Extreme Networks Inc (EXTR) 2005 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Extreme Networks fourth fiscal quarter earnings conference call. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded today, Wednesday, August 3, 2005.

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

Please go ahead, sir.

Good afternoon, everyone.

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

This afternoon we issued a press release announcing our financial results for Q4 of fiscal 2005.

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

A reminder, the call is being broadcast live over the Internet today and it will be posted on our website and available for replay shortly after the conclusion of this call.

Let me also note that some of the remarks we make during this call may contain forward-looking statements about guidance, product introductions and customer developments 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 the actual results to differ materially.

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

With that, let me turn the call over to Gordon.

Thanks, Bill, and thanks, everyone, for joining us.

I will begin this call with a summary of the financial results, review our quarterly and annual business highlights, and then turn the call back over to Bill for a detailed discussion on our financials.

First of all, let me say that I'm pleased with our results for the quarter and for the fiscal year.

We had revenue during our fiscal fourth quarter of 96.1 million and a profit of $0.1 million.

For the fiscal year we achieved revenue of $383.0 million, an increase of 9% over fiscal year 2004.

We were profitable for the entire year, which is a positive shift for the Company and a positive indication for the future.

During the year we had strong growth in the Americas and in EMEA.

The Americas grew by 22% year over year whereas EMEA grew by 28% year over year.

In both of these territories we broadened our channel footprint, which helped us record these growth rates.

Combined these two territories grew by 24% year over year.

We believe that these regions will continue to drive the Company's growth as we begin fiscal 2006.

This growth is a testament to our sales leadership which we installed a year ago.

Asia, though a smaller part of our business, also experienced growth, but the year in Japan was less fruitful.

We have recently installed new leadership in Japan and we're confident that the new leadership, focused on executing our strategy, will result in improved results moving forward.

This was also a milestone year for us in our corporate strategy.

About a year ago, we began discussing the concept of open converged networks, our vision for the next generation of enterprise networks.

An open converged network is one that integrates voice, video and traditional data and that carries applications that are transaction-oriented, that our connection-oriented, and ones that carry streaming media.

Our vision is that access to this information and to these applications is universal and can be wired or wireless, and it must be seamless to the user.

Users not only want access to these converged applications and the underlying data, they want choices.

Our vision of open converged ensures that users can make choices of technology and architecture and ultimately of vendors.

This is differentiation that is working today with customers and prospects.

It sets us apart from our competition in customers' eyes.

This strategy has tied together how we work with partners, it has tied together how we work with channel partners, and it has tied together how we invest in technology.

Our technology and our business practices all support our vision of open converged networks.

During this year we made many enhancements in delivering on the promise of open converged networks.

On the technology side we continue to enhance our BlackDiamond 10K which is our product line for the core of open converged networks.

The 10K brings new levels of reliability and availability to the core of the network that is so necessary to ensure the delivery of dial tone, of data and of streaming media.

This quarter saw strong growth for this important platform.

During this year we completely overhauled our products for the edge of the network.

Our two-tier strategy simplifies the design of open converged enterprise networks by eliminating the middle or aggregation layer and moving that functionality to the edge.

Our BlackDiamond 8800 was delivered in January to meet the requirements for the edge for the open converged network.

It delivers on all of the requirements for high-density IP telephony combined seamlessly with data and video applications.

Needless to say the BlackDiamond 8800 contributed more than 10% of our revenue during the June quarter, representing the excellent customer acceptance of this strategic product.

Complementing the BlackDiamond 8800 is our Summit 300 and new 400 series switches.

These products bring our open converged network solution to fixed configuration products and delivers medium density for IP telephony applications at remote sites or in smaller wiring closets.

Over the past year we focused on delivering high availability to support IP telephony applications.

As we move forward into fiscal 2006, we will focus more and more on adding security as part of an open converged network.

One of the key metrics customers use for success of a converged network is delivering dial tone, and integrated network security is a big part of this.

Viruses, worms and other network attacks can create problems for systems and for network devices, thus impacting converged applications.

We've approached security in three areas.

The first is access security, which is investing in authentication technologies to assure access to the network.

This is done in a seamless fashion independent of whether the user is wired or wireless.

The second is hardening our network switches from attack.

Now these first two allow us to create a strong secure network infrastructure for our customers.

The third area of investment is in protection against a broader range of attacks.

In May we introduced our strategy for Day Zero threats with an innovative approach that is different from what others in the industry are doing.

Typically today customers install an appliance on each network link that they want to protect.

This works, but results in lots of appliances to manage and some significant performance limitations.

Extreme's approach is to invent security functionality into the core of the network which allows us to protect all network links simultaneously and at 10 gigabit ethernet speeds.

The technology we use for this is our CLEAR-Flow world engine, a real-time mechanism for monitoring network behavior and taking action based upon observed patterns.

During the last quarter we introduced Sentriant, an extension to CLEAR-Flow that provides excellent protection for so-called Day Zero attacks.

We believe that going forward the combination of CLEAR-Flow and Sentriant is a key part of delivering the high availability and protection customers require to keep the promise of an open converged network.

Now that I've addressed the switching systems we've developed and some of the solutions, I'd like to take a moment and talk about our platform.

Our strategic platform is ExtremeWare XOS, the industry's first open, scalable, modular network operating system.

XOS was built from the ground up to deliver open converged networks.

It was designed around the principles of high availability -- that is to keep writing no matter what happens on the network.

It was designed to be resilient to attacks and it was designed for seamless upgrades.

All of these characteristics put together allow us to deliver dial tone, data and streaming media on a converged network.

Perhaps most importantly XOS was designed for open collaboration.

XOS is truly a platform upon which applications can be built, and one that allows us to effectively work with partners to deliver their applications.

XOS is based on open XML interfaces, and by the nature of its modular design allows multiple development organizations to build functionality into it.

The delivery of Sentriant, an external appliance closely tied to the internals of our core switches, is an example of that level of integration.

During this past year we brought XOS to the entire network.

In 2004 we delivered XOS on the BlackDiamond 10K for the core of the network.

During this year we delivered XOS on the BlackDiamond 8800 and on the Summit X450, providing users with the opportunity to build end-to-end networks around the XOS platform.

To summarize our technology advances during the year, we introduced our new two-tier architecture for open convergence; we successfully introduced new systems to build that two-tier network; and we introduced our revolutionary concept of delivering security in the core of the network, all of this running and built upon our platform for open convergence, our ExtremeWare XOS software.

I've talked about the technology that we developed to support our open converged strategy.

Now I'd like to address some of the changes we have made to our business to deliver open converged networks to a broader range of customers.

During this fiscal year we made substantial progress in working with our partner Avaya.

As you know, Avaya is the world-wide leader in IP telephony, a key part of delivering true convergence in the enterprise.

We entered into our partnership in fiscal 2004 and made significant strides in that partnership during fiscal 2005.

Sales in the June quarter were up strongly, resulting in high single digits of percentage of our overall sales to this partnership.

We're learning to work with Avaya directly to penetrate large accounts and to work with them broadly to open new channels focused on convergence that were previously not available to us.

I expect that the growth of this important partnership will continue and result in strong results for both companies as we move into fiscal 2006.

When we talk about the growth and success of our business it really all comes down to what customers think.

For enterprises today, IP telephony and the support of converged applications are top of mind.

They also want choices.

I hear time and time again from CIOs that they want to be agile, that they want be able to support new applications that will drive their business, and that they want choices -- choices for network strategy and choices for vendors.

Our strategy of open converged networks resonates with them.

Now I would like to take a couple of minutes and talk about some of the customers that we worked with during this last quarter.

In the higher education arena, the spring was once again a busy time for schools as they prepare for the new year.

Extreme Networks is pleased to be working with California's newest university, University of California Merced.

Opening in the fall, UC Merced is the first American research university built from the ground up in the 21st century.

We will be building a state-of-the-art computing and communications infrastructure enabling streaming media and high-performance computing.

UC Merced will rely on Extreme's newest generation of products including the BlackDiamond 10K, the BlackDiamond 8800, and Summit edge switches, to create a highly flexible, predictable and secure network with the added benefit of high resiliency for converged applications.

I'm also very proud to report that Georgia State University will be performing an Extreme makeover of its campus network in order to support emerging technology such as voice, video and bandwidth intensive grid computing applications.

The new network, to be called CATNET, an acronym for converged access technology network, will bring the university forward with many of our latest technologies including hitless failover for added availability with our ExtremeWare XOS operating system, (indiscernible) scalability in the network core, and the added benefit of sub-50 millisecond failover throughout the network delivered with Extreme's ethernet automatic protection switching protocol.

These capabilities of the Extreme open converged network will allow Georgia State to deploy new services such as H.323 videoconferencing, multitask and IP telephony.

On a lighter note, or perhaps a more serious note, in June Extreme Networks and Avaya supplied the voice and data network for the US Women's Open Golf Tournament at Cherry Hills Country Club in Denver, Colorado.

This was a nationally televised sporting event sponsored by the USGA.

Throughout the tournament 156 players and 2800 volunteers, journalist and broadcasters from around the world enjoyed the benefits of our converged network featuring Extreme's core and Extreme's wireless edge technology.

The converged network performed with excellent results, allowing everyone involved to share both smoothly and rapidly.

Health care continues to provide key opportunities for our converged networks.

A significant win for Extreme in the hospital segment came from Synergy Health (ph) of Wisconsin which is opening the highly modernized St. Joseph's Hospital next week.

The facility will reap the benefits of our open converged network featuring wired and wireless connectivity, as well as a complete IP communication and enterprise messaging solution from our partner Avaya.

The Avaya-Extreme solution provides St. Joseph's with a more efficient and dynamic health care environment where patient and staff information can be shared quickly, reliably and securely.

At the foundation of the new hospital is a robust network infrastructure powered by Extreme Networks' BlackDiamond 8800 and Summit 300 switching families, providing for a robust 10 gigabit core and a network edge supporting IP telephony and wired and wireless applications.

This highly resilient network provides the necessary bandwidth, reliability and flexibility to support St. Joseph's advanced electronic patient record systems, the hospitals' migration to pure digital radiology imaging for x-rayed CAT scans, as well as for the delivery of converged mobile IP voice.

This is just to name a few.

All in all we're very proud of the significant new customers that chose Extreme during this past quarter.

In conclusion, and looking forward, open converged networks has become our calling card with channel partners and with customers in the US and EMEA.

To these customers and partners converged networks are important, and for these partners security is top of mind.

Our product line is focused on this solution set.

We had strong growth in the Americas and EMEA and we hope to continue that in the future.

We look forward to increasingly strong contributions from Japan and Asia.

And we look forward to continuing our pattern of increasing sales while also increasing margins and probability.

With that I'd like to turn things over to Bill.

Thank you, Gordon.

I'm going to briefly review our financial results for the quarter and then update our expectations for future performance.

As Gordon noted for you, we're pleased with our financial results for the quarter.

Our 5% sequential revenue growth is in line with the expectations we set at the beginning of the quarter.

And our book-to-bill was above 1.

This was a good result coming off a tough March quarter, and we do believe that the tone of business in our industry improved in June.

Our business outside of Japan grew 10% sequentially and grew 18% compared to the same quarter a year ago.

Our growth in the US and EMEA was particularly strong, as Gordon noted for you.

And we believe we're taking share in these key markets.

While revenues in Japan were down sequentially, we do believe that quarterly revenues there have likely bottomed.

Gross margins expanded sequentially by 1.6 percent of sales to 53%.

We recorded higher margins on both the product and services lines.

Our operating expenses for the quarter were unusually high due to $2.8 million in legal expenses incurred during the Lucent trial this quarter.

This was a one-quarter event that we flagged for investors with a press release in May, but I realize that many of you may not have included it in your earnings model.

Going forward, we expect a significant 3.5 to $4.5 million reduction in the our operating expenses on a quarterly basis and a return to a much lower ongoing expense level.

For FY 05 as a whole revenues were $383 million, up 9% compared to fiscal-year '04.

Gross margins were 52.9%, up 2% of sales compared to the last year.

Net income for fiscal '05 was 12.9 million or $0.10 per fully diluted share, improved from a loss of 1.7 million, or $0.01 per share in FY '04.

This represented a return to profitability for Extreme on a full fiscal year basis.

Looking at revenues now in more detail, revenue for the quarter was 96.1 million, consisting of 80.5 million in product revenue and 15.6 million service revenue.

As I noted, our book-to-bill for the quarter was above 1.

Our revenues and book-to-bill for the quarter benefited slightly from having an extra week in the quarter since this was the quarter that we caught up on our fiscal-year calendar, meaning Q4 of '05 had 14 weeks rather than 13 and fiscal '05 had 53 weeks.

Service revenue was up 3% sequentially, making this the seventh consecutive quarter in which service revenues have been flat to up on a sequential basis.

Service revenues were up 18% compared to the year-ago quarter.

Product revenue increased 5% sequentially and 2% year-over-year.

Shipments of modular products represented 51% of sales with stackables representing 49%.

This was a shift towards stackable products from last quarter, driven in part by the early success of our new XOS based stackable product, the Summit X450, and by sales of our wireless and PoE Summit 300 line.

(indiscernible) enterprise sales and service provider sales was 79% to 21%, similar to Q3 and generally consistent with our typical mix.

We had no 10% customers during the quarter.

We saw solid contributions from the BlackDiamond 8800.

As Gordon noted for you, this product is now contributing more than 10% of our product revenue.

We also saw sequential and year-over-year growth from the BlackDiamond 10K, our wireless products and our stackable products.

In other words, this was a very solid quarter for recently introduced products, including XOS-based chassis and stackables.

Sales of some of our older chassis products declined, which is entirely consistent with a shift towards newer products.

10 gigabit port bookings were up sequentially from the December quarter.

This continued a shift from gig to 10 gig in the network core and is contributing to the success of the BD 8800, BD 10K and Summit 400 and 450 stackable products in particular.

New bookings for PoE ports were also up sequentially in Q4.

You may recall our PoE port shipments were down in Q3, which we attributed at the time to the introduction of the Summit 300 24 port switch which has taking sales from our 48 port switch.

We expected that to be a one-quarter issue and it has been with PoE ports up nicely sequentially and with the entry price for our PoE switches now reduced.

We expect PoE ports to continue on a growth trajectory driven by demand for IP telephony and wireless.

Bookings through our Avaya channels, both the direct and indirect resellers, increased again in Q4 following the strong Q3.

Avaya channels are now contributing revenue in that US, EMEA and Asia Pacific.

And as Gordon illustrated in his comments, we're getting increased exposure to large deals through the Avaya partnership.

Looking at sales geographically, revenues in the US were 43.1 million, up 14% compared to the fourth quarter a year ago and up 6% sequentially.

For the year as a whole our business in the US grew 22% in fiscal '05.

In EMEA, our European operations which includes the Middle East and Africa, our revenues were $35 million for the quarter, up 42% compared to the same quarter a year ago and up 28% sequentially.

For the year as a whole revenues in EMEA were up 25% compared to fiscal year '04.

These results in the US and EMEA were excellent this year and we believe we're gaining share in these key geographies.

We've seen very strong sales execution in these geographies and we have benefited from a broad channel footprint in both geographies.

In Japan revenues were $9.7 million, down sequentially from 13.2 million and down compared to the same quarter a year ago.

Gordon noted for you the change in leadership that we have just announced in Japan.

That change, along with our current pipeline of opportunities, gives us confidence that we're addressing revenue issues in Japan going forward.

Looking at Asia outside of Japan, revenues were 7.8 million, down from 9.9 in the fourth quarter a year ago.

Revenues in Asia are lumpy for us as a result of a large contribution from service provider business.

Gordon noted for you a change we're making in our management team in Asia Pacific going forward.

Bookings through our Avaya channels worldwide were up nicely both sequentially and versus the same quarter a year ago.

And as Gordon noted, Avaya revenues were once again more than 5% of worldwide revenues for the quarter.

Turning to gross margin, gross margins as a percentage of sales were 53%, up from 51.4% sequentially and up from 52.5% in the fourth quarter a year ago.

Gross margins improved for both products and services with the total 1.6% sequential improvement in gross margins being slightly better than our guidance at the beginning of the quarter.

Product gross margins were 54.6%, up 1.1% of sales sequentially.

Product margins benefited from higher volumes generally and from lower costs on the BlackDiamond 8800, which is now well past the early startup costs associated with its introduction.

Service gross margins were 44.4% for the quarter, up from 40.6% in Q3.

Service gross margins benefited from both higher volumes and lower repair costs generally.

Service margins increased by 10% of sales compared to the fourth quarter a year ago which is terrific progress and the result of ongoing efforts to improve pricing and service offerings and to optimize our service operations.

Looking forward into fiscal Q1, we expect to see gross margins as a percentage of sales that are generally in line with this quarter, meaning they may be slightly higher or lower depending on the exact mix of product and regional sales.

Looking further out in the fiscal year, we believe the combination of new products, higher revenue and operational improvements will lead to further expansion in gross margins from current levels.

Turning to operating expenses, sales and marketing, R&D, and G&A expenses for the quarter were $51.4 million compared with 46.5 million in Q3 and with 46.3 million in Q4 a year ago.

The increase in expenses sequentially are the result of approximately $2.8 million of costs incurred during the jury trial related to the IP infringement lawsuit brought by Lucent and a $2 million increase in sales and marketing expenses.

As for legal expenses, they represent a one-quarter increase in our G&A spending.

We did prevail at trial with the jury finding that we did not infringe on three of the four patents at issue and awarding Lucent 275,000 in the case of the fourth patent which involved a feature we have removed from our product sometime ago.

We also saw a $2 million sequential increase in sales and marketing expense in Q4.

This was due to various expenses, including year end commission accelerators in the US and Europe, purchase of demonstration units for new products and incremental marketing programs.

Looking forward into Q1, we expect to see a significant reduction in operating expenses as we move past year end and past the trial expenses.

All in, we expect that operating expenses will decline sequentially by 3.5 to $4.5 million, primarily on the G&A and sales and marketing lines.

Looking at net income, in Q4 on a GAAP basis, including the 2.8 million in costs and expenses associated with our trial, we recorded an operating loss of $0.5 million.

Adding in 1.1 million in net other income results in a profit before tax of $600,000 and a profit after tax of $100,000 or breakeven on an EPS basis.

Total shares used to calculate diluted EPS in the quarter was 124.3 million.

Total shares outstanding at quarter end were 121.9 million.

Looking at the balance sheet, total cash, cash equivalents and short-term investments on July 3, 2005 was $440.4 million, down 2.9 million sequentially and up 14.7 million from the end of fiscal '04.

Accounts Receivable were 30.8 million, down 0.8 million sequentially.

DSOs at quarter end stood at 29 days, down 3 days from the end of Q3 as a result of a more linear quarter from a revenue standpoint.

Net inventory at quarter end was 25.9 million, up from 22.1 at the end of Q3.

Inventory turns are down slightly as a result of a conscious decision on our part to run with slightly more inventory in order to reduce stock-outs and reduce material expediting costs.

At 7 turns for the quarter, our inventory levels remain very well-managed.

Both accounts payable and accrued liabilities were down sequentially, payables by 3.8 million and accrued liabilities by 6.3 million, representing a total use of cash of $10.1 million.

This was the result of the additional week in the quarter which moved our quarter end from just before the end of the month -- for instance, March 26 in our Q3 -- to just after the end of the month, July 3 this quarter.

This meant that incremental payables came due during Q4 and that an additional payroll cycle was processed during the quarter reducing accrued compensation.

As a result, we used more cash than we usually would in a quarter.

I expect that going forward our cash generation in a given quarter will typically approximate our net income for the quarter.

Some other items to note -- depreciation and amortization for the quarter was 5.5 million and capital expenditures were 2.5 million.

Headcount at quarter end stood at 795 regular employees, which compares to 784 at the end of Q3.

We also had 39 contractors on board at quarter end.

Turning now to guidance, for revenues, in the September quarter we currently anticipate that our revenues will be in a range of 95 to $100 million.

The opportunity for higher revenues come from the strength we've seen in the US, the strong response we've seen in the BlackDiamond 8800 over the last two quarters, and the steps we have taken to improve our revenue in Japan and Asia-Pacific.

That said, over 35% of our revenues now come from EMEA where the September quarter is typically seasonally down.

For that reason we need to leave open the possibility of a small seasonal decline in revenues.

On gross margins, our expectation for the September quarter is that gross margin as a percentage of sales will be in line with gross margins this quarter and ultimately will be most dependent on the mix of products and geographies in our final sales.

As we look out further into FY '06, we believe our gross margins will expand from current levels as volumes increase, recently introduced products become a larger portion of the mix, and as a result of further optimization of our service business.

On operating expenses, our expenses this quarter were unusually high as a result of legal expenses and year-end expenses in sales and marketing.

Looking into Q1, we expect our total operating expenses to come down and to approach a quarterly spending level of 47 million $48 million.

Looking further into fiscal '06, we expect to operate throughout the year with expenses at or very near that range on a quarterly basis, bringing operating expenses down as a percentage of sales year over year.

On other items for your model, at current interest rates we expect net interest income of approximately $800,000 a quarter.

We expect a corporate tax rate of 20% in fiscal '06.

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

Investors should note that our quarters are back-end loaded with approximately 50% of our business done the last month of the quarter, so it's fair to say our visibility can be limited.

And it is still a case where one or two large deals of quarter can make the difference between sequentially up or sequentially down revenue.

Let me summarize my comments this way -- this was a very solid quarter for us, particularly from a revenue and gross margin standpoint.

We saw excellent growth in the US and EMEA and our gross margins expanded both sequentially and year over year.

Fiscal '05 as a whole represented a year of revenue growth, gross margin expansion and profitability.

As we look forward into the first quarter of fiscal '06 and beyond, we believe we're positioned for another year of revenue growth and gross margin expansion, which, when coupled with a much lower operating expense level than we showed this quarter, can lead to another year of both growth and higher profitability.

And with that, I will turn the call back over to Gordon.

Thanks, Bill.

To summarize, we're very pleased with the results of the quarter and to have returned to probability for the year.

And we're very proud to be increasing margins in this market.

We're pleased with the momentum that we've gained in the market and particularly in the Americas and EMEA where we had 24% year-over-year growth.

We believe this reflects the success on our strategy to be the leader in open converged networks.

Our new technologies built to support this strategy are gaining customer acceptance and gaining market momentum.

Our new partnerships and our global channels are all working.

We look forward to a great 2006.

Thanks again for joining us.

And at this point, Operator, we would like to open up the call for questions.

(OPERATOR INSTRUCTIONS) Jiong Shao.

Lehman Brothers.

Thank you very much.

I have got a couple of questions.

First, Bill, I was wondering could you comment on option expansion for your fiscal year going forward?

I'm sorry.

Did you say comment on --?

The options -- stock option expensing impact.

We're concluding our analysis of that as part of preparing our 10-K.

Were I to estimate it for you today, and I will reserve the right to alter this as we finish our analysis, I would estimate that option expenses will add 3 to $4 million a quarter to our expenses.

Okay.

And I think you need to -- if the current rule holds you need to expense that starting this quarter, right?

Correct.

Okay.

Great.

My next question is on the extra week.

You mentioned that the extra week helped the booking a little bit.

I was wondering just is there anything in your revenue that was helped by that or not at all?

Really what the extra week did is it helped us deliver a book-to-bill above 1.

We focus -- as you know, one of our corporate goals is to build backlog in order to improve our linearity and to improve our predictability.

And that's where the extra week helped us more than anywhere else.

It hurt us a bit on expenses and it hurt us a bit on cash flow.

Great.

My last question -- sorry, just one last quick question on security.

Gordon, you mentioned a couple of times on the security front.

I was just wondering are you talking about just enhancing the security in your switches, in your network?

Or are you talking about more beyond that, maybe looking at stand-alone for the security devices you're updating into the market or not?

I guess I would say it's a combination of those two.

And that is that we are putting security capabilities into our switches that previously had been handled by appliances.

Thank you very much, guys.

As we turn in over to the next question, I think in the interests of time we're going to try and limit everyone to one question as we go.

We've got a lot of folks to get through here.

Tim Long.

This is Jeff Slubert (ph) dialing in for Tim.

Can you provide color regarding the overall demand environment, how it changed quarter to quarter in regards to the linearity, and then how much of the revenue increase came from deals that were maybe pushed out from the previous quarter?

Our linearity was better this quarter than last.

In part I think that was because last quarter we saw deals pushed out into this quarter.

But in terms of trying to put X percentage to it or X number of dollars to it, I'm going to stay away from that.

It's a bit subjective.

But our linearity was improved this quarter.

Going forward should we see a return to more normal linearity?

I would expect for now our typical linearity of 20, 30, 50 is the sort of pattern to expect.

We obviously work as we can to improve that, but some of it is just customer behavior and the dynamic of the industry.

Stephen Kamman.

Steven Kamman, CIBC World Markets.

I have got two quick questions, if that's all right.

One, just top speed on your gross margins, both on the product side, foundry, Cisco running the 60% range, is that achievable?

And then most importantly I think on services, I mean I think we're kind of getting the 45% range and my understanding is that is sort of when we will probably top out.

Are we wrong in that?

So that was the quick question.

Second thing, any comments on pricing?

But you and foundry very strong on stackables.

Anything going on there?

And just can you talk about pricing environment, both for power over ethernet, any premium you're getting there or have you kind of cut that back, 10 gig and overall pricing environment?

Do you have any other questions, or --?

Just a few sub-parts to that.

I apologize.

Gross margins and pricing, to summarize.

It started as two quick questions.

Let me take the gross margin question.

Previously we'd laid out a goal of achieving gross -- or getting to a range of 54 to 57% gross margin as a company.

This was a goal we laid out last February in our analyst meeting in New York.

Now with the drop in revenues in Japan we're making more -- our progress towards that goal is slower than we would have liked.

But that remains the goal, 54 to 57 points of gross margin.

And I do believe that goal will be achievable here in fiscal '06.

And that's 54 to 57% on a quarterly basis.

I expect we will achieve that in '06.

And product service, any --?

I think that both margin lines can improve from where they are now.

And then pricing, PoE, 10 gig, stackables?

Pretty benign; not too different from previous quarters.

Our focus is not so much on speeds and feeds, but on the value we deliver through an open converged network.

And therefore, we're not getting into the direct port-to-port price competition.

Okay.

Samuel Wilson

JNP Securities.

I have 1 question with 47 parts.

Actually, I'm just kidding.

I'd like to know what are the attach rates right now kind of along with ethernet switches for things like wireless LAN and the new security products?

And then how much success are you having kind of selling those also back to the installed base?

And then just a very simple question on CapEx.

I noticed it made kind of a jump here at the end of the fiscal year.

Was there anything to that?

Thank you.

Let me address the first two parts and then the third part let Bill address.

Looking at attached rates, particularly for wireless and security, it's tough to say on wireless.

It was increasing this quarter.

This quarter was better than previous quarters.

So we are seeing a fair amount of success there.

And we're pleased with that.

And with some new products we have introduced we expect that that will continue.

But I don't have a specific metric there.

On the security side we have not begun delivering that product in production yet, but we have been booking orders and spent a lot of time talking to customers there.

And there's a couple of opportunities there.

One is to go back into the existing installed base and deliver the security solutions.

And from what I've seen from beta sites and early orders, there's a lot of going on with our team.

But it's also a great entry point to go into a new account and to go in with a security solution and really form of beachhead that way and create the opportunity to bring switches in later.

On capital, there was a small bump up this quarter.

I would characterize it as about $0.5 million.

That was the result of opening up our office in Chennai, India where we will be increasing our efforts to do development, some infrastructure work there.

But we needed to fit out that office this quarter.

John Mark Duncan.

This is Eric Suppiger for John Mark.

Can you comment a little bit about Japan and Asia?

It looks like both of them were disappointing.

I thought that Japan might have been at a low point last quarter.

So why do you think that's going to start growing at this point?

And then secondly, if you could comment -- it sounded like you had suggested OpEx would be flat going forward.

Does that suggests that hiring is going to freeze at these levels?

Or what are your thoughts in terms of why OpEx is going to be fairly flat here?

I will take the operating expense question and turn it over to Gordon to handle your first question.

On the operating expenses, as I said, we will bring it down to a range of 47 to $48 million and then manage it within that range going forward.

Total hiring may actually move up a bit.

I just mentioned that we have opened an office in India, and so we will be using that as a way to provide lower cost services, lower cost engineering, etc.

That may lead to some amount of headcount increase, although will still allow us to operate within the operating expense band.

On the Japan/Asia, we certainly are disappointed with the sales results from both of those areas.

Asia tends to be lumpy and we had some great wins in Asia.

We won a large deal with Samsung in Korea, a very large enterprise deal.

So we have had some great success in some of the regions there.

But it's tended to be lumpy, and there tend to be quite a few big deals there.

Japan, as Bill noted, we believe that we have hit bottom.

We have put new leadership in place in Japan.

And very shortly we will be putting new leadership in place in Asia.

We're looking for more profitable growth out of both of those regions as a result of these changes.

Thank you.

Alex Henderson.

I really want to ask a question on a longer-term kind of viewpoint.

The Company has in the past given some sense of what it thought it could grow at on a longer-term basis.

You have had obviously a pretty good hit to your growth rate because of Japan in the fiscal year that just ended.

Can you give us some sense of what you think the growth rate might look like on a full-year basis, '06, '07, assuming reasonable economic environment?

Can we go back and start thinking about this Company as a 15 to 20% plus growth Company?

Or are we going to labor under single digits for a while as you get your house in order and hope to do 10% longer term?

Is this a 10 to 20% type growth Company, 15 to 20, 15 to 25, what do you think?

So in the US and Europe where I think we're executing very well this last year we did grow in excess of 20%.

And I think our previous goals of 10 to 20% year-over-year growth certainly still hold for the US and for Europe.

At the moment the year-over-year comparisons are being hurt by Japan, which is pulling at current rates almost 8, 9% off the year-over-year growth rate.

I do expect that Japan can get back into a sequential growth mode here perhaps as early as next quarter, definitely by the December quarter.

And as we get out into the second half then of fiscal '06 the year-over-year comparisons will start to look better for Japan and the rest of our business.

And at that point I think we can be growing in the rates we have previously discussed.

I'm going to stay (multiple speakers)

Which is?

Can you remind us?

At our February analyst meeting we laid out a goal of growing the Company of revenue 10 to 20% a year on a year-over-year basis.

And we're still doing that within the US and Europe, but at the moment in Japan and Asia we are a little behind that goal.

In Japan, quite behind that goal.

And then, if I could, I don't think you quite answered the question on the service provider -- on the services margins.

Do you expect them to continue to move up?

I think the question was asked earlier does it top out at 45.

Is there room above that?

Excuse me.

We do expect them to continue to grow up to -- to grow, to expand, and there is room above 45 points, yes.

I didn't mean to ask two, but that one didn't get answered and it was something that was on my mind.

Thanks.

Mark Sue.

This is Jennifer for Mark Sue.

RBC Capital Markets.

Just two quick questions, if I could.

We wanted to know if you could give us some color on the trends with Avaya when it becomes 10%, your thoughts on that.

Also, if you could give us an outlook for (indiscernible) in September.

I'm sorry, Jennifer.

What was the last question?

Your outlook for federal spending for September quarter (multiple speakers)

Let me take those in reverse order.

Federal spending is -- it's tough to predict.

And frankly, it's not a huge part of our business.

So I'll defer on that one.

For the business with Avaya, as I mentioned we are in the high single digits percentage-wise and we do expect that to continue to grow nicely.

No thoughts on what quarter specifically would be 10% or better?

No specific thoughts.

Thank you.

We're going to try to hold folks to one question now in order to get through the remaining queue.

Long Jiang.

UBS.

I was looking at this deferred revenue for the quarter.

I think it's pretty stable, up sequentially just slightly.

Now I see a decline in your short-term deferred revenue offset by increased in longer-term deferred revenue.

Are you changing your practice in booking deferred revenue?

And it looks like a acceleration of your deferred revenue going forward just looking at bookings for the quarter.

Two things are happening.

One is we are now breaking out deferred revenue in both long-term and short-term deferred revenue.

So that's one of the things that's going on.

I'm sorry, I didn't --

I just wanted to see whether you're able to realize deferred revenues just at the same pace as before.

I see.

Yes.

In fact, were you to look under the covers a bit you would find that the deferred revenue for our service business, for instance, for the next several quarters is up nicely versus where it was a year ago at this time.

Great.

Thanks.

Andy Schopick.

Nutmeg Securities.

Trying to keep this concise.

Can you give us the foreign exchange impact in the quarter and the year, Bill, in the other income line?

I'm talking about the transaction-related gain or loss.

We don't break that out on the call.

I don't have the information here in front of me.

Typically foreign exchange is a swing factor of -- in some quarters it is a positive 1 or $200,000 in other (indiscernible); in other quarters it's negative.

I don't have the specific number in front of me here.

This particular quarter it was a slight positive in other income.

That's what I assumed given what you said about the 800,000 going forward.

That's exactly so.

One other thing, Bill.

Any comment about how you're going to for financial reporting purposes account for options expensing?

This Company has a very clean GAAP presentation.

A lot of companies are going to try to ex this out now.

What are your thoughts?

We will definitely -- obviously we will report cap (ph) and then definitely break out option expensing in a way that makes it clear to investors our results with and without.

Thank you.

Manuel Recarey.

Kaufman Brothers.

Question about enterprise spending.

It certainly improved from the March and the June timeframe.

Anything that you can kind of point to to give us a little bit more confidence that that is sustainable going forward?

Is there anything that is pushing enterprises to spend now that they weren't six months ago?

I think our experience during this past quarter, both in the US and in EMEA, was what I would call more normal spending patterns, a little bit more predictable on the sales cycle, which is certainly a good thing.

The March quarter was lumpy and at the end very disappointing, not only for us, but for a lot of enterprise companies.

I think this past quarter was much more consistent.

In the direct conversations we had with people, my impression is people were being very rational towards investment and more normal than they have been for quite a few quarters.

Did the sales cycle short or lengthen or change at all?

It's hard to say when you're in the middle of it.

I can say that our pipeline tracking is very good and very strong.

The type of sales, particularly the large deals that we work on, tend to be bimodal.

There are some that we work on for a year or more and close and others that happen in three, four, five, six months.

So there tend to be kind of two ends of that.

But again we're seeing what I would call more normal patterns.

Let's move on to the next question.

Thank you Manual.

Stanley Cobbler (ph).

Stanley Cobbler for Merrill Lynch calling in for Tal Liani.

Just a quick question on the Asia and Japan weakness.

I was wondering if you can tell us if that was more carrier-related or enterprise-related.

The challenges in Japan, the carrier business there tends to be lumpy.

And we've had great success in Japan in carrier build out.

And some of those carriers are in a cycle between network upgrades, and so we've certainly seen a drop off there.

We certainly expect those carriers to resume as they build up the next generation of networks, and we do see significant opportunities there.

But I think that that was a -- has been a big part of the issue there.

Also, as we've said in the past, I'm disappointed in our enterprise performance there.

And we are really stepping up the investment to balance that business and have stronger enterprise presence in Japan.

Thank you.

William Becklean.

This is Pria Persoman (ph) for Bill from Oppenheimer.

I was wondering if you could talk about what the interest levels have been for the Sentriant security of plans both from new and existing customers.

We've seen a lot of interest on Sentriant from existing customers.

Those customers that are using our core switches had can add Sentriant at a low-cost and really dramatically change the security protection of their networks.

We have seen a lot of interest from existing customers.

We've also seen a fair amount of interest from new customers, people that have seen the product at trade shows or heard about it and open the door to us based on security.

And we take the opportunity to go in and talk to them about infrastructure.

Thank you.

Christin Armacost.

This is Lucas Bianci (ph) from SG Cowen for Christin.

I was just wondering with regards to Europe what happened there exactly.

Was it mainly a couple of big deals, or just simply better sales execution?

We certainly did have some big deals in EMEA, not that that's unusual.

But there were some in the quarter.

I think if I look at the EMEA I would say we have had just terrific execution.

We have very strong partners.

Our team there has done a great job all around.

So was it mainly through these partners that you got the big deals, or --?

Yes.

Would it happen to be Avaya?

Avaya, we began selling through Avaya in Europe just this calendar year.

That is still a pretty small part of our European business right now.

Most of our growth in Europe not only this past quarter but over the last year has come from existing partners.

And we've put in place a lot of plans and very strong sales management.

You look at those growth rates and it was broad-based and it was across the Continent.

Thank you very much.

Ben Kadlec.

Buckingham Research.

You kind of touched on it, but I was wondering about federal sales in the quarter.

I know you said they were small, but at one point you were 10% and I was wondering if you had any initiative to try to increase those.

I'm sorry.

We heard a federal sales and then could not make out the rest of it.

I was wondering if -- I know -- if you could give us a percentage in the quarter, I know they were small, but also if you have any new initiatives or trying to attack that market again.

We don't break out our federal sales quarterly.

As you say, it is a relatively small part of our current sales.

And in terms of initiatives I will turn that over to Gordon.

We continue to have a presence in federal.

We have some marquee accounts in federal and we continue to sell there.

It's again, as Bill said, not something we break out.

And I don't believe we had any 10% customers there.

Correct.

Thanks.

Gentlemen, there are no further questions.

Please continue with any closing remarks.

Thank you all for joining us and for your support over the last fiscal year, and we look forward to speaking with you soon.

Thanks everyone.

Ladies and gentlemen, this concludes the Extreme Networks fourth fiscal quarter earnings conference call.

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