Extreme Networks Inc (EXTR) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

Welcome to the Extreme Networks 2009 third quarter conference call.

(Operator Instructions).

On the call today, the Extreme Networks are Mark Canepa, President and Chief Executive Officer, and Karen Rogge, Senior Vice President and Chief Financial Officer.

As a reminder, this conference is being recorded today, April 23, 2009.

This afternoon, Extreme Networks issued a press release announcing the Company's financial results for the third fiscal quarter of 2009.

A copy of this release is available at the Company's website, at www.extremenetworks.com.

This call is being broadcasted live over the internet and will be posted on the Extreme Networks website for a replay shortly after the conclusion of this 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 the Company's expectations, regarding its financial performances, strategy, growth of customer bandwidth, demands, development of new products, customer acceptance of the Company products, customer spending and economic conditions in the Company market.

Actual results could differ materially from these projects in the forward-looking statements.

As a result, certain risk factors, including, but are not limited to fluxuations in demand for the Company's products and services, a highly competitive business environment for network switching equipment, it's effectiveness in controlling expenses, the possibility that the Company might experience delays as the development of new technology and products, customers' response to its new technology and products, the timing of any recovery in the global economy, risks related to pending or future litigations and a dependency on third parties for certain components and for the manufacturing of the Company's products.

The Company undertakes no obligation to update the information on this conference call.

More information about potential factors that affect our business and financial results is included in the Company's filings with the Securities and Exchange Commission, including, without limitations under the captions Management's Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors, which are on the file for Securities and Exchange Commission.

Throughout the conference call, the Company will refer to GAAP and non-GAAP financial results.

The Company has provided a reconciliation table for the GAAP to non-GAAP and information on the tables of the accompanying press release on the website.

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

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

I would now like to turn the conference over to Mr.

Mark Canepa, President and CEO of Extreme Networks.

Please go ahead, sir.

Thank you, Patty, and thank you all for joining us today.

Revenue for the quarter was $77.2 million, down 6% from the quarter last year.

Proforma EPS was $0.01 per share.

I'm pleased with the cost cutting effort we put in place and our ability to retain proforma profitability in a very tough economic market.

While book-to-bill was below 1 and while we were cash flow negative for the quarter, primarily due to timing of payables and receivables, we were able to maintain constant inventory levels, despite a drop in demand for the quarter.

Business this past quarter was slow to start and was more back-end loaded than normal, with linearity weighted even more than usual towards the last few weeks of the quarter.

Karen will go into further detail on the financials in a few moments.

The slowdown that started in the US last summer has spread to other economies across the globe and we would expect it could be at least a few quarters until capital investments and operating expenditures begin to recover.

To add more color to what we have seen in our geographies compared to Q3 last year, the enterprise business saw a significant drop in North America, consistent with the depth of the US enterprise slowdown.

The enterprise business was roughly flat in EMEA and was up in Asia-Pacific.

The service provider business was very strong in North America and up significantly from last year, reflective of our focus on the carrier market.

The developing business with NEP strategic partners more than offset the macroeconomic slowdown.

In EMEA and A-Pac, we saw a slowdown in ESP business consistent with the trend of lower carrier spending.

While we wait for signs of a recovery, we continue to make progress.

For the quarter, we added more than 100 new customers to Extreme.

Even in tough economic times, thoughtful customers clearly see the value proposition that Extreme Networks, our products and our capabilities offer to them.

We help lower their capital expenditures, control operating costs and let them deliver new services more quickly.

A great combination for cost-conscious customers who need to do more with less.

Despite the recession's impact on overall levels of business, we continue to demonstrate progress in the service provider markets, in our chosen enterprise verticals and in the data center.

The carrier ethernet market represents an increasing part of our business and now generates more than 30% of our revenue.

Our primary focus has been on Tier 2 and Tier 3 players, which are less dependent on large legacy networks and are more likely to gravitate towards best of breed equipment providers to gain a competitive advantage.

Extreme products are also being deployed into Tier 1 carriers through deployment by our strategic partners.

We currently enjoy the number 3 market position in the carrier switch market, according to Analyst Firm in Phonetics Research Report for the fourth quarter of calendar year 2008.

The need for increased bandwidth remains constant for all carriers.

In a good economy, as well as in difficult times.

Customers come to us because we help them drive their profitability by delivering increased services over a common ethernet transport infrastructure.

Now more than ever, the particular needs of the small and midsize carriers play to our strength.

We're helping carriers win by demonstrating their highly scalable ethernet transport solutions, provide the best value for delivering ethernet services to businesses, Triple Play aggregation for residences and ethernet mobile back haul solutions.

For example, P2 in Slovenia, is able to provide Triple Play services to residential customers, materially less expensively compared to the incumbent based on the efficiencies and reliabilities of our product.

With our extensive product refresh over the last year, we believe we have the most scalable and cost effective carrier grade ethernet switches in the industry, which I believe will enable us to gain market share in the service provider market.

This quarter, we began production of the BlackDiamond 20K family of products with shipments to four carriers and evaluations begun in 8 more.

In connection with the availability of the BD 20K, this past quarter we launched an initiative to focus on the segment of the carrier market that caters to small to midsize markets and provide a range of residential and business services, as well as wholesale wireless back haul.

They need powerful, scalable, yet easy to deploy solutions.

For example, Vernon Telephone Cooperative of Wisconsin is seeking high performance and value for its network to support services, including voice, IPTV and internet.

They selected the new BlackDiamond 20K switch for performance, reliability and lower costs.

In Europe, we continued our business with a number of carriers, such as Telecom Croatia, (inaudible) of Germany and WIND of Italy.

Each of these leverages Extreme to build resilient scalable networks that support a mix of residential and business services.

In Asia, we've seen traction with carriers through our relationships with Nokia Siemens Networks and Ericsson for both Triple Play networks and wireless back haul.

The converge campus enterprise market has been a large and traditional market for Extreme.

Customers in this market continue to deploy new applications, which drive more requirements with their networking infrastructure.

Customers need networking equipment, which can scale and be flexible to support their needs, while being cost effective.

This is more than ever true now, when most enterprise IT budgets are under extreme constraints.

Our customers recognize that we simply provide better value for their implementations, especially in the markets we've chosen to serve.

Education has been one of our key vertical areas of focus.

We continue to do very well with K-12 schools, colleges and universities, all of which are making better use of converge communication, the internet and wireless mobility to improve the experience across their campuses.

We believe we're gaining market share by focusing on our current customers and adding new ones.

For example, we believe we've increased our revenue in the US education market by 25% over the last 24 months.

Specifically during the quarter, we finished building a converge network for Boulder Valley School District of Colorado.

Extreme was also selected by the Farmington Public School District in Minnesota where Extreme has replaced a Cisco network.

Government, both in the US and abroad, has also been an area of growing strength for us.

This segment tends to demonstrate more consistent spending in times of economic distress and is an area that has been identified as a recipient of significant stimulus spending.

As evidence of this growth, during the recent quarter, we helped a number of states, including Nebraska, Oklahoma and North Dakota.

We built converge networks for local municipalities including the cities of Memphis and Beverly Hills.

Finally, within the US military, we continued our business with the US Army and Marines.

Outside the US, we had significant government wins in Korea, with the Seoul government and in various local governments in India.

Last month, the Summit X 50 switch was named the infrastructure product of the year by the UK's leading network magazine, network computing.

The award is a testament to our attention to converge ethernet technology and our continued innovation in the market.

The data center is another area of focus for us.

Customers are building data centers with ever-increasing computational and storage capabilities and are estimated to purchase about $5 billion of ethernet networking equipment on an annual basis.

Data centers require large amounts of networking bandwidth and similarly to what is happening with carriers, the demands are expected to grow rapidly, driven by virtualization, server consolidation and the expanding array of applications brought on by Web 2.0 and cloud computing.

There is a very real need for more and faster bandwidth in the data center, which is quickly driving the push from 1 gigabit to 10 gigabit ethernet.

Simultaneously, we predict a push to drive down costs and consolidate into fewer data centers by leveraging 10 gigabit.

With our latest products, partnerships and focus, we are at the forefront of this progressive evolution.

For example, in December, we began shipping the Summit X 650, a fully stackable 10 gigabit switch, which was designed specifically with the data center in mind.

Just like the Summit X 450 mentioned previously, the X 650 also received network computing's annual award, being named the data center product of the year.

Extreme was selected by the publication by thousands of readers for having a standout solution in the emerging data center market.

Customers such as video gamers, government and research organizations and hosting companies are evaluating and purchasing the Summit X 650 to meet the needs of their bandwidth intensive applications and data center environments.

Continuing on the successes of the Summit X 650 top of rack platform, we announced the Summit X 650 24T Copper, the first 10 gigabit ethernet switch introduced to reach a portion of the market that works with standard ethernet copper cabling.

While nearly all of the latest 10 gig solutions being pushed into the marketplace are designed for fiber only, we recognize that in reality, many existing data centers will continue to rely extensively on standard copper cabling, as they migrate from 1 gigabit to 10 gig bits.

We are unique in offering our data center customers a cost effective and realistic migration to 10 gigabit, while giving the choice of copper or fiber 10 gigabit networks.

To summarize, we believe that our overall results for the quarter are a reflection of the current global economic environment.

Nevertheless, we continue to make progress and are optimistic that we can gain additional market share in our particular verticals.

We compete by providing superior value and offering innovative solutions tailored to fit the needs of our individual customers.

At the same time, we're focused on managing our business towards positive earnings and cash flow from operations.

I'm now going to turn the call over to Karen.

Karen?

Thanks, Mark.

Revenues declined this quarter as a result of the global macroeconomic downturn.

In light of those conditions, we took expenses out of the business, increased gross margins and were profitable on a proforma basis.

Revenue for the quarter was $77.2 million, which is down 6% from the year-ago quarter.

Product revenue was $62 million, down 15% from Q2, and 8% from the year-ago quarter.

While the steepest decline was in the Americas, the economic downturn appears to have spread across the globe to each of the geographies we serve.

Our service business continues to show further signs of improvement and it was up both year-over-year and on a sequential basis, as our customers look to us to help them protect the value for their network investment.

For the quarter, services revenue was $15.2 million, up 4% from a year ago, and slightly up from Q2.

The ratio of enterprise service provider sales for the quarter was 69% and 31% respectively, and in line with historical averages.

Sales of new products introduced into the market in the past 24 months was 35%, down slightly from the prior quarter, primarily due to the maturing of our Summit 450 and 250 product families.

As we ramp our newer products, such as the BlackDiamond 20K and Summit 650, we believe this ratio will increase over the coming year.

The ratio of stackable and modular product sales was 60% and 40% respectively, which is in line with our historical pattern.

Looking at revenues by geography for the quarter, revenues in North America was $26.9 million, which declined 13% from a year ago and 19% from Q2, as the extent of the recession in the US appeared to deepen.

At the start of Q3, customers were reluctant to commit to purchase decisions.

Even as the quarter moved on, the sales process was more prolonged than usual, as customers were trying to gauge the extent and duration of the recession's impact on their own business.

Product revenue in North America declined 18% from the prior year and service revenue in the region was down 3%.

Revenues in EMEA increased slightly from the year-ago quarter.

Product sales in EMEA declined 3% from the prior quarter and our services business grew 35%, primarily due to the growth of maintenance renewals and professional services.

Asia-Pacific revenues declined 8% from a year ago and were flat with Q2.

Compared to the year-ago quarter, A-Pac product and services revenue declined 6% and 24% respectively.

Turning to our non-GAAP gross margins, which exclude the effect of stock-based compensation and restructuring, as a percent of revenue, proforma gross margin was 57.8%, in line with the year-ago quarter.

Product gross margins declined 1.9 percentage points year-over-year, as a result of competitive pricing and changes in product mix.

On a sequential basis, compared to the second quarter of fiscal 2009, product gross margins improved 1.2 percentage points as a result of lower distribution costs and strong expense controls offset by lower volume.

Service margin at 56.8% of revenue increased significantly from the year-ago quarter, up 10% primarily due to the use of fully reserved inventory of $0.8 million, lower repair costs of $0.6 million due to improved quality and $300,000 due to increased revenue.

On a sequential basis compared to the second quarter of fiscal 2009, service gross margins improved 6.1 percentage points primarily due to the use of fully reserved inventory of $800,000.

We anticipate the favorable effect of fully reserved inventory usage to continue over the next several quarters.

Non-GAAP operating expenses were $4.4 million, a decrease of $4.2 million from the year-ago quarter, and a decline of $2.1 million from Q2.

Compared to the year-ago quarter, sales and marketing was down 4% to $23.9 million, primarily due to lower commissions on decreased sales and reduced spending for marketing events and travel.

R&D was down 11% to $13.5 million as a result of a reduction in variable compensation and reduced project materials spending.

G&A declined 20% to $6.7 million on lower litigation expenses, as well as lower professional services fees and variable compensation.

During the quarter, we announced plans to reduce employee head count by approximately 6%.

As a result of these actions, we have recorded a restructuring charge of $2.1 million, consisting of $2.6 million for severance, asset impairment and facilities charges, partially offset by $0.5 million of additional sublease income related to our prior restructuring charges.

Non-GAAP net income was $1.2 million, or $0.01 per diluted share, excluding the effect of stock-based compensation and restructuring expense compared to net income of $1.1 million, or $0.01 per diluted share in the year-ago quarter, excluding stock-based compensation.

Turning to the balance sheet, cash and investments were $120.8 million, a decrease of $22.7 million sequentially, primarily due to the timing of trade accounts payable and accrued liabilities payments, which vary throughout the year.

In general, the fluctuation in cash flow from operations is primarily driven by the timing of shipments over the quarter and payments on inventory purchases.

Revenue for the quarter was down sequentially and shipments were more back-end loaded than the historical pattern, resulting in lower accounts receivable collections in the quarter.

While inventory was flat quarter over quarter, payments for inventory purchases in prior quarters on deferred payment terms negatively impacted cash flow this quarter.

Net for the fiscal year cash used in operations was $4 million.

We ended the quarter with 817 regular employees, down 47 from Q2 as a result of cost reduction actions.

Our total workforce, which includes both employees and contractors has declined over 100 people or 11% from the beginning of the fiscal year.

We continue our practice of not providing specific guidance for the coming quarter.

Macroeconomic conditions remain uncertain and we are focused on the need for fiscal discipline and executing in the areas that we can control.

In summary, revenues for the quarter were down, primarily as a result of the global macroeconomic climate.

During the quarter, we reduced expenses, increased gross margins and delivered profitable proforma earnings.

Looking forward, given the continued weakness in the worldwide economy, we are focused on reducing inventory levels to be in line with our current operating needs, aligning operating expenses with anticipated revenues and managing the business to be cash flow positive.

We are tightly managing our expenses, while we're tightly managing our expenses, we are continuing to advance strategically in technology, products and partnerships to bring our new solutions to market.

With that, I'll now turn it back over to Mark.

Thank you, Karen.

This concludes our prepared remarks, and we're now ready to take your questions.

Patty?

Thank you, sir.

(Operator Instructions).

And our first question comes from the line of Rohit Chopra from Wedbush Morgan.

Please go ahead.

Hi Karen.

Hi Mark.

This is (inaudible) for Rohit Chopra.

Let's talk about Europe and what's going on there.

Eastern TELCO was an area of strength.

Could you maybe talk about what's the dynamics for eastern European service providers?

Sure.

Well, Eastern Europe is not a monolithic block and certainly, as you know with the capital flows flowing from Eastern Europe back into Western Europe, there is certainly some pressure on the eastern European companies in general to raise sufficient capital.

However, our current incumbents are continuing with their network deployments.

I spoke of T-Com Croatia, for example.

They were one of the recipients of the new BlackDiamond 20K products and so they are actually very excited about augmenting their network deployment.

I personally went and visited (inaudible) Croatia Telecom just last month and had a very positive meeting with them.

So, a number of them are continuing.

Our business, for example, in Russia, there's a lot of deployments that are taking place there.

So in our base, obviously people are careful, but we see, we see continuation of the business.

That said, we're being -- we're being cautious and we know that even our customers aren't totally immune from the overall environment, and so, we continue to watch this thing carefully and see how the situation in Eastern Europe develops.

Got it.

Couple more questions.

On the -- I think in your prepared remarks, you talked about maybe some pricing pressure, intensifying competitive environment.

Is that coming from larger players, or there's more -- the smaller guys?

Oh, well, if you look at, in any particular deal, most of the time there's not a smaller player that's competing against us.

The competition is really vis-a-vis Cisco.

Okay.

And so it's a function of the dynamics of is it an account that, you know, is it a big deal for Cisco to want to save is or not and things of that nature.

But in general, we see the customers themselves are -- their budgets are being cut and they are much more careful and so in general, you have to look at the overall environment that's taking place out there and how we need to respond to it.

Certainly we're out there with -- with competitive products and we want to be successful with our customers.

And so where necessary, we get aggressive to win the business.

Got it.

And then Karen, maybe you could walk us through the improvement in gross margin sequentially?

That was nice to see.

Could you maybe walk us through maybe the sustainability of it on the services side?

And then maybe talk about the uptick on the product gross margin sequentially as well?

Okay.

Well, let's talk first about the services gross margins.

We did see improved services gross margins this quarter driven by two factors.

One's more longer term and the other, shorter term.

As I mentioned, we're seeing the benefit long-term for the reduced repair costs due to our improvements in product quality.

And then shorter term, we are seeing an improvement due to our ability to utilize previously expensed inventory.

Based on business circumstances in prior periods, we expensed a portion of our inventory that we can now utilize.

We have remaining $1.6 billion of previously expensed inventory that we intend to utilize over the next few quarters based on customer needs.

So, you can expect to see that over the next several quarters as well.

In terms of the product gross margin, we had good product gross margin on a sequential basis, especially in light of the lower revenues sequentially.

And on the product side of the house, the 1.2% improvement in gross margins was basically driven by lower distribution costs in the quarter and our strong expense controls that were somewhat a little bit offset by the lower volumes.

Did that answer your questions?

Absolutely, Karen.

Thank you.

And my last question, I know you guys were not going to talk about guidance, but you did say the quarter was heavily back-end loaded.

Given the first couple of weeks of April, is there -- do you see things maybe not getting worse or have things kind of leveled off and maybe you can talk about the first couple --

It's way too early to tell.

It's, it's too early to tell.

Fair enough.

Thank you.

(Operator Instructions).

Okay, if there are no further questions, thank you, Patty, for driving the conversation today.

Thank you, all, for joining us this afternoon.

I want to thank all of our employees for their ongoing dedication and effort during these challenging times.

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

Thank you.

Ladies and gentlemen, that does conclude our conference for today.

Thank you for your participation.

You may now disconnect.