Extreme Networks Inc (EXTR) 2004 Q1 法說會逐字稿

God morning ladies and gentlemen and welcome to the Extreme Networks, First Quarter Fiscal 2004 Conference Call.

At this time all participants are in a listen only mode.

Following today's presentation, instructions will be given for the question and answer session.

If anyone needs assistance at anytime during the conference, please press the * followed by the 0.

As a reminder, this conference is being recorded today, Friday, October 24, 2003.

I would now like to turn the conference over to Candice [Schmidt], please go ahead.

Thank you and good morning.

On the call with me today is Gordon Stitt, Chairman, President and CEO, and Alex Gray, Chief Operating Officer.

Earlier this morning we issued a press release announcing our financial results for our first quarter 2004.

A copy of this release is available on our website at www.extremenetworks.com.

I would like to remind you that 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 this 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 our financial results or financial conditions or product introductions and their success, should be considered as forward-looking statements.

These forward-looking statements may differ from actual results and are subject to risk and 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 Candice and thanks everyone for joining us so early today, particularly those of you on the West Coast.

I would like to begin this call with a review of the financial and operational highlights of the quarter.

I will then discuss our new networking solutions and Alex will then review our channel activities.

This quarter marked the beginning of the turnaround that we outlined last quarter, as we returned to profitability, improved our margins, continued to reduce our operating expenses, strengthened our channel relationships, and charged ahead with new products.

First let us cover the financials.

For the first quarter of our fiscal 2004, we generated revenue of $87.4m, modest increase over Q4.

Operating income was $1.2m and bottom line GAAP earnings were $0.02 a share.

So let me give you some of the detail behind this return to profitability.

First of all we saw significant improvements in margins.

Product gross margin improved over 1,100 basis points from 45% to 56.4%, largely due to supply chain efficiencies, lower manufacturing costs, lower warranty costs and some benefits from one-time charges.

Our operations team under Alex and Dianne [Pewitt's] leadership have done a great job and they are firing on all cylinders.

Service gross margin from a negative 17% last quarter to positive 15%, a swing of 3,200 basis points.

We made great strides in productivity in our service organization and experienced significantly low RMA, along with one-time charges.

Operating spending was $42.2m, down $4.3m from Q4.

This is exclusive of restructuring and deferred compensation.

This decrease was largely the result of spending controls and efficiency improvements, we end up with an even more impressive $6.3m.

During the quarter we increased our real estate reserves by $1m which represented an adjustment to prior estimate.

Net other income of $2.3m benefited favorably from the settlement of a legal case in our favor during the quarter.

Now I would like to move the balance sheet and go through some of the highlights.

Our cash and marketable securities were essentially flat with Q4 slightly more than $400m.

Accounts receivable remained flat at $27m with our DSOs continuing at a historical low of 28 days.

Capital spending was $2.3m, up slightly from last quarter.

This was largely the result of funding additional equipment for software tests and manufacturing fixtures after the production of our new 10 gigabyte systems.

Accounts payable reduced by $10m, partly due to quicker contractual payments to our contract manufacturers.

Our headcount declined to 800 people from 841 as we completed the restructuring we began in June.

There were no charges during the quarter related to those reductions.

Again, there is more financial detail on our web site which you can view at www.extremenetworks.com.

Now some comments about our business.

Our customers continue to tell us that we provide the simplest, most cost-effective solutions to their networking problems.

This feedback reinforces our continued committed to innovation which we strongly believe to be a principle enabler to support the drive for growth in both our business and our customers' infrastructure.

As many of you may recall, we began talking about our innovative new solutions, including our third and fourth generation ASIC technologies, last spring.

I am pleased to say that we have met our milestones and delivered the new product as we said we would.

Our new unified access in scalable core solutions are being very well received.

Our customers are clearly responding to our message of higher performance and resilience to build a network that easily integrates voice, video and data, and can support wired or wireless comm activity that is fast and secure.

We introduced our new Enterprise edge strategy Unified Access back in April.

Unified Access integrates wired and wireless as well as IP telephony into a single unified architecture that provides security, flexibility and simplicity.

The first product that implements UAA is a purpose-built switch, the Summit 348.

In our last call we committed that we would deliver the Summit 300 in Q1.

And I am pleased to say that we have achieved that goal by delivering the Summit 300 and the first release of UAA software to both new and existing customers.

The response to our UAA architecture has been universally positive from industry analysts, press and customers.

Our customers have helped us build a good backlog for this product.

Our strategy and emphasis on seamless integration of wired and wireless towards voice and data has been validated by [Gardner] at their CIO Conference that has just concluded.

One of the key themes there has been LAN, wireless LAN and security coming together in a universal switch.

This has been a strategic area of investments for us since we established an independent business unit to address this more than a year and a half ago.

This product is already opening up new markets and new opportunities for Extreme.

Our customers are very interested in the switch and we will continue to ramp production this quarter.

Now our original vision of a single unified network based on Ethernet and IP, embraces new drivers for growth that we see in the future.

Our technology is specifically capable of easily handling the rapidly increasing demands of security and growth for mobility, but also the burden in demand for the network to provide communication for single use devices, particularly over wireless networks.

This demand changes the fundamental calculations used to plan and architect the network infrastructure.

No longer can IT managers plan capacity of network connections by focusing on single applications and the number of users in a network.

IT managers must now plan for everything to be attached to the network.

This means network designers must anticipate and plan for hundreds and tens of thousands of devices, and a much broader range of applications and traffic types.

Support for the principal enablers for this change, such as wireless, cannot be thought of as just a basic upgrade.

Now changing gear to Triumph.

As you know we have been shipping the blades for Triumph third generation ASIC architecture.

These added increased density, performance and value to our Black Diamond and Alpine platforms.

We told you that one of the key aspects of Triumph was to address the emerging gigabyte to the desktop market.

This key technology has allowed us to accelerate gigabyte adoption and has enable our gigabyte port sales to grow faster than the overall market.

During the quarter we introduced the other part of our Triumph architecture.

This is a new switch fabric, initially targeted at our Black Diamond platform, that brings a critical new capability to core and aggregation networks.

This capability is commonly referred to as hitless fail-over.

This technology, combined with some of our ground-breaking protocols such as EAPS which, by the way, has just been published by ITF as an RFC, creates the ability of a network to instantaneously self-heal without the cumbersome delays imposed by traditional [rally] protocols.

In this new environment, with most of our IP and on-line wireless communications devices, hitless fail-over is a critical capability for ensuring business continuity.

And until now this capability has only been available in traditional telecommunications networks.

As an example, our customer, [Phonoscope], a Houston based service provider to Fortune 500 energy companies, uses this new technology to enable network upgrade without taking down the switch or interrupting the service level to their customers.

Now this brings us to 4GMSS or what we have called our Genesis technology.

We have found that the trade-off between capacity and availability must always take into consideration the effect of downtime on any business.

With everything connecting to the network, the need for a highly resilient, scalable, flexible core becomes paramount.

This is where our fourth generation technology in its first instantiation, code named the Mariner, is positioned.

We have already seen significant advance orders for this platform.

It combines capacity and extraordinary levels of resiliency with the flexibility to natively support [IPP6] and PLS and tunneling.

Our customers are clearly recognizing that this allows them to deploy and maintain this technology and platform for an extended period without the need for hardware upgrades.

We are now starting to see real demand for these advanced protocols across mainstream enterprise and carrier organizations.

For example, IPP6 now becoming a standard requirement for new federal networking procurements.

Mariner builds on the hitless fail-over capabilities of Triumph and extends it to the core of very large scale enterprise and metro networks.

The combination of Unified Access on the edge, Triumph in the aggregation and Genesis in the core of the largest networks, delivers on the requirements of simplicity, resiliency and flexibility.

We are now convinced that we have the best technical and business solution for large enterprise.

Now the other part of the equation is bringing these products to the strategic customers that will support our growth in the future.

And with that I would like to turn the call over to Alex Gray, our Chief Operating Officer, to discuss the progress made with our channel partners and some specific customers.

Thank you Gordon and good morning.

In the US we continue to build strong relations with our national reseller partners such as Dell, SPC, Siemens and Verizon.

These partners accounted for 28% of our North America's business.

But, more importantly, we saw continuing strength within these partnerships in specific market segments such as the higher education market with [Cornel] University; health care in government such as the Detroit metro area.

We also saw strong performance in federal government with significant wins such as Fort Knox through our partner, General Dynamics.

We continue to have success in our key vertical markets such as higher education.

As evidence, Extreme is providing Penn State University with a campus network solution using our core and edge switching solutions.

PSU is integrating Extreme into the network for our ability to provide essential quality of service for converged applications.

We are also used at the edge of the network where 802.1x networking logging capabilities validate the identity of users coming on to the network.

Ohio State University came to us to help to create a sophisticated new conference facility on their Newark campus.

The John Gilbert [Rees] features 10 gigabyte and gigabyte to the desktop comm activity based on our Triumph technology.

In the manufacturing segment, Liberty Medical Supply continues to work with Extreme to support its national operation, providing essential diabetes supplies and services relied upon by more than 0.5 million customers.

The company augmented its existing redundant network with our high performance 10 gigabyte Ethernet connections.

This creates a redundant infrastructure from growing amounts of traffic.

During the quarter we also announced a partnership with China's leading IT company, the Legend Group, to double our presence in the region.

Legend is a leading provider of computing systems and solutions in Asia and brings in new aspect to our business, helping to expand our presence from being primarily service provider focused to a significantly greater presence in the enterprise market.

We expect this relationship will begin to show results over the next few quarters and build on significant wins with other new partners such as PPCW and Hong Kong Hospital Authority, serving all Hong Kong public hospitals.

We also saw significant wins in both North and South China with [Wanon Lee Gon] University and Beijing Post and Telecom University.

We continue to expand our Japanese business in both native Ethernet metro markets with continuing build out at Powercom, NNT Group, Japan Telecom.

And ongoing expansion of our Japanese Enterprise business with new customers such as [Nagoya] Railroad, [Pukoyee] Hospital and Yoko University.

Despite typical seasonal slowness in Europe, we continue to see good progress in our two key markets of the UK and Germany.

We also maintained strength in two key vertical markets.

In the first vertical, media, we saw new customers such as RTL, a leading European broadcaster, turn to Extreme to solve their network connectivity issues.

In the second vertical, finance, we saw expansion of our existing footprint at Deutsche Bank and wins at [Fineresse] and [Uni Credito], two of the largest banks in Italy.

We believe in the strategic importance of channels to our long-term success.

We are seeing the benefits our past investments and will continue to invest in strengthening these relationships.

And now I would like to hand the call back over to Gordon.

Thank you Alex.

A couple of final points.

First of all, I would like to update you regarding our CFO search.

I am very pleased to announce that we have hired a new CFO.

Bill [Flickay], current the CFO at [Handspring] will be joining the Extreme team in mid November.

As I mentioned in the last call, we are planning to hold a financial analysts day in New York City in December where you will have an opportunity to meet Bill and the other members of the Extreme leadership team.

So let us now turn to guidance.

We remain confident in our revenue goal of $400m this fiscal year.

Having exceeded our goal of break even and having achieved profitability this quarter, we remain confident that we can run a profitable this fiscal year.

Now, in the next quarter, that is the current quarter ending December, we do expect to see pre-production manufacturing costs for several of our new products putting some pressure on margins.

And we will also see some transition costs as we complete our consolidation on a single contract manufacture.

Despite this, I remain confident in achieving our stated goals.

We now have a strong and complete management team, a rich set of partners capable of delivery in all geographies and to all our key target markets, and excellent new products already shipping, with more to come.

To summarize several points.

First of all we have moved to profitability according to plan but slightly ahead of schedule on the strength of our Enterprise and Japan business, and the cost reduction measures that we have put in place over the last few quarters.

We have achieved the product milestones that we discussed last quarter.

And we are seeing very high rates of customer interest and advance orders from new products that we expect to be shipping this quarter.

To achieve our goal of providing a superior alternative in the enterprise market, we continue to invest on our partner relationships and continue to explore new relationships that bring new and innovative ways of solving problems to our customers.

Operator, we are now ready for questions.

Thank you sir.

Ladies and gentlemen at this time we will begin the question and answer session.

If you have a question, please press the * followed by the 1 on your push button phone.

If you would like to decline from the polling process press the * followed by the 2.

You will hear three tone prompts acknowledging your selection.

Your questions will be pulled in the order they are received.

If you are using speaker equipment, you will need to lift the handset before pressing the numbers.

One moment please, for our first question.

Our first question is from Natarajan Subrahmanyan.

Please go ahead with your question.

Thanks.

Good morning.

Can you just provide a little bit of color on the cost issues that you mentioned going into next quarter?

You mentioned some pre-production costs putting pressure on margin and the consolidation transition cost.

And you also mentioned for this quarter's gross margin that there was a number one time benefit.

If you could kind of back that out and give us what time benefit of this quarter's margin was?

And what kind of pressure we can expect on that next quarter?

Sure and good morning Subra.

Let me do those in reverse order.

So, the one time benefit to gross margin was the reversal of a charge and that was somewhat less than $1m in terms of the impact to gross margin.

And that was, as I indicated, a one time charge, a one time benefit.

Regarding the costs this quarter, as you know we are in the process of launching our Mariner systems which we expect to ship late in this current quarter.

And this is a pretty high end system with pretty significant cost of goods.

Given that we are building this initially in very small volumes, we do expect the manufacturing costs of this system to be considerably higher during this quarter than they will in the future.

Just largely due to the volume and the fact that we are just ramping production.

As we indicate, we expect to see some little bit lower gross margin on that product than we anticipate once when we get to full scale production.

And just another note there that, given that impact and also the fact that we are consolidating our contract manufacturers, you can expect that inventories may go up slightly and then return to more normal levels.

And should we expect you to kind of maintain the profitability through this transition?

Yes, certainly that will be our focus.

Okay.

One of the things you traditionally provided is just kind of rough geographical split and carrier versus enterprise kind of splits.

I do not know if I missed them.

Can you just give me US and Asia specific, what they were in enterprise carriers split?

Yes, I mean rather than simply reading through all that.

We put all those details up on our web site and so that is all available to you and to others.

Alright.

Thank you very much.

Gordon Stitt.

Thank you Subra.

Thank you.

Our next question comes from Sam Wilson.

Please state your company name followed by your question.

Good morning.

It is Sam Wilson from JMP Securities.

A couple of questions for you.

Can you just describe linearity?

Normally the third quarter is a little bit wacky because you get August going on with the vacations and those kind of things.

So can you just kind of generally describe linearity?

And as part of that you mentioned backlog for the wireless LAN products.

I think the word you used was a good backlog.

Can you describe overall company backlog with the number of new products coming through the channel?

Thank you.

Yes, and good morning Sam.

Linearity was, I guess I would say, typical in that we were very close to our normal 20, 30, 50 line.

Backlog, in terms of backlog for wireless, as we said, was good.

Our actual backlog at the end of the quarter was somewhat lower than we began the quarter but still within normal ranges.

Thank you.

Thank you.

Our next question is from Alex Henderson.

Please state your company name followed by your question.

Thanks.

Smith Barney.

So that implies the book to build was lower.

I recall it being pretty close to one, so book to build somewhat under one I assume?

Yes, still pretty close to one but slightly under.

Can you talk a little bit about where you are with respect to ramping powered Ethernet?

What the trajectory was on wireless LAN and then a little bit more granularity around gigabyte Ethernet please?

Sure Alex.

In terms of power over Ethernet, we are shipping one platform today.

That is the Summit 300 that provides power over Ethernet on all ports.

And we have other products coming out that, will come out shortly, that power over Ethernet in different configurations.

We also will be adding power over Ethernet to our modular platforms very shortly.

So, what kind of response are you getting on the product?

The Summit 300, which is our Unified Access Architecture, which also provides power over Ethernet, as I mentioned, has received a terrific response.

And gigabyte Ethernet ports, can you give us some sense of what the growth rate was, quarter-to-quarter, on that?

Yes, I do not have the specific number in front of me Alex but we were growing at a higher rate than a gigabyte port growth that [De Lauren] Group reported.

So since we brought down the price per port, particularly in the price per copper port significantly, and brought our densities up, we saw some significant growth there.

And once again I just did a mark to the market.

Okay, so going back to the channels.

I know you have expanded your relationship with both Verizon and SPC.

I assume that you are ramping those relationships?

Obviously you are implying that you are getting some traction there.

Can you talk about how long it takes to get them fully up to speed and ramped?

When do you think that they will hit the full flavor of that relationship in the numbers that are going forward?

Yes, as you know, those have been a lot of work over the course of quite a few quarters.

Certainly, we understand and believe that any type of large scale relationship takes time to develop.

It takes time for companies to get to know each other, and time for the sales organizations to get to know each other and the products and the customers.

So these are relationships that have been ramping pretty smoothly over quite a few quarters.

In terms of when are we at full production, full productivity of these relationships.

I do not know yet what full productivity is but we are certainly very optimistic that that business, that is our particular national resellers, will continue to grow and continue to grow as a percentage of our overall US business.

I am sorry One last question I forgot to ask.

The interest line, you said there was a one-time gain in there.

What was the magnitude of it so we can get our [apple] samples number there?

Yes, the magnitude of that gain was approximately $2m.

$2m.

Thank you.

Thank you.

Our next question comes from Mark Su.

Please state your company name followed by your question.

Thank you.

Mark Su, Unterberg Towbin.

Gordon, any further thoughts on the advance orders for the Mariner product?

And also is it in data trials now and will you recognize revenues in the December quarter?

Hi Mark.

Good morning.

Yes, the Mariner system is in data.

Once again, this is a complex product with a lot of capabilities and so we have been doing extensive testing since very early in the year when we first put it into a customer site.

So our plan still is to ship per revenue this quarter, that is during the December quarter.

Got it.

And separately on the services gross margins.

Any thoughts?

You saw quite a bit of improvement on that segment.

Any thoughts on where that might settle over the next few quarters?

Well, our goal is to have that settle on the upside.

Okay, any metrics that you want us to use in terms of our forwarding modeling?

Yes, I am not really prepared to give specific guidance there other than we are continuing to work very diligently.

And as I mentioned, that organization is now part of Alex's group so very closely aligned with manufacturing and with engineering.

So all those teams are working to hard to improve a lot of our business processes.

It sounds good.

Thank you Gordon.

Thanks Mark.

Thank you.

Our next question comes from Tim Luke.

Please state your company name followed by your question.

Hey Gordon.

I was just thinking that it would be helpful if you give the geographic split.

I was just looking at the web site and it was not entirely apparent where to find it.

If you could give us a sense of the percentages that might be helpful.

Sure, hold on just a second.

So the percentages, once again this is during this September quarter just closed.

They were 41% in the Americas, 21% in EMEA, 23% Japan and 15% in Asia.

All of those are pretty close to our prior quarters, certainly within rounding error.

EMEA was down as a percentage which would be typical seasonality that we see there during the September quarter.

And Japan was up due to stronger Enterprise sales there.

And any color on the North American business?

Just looks likes that was fractionally lower.

Yes, fractionally lower.

There are some orders there that came in a little late but, once again, I would call that within a normal range.

And just one follow-up on Alex's question on the other income line that was $2m, sort of one time item I think you mentioned.

What did that relate to?

It related to favorable settlement of some legal issues.

And the services margin, taking a big move upwards.

Could you just talk through some of the factors that helped there?

And also just clarify, did the product gross margin also go up?

First of all in reverse order.

Yes, product margin went up pretty substantially overall, about 1,100 basis points in product margin.

Excluding the one million one time in the margin, how many basis points up was that?

I do not know.

I do not have that number in front of me, hopefully that is pretty easy to calculate.

On the services side, as you know that has been an area where operationally we have not performed that well over the last several quarters.

We have put a lot of focus on that in terms of improving our business processes, internally improving our logistics on a global basis.

And just really focusing our energies there on doing a good job and that team, as I noted, has seen significant improvement.

We know we have a way to go there and that we plan to continue to improve that.

Thank you very much.

Thanks Tim.

Thank you.

Our next question comes from Sanjiv Wadhwani.

Please state your company name followed by your question.

Piper Jaffray.

Gordon two questions.

The first one is, could you give us any flavor on the Triumph product sales in the quarter, be that as a percentage of sales or how they performed versus last quarter?

Sort of any metrics that we could us.

Yes, good morning Sanjiv.

We do not break out the Triumph specifically as a percentage.

I believe, based upon our previous experience when we have transitioned from one generation of architecture to the next.

It is generally a four quarter or so phenomenon and that is the way that the model it.

The Triumph comes in and grows steadily over roughly a four quarter period.

And the previous generation, that is the Inferno generation, declines over that same period, and it is following our internal forecasts and our model.

It has been a very smooth transition, has not been very lumpy at all.

The blades that we have introduced are higher density.

They provide lower before costs and, particularly on the gigabyte to the desktop area, there are some significant benefits.

There are also benefits to carriers in the Triumph technology in terms of all the enhanced rate shaping and the two level rate shaping.

And people are really excited about those capabilities but a carrier typically takes quite a while.

That is several quarters to do a qualification before deploying that.

So we have not seen the benefit yet of sales of Triumph in that market.

Also, as I did mention, the other half of the Triumph story is the new switch fabric and that is what we call the MSM3.

And that provides this hitless fail-over capability which I believe is just a critical capability as we look over the next several years, an important technology.

We just began shipping that during the last couple of weeks of September.

So I expect that to transition a little more quickly.

And then second question.

Any guidance on geographic expectations for December?

Do you expect the US to come back a little bit?

And also Europe, I know it is economically weak, but do you expect any seasonality over there too?

Thanks.

I think it is certainly too early to tell what the mix is and I would expect the mix to be certainly within the range of our typical mix.

It may be a little bit more like the June quarter than this quarter.

But once again, we are talking a couple of percentage points swings either way.

And Japan.

Do you expect the momentum there to continue?

You know, once again, I do not want to predict any specifics on a geographic basis.

But I expect Japan to be within normal percentage range.

Got it.

Thank you so much.

Thank you.

Our next question comes from Richard Church.

Please state your company name followed by your question.

Wachovia Securities.

Thanks.

Just to follow up a little bit on that.

Can you talk about North America, what you are seeing so far in October?

And you mentioned the orders coming in a little late.

Have they started to, seeing that, transpiring in the current quarter?

Yes, I think Richard it is a little hard to speculate on the December quarter yet, given normal linearity.

And also commenting that, although the number was down percentage from last quarter, it is not a huge difference.

In terms of the overall market, I think that the US market remains challenging, although it does not appear to be getting worse.

I think that is pretty consistent with what I have heard from other companies.

So we did have, we have had strong bookings.

And we also just did receive some orders from all around the world a little bit late last quarter where we were not able to ship them out.

So I think it is a little too early to predict the geographic issues this quarter.

Okay, thanks.

Thank you.

Our next question comes from Steven Kamman.

Please state your company name followed by your question.

CIBC World Markets.

Two questions.

Deferred revenue is over 50% of revenues.

Just sort of what is in that bucket and how should we expect that to float through the revenue line?

And the other question is, massive swing in the services margin which is, I think, a positive, assuming it is sustainable.

And just any color on where that is going and what was driving that?

Good morning Steve.

Let me go through your first question and that is in terms of deferred revenue.

That includes basically two things, that is a maintenance where we book maintenance on an annual basis and recognize it on a quarterly basis.

So that builds up.

The other aspect there is distributor revenue in that when we sell to a distributor, we do not recognize the revenue until they sell it through.

So that is just the way we show that on our balance sheet.

Okay.

And then the services margins.

Just why the swing?

I know that there have been some concerns about that going negative and I am very happy to see it go up.

But how did you work that swing in the quarter and what do we look for that going forward?

Yes, I think the answer there is pretty simple.

It is focus and execution.

We put a lot of our management time over the last couple of quarters really looking at that from all aspects.

From an operational aspect, from a logistical aspect, from a personnel aspect.

And Alex and his team have just done a great job on what I would call the hard work of operational improvements there, really looking at all aspects of that as a business.

We did see lower RMA costs, as I mentioned, which was a big part of it.

And we plan to continue to improve our service margins.

Okay.

One out of two and one to go.

Enterprise service provider, you have given that before.

And are there any other charges besides the $2m in other income and $1m in gross margin that we should be aware of?

Yes, I am just looking up the service provider enterprise breakout.

I do not have that handy.

My gut feel is it was within a normal range of kind of 15% carrier.

And I am sorry, what was your second question Steve?

Just any other charges besides the $2m and other income and interest, and the $1m in gross margin that we should be aware of just for modeling.

Yes, I did mention that there was an additional charge related to real estate that was somewhere in $1m range as we revalued our existing leases to market.

That was positive or negative?

That was a charge so it was an expense.

Thanks.

Thank you.

Thank you.

Our next question comes from Erik Suppiger.

Please state your company name followed by your question.

Pacific Growth Equities.

I would be curious to know the.

Did you say that your national resellers are now 28% of your revenues?

Is that correct?

At 28% of North America.

How does that compare to the previous quarter?

A little bit up.

And can you give us a sense for which ones are the largest?

You mentioned a few but can you put a prioritize them?

Yes, I prefer not to do that since those numbers do move around on a quarter by quarter basis and we track as a category in terms of national resellers.

But some of the companies that we include in there are SPC, Verizon, Dell, Siemens, General Dynamics.

Okay.

And then, secondly, looks like book to bill was down.

I would have thought that might have been up, given that your are taking orders for a lot of new products.

Where did you see a deterioration?

I do not have a specific breakdown but there are also some issues there in terms of how we actually recognize a booking.

So, once again, it was slightly below one.

Thank you.

Gordon Stitt.

Thanks Erik.

Thank you.

Our next question comes from Christin Armacost.

Please state your company name followed by your question.

Thank you.

Two basic questions.

First, on the going forward, you called out some change in the contract manufacturers bringing it down to one and the Mariner carrying lower growth margins.

Can you quantify that for us?

Are we talking in one percentage point, three, four, five?

My question.

I cannot really quantify it other than just indicating that it is something we are looking out for.

It may be insignificant.

I do not expect it to be huge in terms of five points or something like that, just given the nature of it.

The Mariner systems are relatively expensive.

We will see a little bit of inventory build up and because we are producing them in low volume the labor costs are going to be high.

But this is not going to be a material part of our aggregate business this quarter.

That is helpful, thank you.

And then just looking backwards.

With the improvements that you saw in the gross margins, can you spend a little bit more time on the supply chain?

Did you change accounting policies, timing of how you are allocating service costs?

I am just trying to understand some of the inputs on the 1,100 basis point swing on the product side plus the service margins.

Yes, so there were no changes in accounting policies.

Everything is measured the same as previously and this was what I would call operational and supply change improvements, and that is negotiating with vendors for better prices.

Sometimes changing vendors in terms of supply of certain components and also certain services that we use.

And that comes through at a, through cost of goods at both the variable cost associated with the product, and also the manufacturing overhead.

So once again this was, as I mentioned, this is real operational focus by Alex and Dianne and their respective teams in making us much more efficient as a manufacturer.

Thank you.

Nice job on the margins.

Thank you.

Thank you.

Our next question comes from John Anthony.

Please state your company name followed by your question.

Global Partners.

Gordon, can you give us some sense for where you see the mix of modular and stackable trending going forward?

Sure John.

You know the question that comes up quite a bit.

The mix this quarter was 46% stackable, 54% modular.

About 2% off from last quarter.

If I look at the trending over the last couple of quarters, specifically the last four quarters, modular is 53%, 50%, 56%, 54%.

So it is clustering in a range.

We kind of model a 50-50 basis so it floats around.

But, again, the point here that I would like to make is that customers buy networks from us.

Different customers choose to design and architect the networks differently.

Some prefer a mix of stackables and modular.

Some prefer mostly modular systems but all of our customers buy from both product lines.

So I typically model a 50%.

Okay.

And also I was wondering, you have given us obviously the goal of $400m, and I apologize if you have done this in the past.

But can you kind of give us a sense for what contribution you think wireless might have to that goal?

I have not broken that out.

I think that for us we are seeing two benefits from wireless.

One is, of course, bookings for those products but also is the overall improving the win rate of aggregate networks and effectively dragging some of the other products.

So because we have such compelling wireless solution, a customer would choose our overall solution versus a competitor's.

But I have given any specific guidance as to percentage of revenue for the fiscal year.

Okay.

And lastly can you just talk a little bit about what the ASP environment looks like?

Yes, ASP is pretty stable, did not see many changes there.

Okay, thanks.

Thank you.

Our next question comes from John Wilson.

Please state your company name followed by your question.

Hi this is Daniel Cohen calling for John Wilson from RBC Capital Markets.

Back to the product side.

In terms of new product introductions, do you intend to introduce a Summit line with your Triumph ASIC?

And do you intend to introduce more wireless products?

Good morning Daniel.

So, in terms of Summit and Triumph.

There are currently no plans to put the Triumph technology into our Summit series and the answer is, yes, we do intend to introduce additional wireless products.

At what point do you intend or do you anticipate that all these new products will start to positively impact your top line?

I am sorry you are breaking up there a little bit.

Sorry.

At what point do you anticipate that all these new product introductions will start to positively impact your top line?

Well, once again, I do not want to give any near term guidance but I am sticking to the $400m for the year.

We just see a lot of very positive demand in terms of what customers are telling us, and particularly those we have shown the new products to are very positive.

Thanks.

No further questions.

Thank you.

Our next question comes from Jaul Leone.

Please state your company name followed by your question.

Good morning.

Merrill Lynch.

I am wondering if, Gordon, if you can speak about the linearity in the quarter?

You are the third company that is reporting stable revenues versus expectations for a strong quarter in the US especially.

And we received some comments from Cisco back in August that August was better.

And I am wondering if you have seen good August and then decline in September or vice versa?

Hi Jaul.

Linearity was pretty typical.

Certainly Europe was slow which we anticipated and which we anticipate each year during August and then picked up in September.

But, once again, we were roughly in a 20-30-50 and it is has been pretty consistently that way for the last couple of quarters.

The problem is it moves a couple of percentage points around and can have a big impact on revenue at these levels.

But we did not see any major changes other than the expected slowness in Europe during August.

When it comes to your revenue target, you are a bit below the consensus estimate.

What was the area that you were surprised with on the negative side that led to this may be 4% gap between the number and the expectations?

First of all, we did not give any specific guidance for the quarter.

We have been really focused on two things, the other thing being profitability.

I set the goal, I did give guidance towards having a break-even this quarter and I wanted to make sure that our team was very focused on achieving that.

And do you expect to further reduce operating expenses?

Do you expect to also maybe further reduce number of employees?

I do not expect to reduce number of employees.

I think we are at the right number.

In terms of operating expense, the answer is yes.

There certainly are some opportunities we still have to work some costs out of our system and we are going to be aggressively pursuing that over the next couple of quarters.

Okay, thank you.

Thank you.

Our next question comes from Chet White.

Please state your company name followed by your question.

Merriman and Company.

Question on gross margins.

I know you have not given out a target range but things have come in very strong, and this has happened with a few companies in your area.

And a few of those companies have given out general longer term goals which they have increased.

I wonder if you could give us some color?

Do you feel more optimistic at least or is there a potential target that you could give us, say, what your goal might be over the long-term?

And also is there any color you might be able to give us on the percentage of new products that you are selling today?

Either today or potentially your goal for the transition to a new product line over the next 12 months?

Yes, good morning Chet.

On the gross margin, once again, we made some great operational improvements.

A lot of this was work that was started prior to the quarter and was executed and completed during the quarter.

And, once again, we are going to continue to really focus on operational costs, on supply chain costs.

I mentioned that there may be some impact to margins this current quarter December due to Mariner.

But please understand that is a pretty minor part of our business and I think Christon asked the question in terms of relative scale.

And I would just that is a small impact.

We do believe that margins in our business over a long term, that is over several years, should be in the mid 50s.

But if we can get some hot products going and get above that, we are certainly not going to stop at that number.

We will continue to push that and, once again, I am optimistic.

And any color on what the transition of the new product portfolio looks like as far as a percentage of sales, either now or kind of over the next several quarters?

Yes, again, I do not break that down specifically, other than as I indicated, Triumph has been strong.

It has been transitioning over from Inferno, particularly in the enterprise with gig to the desktop being an important driver there.

I think the switch fabric part of the business, which we just introduced in September, I think that will change over pretty quickly because customers just love this hitless fail-over capability.

We have just got great feedback from that.

It makes the operational issues much easier from software upgrade and network changes.

So I expect that Switch fabric to do really well.

We also introduced some new members of the Summit product which I did not talk on during the prepared remarks, in terms of the Summit 200 which is doing very well.

And the wireless business which is also doing well.

So the percentage of new products is growing pretty rapidly and I think, once the Mariner systems come out, we will see more acceleration.

And do you see anybody else out there with the hitless fail-over and the switch fabric?

I am not aware of anyone.

Thank you very much.

Congratulations.

Thanks Chet.

Thank you.

Our next question comes from Gina Succolo.

Please state your company name followed by your question.

Buckingham Research.

First of all, you gave us guidance last quarter for the full year revenue of about $400m.

Is this still doable?

Yes.

Okay.

So that means that you will have an acceleration in sequential revenue some time this year.

Do you think it will be towards the middle half of the year or towards the end of the year?

Or can you give us any color on that?

Tough to say at this point Gina other than we are very confident of that number.

Okay.

Did you also [budget] out your 10% customers.

I believe Tekdata was our only 10% customer.

I am sorry I did not mention that before.

And was that more than 10%?

How much of the quarter was it?

I believe it was slightly more than 10%.

Okay.

And then I am still a little confused about your book to bill.

If you have orders for new products in there and orders that were wait and being booked in the first quarter, I would assume that your order book would be pretty strong.

And therefore your book to bill, I am sorry, and therefore your bookings, would be stronger than they were last quarter.

So why would they be down?

Well, first of all it was not very much of a change in that we are talking about very slight numbers here.

But also in some cases, particularly in some government business where we are awarded a contact but officially the purchase order is not placed.

And we had some cases where we had anticipated being able to book and ship after an award.

Due to some bureaucracy we were not able to get that done.

Okay.

That is good you said that.

So, can you break out how much your government business was all in and what that compares to last quarter?

And what your outlook is for the government?

I did not break government out in the numbers I have in front of me.

Will that be available?

We do not typically give that as a percentage.

Okay.

Thank you.

Thanks Gina.

Thank you.

Our next question comes from Raj Sukent.

Please state your company name followed by your question.

Deutsche Bank.

Thank you.

Gordon, the question I have.

You say you are pretty confident of $400m.

You did $87m in the first quarter, that leaves over $100m for the next three quarters to achieve that.

Granted that your restructure there is ahead of schedule in terms of becoming profitable this quarter, but how you are going to achieve the top line, especially given where you are today?

Yes, as I said Raj, we have a plan and we are confident in that plan.

Okay.

And with regard to gross margin, it is very impressive in terms of product gross margin.

So given the very slight impact that you are talking about new product introductions and all.

Can we assume that the gross margin will be in the 45-50% range going forward?

Are you talking about the aggregate gross margin?

I would expect it to be higher than that range.

Thank you.

Thank you.

Our next question comes from William Buckley.

Please state your company name followed by your question.

Thanks.

Oppenheimer.

What kind of mark-up do you believe your resellers are getting on your products?

And in that same regard, there is at least one competitor that plans to change that metric a little bit by giving more margin to the resellers.

Do you think that can ultimately impact your gross margins by pushing them down?

Well, I am not sure which competitor you are talking about but there are a couple of dynamics.

And once again we have been very focused on resellers since the founding of the company.

And our channel teams do a great job, not only here in the US but throughout the world.

We stay in very close contact.

And one of the reasons we have been successful is because resellers do make money selling our products.

And that comes from being able to have customer demand on one side and reasonable pricing on the other.

So, resellers choose us frankly because they can make money and because their customers ask for the product.

And I expect the channel part of our business to be stable to growing.

Do you have any idea what kind of mark-ups they get?

What kind of margins the resellers are able to extract?

Well that would depend upon the class of reseller and on the particular deal.

I mean that is a pretty complex question.

Okay, thanks.

Thank you.

Our next question comes from Tim Lehewey.

Please state your company name followed by your question.

Yes, Tim Lehewey from Wedbush Morgan.

Just a real quick question on the real estate expense, the $1m charge.

I assume that is in G&A?

It is broken out on a separate line.

Okay.

Thanks.

I think it is shown as restructuring Tim.

Okay.

Thank you.

Our next question comes from Andy Schopick.

Please state your company name followed by your question.

Yes, good morning.

Morning Andy.

A couple of clarifications.

Again, I think it would be have been a little more helpful on the presentation of the cash flow statement in terms of some of these non-recurring or non-operating items.

Gordon, I am looking at the cash flow statement.

Was there also, it appears a benefit or reversal on the doubtful accounts of $200,000 in the quarter?

I am reading that correctly and would that have been a reduction of G&A?

Hold on a second.

Let me see if I can get to that pretty quick.

I do not have that handy.

I honestly do not know the answer to that.

Okay, I am going to ask you one other one on the balance sheet.

I see that the accrual for warranty reserves has gone down by about $1.4m and wondering what might be contributing to the reduction in the accrued warranties?

Lower return rates.

Is that something that you now believe will be kind of consistent going forward?

Yes.

Okay.

Also, you had mentioned there was additional financial data on the web site and I remember in past periods there was like a financial data sheet.

I was going to the web site trying to locate some of the additional financial or supplemental data but I could not find anything that was incremental or different.

Is there still something there on the web site?

Where exactly would it be?

Yes, Andy, it is under IR financial data.

I believe so.

It is the same information we have had up in the past and it is updated.

We put that up early this morning.

I just was unable to find it and still was unable to find it.

Perhaps I can get back to someone later to help me navigate it.?

Sure, you bet.

Okay thanks.

One more question.

Thank you sir.

And our final question is from Ryan Malloy.

Please state your company name followed by your question.

[indiscernible].

Thanks.

The sales and marketing line item was down about 11% sequentially.

Just wondering if there was more attributable to headcount reductions or restructuring initiatives or may related to the disappointing sales this quarter?

How sustainable is that going forward?

I would think if you are going to grow sales to get to the $400m it would probably have to pick up.

Yes, a lot of that is specifically related to lower commissions and also to a lot of work we have done just reducing overhead in terms of real estate costs, that sort of thing.

So in terms of, it depends if you look in absolute dollars or percentages.

In absolute dollars as sales increase, I would expect that to increase as the variable costs increase.

Not if you expect December, expect December to go up, do you think sales and marketing would also go up along with it?

Yes.

Thank you.

Mr. Stitt please continue with any closing statements.

Okay, well with that I would like to conclude.

Thank everybody, particularly in the West coast for getting up with us so early this morning, and we will look forward to speaking with you again soon.

Thank you very much.

Thank you sir.

Ladies and gentlemen this concludes the Extreme Networks first quarter fiscal 2004 conference call.

If you would like to listen to a replay of today's conference call please dial 800-405-2236 or 303-590-3000 using the access number of 541-841.

We thank you for your participation.