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Extreme Networks, Inc. (NASDAQ:EXTR)

F1Q10 (Qtr End 09/27/09) Earnings Call Transcript

October 26, 2009 4:30 pm ET

Executives

Bob Corey – CFO, SVP, Acting President and CEO

Gordon Stitt – Chairman

Paul Hooper – Chief Marketing Officer

Analysts

Steve Salberta – Boenning & Scattergood

Rohit Chopra – Wedbush Securities

Douglas Ireland – JMP Securities

Operator

Good afternoon ladies and gentlemen, and welcome to the Extreme Networks 2010 first 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 Bob Corey, CFO and Acting President and CEO; and Paul Hooper, Chief Marketing Officer.

As a reminder, this conference is being recorded today October 26, 2009. This afternoon Extreme Networks issued a press release announcing the company’s financial results for the first fiscal quarter of 2010. The conference release is available at the company’s website at www.extremenetworks.com. This call is being recorded and broadcasted live over the Internet and will be posted on Extreme Network’s website for 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 the financial performance, strategy, growth of customer bandwidth demand, development of new products, customer acceptance of the company’s products, customer spending and economic positions in the company’s market.

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 fluctuations in demand for the company’s products and services, supply chain constraints and availability of third parties to manufacture the company’s products and components bear up of a highly competitive business, environment for the 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 the new recovery in the global economy, and risks related to pending or potential future litigation.

This 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 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 may be subject to change when the review of the fiscal quarter is concluded and/or the 10-Q is filed.

I will now turn the conference over to Mr. Bob Corey, CFO and Acting President and CEO of Extreme Networks. Please go ahead, sir.

Bob Corey

Thank you, operator, and thank you all for joining us today. We have Gordon Stitt, our Chairman of the Board here. And I would like to turn it over to Gordon for some opening comments. Gordon?

Gordon Stitt

Thanks, Bob, and thank you all for joining us today. I wanted to comment on the recent leadership change that we announced last week. Mark Canepa who has been our CEO since August 2006 has decided to resign to pursue other interests. Board has appointed Bob Corey, our Chief Financial Officer as Interim President and CEO. Board has initiated a search for a permanent CEO.

Bob has been our Chief Financial Officer for about three months, but he’s been involved with Extreme for almost six years as a Member of our Board of Directors, and Head of our Audit Committee, so he knows the company very well.

We are both pleased and excited that Bob has agreed to assume the role of Interim President and CEO. His leadership and experience will be essential as we continue to drive change within Extreme Networks to position us for continued success and to ensure that we remain focused on delivering innovative solutions to our customers.

With that, I am very pleased to turn the call over to Bob.

Bob Corey

Thank you very much, Gordon. As Gordon just outlined, we’ve had some significant changes last week with the execution of our reorganization. We believe the reorganization will streamline operations and accelerate decision making. I will comment more on the reorganization later in the call.

Regarding Q1, we did not execute according to our expectations this quarter, and are taking a number of important steps to address the issues that impacted us. In particular, our results were hampered by the combination of a reduction inventory in Q4 and constraints on our supply chain, which kept us from closing transactions and recognizing revenue.

While there is some positive news such as an increase in backlog going into Q2 as well as a $3 million increase in total cash and investments, our performance this quarter is unacceptable. We do not believe our performance this quarter is an indication of marketplace demand for our products or our ability to win deals.

I have asked Paul Hooper, our Chief Marketing Officer to comment on demand drivers we see in the market, discuss some of our recent product releases and customer wins, and our upcoming launch regarding the datacenter opportunity. So I would like to turn the call over to Paul. Paul?

Paul Hooper

Thank you, Bob. I will start by saying that our confidence remains high. The demand for more bandwidth, more services and more cost effective communications infrastructure continues to grow. We also remain convinced along with the growing percentage of metro carriers and enterprises that Ethernet is the right choice to meet these demands.

As the economy shows signs of stabilization and early indicators of recovery, it is our belief that there is a pent-up demand for infrastructure upgrade to support new and enhanced services for delivery to a broader cross-section of residences and enterprises. We further believe that our investment in our portfolio of Ethernet choices and our single edge-to-core switch operating system ExtremeXOS has positioned us well to take advantage of this demand.

Across our three core markets, enterprise, carrier and datacenter, the pressure of the economic downturn has driven additional considerations into the list of infrastructure investment criteria. Firstly, a deeper and more vigorous scrutiny of acquisition and ownership costs; secondly, closer attention to energy advance and the associated costs of running the infrastructure; and finally, the need to simplify and reduce operational complexity, and as a result benefit from improved simplicity through open and standard based infrastructure.

These new evaluation and selection criteria play well to our strength in these markets. We can and do demonstrate that the total cost of an Extreme Network solution is lower. Our Ethernet switches are some of the most power efficient in the industry, and our uniform approach to software across our complete switch portfolio remains a core differentiator.

I will now discuss our three target markets and cover recent exciting product announcements targeted at those markets. In the carrier market, the drive towards convergence on Ethernet-based infrastructure continues with carriers around the globe and Ethernet holds the price of greater scale, improved service flexibility, and lower cost of ownership.

In addition to the deployment of converged triple-play networks within metro carriers, cellular voice and data networks run by wireless carriers continue to be an area of increasing focus for us. Working with our large strategic and alliance partners, we help deliver cost effective Ethernet network solutions that meet the requirements and specifications when serving in the backbone and backhaul for converged wireless voice and data services.

We continue to strengthen our hardware and software offering in this important market. In October, we announced the availability of the BlackDiamond 2804 Ethernet Transport Switch, the latest addition to our flagship product line, the BlackDiamond 20k. The BlackDiamond 2804 model like the larger 2808 is specifically engineered to handle the growing demands of residential video, business Ethernet, and mobile backhaul services.

The smaller form factor of the new BlackDiamond 2804 offers a flexible solution where the full physical scale of the larger chassis is not required. Our BlackDiamond 20k family enables carriers to increase their network longevity and scale by gracefully expanding simple voice and other services while their network while providing higher availability infrastructure using proactive service management software and protocols at a lower overall cost of ownership.

Additionally, in August, we announced the acquisition of the software of Soapstone Networks. The Soapstone software provides the foundation for provisioning new infrastructure and services along with the associated service assurance. This software enables carrier operators to be able to view, provision and control critical transport protocols, including provider bridging, provider backbone bridging PBB, Ethernet access protection switching, and virtual private line sessions and services.

With the addition of Soapstone software and the ongoing development of our ExtremeXOS operating system, we will be delivering new capabilities and features to support these industry-relevant protocols over the coming quarters.

During the quarter, we continued our work with China Mobile throughout China, as they build out their next-generation wire line and wireless infrastructure. Although, this is an aggressive market, working with Ericsson in China, we successfully opted the best price performance solution and we look forward to continuing this build out in China Mobile over the course of the quarters ahead. To date, we have over 100 carrier customers worldwide and we continue to build and extend carrier deployments around the globe.

Turning to the converged enterprise market, we have announced the additional management and line cards for our BlackDiamond 8K chassis family. The new BlackDiamond 8500 series modules offer value based connectivity solutions that provide distinct advantages over the competitive HP and Cisco solutions at the network edge. The 8500 series modules offer customers feature rich, secured functionality in conjunction with resiliency and high-availability options that our customers have come to expect of their enterprise networks.

The addition of the 8500 series modules following the recent announcement of the 8900 series modules two quarters back offer our customers the ability to scale one chassis from a wiring closet all the way through to the datacenter. This simplifies the life of a network engineer and also it maximizes the investment protection from the time of the first acquisition.

Within the enterprise market, we continue to see the growth and adoption of wireless connectivity. This growth creates a new set of challenges for the IT organization including the predictability of service level, the performance of the connection, and a secure manageability of the wireless service.

Although our existing wireless network portfolio addresses many of these challenges, we realize that the next generation of wireless services will require fully converged technology, an environment in which the edge of the network offers wired and wireless services without increasing management overhead, without reducing or compromising service levels, and offering far brighter levels of infrastructure flexibility.

With these drivers in mind, we announced in October a new relationship with the Enterprise Mobility Solutions division of Motorola, through which we would deliver a new wireless switching portfolio. This portfolio expected to ship in the December quarter is initially an OEM of the Motorola products, but it will evolve to a Motorola wireless software, becomes a modular component that can run on the (inaudible) Extreme Summit switches.

In doing so, we intend to provide the infrastructure flexibility being demanded by IT organizations, the converged management of both wired and wireless connectivity and inherent security with the Motorola wireless technology.

As part of our continuing efforts to reduce the cost of ownership for the enterprise network, we recently unveiled limited, life-time warranty on select Extreme Network switches. In combination with this warranty offering, we have put express, advanced hardware replacement, meaning that the majority of our customers can see a replacement switch in the event of failure on the next business day. This differentiates us in the market as our competitors generally do not offer such speed in customer service.

In the federal and local government markets, we just announced more of our Summit series edge switches have received TAA compliance, dramatically smoothening the path to integrators and VARs that work business through long establish GSA governmental and education contracts. Following this announcement, the majority of our Summit and BlackDiamond 8K portfolios are TAA compliant.

And now turning to the datacenter marketplace, with the arrival of virtualization into the datacenter and its promise to offer very powerful and enabling flexibility and scale, we firmly believe that while this promise offers greater and compelling value, it’s going to be accompanied by increasing complexity and results in operational risk and IT organizational confusion around the datacenter network.

Over the past quarters, we have announced and delivered for the datacenter market the Summit X650, the first switch to offer copper and fiber 10-gigabit connectivity in the top of rack form factor, the BlackDiamond 8900 series modules to allow enterprises to scale their end-of-row chassis solutions to a 120-gigabit first lot and our modular operating system ExtremeXOS that provides detection and response to migration of virtual machines within datacenters. This is only the start of the technology and the solutions that Extreme will offer our enterprise and carrier customers around the globe, as they seek innovative, effective and scalable solutions as they build and operate next-generation datacenters.

As we look forward, we have exciting and innovative developments underway to deliver a new approach to addressing the deployment and operational complexity of next-generation datacenters. We look forward to talking to you about these projects over the course of the next two quarters.

As one example of a new datacenter win this quarter, in San Antonio, Texas, CityNAP is a Tier 1 access point, an Internet hub and a datacenter that serves as a point of convergence for multiple fiber optic networks, has selected the BlackDiamond 20K for their fiber connected WAN and the BlackDiamond 8900 series switches to enable hosting and high-performance server connections within the facility.

CityNAP provides carriers with natural collocation and Internet exchange services for enterprises, content companies, system integrators and network services providers. And in doing so, it represents the next wave of infrastructure that creates the backbone of the crowd.

The datacenter market is growing. It’s an area of excitement, attention and investment within our customer base, and we have and we will continue to respond with solutions to address their requirements, while also offering the flexibility and scale they expect from their infrastructure and from Extreme Networks.

I will now hand the call over to Bob for his review of the quarter’s results.

Bob Corey

Thank you so much, Paul. As a reminder, with the exception of revenue and the number of shares outstanding, all of my comments will refer to non-GAAP operating results unless I state otherwise. Non-GAAP operating results exclude the effective restructuring charges and stock-based compensation.

Turning to Q1 results, I wanted to first comment on the change in revenue from Q4. In Q1, we reported $66 million of total revenue, representing a decrease of around $15 million. Roughly $14 million of the decrease was related to a decline in product revenue. I want to be clear, we don’t believe the decrease resulted from a drop in demand for our products.

Approximately $9 million of the decrease resulted from our inability to deliver products. Of this, about $5 million was for orders we booked and couldn’t ship and about $4 million was from orders we lost, because we couldn’t commit to a ship date within the quarter. An additional $3 million of decrease resulted from delays in booking orders that have slipped into Q2.

Of this amount, we have booked $2 million this quarter so far. Beyond this, it is difficult for us to quantify the impact of our inability to ship product, because we can’t know how many orders were presented to us as it became widely understood in our channel that we were having difficulty in delivering products. As noted in our pre-release, our inability to ship product during the quarter was related to a change in delivery lead times in our supply chain.

During Q4, in an effort to gauge the effect of the global economic recession, we made decisions to manage inventory down and to closely monitor cash flow. We overcorrected in Q4 an inventory decline by about $10 million or by 45%. Our supply chain has been operating at a 10 to 12-weekly time with opportunity to pull in certain materials.

During Q1, our lead times almost doubled to 16 to 20 weeks, as our key suppliers reduced their capacity in response to the global economic recession. The combination of significantly reducing our inventory and our product lead times extending to a firm 16 to 20 weeks created a situation in that it was difficult for us to meet customer delivery request. While we did everything we could, expedite materials, rush freight, buying other broker market, we were not able to procure sufficient products to meet Q1 customer demand. This is clearly an internal execution issue.

What are we doing to improve the situation and what impact might it have on Q2 revenue? First, we are increasing our investment in inventory from $12 million in Q4 to approximately $16 million in Q1. We have not replenished inventory levels on all major products as of the end of Q1, but we will continue to do so throughout Q2. Also, we are increasing safety stock of inventory at key supplier locations.

Lastly, we are improving the integration of sales forecasting and materials requirements planned. While we believe we will back to normal deliveries by the end of Q2, certain product constraints will continue throughout Q2 and may have a negative impact on Q2 revenue.

Net revenue was down in all geographies reporting $66.3 million, thus compared to net revenue of $81.3 million in the June quarter. Product revenue declined 22% from the June quarter and 32% from Q1 last year to $50.7 million primarily for the reasons I just stated.

Service revenue was off 6% from the June quarter and increased 2% from Q1 last year as our efforts to bring stability to that part of the business have taken hold. Service revenue comprised nearly 23% of total revenue this quarter.

Net revenue was down in all geographies due to the combined impact of the constraints and the difficult in closing deals by quarter-end. As compared to the June quarter, North America revenue was down 23% to $26.9 million; revenue in EMEA was down 11% to $28.1 million; and revenue in Asia Pac was down 23% to $11.4 million.

Product bookings for Q1 were mostly impacted in North America, as they declined by 25% from the June quarter with bookings in EMEA declining by 7%, while booking in the Asia Pac actually increased 8% as compared to bookings in the June quarter. Our sales team in China posted the strongest bookings for sometime. Our book-to-bill for Q1 exceeded 1. Sales of new products introduced in the market over the last 24 months was 28% of total revenues, which is down from 31% of total revenues in the June quarter.

We look to ramp our newer products such as the BlackDiamond 20K, the Summit X650 and the recently launched BlackDiamond 8500, 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 first quarter was 74% and 26% respectively.

The mix of enterprise and carrier orders for Q1 was 72% and 28% as compared to 76% and 24% in the June quarter respectively. This primarily reflects the decrease in enterprise revenue mostly in North America.

Turning to gross margins, the overall first quarter gross margin percentage declined to 55.7%, compared to 56.8% in the June quarter and reflects the significant decline in product revenues partially offset by a greater mix in service revenue which carries a higher gross margin percentage.

Product gross margin declined to 53.4% from 55.3% in the June quarter. Product gross margins were impacted of course by the reduction in volume and by charges to warranty of $600,000 and additional E&O charges of $800,000.

The warranty charge related to a date, time chip failure used in our X450 Summit products and the charge to E&O related to the excess component chips of specific products that are approaching end of life.

Service gross margins remain greater than historical averages as we continued to further deplete the use of the previously written off spares inventory, which was a $700,000 benefit in the quarter. We got fully utilized the written off spares inventory and anticipate the service gross margins will normalize and trend between 53% to 55% in future quarters.

Overall, Q1 operating expense was $41.5 million, and as compared to the June quarter declined by $1.7 million, but increased as a percent of net revenue of 63% from 53% due to the lower reported net revenue.

Sales and marketing expense declined $1.6 million to $21.3 million, resulting from reduced variable commissions on lower revenue, and reductions in marketing events and travelling. Research and development expense was essentially even at $13.2 million as development projects remain constant or consistent between the quarters. G&A expense remained unchanged at $6.9 million.

As compared to Q1 last year, operating expense declined by $9 million, an increase as a percent of revenue to 63% from 56%, again due to the lower reported revenues in Q1 of this year.

Sales and marketing expense declined $4.4 million to $21.3 million, resulting from reduced variable commissions on lower revenue and fewer marketing events and travel. R&D decreased by $3.2 million to $13.2 million on reduced variable commission and lower project material cost. G&A declined $1.4 million to $6.9 million on lower litigation expense, reduced professional service fees and lower variable compensation.

The net loss for the quarter was $4.9 million or a loss of $0.05 per diluted share compared to net income of $2 million or $0.02 per diluted in the first quarter a year ago. Total shares used from the fully diluted earnings per share were $88.9 million.

Turning to the balance sheet, cash and investments were $130.7 million, an increase of $3.3 million from a $127.4 million at the end of the June quarter. Cash flow from operations was $4.1 million positive. Inventory was $16.2 million representing an increase of $3.8 million from the June quarter.

As we mentioned on the last call, our normal investment level and inventories going forward is expected to be between $15 million and $17 million. Inventory increased this quarter due to increased shaky stock on certain products and forecasting mix of products greater than actual bookings for those specific products shipped in the quarter.

Lastly, deferred revenue increased $2.3 million as a result of increased distributor inventory and support revenue. We ended the quarter with 788 regular employees which compares to 786 at the end of the June quarter and 861 at the end of the June quarter a year ago.

Turning to guidance, as we previously announced, we have completed the reorganization of the company and reduced headcount by up to 70 people or around 9%. The goal of the reorganization was to streamline operations, simplify the organization and accelerate decision making.

As a result, we have lowered our breakeven to below $70 million in revenue and reduced quarterly operating expenses by about $2.5 million per quarter. To that end, we have eliminated the business unit structure and adopted a simple organizational structure with centralized marketing and engineering, both of these organizations are being headed by their previous general managers of the business units.

A charge for the reorganization will be recorded in Q2 for approximately $4.2 million, consisting of a one-time cash severance. We remain committed to our channel partners and customers and delivering Ethernet network solutions targeted at the converged enterprise, the datacenter and the service provider markets.

We are going to give limited guidance for our next fiscal quarter. Our guidance is on a pro forma basis and excludes stock-based compensation and restructuring expenses. As we see the signs of economic recovery, it’s clear that the recovery rather will be uneven across geographies. We believe the US economy is still fragile, but is showing early signs of recovery.

Demand in EMEA has stabilized in the enterprise sector, while we continue to see softness in the service provider demand. Asia Pac, especially China and Japan, have been performing over the past couple of quarters and don’t appear to be as hard hit by the economic weakness impacting other geographies.

With that as a backdrop, we believe the total revenue for Q2 will range between $76 million and $78 million. This range anticipates some impact on revenue as we normalize our supply chain deliveries throughout the quarter. We believe the total operating expenses will range between $40.5 million to $41.5 million for Q2. This does not include the full quarterly benefit of the reorganizations we’ve just completed.

Cash flow for the quarter is projected to be negative and will include the impact of the severance costs paid in the period. We project that the gross margins will be between 55.5% to 56.5%. After completing the restructuring, we expect that our short-term financial model target on an annualized basis will be as follows. Gross margin 57% to 59%; R&D 13% to 14%; sales and marketing 25% to 26%; G&A 7% to 8%; operating income 11%.

In closing, I would like to emphasize what we believe our reorganization will streamline operations, simplify the organization and accelerate decision making. This in turn will make us more competitive and we remain committed to our customers, our channel partners, and laser focused on delivering the leading Ethernet network solutions and global support.

With that, I will turn it over to the operator to open up for questions. Operator?

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator instructions) Our first question comes from the line of Steve Salberta with Boenning & Scattergood. Please go ahead.

Steve Salberta – Boenning & Scattergood

Hi guys.

Bob Corey

Hi there.

Steve Salberta – Boenning & Scattergood

Can you talk about the mix of revenue of product relative to what you were thinking going into the quarter? Was this situation where you expected to sell a lot more of the new products and the older what was in demand?

Bob Corey

Yes, this is Bob. I will go and take that question. We had expected that our newer products would be the larger sellers for the quarter, right? And that was where we particularly were hard hit, because when we brought down inventory in Q4, it was our high runners that were selling in Q4. And then as the supply chain firmed up in Q1, the higher volume products we had difficulty getting to ship.

Steve Salberta – Boenning & Scattergood

And what is or why was there a change there in demand? Do you have a lot of demo units out there I mean or is it just a function of decision making by your customers?

Bob Corey

Yes, what we are trying to say is, we didn’t really see a significant change or drop in demand. What we saw was continued demand and our inability to deliver the products is what impacted the revenue, right? So we saw our bookings in backlog actually increased by over $6 million going into Q2.

And our supply chain basically extended their lead times as they were trying to assess the economic recession impact like we were in Q4 as well, right? So we are trying to be really clear, there is not a decrease in demand for our products. It really was the combination of Q4 taking the inventory down and the supply chain firmed up on us in Q1.

Steve Salberta – Boenning & Scattergood

Okay. Can you tell us how much of your revenue guidance or I guess the implied product revenue – how much of that you have covered in backlog at this point?

Bob Corey

Yes, we don’t disclose the actual backlog. But we did comment in our prerelease because of the demand situation, the backlog and deferred revenue did increase by over $6 million in the quarter, but we don’t disclose the total backlog.

Steve Salberta – Boenning & Scattergood

Okay. And then finally on service revenue, I see that down sequentially. Were there maintenance contract catch-up payments in June?

Bob Corey

Yes, that’s right. Yes, for the June – the June release, we commented there was an annual catch-up benefits that we recorded in Q4. So we are continuing to see renewals of service contracts going forward, but the downtick you are mentioning was particularly strong in Q4 and more normalized in Q1.

Steve Salberta – Boenning & Scattergood

Okay. My last question guys. When do you expect to get to the 11%? Is there a time period in that short-term target?

Bob Corey

I would kid around tongue-in-cheek as fast as we can. The reason we did the restructuring was to position the business, so we can really accelerate earnings, right? And I can’t give you a hard timeframe to get to 11%, but we are going to be as aggressive as we can to get to the double-digit operating income contribution.

Steve Salberta – Boenning & Scattergood

Great, thank you.

Bob Corey

All right, thank you.

Operator

Thank you. Our next question comes from the line of Rohit Chopra with Wedbush Securities. Please go ahead.

Rohit Chopra – Wedbush Securities

How are you doing, Bob?

Bob Corey

I am good. Thank you.

Rohit Chopra – Wedbush Securities

Can I just come back to that new target model instead of asking the timeframe? Is there an implied revenue that you want to throw out there for 11%?

Bob Corey

No, but what I will throw out there is that a $1 of incremental revenue generates about $0.45 of operating income additional contribution, so. You guys can work the calculation there.

Rohit Chopra – Wedbush Securities

All right, thanks.

Bob Corey

Okay.

Rohit Chopra – Wedbush Securities

What specifically was unavailable or what specifically was the item that was -- where the lead times had actually doubled?

Bob Corey

Yes, as long as the lead times are on the chips, right? We use outside assembly plants to actually configure the board and the boxes, et cetera, so it was mostly on the chips.

Rohit Chopra – Wedbush Securities

And then, I think this is important, because of the – has been an issue for a while with Extreme. And I just wanted to see -- are you also making changes in the channel? And I think we’ve had this conversation before, but is it part of the restructuring to sort of revamp the channel, try to expand the channel potentially, or is there anything going on there?

Bob Corey

No, actually we feel we have great relationships with our channel partners. As a matter of fact, I just attended the North American channel partner conference last week and we are trying to strengthen our relationships with the channel, and because we need them to be successful, they need us to be successful, so. We are calling channel partners from time to time, right, to drive efficiencies, but there is no change in the basic go-to-market or channel structure.

Rohit Chopra – Wedbush Securities

All right, and then two last questions. Any change in your Avaya relationship this quarter, is there anything changing there?

Bob Corey

No, no, we had a good quarter with Avaya and we continue to have a good strong relationship with them.

Rohit Chopra – Wedbush Securities

Right. And then last question, will it be possible to provide us with the total amount of NOLs you actually have right now?

Bob Corey

Yes, I think I can go find that out, but it should be in the 10-K for the annual report right in the footnote, so probably didn’t change that much for Q1.

Rohit Chopra – Wedbush Securities

I appreciate it.

Bob Corey

All right. Okay. I will make a note and then I will follow up and try to give it to you.

Rohit Chopra – Wedbush Securities

Thanks Bob. I appreciate it.

Bob Corey

Sure.

Operator

Thank you. (Operator instructions) Our next question comes from the line of Douglas Ireland with JMP Securities. Please go ahead.

Douglas Ireland – JMP Securities

Hi Bob, this is Doug. (inaudible) on an airplane.

Bob Corey

Hi Doug, how are you doing?

Douglas Ireland – JMP Securities

Good, thank you. I have a couple of questions. First, you have talked about streamlining the business and eliminating a lot of the overheads, but headcount hasn’t come down quarter-over-quarter. So I was just wondering if we are going to see a change there – a further change or if that’s completed?

Bob Corey

Yes, sure, yes. The part of the restructuring we’re eliminating 70 heads, about 9% of the headcount that we exited Q1 with. So we are at 788 coming out of Q1, we will be down to 718, but we are probably down there right now, because obviously we completed the restructuring last week.

Douglas Ireland – JMP Securities

Okay, great. And then to go on from that, are you going to be able to continue to support these three areas of focus which I mean there is a lot of overlap, but there is a lot of differences between the datacenter, enterprise and carrier markets. I am just wondering if those three which seem to cover all of switching in my mind are all going to be equally supportive.

Bob Corey

Yes, we are going to – our stated strategy is that we provide network solutions, right, for the enterprise, the service provider and the datacenter markets. We feel we are going to get tremendous efficiencies out of the consolidation of the business unit structure.

Just a quick example, if you take engineering as a point in case, we had three business units and they were each doing development at three different locations. We do engineering development here in Santa Clara, in RTP and in Chennai. So if you do the math, that’s nine different groups working on software and hardware development and trying to interface, connect them and make them work together, all right?

So by consolidating the business units, we are going to really a consolidated engineering structure run by Suresh, right? And we think we will get much greater efficiencies and a sufficient bandwidth continues to develop and make the investments to support those markets.

Douglas Ireland – JMP Securities

Okay, because I was at SUPERCOMM last week and I was thinking about how different the demands in the carrier market are from the demands of the enterprise and then switching closet versus datacenter, just seems like an awful lot to support and sell as you go forward.

Bob Corey

Yes. We have Gordon here. Hold on a minute.

Gordon Stitt

Yes, hi, Doug. How are you doing?

Douglas Ireland – JMP Securities

Good.

Gordon Stitt

Yes, I understand your question. I think one way to look at it in terms of our development is we develop a series of platforms and those platforms need to be high availability. And on top of those platforms, we build layer two and layer three services in software, something that we do across all of our markets. So there is a lot of commonality.

When you look – and again using your example, there are certainly some features that are specific to the metro Ethernet carrier market, there are some features that are specific to the hosting markets, there are some features that are specific to the large enterprise market. But the bulk of the platform engineering and the core high availability XOS and the layer two and the layer three services, it’s literally the same.

Douglas Ireland – JMP Securities

Okay. Yes, I just looked at it and it seemed like a lot support as you trim down, but I am sure that you’re – you have got that well planned out.

Gordon Stitt

Yes, just one added comment as Bob noted, by bringing our different engineering teams together under one leader, I think we will be able to drive much higher efficiencies even with the lower overall corporate headcount.

Douglas Ireland – JMP Securities

Great. Now the last question I had was in terms of the life-time warranty and I know that HP was offering that and it was putting some pressure on the other competitors. Do you see that affecting your margins going forward as you maybe lose the ability to charge for that service and support?

Bob Corey

Well, yes, obviously I mean we can’t charge for it nor providing any other it’s going to be a margin hit. We’ve kind of run the numbers. We don’t anticipate it’s going to be a material margin hit, right? And we think we are going to expand the other service offerings and hopefully continue to mitigate or offset any margin hit from that limited life-time liability.

Douglas Ireland – JMP Securities

Okay, great.

Bob Corey

All right, thanks, Doug.

Operator

Thank you. At this time, I am showing no further questions, I will turn back the call back to management for any closing remarks.

Bob Corey

Okay, well, I guess that’s pretty much all we have for today. I want to thank everybody for dialing into the call and looking forward to give you an update in January on our fiscal Q2 that ends in December. Thank you very much.

Operator

Thank you, sir. Ladies and gentlemen, this does conclude the Extreme Networks 2010 first quarter conference call. If you’d like to listen to a replay of today’s conference, please dial 303-590-3030 or 1-8-00-406-7325 and entering the access code 4166330. We would like to thank you for your participation. You may now disconnect.

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Source: Extreme Networks, Inc. F1Q10 (Qtr End 09/27/09) Earnings Call Transcript
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