Extreme Networks Inc (EXTR) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Extreme Networks second quarter 2004 earnings conference call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the conference over to Mr. Bill Slakey, chief financial officer with Extreme Networks.

Please go ahead sir.

Good morning, everyone.

Thank you for joining us today.

On the call with me today is Gordon Stitt, chairman, president and chief executive officer of Extreme Networks.

Earlier this morning, we issued a press release, announcing our financial results for the second quarter of fiscal 2004.

A copy of this release is posted on the investor relations section of our Web site 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 Web site 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 risks and uncertainties as detailed in our filings with the SEC and in our press release today.

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

Thanks Bill.

And thanks to everyone for joining us so early in the morning.

I would like to begin with a brief overview of the quarter and update you on some of our current initiatives, then I'll turn the call over to Bill for additional financial and operational color on the quarter.

For the quarter, we generated revenue of 83.4 million dollars.

Our operating loss was $5.8 million and our loss after other income and taxes was $5.6 million or 5 cents a share on a GAAP basis.

Our book-to-bill ratio for the quarter was above one to one.

Our backlog expanded during the quarter and we anticipate sequentially higher revenues and improved margins in the March quarter.

These results and our future expectations are in line with the update we provided you on December 16 at the Analysts day in New York.

Bill will go into our results in more detail shortly.

In the quarter, we undertook some major activities to strengthen our position in the networking market.

One in particular was the announcement and shipment of our Black Diamond 10 K Chassis switch, which is built on our new genesis ASIC technology.

We are pleased to say that after extensive development of a complete new service of ASIC, a new operating system and a carrier class high-density system, the product shipped on time to customers.

Initial orders for the system were from a broad range of market segments that included cost of computing, naturally for net carrier, and natural services manufacturing and oil and gas.

Some of these customers are the classic early adopter a type that is typical what one would expect.

But we're also very pleased that some of the customers with the early majority types focused upon business process improvement.

I believe this is dollar based which featured as market targeting of our new technology.

Customer response overall to the 10K has been very positive.

They tell us they like the underlying technology for the following reasons.

First of all, high availability and resiliency, we started to see this trend some 18 months ago and have seen it accelerate as of late.

All types of customers are looking for very high availability, very high uptime on their networks.

They see the network as a strategic asset to have the expectation of carrier class availability.

We introduced our hit list fail over capability last year as part of the triumph launch and we continue that capability in the 10K.

This ensures upgrades and enhancements without down time.

Now hit list fail over is just one of the new features in the 10K and we've seen a positive overall reaction to the extent that we see in the primary ability feature in this new product.

Second feature customers really like is what I like to call all of the time non-blocking.

One of the characteristics that users really appreciate about extreme products is you can turn on all of the features without impacting performance.

Whether its access control list rate shape are or new protocols brought by my 10K maintained scope you prefer.

Many customers fed up with suppliers who claim these features but were they turn them on performance are impacted and the network suffers.

And finally, customers are responding very well to our flexibility and future proofing.

The programmability of our ASICs and open interfaces into extreme ware EXOCS provide a compelling base of the future enhancement and upgrades this system that will allow growing and adapting without wholesale replacement.

In addition, to strong customer interest and they switch the Black Diamond 10K was just recognized as product of the year for 2003 by the well-respected publication info world magazine.

Our Black Diamond 10K was selected from a field of more than 200 products reviewed during the past year.

Info world named the Black Diamond 10K the best networking hardware stating that the product presented, quote, an excellent mix of lot 10K performance and polished management capabilities.

We're very proud to have won this prestigious award.

With the introduction of the Black Diamond 10K extremely is delivering on its strategy for revitalizing the network infrastructure from edge to core to manage the hundreds or thousands of advisers both computing and non-computing that will be managed from the network.

While the Black Diamond 10K offers next generation performance for the core, our unified access architecture brings our solitary 100 switch thinks LAN, wireless LAN and security all together in a universal switch for the edge.

Our unified access architecture, which integrates, wired wireless and IP velocity does all of these things.

The approach with initial acceptance of all wireless products we began shipping with some of 300 switches in September and achieved volume shipments in the December quarter.

We began shipment of our altitude tri-band access points in November and hit the volume production within the quarter.

Initial sales of UAA are a mix of evaluations networks with some of valuations becoming full-scale deployments in the quarter.

Initial customers, are in education, health care, government and manufacturing sectors.

We are seeing a mix of existing extreme customers and new customers embrace our unified access architecture solution.

Initial customer feed back is that the value the security capabilities to the extent of management and see most integration between wired and wireless.

Customers see this as an important step towards a single integrated network.

Although the revenue contribution was modest from the summit 300 and altitude access points we expect it will ramp throughout the year.

Based on initial customer response, the strength of the demand for those and other products, we continue to expect sequential revenue increase in the March quarter.

We continue to see that our customers are coming to view the enterprise as a foundation for building a single network with higher performance and resilience to simply integrate voice, video and data.

And increasingly those customers are looking to integrate wired and wireless on that single network with connectivity that is not only fast but also secure.

No longer just a conceptual cliche, the so-called network convergence is rapidly becoming a common approach for those looking to build out their network for the next generation.

IT managers recognize that sooner or later everything will need to be attached to a network which means building a platform capable of scaling to handle hundreds of thousands of devices and a much broader range of application in traffic types.

We believe that plays to our strength as we leverage the platform of products that we've only just begun to introduce into the marketplace.

I'd like to spend a moment to talk to you about our partnership with Avaya.

Strength and our ability to provide converge solutions extreme formed a global strategy alliance with Avaya, announced on November 4th this partnership is already enhancing our relationship with customers.

As you have heard from suppliers, industry analysts and customers themselves, converge networks are a hot topic within enterprise networking.

IP telephony that is running business quality voice and voice applications over an IP data network is a hot topic.

By converging that is combining voice and data on a single network, customers are seeking dual benefits.

Lower management and connectivity costs achieved by having a single converge network and as a way to transform their businesses by adding new applications that make their business processes more efficient.

From an overall perspective, there are three components to this relationship.

The first is a joint development agreement, which calls for an investment by each company for the development of technologies and ultimately products for converge communications.

The second part of the agreement calls for Avaya to resale extreme networks product and portfolio on a global basis.

Our solution will complement existing gateways and infrastructure products and provide customer with a single point of contact for IP telephony and network infrastructure.

The third part of the agreement is related to global services, by global services will provide a broad range of support for extreme product from planning and consulting to support and management.

I'd like to update you today on the progress and status of the resale component of this agreement.

Avaya will resale Extreme Networks products through direct sales and promote extreme to its indirect channels with an immediate focus on our Black Diamond, Alpine and Summit product lines.

Although this is a global agreement, there will be particular focus in the U.S. market where 90% of the Fortune 500 is called on by the Avaya sales force.

We began gauging with the Avaya field organization and planning for how we would approach customers.

The engagement involves Avaya's direct channels that are direct sales from Avaya to end users, as well as indirect channels, including distributors and resellers.

At this stage, we've built a direct pipeline and identified a series of opportunities.

We've also engaged distributors and resellers and are in active negotiation with members of the channel.

We are excited in working with these new channel partners, as their customer base and expertise is different from the typical data networking reseller.

We've begun the process of training of respective systems engineering teams in December and we will continue that process through this quarter and next.

We have achieved some early sales results, though I would characterize many as opportunistic.

The strategic sales are where both companies will benefit and where our resources are being directed.

One thing for sure, customer receptivity to the joint story for converge sales has been excellent.

This significantly broadens the channel for extreme products both to Avaya's direct customers as well as promoting extreme through their indirect convergence reseller partners.

This provides customers with a superior alternative in the world of converged communication communications.

It gives customers a single source not just for supply but also for world-class convergence services.

I think this is very significant.

Customers can get a solution that includes IP telephony and the underlined enterprise infrastructure from a single source.

This summarizes from the extreme perspective, which is a very exciting agreement with potential for technology development, broadening of our channels and moving from discussions of speeds, and feeds to service orientation for application, establish a dialogue with the network infrastructure.

Now, I would like to provide you with an update on our channel partners.

In the US, we continue to build strong relationships with our national re-seller partners such as Dell, SBC, Siemens and Verizon.

These partners accounted for an in excess of 20% of North American business during the quarter.

Together with our partners, we continue to win new customers.

During the quarter, Extreme began working with companies in health care, government, and oil and gas markets.

Some examples.

For the Samsung Investment Company, which is one of the top 20 independent US based oil exploration and production companies handling very large geophysical images was causing network issues.

With our new black Diamond 10-K, they have improving performance flexibility and scalability along with 10 giga-bit Ether net connections found only in our switch.

Lowell General Hospital in Massachusetts relies on our unified access architecture for steam less wires and wireless productivity to support patch applications and provide improved bedside patient care.

A new E -91 emergency dispatch system is possible for Oakland County in Michigan with our summit and Alpine switches.

The counties new law enforcement information network will enable all law enforcement and city agencies to easily share information with a network well suited for growing traffic.

Now, before turning things over to Bill, I would like to make some comments on the general business climate.

We are seeing a slightly more positive business environment generally.

We base this on our order flow, on our pipeline metrics and our customers' commentary.

This combined with market analyst forecasts for networking in the calendar year 2004 gives us confidence in generating sequential growth throughout the calendar year.

With that, I'll turn the call over to Bill Slakey, our CFO for additional color on the quarter.

Thank you Gordon.

I'm going to briefly review our financial results for the quarter as well as review for you our expectations for future performance.

Starting with revenue, revenue for the quarter was 83.4 million dollars, consisting of 71.5 million dollars in product revenue and 11.9 million dollars of service revenue.

Service revenue was up 13% sequentially and up 23% versus the year ago quarter.

This reflects our continuing efforts to expand this part of the business.

Service revenue was up across geographies and the book-to-bill ratio was above one.

Product revenue was down 7% sequentially and down 11% year-over-year.

As you heard from Gordon, our book-to-bill was about one for the quarter, increasing our backlog-heading inch for March quarter.

Shipments of modular products represented 53% of sales and stackable products represented 37% of sales.

This mix was essentially unchanged compared to Q2.

On the modular side, we did ship a small amount of black Diamond 10-K for revenue in December.

We remain constrained on shipments here in January.

We expect those constraints to ease through the quarter and we expect to be unconstrained by quarter end.

In stackable, we continue to see good demand and increasing revenue for the summit 200, which began shipping in Q1.

Sales of the summit 300 wireless products are growing albeit from a small starting point.

In the US, we are seeing early validation testing and department level deployment outside the US, particular in Europe, we are seeing broader building or campus wide deployment.

Looking at revenue geographically on a sequential basis, we saw revenue increases in Japan and Europe, a modest decrease in Asia Pacific and a decrease in Asia Pacific and a decrease in the US.

In Europe, revenue was $24.7 million or 30% of sales.

Revenue in Europe increased 19% sequentially driven in part by seasonal improvements and stronger demand in the UK.

In Europe, we are seeing a slightly faster uptake of product, which helped the sequential comparison.

In Japan, revenue was $19.7 million or 24% of sales.

Revenue in Japan grew 5% sequentially as a result of the good quarter service provider business there.

In the U.S., revenue was $29.2 million or 35% of sales.

This represents a decline in U.S. revenue of 20% sequentially.

However, in the U.S. we experienced a book-to-bill notably higher than one and in fact bookings in the U.S. were flat compared to the previous quarter.

Demand in the U.S. in Q2 included good early orders and interests in the Black Diamond 10K and our revenue for the quarter was impacted somewhat by the shipment constraints on that product.

Looking forward into Q3, we anticipate better availability of that product and increasing contribution from wireless products, early traction with the Avaya and an expanded pipeline generally.

This all helps contribute needfully to a return in sequential revenue growth in the U.S. in Q3.

For Asia, outside Japan, revenue was 9.8 million dollars or 12% of sales.

For the quarter, we had no 10% customers.

Let me note for you that our revenue for the quarter was reduced by 300,000 dollars due to amortization of the portion of the costs associated with the warrants issued to Avaya in conjunction with our recent partnership agreement.

Q3, this charge will increase slightly to 400,000 per quarter and we will amortize the value of the warrants through the December 2006 quarter.

Turning to gross margins now.

Total gross margin was 48 1/2% down from 51.4% sequentially.

This is in line with our preliminary expectations announced in December.

Product margin was 52.3%, down 4.1% sequentially.

Product gross margin was reduced sequentially due to slightly higher warranty expenses, standard cost revisions, a start-up manufacturing costs related to the Black Diamond 10K and summit 300.

In addition, you may recall the Q1 gross margins benefited by about 1% from one-time events.

These were not repeated in Q2.

Service gross margins expanded from 14.9 to 25.5% sequentially.

This expansion was due to revenue growth and to lower costs particularly lower consumption of components and service inventory.

Looking at operating expenses now: Total-operating expenses were 46.2 million dollars up from $42.7 million in Q1.

This figure from Q1 does not include $1 million of restructuring charges.

G&A expenses increased 900,000 dollars sequentially due to increased legal expenses and end of contract payments to IT and other vendors.

Sales and marketing expenses are up $1.8 million sequentially due in parts to an increase in marketing programs, product introduction costs as well as end of contract fees.

R&D costs are up $1.3 million sequentially.

Of this, 1 million dollars is the non-cash amortization of the cost of warrants issued to Avaya in conjunction with our partnership agreement.

In Q3, this amortization will increase to $1.5 million a quarter and remain at that level going forward.

We will amortize the value of the warrants through the December 2006 quarter.

Looking forward on operating expenses: We anticipate the total level of operating expenses in Q3 to be in line with Q2, meaning slightly up or down.

Although spending will vary line item to line item.

G&A will most likely be down and R&D most likely up.

The operating loss for the quarter on a GAAP basis was 5.8 million dollars.

After other income and expense in taxes, the net loss for the quarter was $5.6 million or 5 cents per share in line with our expectations from December.

Moving to the balance sheet now: We had a strong performance on several measures, total cash, cash equivalents and marketable securities on December 28 were 413 million dollars, an increase of 10 million dollars in the quarter.

Accounts receivables were well controlled at $24.4 million, which equates to a DSO of 26 days that compares to 28 days at the end of Q1.

Net inventory on December 28 was 20.5 million dollars compared to $16 million at the end of Q1.

Inventory turns stood at 8, down from 11 the previous quarter.

Accounts payables increased from $9 million to $16.4 million sequentially, a 7.4 million dollar source of cash that contributed to the company's positive cash flow for the quarter.

At 9 million dollars payables were unusually low in Q1 and the balance at the end of Q2 is nearer the range of $19 million to $23 million that the company operated in for most of calendar year 2003.

Head count at quarter end stood at 800 regular employees unchanged from the end of Q1.

As of December 28th, the company had 118.4 million shares of common stock outstanding.

Let me turn now to guidance.

Our expectations for the March quarter and our goals for calendar year 2004 remained unchanged from the comments we made in mid December with the exception of a small modification to account for the non-cash amortization expense of the Avaya warrants.

On revenue, for the March quarter, we expect revenues in a range of 85- to 90- million dollars.

Our goal for calendar year 2004 is to deliver sequential revenue growth quarter to quarter throughout the calendar year and to deliver revenue in the December 2004 quarter that is 15% to 25% higher than the revenue we had just reported.

On gross margin, we anticipate a modest improvement in gross margin in the March quarter.

Our goal is to expand our gross margins as percentage sales through the year.

We may not expand our gross margins sequentially each and every quarter, but our goal is to be operating within a range of 52% to 55% total company gross margin by the December 2004 quarter.

On improving operating leverage in our business, our goal is to improve our operating leverage by reducing operating expense as a percentage of sales through the year.

As I noted a moment ago, we expect operating expenses in March to be in line with expenses in December in terms of dollars spending.

With higher sales this should lead to a modest reduction in expenses as a percentage of sales.

Through calendar year 2004, we may not improve our operating leverage sequentially each and every quarter, but our goal is to make a significant improvement by the December quarter of calendar year 2004.

In our December Analysts meeting, I stated that our goal was to have operating expenses within a range of 41% to 46% of sales by the December 2004 quarter.

The small modification I will make to that guidance today is to raise that range by 1% of sales to recognize that we will be recording 1 1/2 million dollars of incremental R&D expense each quarter related to the amortization of the Avaya warrants.

So our goal for the December 2004 quarter is now to be operating with operating expenses in a range of 32% to 47% of sales.

And with that, let me turn the call back over to Gordon.

Thanks, Bill.

Before concluding and opening up for questions I would like to summarize.

With our third and fourth generation technology as well as our unique wireless LAN offering shipping, we are well positioned to catch the next wave of networking.

Customers around the world are showing tremendous interest in our networking strategy and switching solutions.

They see the value of industry leading performance, scaleability, resilience and our secret sauce, our extreme ware software.

As we enter this new year, we are seeing the results of our strong commitment to R&D and our unique ability to go beyond convention and provide innovative networking technology that truly enable our customers to build an infrastructure that serves as a strategic asset to their business.

With that, let's open the call up for questions, please, operator

Thank you, sir.

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

[OPERATOR INSTRUCTIONS]

The first question is from Alex Henderson.

Please state your company named followed your question.

Thanks, Smith Barney.

I was just looking at the guidance you are giving on APEX costs and at 42%, that would I would imply is assuming your guidance of the upper end of the band that you gave for the revenues for the December quarter.

Would they actually be 42% down on an operating cost basis year over year and even at 46% it's pretty flattish.

Can you give as you little bit more clarity on how you plan to achieve those levels of improvement on the APEX lines and whether in fact I'm doing my math right here, but it seems like a pretty aggressive set of assumptions on the APEX lines?

This is Bill.

On the operating expense line, generally speaking, what we will be doing is operating with R&D in a range of 16 to 18% of sales.

That's including the amortization of the Avaya warrants.

That's similar to the range it's in now or similar to a range it has operated in recently.

On sales and marketing, our goal is to get that to a range of 23 to 21% of sales.

We'll need to accomplish that primarily through revenue growth.

If need be, we can edit around expenses to get into that range.

G&A, the goal is to be operating in a range of 5 to 6% of sales and there we have some work to do.

So that would actually be a decline in G&A costs and absolute dollar basis year over year?

Yes and it would be a decline in a quarterly basis from where we are operating right now.

Some of our expenses in the current quarter related to terminating some agreements making some changes in our IT infrastructure and other parts of our G&A infrastructure that I think will begin to pay off in lower absolute dollar spending on that line item in future quarters.

One last question.

The deferrals of products out of the December quarter into the March quarter, particularly in Japan, but also on your high end products, will that have a positive impact as they kick back in, in terms of improving your gross margins next quarter?

Shipments -- as black Diamond 10K becomes a bigger part of the mix, some of our other products become a bigger part of the mix, yes, those will have positive effects on our gross margin, that is some of the reason for our optimism on improving gross margins sequentially.

You are going to be able to ship to that Japanese order this quarter, right?

Yes.

Great.

Thank you.

Thank you.

Our next question is from Samuel Wilson.

Please state your company named.

JMP Securities.

Good morning, I want to ask a few questions with three parts on partners.

Could you just give us some indication of when you expect the first joint products out from Avaya or at least joint solution out from Avaya?

Secondly, can you give us some magnitude of how much resource you're putting into the partnership on the R&D side versus them, number of engineers, or number of dollars, something to that effect.

And number three, on legend is that partnership getting anywhere?

Have you booked any revenue from it?

Have you selling the products yet?

Just some update on that.

Hi, Sam.

Good morning.

Sure, in terms of the from the middle out.

In terms of dollars, we've indicated when we made the announcement in November, that we would be spending several million dollars a year on specific R&D for our global strategic partnership with Avaya.

That's you know the money would be, we would each equally contribute to that.

You know, at this point, it's hard to say and I'm not comfortable making a commitment when a specific product in terms of hardware line item would be available.

But in terms of where we are today, we have done extensive interpretability testing and certification between the products, so customers can buy a solution today that is certified.

You will see as we move through the year quite a few enhancements to our software to better enable converged communications.

So in terms of -- does that answer your question on the first two points?

Is it fair then just based on that answer to characterize that most of the development right now is on the software side not necessarily on the hardware side?

Yes that would be fair in the initial stages, that's correct.

OK, and then just the follow up on legend.

Yes, so on legend, you know, we are engaged with them.

They are a large company as you know.

And much of some of the large partners we have here in the US, there are time involved in doing the training of both SC and sales training.

So you know that is progressing.

There were some sales during the quarter.

But I expect to see the up side there will come in the future.

Thank you.

Thank you, Sam.

Next question, please.

Thank you.

The next question is from Christin Armacost, please state your company name followed by your question.

Thank you.

Two questions.

First, you had taken some unusual steps beginning in the September quarter to reduce costs including closings around the holiday period and executive pay-cuts which were expected to expire after the December quarter.

I wanted to get an update on what you're doing in those initiatives and how that factors into your op-ex guidance.

Then the second question is just around the wireless LAN.

I know it's still very early, but what kind of number of users in some of the early deployments are the wireless LAN solutions supporting?

Thank you.

Christin, on the operating expense wise, we did have holiday shutdowns in December, we do not plan on shutdowns here in the March quarter meaning that would increase our expenses quarter to quarter, however, we have identified spending cuts in other parts of the business and in other spending categories such that uncomfortable, cant believe that, we expect operating expenses in total dollar terms to be flat generally quarter to quarter.

This is Gordon.

On the wireless side, our solution is targeted at you know very large enterprise and you know, so the initial deployments without knowing the specifics, I would say there are, you know, many hundreds of users being connected to the network, albeit not all simultaneously.

Thank you.

Thank you.

Our next question is from Mark Sue please state your company name followed by your question.

Thank you, Mark Sue, Unterberg Towbin.

Gordon, are you considering any additional decline in traditional products for the March quarter or are there customers that will continue to purchase these products?

Also, what should we assume between the revenue split for services and for products in the March quarter?

And any thoughts on what the contributions might be for the 10K in March?

So, a couple of questions there, I think the ratio, first of all, between service and product revenue will remain relatively constant.

And you know, I expect that over the next couple of quarters, we do expect to grow both parts of that.

In terms of forecasting, the 10-gig contribution for this quarter I think that's a little difficult to do at this point.

We did enter the quarter with a backlog as we were unable to meet demand.

And you know, we do have the product under evaluation at a number of potential sites.

So we certainly have you know some high hopes there.

In terms of the mix of products is how I would describe your other question.

In terms of existing or older products, you know, versus new products, you know, we continue to see a very smooth transition from our original inferno products to our triumph products so that process continued during the quarter.

I would expect that would continue through the March quarter.

We do expect to see more growth in our new products and we expect a ratio of new products, which we define as something that began shipping in the last 18 months to be an increasing part of our revenue during this product.

You don't expect existing products to drop off significantly, it should hold steady here?

Our goal is to migrate people across in a smooth fashion.

Got it, thank you.

Thank you, mark.

Next question, please.

Thank you.

The next question is from Sanjiv Wadhwani.

Please state your company name followed by your question.

Thanks.

Piper Jeffray.

Two question, the first one on Avaya.

Gordon, any sort of color on what we should expect in revenues for the March quarter, perhaps if you can give us a round about number that would be helpful.

Also, Bill, as you're looking to increase gross margins in the March quarter and beyond, should the increase be primarily be focused on the product side or service side?

You've obviously had a huge increase in service margins from negative to 15% or about 26%, should we expect that ramp to continue?

Is the improvement now going to be focussed on the product side, thanks.

Let me take that last question first.

On gross margin, we would anticipate over the course of the year expansion of both product and service gross margin.

It may be a bit lumpy.

We may not do that each and every quarter.

I would say the service gross margins are probably going to be a little bit more up and down quarter to quarter, but we would certainly anticipate an improvement on a year over year basis in the December quarter, both in service and products.

In terms of your first question about you know forecasting revenue for Avaya, given where we are in terms of building the pipeline and opportunities, you know, I'm not comfortable putting a number out there quite yet.

Thanks.

Thank you.

Our next question is from John Shaw.

Please state your company name followed by your question.

Lehman Brothers.

Thanks.

Gordon, now you have the Black Diamond 10K and (inaudible) you are already shipping.

What kind of new products should we be looking for over the next six months?

Was something like 10K stackable switch make any sense?

Hey John, I'm not in a position to announce any new products on the call today.

The 10K were a big launch for us.

The culmination of more than three years of R&D in both software and hardware.

And you know, we still have, we saw some work to do there.

You know, we do have a pretty full suite of products that will come out throughout this calendar year.

So certainly you can expect new products but we're not in a position to make any announcements today.

OK.

One other question I had is the national reseller;

I think you may have mentioned last quarter it was 28% of your U.S. sales.

And this quarter I think you said 20%.

Was that right?

If that is right, it seems to be a big decline.

And could you comment on that?

You know, I don't have, Bill and I don't have that data in front of us.

But we'll look that up and get back to you on it.

OK.

Then last question, regionally, I know you are looking for revenue growth for March quarter, sound like you expect the U.S. really to be up.

I was wondering do you have any comments on Europe, Japan or the rest of the Asia?

We do expect the U.S. to be up and hopefully we expect to grow all regions.

OK.

Thanks.

Thank you.

Our next question is from Rich Church.

Please state your company name, followed by your question.

It's Wachovia Securities: A couple of quick questions.

Can you give us the split-out between enterprise versus service provider?

And then also, can you give us some color on the U.S. market?

For example, if you would have been able to ship all the products that had been ordered with the U.S. have been flat sequentially or what's the order of magnitude there?

And then finally, could you talk about the tech data relationship and where that stands as a percent of rev.

On the service provider breakout, the split was approximately 71% into enterprise, 29% into service providers.

In terms of the effect of product constraints, as we said at our December Analysts meeting that absent the product constraints on the Black Diamond 10K and a few other smaller products, revenues could have been flat sequentially in total.

Also yes, that would have been a big part of that increase would have been in the U.S.

And I'm sorry, what was the last part of the question?

Oh, on tech data, what percent of revenues?

Yes, the tech data was below 10% and that's really just a reflexion of that North America overall performance.

OK.

Thanks a lot.

Thank you.

Thank you.

Our next question is from William Becklean.

Please state your company name followed by your question.

Yes, thanks.

Oppenheimer.

Talk a little bit about your perception of Avaya sales pitch to their install base.

Probably most of Avaya's installed base has a reference network provider right now, in most cases Cisco but other people.

As they go into a legacy account within Avaya PBX story how does extreme play into that?

Does it have to be a branch office opportunity?

Are people going to rip out old infrastructure?

What's the mechanism that's working there?

First of all, you know, we do have a number of early engagements.

And so, you know, please bear in mind that my answer are based upon a relatively limited experience at this point.

You know, we have seen some things move along pretty quickly in what I would call a mid size enterprise in terms of customers doing a large-scale upgrade to IP telephony and doing an upgrade of the network at the same time.

We also see when there's what I would call a green field opportunity that, is a company moves into a new facility or expands their campus and looks at that as an opportunity to provide a converged communications.

You know, that allows Avaya and extreme to go in and make a proposal that includes the network as well as the IP telephony solution.

OK.

So, you're really talking significant upgrades?

We're not talking and how many of those do you expect those will be particularly among large customers that will do a whole scale upgrade?

Once again, I mentioned it's early to say, but certainly the responsiveness from customers has been very positive.

And I think the fact that we go in as a best of breed partnership and can look people in the eye and say this will be fully supported.

This is how the Q. 0 OS works together to support IP telephony, here's what you can expect and here are the services to make it work.

As we've indicated since our announcement, we're bullish there.

Thanks, Gordon.

You bet.

OK.

Thank you, bill.

Next question, please.

Thank you.

Next question is from Steve Kamman.

CIBC World Markets.

Two questions.

One, 3 com is saying some very aggressive things about distributor payments and really trying to push hard in the channel.

Wanted to see if you had seen any impact on that, and kind of as they roll that out, how do you plan to respond in terms of your own relationship with channel partners?

Or are you paying the 10, 15% pay out that they're promises already so did isn't an issue?

Secondly, just to follow up on the Avaya question, any sense of how much opportunity there lies in kind of the installed basis of Avaya Cajun gear, I know it's long in the tooth right now and wanted to sense how much opportunity there is immediately there.

Obviously the rip and replace is beg to be an easier sell and then beyond that, any additional color you can offer.

Im sure Steve.

I think most of 3 com's partners targeting smaller accounts than we do.

I would say there's not much overlap within channel partners between extreme and 3 com.

So we haven't seen any impact there.

You know, in terms of, you know, Avaya and their installed Cajun base our target with Avaya is to provide converged targeted solutions, not to go out and replace Cajun gear.

So it is a very strategic relationship looking at the large-scale IP telephony deployments and primarily new deployments.

Thanks very much.

Thank you.

Our next question is from Erik Suppiger.

Please state your company name followed by your question.

The growth equities, a couple of questions here.

First of all, Gordon, when will the Avaya sales channel both direct and indirect be trained on extreme?

And if you don't want to speculate as to forecasts, can you just give as you sense as to when you think that channel will reach a relatively sustained level or at least it will be up to where you want it to be on an ongoing basis?

Yes, I think the last part of your question is the key there in terms of when do we get some momentum built.

You know, I see that happening, you know, right around mid calendar year.

We have begun training already.

We began training in December.

But as you know, they have a very large organization and it's going to take some time to get everybody up to speed, not only within Avaya but within their channel partner community.

So we do have teams doing that as we speak.

And I think we'll get through the bulk of that, you know, in the next two quarters.

OK, and then secondly, can you just comment, what percentage of your revenues are currently coming from new products.

You said it's going to increase.

Do you have a sense for what it is right now?

No, we haven't been reporting that specifically.

OK.

Thank you.

Thank you.

Our next question is from Andy Schopick.

Please state your company name followed by your question.

Thank you and good morning.

I did want to come back to the Avaya and tech data relationship.

Specifically the question I would like to ask you Gordon, is how do you anticipate the Avaya relationship impacting your traditional relationships with two-tier distributors such as tech data?

Are we going to see more or less of a reduced use of that channel to market as Avaya builds up?

Hi, Andy.

Good morning.

I don't see that happening.

You know, I look at that, at the business for converged communications, from what I've seen, it's pretty independent as a channel.

You know, we've had a great relationship with tech data for many, many years.

You know, I don't see that changing.

I don't see them, you know being replaced, you know by a different type of distributor.

I think they will continue to provide extreme solutions into the broad data networking of market.

And we may have some distributors that are very specific to our strategic partnership with Avaya.

It just seems that the tech data business is on a down slope for whatever reason they've traditionally almost always been a 10% customer and it does seem like there is some softness in that particular channel.

Yes, I wouldn't call it softness.

I would say there was an overall decline in the Americas that pushed tech data below 10%.

But you've also, you know, we have been investing in our national partners as I mentioned, Siemens, Dell, SBC and Verizon.

And you know, a smaller percentage of that business goes through tech data.

One last question for Bill.

Bill, I notice there has been no provision for any inventory reserves through the first half of the current fiscal year.

Do you recall the last time the company took any provision for inventory?

I think it's been close to a year.

I believe the last time that a significant re-structuring was in Q2 of 2003 where the company took a 26.9 million dollar restructuring charge that included inventory write-downs.

Yes and again, I mean with inventories back on the rise, I just wondered to what extent it might be proper for the company to be looking at those reserve

Our inventory, the inventory that's there on the balance sheet, the net basis is fresh inventory, we fully anticipate selling that through.

We're doing a much better job of controlling where inventory is, what our inventory is, thinking it with forecasts.

No, I'm very comfortable with what's there.

Returns, we are down from 11 to 8 sequentially, but we anticipate improving those turns going forward.

Thank you.

Our next question is from Chet White.

Please state your company name followed by your question.

Good morning, Merriman, Curhan and Ford.

Just a couple of quick questions.

Better give us an idea on new products as a percentage revenue or just momentum, I know that you said you don't track it, but is there any way you could comment on how the triumph is doing it?

That seems to be the missing piece of the puzzle.

Where you can quantify 10-gig wireless LAN as being relatively small.

Hi, Chet.

Yes, I mean it's not that we don't track t it's just that we don't report it.

I can assure you our product managers do track their products and we watch those transitions very, very closely.

So I didn't make any comments about the triumph.

I didn't mean to not state anything other than the transition to the triumph products is going very smooth.

It's a growing part of our product line.

And it is providing a complete refresh of our Alpine and black Diamond.

If I look at the MSN three and some of the blades in the black Diamond have really done a great job in providing functionality for that product line.

Is there any way to give some scale to how well that's doing?

Not really.

Other than when we first introduced those I indicated it would be approximately a four-quarter transition from inferno to triumph and that there would be some people who would not transition over, some carriers tend to be in a four quarters to six quarters range, but everything is moving over as I had expected.

OK.

Just a two more quick ones.

Is it fair to assume that backlog at a minimum went up by 4 million dollars that's what disappeared on the quarter?

Or could it have gone up more?

And government, you mentioned that as a good vertical.

As percentage of revenue?

Roughly, where is that?

Hi Chet.

On backlog.

Backlog is definitely up sequentially, but we don't report exactly what the figure was nor the changes in it in dollar terms, but it was absolutely up sequentially.

In our government, we don't break out verticals either.

Yes, government was relatively low in low single digits.

OK.

Thank you very much.

Thank you.

Thank you.

Our next question is from Jason Ader, please state your company name, followed by your question.

Thomas Weisel Partners.

I just wanted to go back to this black Diamond 10K supply constraint issue.

Bill, am I right to think that the dollar impact from the 10K was around 4 million dollars?

Is that what you're saying?

It was near that.

OK.

So that seems relatively high.

I mean were you guys surprised by the interest?

It's extraordinarily, obviously in an early stage for a 10 gig of Ethernet?

Yes, we've been very pleased with the demand early orders of that product.

Absolutely I'll stop short of saying we were wildly surprised by, but we're very encouraged by it, certainly.

OK.

So then what I was going to ask is that if you take -- if you add back that 4 million dollars, you still would have been down in the U.S. in what otherwise seem like a pretty strong seasonal quarter.

So I guess I'm wondering you talk about the national resellers doing better and you talked about tech data, not being much softness.

What is going on in the U.S.?

And how do you explain the weakness because even with the black Diamond 10K you would have been down?

Can you help us understand why you're going to start doing better in the U.S., you know, is there some kind of structural change beyond Avaya which obviously could be a contributor?

Yes, this is Gordon.

You know, we don't plan any structural change, you know, our optimism for the March quarter in meeting the commitments that Bill talked about, you know, it based upon, you know, the pipeline and our internal metrics.

So is this a product, is this a product recovery or product cycle recovery in the US, Gordon?

I just think that that's a big part of it.

I also think that, you know, at levels, a couple of deals slip around a little bit and you know it could have been up sequentially or down sequentially based on timing of some deals.

So, you know, there were no any major structural changes that we observed.

You know, we did see a shift in the products.

And although I don't have any, you know, I don't have any evidence, you know, I can't help but wonder if some people may have delayed black Diamond 6800 orders while they waited to see what the 10K was like and what it did.

But again, I don't have any data that would suggest that.

OK.

Thanks.

Thank you.

Thank you.

Our next question is from Gina Sockolow.

Please state your company name followed by your question.

Thank you, Buckingham Research.

Could you give us a revenue breakout between enterprise and carrier separately for the US, Asia and Europe?

No Gina, we don't break it out that way.

OK.

Can you tell us when you look at the Avaya IP telephony demand.

If it's not a green field or forklift, is this when extreme goes in, is it an upgrade or replacement to existing gear?

And what type of gear is affect affected?

Pulled out, is it shifted, what's affected?

Once again, Gina, I want to emphasize it's stiller early and this is speculation on our part.

But there are a number of opportunities we're pursuing, some of these opportunities are, you know, are our green fields, and that is it's a new building or expansion of a campus.

It's pretty typical in that case for people to leave behind, if you will, their old equipment as they move out of a building and use that as an opportunity to upgrade.

If you think about the logistics of moving from one building to another, it's pretty challenging to, you know, to move a network and a phone system over a weekend.

You know, what we see typically is people will build a new network rather than pulling out the old one and physically moving it just from a logistics perspective.

So, that's one opportunity.

It's something that obviously our sales folks are going, going to focus on when there's a change that are coming, we want to make sure we're there.

But for the, are you saying that most of your prospects right now at green field and you see little upgrade from existing?

Once again, we are early in the cycle.

And there are certainly some that are upgrades, you know, from existing networks as IP telephony is installed.

Right.

So for those, those that are upgrades can you talk about the equipment displacement on the Ethernet switch side?

Let me look at my list here.

I'm not sure that we have been specifically tracking that.

Hold on just a second.

I don't have that data broken out by account.

Do you have an every view of how it looks?

Once again, you know, I've got the list here of the opportunities but it does not indicate what networking gear is currently installed.

OK.

My last question is in your guidance, are you factor, are you seeing any or anticipating any change in component prices and are you factoring that in?

You're factoring that into the guidance?

When and how do you think the change in component pricing will impact your costs?

Gina, we're not factoring in any significant or fee change in component pricing up or down.

We do factor into our product cost targets a continuing improvement and of our ability to negotiate prices and move down our component costs and move down our products through engineering.

Thank you.

Thanks, Gina.

Thank you.

Our next question comes from a Raj Srikanth.

Please state your company name followed by your question.

Thank you.

Deutsche Bank.

Gordon, I have two questions, one related to, I'm not going to ask you about estimates for the Avaya relationship, but more importantly, the third point that you covered there was that the service aspect of this whole Avaya and global services deal.

Does that mean that the product that you sell through the Avaya relationship the service associate of those deals would go to Avaya rather than anything going over to extreme?

That's the first question.

Then the second question, Gordon if you could shed some more light on this wireless LAN switch business, how see that developing, how it's going, but the one point in time the big issue regarding wireless LAN adoption at the switch level was primarily related to security.

What is going on with that?

Has that changed or improved in the past.

Thanks for that.

Hi, Raj.

On the service side, the answer there is it's too early to tell, in that getting the service relationship in place is going to take longer than getting the resale relationship in place.

So I don't have a good answer for you there.

I expect we'll be able to update that next quarter.

OK.

In terms of wireless LAN.

Certainly it's pretty well known that over the last couple of years, deployment in enterprise has been more restricted because of concerns over security.

I think and this is supported by the market forecasts from Dell lore row and Gardner that people expect 2004 to be a stronger year for enterprise deployments because many of the security issues have been solved.

So for example, all of the access points that we have shipped were ch (ph) were all tri-band ABS access points, they all have IBS encryption.

So the encryption over the air there is very strong and secure.

Also, in our software, we have extensive security capabilities such as rogue access detection and user authentication.

So the security, it's difficult to describe in an n 100 words or less.

I do their think it has been an issue towards deployment and I believe our product solves those issues.

Are you seeing sort of in terms of the enterprise side of the equation that people are indeed satisfied with the level of security and deciding to deploy more and more?

You know, we really began shipping, you know, complete systems that is access points and switches during the December quarter.

You know, there were some that were set up as evaluations.

And I think that's pretty typical once again given the concerns that you mentioned that people do want to try it out.

But you know, those have been very successful.

So I think people are getting comfortable with our security implementation.

Great.

Thanks, Gordon

Thanks, Raj.

Thank you.

Ladies and gentlemen our final question is a follow-up question from Sam Wilson.

Please go ahead.

Just a quick question on tax rate.

Do you expect to accrue your normal 35% tax provision?

Once we turn profitable.

At a loss, we will not be benefiting the loss with taxes.

Perfect.

Thank you.

Thank you.

Thank you.

Gentlemen, please go ahead with any closing statements.

Just wanted to thank everybody for getting up so early and thanks for your time.