

Thanks. My question goes back to your initiative in the Metro market. You've already mentioned Cincinnati Bell. There's been a lot of talk about one of the RBOCs started to deploy Metro Ethernet. My question is, are you in the hunt for that business, who else is in the hunt with you, and what are your expectations for that kind of a deployment in 2002?

Well, in terms of talking about things that we haven't specifically announced, I'll defer on that topic. But looking in general at this market, this has been a growing market for us. We did see a -- during the quarter, a slight increase in the percentage going into that market from the previous quarter. And this is a worldwide market.

The U.S. has been slow during calendar year 2001, you know, due to economic conditions and also just a slowdown in capital spending, and frankly a lack of competition on the Ethernet front.

You know, we continue to build out some of the largest Ethernet Metro networks there.

, who we've mentioned in the past and on this call, you know, is one of the largest providers of Ethernet Metro service within North America, and you know, continues to be a strong Extreme customer.

Throughout the world, we have built large scale Metro networks -- in Japan, throughout Asia, and in Europe as well.

Next question, please?

Thank you. Your next question is coming from Mike Funch of JP Morgan.

Great. Thanks very much. I hate to go back to North America again, but last quarter, you guys mentioned that you lost, you know, roughly two weeks due to the events of September, which was really kind of a $10-ish million range, plus or minus. Your North America was only up about five million sequentially. So could you kind of highlight what's going on in North America?

And then similarly in Asia Pacific, you had the big Japanese Metro deployment, which you said gave you about an additional $10 million in the last quarter, yet Asia-Pac was basically flat sequentially. So obviously there's some nice strength elsewhere in that region. Could you kind of help us understand what's going on there as well? Thanks.

Sure, Mike. This is Gordon. Yeah, we've continued to see strength in Asia. And, you know, that's been a real positive, you know, for us in the past. I think relating to September 11, of course, you know, it's hard to figure out exactly what happened from a demand perspective. But I would characterize it as, you know, what happened was a general delay in that people delayed purchases and they haven't yet woken up and say, "Oh my gosh, I need to go buy that, that I had intended in September."

And I think what we saw was a general reassessment of spending patterns, you know, throughout our U.S. market segment. And, you know, as I mentioned a few moments ago, you know, what we're seeing is, you know, prudent decision-making with certainly, you know, extended sales cycles from where they were a year ago. But we are seeing people make decisions and move ahead.

Yeah, I just add, Mike, that we had three resellers in Japan that had in the single digits as a percent of our total revenue. So we've seen good broadbased movement in Asia. Next question, please?

You next question is coming from Rik Suppiger of Pacific Growth Equity.

Hi. Can you comment a little bit just in terms of how Cincinnati Bell is using your products and how material of a deployment that could be for Extreme?

Hi, Rik. This is Gordon. Well, we're very pleased to have Cincinnati Bell select our products and technology. This is an Ethernet Metro product that they are beginning to deploy. We did have initial shipments to them in the December quarter. And, you know, it is a -- you know, a long-term deployment as these all tend to be.

In terms of the size of the deal, you know, we have a policy just, you know, of not discussing the specific size of the deal.

Next question, please?

Thank you. Your next question is coming from Christine Armacost of SG Cowen.

Thank you. One clarification and one question. When you said gross margins would be higher over the next couple of quarters, were you saying that you expected them to trend up, or just higher on an absolute basis than what you reported in December?

And then also, I was wondering if you can discuss or give us any color on China as a percent of your Asian sales relative to Japan? And from my understanding, Japan is still the largest part of your Asian business. Thank you.

Yeah, in regard to the gross margins, we reported, again, $52.9 for this past quarter. And we do expect them to go up as a percent of revenue going forward over the next couple quarters in each one of those quarters.

And in terms of China and Japan, we don't break that information out, but Japan is the bigger part of our overall revenue in Asia.

Next question, please?

Thank you. Your next question is coming from Sanjiv Wadhwani of Dain Rauscher Wessels.

Thanks so much. Gordon, I had one quick question on voice over IP and the enterprise. From our checks with a lot of distributors, looks like there's a lot of interest in voice over IP from customers. I'm just curious to see where you guys are playing in that market and if you are actually noticing, you know, some traction from customers for that product.

Hi, Sanjiv. Certainly we have a number of customers running voice over IP on our network infrastructure. And we certainly do see that as an important application. I want to highlight that there -- you know, there have been some vendors talk about how this, you know, is a great opportunity to renew network infrastructure.

I point out to folks that customers that bought our first product, the Summit

, back in the first half of 1997, have a product and a network infrastructure that is already voice over IP enabled.

And I think we've been able to use that very effectively in our marketing in showing people that we really do build the best applications infrastructure that not only supports voice over IP today, but has supported voice over IP throughout our history.

Next question, please?

Thank you. Your next question is coming from Stephen Kamman of CIBC World Markets.

Sorry about that. Had mute on.

One question -- given that IT budgets are pretty much set for the year, and I realize there's no guidance, but do we have any expectation of growth beyond, say, flat for '02 calendar year? And -- or are you seeing a share gain here? And if so, you know, any context on people adding -- you know, some people have come out with some boxes in the last six months that have been sort of dubbed quietly "Extreme killers," in the sense of very dense boxes that are really going up against some of the stuff you've been leading in.

Kind of looking at the outlook, I guess one, where is the growth coming from? Two, is it getting to be a tougher environment?

Well, in regard to the revenue going forward in calendar '02 and so forth, our goal is to have sequential increase in revenue as we go forward. So if that happens, then we would have a growth on a calendar year basis.

Again, we're seeing good activity, we believe, across all of our regions. North America is the one we're waiting to come back to a more normal level. And even though budgets are tight right now, people are spending money to increase their productivity and improve their performance. And from an international standpoint, we've seen good activity at the service provider level.

Gordon, you have anything you want to add?

Yeah, Steve, I certainly do want to comment on the taking share in that, yes, we believe we can share, you know, as we move through calendar '02. We have a tremendous confidence in our existing product line and in our product pipeline. And yeah, we expect to take share.

Thank you. Your next question is coming from Jason Ader of Thomas Weisel.

Yes. My question relates to Asia and whether you can give us a sense of how much of the Asian business is from service providers and how much is from enterprise?

Yeah, Jason. This is Gordon. The mix in service provider is higher in Asia -- excuse me -- than it is in other parts of the world. And frankly, it's lowest in the U.S. of other parts of the world. So in Asia, it's roughly 50/50.

Next question, please.

Thank you. Your next question is coming from Paul Johnson of Robertson Stephens.

one full quarter at the helm of the finance

, you've shown tremendous progress on cutting costs in a flat revenue environment. Are you encouraged, discouraged about the opportunity to continue to take costs out, even if revenue shows sort of modest sequential growth over the next couple of quarters?

Yeah, I think we've made this a number of times that we have an operating model that we're shooting for. And our goal is to hit that operating model in terms of percents of revenue for each one of the key categories, regardless of revenue growth.

Now, certainly, it's going to be easier for us to hit those goals if we're growing our revenue, which we do plan on doing, but we have an operating model that we're shooting for.

Next question, please?

Thank you. Your next question is coming from Tad LaFountain of Needham & Company.

Don't let Ken talk you into saving money by buying some old paint from KLA. Keep your current color scheme.

MCMS and Nortel, could you give us an update on those two situations?

Yeah. MCMS has been sold to another company that's much more financially viable, and we don't believe there's any issues with them any longer. In terms of Nortel, we do have litigation going on with them. We're hopeful that we'll reach some type of settlement with them. And in our operating model plans, we targeted what we think are reasonable expectations in that regard.

Thank you. Your next question is coming from Seth Spalding of Goldman Sachs.

Thanks very much. Just getting back to the gross margin briefly -- with the upward trend over the last several quarters, can you speak to whether that is due to stability of pricing in the market or product mix, or maybe component costs coming down? How much a factor is each of those in the gross margin coming out? And then going forward, when do you expect to see sort of driving it next couple quarters? Thanks.

Yeah, the largest single factor is really managing our materials more effectively. We are benefiting somewhat from component price declines, but again, the large part of it is really being more effective in terms of how we manage our materials, how we work with our supply chain, making sure that there's tight linkages between us and our suppliers in terms of forecasts, managing inventory, and all those aspects.

So we expect as we move forward we're going to continue to see expansion in our gross margin as a percent of revenue, as a result of those programs.

We're not planning on any major improvement from a product mix standpoint. As we indicated, we think it's going to say fairly consistent between modular and stockable.

Thank you. Your next question is coming from Ted Jackson of Piper Jaffray.

Thanks. Actually, real kind of bullet point questions. So first thing is, in the strength of North America, are you expecting it to be or finding it to be mainly at the enterprise level? And then secondly, can you just say what the cash flow was for the quarter and cap ex?

Yeah, if you look at our cash, taking the

out of the equation, we actually dropped by approximately $14 million. And if you recall on our last earnings call, we talked about having $20 million to $25 million of non-operating payments that we had to make, primarily related to some milestone achievements for acquisitions that we made. So, from operations, we actually generated positive cash.

In terms of our capital expenditures, we really don't break that kind of information out, but in our goal of being cash positive from operations, that does include our cap ex, which, you know, somewhere between $10 million to $15 million a quarter.

Thank you. Your next question is coming from Kevin Giboney of DA Davidson.

Good afternoon. I was wondering if you could share a little bit more in terms of the product path. You had mentioned that you -- or least implied, I guess, in previous comments that you were looking at taking some of the Ethernet, I guess beyond your typical MAN and LAN type of environments, more into a global situation. Would that involve, I guess, breaking some of the limitation of long distances currently, or could you enlighten exactly what you're thinking on that?

Sure. I guess there's a couple parts here in that question. First of all, regarding distances, today, we produce our products with a wide range of fiber optic modules that range in distances anywhere from 500 meters out to, I believe, a maximum of somewhere around 110 kilometers. And we've really focused on that solution for the Metro area.

Distance is certainly one of the elements of the equation. The other elements are continuing increases in bandwidth. You know, for example, when I described

, limited Internet exchange, they deployed some of our initial proprietary 10-gig technology. Now that's technology we've been shipping since September a year ago. And then in last September of this year, or excuse of this past year, we did publicly demonstrate our standards based 10-gigabit solution.

So we've been very active in 10-gig, first from a proprietary basis, which we're still delivering into the market. And you'll see us deliver our standards-based solution during this calendar year. And so, that's been a big part of the move into Metro as providing very, very high scaleable bandwidth.

Next question, please?

Thank you. We are near the end of our scheduled conference, so our final question is coming from Ilya Grozozski of Soundview.

Thanks. Snuck in under the bell.

Just a quick question on visibility. Obviously you guys have, even though you're saying you're not really giving guidance, you are implying certain guidance. How comfortable are you that the revenue level that you're at now is sustainable for the next couple quarters, and what gives you that comfort?

Yeah, I think again, on the guidance, we indicated that we're optimistic that we can get some sequential growth. The reason we didn't get a guidance is because it's still not totally clear that we can do that. So we'll keep you updated on our progress.

Thank you. Then that will conclude our question and answer session. Gentlemen, do you have any closing comments?

Yes, thank you. A few comments -- this is Gordon. As a company, we certainly remain cognizant of the dramatic fluctuations in the market. We are pleased with how we're managing the business and with our operational and financial results under the current conditions.

We continue to win new customers, and we continue to generate sales. We also continue to release new and compelling products, and we're in a very strong cash position. And we believe that we are operationally efficient for the current market without sacrificing any of our potential to invest in the long-term future of the company.

In conclusion, let me say once again that we will continue to take the necessary steps to ensure that Extreme Networks maintains its leadership position and that we will be well positioned for future growth when the high technology sector returns to its more typical pattern of stability and growth. Thank you very much for your support.

Thank you all for your participation. The does conclude the teleconference. You may disconnect your lines at this time. Thank you.