Extreme Networks Inc (EXTR) 2005 Q1 法說會逐字稿

Good afternoon ladies and gentlemen and welcome to the Extreme Networks quarterly results 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 any time during the conference, please press the star followed by the zero.

As a reminder this conference is being recorded today, Wednesday, October 20th of 2004.

I would now like to turn the conference over Bill Slakey, CFO with Extreme Networks.

Please go ahead sir.

Thank you, operator.

Good afternoon everyone.

Thank you for joining us.

On the call with me today is Gordon Stitt, President and CEO of Extreme Networks.

This afternoon we issued a press release announcing the financial results for Q1 of fiscal 2005.

Copy of this release is available on our website at www.ExtremeNetworks.com.

Let me remind you 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 contain forward-looking statements about guidance, product introductions and customer development which reflect the company's current judgment on those issues.

Because such statements deal with future events they are subject to risks and uncertainties that could cause actual results to different materially.

In addition to the factors that may be discussed during the call important factors that could cause actual results to differ materially are contained in the company's Form 10-Q's and 10-K which are on file with the Securities and Exchange Commission and available on our website.

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

Thanks, Bill, thanks everyone for joining us.

I would like to begin by saying we are very pleased with the results for our first quarter in our new fiscal year.

The results represent another quarter of positive momentum and market acceptance for our innovative networking technology.

Amongst both our install base and new customers.

First quarter is typically a slower quarter for us due to seasonality issues, which includes our fiscal year ending the previous quarter and summer slow downs in some regions.

So it pleases our team even more that we increased revenue, increased profitability, increased gross margins, and increased cash flow over the previous quarter and over previous year results.

During Q1 we grew revenue to 95.1 million and we achieved the top line range that we mapped out for ourselves last quarter.

We remain on target to deliver on our calendar 2004 goal to grow revenues in the December 2004 quarter by 15% or more above the 83.4 million reported last December 2003.

After returning to profitability last quarter, we are pleased to report increased profitability this quarter.

This is the result of our operating discipline, the strength of our new product cycle and the match between our products and the market requirements.

We also believe that there is a gradual improvement in the networking infrastructure market and again that demand is a match to our product lines.

Now, I want to be clear that from time to time there may be some noise around that trend line, but we do see a gradually strengthening environment.

There are some distinct factors that are driving this strengthening of demand for Extreme Products.

I would like to address these first in our Enterprise Market and then follow up with the factors in the Metro Ethernet market.

Many enterprise networks were upgraded in anticipation of Y2K.

Those networks, installed with state of the art 1999 switching technology are getting older.

Conventional thinking would have it that when these products are fully depreciated they would be replaced.

However in these economic times that conventional view has been thrown out.

Enterprises upgrade when they have a reason to not when the clock runs out.

So it is important to understand the environment, what is changing and what will drive these enterprises to upgrade.

We believe that there are several factors that will drive enterprises to upgrade their infrastructure.

One of the most important is conversions, that is the integration of voice, video and data onto the data network.

Now, in the past, we have seen performance as a driver for network upgrades.

We see this as a less important factor today.

Networks installed in the last three to four years have adequate raw performance for today's applications, but existing networks are hampered in their ability to deliver on converged applications such as voice and media.

I believe that those suppliers that deliver infrastructure supporting conversions will be in position to win the vast majority of upgrades over the next several years.

The days of speeds and feeds in our business are over.

The companies that focus only on performance will be relegated to niche status.

We've already seen some suppliers of enterprise networking equipment report poor results and I think these trends will continue.

So let me spend a few minutes and comment how I think Extreme is well positioned.

I would like to address technology first then our partnerships and channels.

So the technology necessary for conversions applies at a number of levels.

And it is important to look at those to see how we drive a network upgrade.

The first technology required for convergence is end to end quality of services or QOS.

That is the ability to segregate traffic based on the different requirements for delivery.

Now the most important characteristic is delay.

For example if a web page is delayed, no problem.

But if voice packets are delayed communications can be disrupted.

The lack of end to end QOS in the aging installed base will be a driver for upgrades.

Now Extreme has deep experience and expertise in QOS.

Our first products introduced in 1997 delivered the first comprehensive QOS for gigabit Ethernet.

Over the last seven years we have evolved this technology and continued our leadership, and importantly our organization has deep experience in assisting customers with implementation.

We are the leader in our ability to efficiently deliver and implement QOS.

Now the secondary of technology that can drive a network upgrade is network availability.

This is the drive toward 100% up time in IP networks.

Let me give you an example about why this is important, and why it can drive an upgrade cycle as convergence is implemented.

In a web world, we have become accustom to rapid response when we go to an application or website.

But occasionally we have to click refresh because somewhere on the IPnetwork there was a packet loss and the transaction disrupted.

This is no big deal for most applications.

When we click refresh the required command is resent, page reloaded, we're back in business.

But in a converged network the several second delay has a different impact.

The three second drop out on a voice over IP call is very noticeable and the user will likely call the IT support organization and complain.

If this happened on a high priority conference call the urgency of fixing that dropped call will escalate.

The solution is to build high availability into enterprise networks.

High availability is a key enabler to converged applications and it is not wide spread in older networks.

Network availability has been a key area of investment for Extreme for many years now.

From our perspective there are two areas where high availability technology is applied.

In a switch itself and in the protocols that connect switches together.

In other words they are system or box level technologies and network level technologies.

Let's look at the systems level first.

Extreme was one of the first companies to provide redundant switch fabrics in a module layer three switch.

Redundant switch fabrics allow forwarding in a case of a failure.

If followed with hitless fail over, that is the ability to move traffic very rapidly from one fabric to another without dropping packets.

In other words we can maintain voice calls in the event of a fabric change-over.

Now there are many other capabilities in our hardware that contribute to high availability, including redundant power, redundant fans, fail-safe mechanisms, et cetera.

And our experience over the years has led us to deliver the hardware - - high availability that you see in our systems today with our BlackDiamond 10K being a prime example.

But having hardware high availability is only part of the technology answer.

The more complex and challenging aspect of high availability is delivering it on software.

Several years ago we initiated a project to deliver a highly reliable, highly available networking environment.

We call this new operating system Extreme Wire XOS, or XOS.

Development began in the 2000 timeframe and XOS was first delivered to customers in December of last year.

XOS implements a wide range of parallel high availability features.

It is a robust operating environment that provides features such as symmetric multi-processing, modular process loading, and process restart.

We also dramatically simplified the environment and created open interfaces so we can integrate software from partners into this high availability platform.

During the quarter, we introduced the second major release of ExtremeWare XOS, version 11 which broadened the feature set even more.

Interesting to note that a large router manufacturer recently introduced their new high end router for carriers and spoke glowingly of their new operating system with words such as voice grade availability.

They talked about modularity being a critical component to delivering this voice grade availability.

They also made it clear that this was a carrier platform.

Now we couldn't agree more on the modularity requirements, but we believe that voice grade availability should apply to all networks, not just those in the carrier core.

XOS delivers today to enterprises that voice grade availability.

Now this is a significant differentiator for Extreme today and moving forward.

Our ongoing investment in the software platform is focused and is significant.

It is one of the reasons people will choose to upgrade and will choose Extreme.

From a systems perspective our investments in high availability networking in both hardware and software position us well for the next upgrade cycle.

So what about the network itself.

We've invested in the systems but how do we make it all work together to deliver convergence.

Again in our early roots as a company, we designed network level features into our products for high availability.

We've implemented dual homing from the beginning, giving our customers the availability to have redundant connections to core switches.

We introduced ESRP our redundant routing protocol that operates at both layer two and layer three, again providing high network availability.

Several years ago, our carrier customers were asking us for a ring redundancy protocol.

That is a way to provide voice class resilience on a metro network.

We invented a protocol that we call EAPS, which is an acronym Ethernet Automatic Protections Systems that provides for a voice class resilience.

This technology widely used in our carrier customers is now being deployed broadly in enterprise applications.

Each brings carrier class, voice grade protocols to the enterprise, and allows extreme to build networks that deliver high availability.

So from a technology standpoint we are exceptionally well positioned to deliver converged applications in the enterprise.

So I've spent time talking about the enterprise market and what is driving upgrades, I would like to now shift gears to the Metro Ethernet service provider side which represents 20 to 25% of our business.

Now, interestingly there are many parallels.

We are seeing some aging networks as we do in Enterprise and we are seeing requirements for convergence.

Carriers are focused on incremental revenues and services and that means voice and video.

These so-called triple play for carriers is a delivery of voice, video and data to customers and that is the hot button that will enable Metro Ethernet carriers to increase revenues.

So for Extreme, the same QOS that integrates voice into the Enterprise enables the triple play.

We've built extensive capabilities for very fine grained QOS into our triumph generation of ASICs and into our fourth generation Genesis ASICs.

And as I mentioned for enterprises we have the same level of expertise in implementing QOS for customers.

This is a significant competitive advantage for us.

We feel we are well positioned to win new customers as well to upgrade existing networks.

Now the high availability requirements of carriers are well known and I don't need to explain those to you.

Investments that we have made in both system availability and network availability will service well in the metro Ethernet market.

That brings us to the next topic, which is the partnership and channels that we have developed capitalize on these network upgrades.

As you recall, we announced a comprehensive partnership with Avaya late last year and kicked off activities at the start of this calendar year.

The Avaya, Extreme relationship continues to grow stronger.

As discussed on previous calls our two sales teams are working well together around the world.

We continue to train and certify their sales force and their extensive channel partners.

Last spring the two companies demonstrated IP telephony running on the (inaudible) show Interop NetWorld in Las Vegas.

This was a great demonstration of the best of breed converged infrastructure.

We also demonstrated some of the technology from our joint R&D efforts which included network management applications for the first time allow users to manage a multi-vendor IP telephony network from a single console.

We are on track to ship our first joint technology early in calendar year 2005.

With the success of the partnership I am pleased to say that the two companies have recently extended the relationship for another year making it a four-year partnership.

Our relationship with Avaya and other technology leaders is a very important component of our open converged network strategy.

Please allow me to change gears for a moment and discuss some of the changes we have made here at Extreme in our team.

Last quarter we announced that we appointed a new SVP of Worldwide Sales, Frank Carlucci.

Frank was joined by Sean Darcey (ph) who came to us as VP for North American Sales.

A transition in a sales organization are always challenging and we put in place a number of incentives during the June quarter to ensure top performance of our sales organization as we went through the transition.

After the first quarter with new sales management I am very pleased with the success of the transition.

Both Frank and Sean have immediately integrated into the team, they have taken leadership of the organization and put up the numbers in what is typically a seasonally slow quarter.

Not only the sales team put up the numbers but there is a strong sense of momentum within Extreme that will carry us through this year.

The real results come from customers.

I would like to spend a few minutes going through some of our wins and installs during the quarter.

Now last quarter I discussed how leading research organizations have been deploying our switch solution and BlackDiamond 10K switch in particular.

Today I would like to review some of the recent enterprise customers deploying this award winning core switch.

This core switch offers unique and advance features delivering the resiliency and scalability that mainstream businesses have come to expect.

National Electronics Retailer, Radio Shack of Texas, a leading consumer innovator will be implementing a converged network solution from Extreme Networks and Avaya at its newly established corporate headquarters in Fort Worth.

Extreme and the BlackDiamond 10K switch was selected for its ability to deliver a complete enterprise solution with functionality, scalability and comprehensive approach for reliably delivering converged applications over the network.

Specific Title and Art Studio of Hollywood produces the majority of domestic movie trailers for theatrical distribution.

The company considered a new IP network to support its advanced equipment including scanners capability - - capable of digitizing film at very high resolution and laser film recorders for full digital production.

Specific title takes media and convergence truly to the extreme.

They are implementing the BlackDiamond 10K switch and our Summit 400 gigabit Edge switch solutions to establish a very high performance land where film resolution with file sizes in the hundreds of gigabits can be easily exchanged across its multiple buildings.

Great Britain's Auto Trader website, the U.K.'s largest used car online forum is enhancing its network performance and availability with Extreme Networks.

The expansive site hosts 2 million unique user visits per month where they come to view a rich assortment of cars and can choose to have content distributed via mobile and digital platforms.

This site is powered by Extreme Summit 400 switch, this results in a highly scalable network with gigabit connectivity at the edge and a boost to these core applications.

Now in the service provider side.

Service providers and local governments are sponsoring metropolitan IP network projects that are aimed at delivering advanced applications and services.

In China, two regional cable TV service providers, Jiuqugang Cable (ph) and Yueging Cable (ph) are relying on extreme switching solutions including 10 giga bit ethernet capabilities with our BlackDiamond 6800 platform to deliver Internet access across residential ethernet connections Extreme offers a cost effective way to roll out these services and delivers the backbone scalability as communications grow in scale and content.

In the local government segment, Michigan's Oakland county incorporating cities such as Auburn Hills, Bloomington and Pontiac is finishing an immense network upgrade implementing our Alpine and Summit switches to establish a county wide metro network.

Network all managed and monitored from a single console with our Epicenter management application supports high speed emergency voice communications over IP transport.

Additionally the criminal justice department can now rely on IP video streams to modernize the arraignment process taking up less time and resources.

Also in the metro Ethernet area we are working with KAMO, and KAMO is an acronym for Kansas, Arkansas, Missouri and Oklahoma.

Their K power net, a leading edge data voice and video service capable of offering scalable and flexible Ethernet data services in the four state metropolitan area.

KAMO has been utilizing extreme networks EAPS capability on its network to achieve carrier class resiliency with sub 50 mila second fail over for services that are supported by Extreme Networks Alpine switching platform, retail fiberoptic cabling, and wireless network connectivity.

Another example is Brookwood hospital of Alabama.

The 546 bed facility is implementing Extreme to enable a transcription dictation system called Healthy Net.

This allows personnel to carry tablets or laptops with them where they can immediately access transcription information from any area of the hospital.

A 48 port and 24 port Summit switching solution spring bring flexibility allowing them to deploy access points for any given floor of the facility.

And finally, the Georgia Court of Appeals has been implementing our UAA Solution for a new court room wireless LAN internet access and communication system.

With the system, courtroom staff can access research materials on the internet throughout trial proceedings.

They also use the network to enable instant messaging between personnel.

Now these capabilities increase the efficiency of the proceedings while minimizing interruptions.

So before turning things over to Bill let me summarize.

We believe that the demand is firming.

We believe that there is a significant opportunity ahead for network upgrades.

We have excellent technology, strong partnerships and strong channels to capitalize on this opportunity.

Our performance over the last few quarters demonstrates how we have undertaken the right steps to grow while many others in our sector are contracting.

With that, I would like to turn the call over to Bill.

Bill.

Thank you Gordon.

Good afternoon again, everyone.

As always I am going to briefly review our financial results for the quarter and then update our expectations for future performance.

Revenue for the quarter was $95.1 million up 3% sequentially and up 9% year over year.

Revenue consisted of 81 million in product revenue and 14 million in service revenue.

Service revenue was up 6% sequentially and 31% compared to the year ago quarter making this the fifth consecutive quarter in which service revenue has been flat to up on a sequential basis.

Service revenue now makes up 15% of total revenue compared to 14% in Q4.

And versus 12% in Q1 a year ago.

Product revenue increased 3% sequentially and 6% year-over-year.

Shipments of modular products represented 54% of sales and stackables represented 46%.

This was a slight shift toward stackable products from last quarter but generally consistent with the typical mix.

The split of enterprise sales and service provider sales was 75% to 25%.

A slight shift toward service providers compared to Q4 but generally consistent with our typical mix.

We had one 10% customer during the quarter, Tech Data.

During the quarter, we saw a sequential increase in revenue from our BlackDiamond 10K product line.

Gordon noted for you that the XOS related upgrades are now available for the BlackDiamond 10K, specifically XOS 11.

This upgrade noticeably enhances the capabilities of the product and is playing an important role in increasing revenues.

Another driver of demand for the BD 10K is increasing use of 10 gig in the Core networks as evidence of that trend our bookings of 10 gig ports worldwide increased over 50% sequentially in September.

Revenues attributable to our Avaya relationship increased sequentially during the quarter as well.

We are now getting incremental traction in Europe as well as the U.S.

We have also refocused our Avaya sales team, or I should say transitioned our Avaya sales team in the U.S. moving them out of the training and support role they have played during the first few quarters of the relationship in getting them more directly involved in driving sales and pipeline increases.

Avaya revenues now account for more than 5% of our total revenue.

And we are targeting to add at least $1 to $2 million sequentially to our revenue each quarter as we did this quarter.

In other parts of the product line we saw strong contributions this quarter from newer products such as the Summit 200 and 400.

With the Summit 400 benefiting in part from an increase in the role out of gigabit to the desktop.

We also saw sequential increases of sales in our Alpine products, including sales of our new power over Ethernet and unified access capable blades.

Another indication of customers ordering for voice over IP requirements.

Sales in some of our older stackable and chasey (ph) products declined during the quarter consistent with a shift in mix towards newer products.

Our book to bill for the quarter was below 1.

This was a function of a very strong Q4 bookings result when year-end sales activities resulted in unusual number of bookings for Q1 delivery occurring in Q4.

One way to normalize for this is to look at book to bill over the six-month period of Q4 to Q1.

And our book to bill is above 1 for that period in total.

Our expectation is that we will return to a more typical pattern of book to bill being at to above 1 in December, and our current read of our order pipeline supports that view.

Looking at sales geographically, revenues in the U.S. were $40 .4 million up 5% sequentially and up 11% versus the first quarter a year ago.

This is now our third consecutive quarter of sequential revenue growth in the U.S..

In the U.S. our national resellers, Dell, SBC, Siemens and Verizon, in total accounted for approximately 24% of our U.S. bookings, an increase from approximately 21% in Q1 a year ago.

A particular note in the quarter was sequentially higher revenues from Europe in what is typically a seasonally week quarter.

Revenues in Europe were $25.2 million up 2% sequentially and up 21% versus the same quarter a year ago.

A very good result.

We saw good sequential growth in southern and central Europe and in areas that did not grow sequentially we generally saw less of a seasonal decline in revenues relative to the last two years.

Of note -- excuse me.

In Japan, revenues were $18.2 million, down 5% sequentially and down 3% from the first quarter a year ago.

We are gradually growing our enterprise business in Japan.

But lumpiness in our service provider business may obscure that from one quarter to the next.

Looking at Asia outside of Japan, revenues were up 14% sequentially, at 11.3 million in line with revenue of 11.5 million in Q1 a year ago.

Revenues in Asia can be lumpy for us but this is now two consecutive quarters of sequentially higher revenue.

Looking at gross margins now.

Total gross margin increased to 53.2% in the quarter.

From 52.5% in Q4.

Product gross margins were 55.3%, roughly flat with the 55.5% reported in Q4.

Product gross margins were down from 56.4% reported in Q1 a year ago.

However a year ago you may recall we had a benefit of one time items on the cost of goods line which we noted for you at the time added approximately 1% to our product gross margin in that period.

Absent that benefit, product gross margins were approximately flat compared to a year ago.

Service gross margins were 40.9% from the quarter, up from 34 .5% in Q4 and substantially up from 14.9% in Q1 a year ago.

Our service gross margins have benefited over the past year from higher revenues as well as improvements we've made in reducing the price per unit, repair cost, failure rates and overhead.

Turning to operating expenses.

Total operating expenses for the quarter were $45.8 million down from $46.5 million in Q4.

This Q4 figure does not include a restructuring charge last quarter.

The sequential reduction in operating expenses was driven by $1.5 million reduction on the sales and marketing line as we moved past year end commission accelerators and marketing activities that were part of the spending mix in Q4.

G&A spending was up sequentially on slightly higher legal bills and Sarbanes Oxley related spending.

R&D was up slightly as well on higher project spending.

Our operating expenses, not including restructuring charges have now been in a range of 45.8 million to 46.6 million for four consecutive quarters dating to fiscal Q2 of last year.

This is consistent with the goal we have laid out previously to reduce operating expenses as a percentage of sales by keeping spending generally flat while revenues rise.

Over the last four quarters , this formula has resulted in over a 7 point reduction in operating expenses as a percentage of sales from 55.4% in Q2 of fiscal 2004 to 48.1% this quarter.

Operating income for the quarter on a GAAP basis was $4.7 million or 5% of sales compared to an operating profit of $1.2 million or 1.4% of sales in the same quarter a year ago.

The year ago results included a restructuring charge of $1million.

Adding $100,000 of net other income and expense, leaves income before taxes at $4.9 million for the current quarter.

After-tax income was 4.1 million or 3 cents per share.

The total shares used to calculated diluted EPS in the current quarter was 123.4 million shares.

Total shares outstanding at quarter end were 120.8 million shares.

A note on our tax rate, which was 15% for the quarter.

As a result of tax losses incurred by the company over previous years, which we use today to offset some of our tax liabilities, we anticipate a relatively low effective tax rate on our results for some time.

The 15% rate used this quarter is representative of the rate we expect to record against our results throughout this fiscal year based on our current level of profitability.

Turning now to the balance sheet.

Total cash, cash equivalent, short-term investments and marketable securities on September 26 was $439.9 million, up 14 .2 million from the fourth quarter and up 36.6 million from the first quarter a year ago.

This was a very solid performance during the quarter and was the result of both our improved profitability and good working capital management.

Accounts receivable were 28.8 million, DSO at quarter end stood at 27 days an improvement from an already respectable 33 days at the end of Q4.

Net inventory at quarter end was 23.9 million down 2 million sequentially.

Inventory turns stood at a very good 7 turns for the quarter.

Accounts payable balances at quarter end were 20.4 million which is 1.4 million higher than balances ending Q4.

Some other items for you, depreciation and amortization for the quarter was $6.3 million.

Capital expenditure for the quarter was $2.2 million.

Head count at quarter end stood at 788 regular employees, which compares to 784 at the end of Q4.

We also had 56 contractors on board at quarter end.

Turning now to guidance.

For revenues in the December quarter, our expectations are that the environment for networking vendors will improve modestly and provide a back drop for revenue growth.

Gordon has outlined for you the logic behind that expectation.

As for growth opportunities specific to Extreme, we think that a continued focus on new products and a continued contribution from our Avaya relationship and continued sales execution can help provide the basis for revenue growth from the September quarter to the December quarter.

We currently anticipate the revenues will grow 1to 5% sequentially from September to December.

If achieved that would leave us with revenue growth in the range of approximately 15 to 20% in December, 2004, compared to the December quarter a year ago.

This is consistent with the goals we first laid out for you last year.

On gross margins, to remind everyone of our previously stated goals for calendar 2004, our goal was to expand gross margins as a percentage of sales generally throughout the year.

We may not expand gross margins sequentially each and every quarter but our goal has been to operate in the range of 52 to 55% total company gross margin by the December calendar quarter.

We actually began to operate within that range in the June quarter and moved up in that range in September.

Our expectation for the December quarter is that gross margins as a percentage of sales will be similar to the 53.2% that we have reported for September by similar we mean slightly up or slightly down, depending most importantly on the precise mix of product and channel sales we ultimately record for the quarter.

On operating expenses and improving the operating leverage in our business, our previous goal for calendar year 2004 has been to improve operating leverage by holding operating spending very close to current levels while increasing our quarterly revenue rate such that operating expenses fall to a range of 42 to 47% of sales by the December quarter.

We have made progress towards that goal each quarter of calendar year 2004, our current expectation for the December quarter that operating expenses will be in a range of 46 to 47 million in total.

Meaning that we are within striking distance of operating within our target percentage range in December.

Ultimate success will depend on the precise level of revenues and spending within the ranges we've laid out.

To reiterate my previous comment we anticipate a tax rate of 15% going forward through this fiscal year.

As always, I will note there are risks associated with our expectations.

It is important to note after that three quarters of revenue growth we are still in the beginnings of a return to sequential growth for Extreme and it is too soon to call any trends.

We are encouraged by the revenue growth we've seen in the U.S. and in Europe in the pat two quarters and by the progress we are making on new products and on the Avaya relationship.

But it is still a case where one or two large deals a quarter can make a difference between sequentially up or sequentially down revenues.

Our quarters are back-end loaded I will remind you, with approximately 50% of our business done in the last month of the quarter.

Let me summarize my comments this way.

We are very pleased with the revenue growth and improved profitability that we have delivered this quarter and that we have delivered each quarter of calendar year 2004 thus far.

We're pleased that for the third consecutive quarter we've laid out our expectations for investors and then delivered on those.

A number of parts of our business showed solid improvement sequentially and year-over-year and we are looking forward to and planning for additional progress in the December quarter.

That said there are several risks associated with our plans and we'll be watching them closely.

With that let me the call back over to Gordon.

Thanks, Bill.

I would like to summarize a couple of points before opening things up for questions.

First of all, we believe that the climate is getting gradually better.

We believe that there are strong upgrade cycles ahead in the marketplace and both of our markets in Enterprise and Metro Ethernet.

We believe we are well positioned to capitalize on those upgrades.

While our competitors struggle with products, performance and viability issues, we have been investing in building the foundation for success.

We have strong products that deliver on the requirements for convergence, we have strong partnerships to broaden our appeal and increase customer stickiness.

We have strong global channels, well diversed in the requirements for large scale Enterprise and Metro Ethernet networks. and we have a fantastic customer base from the largest companies and carriers in the world that have taught us well in terms of their requirements.

Operator, with that I would like to open up for questions.

Thank you, sir.

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

If you have a question, please press the star, followed by the one on your push-button phone.

If you would like to decline press the star followed by the two.

You will hear a three tone prompt acknowledging your selection.

If you are sensing speakerphone you will need to lift the handset before pressing the numbers.

One moment, please, for our first question.

The first question is from Mark Sue, please state your company name followed by your question.

Thank you.

RBC Capital Markets.

Gordon, can you comment on government spending, was it a regular vertical for you during the quarter or do you see a strong flush at the end of the quarter and how are things shaping up for the government vertical for the December quarter and maybe you could split your commentary between Federal and state and local.

And Bill if you could just comment on deferred revenues that was done a little bit in the current quarter.

Hi, Mark.

In terms of looking at September quarter, and I think you are interested primarily in Federal, we did not see a major flush of budgets our Federal business, you know, continued on.

I don't have the exact numbers in front of me.

But we did not see a year end flush.

In terms of you know guidance going forward, state and local has been strong.

I mentioned a couple of wins on the call in terms of metro networks that are being implemented by governments.

Now we count those in the metro space not as an enterprise, so we don't breakout that subset.

But that part of the business is strong.

And, Mark, this is Bill.

On deferred revenue it was down approximately 3 million in the quarter that was due almost entirely to service contracts, professional contracts, professional services and warranties.

Extended warranties.

Thank you.

Thank you.

Thank you.

Our next question is from Alex Henderson.

Please state your company name followed by your question.

Thanks.

Smith Barney.

Your comment that the climates gradually improving seems to contradict I think a lot of people's view on what is going on externally.

Certainly, if you were to look at the supply change numbers over the course of the last couple of months, lead times on chips have rolled over most of the chip companies have missed numbers, the contract manufacturers have brought down production expectations and there seems to be a growing view that conditions are, in fact, rolling over a little bit.

What gives you the confidence in the statement that the climates improving?

Can you give us a couple of indicators that you are looking at , for instance, are you tracking your va var (ph) activity rates, have you seen any improvement in closure rates, have you seen increase in deal sizes or any of the variables along - - those types of metrics?

And just to be sure I understood what you said you expect revenues up 1to 5% for the next quarter with a book to bill above 1 in the December quarter, is that correct?

Alex, this is Bill.

Let me jump in on the last question and leave the first set of questions for Gordon.

Yes we did say revenues up 1to 5% sequentially and that we anticipate book to bill at or above 1in the December quarter.

Yes Alex this is Gordon.

In terms of why we say demand is strengthening.

Again, as I mention in the prepared remarks, that we feel we have an excellent solution for what people are buying and to drive people towards a network upgrade cycle.

I think that's an important differentiator for us.

We base it in general on pipeline measurements.

We do very careful tracking of our sales pipeline, our close rate, we also look in detail at what our regional commitments are and what the upside is.

We do see a great pipeline.

We do see a lot of activity that's been going on.

I would say that's been going on for the last several quarters.

I have made that comment in the past.

So if I could just follow up, so you are saying your pipeline is accelerating.

Is it accelerating at a rate faster than the rate of acceleration and revenues you are giving for guidance toward?

And if your closure rate is starting to show some improvement or is it flat and did you mention deal sizes?

Yeah, I mean, my answer was really to your question of a general one of why do we feel that things are firming and demand is strengthening.

I would rather not get into any specifics of being measured quarter to quarter, month to month on our internal sales statistics other than to say that is the source of our confidence.

So your confidence seems like it is predicated primarily on extreme based issues, that doesn't necessarily imply an improving economic climb or back drop.

Would you say that you also think the economy's - - or the back drop broadly for the overall industry is improving or is it just an extreme specific comment?

Alex, I am sorry I am not that smart.

I can't predict the overall economy.

All I can say is looking at our metrics we have a little more confidence.

Okay.

Thanks.

Thank you Alex.

We are going to try to limit questions to make sure we get through everyone who's on the list right now.

Operator could we take the next question.

Our next question is from (technical difficulty) please state your company name followed by your question.

Sanders, Marks, Harris.

A question about fourth quarter.

Do you see any signs of a budget flush from the customers or again is it more related to your specific Avaya relationship and new products you are seeing this growth?

And then I had a question on the Siemens, Suave relationship that was recently announced - - Siemens is an important reseller do you see any change in that position given their relationship with Suave?

We have an excellent relationship with Siemens that dates back, you know, quite a few years, almost to our founding, so we continue to value that relationship and I don't anticipate any material changes there.

You know, again, in terms of, you know, the December quarter in terms of year end, I think it is too early to tell.

Last year as we mentioned, we did not see a year end budget flush on the calendar year, so, again, I am not smart enough to be able to predict or not predict that.

But our information is looking at kind of an extreme specific situation.

Maybe looking at it competitively do you think there are share shifts going on, that you are gaining share in the market?

Yes, I do.

Thank you.

Next question, please.

Thank you, our next question is from Jiong Shao, please state your company name followed by your question.

Lehman Brothers.

Thank you very much.

I have a couple questions.

The first question is related to book to bill.

I was wondering, was it below 1book to bill in line with your prior expectation or not?

And also booking linearity, could you comment on the bookings linearity throughout the quarter because won't the competitors have a reason to talk about now the quarter seem to be more back-end loaded than it has been over the last couple years.

Okay.

This is Bill.

The - - as far as linearity goes the quarter was sort of the typical linearity generally.

It was actually a little bit improved linearity in some geographies, Europe in particular, but generally speaking, the same sort of linearity we usually see.

Jiong your first question?

The book to bill, below one was that in line with your prior expectation?

Given this was a seasonally weak quarter both for reasons of Europe and our typical Q1 this was always a possibility and yes it was on our radar.

The second question is about the gross margin.

I know you guys guided gross margin to be sequentially down and it was actually up nicely.

So I was wondering could you comment on what are the positive surprises of the things worked up to your favor that have pushed that gross margin above your prior expectations?

Gross margins were a little higher than we expected this quarter, it was driven by a very solid result on the service side where gross margins were up over 6 points sequentially that's enough to move the overall needle.

Going forward we anticipate gross margins something similar to what we just reported.

It will be very sensitive to product mix and channel mix.

Okay.

Thank you, guys.

Thank you.

Thank you, our next question is from Kristen Arbacof (ph), state your company name followed by your question.

Thank you I had a question about your service provider business picking up a little bit.

Usually we associate a bulk of the service provider opportunity in Japan, but if Japan was a little bit weak, what other areas did you see growth in service provider?

Maybe just talk about, you know, are we potentially looking at 2005 as finally starting to see the metro Ethernet deployment in the service providers people have been looking for.

Hi Kristen it is Gordon.

Without having a specific deal by deal in front of me, we did see improvements in most parts of the world.

You know, that is Asia, even some business in North America and certainly Europe.

A good part of our service provider business is in Japan, and as we've noted that business, you know, can be and has been fairly lumpy due to the customer concentration.

In terms of forecasting the Metro Ethernet deployment.

It has been a good business for us and a good steady market.

I think you are referring to the U.S.

And I think the U.S. is really challenging there to look at large carriers and I don't think they are in any particular hurry to go to this type of infrastructure.

And the build up we are seeing in the U.S. is coming more from government entities, from state, local, county governments that are building their own private metro ethernet networks.

Thank you.

Thank you.

Next question, please.

Thank you our next question is from Rich Church, please state your company name followed by your question.

Unterberg Tobin.

Can you give us anymore color on the strength in Europe is that Avaya related?

And then also Gordon if you can talk about - - you talked about converged applications, can you give us any sense for what percent of revenue that comprises today and what kind of the goal would be over the longer term.

Okay Rich as it relates to Europe, Avaya was one of the contributors to the strong results but far from the only.

We did see strength across our traditional channels and traditional products and pipelines.

Yeah, and in terms of the percentage of business, you know , from converge I think that's very hard to determine.

I could give you anecdotal evidence that in terms of the specific enterprises that I've talked to or been involved in the deals, a big consideration for them in doing a network upgrade is towards implementing converged applications.

Hence my comments, my prepared comments on the call and that is a very large factor in what's driving new networks.

Could I just follow up.

Gordon, any comments on any new product areas on the horizon?

Yes, we will have new products.

Okay.

Thank you, Rich.

Next question, please.

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

Hi.

Thomas Weisel Partners.

On the 10 gigabit Ethernet comments that you made, I think Bill you made them.

On the growth there, how much of that was service provider related versus enterprise related?

And then just sort of a follow-up when do you think we might see an influxion point on demand within the enterprise for 10 gigabit Ethernet?

Let me address that Jason, this is Gordon.

Demand for 10 gig is really driven by the size of the network, you know, it is driven by the demands for performance at the edge of the network.

It is not going to be a desk top technology and therefore I think the growth curve will be a little bit different than what we saw for the 100 megabit and for gigabit.

It has been good and steady and our market base has been more what I would call, you know, more mainstream versus the early adopters, little bit less of the guys building massive compute farms and buying 10 gig for performance.

Much more focused on the core of large enterprise where it is very high functionality in terms of routing and security capabilities along with 10 gig performance.

The enterprise service provider mix, Gordon?

For 10 gig specifically?

Yeah, do you have kind of a sense of where it is going?

Where it is going from us in terms of what our break down will be.

I think it is more on the enterprise side today but I think as we move into next year you are going to see, you know, metro Ethernet carriers starting to upgrade their networks to 10 gig.

Okay.

Thanks.

Thank you.

Next question, please.

Our next question is from Stephen Kamman please state your company named.

CIBC World Markets.

Just on the - - wanted to ask about sort of layer of four to seven its obviously been refocusing there, Cisco may or may not be doing something in that space.

Any thoughts on where you guys may go on that in terms of adding functionality there, also on the security side, when you talk about new products is it going to been incremental functionality or where are we going?

Yes Steve, so in terms of the layer four through seven, we've chosen to work with partners there.

It is not an area you should expect us to introduce specific products for.

I think on the security side we do have a very robust security solution that is one of the reasons that people choose us.

We break security down into two areas, one is at the edge of the network where we have our Unified Access, which provides for access security in network and the other is in our core products where we have extensive security capabilities around our clear functionality and access control lists.

That's probably something worthy of a separate conversation.

But those are the areas that we are investigating in in terms of what you would call increased functionality.

Thanks very much.

Thank you.

Next question, please.

Thank you, next question is from Samuel Wilson.

State your company name.

JMP Securities.

Two questions really.

First, in general you talked about the high end BlackDiamond products, but can you talk a little bit about the Summit products and how they are doing?

I know you released a whole new suite of them, you know the 200, 300, 400.

And also a little bit on the wireless LAN products.

How is the ramp in wireless LAN gone versus your expectations?

The products have been generally kind of available now for almost a year.

And Bill, just a question for you, cash flow from operations was relatively strong again this quarter, it doesn't look like it was from a significant reduction in working capital.

So kind of what is driving the cash generation right now, do you think that's sustainable?

Thank you.

This is Gordon.

Wireless was roughly flat from last quarter in terms of the switch revenue.

As you probably saw earlier this week we introduced another member of our family there, the Summit 300-24 and provided a lower entry point.

One of the things that people felt was that we have too many ports on our wireless switch.

So we now have two Summit version of the wireless switch and we also during the quarter added wireless capability to the Alpine System and that did sell very well.

Overall dollars were roughly flat.

I would note that going forward that will be more difficult to measure since we are adding wireless capability into the modular systems.

It is tough to tell when somebody buys up delayed, A, how to allocate that and, B, whether it is associated with wireless or more with power over Ethernet.

The first part to your question was around the Summit products.

As you noted we did introduce three new families this calendar year, that is the Summit 200, the Summit 300 and the Summit 400 and just this week enhanced the Summit 300 series.

Those new products are all doing well.

I think the Summit 400 in particular, you know, has been tied up with our BlackDiamond 10K and provides a very nice solution for people giving a lot of security and performance in the core and great feature set at the edge of the network. so those product lines are all doing very well.

Sam, this is Bill.

Your question on cash flow.

The cash flow for the quarter was strong and some of it did come from working capital but not all of it.

Just a reminder that as I noted there, we do record about $6.4 million a quarter in depreciation and amortization and noncash charges and so with net income of 4.1 million plus 6.4 in noncash expenses, that's $10 million just from the income statement if you will.

And going forward, I do expect that we'll continue to expand profitability, drive cash that way, but I do expect that we will need to consume some cash to - - as we grow for working capital.

Thank you, gentleman.

Thank you.

Thank you, our next question is from Erik Suppiger please state your company name followed by your question.

Pacific Growth Equities.

Few questions.

First of all with Avaya you noted it has moved from training to actually selling.

Can you just talk about how many of the Avaya sales reps at this point are getting compensated or have quota related to Extreme?

Yeah, this is Gordon.

Avaya reps are compensated, get normal commissions on sales of Extreme products.

That's been, you know, true this calendar year.

In terms of quota, they don't have a specific quota that's broken out by product line.

How broadly is it all sales reps that are compensated?

It is all U.S. sales reps.

Okay.

You had noted that's gone worldwide, when did that go worldwide?

The original agreement that we signed in November was detailed in the North America market and I'll just say less detailed in the over seas markets.

So we've been working region by region there to put the agreements into place.

Okay.

And you noted your first joint product with Avaya will be coming out in early '05.

Can you give us any discussion on what kind of form factor that would be or what we might look for?

It is actually -- I would term it a technology versus a product and it is a technology that we will implement across all of our products through software and there will also be some converged management tools, you know, which we'll see which is also a software solution.

I just wanted to clarify here, I am being corrected all of the reps around the world are compensated, not just North America.

Okay.

The book to bill, Bill I just wanted to understand by suggesting that it was up from six months ago can we presume it was only slightly less than one, is that kind of the message to take away?

Yeah, the message is for the last two quarters together the book to bill is above one.

It was just a little shift from one quarter to the next that effected the specific measurement this quarter and we are talking about just a few million dollars of shift.

So slightly less than one is a reasonable calculation or reasonable way to look at it?

That's fine.

And then finally, where you noted that deferred revenues were because of the service -- because of the service contracts and whatnot, were you not seeing renewals on those, or is it just the timing of when contracts expire that caused deferred revenue to come down?

A little bit of timing of expirations but the other thing that's going on is the contract services, or professional services business is growing where we would be payed up front for, for instance helping to develop or helping to design the RF network at a customer, helping to design the network itself and then the revenue is recognized as certain milestones are hit.

So that is a part of the service business we're trying to grow.

And this particular quarter it did come out of deferred revenue.

Why does that come out of deferred revenue?

If you are payed up front you get the cash but you don't recognize the revenue until certain performance milestones are hit.

Alright.

So you just hit some milestones this quarter?

Correct.

Very good.

Thank you very much.

Our next question is from William Becklean, please state your company name followed by your question.

Oppenheimer.

Bill can you give us some guidance on share count going forward.

Share count has been from an EPS basis has been expanding 1or 2 million a quarter and I think that's a fair sort of range to use going forward.

Thanks.

Yeah.

Thank you.

Our next question is from Chet White (ph), please state your company name followed by your question.

Hi.

Merriment Current and Ford Company.

Congratulations on sticking with your goals for the year.

Excellent job.

And question on the application.

If you could maybe describe the application of some of the increasing metro opportunities you are seeing and I guess by that I specifically mean are you beginning to see some of the Ethernet backhaul opportunities in the broadband access network or is this more of a typical metro Ethernet opportunity?

And then one follow up.

Yes Chet it is a mix in some of the geographies there is a fair amount of DSL backhaul that's been a nice business for us.

Some of it is the pure metro Ethernet where we are delivering a fiber connection directly to a business.

I see.

Would you expect '05 metro business to continue to be strong and possibly even become a bigger percentage of you revenue or are we in that type of early stage cycle that could become exciting?

That's a tough one to call.

I am not prepared to make a breakout forecast by market.

I certainly am bullish on that market overall.

But I am also bullish that we can grow the enterprise market quickly next year.

Okay, then the last follow-up was the XOS is that migrating now through the rest of your product portfolio?

Or what is the rough timing on that?

Our plan is that, you know, we will put XOS on multiple platforms.

And so I can't claim that it will blow our product line like a hurricane but we'll get it there.

Okay.

Thank you very much.

Thank you.

Operator, are there any other questions.

We do, our next question is from Paul Leony (ph), please state your company name followed by your question.

Hi.

I have one question left.

The question is on the margin level.

There was improvement this quarter and the question is what is your long term goal?

And second, how much more can the service margin improve in the near term and longer term?

Thanks.

This is Bill.

The goal that we laid out for the December quarter was gross margins in a range of 52 to 55%.

I'd like to finish the December quarter, hit that range and then we will outline future thoughts once we've operated within that range for December.

As far as service goes we've seen quite a bit of improvement over the last year on the service gross margins.

I expect that the improvement from here will be much, much more modest, particularly over the next several quarters where we will be putting in place some infrastructure and such to handle the growth that we've seen in that business.

Thank you.

Thank you.

Thank you.

Our final question is from Andrew Schopick, please state your company name followed by your question.

Thank you Nutmeg Securities.

Most of what I wanted to cover certainly as been covered.

But Bill I'll ask you one question about just asset management in general on your marketable securities.

What is anything are you doing if anything to initiate programs to shorten maturities to take advantage of rising interest rate?

Can you comment on that?

To be honest I'd rather not go into our cash flow management strategy other than just to note that it tends to be very conservative.

We have been moving a little it more short term to take advantage of what we do think will be a rising interest rate environment.

But beyond that I'd really rather not go into the specifics of it.

Okay thanks.

Thank you.

Gentlemen that is all our questions.

Alright.

Thank you everyone for joining us this afternoon.

We appreciate the time.

Thank you.

Ladies and Gentlemen this concludes the Extreme Network's quarterly results conference call.

If you would like to listen to a replay of today's conference you may dial 303-590-3000 or 800-405-2236 follow by access number 11010857.

Once again we thank you for your participation.

Have a great evening and you may now disconnect.