Extreme Networks Inc (EXTR) 2007 Q2 法說會逐字稿

Welcome to the Extreme Networks second quarter revenue results conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference call is being recorded today, Thursday, January 25, of 2007.

I would now like to turn the call over to Mike Palu, acting Chief Financial Officer with Extreme Networks.

Please go ahead, sir.

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 the second quarter of 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.

With that let me turn the call over to Mark.

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

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

I will also give you an update on the other activities that have taken place during the past 90 days.

Mike will then follow-on with a more detailed discussion of our financials.

This quarter, revenue increased modestly.

Revenue for the quarter was 86.9 million, consisting of 71.1 million in product revenue and 15.8 million in service revenue.

Product revenue increased 4% sequentially and decreased 8% year-over-year.

Service revenues were flat sequentially and comparable to the year ago quarter.

The split of enterprise sales and service provider sales was 73% to 27%, a 1 percentage point shift toward service provider business this quarter.

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

Gross margin percentage, without the adjustment for stock-based compensation, increased sequentially for both products and services.

Day to day operating expenses, without the adjustments for stock-based compensation, restructuring, and stock option investigation, decreased during the quarter.

Backlog increased during the quarter due to higher than expected demand and our inability to sufficiently ramp production on some of the most recently announced model numbers of the X450 family.

Last quarter, we introduced new switches to our fixed configuration SummitX450 family.

These compact one [Inaudible] unit switches are among the most versatile products in our portfolio.

They combine high density gigabit ethernet ports with options for power over ethernet and 10 gigabit ethernet uplinks.

The SummitX450 switches are a critical part of our strategic transition to the ExtremeXOS operating system, the industry's leading standards based modular operating system with a full range of layer 2 to layer 4 features on a report.

With support for hardware-based routing for both IPv4 and IPv6 these products position our customers to enjoy the benefits of IPv6 now or in the future.

We expect the SummitX450 to find traction in both enterprise and service provider markets.

In the enterprise these switches support advanced EDGE initiatives like IP handsets, gigabit to the desktop and integrated access security.

Their optional 10-gigabit capabilities deliver a great platform for aggregation applications.

In small networks the SummitX450 can be a core switch with a powerful combination of resiliency, performance, and low price.

In service provider networks the SummitX450A is targeted as a first level aggregation device for use in local central offices.

As Extreme Networks capitalizes on the industry shifts toward carrier ethernet the SummitX450 will be an important element of a highly scalable end to end ethernet network for service provider.

This quarter, also saw the delivery of the latest release of our industry leading modular operating system, ExtremeXOS.

This release represents another milestone in the evolution of this operating system platform that has demonstrated solid and clear benefits with both metro and enterprise markets.

Of special note, the ExtremeXOS 11.6 release includes the universal port feature.

This enables the network platform to automatically configure numerous attributes on a port by port basis when device are connected.

For example, would include the automatic configuration of voice quality parameters when a handset is connected to the network platform, or specific video attributes when a network camera is attached.

This allows enterprises to reduce operation costs through automation while also establishing higher levels of infrastructure security and stability.

Our 11.6 release also includes a DHCP enforcement mechanism that enables enterprises to deploy improved network access control capability without the need for a complex 802.1X deployment or a network upgrade.

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

For example, new field hospital, Britain's oldest not-for-profit hospital group, selected Extreme to displace the entrenched incumbent to build out its new network by deploying the SummitX450 throughout 40 individual hospitals across the U.K.

Newfield required flexibility to manage their critical needs for convergence, scalability, wireless, and security today, and to address future demands.

In Mexico, the ASA Mexico City airport is working with Extreme and Avaya to complete a new terminal which will manage an expected 5 million passengers annually.

The project is being implemented now and it includes extreme's BlackDiamond 10K, SummitX450 and Summit300 EDGE solutions.

This will create an end-to-end high-performance network that supports voice convergence both securely and reliably.

Al Safat hospital in Kuwait chose Extreme to help manage specialized departments, including maternity, surgery, internal medicine, and pediatrics.

Extreme is providing a state of the art network for both wired and wireless users.

Products supplied with the solution include the BlackDiamond 8800, the SummitX450, the SummitWM wireless solution, and EPICenter.

The Marine Nationale, the French Navy, is in the middle of a major multiyear technology modernization product.

They chose Extreme to build out a new backbone for its naval ports in the city of [Tulong] and [Brest].

By choosing our BlackDiamond and Summit solutions with ExtremeXOS as part of a high performance network they gain performance, reliability, and flexibility in their network to support their mission-critical around-the-clock operations.

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

Uniphone de Mexico, the third largest cellular phone company in Mexico, which provides service such as mobile Internet, long-distance, wireless portals, photo and video has selected Extreme Networks.

Uniphone selected our award winning BlackDiamond 10K modular switch in the coordinant network and our Summit400 switches at the EDGE.

[Enti Solat] a United Arab Emirates-based telecom carrier has been awarded a 3G network throughout Egypt.

Enti Solat chose Extreme Networks and Ericsson to build a next generation IP network to support emerging multimedia and data services for the mobile market.

Together with Ericsson we're poised to advance Enti Solat in its mission to be the region's most complete and reliable communications provider.

Wind [Avinda], an innovative Italian telecom carrier and longstanding Extreme customer continues to leverage Extreme Networks BlackDiamond and Summit switching solutions to deliver triple play services and high-speed data services to businesses throughout Italy.

Extreme Networks was founded on the principal that one could take expensive IP routing functionality and deliver it at dramatically lower costs using ethernet switching technology, and one could deliver significantly better quality of services on these networks.

To accomplish this Extreme developed key competencies in both hardware and software development in two market segments.

Service providers that required sophisticated quality of service and traffic management capabilities to manage diverse data flows, and medium to large enterprises that have complex network problems.

Following an extensive review over the past 90 days I concluded that Extreme will continue to focus on these two market segments as it has in the past.

Both these market segments continue to require innovation that Extreme is well positioned to deliver.

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

At that time same time, during the past 90 days, we have significantly sharpened our focus within the enterprise segment to those subsegments that are best aligned with the capabilities of our technology, products, and partnerships.

As I have mentioned earlier, Extreme is focused on solving complex network problems for our customers.

In the enterprise this means not just providing highly capable network platforms but it also means integrating wired networks with enterprise capable wireless access and at the same time integrating sophisticated security and network access control capabilities.

These requirements manifest themselves particularly in three industry verticals.

Healthcare, hospitality, and higher education.

These verticals also require serving highly diverse and transient end users with diverse network requirements for data and increasingly more sophisticated voice and video services.

Another industry vertical that shares these complex requirements is the Federal Government in the U.S. as well as the governments of a number of other nations around the world.

By focusing our engineering, marketing, and sales on these enterprise industry vertical segments we can be more proactive in responding to their particular needs and improve our execution with product features, services, solutions, and the right partnerships required to distinguish ourselves from the competition.

We believe that the features and capabilities developed for these industry verticals can be readily applied to other verticals of interest such as state and local governments, K-12 education, financial services, and media.

During the last call I spoke to you about the need to deliver 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.

Extreme must continue to deliver differentiation as the core of its strategy, but it also has to deliver products to a more mature and therefore more cost-sensitive customer set.

To achieve those objectives, I have decided to make a number of changes to better focus the organization on the challenges at hand and improve our ability to execute against those challenges.

I have eliminated the office of the Chief Operating Officer, thereby eliminating a layer of management in the Company.

The manufacturing, customer service, and IP organizations now report directly to me.

I have split the engineering and product marketing organization from a completely functional team into three product groups which contain the engineering and the relevant product management and product marketing teams.

These organizations each headed by a Vice President, are the primary entities to accomplish our product strategies, product road maps, and product engineering execution.

These three organizations report directly to me.

The first of these organizations, scalable products will continue to focus on developing products that use our internally developed ASIC technology and will be responsible for the BD 10K and BD 12K product lines.

The second of these organizations, volume products will focus on the Summit and BlackDiamond 8800 product lines.

The third of these organization, emerging products, will focus on our wireless and security products as well as on driving our wired, wireless security integration strategy.

With the creation of these product groups, and the alignment of engineering within them, I have eliminated the position of Senior Vice President of Engineering.

This eliminates a second layer of management in the Company and brings a significant improvement in the speed of decision making within the organization.

The head of scalable products and the head of emerging products have been named and are in place.

The head of volume products will be named shortly.

I have also decided to have the Vice President of our customer advocacy organization responsible for our services and support business, report directly to me.

This organization is accountable for driving the service and support P&L for the Company.

The head of the customer advocacy organization has been named and is in place.

Last time, I spoke to you about improving our cost structure, of our supply chain.

Following a review of our alternatives I have decided to move the manufacturing of the BD 8800 product line to an Asian facility this will be done during the balance of this year in conjunction with the design of a new set of higher functionality and performance blades for this product.

We expect to see significant cost improvements because of this decision.

Following a review of the current residential and commercial real-estate market in the Santa Clara area, I have come to the conclusion that market conditions are such that the sale of the campus and the relocation of the organization is not the right thing to do at the present time.

The residential market is weak and leases for commercial real estate are continuing to strengthen.

We would foresee a substantial negative P&L impact of executing this transaction at the present time, therefore we will remain in our current location for the foreseeable future.

Given that we have excess space in our Santa Clara facility we are looking to separate and lease one of the buildings as a way to generate cash to offset general operating expenses.

While we have been able to sequentially improve our business results during the past two quarters on a worldwide basis it is clear that our sales in the Americas continue to struggle to achieve the kind of growth rate that we need to drive the overall company revenue.

A higher than desirable attrition level coupled with the necessary time to train and build the pipeline with new sales people is the primary driver of this performance level.

We are not yet through this but we continue to aggressively focus on retention.

Some of the actions taken include a greater focus on fewer industry verticals to improve the overall solution and sales process.

The creation of a Senior Account Manager position to financially create incentives and reward our most senior and most productive account managers, an executive engagement program where we couple a senior corporate executive with account teams for our larger opportunities, a greater emphasis on recruiting and coupling the right channel partners to the appropriate account teams, and a look at our quotas for selected account teams to ensure that the goals are aggressive but achievable.

While I am pleased at the pace of the organizational and process changes that are being made in many places throughout the Company, significant improvement in our financial results are not going to happen instantaneously.

We have increased revenues, margins, and have controlled our costs this quarter.

We have also benefited from what is seasonally an up quarter.

I am pleased that outside the Americas we have generated solid sequential growth.

There will continue to be some quarterly ups and downs in our costs as we taylor where our investments need to be.

Stay tuned.

A lot more to come.

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

Thank you, Mark.

I am 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 related to stock option grants.

The special committee has hired independent legal and financial experts to conduct the investigation.

We have preliminarily concluded that the appropriate measurement dates for financial accounting purposes of certain stock option grants differ from the reported grant dates of those awards.

The additional noncash charges for stock-based compensation expense is expected to be material with respect to certain fiscal periods, and the Company will therefore restate certain historical financial statements to record the additional stock-based compensation expense, tax related impacts, and will evaluate whether any other unreported adjustments previously determined to be immaterial need to now be recorded.

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 2, 2006.

Our quarterly report on Form 10-Q for the first quarter of fiscal 2007, nor have we included financial statements in our Q2 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 February 9, 2007.

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

Now looking at revenue, revenue for the quarter was $86.9 million, consisting of $71.1 million in product revenue and $15.8 million in service revenue.

Our book-to-bill ratio was greater than 1.

As Mark mentioned we built backlog in the quarter primarily related to bookings for our newly introduced models of the SummitX450 family.

We experienced significantly higher demand than anticipated for these newly introduced products.

Looking at revenues on a geographic basis, in EMEA, which includes our European operations, the Middle East, and Africa, our revenues were $36.4 million.

This is an 11% increase sequentially.

This is also a 16% increase from the $31.4 million of revenues in the prior year same quarter.

We continue to see good growth in Europe and in particular with regional service providers.

In the U.S., revenues were $31.5 million, down from the $34.2 million in the September quarter and down from the $31.9 million in the second quarter of the prior year.

Revenues in Japan were $4.6 billion, flat with the Q1 '07 results.

As mentioned in our last quarterly call, we took actions at the end of Q1 to rationalize expenses in line with the current revenues and are pleased to see the revenues leveling off in Japan.

Looking at Asia outside of Japan, revenues were 13.4 -- excuse me, $13.4 million, an increase from $11 million or 21% sequentially.

This was the second highest quarterly revenue reported by our Asia Pacific operations with only Q2 fiscal '06 with higher revenues at $16.6 million.

Revenues in other geographies, primarily North America outside of the U.S. was $1 million in Q2 '07, $1.1 million in Q1 '07, and $1.9 million in Q2 '06.

Shipments of modular products represented 45% of sales with stackables representing 55%, which is a couple of percentage points shift in the mix towards more stackable products than in Q1.

This is due in part to the success of our SummitX450 products with service providers.

The split of enterprise sales and service provider sales was 73% to 27%, which is a slight shift towards service provider as compared with the prior quarter.

Just to note, we have amended the enterprise to service provider sales split in Q1 '07 from what we previously reported to 74% enterprise and 26% service provider.

So we have experienced a 4% shift towards service provider sales in Q2 '07 as compared to Q4 '06.

This is consistent with the growth in revenues and penetration into service providers in our EMEA region.

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

Sales of XOS products grew to in excess of 40% of product bookings, up sharply as a percentage from Q1.

Bookings of our BlackDiamond 12K increased sequentially in the quarter driven by demand from service providers in EMEA and South America.

Bookings of our SummitX450 family of products which brings our ExtremeXOS operating system to the edge of the network were also up sequentially this quarter.

New bookings for POE ports increased sequentially and 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.

Ten gig port bookings increased sequentially also.

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

Now I would like to comment on a couple of trends affecting our costs.

Looking at gross margin trends excluding the effect of stock-based compensation, we saw overall gross margins improve this quarter compared to the prior two quarters.

Product margins improved due to a shift in product mix, geographic mix, and lower product cost.

Service margins increased several percentage points as compared to Q1 '07 and are similar to the service margin in the Q2 '06 quarter.

Turning to operating expenses, and excluding stock-based compensation, costs related to our option investigation, and restructuring charges, overall operating expenses were lower in Q2 as compared to Q1 primarily on lower G&A expenses.

Q1 was affected by approximately 1.2 million increase in legal costs related to intellectual property litigation that did not recur in Q2.

However, we expect to incur higher legal fees related to intellectual property litigation in the next several quarters.

Regular headcount at quarter end stood at 874, up from 856 at the end of the September quarter.

Other income was $2.2 million in the quarter.

Total shares used to recalculate -- to calculate diluted EPS in the current quarter were 115.1 million shares.

Shares used to calculate basic EPS in the current quarter were 113.6 million.

Total shares outstanding at quarter end were 114.1 million, down approximately 900,000 shares from the end of the September quarter.

Looking at the balance sheet, cash and cash equivalent short-term investments and marketable securities on December 31, totaled $204.2 million, down $219.2 million sequentially.

During the quarter, we paid off our $200 million of subordinated debentures and we are now debt-free.

We concluded our share repurchase program in the current quarter.

In this quarter we used $3.4 million to purchase approximately 900,000 shares.

From inception, we have used $48.3 million of cash to repurchase 11.1 million shares of stock or approximately 9% of the shares that were outstanding as of October of 2005 when we announced the program.

Other items affecting cash flow in Q2, capital expenditures were approximately $1.9 million, depreciation and amortization were approximately $1.8 million, and amortization of the warrant was $1 million.

Net inventory at quarter end stood at $23.2 million, a decrease from 24.1 million at the end of Q1.

Inventory turns stood at 7 for the quarter.

Accounts receivable were $30.2 million, up from 27.8 million sequentially, primarily due to higher revenue this quarter compared to the prior quarter.

DSOs at quarter end stood at 31 days, a slight increase compared to the result at the end of Q1.

Accounts payable were $16.7 million, down from the 24.4 million in Q1, primarily due to timing of inventory purchases in Q2 as compared to Q1.

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 and so it was fair to say our visibility can be limited.

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

With that let me turn the call back over to Mark.

Thank you, Mike.

As you can see we continue to make the changes to lay the foundation for future success.

We're in a growing market and the need for solutions to complex network problems does not appear to slow down any time soon.

So at this point I'd like to conclude the prepared remark portion and open it up for questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question comes from Samuel Wilson with JMP Securities.

Good afternoon, gentlemen.

A clarification and a couple of questions.

On the clarification I just missed what cash from operations was?

And then in terms of questions, just two.

Can you give us a sense of OEM sales and what the pricing environment was like during the last quarter?

Thank you.

Yes, this is Mike.

I'll take the question on cash from operations and I'll let Mark answer the second question.

So on the -- it's a little bit difficult to speak directly to cash flow from operations given the fact that we are not presenting full financial statements in the current quarter.

I did try to highlight in my prepared remarks some of the changes in the balance sheet accounts that I think will have an impact on the cash, namely the increase in the receivables in the quarter and the increase in inventory over the last two quarters and the reduction in payables, which I think from those balance sheet account changes we'll see a use of cash from operations in the current quarter.

That's what I thought.

Now on the OEM sales, first of all, the overall pricing environment clearly continues to be very competitive.

We're out there kind of slugging it out every day.

But that said, you've seen from our remarks that our overall product margins improved well this quarter.

So our product costs are competitive, and I feel that we have the wherewithal to go fight the competition.

Now, with regard to question of OEM sales, depending on -- we don't break out OEM as a particular segment of our sales What I can tell you is that we've been talking about sales to our strategic partners.

Avaya, Ericsson and Siemens.

Together, those three are at their highest levels they have ever been.

So we continue to enjoy a lot of success with the kind of strategic partnerships we can use.

Yes, I understand.

I was asking specifically about the security products OEM and--?

Okay.

I don't have that data with me.

I know we've been pretty aggressive this past quarter.

We have run a number of promotions, we've tied together wired and wireless and security, so we have enjoyed good growth in unit counts of our Sentriant product line, for example, but I don't have that revenue break out off the top of my head here.

That's fine.

But it sounds like it's growing quarter on quarter?

Yes, it is.

Great.

Thank you.

Thank you, sir.

The next question comes from the line of Tim Long with Banc of America Securities.

Good afternoon.

This is [Jeff Slubert] dialing in for Tim.

Much better results in Europe and Asia excluding Japan.

I just wanted to know if you think these trends are sustainable.

And then service provider business has been improving for two sequential quarters.

Should we expect that to continue to go up on a go forward basis, and do you have some sustainable advantage in service provider where we should see more of a focus there?

Well, we've -- if you look particularly in EMEA and Asia, the -- we have a pretty good product line, the teams are focused.

We've begun to address our -- some execution issues here over the last few months.

We got a long ways to go.

That said, the competitive landscape is the competitive landscape.

The enterprise business tends to be a little bit more predictable over time, given the fact that the deals tend to be -- each one tends to be smaller.

The service provider business tends to be lumpier.

The deals tend to be bigger, but the service providers tend to purchase in a lumpier fashion so it it's hard to tell.

The reason I think overall we have been successful over the last few quarters in the service provider space is that more service providers are beginning to get the idea that by using ethernet networks relative to legacy technology they can in fact provider better services at a lower price.

As more folks get that idea, I think our products are designed for that.

So we believe that over time the market is kind of moving in our direction.

Now, that said, the smaller service providers around the world tend to be quicker to react to these trends because they have less of an installed base to have to deal with and amortize, which is why you see most of our business wins right now tended to be outside the United States, but we continued to focus on that and we teal that overtime as more people catch on to that, are going to help.

In addition, certain models of the X450 products line, in addition to the 12K, are well designed for service providers.

We believe if we continue to put product out there we're going to start to see more wins.

Do you think the Americas has stabilized around here or should we expect some more growing pains going forward.

I think we're making progress in the Americas, but I think we've got more to go.

We're working pretty hard on it.

We have got a lot of our energy focused in that area, but while the trend over a few quarters I think is going to be in the right direction, don't be surprised if there's a few bumps along as we're going.

I outlined a few things that we did during the quarter to bring this stuff into sharper focus, but it continues to be an area that uses up a fair amount of my attention right now.

Great, thanks.

Thank you, sir.

The next question comes from the line of Jiong Shao with Lehman Brothers.

I have a couple of questions as well.

First, thank you so much for the color on the gross margin.

I thought that's very helpful, but I was hoping you can share a little bit details on the OpEx.

I think you said OpEx was down sequentially.

But I was wondering, is that lower or higher -- how that compared to the June quarter last year?

Any color you can provide will be helpful.

I'll let Mike kind of address that.

As we discussed kind exiting Q4 in our conference call.

We disclosed that we were going to be expecting expenses to increase as we entered into fiscal '07 and Q1 and hopefully we got that message across in the last call also, primarily in the sales and marketing area, but also a little bit in the research and development area.

This quarter, we are -- our expenses are down sequentially, and primarily in the G&A area and primarily related to legal fees that we experienced in Q1 that didn't recur in Q2, but as I mentioned that will reappear as we move forward with some claims.

In relation to Q4, we are in close proximity to that number, without getting too too specific on the exact numbers, given we can't produce financials.

Okay, sure.

So using that as the rough gauge, if I do my rough math, it looks like the pro forma EPS, if I just plug in all that's comments, is like $0.01 to $0.02.

Am I in the right ballpark?

Sorry, we just have to have a model.

Yes, I want to help you on this one, but given the fact that we can't publish financial statements, I can't give you a number.

Okay.

But you're profitable?

I think you're going in the right direction with your analysis.

Okay, great.

My second question is -- is about book to bill and also the Summit450.

I was hoping you could provide a little bit more color on book to bill.

Is that sort of comfortable level?

Sounds like you said that demand is significant above your expectation.

Just want to make sure am I understanding right, looks like book to bill may be comfortably above 1?

And also just for 450, could you elaborate, what's special about a 450, kind of why that demand is so strong, or stronger than you expected?

Let me start with the second question on the 450.

The demand was strong for a simple reason.

We finally got the power of XOS, modular, scalable, open standards operating system with frankly the feature set of things you would expect in big expensive boxes, and we were able to put it in a one-rack unit stackable with 24 ports, or 48 ports, or enterprise version or service provider version, or a version with POE and a version with DC Power.

So there's a number of these kinds of models.

So it's a lot of features in a small package for a really good price.

When you put out something like that people catch on pretty quick.

And so we enjoyed very good success for that product.

And so we were able to build a bunch of backlog with it, which clearly is good on one side but you want to work off as fast as you can.

We're all being pretty aggressive at ensuring that we're driving the the supply chain in the right direction so that we can catch up with the bookings environment for that product.

In terms of the backlog, itself, the book to bill was clearly above -- book to bill, clearly above 1 during the quarter as I said we build some reasonable backlog here in a few areas but most notably because of the significant improvement in demand on the 450.

Thanks a lot.

Thank you, sir.

The next question comes from the line of Matt Shimao with Bear Stearns.

I wanted to ask again, about your regional sales break down in Q2, maybe get some more colors on the competitive dynamics in the Americas and International and I wanted to ask specifically, do you think the results properly reflect your competitive position in those regions, or are there some unusual nonrecurring things going on that important to understand, for example, large deals or something else like that?

Thank you.

Well, so let's focus outside the Americas.

I think if we look at our business in Asia and our business in India and Latin America I don't see any reason why businesses in those regions don't reflect a normal competitive position.

I didn't see anything unusual in what was taking place in those areas this quarter.

So I think it's a fairly, as much as we can predict these things, is a reflection of what is kind of going on.

I think the reflection of our performance in the Americas is still much more due to sort of internal execution issues than it is to the overall effectiveness of the product line.

After all, if we are able to be pretty successful selling this stuff in EMEA and in Asia, the competitive position, with the exception of perhaps the fact that outside the Americas the average service provider tends to be a little smaller and a little quicker to move to ethernet based technologies, the competitive -- and outside the U.S. we tend to have perhaps a few more mid-size customers compared to the U.S., but aside from a couple of those areas the competitive landscape isn't hugely different, so I believe that most of what we face here in the U.S. is basically internal execution issues.

Thank you, sir.

The next question comes from the line of Erik Suppiger with Pacific Growth Equities.

Can you just, following-up on Matt's comments, can you say how North America did relative to your expectations going into the quarter?

Was the market what you had been anticipating, or -- just give us a little flavor in terms of how it did compared to what you were looking for.

Well, it was kind of about where we expected it given sort of everything that's going on, but I'll be honest with you, I certainly would have liked to have seen a little bit better performance in the Americas, and especially in the U.S.

That's why I continued to be very, very focused on the U.S.

I spent a fair amount of my time in the country visiting the particular regions and talking to folks.

There's some key challenges that remain.

I want to make sure that they get solved, and I think with the right adjustments we can make significant progress.

Would I like to be further ahead in this process?

Absolutely.

But, it's -- I think things just got -- they are a little more stubborn than I probably wanted them to be.

Yes, overall, I'd like to be a bit further along in the Americas.

I think we're making the right changes.

It just seems like it's taking a little longer for these changes to bite.

How is the recruiting going for bringing on additional sales?

The recruiting is going well, The key with all of this is to make sure that the right programs are in place to get them once they're on board to very quickly get them into their patch and for them to be able to build their pipeline as quickly as possible.

So we have the ability to hire, the team is hiring, they're doing this consistently.

The quality of the candidates is pretty good.

I really am focusing making sure that we can get them up to speed as fast as possible.

Like I said we're making progress, but I wish we were a bit further along.

You talked a little bit about government.

Any thoughts in terms of that vertical as we look -- I don't know what your contribution from federal is, but any thoughts that sounds like that could start getting weaker as we get into the March quarter.

Any thoughts on that?

Well, I don't know about that.

I was -- we don't break out our federal business separately, but what I can tell you, I was just with the Director of our federal business, and we were kind of wandering around the country visiting a bunch of defense department customers, and I asked him kind of that question, so what do you think is going on.

Right now he actually thinks the environment may get a bit better.

The problem is there's -- the government is still operating kind of on a continuing resolution mode given the federal budget, start of the fiscal year.

Our buddies in Washington are still kind of working through all of this stuff.

And so he actually feels that right now it's a bit more hand to mouth because of -- because the government isn't free to spend to its budget.

We are going to have to see as the continuing resolutions turn into more formal budget allocations.

Lastly, just on the backlog, can you give us any flavor for what additional upside you might have had if you had had -- like how significant was the constraint?

So we don't break out bookings nor backlog, so we can't say much more than we've already said other than to say we sold -- we booked a lot of 450s that I wish I could have shipped.

Expect the book to bill to be less than 1 next quarter as you burn off some of that backlog?

It's -- I don't know, Mike, do you want to comment at all on that?

Yes, it it's hard to tell.

One of the reasons we don't break out backlog is because our orders tend to turn relatively quickly, and the backlog, from our point of view, doesn't represent meaningful forecasting tool for everybody.

So that's one of the reasons why we don't break it out.

And the change in the backlog and the change in the book-to-bill ratio are generally relatively small, and our billings and our bookings and revenue generally track pretty close in line.

That said, there's a big incentive to get products shipped.

Mostly for customer satisfaction reasons, right?

I mean, new, exciting products people want them and when they want them, they want them.

So financial issues aside, clearly the manufacturing team is working as hard as they can to get supply to catch up with demand.

Very good.

Thank you very much.

Thank you.

Next question comes from the line of Subu Subrahmanyan with Sanders Morris.

I had two questions.

First, just in terms of seasonal patterns, I know you're not providing specific guidance but can you talk about what the season patterns you are seeing into the March quarter?

Do you expect to see the normal kind of seasonality some declines in Europe and U.S. enterprise and also could you speak to Japan, the business you talked about kind of stabilizing the cost situation getting more fixed -- but NTT has this large build-up plan.

I know you guys have been suppliers to NTT in the past.

Any sense on when the next generation network build starts?

And how that might benefit Extreme?

First of all, seasonality, it's hard to tell, because when we go back and look at our seasonality, sometimes we -- sometimes the business tends to fall off the normal seasonality patterns that you would expect with the even quarters being a bit stronger than the off quarters, and sometimes we buck that trend.

So in many cases, as Mike said, sometimes a few deals moving one way or the other can change the seasonality pattern on that.

And with 50% of our business being in Q3 -- I'm sorry, being in the last month of the quarter, it's kind of early to tell how would a Q3 be shaping up.

So right now I don't have any words of wisdom as to whether we're going to follow the seasonality or buck the seasonality this quarter.

Regarding Japan, NTT continues to buy for the deployments that they are doing.

While the business plan for Japan has specific direction to go build a more predictable enterprise business, and we're working pretty closely for it to happen, we're still paying lots of attention to the service provider space and where they are communicating with NTT on an ongoing basis and at some point they are going to go build -- they are going to go deploy a network that requires ethernet technology and we're going to be right there with it.

Meanwhile the good news is that the same products are having quite a bit of success in other parts of, especially in India and Latin America.

So we're not stopping our investment effort in the hardware and XOS.

So whenever NTT is ready to go do something, I think we'll be there with some pretty good products to offer them.

Thank you.

The next question comes from the line of Munjal Shah with Piper Jaffray.

Yes, hi, this is Munjal Shah for Troy Jensen.

A couple questions, one on taxes.

How should we model taxes going forward?

What percentage should we model?

And when do we expect you to be on that normal tax level?

Yes, so the question on effective tax rate for us is a little bit more complicated than maybe normal given the fact that we do have a full valuation allowance on our deferred tax assets.

What I'd recommend you to do is take a look at our published financial statements for the last two years and look at the -- kind of the actual level of tax expense in those financial statements, and use that information in order to project forward into the current quarter.

Because as we have -- the effective tax rate on us is a little difficult because as we have increasing profits we benefit from the net operating losses in the U.S.

And given the fact that we have a lot of international subsidiaries that are structured in the manner that they pay taxes locally we actually have a fixed level of tax expense on an international basis so when our revenues or taxable income grows the taxes don't change, but then as our profits kind of approximate or come close to or below breakeven we don't benefit from that either because of the international taxes.

Take a look at the prior financials and use your best guess.

Can we do that for just the one quarter or how about like one year out or for fiscal '08?

Do you think it will be similar phenomena or?

I would say that for the next couple of years, or through this one and then if you want to use it to project forward, almost use a fixed amount of tax expense regardless of the taxable income.

One more question on U.S.

I know you mentioned that most of the issues were related to the internal execution.

If you were to point out something outside of the Company, would it be something like in terms of competitive dynamics or pricing or customer demand?

Is there any one thing that you can point out to as to why U.S. would have been--?

there really isn't.

The pricing environment hasn't changed dramatically here in the last few quarters.

So it's mainly really getting the sales force in place with the right tools, focus on the right verticals, a number of the things that we have already outlined.

Thanks a lot.

Thank you.

The next question comes from the line of -- excuse me.

From Tal Liani with Merrill Lynch.

Thanks.

It's actually [Inaudible].

Just have a quick question first of all on -- can you help us estimate the interest income line and I wanted to see if you could give us the number of employees, and I have some questions about the sales force if I can follow-up.

Yes.

So the other income line for us is going to include interest income on our $200 million plus of investments.

So $200 million of investments and then pick your favorite interest rate.

The other item that gets into the other income that kind of bounces up and down a little bit is foreign exchange gains or losses, and so I think the number that I had quoted earlier for this quarter, give or take several hundred thousand dollars is probably a good number for your model going forward.

On the headcount, I disclosed that in our prepared remarks.

At the end of the quarter we were at 874 employees.

Great.

Wondering if you can disclose how many of those are actually salespeople?

And just wondering from a high level as you add employees to your sales force what kind of productivity level, I guess, you're looking for them to achieve, if you can talk about maybe a range, six to nine months out, when they get up to speed on the products and their customers.

Yes.

We don't break out sales headcount separately.

But a good -- you can -- of net adds in this company are going into the salesforce because it's clearly the area where we can generate the best short-term return on it.

We don't break out sort of sales productivity.

It gets kind of complicated.

You have got account managers, you've got people managing the channel, you've got all sorts of different things, and so breaking these things out starts to get complicated, but we do monitor those things internally very very carefully and I do set goals for not only the salesforce on a worldwide basis but for each geography has a cost to generate -- the number of pennies they get to have to generate a dollar in revenue.

And those things are monitored very very carefully on an ongoing basis.

Thanks.

Maybe I can squeeze one in about the business model in general.

Just wondering if you're looking at it from an annual perspective just to give us a view of when we can expect, or at what level we can expect you to achieve operating profitability.

You came close obviously this quarter relative to September but I was just wondering how many more quarters, or on an annual basis what you think the break-even should be just for our sort of high-level modeling?

Thanks.

That's all from me.

It's kind of tough to break that down sort of on a quarter by quarter basis, right, there are some things that spill over from one quarter to the other.

I don't try to manage every quarter by itself.

I want to make sure that we are sustainably profitable and at the same time we keep a product pipeline going in the right direction.

Certainly I want to get the break-even of this company to be as absolutely as low as I can, consistent with a sustainable business.

So I continue to focus on that.

I think it -- as we get to the point of being able to get the 10-Ks and the 10-Q's published again, I think we can have a bit more of a rational conversation about that.

Because we'll be able to lay a bunch more of the numbers in front of you.

So I'm spending most of my energy making sure that we can kind of get through this period where our our ability to give you information is limited and we can get back to a more normal place where we can have some more in-depth conversations.

Thank you, sir.

Gentlemen, at this time we have reached an hour.

We have one final question from the line of Cobb Sadler with Deutsche Bank.

Thanks a lot.

I may have missed it but have you all started recognizing revenue from Telefonica yet or not?

I may have missed it.

Sorry.

We didn't mention it specifically, but Telefonica bought from us in this quarter, I can't remember the exact -- the numbers.

I don't look at it in any particular deal.

But the buildout continues.

We received order from the relationship during the quarter, so nothing major new to report there.

Got it.

Then just one last general question.

On ethernet RFPs, are you seeing kind of 10,000 feet, are you seeing an acceleration deceleration or you're kind of the same number RFPs that you've been seeing over the last six months?

Thanks a lot.

I don't know if I'd look at it on a per RFP point of view.

What I can tell you in general is I'm out there talking to bunch of carriers, that the direction is definitely headed towards ethernet rather than away from it it.

So the key question is how quickly and as I mentioned earlier, the smaller and mid-size carriers tend to get there a whole lot quicker because they have fewer infrastructures to depreciate over these long depreciation cycles.

So our game plan is pretty simple.

We knock on the right doors, and we were there with the right products as they get there, and then as the market transitions our hope is to catch our share of it.

Gentlemen, please go ahead with your closing statements.

Great.

I'd like to thank all of you for your participation today.

I will continue to provide time with you as group, or individually to discuss the continuous progress that we're making here at Extreme Networks.

So for now thank you and look forward to continued communication.

Thank you.

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

If you would like to listen to a replay of today's conference please dial toll free 1-800-405-2236, or 303-590-3000.

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Once again ladies and gentlemen if you'd like to listen to a replay of today's conference, please dial toll-free 1-800-405-2236, or 303-590-3000 with the passcode of 11081087.

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Thank you.