Extreme Networks Inc (EXTR) 2003 Q1 法說會逐字稿

Welcome to the Extreme Network’s first quarter fiscal 2003 earnings conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation. Later we will proceed with that question and answer session. At the time, if you have a question, you will need to press the numbers one, followed by four on your telephone keypad. As a reminder, this conference call is being recorded today, Wednesday October 16, 2002.

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

Thank you. Good afternoon. And, on the call today are Gordon Stitt, President, CEO and Chairman of Extreme Networks and Harold Covert, Vice President and CFO. Earlier this afternoon we issued a press release announcing our first quarter fiscal 2003 fiscal financial results. A copy of the release is available on our website at www.extremenetworks.com. A couple of reminders, this call is being recorded and broadcast live over the Internet. It will be posted on our website and available for replay shortly after the conclusion of the call. Some of the remarks made during the call may include forward-looking statements as governed by the Private Securities Reform Act of 1995. Any statements about future events and trends, including steps we plan to take to improve the financial results or financial conditions should be considered as forward-looking statements. These forward-looking statements may differ from actual results and are subject to risks and uncertainties as detailed in our filings with the SEC and in this press release today.

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

Thank you, John. And, thank you for joining us today. This afternoon I’d like to address three topics with you. First, I’d like to summarize our performance for the September quarter, then I’ll provide an overview for reducing our breakeven point. And, finally, a review of our target markets.

As you may recall, about two weeks ago, on the morning of September 30, we issued a press release providing a preliminary estimate of our financial results for the September quarter. In the release and ensuing conference call we noted that we expected revenue for the period to be approximately 100 million and earnings per share would be a loss in the range of 3 cents to 4 cents.

The actual results for the quarter were in line with these estimates. Revenue was 100.6 million and EPS was a loss of 3 cents on a pro forma basis, excluding amortization expenses. Including this expense on a GAAP basis, EPS was a loss of 4 cents. This compared with revenue in the June quarter of 113 million.

We feel that the falloff in our revenue is due to the ongoing market softness and was driven primarily by customers pushing out decisions to purchase and not a change in our account wintering. We believe customers are continuing to push down the size of deals and are delaying their network implementations due to concerns about the economy. We saw this softness across all geographies, as evidenced by our regional sales mix being largely unchanged from that in the June quarter. And our service provider to enterprise mix also being consistent with our historic rates.

I do want to emphasize that the enterprise business is a robust business that has seen slowdowns not to transformation. We’ve seen many markets in networking, particularly in the optical and carrier space, that are going through a merry-go-round of fundamental transformations due to overcapacity and lack of demand for new services. This is now what we are seeing in enterprise. The enterprise business is delaying because of economic conditions. We do expect it to come back once conditions improve. And we will be ready with products, technology, and the right distributions to win an enterprise.

One of the things that we need to do is to balance our goals for achieving profitability with the realities of a slower marketplace. We announced on our call on September 30 that we would lower our breakeven to $90 million quarterly revenue level so that we would be profitable at 100 million and above. We begun this process of implementing these cost reductions, which includes streamlining our supply chain, reducing corporate overhead and refining our distribution and channels to address the enterprise business. We will continue to refine and focus these plans and believe we are on target to exit this quarter with our current breakeven point at $90 million, while maintaining our customer and technology focus on our business.

I’ll have Hal outline these programs in greater detail in a few moments. So, even in this current uncertain environment, the drivers for the deployment of networks remain. Let me spend a few minutes addressing this third point and shed some light on what we’re seeing from our customers. I’ll review what we’re seeing as the needs of large enterprise and then outline how this relates to the vertical markets that we address.

As you are aware, we target customers with large networks, some that have 10s of 1,000s of nodes. Let me outline the needs of these customers, which can be very different from the needs of the small to medium enterprise or the home office environment. These environments may need only basic functionality. Again, as a reminder, the SME and CILCO [phonetic work] markets are not segments that we target.

So, here’s what our large enterprise customers are telling us that they need. First of all, they need a vender that can provide a meaningful target for their network. For us it means that they’ll either provide complete Ethernet solutions from the wiring closet to the enterprise network’s core. Our customers look for a networking solution that incorporates both stackable and modular and handles both voice and data. They need solutions that address their current and future needs without the constant need for upgrades to maintain performance. Enterprisers need a solution that is adaptable to new applications, and which runs those applications at full speed.

For us it means that we design our products to have the horsepower to turn on all features, such as quality of service and security access control lists without have the user experience a degradation of performance. Many of our competitors fail in this regard. Our large enterprise customers tell us they need solutions, which incorporate a number of specific features. They need high availability and infrastructure that keeps running. They need bandwidth and scalability to modernize applications and move to a lower cost application infrastructure. They need maximum control on security. And, they need simplicity. They have fewer people available today to run the network and they don’t have the funds for expensive training.

And beyond product features, customers with large networks want support and professional services capabilities for both network design and the post installation support. And, finally, they are looking for solutions that wrap this all together with the lower total cost of ownership. TCO has become the mantra for large enterprise. This means not only the initial capital outline for leading features and scalability at a lower price with less complexity, it also won with lower deployment costs with an architecture design for operational simplicity, allowing faster deployment and lower network operating costs, as well as lower network support cost, but, a single architecture and management system across all platforms so the network operators and administrators can quickly become knowledgeable and productive.

We are extremely well-positioned to address these needs. Our common architecture based on our inferno ASICS [phonetic work] and common Extremeware operating systems reign across all our product lines consistently. Provides for networks that are highly available, scalable, with security at the network level, while maintaining the simplicity and thereby yielding a lower cost of ownership for our customers. Our redundancy and high availability features, such as ESRP and EAPS are industry leading.

So, let’s take a look at how this applies to customers across government, education, healthcare and traditional large enterprise verticals we’re finding customers demanding these features. So, I’ll spend a few minutes and show you how we’re winning in these segments. So, first of all let’s start with government, including federal and local government, as well as those outside of the U.S. You’ve heard us talk about installations we have at the Pentagon, at various military bases, and also those at state and municipal levels.

Typically these customers are looking to provide new services to the their constituents on prude communications between sides on a regional area. This often provides and excellent example of the extension of the LAN experience where a user at any physical site using the network can share common data and applications without the complexity of use or degradation of performance, where the user can get the same network experience using an application from a work station, either down the hall from the data center or across town.

We often see organizations partnering with providers for MAN services or building out their own private MAN's. So, let me provide you with an example of a newly added customer and how Extreme is able to meet their needs and win in this market.

The San Francisco Municipal Railway, known locally to us as MUNI, is the public transit agency for San Francisco. They operate all the buses, trains and historic cable cars that move people around the city. The network encompasses 20 main sites around the city and is approximately 3,500 nodes. They use a combination of our Alpine Modular and Semitics configuration switches.

So, let’s talk for a minute about why San Francisco MUNI upgraded their network and why they selected Extreme. First of all, there’s a ploy in networks to support two new applications, new scheduling system for all the trains, buses and cable cars, and second the vehicle maintenance system. They also need improved email and general productivity improvements. They needed a network they could employ today who would also meet their needs for future applications, which includes streaming video from buses, trains and stations for security and monitoring purposes. Extreme Networks provide the best platform for today’s applications and offered the best investment protection for delivery of future applications.

Now, the reason Extreme won the deal is because we offered the higher ROI with lower total cost of ownership while delivering a very, very rich solution set. With their limited IT staff resources and occasional staff rotation, the simplicity of ExtremeWare allows MUNI to maintain current staffing even with a larger IP network. And provides them the ability to quickly cross train new IT admins during any rotations. From initial cost they found their Summit 48SI could be a very effective edge platform, combining low cost, with feature [indiscernible] at high density.

And, finally, our partnership with SBC Datacom was very important. SBC Datacom combined Extreme’s best of breed solution with their broad range of professional services to deliver a turnkey total network solution to a customer.

Another vertical that we target is education, not only higher education, but also at the unified school district level. As with the government sector, these networks allow for an extension of services, improving process efficiencies, as well as having an extended geographic reach. This sector in particular provides an example of the convergence of the LAN and MAN, a topic we’ve been discussing for some time.

Institutions demand a network infrastructure that can support delayed sensitive applications with enforceable bandwidth and latency guarantees. Low total cost of ownership is a critical consideration and security in the education market is very, very important. Our scalability and the simplicity of our solutions, allows for multiple phase rollouts as needs evolve and networks build out. Because our product, software and management architecture share a consistent command set, we can help customers design networks that can easily support today’s educational needs and seamlessly scale to meet future needs without increasing costs or complexity.

Our customers we’ve talked about in the education vertical have included Oklahoma State, PCU and UC Berkeley. But, let me provide you with a recent case and another reason why Extreme wins. The University of Massachusetts at Lowell is one of Massachusetts’s largest higher education institutions. UMASS appreciated the total cost of ownership proposition from Extreme and chose Extreme because of our single consistent architecture, our true Layer 3 capabilities instead of the Layer 3 add-ons. They run a typical large university network where they have to support a large quantity of applications such as gaming and music, along with typical Internet access. They use QOS to throttle traffic and Extreme tested out to be superior in performance over competitors.

Now, a third vertical, whose needs require a solution that can scale and provide a rich network is healthcare. Hospitals today are pushing to deploy cutting edge applications like enterprise scheduling, telemedicine, distance learning and networks for medical imaging. But, in their rush to improve patient care, many hospitals find out they’re still saddled with legacy technologies that can’t support today’s medical systems. Also, new regulations require protecting patient privacy and safeguarding medical data and this is a federal mandate. So, network security is even more critical.

Now, our solutions eliminate these risks with features such as access control lists, or [indiscernible] encryption and network login. Now, in the past you’ve heard us talk about the Houston Medial Center and San Antonio Community Hospital in California. But, an example of a new Extreme customer in the healthcare sector is Tenet Healthcare Corporation [phonetic work], a healthcare network covering a 16-state region. They’re implementing new business initiatives to improve patient care and productivity. This is driving the need to install new patient care software applications, as well as the need to support PAX digital imaging.

These applications require highly resilient network capable of managing heavy bandwidth loads. Their legacy networks were five to 10 years old and including a mix of FDI token ring, as well as shared Ethernet, which just couldn’t support the new applications. Tenet wanted a network that they could install today and still have it operating five or more years from now and one which would be able to run any applications that come along over the next several years.

This is why robust Layer 3 switching to the edge of a network, incorporating rich QOS features was a requirement and a network design and ruled out many of our competitors’ solutions.

And, finally in the verticals, let me turn to traditional large enterprise. Large enterprises continue to leverage the technology to improve productivity and improve the ease of doing business with customers and venders. E-commerce, ERP, private Internets, supply chain [indiscernible] are redefining how business gets down. Information comes from multiple sources and traffic is unpredictable, change is rapid and constant. And the emergence of new applications will keep them [indiscernible] change of moving forward.

Extreme Networks was selected by PenEx, the largest oil company in Latin America, and one of the top 10 worldwide energy companies to outfit their gas and petrol-chemical production division with a new network infrastructure. Extreme’s performance results were superior to competitors and combine functionality and simplicity while achieving performance using a smaller number of devices. PenEx is deploying a gigabyte Ethernet MAN ring and will be running manufacturing, finances, geological applications from multiple venders, including SAP and others.

So, as you can see, we are addressing markets with customers who see their networks as a critical element of their business infrastructure, allowing them to provide additional services while enabling process improvements and productivity gains. Even this environment of push-outs and push down, the size of network implementations and concerns regarding enterprise IT spending, we believe the segments I’ve outlined will continue to deploy networks as part of our customers’ continuing efforts to improve their own operational efficiency.

So, in summary, the current softness was driven primarily by customers pushing out decisions to purchase due to concerns about the economy and world politics. The structure of the enterprise business remains in tact. We are targeting the right vertical markets. Despite IT spending delays, Extreme continues to penetrate these important markets.

We have the right value proposition. The total cost of ownership is top of mind and we’re focused on the delivery of the industry’s lowest total cost of ownership. Our products are best of breed and provide performance along with lower TCO. And, we are very focused on our financial performance, generating cash and in restoring profitability. And we’re taking the appropriate steps.

At this point I’d also like to take a moment to introduce a new member of our management team, Alex Gray. Alex joined us this last month as our COO and he’s responsible for all of our operations, engineering and worldwide logistics. Alex comes to us with an extensive operations and engineering background in a wide range of companies of both enterprise and carrier. Alex will be instrumental in improving our financial performance and speeding our delivery of new products and technologies. I have tasked him with delivery the industry’s best concept to volume product cycle time.

With that, I’d like to turn things over to Hal for a review of our financial results. Then I’ll come back for some concluding remarks.

Thank you, Gordon. Our financial results for Q1 FY2003 are in line with the estimates for the quarter that we discussed during our call held on September 30, 2002. Before reviewing details of our financial performance, I would like to update you on our progress to move our breakeven point down to approximately $90 million of quarterly revenue. There are several programs and related actions that we are pursuing to achieve this lower breakeven level.

First, over the next short period of time we will reduce our workforce from approximately 1,000 to 900 employees and temporary personnel. This reduction will be across all functional organizations. Next, we are in the final stages of consolidating our contract manufacturing operations from three in suppliers to two and we are well into the transition process of having our products manufactured in a more cost effective locations.

Finally, as a result of utilizing our new ERP and CRM systems we have streamlined a number of our business processes and practices that will have a positive impact on cost of goods and operating expenses. With these actions our goal is to exit the current quarter with approximately a $90 million breakeven point. At this time we do not anticipate that it will be necessary to take a special charge related to these actions in the current quarter.

Turning to our financial results for the quarter, please note that my comments regarding expenses, operating loss and pro forma net loss do not include deferred compensation. For Q1 FY2003, we incurred deferred compensation expense of $2 million. This charge, on an after tax basis, equates to approximately 1 cents per share and represents the difference between pro forma and GAAP loss for Q1 FY2003.

Revenue for Q1 FY2003 was $100.6 million versus $113.1 million in Q4 FY2002 and $108.3 million in Q1 FY2002. Our book to bill ratio was slightly over 1 for Q1 FY2003 and we ended the quarter with backlog that was within our normal range.

On a geographic basis, the Americas represented 42 percent of our revenue for Q1 FY2003 versus 43 percent in Q4 FY2002 and 31 percent in Q1 FY2002. Europe represented 21 percent of our revenue for Q1 FY2003 versus 21 percent in Q4 FY2002 and 23 percent in Q1 FY2002. Japan represented 28 percent of our revenue for Q1 FY2003 versus 27 percent in Q4 FY2002 and 34 percent in Q1 FY2002. And, Asia, not including Japan, represented 9 percent of our revenues for Q1 FY2003 versus 9 percent in Q4 FY2002 and 12 percent in Q1 FY2002.

For Q1 FY2003, we had two customers 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. And Hitachi Cable, a Japanese reseller, accounted for 11 percent of our revenue for the quarter.

The revenue split between enterprise and service provider segments for Q1 FY2003 was approximately 75 percent enterprise and 25 percent service provider. Enterprise includes government and educational customers. Our service provider customers are primarily international.

Product mix consisted of about 62 percent modular and 38 percent stackable for Q1 FY2003 versus 56 percent modular and 44 percent stackable in Q4 FY2002 and 56 percent modular and 44 percent stackable in Q1 FY2002.

Q1 FY2003 gross margin was 48.8 percent compared to 53.6 percent in Q4 FY2002 and 52.1 percent in Q1 FY2002. The decrease in gross margin percent is primarily due to warranty related expense that was higher than normal during the quarter. Warranty expense was higher than normal due to specific component problems and our decision to replace the products impacted with new products in most cases. This decision was made to ensure that customer satisfaction remains high. We expect warranty expense to trend toward the normal level in the current quarter and we are attempting to recover some of the expense that was incurred from the component suppliers.

Looking at product pricing, while at the micro level there is always competitive pressure for specific deals. We did not experience a major change in the macro environment. ASP’s for Q1 FY2003 were consistent with recent historical trends.

Operating expenses were 54.7 million in Q1 FY2003, 55.6 million in Q4 FY2002, and 58.8 million in Q1 FY2002. For Q1 FY2003 R&D expense represented 14.4 percent of revenue, sales, marketing and service, 33.1 percent and G&A 6.9 percent.

Operating loss for Q1 FY2003 was $5.6 million versus $5 million profit in Q4 FY2002 and a $2.4 million loss in Q1 FY2002.

Other income and expense for Q1 FY2003 was $.9 million compared to $.9 million in Q4 FY2002 and $2.4 million in Q1 FY2002. The difference on a year-over-year basis is primarily the result of a drop in interest income due to a decrease in interest rates and expenses related to our convertible bonds. The convertible bonds were issued in December 2001.

Pro forma net loss for Q1 FY2003 was 3.1 million, compared to $3.8 million net income in Q4 FY 2002 and breakeven for Q1 FY2002. Pro forma loss per share was 3 cents for Q1 FY2003 versus earnings per share of 3 cents for Q4 FY2002 and breakeven in Q1 FY2002. Our long-term pro forma tax rate remains at approximately 35 percent.

Moving to the balance sheet, I would like to highlight several items. First, our cash, cash equivalence and marketable securities balance on September 30, 2002 was 409 million compared to 400 million on June 30, 2002, and 205 million on September 30, 2001. Please note that we issued $200 million of convertible bonds in December of 2002, from which we received net proceeds of approximately 194 million. Q1 FY2003 represents the sixth consecutive quarter that we have generated free cash flow.

Accounts receivable were $40 million on September 30, 2002, which equates to a DSO of 36 days. DSO for Q4 FY2002 was 41 days and DSO for Q1 FY2002 was 43 days.

Net inventory on September 30, 2002 was $34 million, compared to the $25 million reported on June 30, 2002 and $52 million on June 30, 2001.

Channel inventory was within targeted levels at the end of Q1 FY2003. Keep in mind that we recognize revenue based on sale out for distributors. Therefore, the shipment with inventory into the channels does not impact reported revenue. Revenue related to resellers and direct sales to end-users is generally recognized when we ship products to the reseller or end user. Resellers and end users do not have inventory return privileges.

Staffing, including temporary personnel, as of September 30, 2002 was 1,003 versus 987 on June 30, 2002 and 1,080 on September 30, 2001. As of September 30, 2002, the company had 114 million shares of common stock outstanding on a fully diluted basis.

Now, I would like to address financial guidance. As a result of the uncertain global macroeconomic environment in general, and in particular in the technology sector, we will not provide any specific financial guidance. We believe that the current business environment is not likely to change in the near-term. Therefore, we are adjusting our operating model to take this view into consideration. Key actions that we have taken or that we will take include, driving down our breakeven point to approximately $90 million of quarterly revenue, continuing to effectively manage working capital, tightening payback and return on investment criteria for capital expenditures, and continuing to streamline and improve the effectiveness of our business processes and practices.

In closing, I would like to point out that the $90 million breakeven revenue level does not represent an internal goal for revenue generation in the current or future quarters.

Now, I would like to turn the call back over to Gordon.

Thanks, Hal. Now, some final comments before we open things up for questions. We are extremely confident of our strategy, our products and our channels. Customers resonate with our message of high performance, simplified networks and reduced total cost of ownership. Our product line remains very strong. We are confident of our ability to continue to improve internal operations, deliver to infrastructure and improve our profitability in the current climate. Our business infrastructure is more capable than ever. They are well positioned and we will improve our execution as we move towards our strategic goal being a clear alternative in the large enterprise market and to lead in the emerging metro market while delivery solid financial performance.

So, what will it take for Extreme to win in the future? First of all, the winners in the future are those that take care of their customers today. And customers today are looking for value today. They’re looking for total cost of ownership and they will reward those deifiers and deliver, the fact that it takes innovation. Customers are looking for a solution today and a vision for tomorrow. We’ve demonstrated our vision in Layer 3 switching space and will continue to show vision in new areas.

And, finally, it takes financial discipline to win. Winners of tomorrow are those that make the financial tradeoffs today and those who manage the right balance of innovation and fiscal conservatism. Now, with that, I’d like to turn the call back over to John and to begin the Q&A.

Thank you. We’d now like to open up the call for questions. In the interest of time, please keep your call to one question. Operator, go ahead with the first question.

Thank you, gentlemen. The floor is open for questions. As a reminder, ladies and gentlemen, to register your question, please press one, four on your touchtone telephone. We do ask all participants to please limit yourself to one question.

Our first question is coming from Richard Church of Wachovia. Please go ahead, sir.

Thanks. Gordon, you talked a little bit about the applications among different sectors that are driving deployments today. What do you think was in the large enterprise or the top five applications that will drive the return to spending?

Well, I think there’s a number of applications that drive the need for network infrastructure upgrade or replacement. Certainly, any large-scale application, whether that’s ERP or CRM, often requires massive network changes. Also, as people move towards and Extranet model where they have, you know, a lot of their business partners communicating with them over the network, that drives the need for a network upgrade. There are also some new applications that are still in the early stages, voice-over-IP being one of those, that really drive a close inspection and upgrade on a network.

Do you think any of these applications are beginning to take hold? For example, voice-over-IP, the timing of such application, do you think it builds an O-3 or is that further out?

I think we’re still pretty early in the move towards a voice-over-IP. I think that’s something that, you know, we see today, you know, in a relatively small percentage of new networks, but something that does drive upgrades.

Okay. Thanks.

Thank you. Our next question is coming from Lissa Bogaty of Credit Suisse First Boston. Please go ahead.

Thank you. I just have -- would like some clarification on the 90 million breakeven. First of all, are you talking about EPS breakeven? And, secondly, it would imply, I guess according to my model, at least $20 million in annualized operating income expense savings, which would not equate to the number of people you expect to have leave. So, I’m just wondering where the rest of it’s going to come from, whether you’ve been outsourcing or if there’s some big chunk of spending that’s going to get hit? And, then, the other thing is the gross margin would have to also materially improve. And, I’m just wondering, you know, how much you expect that can improve once you’ve got the contract manufacturing situation settled. You also seem to imply that there’d be a little bit of a lag on the warranty maybe. There’d be a little impact in December. I’m just wondering what that would be and then offering [indiscernible]. Thanks.

I think there were three or four different questions in there. Let me start off with the $90 million breakeven level. And that would be breakeven on a pro forma basis. And, as I indicated earlier, we had about $2 million of deferred compensation expenses that’s probably going to stay relatively consistent for the balance of this year. So, there’ll be about a penny difference between pro forma and GAAP earnings. So, again, the $90 million is on a pro forma basis.

Secondly, on the savings that we anticipate, there’s three primary areas that we will get these savings from. Number one is the operating expense area that will primarily be driven as a result of the reduction in staff that we talked about. Secondly, we believe that we have major opportunities in the supply chain. One of them I mentioned going from three to two suppliers. And there’s other aspects of that built into a component purchases and other efficiencies of manufacturing offshore and things of that nature.

And, then, finally, we also believe that there is major opportunities for us to improve our period expenses that are above what the operating expense line of the gross margin last. So, there’s a number of activities that we’re pursuing there. So, the combination of these actions and programs will result in a $90 million breakeven point.

And, then, finally on the warranty, we do believe that the expense related to that is behind us and that we’ll return to a normal level in the current quarter. And the warranty expense that we did incur in quarter one was the primary difference between the gross margin that we have been running over the last two or three quarters in the 48.8 percent that we did report for Q1.

Thank you. Our next question is coming from Tim Wilson of Merrill Lynch. Please go ahead.

Good afternoon, gentlemen. We’ll stretch you with one question per person here. Hey, Gordon, can you talk a little bit about your partnership strategy? I know that it’s been changing and rallying over time. You’ve mentioned SBC. Can you try to tell us how that came about, what SBC sees in Extreme and how that partnership’s going?

And, then, Harold, can you talk a little bit about deferred revenues? It was up 11 percent sequentially. How much of that is service contracts? How much of that is, you know, products out on SAD 101 contracts, some of that kind of stuff.

Sure, Tim, this is Gordon. Regarding, you know, partnerships and particularly in the resale and system integration area. You know, we began this year with some changes in our distribution system, you know, particularly in the U.S. And, you know, really began focusing on large-scale integrators, you know, people who can take our products into, you know, a broader range of companies and basically a larger set of companies, or larger companies. And SBC is one of those folks. They’ve been reselling our product now for quite a few months and we’re starting to see some wins. You know, all of these partners, you know, operate like a large flywheel. You know, it takes a while to, you know, to get things going and to get it up and spinning. But, once it starts moving, you know, we feel that there’s considerable leverage that can be generated there.

So, Harold, if you want to talk about deferred revenue?

Yes, the deferred revenue were up to 45.2 million from 40.8. So, the $4 million increase is about split 50/50, half due to service contracts and then half due to some deferred revenue related to acceptance and other criteria.

Thank you, gentlemen.

Thank you. Our next question is coming from Alex Henderson of Salomon Smith Barney. Please go ahead.

Great. Thanks. I was hoping you could get into a little bit more detail on how you’re splitting the cost benefits from these actions between the various line items, and specifically, how you splay the benefits between the current quarter, i.e. the December quarter, and the March quarter? If you’re saying you’re going to be completely done taking people out, presumably a portion of the cost savings will be in the current quarter and then you’ll have a follow-through for whatever didn’t accrue in the first -- in the current period. So, could you go into the individual line items to talk about how you’re splitting it? I mean, is the benefit 50 percent in R&D and 50 percent in op ex and how does it split between the other pieces.

Let me take the easier part first. You know, our belief is that we’re taking these actions in terms of the reduction in force, early in the quarter, and, in fact, this month and we did a lot of the activities already today. So, based on our severance programs and so forth, we believe that most of the expenses related to that reduction will wash through as we complete this quarter. So, we shouldn’t incur a large amount of expense next quarter for those type of activities.

I’m sorry. That’s not the question I’m asking. I’m asking for the benefits. Assuming you didn’t take them out day one, the very first day of the quarter, obviously, it’s not going to fully accrue this quarter.

Yes. We don’t expect any of the benefit from the reduction to really be felt this quarter because of the severance packages. So, the first time we’ll feel the benefit will be at the beginning of our next quarter, Q3.

So, it’s a full step down in the March quarter then?

That’s right. So, our expressed run rate should stay relatively consistent with the Q1.

I see. Then, since that’s such an easy step down answer, let me just ask one quick follow-on. Did the bookings decline following exactly in step with the revenue decline, or was there some of a variance between the two. Did you add your bookings -- or did you book the decline less than revenues?

No, it was fairly consistent. As we mentioned, we had a one-to-one book to bill ratio, so it was pretty consistent.

Thank you.

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

Hi, folks, just on the accounts receivable down, inventories up and pre or pre announcement, it sounds like things really flattened out right at the end of the quarter. Just any color on that, was that a specific product? Was that the overall market? Was that people, you know, sort of what happened here, what should you expect going forward on those revenues coming back?

Yes, in regard to accounts receivable in particular, the slow down did happen right at the back half, as we mentioned. So, that basically enabled us to collect more money than we normally would, you know, toward the end of the quarter because we didn’t have the up tick right at the end. So, our DSO will probably go back to a more normal level for us, which is in, you know, the mid-40’s. In regard to the inventory, there was some up tick in the inventory because with the drop off in revenue. And we also were transitioning one of our product lines. So, we did have extra inventory to take care of that. We do believe our inventory will drop during the current quarter.

In regard to what product it impacted. It was pretty uniform across all of our product lines. And we do believe that we will start picking up again going forward.

Was this delays or just what happened? What happened the last couple weeks of September?

I think, as Gordon indicated earlier, there were pretty much delays in push offs.

Thanks much.

Thank you. Our question is coming from Mark Sue of Unterberg Towbin.

Thank you. Gordon, if I look at your backlog and your book to bill and combine that with your comments on the push outs and the delays, and if I look at some of the seasonality within the December quarter, can we -- is it reasonable for us to estimate that the fourth quarter should be modestly up? And if you really don’t want to comment on it, if you could at least give us some sense of linearity for the December quarter. Thank you.

Yes, Mark. I think, you know, regarding, you know, this particular quarter, there’s been a lot of speculation. I’ve heard from folks about, you know, about whether they’ll be year-end budget flush or anything like this. You know, I think where we stand today, you know, the second week of October, it’s just too early to tell.

And, would the December quarter be more linear than your typical other quarters?

Pretty consistent with other quarters.

Okay. Thank you.

Thank you. Our next question is coming from Eric Suppiger of Pacific Gross Equities.

Hello. Can you just comment a little bit in terms of why you’re stackable switch products would be down disproportionate to your modular? And is there reason why we wouldn’t expect that trend to continue or, you know, where you think that might go?

Hi, Eric, this is Gordon. You know, as you know, we started out 100 percent in stackables, you know, six years ago. So, it’s been trending down as a percentage pretty consistently since then. We do emphasize our modular products. They do carry higher margins than our stackable products. But, you know, as we talked about in some of the examples I gave on this call, you know, all of our customers buy from multiple product lines. So, we do expect to see a little bit of, you know, bounce around in that mix. But, you know, our strategy has certainly been, you know, over the last several years to emphasize the modular product line.

In the past year it’s been in the range of 40 percent to 50 percent of revenue for stackable. Do you not see that -- you don’t see that mix returning?

I see it being, you know, continuing where it is today. And, once again, you know, our strategy is to increase our mix of modular. If you look at our target markets, once again, our focus on the large enterprise and really the largest of enterprises, you know, they tend to use much more modular than stackable products.

Thank you.

Thank you. Our next question is coming Tim Luke of Lehman Brothers. Please go ahead, sir.

This is actually Jim Shaw [phonetic work] for Tim. The mix between different regions seems to be almost identical to last quarter. I was wondering why it seems we are now seeing incremental weakness in Europe because of summer seasonality or perhaps in Japan?

Well I think that -- this is Gordon, you know, what’s in the mix was relatively consistent. We certainly, you know, did see the summer slow down come in Europe and that is a typical seasonality factor. But, you know, that was offset then, you know, by declines in some of the other regions that would not be typical due to seasonality. So, we did see the same mix as the previous quarter.

Any comments on Japan?

You know, Japan has always been a strong market for us. We did see, you know, Asia, you know, overall show a little bit a weakness, most of that coming from Japan. But, that remains one of our best markets.

Could I also ask about your relationship with Dell? I understand they’re a key partner of yours?

Dell has been a reseller of our products for some time.

Right, right. And, should we be concerned Dell is getting to the high-end switching market?

You know, that’s hard for me to comment on. You know, as I said, they’ve been a reseller partner of ours for quite some time.

And, we’ll need to keep our questions to one for each call. And you can re-queue if need be.

Next question?

Thank you. Our next question is coming from Christin Armacost of SG Cowen.

Thank you. I just wanted to follow-up on the partnerships. You’ve talked about them quite a bit. And mentioned that Dell has been a partner of yours for some time. When do you think or what will it take for a Dell or some other enterprise centric venders to become more material contributors to your business? And what are you doing to help them accelerate the sales of your equipment through their channels?

Hi, Christin, this is Gordon. You know, we work with a number of partners, as I indicated, you know, starting in January, you know, we really began transitioning to larger partners that really bring us into large enterprise or larger enterprises I should say. You know, there are a lot of programs that we run with these folks. You know, there’s a lot of training. There’s a lot of one on one with our sales teams and their sales teams. You know, and it takes time to educate. But, we do have a very strong value proposition. They see better margins in Extreme products than in other products. And we’re not over distributed as Cisco products are.

Thank you. Ladies and gentlemen, as a reminder, please do limit yourself to one question. Our next question is coming from Inder Singh of Prudential.

Hi. Gordon, a question regarding the competitive environment, with the issues that you had on product components and [indiscernible] in the quarter, do you see any long lasting effect on your competitive position? Are you seeing any impact on customer satisfaction? Can you sort of comment on how you see that playing out? And, one quick point for Hal, on the investment. Can you comment on what’s included in the roughly $139 million investments on your balance sheet? Thank you.

Yes, let me just say, you know, we did have some component issues, some component sets that we buy from our suppliers. And, you know, basically we took the approach of immediately replacing those products for our customers even though that was a high expense. And, ultimately I think that builds a much better relationship between ourselves and our customers and dramatically improves customer satisfaction when customers recognize, you know, that we’re looking out for them. So, I do not see any long-term impact from that.

On the investments, this is Hal, we have $185 million of marketable securities and then we have a cash balance of, which includes cash equivalence and investments, of $223 million. So, in total it’s roughly 409. And our investments are in government securities and other highly secured type of vehicles.

Next question?

Thank you. Our next question is coming Andrew Shopick [phonetic work] of Nutmeg. Please go ahead.

I’d like to ask one quick question about the convertibles. Have you given any consideration or are there any provisions that would restrict you from repurchasing any of those convertibles, which I assume are traded at, you know, a discount.

Yes, in regards to the convertibles, right now we don’t have any plans to repurchase any of those bonds. We initially did the convertible offering to strengthen our balance sheet from a competitive standpoint. And we think that’s particularly important now. We will continue to look at the situation. And if it does become a move for us to repurchase bonds, then we’ll look at it at that point and time.

Also, could you give us...

And there are no restrictions on doing that.

There are no restrictions?

No.

Could you give us a split between enterprise and service provider from a year ago comparable quarter?

Yes, it was roughly about 70/30 a year or so back and 75/25 now. So, pretty much in the same ballpark.

Thank you.

Thank you. Our next question is coming from John Anthony of Fulcrum Global Partners. Please go ahead.

Sorry about that. If you could just give the inventory breakdown? And, also, could you break out the warranty expense during the quarter?

Inventory we talked about it being roughly about $34 million as of the end of the quarter.

Right. But, could you give the breakdown.

By finished goods and so forth?

Yes, please.

We really don’t break that information out on the call. So, I don’t want to do it right now. And, in regard to the warranty expense, we normally do not break that out either. But, the majority of our gross margin difference for the quarter was due to that. And, again, we think it will return to normal level in the current quarter.

Okay. Thanks.

Thank you. Our next question is coming Tad LaFountain of Needham and Company. Please go ahead.

With the modular side being static quarter-to-quarter, I’m wondering, first of all, if there were any differences between the product lines there, whether the Black Diamond, in fact, has been carrying more than its share. And, also, whether, as part of that, you recognized revenue during the quarter from the 10-GLRI?

Again, our breakout for revenue, Tad, is between our modular and finished products. And we don’t really break out the modular piece of that. And, so we really can’t do it on the call here. And, the 10-gig revenue would be part of the normal sales of those products. So, again, we don’t highlight that as an individual item.

Could you -- were you able to recognize revenue in the quarter? You don’t have to quantify it for me.

Yes.

Yes, we were able to.

Okay. Thanks.

Thank you. Our next question is coming from Alex Mou of Hotovec.

Thank you. Could you elaborate a little bit more on the pricing picture in the quarter, particularly geographically, as well as across different product areas? And, if you could also comment on the going into October what do you expect from a pricing environment standpoint?

Hi, Alex, this is Gordon. Pricing has been, you know, or I should say pricing during the September quarter was pretty consistent with previous quarters. We didn’t see any particular unnatural acts. And, you know, it was consistent in the regions with the previous quarter. And, we’re not expecting, you know, this current quarter, the December quarter, to be any different, or there’s certainly no indications that it will be.

In terms of the current quarter in December, do you -- what do you expect the pricing environment from what you’re seeing right now?

I expect it to be very similar as the quarter just closed.

Thank you.

Thank you. Our next question is coming from Ted Jackson of US Bancorp. Please go ahead.

Hi, guys.

Hi, Ted.

Sort of a build-up kind of question and it has to do with, I guess you would say sort of the CRM and ERP driver in your business. Listening to these discussions where you went over some of the examples of customer wins for the quarter. You know, you couldn’t help but notice that in most instances you would also highlight the fact that they were either implementing or upgrading some sort of ERP and CRM system. And, so the question is, sort of two parts, is when you look into sort of your revenue, how much of your business do you think is actually driven from upgrade of existing European CRM systems? And, do you see as one of the causes of weakness in the just completed period, you know, a put off in terms of that upgrade activity and do you expect to see that to be a continued problem as we move forward? Thanks.

You know, if you look at the things that drive a network upgrade, you know, as we answered in a previous question, you know, certainly, you know, major applications such as a CRM and ARP are drivers for that. You know, there are also other drivers. And that may be just the age of a network or sometimes people will move, you know, groups around within their campus or within their buildings and use that opportunity to reimplement the network using more modern technology. So, there’s a lot of factors. You know, we’ve looked, from our own forecasting standpoint, and tried to figure out, you know, can we draw a connection, you know, directly between any one particular application and it’s pretty hard to do and get reliable results from that because there’s just so many things that drive a particular upgrade.

So, in answer to the, sort of my question would be that you don’t know how much of your business is being driven from, you know, say upgrading of older networks, as opposed to upgrading because of the implementation of any type of new enterprise software?

You know, our business is based upon a mix of new network installations and an upgrade of old ones. And, in all honesty, you know, we don’t have great data to track that.

Thank you. Our next question is coming from Reg King of WR Hembrecht.

Great. Thank you. Regarding the contract manufacturing [indiscernible] I was hoping you could give us some sense of timing of that portion of that is also a March quarter event. And, then, secondly, if you can give us some sense of proportion of the savings that would get us to the $90 million breakeven point.

Yes, in regard to the timing, we have, I think, a large part of it behind us now. We are manufacturing products in two new locations. And we expect to continue to pane savings from those activities over the next two or three quarters. And that definitely is part of the program to push our breakeven point down to the $90 million that we talked about earlier. And the breakout between the expenses kind of above the gross margin line and below the gross margin line, we haven’t given a lot of detail at this point. We’ll try to do that as we start to -- the savings start to materialize.

Thank you. Our next question is coming from Ryan Malloy of SoundView Tech Group.

Thanks. From a geographic perspective, moving into the December quarter, is there a particular region you feel more comfortable with, you know, can we expect perhaps Japan to bounce back a little bit, and just some color on that if possible. Thanks.

Yes. It’s, once again, two weeks into it, very tough to say. You know, our best information at this stage is that we’ll maintain the similar breakdown as we did in the last two quarters.

Thanks.

We’ll have time for one more question.

Our next question is coming from Doug Ruddish [phonetic work].

Hey, guys, since I’m last here, I’d love to sneak in a couple. The first two are just quick financial clarifications. One is your cash breakeven actually at a lower level than the $90 million EPS breakeven?

Yes, it is. I would say it’s approximately at in the $80 million range from a cash standpoint.

And what’s the difference between the two?

It’s essentially our capital expenditures and related depreciation.

Got it. A secondary question, it sounds like you are going to take some severance costs next quarter, but -- excuse me, this current quarter, but actually run them through the PNL, is that correct?

That’s right, our plan is not to take a special charge, just to let the severance pay flush through the quarter. And we think the majority of it will be completed this quarter.

And our last question.

Our last question is coming from Christin Armacost of SG Cowen.

Christin, do we have you? We’ll have concluding remarks from Gordon Stitt. Gordon?

Yes, thanks, John. I just wanted to thank everybody on the call for their support and for your time to thank all of our employees for their hard work during this difficult economic time.

And that will conclude our call today. Operator?

Gentlemen, Christin Armacost is live.

One more question, go ahead Christin.

Thank you. The operators were being very nice. Can you tell me, on a sequential basis, I know you don’t break it out, Alpine versus Black Diamond, but can you explain or give us some color on which one held up relatively better on a sequential basis?

Well, isn’t that really asking the same question?

Well, it’s not breaking out the percentages, just which one grew more or held up better.

Yes, we -- we just track it as overall modular.

Thank you.

And this should conclude our call. Thank you for joining us today.

Thank you, ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines and have a wonderful day.