Extreme Networks Inc (EXTR) 2010 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the Extreme Networks 2010 third 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.

On the call today from Extreme Networks are Rob L.

Corey, CFO and acting President and CEO, and Paul Hooper, Chief Marketing Officer.

As a reminder, this conference is being recorded today, April 26th, 2010.

This afternoon, Extreme Networks issued a press release announcing the Company's financial results for the third fiscal quarter of 2010.

A copy of this release and a slide presentation of the supporting financial materials are available in the investor relation section of the Company's website at www.extremenetworks.com.

This call is being broadcast 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 performance, strategy, growth of customer bandwidth demands, development of new products, customer acceptance of the Company's product, customer spending and economic conditions in the Company's markets.

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

As a result of certain risk factors, including but not limited to, a challenging macro economic environment both in the United States and overseas, fluctuations in demand for the Company's products and services, a highly competitive business environment for network switching equipment, the Company's effectiveness in controlling expenses, the possibility that the Company might experience delays in the development of new technology and products, customer response to it's new technology and products, the timing of any recovery in the global economy, risks related to pending or future litigation 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 this information on the 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.

Throughout the conference call, the Company will reference both GAAP and nonGAAP financial results.

The Company has provided a reconciliation table of GAAP to nonGAAP and information in the tables that accompany 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 made subject to change when the review of the fiscal quarter has concluded and/or a Form 10-Q is filed.

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

Rob L.

Corey, CFO and acting President and CEO of Extreme Networks.

Please go ahead, sir.

Okay well thank you, Patty and welcome to the Extreme Networks Q3 fiscal 2010 earnings conference call.

I'm joined today by Paul Hooper, our Chief Marketing Officer.

I'll begin with some brief comments on the quarter, followed by more detailed comments by Paul regarding our new products released during the quarter and our messaging to our markets.

Then I'll summarize and provide guidance for our fiscal Q4.

We'll then open up for our Q&A.

Our goal is to provide more time for questions and answers and less time reading our scripts.

Additionally we posted a slide presentation on our website at extremenetworks.com under investor relations that I hope you'll find useful.

Historically, our Q3 performance for revenue has trended down sequentially from Q2 by a range of 10% to 12%.

Based upon our backlog and trends in the markets coming out of Q2, we issued guidance that did not reflect this historical down performance from Q2.

I'm very happy to report that we achieved the mid-range of revenue guidance at $78.2 million and exceeded the guidance for earnings by 45% with nonGAAP operating income of $4.7 million.

Paul will talk about our new products in a minute.

However, I'm pleased to announce that our Direct Attach data center network solution and architecture has been selected as a Finalist for the Best of Interop 2010 awards.

The Interop show is underway now in Las Vegas.

Additionally to further expand our channels during the quarter, we signed a strategic reseller agreement with CTC of Japan.

CTC is Japan's premiere technology integration company with over $3 billion in revenue.

We remain committed to delivering new products to the data center and our traditional markets to drive revenue growth, take market share and increase stockholder value.

As a reminder, all of my comments will be nonGAAP, except for the revenue and the number of common shares.

There is a reconciliation from nonGAAP to GAAP financial results in the slide presentation under investor relations on our website that I mentioned previously.

Once again, before I go any further, I want to thank every employee in our organization for their dedicated efforts and commitment which contributed directly to our performance in Q3.

During Q3 we continued to perform and improve our operational execution and reported $78.2 million of net revenue, bucking the historical trend of down sequential performance coming off Q2.

With regard to total revenue by geography, the Americas reported $32.6 million for the current quarter.

that's up 19% sequentially and up 21% year-over-year.

The Americas showed increased deal size and a strong contribution from Mexico during the current quarter.

EMEA posted $31 million for the current quarter, that's down 18% sequentially and down 19% year-over-year.

EMEA was more back end loaded this last quarter than normal but posted a book-to-bill greater than one and we anticipate solid Q4 contribution.

Asia/Pacific posted $14.6 million of revenue which is up 3% sequentially and up 23% year-over-year.

Asia/Pac continues to perform well for the Company.

During the quarter we closed 30 new customers with deal sizes above $100,000.

Commenting on the mix of enterprise versus service provider revenue.

Service provider sales in Asia/Pac ticked up while EMEA, Eastern European service providers continued to be soft.

Consequently the mix for the quarter was a slight uptick in service provider revenue representing 29% of revenue, up from 22% sequentially.

Our book-to-bill for the quarter exceeded one over the last-- in Q3 as well as over the last few quarters.

Our gross margin percentage expanded to 58.3% and was for the second quarter in a row the highest in the history of the Company.

We benefited from the recovery of approximately $1.1 million of warranty costs incurred in prior periods.

Without this benefit, the gross margin percentage would have been within our range of expected performance.

Operating income was $4.7 million, or 6% of revenue and again, was the strongest quarterly performance in over three years.

EBITDA for the quarter sequentially increased to $6.8 million, reflecting continued improvement in our operating execution, and was a significant improvement over the $2 million of EBITDA in Q3 last year.

Cash flow year-to-date, excluding about $4.5 million of restructuring costs, was $7.5 million positive, again reflecting continued improvements to operating performance.

We used about $7 million of cash in the quarter, supporting our increased investment in inventory as we position for stronger revenue in Q4 and reflecting the settlement of trade payables in the ordinary course of business.

We exited Q3 with about $128 million of cash and investments and of course no debt.

Total deferred revenue on the balance sheet at Q3 decreased by $2.9 million sequentially, but is up about 13% from year end.

The increase year-to-date primarily reflects increased inventory in our distribution channels.

DSOs and accounts receivable improved to 43 days from 47 days in Q2, and from 50 days in Q1.

Inventory was up to about $23 million as we positioned for increased revenue in Q4.

Inventory turn over at Q3 calculated to seven turns, and we anticipate returning to around eight turns by the end of Q4.

With that, I'll turn the call over to Paul Hooper, our Chief Marketing Officer.

Paul?

Thank you, Bob.

Let me start by saying that we remain later focused on growing our market share and revenue in each of our core markets.

We continue to invest in products and solutions for those markets, on expansion of our routes to markets and our associated presence in those markets.

During the course of the quarter, and the first few weeks of our current quarter, we've announced new products, technologies and solutions to serve our target markets.

These ongoing and targeted investments result in us continuing to win business with new customers in all our markets this quarter.

As a reminder, our core markets are firstly, the campus enterprise LAN, secondly the enterprise and manage hosting provided data centers and thirdly, carrier Ethernet or metropolitan service providers that adopt Ethernet technology.

I will now review the products and solution announcements that occurred during Q3 and the first weeks of Q4.

In Q3 we launched and shipped the Summit X480 family of Ethernet switches.

Highly versatile in their configuration and scalable to address the needs of virtualized data centers, enterprise network aggregation and the age of metro networks.

The X480 offers the performance and flexibility required by customers in all of our core markets.

We also launched and shared additional modules for our enterprise and data center (inaudible) family, the BlackDiamond AK.

The new modules, referred as to the 8900 XL family offered the scale and versatility available in the X480 along with the performance of the BlackDiamond AK modular family.

The launch of the 8900 XL modules represents continued proof of our commitment to protecting our customer investment.

It is now possible to transition a core enterprise chassis from 48 Gigabit onto 128 Gigabit per slot as applications demand without discarding cost investments.

Earlier in the fiscal year, we announced a smaller addition of our carrier class chassis product, the BlackDiamond 20K.

The smallest chassis starting shipping this quarter and we're seeing traction with carriers around the globe who are looking for chassis solutions closer to the edge of the network.

Continuing the theme of protecting customer investments and rounding out our Harbor announcements, this morning we announced a four by 40 Gigabit versatile interface module.

This module is an infield upgrade to existing Summit X650 and X480 switches that enables high speed uplink connections from the edge of the network to the core.

This announcement also broke new price barriers.

With field trials starting in Q3 of this calendar year, we will be offering this module at $3,995 US list, less than $1000 per 40 gig pool.

Industry leading and live on the show floor at Interop Las Vegas this week.

We are also demonstrating a four by 40 gig module for our BlackDiamond AK chassis.

They're expecting to form a launch later this calendar year.

And now turning to our software.

During the quarter, we announced the availability of the latest release of our pioneering Extreme XOS modular operating system EXOS 12.4.1.

With each release, new and differentiated features are enabled for customers of our platforms and this release is no exception.

This release includes a new feature that provides network administrators deeper insight into the user at the age of the network.

The ID Management feature allows the administrator to view the identity of the connected user rather than just an IP address.

Our ID Management feature records, tracks and reports on the user on each port rather than just provide the device credentials.

We see this capability having broad and high value applicability within the market.

For example, virus on network attacks can be associated to user rather than device.

And location information can affect change within the environment.

Device profiles can be changed to match user specific needs.

Turning now to complete solution announcements.

Building upon our four pillar vision for the data center of the future announced in December 2009, in the past few weeks, we announced two innovative capabilities for owners of enterprise and hosted data centers.

As the number of virtualized servers continues to grow, the challenge created by the deployment of on server virtualized switches are causing organizational, operational and performance issues.

Our Direct Attach solution overcomes these challenges and enables switching decisions and actions to occur in the network rather than in the server.

In doing so, Direct Attach eliminates at least one if not two layers of network switching within the data center.

Direct Attach also addresses organizational boundary challenges, returns operational efficiency and effectiveness and improves overall network performance.

Direct Attach is a combination of both software capability on the extreme XOS pad switch and native capabilities of our Ethernet switches, both stackable and modular.

We also announced a new solution to dramatically simplify and improve control throughout the life of the virtualized machine within data centers.

Extreme Networks XNV, software modules for bandwidth-based XOS and centralized EPICenter address the challenges, operational risk and instability created when virtual machines move between servers, switches, racks and between data centers.

With the ongoing adoption of application and server virtualization architects and administrators of data center networks are facing increased operational complexity as virtual machines continue to proliferate and the ability of virtual machines becomes more prevalent.

Extreme Networks offers a path to simplification.

Our XNV solution empowers the network to understand the profile of each virtual machine and then when the machine is created, moved or it is eliminated, an XNV enabled network ensures that all profile attributes are established on the network to match the life cycle event of the virtualized machine.

In summary we continue to focus investment on our core markets to accelerate first to market and price performance leading technologies and solutions that solve real world challenges.

The products and solutions that I've mentioned are being demonstrated at Interop Las Vegas this week.

With that, I will turn the call back to Bob.

Okay great, Paul, thank you.

In summary, we continue to execute well in Q3 and to see signs of improved sales momentum.

We bucked the historical trend of down sequential revenue from Q2 with strong geographic performance in the Americas and Asia/Pac.

The world economies continue to show signs of improvement.

We anticipate that expenditures on networking will continue to increase over the remainder of this calendar year and throughout 2011.

Accordingly, we are increasing our investments in sales teams in geographic areas where we see an opportunity to grow revenue.

We have begun the recruiting and we'll see many of these new sales teams join us throughout Q4.

The competitive landscape continues to change and evolve while remaining strong, particularly in the US.

We see that as benefiting Extreme as an opportunity to expand our partnerships and grow our customer base by providing high performance innovative products and superior services to ensure our customers and partners success.

I'll now turn to guidance for Q4.

As a result of the signs of an improving macro economic climate and increased sales momentum, we anticipate Q4 net revenue to be between $82 million and $85 million reflecting an 8% to 11% sequential product revenue growth.

Further, we anticipate the gross margin percentage being between 57% to 59%, and operating income of between $5 million to $7 million resulting in an earnings per share of $0.05 to $0.07 per share fully diluted.

As I said last quarter, we continue to closely manage our operating expenses while selectively investing for revenue growth to accelerate earnings and cash flow and gain market share.

Hiring of the additional sales teams is underway and focused on gross revenue as we enter fiscal 2011.

We remain committed to making our customers and partners successful and creating value for our stockholders.

With that, I'm happy to open it up for questions.

Patty, I'll turn it over to you now.

Thank you.

(Operator Instructions) Our first question comes from Rohit Chopra of Wedbush Securities.

Hi, Bob.

Hi, how are you doing?

Good, yourself, thanks.

I just wanted to go through a few questions here.

Maybe you could just update us on the CEO search.

I think I asked that last quarter but it's been awhile now so I just wanted to know where the Board was in getting a leader.

Yes, the CEO search continues.

The Board gives me updates regularly and we have some very qualified candidates.

They are coming principally out of the networking business, and that process continues, right.

I can't give you a hard date as to when the new CEO would be on, but I can assure you the Board is diligent and continuing to drive that process to select the right candidate.

And so I'm excited and hopeful that we'll be able to make an announcement soon but like I said, I can't give you a hard date.

Okay, and then I wanted to ask you a quick question on the supply chain.

It's been an issue for a lot of people, it was an issue for you.

Can you just elaborate on where we are on the supply chain issues?

I know you started to get a little bit more inventory build here to spend for next quarter but maybe you could talk a little bit about the supply chain.

Yes, okay.

Great question.

The supply chain issues haven't fully abated for probably most companies in the marketplace because our assessment is that they are not adding capacity back as fast as they took it out, okay.

So I think managing your supply chain is an ongoing continuous effort.

We've done several things within Extreme to manage that.

One is shoring up our relationships with our key providers.

Number two is establishing safety stock programs both at key providers that aren't on our books and some that we carry in inventory on our books, as well as improving the process for forecasting and mix issues, et cetera.

So you have to continue to work those issues.

The increase in inventory coming out of Q3 is principally in anticipation of Q4 demand.

If you look historically the $22 million, $23 million numbers kind of I think where the Company's been as we started to approach Q3, so.

But I think your sense is right, the issue's not gone away you just have to actively work it.

Okay.

I want to ask you just one more question here.

Do you want to talk a little bit about Extreme and Motorola, that OEM agreement, where you are now?

And related to that, is there no reason why you couldn't supply a converged wireless and switching solution to the market?

Yes, I think we can count on it.

Paul, you want to go ahead and answer that or--?

Happy to do so.

Great question.

So the relationship we've got with Motorola is definitely mainstream of the first phase.

We see it as being a two phase relationship.

The first phase is as you know we're OEMing their products in and reselling them on as part of our SummitWM portfolio.

So we've got some significant success and it is a very attractive portfolio and it's being received well by our customers.

The second phase of that and one that we've openly declared and spoke about at the time we embarked upon this relationship was where we build a fully integrated solutions.

So a wired switch, given the power of the modular operating system, we can then pour on top of it the Motorola software code and turn it into a converged wired and wireless switch.

So that work is underway.

No firm timeline regarding when we intend to deliver that to market, but trust me, phase two development is active and is ongoing.

We are still in close conversation with Motorola, a great partnership and we have ongoing discussions with these guys, we will continue to do so and the possibility of becoming a tighter partnership is always there.

But at the moment we're pushing ahead with kind of the development in-house for the converged wired and wireless solution.

Paul, can I just ask a quick follow up?

Does that mean that you'd go after and market that, for example, [Maru] is in and Aruba in one sense on the wireless side?

So when you say go after it, I think our products compete very capably against their portfolio.

I'll go so far as to say in many ways they are a stronger portfolio.

And so we see the industry, the edge of the industry transitioning away from the fixed wire to a blend of wired and wireless.

And we're absolutely going to play in that market space.

So certainly we're going into that space.

Thanks, Paul.

Okay.

Our next question comes from Douglas Whitman of Whitman Capital.

As a shareholder, thank you for the great job of leadership that you've done for the Company.

So we're happy with you not rushing to change that leadership position.

A question about Europe, one of your competitors, Foundry had a-- last quarter had a weak European quarter partly self-inflicted.

But are you seeing demand issues or can we talk a little more specifically about why the bookings were solid in Europe but the revenues were not this quarter?

Yes, Doug.

First of all, thanks for the compliment.

And what we saw in Europe was the bookings were a little more back end loaded than what we traditionally would see, right.

And it could be it just (inaudible) from customer hesitation in finalizing the deals, right.

As you know, Greece continues to be a big overhang for the whole European community.

So I believe there's some uncertainty in the marketplace just because of that.

But that's a macro consideration not so much Company specific.

Not an excuse, but just an observation, they did have a very harsh winter as you know the East Coast in the US was shut down for several weeks earlier on in the winter, so that played out a little bit as well.

Having said that, we did have a book-to-bill stronger than one and we are looking to a solid contribution in our Q4.

So I don't have any real market tidbits I can give you as to-- other than what I just shared with you why specifically it was a little more back end loaded.

And on the positive the North America was unusually strong particularly for a first quarter, is there something that you've changed, done right?

Is there-- is it coincidence?

Or can you talk a little bit about the positive there?

Well I think our leadership team there is doing a great job.

It's been a difficult three to four quarters last year year and a half, right?

And the US economy is actually starting to show some signs of life reflected in larger deal size.

Larger deal size help us bring more meat home to the cave, so to speak.

And so you saw larger deal size, expanding of the pipelines in the US, et cetera.

So it's just solid execution in our strong verticals, education--

Healthcare.

Healthcare, et cetera, right.

So I think the team's doing a great job there and we're looking for more contribution from them.

Great.

We look forward to seeing you at Interop.

And then you'll probably--

Right, cheers.

(Operator Instructions) Our next question comes from Jon Evans of Edmonds White Partners.

Hi, Bob how are you?

I'm good, Jon, how are you?

Good.

Hey I just had a question for you to understand better, I know you're trying to drive this bus to operating margins of 11% at certain revenue levels.

And I guess what I'm really trying to understand here is you had great profitability this quarter and put $0.06 up nonGAAP, and then I think you're guiding to $0.05 to $0.07, but you have incrementally a lot higher sales sequentially.

So is that you're spending some money?

Is it a mixed shift?

Or are you just being conservative or can you help us understand kind of the dynamic?

Well we had a couple benefits in Q3.

One I mentioned calling out my normal comments was the $1.1 million benefit that came to the gross margin.

Sure.

What that is is we had an ODM design a product, right that had a warranty, a faulty product on a capacitor.

As it became a bigger problem, one we recognized the obligation to deal with our customer challenges, so we did that.

Then we went back to the ODM and negotiated, they reimbursed us for these costs.

Okay, so that reimbursement $1.1 million benefited the margin.

In the tax line down below, we had a tax allowance reversal that related to one of our international entities that I think gave us about an $800,000 benefit at the tax line.

So if you kind of-- tax effect of the margin on a normalized basis and you take out the benefit of the $800,000, that would give you a better normalization that really the EPS and performance up in Q4 is continuing to strengthen.

Got it.

Can you talk then just a little bit about, I know that your goal is to hit that double-digit Op margin.

Can you give us kind of a runway or a pathway to what kind of revenue level you think you need to get to to get there, and just help us understand that?

Yes, I think 90.

$90 million a quarter will probably get us there.

So that's where we're driving.

Now we are expanding our sales teams like I said in my prepared comments, right.

We're looking to add teams throughout the fourth quarter to position us toward the strength and the opportunities we see coming in 2011.

As you know the process, you have to identify the candidates, interview them, get them on board, train them, ramp them, et cetera.

So we've started that process and now those requisition are open.

And some of those teams will join us throughout Q4.

And our internal estimates say if we get around $90 million we should be getting to that double-digit operating income.

Great and then the last question I have for you is what is the normal seasonality from March to June?

Well the June quarter's our fiscal fourth quarter.

So you have salesmen or sales people are always in their accelerators for that type of issue.

We normally are up what, Paul, I'm mean I'm trying to think $5 million or--?

5% to 7%.

5% to 7%, right.

Okay.

So I'm getting some background help here on that question, Jon.

Got it.

Hey great, thank you.

Great, thank you.

(Operator Instructions) We have a follow-up from Rohit Chopra Wedbush Securities.

Bob, I wanted to ask you about the research and development line, I think you're down about $1 million in that.

I think, I'm not sure did it say there were some delayed projects or something like that?

Will R&D sort of tick back up again, is that the expectation?

Yes, we expect R&D to get normalized back up over the $11 million number.

There was just timing of projects, et cetera, hiring of people and that type of stuff.

So yes, it should come back up in Q4.

All right.

And I just had one question on competition.

You said you expected competition to benefit Extreme.

I know you did-- you've done one well I guess or coming out of the depths of the great recession.

I know it's been difficult for everybody.

But one of your competitors has been able to grow their revenue sequentially.

They grew it $3 million for the switching area and they have a significant up to 60% off list price sale going on.

I mean how competitive is it out there?

If you could talk about the competitive environment?

Yes, I think you're talking about our friendly competitor Juniper?

Yes.

And we're very aware of their programs, right.

And there are deals where it's very competitive, okay.

And in reality, our goal internally is to not lose on price, right.

Now if you look at our margins, we're able to negotiate and not lose on price and compete and not lose on price and still maintain that margin.

Actually the margins are at historical highs for the Companies.

So we're going to look for ways to drive the cost curve in light of a competitive environment, okay.

So we see competition from Cisco as well, from Foundry, Juniper's in the marketplace, right/ So we see all the above.

We think we're positioned to very aggressively compete with them and we'll continue to do so.

Thanks, Bob.

All right.

I'm not showing any further questions at this time.

Would you like to continue with any further remarks?

Yes, why don't I just make a closing remark.

And first of all thanks to everybody for signing on to the conference call.

We're excited about Q4 and I look forward to a successful Q4 earnings conference call.

It would be, I think in end of July.

Okay.

Great.

Thank you very much.

Cheers.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the program.

You may all disconnect.

Everyone have a great day.