Extreme Networks Inc (EXTR) 2007 Q1 法說會逐字稿

Good afternoon ladies and gentlemen, and welcome to the Extreme Networks fiscal first quarter revenue 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. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded today, Thursday, October 26, 2006.

I'd now like to turn the conference over to Mr. Mike Palu, Acting Chief Financial Officer with Extreme Networks.

Thank you.

Good afternoon, everyone.

Thank you for joining us.

On the call today is Mark Canepa, President and CEO of Extreme Networks.

This afternoon, we issued a press release announcing our revenue results for Q1 fiscal year 2007.

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

This 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 the call.

Let me note that some of the remarks made during this call may contain forward-looking statements about financial and business guidance, product introductions, customer development, and prospective real estate transactions.

These reflect the Company's current judgment on those issues.

Because these 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 10-Ks which are on file with the SEC and are available on our website.

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

Thanks, Mike, and thanks, everyone, for joining us today.

I'll begin this call with a summary review of our quarterly revenue results followed by customer and product highlights.

And since this is my first opportunity to speak to all of you, I will spend a few minutes acquainting you with me and my background and most importantly talking about my impressions after 60 days in the position and thoughts about how we're going to move forward.

Mike will then follow with a discussion of our financials.

This was a quarter in which revenues increased modestly in what is typically a weak seasonal quarter.

Revenues for the quarter were $83.8 million, consisting of 68 million in product revenue and 15.8 million in service revenue.

Product revenue increased 2% sequentially and decreased 17% year-over-year.

Service revenues were up 1% sequentially and down 1% compared to the year-ago quarter.

The split of enterprise sales and service provider sales was 78% to 22% which is consistent with the prior quarter.

Revenues in our European operations experienced good overall growth, both sequentially and year-over-year, while revenue in the United States and Japan declined compared to prior periods.

We have increased the size of our sales force overall and in particular in the U.S., but those incremental resources have not yet gained full productivity.

Last quarter, we introduced new switches to the Summit X450 family.

These new switches provide high density gigabit ethernet ports, with and without standards-based POE, and optional 10 gigabit ethernet ports in a compact one rack unit format.

The Summit X450 switches are highly resilient, modular operating system, Extreme XOS and support a full range of layer 2 to layer 4 functionalities on every port.

These switches also support hardware based routing for both IPv4 and IPv6 to allow IPv6 rollout now or in the future.

In enterprise networks, these switches are targeted to be an aggregation switch for mid-sized networks and a course switch for small networks.

We have also introduced edge switches designed to support large-scale rollout of converged networks that support devices such as IP telephones and wireless access ports.

In service provider networks, Summit 450A is targeted as a first level aggregation device for use in local central offices.

During the quarter, Extreme Networks continued to drive our high performance switching solutions to a wide spectrum of customers, both in the metro ethernet and the enterprise space.

In the metro, or carrier, ethernet segment, we expanded our customer base globally and our new solutions based on the concept we introduced and called multidimensional ethernet.

California [inaudible] selected Extreme as the infrastructure partner to help it efficiently deliver triple-play services for voice, video and data, using the leading edge BlackDiamond 10K and 12K modular switching platforms.

In Australia, Victrack, the railroad company in Victoria, is also building out ethernet based services, including voice, data and video, for local residents using Extreme's BlackDiamond 12K and Summit X450A switches.

The new Notaldia MAN in Sweden is another example of an innovative service provider building a robust 10 gigabit metro ethernet ring using Extreme's products to support IPTV, voice services, the internet and VPM services for residential and business customers.

In the corporate enterprise segment, Extreme continues to drive our business by focusing on convergence, highly [inaudible] networks, integrated security and wireless LANs.

Intramatich, an Illinois-based manufacturer of consumer and industrial energy control products, selected our award winning BlackDiamond 10-K, BlackDiamond 8810, and Summit X450 switches to implement a best of breed LAN.

One area that Extreme has always had success is in mid-sized enterprises.

These are growth companies with sophisticated needs in the area of IP telephony, security and wireless connectivity using ethernet.

A classic example is our work with Croc's Incorporated, a leading shoe designer based in Colorado.

Croc's selected Extreme Networks and our voice partner, [Shortel,] to assist them with very rapid growth during a period when they have more than doubled their employees and significantly grown their sales.

In India, [Jessen] Group Industries, a leading global manufacturer in steel, capital goods and services markets, recently revamped its IT infrastructure using Extreme's BlackDiamond 8810, Summit 400, Summit 200 and our integrated network management suite, Epicenter, as the network foundation.

During the last quarter, we continue to support New York Independent Service Operator, an energy utility that administers the wholesale market for electricity for the entire state.

Our technology attributes and dedication to innovative and open network philosophy outweigh the price advantages of other vendors and led us to a win and a privilege to outfit NYISO's new building with our ethernet solution.

In the government sector, in addition to our continued work with system integrators for federal government agencies, Extreme Networks is now working with our channel partner, Ericsson's new federal organization, in order to serve as its install base of DOD and U.S. intelligence agencies.

As a result, Extreme Networks recently supplied the Marine Corps intelligence activity with a gigabit network using our BlackDiamond 12K switches.

Now let me switch gears and tell you a little bit about myself.

I have been in the technology and computer industry my entire career which spans 30 years.

I have a technical education with a bachelor's and a master's degree from Carnegie Mellon University.

I am also a graduate of the Advanced Management Program at the Wharton School.

For the past 15 years, I have built, run or turned around a number of large competitive businesses for both Hewlett Packard and Sun Microsystems.

At Hewlett Packard, I led the Company's workstation division for a number of years.

I started as the general manager of the then recently acquired Apollo computers and gradually integrated the rest of HP's workstation operations into the division.

Key to the success of the business was not just the transition from Apollo-based technologies to the integration of HP innovations, but also ensuring that the product line was integrated into Hewlett Packard's computer business, sales and marketing effort.

At Sun, I led the product group that built the volume server business from its inception to a $4 billion revenue stream.

Keys to the success of this business were the adoption of a significantly more cost effective supply chain than the one being used at the time, and the much more aggressive use of indirect channels of distribution for the products.

At Sun, I also led the storage products organization through the key industry transition of mainly captive direct attached storage to a networked storage world, where the server and storage bind patterns could be disaggregated.

This required the near total re-engineering of the product line and significant change in the technology partnerships required for success.

In addition, it was clear that the Company required a much more specialized sales force to drive a pure storage sales effort.

This realization culminated with the acquisition and integration of a major independent storage player.

I believe that the combination of experiences, resulting from the past 15 years of running, starting and integrating businesses, will help me drive the strategy and the right level of execution here at Extreme.

Extreme had a great start.

It built a set of leading-edge products, a strong brand and a great worldwide distribution system.

Now, as the Company enters its next phase, it needs someone who has had the experience with the complexities of understanding multiple business models, technology partnerships and the right capabilities to sell and distribute more complex systems.

So why did I join?

Because the network really is the key to application performance and I was pleased to see that Extreme had taken an early start on this.

As I've been building systems for the past 30 years, I was never very far from the network.

As applications become more distributed, application performance and quality become ever increasingly dependent on the network that ties those application components together.

Conversely, the network has to become a more integral part of the application environment.

By embracing standards and building an open scalable operating system with XOS, Extreme is taking the lead in this direction.

I'm sure you want to know more about my view on the Company and the changes in direction that I intend to make.

I've been here close to two months now.

During this period, I've been doing an expansive review of the strategic direction of Extreme, the market segments available, the products and services in the pipeline and the daily operations of the Company.

Extreme Networks was founded on the principle that you could take expensive IP routing functionality and deliver it at dramatically lower costs using ethernet switch technology, and that you could deliver significantly better quality of service on these networks.

To accomplish this, Extreme developed key competencies in both hardware and software development that allowed it to obtain significant competitive advantage and enjoy considerable growth in two market segments, medium to large enterprises that have complex network problems and service providers that require sophisticated QOS and traffic management capabilities to manage diverse data flows.

Extreme will continue to focus on these two market segments as it has in the past.

Both of these markets continue to require innovations that Extreme pioneered and continues to be well positioned to deliver.

New applications, such as telephony and IPTV, require capabilities that go beyond a best efforts environment to one where quality of service must be managed in a much more deterministic way.

At the same time, it is clear that portions of these markets have matured during the past few years, and the level of differentiation required and the price customers are willing to pay for this differentiation has changed.

In the near-term, the challenge that Extreme faces is in execution rather than in strategic positioning.

The market that it serves require a blend of both highly differentiated products to enable new infrastructure capabilities as well as a set of more cost effective products to complement and complete the solution.

The Company has to continue to deliver differentiation as the core of its strategy but it also has to deliver product to a more mature and therefore more cost sensitive customer set.

We compete in markets that require different business models and therefore different cost structures.

Today, Extreme is organized functionally with a single product development and supply chain methodology geared towards internal R&D and a customized supply chain to produce products.

It is also focussed primarily on product development, with a significantly lesser focus on the development of the services required to express more of the value proposition to the customer.

Both product solutions and services have become an integral part of serving our customers.

It is no longer adequate to simply sell speeds and feeds.

We have to move beyond moving packets and begin to offer better ways to address the challenges of convergence in security.

And as Extreme announced on Monday, we're delivering new and innovative ways for our enterprise customers to assess the security and convergence readiness of their local area networks.

An example is John C. Lincoln Hospital in Arizona.

They underwent our new two-day security assessment that provides a comprehensive view of the overall security implementation for connected systems.

After undergoing the Extreme assessment, the hospital discovered ways to improve the protection of patient records and related data.

This was accomplished by applying best practices and technologies to shore up a network against common vulnerabilities.

Looking at it in more detail, at the requirements of the market segments we serve, we need to produce capabilities in four areas.

We will continue to build products as we have in the past, in those areas where we can clearly identify a strong sustainable competitive advantage.

In those areas where customer requirements are not changing as quickly, we will focus more on our supply chain and drive costs and efficiencies, as I've implemented at Sun when building the volume products business.

We need to explore new emerging segment opportunities in a cost-effective manner.

And four, we need to create more capable services to support a more solutions-oriented focus to our selling and to express more of our value proposition to our customers.

With that in mind, over the balance of this quarter, I intend to make a set of structural changes to allow me to focus the organization on the four capabilities outlined above, and drive the appropriate cost structure that each of the capabilities above requires.

This will result in a much more focussed, accountable and measurable team.

In the near--these near-term actions are all designed with the goal of driving the revenue stream for the Company to higher levels and to have a meaningful portion of those revenues drop to the bottom line.

With that in place, we can focus on what has made this Company successful, driving ethernet based network innovation to solve the challenges that our customers will face in the future.

The marketplace will continue to drive more sophisticated applications that will require more network services.

Extreme is well positioned to understand these future capabilities and to engineer products that can creatively deliver on these requirements.

We have great people, a strong technology base, a global distribution system, a network of partners and a strong brand.

Plus, we have a strong cash position to invest and grow our portfolio product and services.

Stay tuned, a lot more to come in the future.

With that, I'd like to turn things back over to Mike.

Thank you, Mark.

I'm going to briefly review our revenue results for the quarter and then provide you with some of our key balance sheet metrics.

As previously announced, a Special Committee of Extreme's board of directors has been conducting a review of the Company's historical practices relating to stock option grants.

This Special Committee has hired independent legal and financial experts to conduct the investigation.

If any accounting errors are identified by the independent investigation, adjustments to present and previously reported financial statements could be required.

Due to the fact that this review is ongoing, and not yet complete, we have not filed our annual report on Form 10-K for the year ended July 2nd, 2006, and nor have we included financial statements in our Q1 release.

We do not expect the Special Committee's review to be completed in time for the Company to file its quarterly report on Form 10-Q for the quarter just ended by the SEC deadline of November 10th, 2006.

Following the completion of the Special Committee's review, the Company intends to file its Form 10-K for the year ended July 2nd, 2006, and to file its current quarterly report on Form 10-Q.

Revenue for the quarter was $83.8 million consisting of $68 million in product revenue and $15.8 million in service revenue.

Our book-to-bill ratio was below one.

Looking at revenues on a geographic basis, in EMEA, which includes our European operations, the Middle East and Africa, our revenues were $32.8 million.

This is a 10% increase sequentially in what is typically a seasonally weak quarter.

This is also a 9% increase from the $30.1million or revenues in the prior year same quarter.

We continue to see good growth in Germany and Eastern Europe driven in part by wins at regional service providers.

Revenues in Japan were $4.6 million, down from $6.4 million sequentially.

Looking at Asia outside of Japan, revenues were $11 million, an increase from 10.7 million sequentially and down from $11.4 million in the first quarter a year ago.

Our revenues in Asia continue to be lumpy with one or two large deals making a difference between meeting our sales targets.

In the U.S., revenues were $34.2 million, down from $35 million in the June quarter and down from the $45.1 million in the first quarter of the prior year.

We have added new salespeople in the last four months, yet they have not reached peak productivity.

We plan to continue to add salespeople, and as these sales teams become more productive in fiscal Q2, we're optimistic that this will drive demand for us in the U.S.

Shipment of modular products represented 48% of sales, with stackables representing 52%, which is a slight shift in mix towards more modular products than in Q4.

Bookings of our XOS-based products continue to increase as a percentage of our total revenues.

All told, sales of XOS products represented in excess of 35% of product bookings, up slightly as a percentage from Q4.

Bookings of BlackDiamond 12K increased sequentially in the quarter, helped in part by availability of the enterprise version of the product as well as the carrier version.

New bookings for POE ports were once again in excess of 10% of total ports booked.

We expect POE ports to continue to grow based on demand for IP telephony and wireless. 10 gig port bookings increased sequentially also.

This quarter, bookings through our Avaya channels, both direct and resellers, were again in excess of 10% of total product bookings.

I do want to comment on a couple of trends affecting our costs.

Looking at gross margin trends, we saw some modest pressure on gross margins this quarter.

While product margins were affected slightly due to product mix, service margins declined due to higher costs related to service delivery.

Turning to operating expenses, G&A expenses were affected by a $1.2 million increase in legal costs related to intellectual property litigation.

We expect legal fees to continue around this level for the next several quarters.

We also expect to incur higher professional fees in Q2 as a result of the Special Committee review.

In the current quarter, we took action to rationalize our operations in Japan to better align the costs with expected ongoing revenue.

We incurred approximately $1.5 million in restructuring charges as a result of our actions.

We will continue to incur transition expenses in our second fiscal quarter, while we implement the restructuring and we expect to begin realizing lower costs in our third fiscal quarter.

Regular headcount at quarter end stood at 856, up from 847 at the end of the June quarter.

Other income was $3.1 million in the quarter, an increase of 1.2 million sequentially.

Total shares used to calculate diluted EPS in the quarter were 115.7 million.

Total shares outstanding at quarter end were 115 million shares, down 2.3 million from the end of the June quarter.

Looking at the balance sheet, cash and cash equivalents, short term investments and marketable securities on October 1st, totaled $423.4 million, down $9.7 million sequentially.

During the quarter, we used $11.2 million to purchase 3 million shares as part of the previously announced share repurchase program.

Since the beginning of the program and through the end of the quarter, we used $44.9 million to repurchase 10.2 million shares of stock.

Through the end of the quarter, we had repurchased 8.3% of the shares that were outstanding when we announced the program in October of 2005.

We have terminated this share repurchase program effective today having purchased just over $48 million worth of shares.

Other items affecting cash flow in Q1, capital expenditures were approximately $800,000, proceeds from the issuance of common stock were approximately $700,000, depreciation and amortization was $2.4 million, and amortization of the warrant was $1 million.

Net inventory at the end of the quarter was $24.1 million, an increase from the $19.3 million at the end of Q4.

Inventory turns stood at 7 for the quarter.

Our prior quarter inventory balance was low for us and had caused some product constraints at the end of last quarter.

The current inventory balance brings us back to a more normal operating level.

Accounts receivable were $27.8 million, up slightly from 27.7 million sequentially.

DSOs at quarter end stood at 30 days similar to the results at the end of Q4.

Accounts payable were $24.4 million, up from 20.1 million in Q4.

Total deferred revenue decreased $2.3 million in the quarter.

This is due to the seasonal pattern of our service bookings which are typically low in Q1 because customers prefer to arrange annual renewal dates to fall in the December and June quarters.

Our debt balance totaling $200 million reaches its maturity date on December 1st, 2006.

Our current plan is to pay off that debt upon its maturity.

In regards to the sale of our corporate campus, the agreement that we had entered into to sell our campus expired under its terms without the buyer proceeding forward.

The contract contained a contingency related to the rezoning of the property to residential.

The parties were not able to obtain the city's approval for the planned rezoning within the time frame provided in the contract, so the contract expired.

We are in discussions regarding the possibility of entering into a new agreement but will also explore other alternatives.

As a reminder, we do not offer specific financial guidance for upcoming quarters.

I would like to note that there are risks associated with our business.

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

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

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

Thanks, Mike.

So to conclude, I want to thank our team of very dedicated employees here for their hard work during the past year.

This was a challenging time.

We have performed well and have positioned us for success during the new financial year.

We have great people here, a strong technology base, a global distribution system, a network of partners and a strong brand.

We have a strong cash position to invest and grow our portfolio products and services.

The capabilities, together with focus and discipline, will help us drive strong execution.

Stay tuned.

More to come.

With that, I'd like to open the call to questions.

Thank you, sir.

Ladies and gentlemen, at this time we will begin the question-and-answer session. [OPERATOR INSTRUCTIONS] Our first question is from Tim Long with Banc of America Securities.

Good afternoon.

This is [Jess Lubert] dialing in for Tim.

Couple questions.

Last quarter there was some product push-outs and some supply issues.

On the last call, you indicated that those issues were resolved.

To what effect did they impact this quarter's revenues?

Yes, this is Mike, Jess.

The impact on the current quarter was a relatively small amount.

And then, for about four quarters now, business in North America has been pretty flattish, product sales have been kind of hanging towards the lower level.

Yet you've had a number of new channel initiatives and hired a bunch of salespeople.

Do you think the current product set, with the current product set, can Extreme win and resume upper revenue growth?

And if not, how long will it take to get the appropriate products in place?

Product development is always an ongoing activity, right?

The market continues to evolve rapidly.

But we believe that the, the primary driver, in the U.S. especially, continues to be ensuring that we have the proper coupling between the product innovation and the sales effort, and just to let everyone know, since the first of July, we have made a number of changes in the America.

We've--Eileen Brooker has been named Vice President of the Americas which obviously includes the west.

It has, she was a very successful regional director.

She turned around the western region in the U.S., and during the first 90 days, that is last quarter, she implemented a number of changes.

She has aggressively worked on driving the size of the sales force and has been aggressively training new people on our products and solutions.

She has expanded the U.S. channel with programs aimed at increasing the number and capabilities of our channel partners.

That is a way of getting a forced multiplier on our sales force and she has focussed on increasing the size of the pipeline that will eventually increase the U.S. revenue stream.

These are all activities that we're actively all focussed on, not just Eileen, but the entire Company, to focus on bringing, bringing the U.S. back to where we believe it ought to be.

Will there be any delay in your hiring process while you work through your business review?

No, right now we continue to run the Company operationally as we have in the past.

So there are no changes to our operational plan.

Thank you very much, guys.

Thank you.

Our next question is from Subu Subrahmanyan with Sanders Morris Harris Group.

Thank you.

I have two questions.

First is on gross margins and operating margins.

Can you give us any detail on kind of levels for the quarter and also talk about, as you go through some restructuring in your business, what kind of target levels you're looking for for gross margin, OpEx and operating margins.

And other question is on Japan.

Japan has continued to decline very significantly as a percentage of revenues for you guys and in absolute terms.

I mean, is there any sense of bottoming out, rebound and how do you look at Japan just going forward?

Yes, this is Mike.

Unfortunately, we have not been able to produce a full GAAP set of financial statements to issue with this release, and so providing any more specifics than in my prepared remarks, I'm just unable to do so, and on a go-forward basis, as we mentioned, we're not providing guidance.

The two comments about the gross margins that I made in my prepared remarks was we experienced some slight pressure on gross margins, slight pressure on the product gross margin due to a little bit of a shift in product mix and a little bit of pressure on costs and gross margin on the service gross margins.

Regarding Japan, as we talked about in the remarks, we've looked at it carefully.

We have taken action to rationalize the expenses and to bring them in line with the revenue stream that we're currently experiencing.

That is just proven business judgment.

But that is just the first step.

The next step is to return to growth on the top line so we're actively focussed there.

We have revamped the leadership in Japan and going forward, we plan to continue to invest in the Japanese market.

Got it.

And in terms of this September quarter tends to be a tougher quarter for you guys, partly because it is just normal Europe seasonality and partly because it's first fiscal quarter and then December is seasonally a stronger quarter generally.

I know you're not providing specific guidance but are the seasonal trends in the market still holding into December, do you think?

Well, we're not providing--we're not providing guidance on a move-forward basis.

My suggestion is look at past, look at past trends and form, form your assessment based on history.

All right.

Thank you.

Thank you.

Our next question is from Matt Shimao with Bear Stearns.

Hello, can you hear me?

Yes.

Great.

So, Mark, you spoke about the need to build capabilities in four areas.

As you roll this out, would you expect sort of disruptive shocks to the system or do you think that overall you've sort of stabilized the revenues and you can grow from here?

Well, we are, we're going to continue to focus on the market segments that I've spoken in the past so our focus is going to continue to be in the service provider market and on the enterprise, and on the enterprise market.

So at the same time, I believe that, given the size of our Company, we can afford to be very focussed in areas where we can create significant competitive advantage in the areas of focus and I can outline a number of those.

So the plan is going to be to--to create more focus, more accountability, move the resources around within the organization to effect--to effect that.

You use the word disruption.

Obviously you want to be able to do this, the analogies have been like the race car is going around the track and you want to tune it up without bringing it into the pit.

Okay?

And so that's going to be the challenge here over, over the next little while to ensure that we drive the focus, we create the accountability and drive the revenue stream in the right direction.

Okay.

Sounds good.

Can I ask a quick question on the Telephonica Deutschland deal announced earlier this month?

Can you talk about maybe the approximate size of this deal and when you might start to recognize revenues on this deal?

Yes.

I mean, like any deal, we, we do not--we do not disclose any deal or the value of any deal that we have.

What I can tell you is we have a great relationship with Siemens and Siemens was a key partner in this with, into selling with Telephonica.

We continue to work closely with Siemens and we'll share some things with you as we are going along.

What I can tell you is that Telephonica has placed purchase orders with us and has purchased our product.

Great.

Thank you very much.

Best of luck.

We'd like to ask that we limit the questions to one each so that we can get through all of the participants that would like to ask a question.

Thank you.

Thank you.

Our next question is from Jiong Shao with Lehman Brothers.

Thank you very much.

I guess I'm the lucky one who get on the line can only ask one question.

Maybe clarification and then a question.

Just following up on Matt's question, just Mark, can you confirm whether or not you have recognized revenue from the Telephonica deal or not this past quarter and what's your expectation for revenue in this quarter without talking about the size of course?

My question is that, Mark, how long you think the--your review of the Company may be substantially completed and a rough timeline using people can start to evaluate the progress in the Company's--in the Company's turnaround of when we start to see the traction of the restructuring plan going forward?

Well, first of all, we can't comment on whether revenue has been recognized on any one particular, in any one particular transaction.

So regarding the evaluation, after 60 days, I have delved into major portions of the Company.

I have reviewed major pieces of it.

Obviously, that's a job that really is never done, right?

You are going to continue to explore and review it.

The key order of business here is to understand the market segments that we're really going to focus.

The ethernet IP market is a very large market and it's about $55 billion and it's growing strongly.

Now, we're a $400 million revenue Company.

So my goal is really to go find those market segments that make sense for us and to really throw the whole Company behind them.

So I am in the process of doing that.

I've also stated during the course of this quarter I will be making some movements around, getting the right executives lined up and the teams lined up in the right--in the right area, primarily to align my skill sets relative to the skill sets of the executives I have around me.

So that will--you're going to see some of that take place this quarter.

As a matter of fact, some of it -- some changes have already taken place within the Company since I've taken over.

So that's about where I am right now.

So stay tuned as I have more to say.

I'm definitely going to share it with you as we're going along.

Okay.

Thanks.

Thank you.

Our next question is from Samuel Wilson with JMP Securities.

Good afternoon.

I have two questions.

I'm just going to violate the imposed rule here.

First question, as you went out and visited customers for the first time as the Chief Executive Officer of Extreme, what was their feedback on what the toughest or most, what's the biggest problem with Extreme Networks' supplying them ethernet products?

I'd just be curious as to what kind of customer feedback has been to you.

And secondly, can you talk a little bit about the overall competitive/pricing environment right now for your core products?

Thank you.

So regarding the first question around what customers have been telling me and I've been on the road a fair amount of time, not to mention on the phone, with a number of our customers, what is really surprising about our customer base is that they are, they really like the relationship that they have with us.

They really like the team, they really like the product.

They really like the level of capabilities that we're able to offer.

So they don't really spend a lot of time telling me the problems that they have with our products. hat they really focus their energy on is telling about the problems they have with their business, what challenges that they have, what keeps them up at night, what new services they're trying to provide, what their business units are putting, what constraints are they putting on them?

And most of it, depends a little bit on the customer, but the key things that come up are convergence.

That is, they're trying to run disparate flows, whether they're in metro or whether they're more sophisticated enterprises, and so they have to deal with the quality service issues that these separate flows provide.

And another area that they more and more they bring up the issue with security.

Whether they're financial institutions, whether they're major centers of higher learning, security is becoming a bigger and bigger problem with them.

So convergence of security tends to be 80% of the discussion and the good news is that it's an area that we--that we have been focusing on for a long time in this Company, and one of the organizational changes that I just did make over the last--over the last few days, is in fact create an emerging products organization within the business, with the new Vice President accountable for it, and security is one of the major focus points of that organization.

And then the second question just on competitive pricing environment?

Pricing, pricing has always been tough and will continue to be tough.

There is a number of competitors in the field.

The important part is to, to segment and create value.

If all you're going to do is go out there and sell speeds and feeds, then the business is going to go to the person who is going to provide the speeds and the feeds at the lowest price.

The important part is to get together with customers and really understand their problem and provide solutions that overall are more cost effective to them.

Where the cost is the entire, not just the acquisition price, not just the service price, the support price, but the total ongoing operations.

I have many customers who tell me, please, Mark, help me save headcount.

Help me make it easier for me to integrate the security problem that I have now.

I had a customer who said, gees, I have people with thousands of new laptops that every semester, happen to be a university, every semester I'm inundated with 5 or 10,000 laptops that are full of potential viruses and I have a very manual process today to ensure that when these guys plug into the network, they don't bring it down.

What can you do to help engineer solutions like that?

So if you can shift the discussion to that, then all of a sudden the equation, the pricing equations changes dramatically, which is obviously by shifting to more of a solutions focus.

That is how we are training our sales force to increasingly have those kinds of conversations with customers rather than just what is the price of a gigabit port.

Got it.

Thank you very much.

Thank you.

Our next question is from Manny Recarey with Kaufman Brothers.

Good evening.

Thank you.

My question is on the metro ethernet market.

In the last conference call, there was a lot of talk about that, and the emerging market and tier 2 type of service providers.

I was wondering if you could give an update of how that is going and kind of the outlook for the next 12 months or so?

Is that an area that is going to see acceleration?

Well, in when we were talking about all of this, we acquainted you with the continued strong performance in year-over-year growth that we've been experiencing in EMEA, in particular, and Latin America and places where there is a number of emerging countries and emerging areas, and where a lot of the smaller regional service providers are.

And a lot of our success in those regions can be attributed to our products doing a really good job servicing that kind of capability.

Customers who don't have large staffs, don't have a huge amount of core competency within their organization, where they need effective track management solutions, effective quality service solution, delivered in a very easy way to get done.

And that speaks highly to, to the kinds of capabilities that our products have, which is why they've generated great interest in our product, and as this idea of multi dimensional ethernet, that continues to gain hold as convergence, as people require the management of different flows, I think we're very well positioned with the kind of flexibility and capability we've engineered into our products.

Okay.

So looking forward you expect--would you expect a mix between enterprise and service providers to start to move a little bit?

I'm sorry.

Say that again.

So looking at your revenue, the mix between enterprise and service providers, would you expect that to start to shift a little bit more to service providers over time?

I'm not going to make a guess as to any of that.

We've got folks in this Company that are focussed on gaining as much ground on the enterprise space and folks focusing gaining ground on the metro space, and we're going to let them run and we're going to see what happens.

Okay.

Thank you.

Thank you.

Our next question is from [Monjo Sho] with Piper Jaffray.

Hi.

This is Monjo for Troy Jensen.

A couple--one on Japan.

Do you see any -- do you think that is share loss or do you think it's overall weakness in the market, and when do you expect that market to rebound?

What are your expectations next year from that market?

There is probably a number of different factors that are all kind of contributing to things and it is tough right now to separate them out--to separate them all out.

So I am -- and certainly not in the first 60 days.

I am planning on looking at all of that.

I am planning to better understand it.

I've certainly spent a fair amount of time already in the last couple of weeks with our--with the general management team from Japan.

We are driving to root cause in understanding the various areas, and as we gain better insight on that, the corrective actions that we're going to put in place are going to be aimed at solutions for each of the components that we end up finding.

And one more question.

Is it still the plan to sell the headquarters property and was there any breakup fee for the contract that expired?

Yes.

So right now all we can see is that the contract's expired and we're still in discussions with the buyer.

We're not going to speculate going forward whether or not that transaction will be concluded and we're currently evaluating all options that we have in relation to the property.

Okay.

Thank you very much.

Thank you.

Our next question is from Long Jiang with UBS.

Yes, hi.

My question again is on gross margin, looks like you have some additional pressure on gross margin this quarter.

Now, last quarter it's already 53 to below your target of 54 to 57.

So I mean, is it--I mean, when do you think you can get back to the range of 54 to 57, and also can you be a little more specific about the product mix?

I think margin actually increased as a percent of your total product sales so what added the pressure on the product (inaudible)?

Thanks.

Yes.

Without putting a time line and giving guidance on all of this, let me get you back to the four--the four elements that I talked about it in my remarks around focusing on four--on driving the, the right margin in the right parts of the business.

Today the Company has been run functionally and sort of as kind of a one aggregate.

Within there, there are--there's a lot of subtlety and as we expose that subtlety we'll be able to drive those in the appropriate direction.

There are some parts of the business where supply chain assessment can help improve margins.

There are some places where investments may drive margin in the wrong direction in a certain--in a certain part of the business.

For example, as you continue to drive into emerging countries, you have to build a service and infrastructure.

You have to have depots.

You have to have spare parts and those.

So holistically I'm looking at the trade-offs of what are the short and long-term implications of entering a new country and is it worth it and what are the payback periods and so on.

So those things are all being looked at, so the combination of that, the combination of looking at all of our products and figuring out each individually what is the appropriate margin that they should be and how to drive the supply chain in that direction, those are the pieces that I am--I am looking at in order to get the margins to the place that they belong.

Okay.

Thanks.

Thank you.

Our next question is from [Todd Seller] with Deutsche Bank.

Thanks a lot.

I had a question on Japan and it's not--it's more of a longer-term question.

There are a couple of at least major RFPs in Japan that are being decided, I guess, between now and year end and you've been successful at Telephonica so it looks like you've got a product, a 10 gig product that is acceptable.

How do you feel about your chances at NTT later in the year, other major deals similar to that?

Is your product up to snuff is the best way to put it?

Yes, NTT is a large company.

There is many parts to it.

They continue to do business with us on an ongoing basis.

We continue to look forward to working with NTT and as new opportunities come up, we intend to be right there, right there with them.

We fully believe that our product in the metro space is competitive.

The trick, as I mentioned earlier, is about carefully selecting the differentiators, positioning them, understanding the problems the customer face and working closely with them to show them how we're able to engineer a solution for them.

Thanks.

One quick follow-up on the enterprise business, can you tell us do you have--do you have a full suite of products, I guess, across the carrier and enterprise business.

I know that you've been a little slow with 10 gig.

Could you give us an update there?

And also, can the enterprise business grow?

The North American enterprise business without a 10 gig product, can it grow?

You asked a lot of different questions there.

So, we believe we have, we believe we have a great product line.

Obviously we're also spending a significant amount of our revenue in engineering to continue to make sure that that product line stays healthy and refreshed.

We've announced a number of great products over the last 12 months, and we're not stopping.

So that is regarding--regarding our product.

And we believe that that is true both across those portions of the enterprise as well as the carrier space that we have chosen to compete in.

The enterprise and carrier space is a very, very big market.

And we are, we're focussed on certain--on certain elements of it.

Now, regarding, regarding North America, we're showing that our products are successful in major parts of the world.

This is why we're able to show year-over-year sequential growth in major markets and so we believe that the same product set has no reason why it shouldn't be successful in North America, also.

So we're working really hard to understand the unique--the unique things about the North America market, which of them might be product-related, which of them are more likely executions, and other factors related to, to make sure that the North America market is thriving like the other ones.

Thanks.

Thank you.

Our next question is from Mark Sue with RBC Capital Markets.

Thank you.

Any thoughts on potentially exiting a geographic theater such as Japan and then fortifying other regions or should we instead look for concerted effort to fix the problems?

Yes, it's the latter.

We have no intention at present to exit the Japanese market.

It is a large market.

It is a market that values a number of different attributes.

It is a market that, that we fully intend to, to focus on, and be there in the long-term.

Okay.

And at a high level, any thoughts on what the market for layer 3 switching is growing at and what the growth rate might be, your assumptions maybe for next year?

My suggestion is that you go look at the standard industry sources like [Deloro] and others.

Those provide kind of the bulk of the data around that.

But beyond that, you got to tear this thing apart into lots of different places, right?

It is not just about the level 3.

There's sub-pieces, there's pieces that are different speeds, there's different pieces of functionality.

So it gets quite complex to look at it so there is sort of the aggregate and then there's submarket segments that are growing far faster and obviously we are looking at those and you can--you might well imagine that it is pretty precious information that we certainly wouldn't want our competitors to, to get a hold of.

Okay.

And lastly from your observations, your pricing on 10 gig, are we seeing normal sequential declines or anything more aggressive in that?

Boy, I don't know if I have that information.

That is something that maybe we can kind of go look offline, but I don't happen to have that off the top of my head right now.

That's fine.

All right.

Well, thank you, gentlemen and good luck.

Thank you.

We have time for one additional question.

Our final question is from Jiang Shao with Lehman Brothers.

Thanks.

Just a couple follow-up question.

My apologies if I missed it because I jump on a little bit late.

The Avaya, was it a 10% customer during the quarter and also did you provide the service provider revenue split as you usually do?

Yes.

This is Mike.

When we talk about Avaya, we talk about the Avaya distribution channel which includes both the direct sales to Avaya and through their resellers and Avaya again was more than 10% of our total sales and then the second question was what, again, please?

The enterprise and service providers.

So enterprise was 78% and service provider was 22% and that's pretty consistent with the prior quarter.

Okay.

Just maybe just one last thing on the regional trend for the fourth quarter.

I understand you are not providing guidance but just regionally sort of what you expect directionally?

Which region do you expect growth, which region you expect stable trends?

If you can comment on that, that would be great.

We're not providing specific financial guidance on a go-forward basis, so sorry about that.

Just direction, I wasn't asking for specific financial guidance.

We're not providing any specific financial guidance.

I think you can look at the trends that we've produced historically and use your judgment going forward.

Okay.

All right.

Thanks.

Thank you.

At this time, I'd like to turn the call back to management for additional remarks.

Well, I'd like to thank all of you for, for, for today.

I intend to continue to provide time with you, both as a group and individually I intend to make myself available and look forward to continued progress here at Extreme Networks.

Thank you.

Thank you, sir.

Ladies and gentlemen, this concludes the Extreme Networks fiscal first quarter revenue results conference call.

If you would like to listen to a replay of today's conference, please dial 1-800-405-2236 Or internationally at 303-590-3000, with access number 11073200 followed by the pound sign.

Once again, if you would like to listen to a replay of today's conference, please dial 1-800-405-2236 or 303-590-3000 with access number 11073200 followed by the pound sign.

Thank you so much for your participation today and have a pleasant day.

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