Extreme Networks Inc (EXTR) 2014 Q4 法說會逐字稿

Good day, everyone, and welcome to the Extreme Networks fourth-quarter 2014 earnings results conference call. This call is being recorded. With us today from the Company is Chuck Berger, the Chief Executive Officer; Ken Arola, the Chief Financial Officer; and Erik Bylin, from Investor Relations. At this time, I would like to turn the call over to Erik. Please go ahead, sir.

Thank you, Sam, and welcome to the Extreme Networks fourth-quarter and FY14 earnings conference call. This conference call is being broadcast live over the Internet and is being recorded on behalf of the Company. Should you wish not to be recorded, please do not ask questions during the Q&A session.

The recording will be posted on Extreme Networks' website, replay shortly after the conclusion of the call. The presentations and recording of the call are copyrighted property of the Company, and no other recording or reproduction is permitted unless authorized by the Company in writing.

By now you have had a chance to review the Company's earnings press release. For your convenience, a copy of the release and supporting financial materials are available in the Investors Relations section of the Company's website at ExtremeNetworks.com.

I would like to remind you that during today's call, Management will be making forward-looking statements within the meaning of the Safe Harbor provision of the federal securities laws regarding business and financial outlook. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which would cause actual results to differ materially from those anticipated by these statements.

These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. For a detailed description of these risks and uncertainties, please refer to our most recent report on Form 10-K filed with the SEC, as well as our most recent Form 10-Q filed with the SEC, in addition to our earnings release posted just a few minutes ago on our website.

Throughout the conference call, the Company will reference some financial metrics that are derived in accordance with Generally Accepted Accounting Principles, or GAAP, while other metrics are not in accordance with GAAP. This approach is consistent with how Management measures the Company's result internally. However, non GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies.

Non-GAAP information should be considered a supplement to, and not a substitute for, financial statements prepared in accordance with GAAP. Reconciliation of the non-GAAP information to corresponding GAAP measures is in the slide presentation under the Investor Relations tab on our website and in our earnings press release issued today.

In preparing non-GAAP information, the Company has excluded, where applicable, the impact of acquisition and integration costs, purchase accounting adjustments, amortization of acquired intangibles, restructuring charges, executive transition costs, share-based compensation, gain on the sale of facilities, and litigation settlements. Now I'll turn the call over to Chuck Berger for some opening comments.

Welcome to the call and thank you all for joining us. I will give you a brief business overview and then Ken Arola will give you a detailed review of the financial performance for both the quarter and the full year. We ended the quarter with stronger-than-expected financial results. We reported non-GAAP revenue of $156.9 million, non-GAAP gross margin of 56.9%, and non-GAAP earnings per diluted share of $0.09, which exceeded our preliminary results announced in July for both revenue and earnings per share.

We experienced better-than-expected strength in EMEA. EMEA's quarterly results grew 4% quarter-over-quarter and 5% year-over-year. Annual results were also up 4% FY14 over FY13. North America also exceeded expectations, driven by three additional NFL stadium wins. We recently announced the Tennessee Titans, which closed in the third quarter, and the Jacksonville Jaguars, which is one of the fourth-quarter wins. We'll be announcing the other wins in upcoming weeks.

Despite the lack of E-Rate funding this year, we had a strong year in the K-12 market. E-Rate-funded business dropped $10 million in the fourth quarter compared to the prior year. In spite of that, our overall K-12 business in the quarter was only down by one-half that amount. The FCC announced that E-Rate funding will be available for Wi-Fi purchases made on or after April 1, 2015. In anticipation of this, Extreme is acting swiftly to put programs in place to capitalize on this opportunity.

For the fiscal year, we reported pro-forma non-GAAP revenue of $624.4 million, down $14 million or 2% from the prior year. Given the lack of E-Rate funding and the complexity of integrating two $300 million companies, keeping revenues nearly flat for the year was clearly a significant accomplishment.

As I mentioned in the last earnings call, we are experiencing integration challenges in our North American sales and partner organization. I am confident, having spent a great deal of time with the North America Management team over the quarter, that virtually all of these issues are behind us.

Additionally, two weeks ago, we held our global sales conference, bringing the entire sales team together for the first time ever. The incredible spirit and unity I saw over the entire event are added signs that the integration issues are behind us. We also held an extremely successful North American Partners Conference that week.

We are conducting a search for a new sales leader. I am extremely pleased with the number and caliber of the candidates that have shown interest in the Company and in the position and feel confident we will be able to announce a successful completion of the search shortly.

Now on to a number of items relating to the integration. On the whole, the integration has significantly exceeded my expectations. Originally scheduled for September, we completed the ERP integration in July, an unprecedented two months ahead of our original schedule. Extreme customers, partners, distributors, vendors, and employees now interface with us through a single system.

Coincidentally, the first order we processed on the integrated system had Summit switches, a legacy Extreme product, on the same order as IdentiFi wireless products, which came along with the Enterasys acquisition. Completing this integration and getting through our year-end audit, which is also on schedule, have been gating items in realizing synergies in a number of areas across the Company.

In July, we launched our new, global partner program, which unites our more than 2,700 partners around the world under one set of business terms, rewarding performance, particularly revenue growth. It is designed to show we are a partner-proactive Company, to encourage existing partners to do more business with us, and to encourage new partners to join the Extreme Partner Network.

At the same time, we launched a new portfolio of service offerings, again, uniting all of our business under a single set of programs and offering our partners an even better business proposition through our PartnerWorks programs. Finally, we are close to completing the overhaul of our distribution network, reducing the number of distributors significantly, to focus only on those that are best-in-class. As a result of doing more business with the remaining distributors, we gain more leverage in the relationship and access greater capabilities.

We completed the conversion of the Enterasys direct distribution model in Brazil to the two-tier model we have for the rest of the Company, reducing costs, improving partner service, and avoiding further tax and legal exposures in Brazil. Overall, we are exactly where we planned to be in integration process and the realization of the related financial synergies.

We have not let the integration slow down the rate of innovation and product launches at Extreme. In June, we announced our software defined networking platform. Extreme SDN extends our software defined architecture, building on the strengths of our Linux-based OS, XOS, and our network management, network access control, and analytics applications.

It is opened and standard-based and designed to allow customers to seamlessly migrate their existing networks, regardless of current vendors, preserving their investment and avoiding vendor lockout. Extreme SDN is based on a comprehensive hardened OpenDaylight control. Our comprehensive approach preserves the integrity of the open API provided by OpenDaylight, while extending data center orchestration, automation, and provisioning to the entire network under a single pane of glass. We believe we are leading the market for SDN and have already hipped over 10 million SDN-ready ports.

To fuel innovation and mind share, Extreme Networks also announced the Extreme SDN Innovation Challenge. This initiative will award prizes for applications that leverage the Extreme Networks SDN platform that best drive innovation. Extreme Networks will extend its APIs to allow developers to create applications with a rich software development kit. The challenge starts in September 2014 and runs until May 2015 and is open to US university students and US Ignite members in good standing.

During the quarter, we shipped our complete line of 802.11ac wireless products, including outdoor access points, key to our stadium business. As we increase our focus on the growth available in the wireless market, our business continues to grow as we had a record quarter in wireless sales. Finally, we released upgrades to our XOS and EOS operating systems, as well as a new release of our NetSight network management and access control application.

It is one thing for us to tell you how great our products are; it's much better when the industry pundits do it for us. Info-Tech Research Group named Extreme a champion, a recognition only Extreme and one other company received. Info-Tech labeled us as a trend-setter and noted our strong market position.

Additionally, SearchNetworking gave Purview and network analytics its 2014 Innovation Award. Finally, and most importantly, we moved significantly up and to the right in the Gartner Magic Quadrants for both wired and wireless LANs and the data center. Gartner commented that any large enterprise should consider Extreme on its short list.

During the quarter, we had a number of key customer wins I'd like to share with you. As I mentioned earlier, we continued our success in NFL stadiums in Q4, with three wins, including the Jaguars. To handle a seating capacity of over 67,000 people at the Jaguars stadium, the Extreme Wi-Fi system is designed to allow fans the bandwidth to concurrently access and use multimedia applications without interruption.

The NFL wins have attracted attention in Division I university markets and the stadium markets around the globe. We had a venue deal in New Zealand, have discussions started in all of our major markets around the globe. University wins are particularly attractive, as it opens the door to the rest of the school, including teaching hospitals.

We also won a strategic deal with the London Internet Exchange, or LINX. This represents the first Extreme Networks 100 gig line card to be sold and deployed. It was an important win, as LINX is considered the thought leader for the broader European Internet exchange community. In this case, the collaborative engineering and lower TCO impressed the LINX team and closed the deal for Extreme.

We continue to make progress in expanding our relationships with key partners, particularly Lenovo. In the last quarter, I met with the Lenovo executive team in China and it is clear they are strongly committed to the alliance. We've also trained all Lenovo North American reps on Extreme products. We continue to believe that Lenovo will begin to generate significant revenues for us starting in our fourth quarter of 2015 and beyond.

In closing, Extreme had a solid fourth quarter to finish a transformative year. We completed major elements of the integration of Enterasys and are on track to realize the synergies we have committed to. I would like to reiterate our prior guidance, that we expect to attain year-over-year double-digit revenue growth in the fourth fiscal quarter, driven by our expected ramp of the Lenovo business and the return of E-Rate funding.

In addition, through focused cost management, we expect to achieve a 10% non-GAAP operating margin in Q4 and beyond. With that, I will turn the call over to Ken to discuss the financials.

Thanks, Chuck. I'd like to start by saying that I am pleased we closed our first year as a combined Company with solid financial results. As I walk through our Q4 and fiscal year results today, I'd like to remind you that this is the second quarter we will be reporting full-quarter combined results. When I mention year-over-year comparisons, I am doing so on a pro-forma basis as if the two companies were historically one.

With that, let's now review our fourth-quarter financial results starting with revenue. In Q4, GAAP revenue was $155.3 million compared to $141.8 million in Q3 and $169 million in Q4 a year ago. Our Q4 non-GAAP revenue of $156.9 million was above our original guidance of $145 million to $150 million and compares to $143.7 million in Q3 and $169 million in Q4 last year.

GAAP and non-GAAP product revenue for Q4 was $121.8 million, compared to $109.9 million in Q3, and $133.4 million in Q4 last year. GAAP service revenue for quarter four was $33.5 million compared to $31.9 million in Q3, and $35.6 million in Q4 of last year. Non-GAAP service revenue for quarter four was $35.1 million compared to $33.8 million in Q3 and $35.6 million in Q4 of last year.

The sequential growth in revenues is largely due to better-than-expected results in North America, including the three stadium wins late in the quarter, as well as quarter-over-quarter growth in EMEA. On a year-over-year basis, revenue declined in North America, largely due the lack of E-Rate funding.

Looking at how the regions performed this past year, or this past quarter, America revenues were 54% of total revenue compared to 51% in Q3, up as the US and Canada strengthened, as we moved past sales force integration issues. EMEA's revenues were 36% of total revenue compared to 38% in quarter three and Asia-Pacific revenues were 10% of total revenue compared to 11% in quarter three. Overall, our revenue distribution has remained relatively consistent over the past year.

Moving on to gross margin and operating expenses. In Q4, gross margin was 53.4%, compared to 50% in Q3. Non-GAAP gross margin was 56.9%, above our target of 55%, and up compared to 55.3% in Q3 and 55.4% in Q4 of last year. The sequential increase in gross margin is largely due to our ability to hold pricing on deals worldwide better than we had anticipated coming into the quarter, as well as the benefits we have started to see in product cost resulting from pricing leverage with our key manufacturers. In addition the 5% increase in service revenues quarter-over-quarter contributed to gross margins, as service carries a higher gross margin as it is delivered from a relatively fixed-cost base.

Q4 GAAP operating expenses were $96.4 million compared to $94.2 million in Q3. Q4 non-GAAP operating expenses were $78.1 million compared to $76 million in Q3 and $75.7 million in Q4 of last year. The sequential decrease in operating expenses -- I'm sorry, the sequential increase in operating expenses is primarily attributable to sales compensation expense associated with the increased quarter-over-quarter revenues.

Fourth-quarter GAAP operating loss was $13.4 million compared to a loss of $23.4 million in Q3. Fourth-quarter non-GAAP operating income was $11.2 million, or 7% of revenue, compared to $3.3 million, or 2%, in Q3, and $17.9 million, or 11%, in Q4 of last year.

GAAP net loss for quarter four was $16.2 million, or $0.17 per share, compared to net loss of $25.1 million, or $0.26 per share, in Q3. Non-GAAP net income for the quarter was $8.5 million, or $0.09 per diluted share, above our guidance range of $0.02 to $0.04 and compares to $1.6 million, or $0.02 per diluted share, in Q3, and $17.5 million, or $0.18 per diluted share, in Q4 of 2013.

On a full-year GAAP basis for 2014, revenue was $519.6 million, gross margin was 51.5%, operating margin was a loss of $50.2 million, or a negative 9.7%, and earnings per share was a loss of $0.60 per share. On a full-year non-GAAP basis for 2014, revenues were $524.8 million, gross margin was 56.5%, operating margin was $36.5 million, or 7% of revenues, and EPS was $0.30 per diluted share.

Before I move on to the balance sheet, I'd like to update you on integration synergies. In Q4, we realized our targeted $5 million to $6 million in savings relating to cost reduction efforts in both cost of goods sold and operating expenses. As mentioned on the last earnings call, some of these savings were offset by increased staffing and inside sales to drive lead generation and marketing associated with NFL and team sponsorships.

In addition, in Q4, we incurred incremental sales compensation expense resulting from the increased revenues quarter-over-quarter, as I just mentioned. While we remain on track to deliver the synergies of $30 million to $40 million annually, we will not be breaking these out going forward, due principally to the fact that the two companies are now fully integrated, and going forward, the efforts to separate normal ongoing cost-cutting activities from execution of synergies will be difficult.

Turning to the balance sheet. Q4 cash and cash equivalents, short-term investments, and marketable securities ended at $105.9 million compared to $106.1 million at the end of Q3 and $205.6 million at the beginning of the year. In the quarter, cash flow from operations was $3.8 million, up from a negative $25.7 million in the prior quarter, but down from $25.2 million a year ago. For the full year, our cash flow from operations was a negative $26.8 million, down from positive $32.2 million last fiscal year. During the quarter, we drew down $24 million on our line of credit, which was repaid in early July.

Accounts receivable were $124.7 million at the end of quarter four, up roughly $30 million over last quarter, and DSOs rose to 72 this quarter from 59 last quarter. This is a result of strong shipment activity late in the quarter, which is attributable to several factors, Including a large number -- a larger than normal percentage of revenue coming in the third month of the quarter, the NFL stadium wins coming late in the quarter, and stocking orders placed by many of our distributors in anticipation of systems being down as we completed our ERP integration in early July.

Revenue on these stocking orders is deferred until the products sell through the distribution channel. However, while our accounts receivables and DSOs are high compared to historical levels, the aging profile of our receivables remains consistent with prior quarters and we do not anticipate any collections issues.

In fact, July was a very solid month of collections and then we expect to manage our accounts receivables and DSOs down in the future. To wrap up comments on the balance sheet, inventory was down $6 million from last quarter to $57.1 million, as a result of our continued focus on right-sizing the inventories.

Now, on to guidance. GAAP revenue is expected to be a range of $149 million to $154 million and non-GAAP revenue is expected to be in a range of $150 million to $155 million. GAAP gross margin is expected to be near 51% and non-GAAP gross margin near 55%. Operating expenses are targeted to be between $86 million and $88 million on a GAAP basis and $75 million to $77 million on a non-GAAP basis.

GAAP net loss is targeted be between $7 million and $12 million, or $0.08 to $0.12 per diluted share, and non-GAAP net income is targeted to be in a range of $6 million to $8 million, or $0.06 to $0.08 per diluted share. The GAAP and non-GAAP net income targets are estimated, based on an estimate of 96 million and 101 million average outstanding shares respectively.

Before I turn the call back to Chuck, I would like to provide a few qualitative comments on how we think about the full year 2015. From a revenue perspective, you should expect the typical seasonality in the business. With that said, fiscal Q2 tends to be somewhat flat compared to fiscal Q1, given that we don't expect a calendar year-end budget flush.

Fiscal Q3 is generally a slower quarter due to the budget-setting process and fiscal Q4 tends to be one of our stronger quarters. We expect to make progress with product gross margins through the year as we continue to negotiate with our suppliers to reduce costs. Our overall efforts to reduce product costs will likely be met by headwinds from pricing pressure in the markets in which we compete.

With the ERP integration completed in early July, we will begin to see IT and administrative costs come down beginning in the fiscal Q2 time frame. Also, with integrated product portfolio, consolidated supply chain operations, and fully integrated sales and marketing teams, we expect to begin seeing operational efficiencies as we move through the fiscal year.

In closing, I will say that we are focused on prudently managing our expenses and will make decisions on expense structure of the Company in order to maximize short-, medium-, and long-term growth, and profitability. Now I'll hand the call back to Chuck for his closing comments.

Thanks, Ken. To reemphasize, we thought the fourth quarter was an extremely solid quarter and it brought the year to a strong finish, keeping revenues nearly flat despite the integration of the Enterasys and Extreme companies into each other. As we look to the future, we have a lot of reasons to be confident going forward, standing behind our guidance, and look forward to our next call, and taking questions now.

Thank you. (Operator Instructions)

Matt Robison, Wunderlich Securities.

Congratulations. Thanks for taking the question. Uppermost is why the guidance for the gross margin declined to 55%? And then hoping you can comment a little bit on how meaningful the OEMs were, Ericsson in particular, the state of the -- conditions for business in Latin America? And also if you can talk a little bit about your plans for transition of the Enterasys legacy modular projects and when that might occur and what you see is the risks with that installed base?

Sure, I'll handle the gross margin question first. This is Ken. A couple things here, as we move through next quarter, even though we saw --were able to hold our pricing during the quarter better than we thought, we're still anticipating there's going to be some continued pricing pressure on the marketplace. We built that in, in relation to our guidance.

The second thing is, during the fourth quarter we got some favorable impacts to gross margin, one of them being, in particular, in relation to aligning accounting policies between the Enterasys business and the Extreme business. By combining the two companies on one consistent policy for a couple of our areas around cost of goods sold, there was, I would call it, a one-time favorable adjustment to cost of goods sold that would not repeat itself in quarter one.

What impact -- what was the magnitude of that?

I would say it was close to about a 0.5 point of margin.

Okay.

I'll comment on the others. Our Ericsson business continues to be relatively flat. We continue to have the opportunity for upside as their hosted cloud solutions strategy unfolds, but they are very early in that process and we have not seen an increase in business from that yet.

As we look to the future, you asked about the Latin American marketplace, we certainly face challenges there. In the fourth fiscal quarter, business in Brazil nearly froze on June 10 when the World Cup soccer matches got started. It didn't help that they lost seven to one to Germany at the end of the process. We're coming up against a fairly important national election in Brazil in, I believe it's the October time frame. So we're confident in our level of business there, but it's not today certainly a growth opportunity for us.

On the transition of the Enterasys modular products, you may recall from my comments that we released both a new version of XOS and a new version or EOS, or Enterasys OS, during the quarter, principally aimed at enhancing the functionality of our S- and K-series legacy Enterasys products. There's a significant part of the installed base that's value the core flow or the proprietary ASIC technology and its ability to do more comprehensive and simpler policy setting, so we continue to plan to include those products in our product line in the future.

Thank you very much.

Simon Leopold, Raymond James.

Great, thank you. First I just wanted to clarify, it was a comment in the prepared remarks by Chuck referring to the fourth fiscal quarter revenue of 2015. I believe you indicated double-digit year-over-year growth in the June 2015 quarter. I just want to make sure I got that note correct?

That is correct and the same guidance we've been giving now for several quarters.

Okay, great. And I wanted to drill down a little bit more on the wireless LAN business. You indicated that it was particularly strong. You talked about a number of stadium wins and offsetting the E-Rate pause slow down. Can we get some sense of this quarter's contribution of wireless revenue, and in terms of trying to help us think about the venue opportunity, is there a way you could size a typical venue, typical stadium value?

Sure. Let's start with an important point. As we've said now for several quarters, we are aligning both our go-to-market strategy and our product strategy against preserving and growing, but we don't expect [that as a] faster rate our wired LAN business, but really putting emphasis on growth in the data center and in the wireless LAN business. We had a record quarter in the fourth quarter, at about $16 million in wireless, up only a couple of million from prior quarters, but heading in the right direction and we're just at the beginning of those efforts.

We've designed our comp plan to incent both our own sales people and our partner's sales people to put emphasis on wireless. We expect significant growth there, especially now with the 802.11ac products shipping across the entire product line and still the market being at a relatively early stage in that conversion.

Stadium deals for the NFL range from upwards of $1.5 million to $2 million-plus, and as I said in my comments, we are now seeing increasing interest. We've already talked about one deal, which will be more formally announced next week, in the university marketplace. Those are similar sized deals; in fact, many of the Division I schools around the country have even bigger stadiums them the NFL teams do.

We're already seeing in the University win that we have had, that spilling over into added business around the rest of the campus for the various facilities, dorms, classrooms, and into the teaching hospitals. So we really view this whole stadium business as substantial unto itself, but also as the tip of the spear to drive penetration into other markets.

Thanks. And you mentioned data center as another area for growth opportunities, that's typically a challenging market, but the specs on your products look good. So just help us understand where you're positioned today competitively and contributions and outlook for data center?

Sure. We think, with the BDX8, we think we have one of the strongest offerings in the data center marketplace. Next to Arista, we are the lowest latency, we have the highest port count, and we have the lowest power consumption and most flexible operating system.

The SDN strategy that I talked about briefly is particularly relevant to the data center. In fact, we just had a meeting with a very large university from the Southeast, that heard the strategy for the first time last week and was received very, very positively by them. That market is growing, as the wireless market is, at 15%-plus, but we have not broken that out as a segment in our reporting.

And then just one last question. General thoughts on the landscape. Over the course of earnings season, we've heard conflicting comments about, particularly, North American enterprise, spending, lead times, deal sizes. Are there some thoughts that you could offer in terms of your opinion and your view of your primary markets' health and trends? Thank you.

Sure. We see our pipeline growing at a pretty rapid rate in North America. That said, there is a -- deal cycles seem to be getting longer, not shorter. And there continues to be a pretty strong emphasis, particularly in enterprise market, around cost containment.

And obviously, in our case with K-12 being such a heavy part of our business, the lack of E-Rate for another couple quarters and for the full year of 2014 that we just finished doesn't help that situation at all. But we expect to get back to strong results. We exceeded our expectations in North America and that's all virtually entirely enterprise business for us; we have almost no service provider business in North America and the trend continues to be positive there from our perspective.

Great, thank you for taking my questions.

Rohit Chopra, Buckingham Research.

Thanks very much. Hey Chuck and Ken. A couple of questions. I just wanted to get a sense, Ken, maybe on the sustainability of service gross margin. I know you mentioned there was some one-time impact. It jumped, if we can say, sequentially. Just want to get a sense of the stability there?

And maybe just overall gross margin? Guiding down to 55%, yet we expected 50% of the synergies to positively impact cost of goods sold, so I just want to get a sense of the stability of the overall 55%, as well? And then my last question is back to Wi-Fi just for a moment, you had a strong quarter; do you expect it to be sequentially up in the upcoming quarter?

On the 55% gross margin sustainability, the Company's done a good job over the past several quarters in getting cost out, from a manufacturing perspective. We still have more work to do there, so there's more opportunity to get cost out on the gross margin line to be able to sustain gross margins in that mid-50% range.

Services, they carry a much higher gross margin than the products do and to the extent we can continue to grow services business, that has a positive impact on the top line. The one thing we really don't have a lot of control over is pricing in the marketplace. To the extent we see a lot of headwinds from pricing, that's going to have some potential impacts on gross margin.

But like I said, we've done things in the gross margin line. We'll start seeing the effects of it as we move through the year here. Recently consolidated warehouses, we had four warehouses for stocking, we're down to three just this past quarter, so we'll start seeing some of that impact in gross margins. We have got a lot of service depots that we're working on consolidating down as well, so again, other opportunities to take cost out of the system and maintain a margin in that range.

As far as the sustainability of the service margins, I am confident on two things around service. One, we are continually increasing our focus on improving our attach rate and our renewal rate on service. Of all the things that we had to integrate over the past nine months, integrating the service infrastructure, service programs, and service delivery was probably one of the more, if not most, complex things we did other than the ERP integration.

In spite of that, we were able to grow revenues there and have a positive impact on gross margins. I still believe there's a lot of opportunity there, as we take the focus away from fixing the legacy Extreme service delivery, which was frankly pretty poor, and that's behind us; complaining the integration, which is largely behind us; and then turning those resources and that level of attention towards increasing the attach and renewal rate. We've taken a conservative approach in our guidance for the next quarter, but there's a lot of opportunity to make that better as we go forward.

Got you. Just on Wi-Fi, if there's any follow-through because of the stadium deals, can you see that up sequentially?

It was a particularly strong quarter with three deals contributing in the $5 million range total, combined with realized revenue and deferred revenue that comes out of those deals. The NFL season starts now. There's already been a couple pre-seasons games.

So the attention from at least that opportunity will shift until we get through the season, although there are a number of deals that are still in discussion. The K-12 and higher ed buying -- K-12 buying season was principally in the fourth quarter. I don't think with E-Rate coming till April 1, people will buy in advance of that. So I wouldn't expect in this quarter to see growth, but we're also in several deals now in very large venues outside the US that could kick in and change that position.

Excellent. Thanks, Chuck.

Mark Kelleher, D.A. Davidson.

Thanks for taking the questions and congratulations on putting a good quarter together with a lot of moving pieces. Just for clarification on the E-Rate program that you were just talking about, there was no I K-12 revenue in the quarter? Is that what I heard?

No, no, no. Quite the contrary. We had no -- we had about $1.5 million of trailing K-12 revenue that had E-Rate funds applied to it, down from, I believe it was $18 million the prior year. That said, despite a $10 million fall-off in the level of our E-Rate funded --I'm sorry, it was $12 million the prior year -- we only saw K-12 business overall drop by $5 million. So we had -- considering the lack of E-Rate funding, which in the last two years was 85% and 90% funding against approved Wi-Fi programs, we felt that we had a strong performance in K-12 in the fourth quarter.

Okay. So if we look forward, we're not necessarily going to $0 on that line. The K-12 should still be there. Should that still trickle through or was that still the end of it in the quarter [the picnic table]?

K-12 business for us is, of the combined Company, is 10% to 15% of our revenues, and we expect that to continue.

Okay. Just touching on Lenovo a little bit, I know you mentioned that in your commentary, if the -- you have got a very strong relationship with Lenovo, if they theoretically were not to close with the IBM deal, there would still be an approach that Lenovo is playing into the enterprise, correct? What happens if that deal doesn't close?

I mentioned that I was in China during the quarter and meeting with the Lenovo executives there in charge of the server business in the Asia-Pacific, but more specifically, the Chinese marketplace. In China, Lenovo already enjoys, I believe, it's a 15% market share.

They have made it a strategic imperative that they move into the enterprise market and move into the compute part of the server market, leveraging partners for storage and networking, specifically us for networking. Obviously, if they don't inherit a $5 billion a year run rate business, that growth will slow down, but I get no indication that they're going to back away from this marketplace. And we can still get significant revenue there, but clearly it won't be the same if this deal doesn't happened.

Just one last numbers question. What's the pro-forma revenue number for Q1 of the year that just ended? What's the number we're going to be comparing back to?

The Q1 pro-forma number was $164 million.

Okay, great, thanks.

Christian Schwab, Craig-Hallum.

Great. Thanks for taking my call. Chuck, solid quarter. Ken, solid quarter. When we look at June of next year, and your implied guidance of at least 10% year-over-year growth, so about $172 million, and you're implying that you will do a 10% operating margin. There's different ways I can get there, but what do you think your OpEx and gross margin structure would be in that implied guidance?

You can back in.

I did the math. If I do about $80 million [in out backs], I still about 56.5% in gross margin, which brings me back to the question of the current gross margin guidance. Are we just looking at that as a conservative metric, or is that $80 million too high and some of the synergies that we're no longer going to talk about, do we have a lower targeted operating expense [in June]?

If you look at the operating expenses that we've just a guided to on a non-GAAP basis, $75 million to $77 million in Q1 here, and we'll be looking at, starting to see some of that cost come out from an IT and administrative point of view, starting in Q2. So you'll see the G&A line start come down a bit as we move through the year here.

Then we also have opportunities to bring some of the other areas down from an operating expense point of view, as we now have got everything fully integrated, start seeing the leverage points, and being able to bring some of the R&D, sales, and marketing costs down. We have an integrated road map, so the R&D teams have done a really great job in doing and getting best products on the road map.

We can start getting leverage there, from that perspective. And again, by putting the two sales teams together, as Chuck said, we went through some integration issues. We think there's still opportunity to drive cost out as we move through the year. So I would say your $80 million number is probably -- can come down. I wouldn't bring it down a lot, but it could come down a bit.

Okay, great. And then, the next few quarters, we've got some new wireless stadium wins, business has stabilized, we're running the Business day-to-day pretty well, tight on OpEx controls, taking gross margin when we can. As we exit this year, after what looks -- appears to be in your mind a big June, we get that wireless initiative, but more importantly, the Lenovo initiative.

They've proclaimed that they want to have $5 billion in sales, 20% attach rate of switches would be $1 billion of network and equipment that would be tied to that. Is 2016, is that with 25% to 30% type of growth in wireless, should happen, with the economy being stable, layering in a stronger Lenovo business, maybe Ericsson will have some of the stuff together. Is 2016, Chuck, really the year that we break out to real growth on a year-over-year basis? Is that the way to think about it?

We certainly don't expect double-digit growth in the fourth quarter of a one-time event, so we should -- all the things you mentioned should be in full swing as we come into FY16. And certainly, by that point, there will be no trailing edges behind us or in front of us of the integration, so we're bullish on what the potential for 2016 is.

Great. No other questions. Thanks, guys.

Thanks, Chris.

Thank you.

Alex Henderson, Needham.

Just following that last line of questioning, can you just tell us what you think your long-term target margin structure should look like when all is said and done and the dust has settled on the integration?

As we look to the future, we certainly expect to continue to be in the mid- to upper 50%, 55% to 60% gross margin range. As Ken mentioned, there's a lot yet to be done there in consolidating the operational and the supply chain and logistics functions and getting better leverage from our distributors.

As I said in my comments, the 10% margin, as well as the 10% growth are not one-time events. How much more we can improve from there as we come into 2016, particularly in light of, if we are able to deliver what we believe we will, which is strong revenue growth, we would expect that model to get better, by how much, we haven't really started to give guidance on yet.

So R&D, do you have a target mindset of what you think R&D should be. Is it 10% to 12%, 11% to 13%, 9% to 12%. What numbers do you think is the right investment rate for that category?

Certainly as we go forward and realize cost benefits and get ourselves, again, as we exit this year, where we expect R&D to be relatively flat year-over-year, longer-term, given the breadth of the product lines we're in and the changes that are coming in this industry, particularly around the software defined networking and the greater value overall of software, that probably goes up a couple of percentage points, but not much more than that.

So you're talking about up a couple percentage points from where you're exiting the year?

Where we're exiting, which will be relatively flat, exit rate for next year.

So that sounds like you're talking about mid-teens type investment rate? Is that what I'm hearing?

This is Ken. We just -- our guidance implies about a 15% investment in R&D as we move through Q1. As we get leverage on the top line, moving through 2015 into 2016, our view is we can hold our R&D line relative to where it is today, and get more leverage on that. So you could see, potentially, if you move out a couple of years, R&D getting into that 12%, 13%, 14% range, dependent on revenue growth.

I see, great, thank you. And on the G&A cost, you made the comment about improvement sequentially into the December quarter. I assume that there's probably some growth after that. Is that the low watermark or does it continue to have a downward trajectory post that December quarter?

I would say once we get back the December quarter, because you'll be past all the integration, we'll be past reducing our headcount post-integration, with people leaving as we move through the second quarter, first and second quarter we'll start at the beginning -- end of the first quarter and move into the second quarter. We'll have everybody on the one systems, as we've been mentioning, for about six months at that point in time, so I would anticipate that G&A expense, as it comes down over the first few quarters here, will start to level off.

[Level off. Will not go up.]

Okay. Just going back to the product line categorization, obviously you're seeing very robust wireless LAN. Can you talk a little bit about what you see are the, by segment, what product line category you see as the primary drivers of your business. Can you rank-order them for us?

80% to 85% of our business still comes from wired campus or LAN business. We're aligning our investments to drive wireless, which is about 7% or 8% of the combined business, and data center, which is a similar amount. We expected the growth to happen in those two categories. That said, as a 3% or 4% market share player in the wired campus, with better sales execution, a solid partnering program, there's no reason we shouldn't be able to get growth there as well.

Okay. And so the service provider is not a key driver or opportunity for you then? You didn't mention. I assume that--?

In our biggest market, the service provider customer base is virtually nonexistent. We are seeing strength in the IXP marketplace outside of the US. I think that will flatten out rather than grow.

Good. And can you give us any sense of what the tax line ought to be doing next year, since we don't have much of a read on that externally?

Basically, will be -- we have lots of NOLs you can use in North America here, so our taxes will be predominately statutory taxes on an international basis. It will be something very comparable to what it was not in Q4, but in Q3. I would assume it's right around about $1 million a quarter or so on a statutory basis. It might fluctuate a little bit here and there.

Right. Just one last question, then. As you're going to the upcoming quarters, where do you see the price pressure coming from? Is that a function of the Arista products getting out in the marketplace and causing price pressure between Arista and Cisco, which bleeds into the other people?

Is it the ACI stuff launching at Cisco that causes some increased competition? Is it NSX? What is it that's going to drive specifically accelerated price competition as we go out over the next several quarters other than the fact that everybody wants business?

Well we're -- frankly, we saw less price pressure in the fourth quarter than we expected to see. It is certainly not being driven by anything Arista is doing; they are at the very high end of the market and have, as you can tell from their financial results, been able to preserve a pretty high margin structure. So that is not a factor that we see causing more discounting.

As you see other vendors, particularly Cisco's, business flattening out, they have been willing to be more aggressive in their pricing behavior than I've seen in the past year that I've been here. So it's driven by your final [herewith truth], the biggest player in this market, in particular, wanting to get back to some strong revenue growth.

Have you actually seen any evidence of that change since the close of your June quarter that would cause you to be acceleratingly cautious on that margin guidance? Has that actually materialized yet or is this just in anticipation that it's going to?

This is just being cautious because we did see, again, not across-the-board, but some of that behavior in the fourth quarter, and if it becomes more pervasive, we want to take a conservative approach in our guidance.

Good. Thank you.

Thank you. At this time, I'd like to turn the call back to Management for any closing comments.

Thanks. Again, thanks for joining us. Solid finish to a year that dramatically changed the face of our Company from basically, not only doubling our size, but giving us credibility in the marketplace that no one expected we would have had a year ago. We look forward to delivering on our guidance as we go forward, and hopefully improving beyond that. We'll talk to in about 2.5 months.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a wonderful day.