Extreme Networks Inc (EXTR) 2007 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, welcome to the Extreme Networks, Inc.

2007 fourth quarter and fiscal year-end 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 Wednesday, August 1, 2007.

This afternoon, Extreme Networks issued a press release announcing the Company's financial results for the fourth quarter and fiscal 2007 year end.

A copy of this release is available on the Company's web site at extremenetworks.com.

The call is being broadcast live over the Internet and will be posted on the Extreme Networks web site for replay shortly after the conclusion of the call.

The Company has asked me to remind you that this conference call contains forward-looking statements that involve risks and uncertainties, including statements regarding our expectations as to products, trends and our performance.

There can be no assurances that any forward-looking statements will be achieved and actual results could differ materially from forecast and estimates.

For factors that may affect our business and financial results, please refer to the Company's filings with the Securities and Exchange Commission, including without limitation under the captions "Management Discussion" and "Analysis of Financial Condition and Results of Operations and Risk Factors", which is on file with the Securities and Exchange Commission at www.sec.gov.

The Company undertakes no obligation to update the forward-looking information in this conference call.

Throughout this conference call, the Company will reference both GAAP and non-GAAP financial results.

The Company has provided a reconciliation table of GAAP to non-GAAP information in the tables that accompany the press release and on its web site.

Please go to the Investor Relations section of the Company's web site at www.extremenetworks.com.

In addition, all announced results are preliminary and may be subject to change when the review of the fiscal year is concluded and/or a 10-K is filed for the fiscal year.

I would like to turn the call over to Mark Canepa, President and CEO of Extreme Networks, Inc.

Please go ahead, sir.

Thanks, operator, and thank you all for joining us today.

I plan to discuss some of the highlights of the quarter and point out the areas where we continue to make real progress, as well as some of the areas where we still have work to do.

Then I will turn the call over to Karen for more specifics on the financials.

First, I want to start by thanking Alicia, Mike and Karen for leading the team that accomplished the enormous effort to complete the filings and bring the Company back into compliance with the various regulatory bodies.

The whole process took nine and a half months, which is on the fast end of the time it's typically taken companies to make it through this process.

For the first time in my tenure as CEO, I can speak to you with the ability to share full financials.

This was a good quarter.

Better, I think, that was fully captured in the financials.

Top-line revenue was the highest it's been in six quarters and was up both sequentially and year-over-year.

In particular, product revenues were up nearly 8% year-over-year for the quarter and showed an increase of nearly 4% sequentially.

As important, revenue for each quarter and fiscal '07 was higher than that of Q4 fiscal '06.

So we're moving things in the right direction.

I believe in fiscal '07 we have established the revenue baseline from which we can begin to grow the Company.

It was also the first time since Q1 fiscal '06 that we have delivered year-over-year revenue growth.

I am especially pleased to note that the Americas finished the fiscal year with a positive quarter of 17% year-over-year growth.

Eileen and the Americas regional directors have made solid progress in developing a better sales pipeline and converting it into revenue, including several large deals.

In addition, with the strong leadership and under the guidance of Helmut Wilke, our new Senior Vice President of Worldwide Sales, who joined us in the spring, we've given our sales force the support that has started to make a difference.

I congratulate our team on their efforts.

As the results show, our new products are being very well-received.

Shipments of our ExtremeXOS-based products were in excess of 60% of bookings this quarter.

With the availability of ExtremeXOS 12.0 and the X250 platform, we now have an entire edge-to-core product line available on a single, modern and reliable operating system.

We're very happy to see these positive signs.

I thank the team for their hard work to get us to this important milestone.

Book-to-bill was above 1 for the quarter.

We were not able to catch up with the demand generated by some of our newer products, particularly the strength of the demand we're experiencing for the Summit products.

Demand for the X450s has continued to outpace supply, and the new X250, in its first quarter of deployment, had record shipment for any product in any initial quarter in Extreme's history.

In addition, 10 gigabit port bookings were healthy and increased sequentially, again, this quarter as did bookings for POE ports.

Due to the convergence trend being central to the enterprise business strategy, we saw a 60% increase of POE ports quarter-over-quarter.

With convergence continuing to drive demand and more POE network devices coming to market every day, we don't see that trend slowing down in the foreseeable future.

Service revenues were down a bit, which was expected.

As the mix continues to shift towards more XOS-based products, we've anticipated a dip in Services revenues which occurred this quarter.

Over time, we expect Professional and Educational Services to become more integral to the Company's financial success.

To this extent, I have asked Mike Seaton, formerly our Vice President of Global Partners and Sales Operations, to assume the roll of Vice President responsible for our Support, Professional Services and Educational Services organization.

Mike has both significant sales experience, as well as past service and support experience.

I will be working closely with Mike and Helmut to bring revenue growth to our services business.

We need to get that business right and complete the transition from services support to a true revenue growth center.

In general, as we strive to become more solutions oriented, I believe that Services, especially Professional and Educational Services, will need to become a more important part of our strategy, and, overall, a larger part of our revenue stream.

For the quarter, EMEA and Asia Pacific were down by comparison to Q3.

We're coming off a number of very robust quarters in those geographies.

Our success in these regions has been with regional service providers and that business tends to be lumpier by nature because of the types of deals and their size.

Overall, we have been experiencing good growth in those markets, and I won't be satisfied until we return to consistent growth in all of our geographies.

Turning to gross margins.

Non-GAAP gross margins remain good for both products and services as we maintain strong discipline over our supply chain and as we continue the shift towards newer, higher margin products.

And we achieved these numbers without benefit from our transition of the BB 800 product line from North American manufacturing to Asian manufacturing.

The new cost reduction design is progressing well and we should see results of these efforts later in the current fiscal year.

On expenses.

With Karen on board, we spent considerable effort this quarter assessing our operating structure to find areas where we could quickly and easily take some expenses out of the run rate of the Company.

To that extent, we completed a workforce reduction at the end of Q4.

I'm pleased to see that we were able to drive our head count from 880 people to 825 people sequentially.

While we intensionally put our head count in a position to do some critical skill backfilling, we intend to continue to manage this metric aggressively.

Areas where we still have work to do, discounts were a little higher this quarter due to the mix of larger, more competitive deals.

And some operations costs were higher this quarter in our excess and obsolete inventory costs.

Continuing to manage the healthy margins will be an area of ongoing focus.

Let's now look at the business by market segments.

In Higher Education, we focused on converged networks for distributed campus environments.

They require secure, reliable access for diverse users.

They also need methods to enforce policy.

Some of our recent wins included Michigan State, Mississippi State, and West Georgia universities.

Also, commune college wins included Iowa Valley and Oakland County, Michigan.

Lastly, we won business at large K-12 school districts throughout the U.S.

Examples are the Inver Grove, Grant, Antelope Valley and Clark County school districts.

Healthcare.

Extreme is well-suited for hospitals and clinical facilities where extensive network needs are driven by diverse applications such as conditions PAX, wireless equipment and electronic patient records.

One of our key wins was with Chelsea and Westminster National Health Service in the UK.

We also continue the buildout of 40 separate hospital sites with Nuffield in the UK, and also various clinics and hospitals here in the U.S.

In Telco service provider arena, Extreme is a cost-effective choice for high-performance Metro networks.

We added new accounts, highlighted by Guangdong Mobile of China.

We continue to sell to T2 of Slovenia, which supports a large and growing residential network for triple play services.

Locally, we continue to work with Yipes Enterprise Services, which delivers transparent land services over Ethernet.

In the Government space, we continue to see traction with our secure and reliable solutions.

The U.S.

Pentagon renewed its support contract as part of its Wedge renovation project.

The Supreme Court of Costa Rica represented a key win in South America.

Other key enterprise accounts were added during the quarter.

Highlighted with new accounts within the manufacturing and energy sectors.

Thompson Machinery Corporation, an equipment manufacturer based in Tennessee, selected a combination of Extreme Networks and Avaya for its new converged network.

Extreme also won the network for SK Corporation, the largest energy and petrochemical company in Korea.

And lastly, within the Financial Services space, Extreme Networks added a significant customer during the quarter, the Citadel Investment Group of Chicago, where our solution is an ideal fit for their mission critical requirements.

To net out this past year, during FY '06, we were reporting substantive, sequential and year-over-year revenue declines.

During FY '07, we established a revenue baseline, and as we exit FY '07 we're able to show real year-over-year revenue growth.

With that, I would like to turn it over to Karen.

She will speak in more detail about our financial results.

Karen?

Thanks, Mark.

I'm going to briefly review our results for the quarter and give you some color on what's behind the financials.

Revenue for the quarter was $87.1 million, which is up 2.3% sequentially and 5.6% year-over-year.

As Mark noted, this is our best revenue performance in six quarters.

Perhaps the best measure of how we did during the quarter is to isolate product revenues which increased 3.3% sequentially and 7.6% year-over-year to $71.9 million.

Service revenues were down slightly, both sequentially and year-over-year, to $15.2 million consistent with our expectations.

Mark noted in his remarks that we look for Professional and Educational Services to become a more integral part of the Company's financial success over time.

In the short-term, we expect product revenues to grow as a percent of total revenues as our new products gain more traction in the marketplace.

Our product book-to-bill was above 1.

The increase in backlog stems from timing of orders received during the quarter, and demand for our newer products ramping stronger than we had anticipated, resulting in supply constraints.

The ratio of enterprise to service provider sales was 82% and 18% respectively.

Over the past year, the ratio was a consistent 76% enterprise and 24% service provider.

The current quarter's enterprise to service provider shift was due to a shift in the geographic mix of revenue with a larger percentage of the business in the U.S., which has a higher mix of enterprise sales and a smaller percentage of the business in the EMEA region, which historically has had a higher mix of service provider sales.

Bookings on our XOS-based products continued to increase as a percent of our total revenues.

Sales of XOS products grew to in excess of 60% of product bookings, up sharply from Q3 of 50%.

We introduced our Summit X250 family of products in the current quarter and continued our expansion of the XOS operating system to our edge products.

Bookings of our Summit X250 family of products were very strong in their first quarter of shipments.

With the strength of some of the newer Summit products, shipments of our stackable products represented 61% of product revenues during the quarter, and modular products represented 39%.

The new bookings of POE ports increased sequentially and grew above 30% of total ports booked up from 24% in the prior quarter.

We expect POE ports to continue to grow based on demand for IP telephony and Wireless.

This quarter bookings of our Avaya channels were, again, in excess of 10% of total product bookings.

Looking at revenues on a geographic basis, U.S.

revenues were up 16.6% year-over-year and 32.4% sequentially to $40.8 million due to increased customer demands on our new products and delivering on several large deals in the quarter.

EMEA, which includes our European operations, the Middle East and Africa, revenues were $33.4 million during the quarter, which is down 2.1% from the prior quarter and up 12% compared to the year-ago quarter.

Revenue in Asia Pacific, not including Japan, was $9.2 million compared to $10.7 million in the year-ago quarter.

During the quarter, revenue in Japan was $3 million.

That compares to $6.4 million in the year-ago quarter and $5.6 million in Q3.

Revenues in other geographies, primarily North America outside of the U.S., was $0.7 million in Q4, $0.9 million in the prior quarter, and $0.6 million in the year ago quarter.

Note that going forward, we have internally combined our Asia Pacific and Japan regions and will no longer break out Japan as a separate geography.

Now, I would like to comment on trends affecting our grows margins, which I'll be discussing excluding the effect of stock-based compensation.

Non-GAAP gross margins were strong for both product and services as we maintained discipline over our supply chain and continued the shift to new, higher-margin products.

Total non-GAAP gross margin as a percent of sales was 55%.

The prior quarter was a very robust quarter in terms of margin as a percent of revenue.

The Q4 results included competitive pricing on large deals, historical levels of excess and obsolescence, overhead absorption and increased distribution costs.

Our non-GAAP gross margin as a percent of revenue increased 170 basis points from the year-ago quarter of 53.3%.

Product gross margins were 56.6%, which compares to 54.3% in the year-ago quarter and 58.4% sequentially.

Service gross margins were 47.8%, down from 48.2% in the prior quarter and 48.8% in the year-ago quarter.

Turning to operating expenses.

Our non-GAAP operating expenses, which exclude stock-based compensation, cost associated with the stock options investigation and restructuring charges, were $49.3 million.

Excluding litigation charges, non-GAAP operating expenses declined $3 million year-over-year.

We expect our ongoing operating expenses to vary somewhat quarter-to-quarter based on business drivers such as revenue seasonality driving the timing of sales commissions, product development cycles driving the timing of prototype material charges and other such events.

That said, we expect our operating expenses, excluding litigation and stock-based compensation, to be in the $45 million to $48 million quarterly range for FY '08.

Sales and marketing expenses at $25.5 million trended up slightly in the quarter due to commissions on higher revenue.

For the year, sales and marketing expenses were $99.9 million, an increase of $4.2 million from the prior year.

R&D trended down sequentially for the quarter at $17 million as investments associated with the introduction of our latest generation of products and initiating our next-generation of products have been completed.

For the year, R&D was $65.3 million, an increase of $5.3 million, or 8.8% from the prior year.

G&A was $6.7 million for the quarter, which includes litigation charges of $1.3 million.

We expect to incur higher than normal legal fees related to intellectual property litigation over the next several quarters.

Upon completion of our workforce reduction a few weeks back, we have reduced our regular head count from 880 to 825 people during the course of the year.

Other income was $2.2 million and primarily includes interest on our investment portfolio.

Non-GAAP net income was $0.3 million, or less than $0.01 per diluted share.

This excludes $5.4 million in stock-based compensation and other adjustments.

The total shares used to calculate non-GAAP diluted earnings per share were 115.2 million.

GAAP net loss for the quarter was $5 million, or $0.04 per diluted share.

This includes $1.2 million in stock-based compensation charges, $1.3 million in costs associated with our stock option investigation, and $2.9 million in restructuring charges.

We continue to look for opportunities to better align our cost structure, and during the quarter, we announced a restructuring related to the closure of a facility and a reduction of positions across several functional areas following a review of our ongoing expense requirements.

Now, I'm moving on to the balance sheet.

The total of cash, cash equivalents, and investments were $215.9 million, an increase of $1.2 million compared to the end of Q3.

During Q4, we generated cash flow from operations of $2.1 million.

Accounts receivable ended the quarter down slightly at $23.1 million as compared to $25.1 million at the end of Q3.

DSOs declined sequentially and at quarter end stood at 24 days compared to 27 days at the end of Q3.

Total inventory for Q4 was $25.3 million, up $3 million from the last quarter.

Inventory turns were at 7 for the quarter and in-line with the March results.

Total deferred revenue was $42.4 million, down slightly from $42.7 million in Q3.

Accounts payable was $21.3 million, up from $19.2 million in Q3, and CapEx was at $900,000 in the quarter.

Given our limited visibility, with roughly half of our business done in the last month of the quarter, we will continue our pattern of not providing specific guidance for the time being.

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

Thanks, Karen.

As you can see from Karen's remarks, we have a good understanding of where we're doing well and where we need to focus our attention.

With that, I would like to open the call up for the Q&A section.

Thank you, sir.

We will now begin our question-and-answer session.

(OPERATOR INSTRUCTIONS) One moment, please, for our first question.

Our first question comes from Samuel Wilson with JMP Securities.

Please go ahead.

Good afternoon, two questions for you real quick.

Discounting, you said, was up a little bit in the quarter, was that driven more on a specific deal or did you see that competitors were more aggressive on pricing?

What was sort of the root cause of the increase in discounting?

Can you give us a sense, you did a head count reduction, can you give us a sense of what areas in the Company you reduced head count in?

Thank you.

All right.

Thanks, Sam.

Well, there were a couple of things that contributed to the discounting.

One is Q4.

Second is the Americas came through with some larger deals and those tend to be fought on a little wider competitive basis, so, we used discounting selectively.

We review the prices on a regular basis.

We make sure we want to stay competitive from a list price point of view, but then when we're out there we tend to not lose a deal based on price.

We usually win well.

We score well on based on technology, and then we go win the deal.

Between the fact that it was Q4 and the fact that there were larger deals, the discounts were just a little above what we would have normally seen in a quarter.

The other -- and in terms of your headcount question, it was in a number of different areas.

We looked at pretty much every function of the Company and we found where we were able to operate with fewer head count.

In general, we worked really hard not to take them out of front-line positions, and so we looked at a lot of our back office, where could we improve productivity, where we could streamline our processes.

That's where we end our headcount reduction.

Thank you.

Take care, Sam.

Thank you.

Our next question comes from Tim Long with Banc of America Securities.

Please go ahead.

Hi, Tim.

Good afternoon, this is Jeff Slubert dialing in for Tim.

I also have a couple of questions.

Just first on the product and the service margin.

Were the improvements there driven more by new products?

Was it supply or sales of more higher end services, and then, I guess, going forward just, obviously, very nice result in the Americas.

Is that sustainable and how are bookings in Europe heading into the seasonally slower summer months than just lastly, did you see any impact from the Avaya buyout agreement and what do you expect from the Avaya channel going forward?

Sure.

All right.

There were a bunch of questions there.

Sorry.

So, I think the first one you asked was related to gross margin?

Yes.

So, in general our new products, they're young and, therefore, they tend to go out there with pretty good margins because they're designed to be very cost effective.

In general, they drive, they tend to be more reliable and so the overall, the cost to support them tends to be a little bit better.

At the same time, we know that and so the price for the support tends to be priced appropriately also.

That is a whole set of variables we have been talking about over the last year about why in the last few quarters, our product revenues have been growing a little faster than our services revenues because most of them were maintenance kind of numbers.

In terms of Europe, we expect to see the typical European Q, Q1, where they tend to be here for the month of July, they tend be gone for the month of August, and then they come back for the month of September.

In general, we don't expect it to be anything different than our typical Q1 kind of European seasonality.

It's still pretty early to tell exactly whether this year's going to be just like the other years past.

We don't suspect it to be terribly different than any other Q1s.

And as Karen mentioned, our linearity roughly continues to be 25, 25, 50, so it's still pretty early with just four weeks under our belt to figure out what is going on.

As to your question on Avaya, right now our relationship with Avaya continues.

We have discussions with them just as we have been at all sorts of levels of the organization.

We continue to plan joint strategies, joint tours, joint marketing activities, joint collateral.

All of that continues unabated.

We have not noticed any material difference in our interaction with Avaya or their interest or excitement about working with Extreme, pre-opposed to them going private.

So we feel very good.

I think their strategies, if anything, will be better honed.

I think the complementary nature of our product lines and our joint objective will continue to get reinforced.

I feel pretty good about the way things are going with Avaya.

Just one follow-up.

Is it fair to think, as the new products ramp, that the gross margin can move back toward last quarter's levels and beyond through 2008?

Last quarter was a particularly good quarter.

When we were doing the calls, we did not have the benefit of sharing the financials with you, and so there was only so much that we could say to temper, talk about the details.

We tend to have very little [you know] and a number of different things.

Over time, we're working hard on gross margins.

I mentioned the fact of the 8800.

It's still being manufactured in North America so we still will see the upside as we drive that product into Asia.

Beyond that, between Karen and I, we have a solid grip and look at all of the elements that go into driving the gross margin line from discount management to really well-explaining our value proposition, to working the supply chain, to making sure new products get designed with the right cost structure in mind.

There is about five or six different variables there.

We're planning on managing them all pretty tightly.

Does OpEx include litigation expense?

The OpEx guidance?

Karen, do you want to -- .

From the OpEx guidance we gave you, it excludes litigation expense.

Okay, thank you.

Thank you, our next question comes from Subu Subrahmanyan, please go ahead.

Thank you.

I had a follow-up question on operating expense, and then one on seasonality.

On operating expense, you mentioned a range.

Can you just talk about what are some of the factors that will impact the range, and given the head count reduction you have done right now, should we start out at the lower end of the range and ramp to the higher levels through the course of the year?

Second question, not just in Europe, but just kind of going out of fourth quarter, being the first quarter, do you expect the pattern through the year to be similar to '07 where we saw some sequential upticks through the course of the year, and what are you thinking about overall annual growth opportunity for fiscal '08?

Subu, let me address the first question related to operating expense and then Mark can comment on the growth that we're looking at.

In terms of operating expense, the guidance that we gave you, we were trying to give you some guidance as we went through the restructuring to help you take a look at what we might be seeing for operating expense during the coming year, and it's affected by a number of drivers within that range, that being things like the timing of our revenue which drives sales, the sales commission is part of it, things like the timing of our product development in various phases that drives material charges.

Subu, we tried to hone in and give you a sense that that would range between $45 million to $48 million per quarter over the year without commenting on any specific quarter.

So, and as we said before in terms of guidance, we're not giving guidance on revenue or margins or net profit for the year.

We've tried to give you a sense into the overall health that we see of the business.

Mark, do you have anything you wanted to add to that?

On the OpEx, I think Karen is correct.

In general, if you go look, the summer quarter tends to be a little bit on the lighter side.

If you go look at where the bookings come in.

People on average tend to take more vacation and, therefore, the way vacations get accrued.

There are a bunch of variables that kind of come in.

It's really difficult to sit here and [quantize] it on a quarter-by-quarter basis.

In general, there is a seasonality and if you kind of go back in our past history, I don't see any reason why under broad brush terms the seasonality for fiscal '08 would be significantly different than the seasonality we have experienced in a number of the other fiscal years that we have had with the Company.

And -- sorry.

There was a third part to your question?

Yes, just an annual revenue market growth opportunity, kind of what you're looking at, and understand you're not, obviously, giving specific guidance and there are underlying factors which can influence yours differently, your overall market, but just market growth opportunity that you're looking at?

Well, clearly, we're here to grow the Company.

We're not providing guidance not because we don't want to, but I want to make sure we get ourselves established with a track record and a baseline of operations here.

Clearly, we're doing everything we can to establish ourselves growing this Company faster than the market growth, and that is the internal, what we all thrive to.

The question is exactly when we would be doing that.

Year-over-year 6% growth this quarter was established that we can grow the Company.

So in general, I think, we're just keeping with our history and not providing guidance going forward, given the nature of our business at this point.

Operator, we're ready to take kind of one more question.

Thank you.

The final question for the call.

Our next question comes from Long Jiang with UBS.

Please go ahead.

Yes, hi.

Just a question about inventory, the irregularity of the revenues for the quarter.

You said during the call that you experienced some supply constraint due to some strong demand, yet your inventory at the end of the quarter grew (inaudible) sequentially and your inventory turnover declined.

Can you just clarify why inventory turnover declined sequentially over the quarter?

And another question is, I mean, given the fourth quarter you had some big deals and does that impact your visibility for the next quarter given some of those large deals could be lumpy?

Okay, let me answer the questions in terms of inventory.

In terms of revenue, you're correct.

In terms of revenue and the growth in backlog, we saw a lot of orders that came in kind of late during the quarter in terms of the increase in inventory relative to the constraints that we're seeing, it's clearly a mix in our ability to forecast the demand for the new products as we had mentioned.

They ramped up much more quickly than we had anticipated and the mix that we had in inventory was somewhat different than the orders that came in during the quarter.

And as we've mentioned, our seasonality over the quarter is kind of 20/20, 25/25/50 with a lot of those coming in late in the quarter.

So, just to clarify what you just said, it appears there is some mismatch of your inventory versus demand, so, obviously, X250 and X450 were pretty strong.

So what product group was below your expectations?

We don't break out individual product groups in terms of taking a look at revenue or shipments at this point.

But what I can tell you, again, is you're correct that our new products did ramp.

We had saw incredible demand on our new products, and the mix that we had in inventory with the timing of orders ended up growing backlog in inventory for the quarter.

Great.

Thanks, Karen.

Okay, thank you.

Presenters, there are no further questions.

Please continue with anymore closing remarks.

Thank you, operator, and thanks to all of you for joining us this afternoon.

I would like to thank our employees for this past fiscal year.

The progress we have made is in large part to do to their efforts and dedication.

We look forward to speaking with all of you again on our next conference call.

Thank you.

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

If you would like to listen to a replay of today's conference call, please dial 303-590-3000, or 1-800-405-2236, using 11092390 as the access code.

ACT would like to thank you for your participation.

You may now disconnect.