Extreme Networks Inc (EXTR) 2009 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen.

Welcome to the Extreme Networks 2009 fourth quarter 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).

On the call today from Extreme Networks are Mark Canepa, President and Chief Executive Officer, and Bob Corey, Senior Vice President and Chief Financial Officer.

As a reminder, this conference is being recorded today, July 30, 2009.

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

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

This call is broadcast live over the internet and will be posted on Extreme Networks' website for replay showing 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 performance, growth of customer bandwidth demands, development of new products, customer acceptance of the Company products, customer spending and economic conditions in the Company's market.

As results could differ materially from those projected in the forward-looking statements.

As a result of certain risk factors included, but not limited to, fluctuations in demand of the Company's products and services, a highly competitive business environment for network switching equipment, the effectiveness in controlling expenses, the possibility that the Company might experience delays in the development of new technology and products, customer response to its new technology and products, the timing of any recovery in the global economy, risks related to pending or future litigation and 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 & Exchange Commission.

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

The Company has provided a reconciliation table of GAAP to non-GAAP and information in the table that accompanies the press release on its 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 subject to change when review of the fiscal quarter is included and/or Form 10-K is filed.

I would now turn the conference over to Mr.

Mark Canepa, President and CEO of Extreme Networks.

Please go ahead, sir.

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

Before we proceed to discuss the results of the quarter and of the fiscal year, I want to comment on two very important additions to the Extreme management team.

First, I am very pleased to welcome Bob Corey as Extreme's Chief Financial Officer.

Bob has wide ranging experience as CFO of private and public companies.

He has been a member of our Board of Directors for the past five years and also been the head of the audit committee of the Board, so comes with deep knowledge of the Company's financial operations.

Bob also has an excellent background in investor communications, so expect an increase in interaction from Bob and me with all of you.

Second, I would like to welcome Vish Nandlall as Extreme's Chief Technology Offer.

Vish joins from us Nortel where he was CEO of the Nortel's Carrier Network Division.

Vish has over 15 years of experience in creating vision and strategy for scalable networks, wireless and carrier's voice-over IP technologies.

This marks the end of our fiscal year in which we, along with most other technology companies, have to adapt quickly yet purposefully to the economic changes that have impacted most of the world's markets.

We've developed a strategy and a road map of where to streamline our operations while preserving our long-term competitiveness.

Consequently, we were able to eliminate almost 15% of our permanent and contingent head count.

In our manufacturing operations, we further strengthened the partnerships and synergies with key suppliers while streamlining our transportation, distribution, and logistics systems and continued with aggressive material cost cuts.

We made major cost saving improvements in our services business while continuing to deliver excellent service to our customers.

We controlled our R&D costs while making the necessary investments to develop and introduce three new product families.

During FY '09, we brought to market the Black Diamond 20 K focused on cost effective carrier grade Ethernet transport.

We brought the market the Summit X 650 focused on ten gigabit data center aggregation.

And we brought the market the Black Diamond 8900 focused on 10 gigabit data center core.

We continued to build our Avaya community to over 700 partners worldwide.

We generated positive operating cash flow and earnings for the year while we continued to stay focused on the ongoing goal of the Company; to deliver great solutions in the carrier convergent enterprise and data center markets.

Aside from the slowdown precipitated by the recession, the underlying economic forces driving continued increase in bandwidth demand has not changed.

Furthermore, Ethernet continues to be the technology of choice to satisfy this bandwidth need.

We don't expect this to change.

Turning to the quarter, we saw a sequential improvement in results reflecting a substantial improvement in North America business while signaling that EMEA continues to weaken.

Overall, revenue was up 5% sequentially, and revenue from the enterprise business in particular was up 15%.

The carrier business was 25%.

We had increased this ratio to about 30% the last couple of quarters but the delay in orders from a number of European carriers affected the results this quarter.

I believe this is signaling that in general, enterprise budgets are stabilizing before carriers.

However, overall visibility remains low as the shape of the three geography overall macro environment and the behavior of both enterprise and carrier customers are difficult to model.

In a minute, I will turn the call over to Bob who will give you a lot more of the details.

I want to highlight and comment on a few of the numbers.

Revenue for the quarter was $81.3 million, driven by increased sales in North America that grew 30% sequentially.

Asia-Pacific Japan grew as well sequentially and more importantly year-over-year.

We have made considerable progress in addressing APJ, and our internal execution there has begun to improve.

Careful expense control allowed us to deliver a 50% increase in pro forma operating profit from Q4 last year.

We were also able to increase our cash position by $7 million.

Despite the mixed economy, we added more than 100 new customers during the quarter.

This signals that customers are looking for alternatives in this market.

The global economy right now is a mixed bag, but appears to be stabilizing in certain markets.

Overall we expect it to be at least a few quarters until capital investments and operating expenditures begin to demonstrate meaningful signs of recovery.

One of our primary areas of focus is the carrier market.

While our carrier Ethernet business was slower this quarter, we remain confident in its long-term strength.

The need for increased bandwidth remains.

Carriers do business with us because our Ethernet transport solutions help them increase their levels of services at a lower cost.

We saw increased business during the quarter in India.

With Erickson, we held four service provider customers, United Wireless Project Limited, [El Tel Sella, Barty Airtel] and BS&L.

In the Middle East with Erickson,n we held Saudi Telecom further the buildout of its metro network.

Also in the Middle East, we worked with our partner Motorola to build the go wireless network for the [Etihad Ashim] Telecom.

The network is one of the largest WiMax implementations in the Middle East.

In Europe, T-Com of Croatia is a significant customer that continued to work with Nokia's networks and Extreme to build its next generation network to better deliver both business and residential triple play services.

The network is built using Extreme's carrier class WiFi 22 K metro core switching platform.

Another key market for Extreme is the converging enterprise market.

Just last week, we announced a major new strategic alliance with global security leader, McAfee Incorporated.

The two companies will go to market with a strong portfolio of networking and security solutions that address the needs of enterprises for reliable, available and secure networks.

The relationship helps our customers choose a network that is complemented with McAfee's broad world class portfolio of security tools, all backed by a global leading brand in security.

IT budgets are still under intense scrutiny, creating opportunities to articulate -- the differentiated value for the customer dollar while supporting high performance and global reach with sales, marketing and support.

For example, Extreme was selected by [Intron] University of Korea for a significant win.

Intron University is building an entirely new campus with a high performance network.

Intron selected Extreme's portfolio of enterprise Ethernet solutions for the core and edge of the network.

The end-to-end network including wireless will ensure consistent, secure and fast connectivity for students and staff alike.

In the US, Georgia State University adopted our highly scalable Black Diamond 8900 series modules to power its data center with dense 10 gig bit connectivity.

In the K-12 segment, Extreme continued business with large accounts such as the Beaufort School District in South Carolina, Rochester Community Schools, and the Oakland County Schools of Michigan.

In healthcare, we experienced a significant win with thE Ministry of Health in Trinidad and in Germany, we had a win with the [Rhinehardt Muttala] Hospital.

In the government market, Extreme's converged Ethernet solutions were selected by the FIN Mechanic Group as the network of choice for the much publicized G-8 Summit held in Italy in early July.

This global gathering of economic and political leaders, including President Obama, required an integrated networking and communications solution with maximum availability and simple management.

We continue with our focus on providing solutions for the data center market.

This past quarter, we introduced and have begun shipping a new family of products called the Black Diamond 8900.

The chassis based products were specifically designed to provide highly scalable and dense data center core connectivity.

When coupled with the Summit 650 which we introduced last fall, we now have powerful solutions in place to help our customers transition to state of the art 10 gigabit Ethernet data centers.

In addition, with the recent release of Extreme's X operating system version 12.3, we have added powerful virtualization technology that works in conjunction with VMware and other server virtualization software to automatically virtualize the network.

This is yet another capability we have added to our software system to make the network a more integrated and seamless part of data center operations.

Capabilities like this one, in addition to others introduced over the past several quarters, enable our customers to build powerful and bandwidth intensive data centers for cloud computing, video delivery and web 2.0 applications.

For example, Continental American Insurance Company in South Carolina has deployed our Summit X 650 ten gigabit Ethernet switches as the high performance network backbone of its data center, giving the Company a strong foundation for its high transaction environment.

Me Tick of France, an internet based social media site, has recently adopted Extreme to drive an extensive website and its growing consumer traffic and web 2.0 technologies.

Video is a key element of data center growth as it requires higher capacity from Ethernet as well as very strong performance, so just latency and quality of service.

For example, [True Telecom] has recently adopted Extreme to power its video-on-demand and multi-cast digital TV services.

This is an example of how carriers utilize the data center to further expand their menu of services while meeting the demand for what connected consumers want most.

The drive from 1 gigabit to 10 gigabit is happening rapidly.

For example, The Planet is one of the largest data center hosting providers globally.

They support an expansive footprint of data facilities.

The Planet is a recent data center win and adopted Extreme's Summit X 650 in its 10 gigabit network.

Cost effective storage based Ethernet is a another driver of the data center.

We have strengthened our relationship with Dell.

In June we announced that our Summit X 450 family of switches are certified and promoted as a networking companion to Dell's fast growing line of ecologic [iSCSI] storage solutions.

This brings to market a high performance, cost effective Ethernet [sand].

This week, we announced a go-to-market relationship with Scale Computing, an emerging company focused on storage clustering, which offers technology that dramatically reduces the cost of storage networking also leveraging iSCSI.

With that, I would to now turn the call over to Bob who will provide you with additional financial details.

Bob?

Thanks, Mark.

I am delighted to be a part of the management team.

As a former member of the Board, I've gotten to know the Company well, and I am excited about the organization and the technology.

Over the past year-and-a-half, I believe we have engineered a broad range of solutions that address the opportunity that is emerging in the data center, the converged enterprise and the carrier markets.

With some signs of stability returning to parts of the market, Extreme is well situated for the growth in demand for simplicity, scalability, and value.

My comments will address our ongoing efforts to align operating expense with the current level of revenue.

I will then comment on revenue by geography and customer type, discuss the results of operations, and review the balance sheet and cash flow.

All of my comments will be addressing non-GAAP operating results unless I state otherwise.

Of course revenue and the number of shares outstanding are GAAP numbers only.

Non-GAAP operating results exclude the effect of restructuring charges and stock-based compensation.

During fiscal 2009, we have been responding to a global economic recession that began in the United States.

We've continued to align our operating expense to our current level of revenue.

Throughout the year, we have implemented initiatives to improve efficiencies and lower costs in our supply chain, and improve product quality resulting in lower warrant costs and improved customer satisfaction.

Further, we have reduced head count, both permanent and contractors, by almost 14% from the beginning of the year, and we used Company shutdowns to lower Company-wide costs.

These initiatives resulted in our reporting operating income for the year of $7 million which is down slightly from the prior year on a decreasing revenue of about 7%.

Further, we reported operating income for the fourth quarter of $3 million which is the highest in over five quarters.

We reported positive cash flow from operating activities of$ 8.7 million in the fourth quarter, $4.7 million positive for the full year and ended with over $127 million of cash and investments.

Turning to revenue, total revenue for the fourth quarter was $81.3 million, representing more than a 5% sequential increase.

We reported increased revenue in both North America and Asia-Pacific, offset by weakening demand in EMEA.

North America revenue was up 30% from the March quarter to over $34 million.

This reflects the sense of stability that we're seeing in North America which Mark has referred to earlier in his comments.

The weakening demand in EMEA highlighted the effect of the global recession on service providers in that market.

Compared to the March quarter, EMEA sales were down 18% to $32 million.

The European markets were among the last to enter the recession and we suspect they will be among the last to recover.

Increased demand in Asia-Pacific reflected improved execution as a result of the changeover in management that we implemented in that region.

Compared to the March quarter, Asia-Pacific revenue increased 25% to $15 million.

The total revenue of $81.3 million for the fourth quarter was down 17% year-over-year as a result of the impact of the global economic recession.

Our service business continues to improve and was up 10% in Q4 over Q4 of last year, and up more than 8% sequentially, making this the first time that our service revenue has comprised 20% of total revenues.

Since Mark joined the Company in late 2006, we have successfully transitioned the service business from a support function to a source of revenue as we actively engage our customers to protect the value of the network investment.

Perhaps most telling is that even though sales in EMEA declined this quarter, service revenue to the region increased 46% over Q4 last year and 15% sequentially.

North America service revenue was flat year-over-year and up 5% sequentially.

The differential is largely due to the volume of carrier business we do in EMEA where services are an increasingly important part of the value that we bring to our customers.

Sales of new products introduced into the market over the last 24 months was 31% of total revenues which is down 35% from the March quarter.

We looked to ramp our newer products, such as Black Diamond 20 K and Summit 650, and believe that this ratio will increase over the course of fiscal 2010 as parts of the global economy improve.

The ratio of stackable and modular product revenue in the fourth quarter was 66% and 33% respectively, which is consistent with our year-to-date trends.

The mix of carrier -- I am sorry, the mix of enterprise and carrier orders for the fourth and third quarter was 76% versus 24% and 69% versus 31% respectively.

This reflects the increase in enterprise revenue primarily in North America, offset by lower demand in EMEA which traditionally has a higher mix of carrier revenue.

Turning to gross margins, the overall fourth quarter gross margin percentage declined to 56.8% as compared to 57.8% in the third quarter.

This reflects a decrease in the product gross margin percentage of 2.7%, offset by increase in the service gross margin percentage of 5.7%.

Product gross margins declined due to change in the mix and an increase to the inventory reserve recorded in the quarter.

The increase to the inventory reserve reduced the product gross margin percentage about 2.2 percentage points in the fourth quarter.

The service gross margin percentage improved 62.5% as compared to 56.8% in the March quarter.

Once again, in Q4 service margins remained greater than the historical averages as we continue to deplete the use of previously written off spares inventory, about a $600,000 benefit in the quarter and a higher mix of service contracts.

We believe we will continue to benefit from the previously written off spares inventory for up to two additional quarters based upon utilization.

Overall operating expense was $43.2 million, a decrease of $11.2 million from Q4 last year and a decline of $948,000 from the March quarter.

Compared to Q4 last year, sales and marketing declined $5.1 million to $22.9 million on lower spending for marketing events and cutbacks in travel.

Research and development was down $2.4 million to $13.3 million as a result of reduction in variable compensation and continued reduction in project material spending.

G&A declined $3.7 million to $7 million even on lower litigation expenses as well as lower professional service fees and variable compensation.

We recorded a restructuring charge of $153,000 during the quarter which was the finalization of severance payments associated with reductions in head count that were announced in the third quarter.

Net income was $2.3 million or $0.03 per diluted share.

That compares to net income of $3 million or $0.03 per diluted share in the fourth quarter last year.

Total shares used in the fully diluted earnings per share calculation were $88.7 million.

Turning to the balance sheet, cash and investments were $127.4 million, an increase of $6.6 million from $120.8 million at at the end of the March quarter.

Cash flow from operating activities was $8.7 million positive in the fourth quarter and $4.7 million positive for the year.

Inventory was $12.4 million at year end, representing a decrease of $10.4 million from the third quarter.

Our normal investment level and inventories is expected to be between $15 million to $17 million going forward and we anticipate returning to that level in Q1.

We ended the quarter with 786 regular employees, down 4% from 816 employees at the end of the March quarter and down 9% from 861 employees at the end of last year.

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

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

Before turning it back over to Mark, I wanted to emphasize that we are committed to running the business profitably and generating positive cash flow.

With our entire product refresh and investment in R&D, we're focused on building partnerships and aggressively growing share in some of the highest growth Ethernet based sectors.

I look forward to getting to know each of our investors and our investors based abroad, and generally a productive, ongoing dialogue with you.

With that, I will turn it back over to Mark.

Thanks, Bob.

Operator, we are ready to address any questions.

Thank you, sir.

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

(Operator Instructions).

Our first question is from the line of Colby Synesael with Kaufman Brothers.

Please go ahead.

Thanks for taking the question.

Just wondering what your customers are saying about the potential impact of the stimulus package as it relates to the spending patterns over the next two or three quarters, whether or not they might be delaying in front of that or when in fact they think they will be getting that funding and could be spending.

Also, I was hoping you could talk a little about linearity of the quarter and maybe just a little bit of color on what you're seeing already in July.

Thanks.

Sure.

First of all, regarding the stimulus spending, it varies greatly by market.

Some markets have access to stimulus money, and some markets do not.

In general, probably the ones that I've spoken to the most that have access to stimulus money tends to be in the area of healthcare.

We've talked to a number of our healthcare customers.

There is a number of things that are taking place that enables them to create proposals, and these proposals can be reviewed by the various governmental bodies.

There is -- my understanding is fairly little of this money has actually flowed, but we'll see how that takes place over time.

Also, there is some stimulus money that is available in the area of the small rural carriers.

We have had a program in place -- in the US, we've had a program in place for a couple of quarters to do that.

And again, they're designing proposals and submitting them for stimulus money.

My understanding is relatively little of that stimulus money has flowed to at least the customers we're talking to today.

Do you think that -- is it fair to say that you expect that when money is released that it will impact your business in a material way?

Or is it most likely not something where you will see that big of an uptick from?

We're going to have to wait and see.

Certainly education, healthcare, and US-based small carriers are a big focal point of ours.

Those are the ones that at least in the press have been reported to be able to access stimulus money.

We're going to have to see whether it comes quickly enough or whether the recession runs its course on its own, prior to the speed at which stimulus money can be made available if that takes place.

On linearity?

As you know, we don't give guidance of the current quarter.

We're only really three weeks into it so it is early, way too early to tell what's likely or not likely to happen in Q1.

As it pertains to Q4, it was about a pretty normal quarter when we go back and look at it in relationship to the quarters -- to the previous Q4s.

The traditional 10, 25, 20 to 550, we were within those kind of boundaries like we were in the last several years.

Great.

Thank you.

Thank you.

Our next question is from Samuel Wilson with JMP Securities.

Please go ahead.

Hey, Sam.

Hi, Mark.

This is Doug Ireland.

Hey, Doug.

I have a couple of questions.

One is about the Nortel auction and how you feel if there is going to be any fallout from that in the both Avaya side and in the competitive environment for carrier Ethernet, considering the bidding there hasn't even started on the metropolitan Ethernet business.

Well, yes.

Certainly, Nortel's business is getting divided up.

I am sure you have all seen the Erickson bid on the metro carrier side which does not contain any of the networking equipment.

It is fundamentally the wireless back hall part of the business.

And the enterprise business as has been reported in the press is coming under auction here in the near future.

Avaya has been reputed to be bidding on that business.

It is going to be an auction and we're going to have to see how all of this turns out.

Meanwhile, our relationship with Avaya continues to be very strong.

Business with the Avaya and the Avaya business partner community in fiscal '09 was up year-over-year which suggests that in spite of the tribulations in the economy, customers who want to buy Avaya-based call centers or telephony systems continue to prefer the Extreme brand when it comes to building the underlying network.

Beyond that, we'll have to wait to see what happens with this auction over the coming weeks.

Do you think that there is any significance to Avaya getting the Nortel networking business as part of getting their voice-over IP business?

Nortel put them together into the same group.

Obviously, we have a close strategic cooperation.

We talk to executives at Avaya on an ongoing basis.

I think it doesn't materially change our relationship with Avaya.

Avaya is really strong in building and creating telephony based solutions.

They had in previous years internal networking developments.

And yet -- in spite of those, Extreme in Avaya have worked very, very closely together to deliver powerful voice solutions from Avaya and powerful data solutions from Extreme that are closely aligned from both a marketing sales as well as engineering perspective.

Great.

Thanks.

On the 10 gig Ethernet product set, do you have plans to incorporate fiber channel over Ethernet or do you now incorporate fiber channel over Ethernet?

Today, it is a non-simple answer.

There is the various competing SOE standards are still being developed.

They're in the standards committee.

Certainly technology is getting developed.

Silicon is getting developed to support the underlying protocols that govern the transport of fiber channel packets over Ethernet.

The primary driver of fiber channel is a lostless environment where Ethernet primarily is a lost fabric so the underlying hardware technologies are getting developed.

As it pertains to the software we're going to be watching it very carefully.

We're going to see how and if and when and in what shape or form the market develops.

There is a number of ways in which customers transport data between servers and storage.

FCOE is just one of them.

I mentioned during my remarks, iSCSI, both in our relationship with Dell and QLogic and a number of other partners, is also a very fast growing way in which people can very cost effectively transport data between storage and servers.

Obviously in FS and TCPIP are a way to do that.

We're going to have to monitor the development of the fiber channel over Ethernet market and depending on how it develops, we're going to respond appropriately.

Okay.

Currently you don't have a plan to license in technology from QLogic or an Emulex or anything like that?

Today if you look at QLogic and Emulex, they provide basically host-based technologies.

They provide cards that plug into servers that are able to generate fiber channel capabilities.

They're reputed to talk about being able to provide fiber channel over Ethernet capability.

As this market develops, it is a way -- we can participate in it.

We're the market to become sizable enough to warrant it.

Our belief currently is that NFIS and iSCSI and some of these other trends or mechanisms are going to occupy a large fraction of this market.

We want to basically stay focused on what a lot of our customers tell us.

We can respond pretty quickly if the market dynamics change.

Okay.

Great.

And then the last question I had was on your carrier Ethernet business, are you targeting specific geographies?

We are not targeting per se particular geographies.

What we have found is that our technologies and carrier Ethernet that we have been shipping tend to resonate very well with a number of markets in Europe, particularly in eastern Europe.

These tend to be newer markets.

Therefore, they tend to be unencumbered by some of the older transport technologies like SONET SVH or frame relay or so on or ATM.

Consequently, they're far more quickly able to build up Ethernet based solutions for their metro transport mechanism.

That just seems to be a market that has developed more quickly.

We believe that it is just a matter of time before the North America market moves in that direction.

Certainly in a number of markets in Asia, we're finding pretty good reception to the new methodology of transporting data over a carrier environment.

Is the meltdown in eastern Europe, should we read the fall in European sales as a macroeconomic-only issue or is there something else happening there?

We obviously talk to our customers in eastern Europe or anywhere in Europe in the carrier space.

The answers that we're getting is there is not a strategic change in how they want to deploy their networks.

Most of these countries are beginning to roll out things like 100 mega bit services to the consumer.

We're not getting any data to suggest that the consumers are not ready to purchase these kinds of services, but it is like everything else.

As their parent companies -- many of these eastern European companies either access capital from western Europe or they're owned by western European companies.

For example, T-Com Croatia which is a company I mentioned on the call earlier, is owned by Deutsche Telecom.

As the parent companies review capital budgets and make global decisions, sometimes their eastern European subsidiaries have to make adjustments and change.

What we're seeing -- we seem to think it is basically a financially driven environment, dictated by the capital budgets of companies, rather than inherent change in either consumer buying behavior or the companies themselves wanting to change a strategy on how to deliver services.

Okay.

This is not an Extreme -- there is no change in your operations in Europe that's causing this?

No.

We don't believe so.

We have had a good team in place.

That team has grown the business year-over-year for many years in Europe.

They're well deployed.

We think in general, the malaise that North America suffered last year, some of it is beginning to catch up with the European theater.

I think that issue goes far beyond Extreme.

Okay.

Thank you.

Congratulations on the additions to your team.

I look forward to meeting Bob and Vish.

Sounds good.

Thank you very much.

Good afternoon.

(Operator Instructions).

Our next question is from Rohit Chopra with Wedbush Morgan.

Please go ahead.

Hey, Rohit.

It is Stan [Jesserili].

How are you, Mark.

Welcome, Bob.

Thank you.

I have a couple of questions.

Mark, last quarter we talked about price competition showing up last quarter with Cisco.

Any change in that this quarter or are we seeing the same pricing environment?

Nothing material, right.

It is a tough business out there.

To some extent, customers are doing what we have always expected customers to do in this kind of environment.

A lot of them don't like either the pricing or discounting policy that their incumbent is providing.

They're out there searching for alternatives.

Once again, we were able to sign up in excess of 100 new customers that had not previously purchased from Extreme.

People are out there making decisions about changing vendors if they're not happy with the incumbent.

Price does play a role, but not just capital budget.

The ability to install a network that is easier to operate, that costs less to run, that uses less power.

Some enterprises rooms are getting filled up with air conditioning.

They can't put more of that.

The power companies are only willing to supply so much energy, especially in saturated markets.

There is a number of variables under this whole cost that drives customers to change vendors and change buying behaviors.

Sure.

My next question goes back to Avaya.

You guys used to give Avaya a percentage of product bookings or total revenue.

Do we know or can you give us some color on how big Avaya is currently?

We don't comment on any one customer.

The Avaya business partner community if you think about -- there is a solid fraction.

I don't have off the top of my head exactly how many.

Of the 700 VARS that we have around the world, there is a meaningful fraction of those partners that are also Avaya voice partners and have been learning on how to be voice and data partners which is way they work very well together.

Beyond that, not a lot more of information that I can share with you, other than those partners are committed.

Those partners enjoy bringing the two technologies together.

They've learned how to do it over a number of years.

They see the value proposition.

They're going into a customer and designing a solution that has Avaya telephony and Extreme data.

The underlying data infrastructure works with for customer, works for the VAR, works with the overall business model.

My next question is it has been a big, busy quarter for you guys.

You have had DFO leave and we have a new CFO with Bob.

The founder is taking on a market development role.

We have a brand new CTO, and we have a brand new relationship with McAfee.

Are all of these changes a sign of a shift or a change in the strategy?

And if so, what is the strategy going forward?

No.

Obviously, the strategy keeps keeps getting refined and tuned every day, right.

That's mostly why I come to work is to make sure we have the very best possible strategy that's driving all of the investment decisions that the Company is making.

I would say within the last quarter, just a lot of stuff just happened to -- all happen at once.

The search for the CTO has been going for almost a year or maybe even over a year.

I was taking my time to hire the right person.

Vish came along from Nortel and I felt he was of a caliber that -- I really felt good about bringing him into the Company.

Certainly, he comes with a lot of carrier background and so you can draw your own conclusions on that.

But we have been talking about spending a lot of time and energy in the carrier business.

We developed the Black Diamond 20 K family over the last couple of years.

That doesn't really signal a change in the strategy.

Certainly, it signals a continued priority and commitment to creating a value proposition for certain parts of the carrier market.

Gordon coming on board, as we started to put together the data center strategy, I felt that having another set of world class neurons in here, helping to develop market strategies -- go to market, potential ways of approaching this, would give the Company a significant competitive advantage.

They all just happened to coincide, but not a signal of any material change in strategy.

Still a focus on the convergent enterprise -- the carrier business and the data center are where the energy of the Company is going.

Right.

Is Gordon going to focus on expanding the overall opportunity or is he focused on maybe the partnership side?

Obviously, I don't want to go into a lot of detail about what Gordon may or may not be doing in a day in and day out basis.

He is a world class individual who has been around the networking industry for his entire adult life.

I will utilize Gordon's skills and capabilities to maximize the success and direction of the Company as I see it as we go forward.

Thanks, Mark.

Thank you.

Our next question is from Jess Lubert with Brean and Company.

Please go ahead.

Good afternoon, Mark.

Welcome Bob, Vish.

I also have a couple questions.

Go ahead.

First, was book-to-bill greater than 1?

Yes.

Book-to-bill was just a little under 1 actually.

And then it looks like a really nice improvement in North America and Asia.

Can you give us a sense of just how sustainable that feels to you?

Do you think it was just some catch-up spending?

Or are customers feeling a little bit more comfortable in their business and therefore, we should expect more normal seasonality at least in those geographies going forward?

Let's separate the variables.

As it pertains to Asia-Pacific Japan, as we look at the results, especially the fact that not only were we up sequentially which is something you would expect to see in a normal seasonality pattern, we were up year-over-year.

That I believe when I go into the depths and look at the data by country and so on, that in fact Paul when he came on board about a year ago made some changes and we're beginning to see the results of some of those changes are made.

All else being equal, I think our execution in Asia-Pacific has improved.

I don't see any reason why that execution shouldn't be able to continue.

Now, all else being equal, we don't quite completely understand what the macroeconomic factors might or might not be within the Asia-Pacific theater.

It seems to be a little clearer to define what seems to be happening in the US and what's happening in Europe.

The Asia-Pacific Japan is not a monolithically behaving segment.

You've got places like China and India where they may be slowing down, but GDP continues -- seems to continue to be increasing.

You have places like Japan whose GDP is in fact suffering significantly.

And then, you have a bunch of other countries in between.

Asia-Pacific, I think the execution there is improving.

North America, we believe that it is a normal environment -- that nothing unusual took place in Q4.

There might have been some deferred spending from Q3 that might have caught up in Q4.

If you remember, it happened last year, too, where the whole industry suffered from an abnormally stringent Q3.

It is tough to tell what is in the mind of the CIOs and CFOs of a lot of the customers.

We're going to -- we're monitoring it carefully.

We are remaining flexible.

We're working hard on the cost structure.

We're going to watch as the quarter unfolds.

Can you give us a sense of what drove the big inventory drawdown?

It seems like the sustainable inventory level is below what we have historically seen.

How should we think of that in regards to future demand?

This is Bob.

As you know, in Q3 inventory [eeked] up around $22 million.

The Company feels that the $15 million to $17 million range is more of a sustainable inventory for the level of revenue we're currently enjoying.

The inventory came down to a little more than we wanted to, to $12.5 million roughly and so we're just going to bring it back up to around $15 million.

How should we think of that in regards to demand?

Just going back over the last several years, historically your inventory levels have been north of $20 million.

Should we take that to mean that this is the current run rate going forward?

Do you think it steps back up to north of $20 million as the demand environment improves?

No.

We've had a lot of programs underway in our supply chain, right, to drive efficiencies, et cetera, for worldwide distribution and assembly relationships, et cetera.

We were focused on trying get the inventory turnovers down to something more competitive and it also relates to cash management.

The Company was very aggressive in managing inventory in the MRP in Q4.

We're going to bring it back up to around $15 million.

We have a specific set of activities to fundamentally drive the turns ratio of the Company up from where it had been historically.

It is an active program within the Company.

In addition, as our supply -- where we manufacture our product shifts around the world, it does give us an opportunity to be much more streamlined with how much inventory we have to keep in order to move the product around the world.

It is all part of a plan to drive it in the right direction.

And then deferred revenue appeared to decline a fair amount sequentially while the service revenue improved quarter over quarter.

Should we expect service revenue to decline in the September quarter?

Clearly, it was a nice quarter for services.

I am just curious whether or not services will be lumpy or how we should look at the deferred revenue line, and what that means for services going forward.

Certainly, we had a good services quarter.

Certainly, as the data shows, not all of it came from new bookings.

Bookings tend to be linear, more or less linear, right.

The service contracts get renewed and all of this stuff.

Revenue recognition of those tends to be a bit more lumpy than the underlying bookings.

We had a good ability to turn bookings into revenue this quarter.

Overall, yes.

Over time, we think the revenue that was generated in the services part of the business was unusually rich this quarter.

It will probably end up being in a more sustainable, based on what we have done the last several quarters.

All right.

And then the decline in product gross margins, is this more a function of pricing?

Is it product mix?

Is it due to weakness in service provider?

How do we think about that?

It was more of a product mix issue.

Plus the real big issue that impacted product margins is we booked a $1.4 million charge increase to the inventory reserves to settle up on consigned inventory that we had off site with a supplier.

Okay.

And then on the service gross margins, over the next couple of quarters as you work off the spares, can we go higher from current levels?

Should it be consistent?

How should we think of -- what is the sustainable run rate for service margins for our models as that starts to tail off towards the end of the next fiscal year?

That's a good question.

Once we consume all of these spare parts inventories, we definitely think the margin is high now because of the benefits we have been getting the last couple of quarters.

Like I said in my comments, we'll probably get that benefit maybe Q1, maybe some in Q2.

But we think the margins were normalized around 55ish percent going forward after that.

And then operating expenses have now declined sequentially for four consecutive quarters.

Can they go down further?

Or is this on an absolute dollar basis, do you think this is the base and you will build from here as revenue improves?

Have you begun to hire selectively in any areas?

I think the Company has been working very hard to -- if you will, align the operating expenses with the revenues we were encountering and the uncertainty as the US and now the world has gone into a global recession.

We will continue, right, to monitor expenses in light of the revenue we encounter.

That said, in terms of selective hiring, yes.

In the fourth quarter, we have begun to cherry pick at sales people in a number of geographies.

We're being very cautious overall.

But as the world begins to stabilize and perhaps decide that someday it wants to get out of the dull drums, having the right number of feet on the street, certainly you want to be there when the customers get into a buying mood.

In a tight environment -- somewhat less tight with the sales organization over this last 60 days or so.

And just one more comment.

One of the things we're trying to do is monitor that expense run rate right so we can position the Company where we do start to see an uptick in revenues and we can accelerate the impact to earnings per share.

All right.

Just one last question.

I will get back in the queue.

Particularly in regards to your data center business, can you provide a little bit more color regarding what you're seeing there?

Has that been an area of strength or weakness.

In Europe, is that trending with the region or has that seen a trend that's held up a little bit better than some other areas in that part of the world?

Sure.

Good question.

At one level, if capital budgets get cut, projects get delayed and the data center component gets delayed alongside with it.

In general, we see maybe -- whether it is this quarter or the next one after that, that in general there is a propensity right now for people to accelerate data center and build more data center capabilities.

Whether it is people going into the business of doing that, providing video services or telecomputing services or those things or enterprises themselves that finding that by having more compute power they can cut costs somewhere else in the enterprise.

Like pharmaceuticals, they do more simulation.

They need to do less drug testing by building the molecules themselves or so on.

We see that that is an area that people are finding attractive.

That's one of the reasons why eighteen months ago we decided to go focus on it.

Transition to 10 gig bit also seems to be happening.

A number of our technology partners are bringing out great new technologies.

I think in general, it is a pretty good place to concentrate.

All right.

Thanks, guys.

Thank you.

Thank you.

I am showing no further questions at this time.

I will turn it back to management for any closing remarks.

Please go ahead.

Thank you.

I would like to thank all of our employees at this point for their ongoing dedication during fiscal '09.

I thank all of you for joining us this afternoon and look forward to meeting with -- and for Bob and I to meet with as many of you as possible over the coming weeks and months.

Thank you.

Ladies and gentlemen, this concludes Extreme Networks 2009 fourth quarter conference call.

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