Extreme Networks, Inc. F3Q10 (Quarter End 03/28/10) Earnings Call Transcript

Apr.26.10 | About: Extreme Networks, (EXTR)

Extreme Networks, Inc. (NASDAQ:EXTR)

F3Q10 Earnings Call

April 26, 2008 5:00 pm ET

Executives

Robert L. Corey – Chief Financial Officer, Acting President & Chief Executive Officer

Paul A. Hooper – Chief Marketing Officer.

Analysts

Rohit Chopra – Wedbush Morgan

Douglas Whitman – Whitman Capital

John Evans – Edmunds White Partners, LLC.

Operator

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 to the question and answer session. On the call today from Extreme Networks are Bob L. Corey, CFO and Acting President & CEO and Paul Hooper, Chief Marketing Officer. As a reminder this conference is being recorded today, April 26, 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 relations 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 reply shortly after the conclusion of the 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, strategies, growth of customer bandwidth demand, development of new product, 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 macroeconomic environment both in the United States and overseas, fluctuations in demands 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 its new technology and products, the timing of any recovery in the global economy, risks related to pending or future litigation and the 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 & Exchange Commission. Throughout the conference call the company will reference both GAAP and non-GAAP financial results. The company has provided a reconciliation table of GAAP to non-GAAP 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 may be subject to change when the review of the fiscal quarter is concluded and/or a Form 10Q is filed. I would now like to turn the call over to Mr. Bob L. Corey, CFO and Acting President and CEO of Extreme Networks.

Robert L. Corey

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 a Q&A.

Our goal is to provide more time for questions and answers and more time for reading our scripts. Additionally, we posted a slide presentation on our website at www.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 midrange of revenue guidance at $78.2 million and exceeded the guidance for earnings by 45% with non-GAAP 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 attached datacenter, 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 premier technology integration company with over $3 billion in revenue. We remain committed to delivering new products to the datacenter and our traditional markets to drive revenue growth, take market share and increase stockholder value.

As a reminder, all of my comments will be non-GAAP except for the revenue and the number of common shares. There is reconciliation from non-GAAP 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 and that’s up 19% sequentially and up 21% year-over-year. The America’s 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 backend loaded this last quarter than normal but posted a book-to-build 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-build for the quarter exceeded one 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 benefitted 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 account receivables improved to 43 days from 47 days in Q2 and from 50 days in Q1. Inventory was up to about $23 million as we position for increased revenue in Q4. Inventory turnover in Q3 calculated to seven turns and we anticipate turning 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 A. Hooper

Let me start by saying that we remain laser 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 and expect expansion of our routes to market and our associated presence in those markets. During 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 resulted 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 land; secondly, the enterprise and managed hosting providing datacenters; and thirdly, carrier Ethernet or metropolitan service providers that have docked Ethernet technology. I will now review the product 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 datacenters, 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 shipped additional modules for our enterprise and datacenter chassis family, the BlackDiamond 8K. The new modules referred to as the 8900XL family offer the scale and versatility available in the X480 along with the performance of the BlackDiamond 8K modular family. The launch of the 8900XL modules represents continued proof of our commitment to protecting our customer investment. It is now possible to transition a core enterprise chassis from 48 gigabyte on to 128 gigabyte per slot as applications demand without discarding past investments.

Earlier in the fiscal year we announced the smaller addition of our carrier class chassis products the BlackDiamond 20K. The smaller chassis started shipping this quarter and we’re seeing traction with carriers around the global who are looking for chassis solutions closer to the edge of the network. Continuing the theme of protecting customer investments and rounding out our hardware announcements, this morning we announced a 4 x 40 gigabyte 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 $1,000 per 40 gig port. Industry leading and live on the show floor at Interop Las Vegas this week. We’re also demonstrating a 4 x 40 gig module for our BlackDiamond 8K chassis that we’re expecting to formally launch later this calendar year.

Now, turning to our software; during the quarter we announced the availability of the latest release of our pioneering Extreme EXOS modular operating system EXOS 12.14.1. 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 in to the user at the edge 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 or network attacks can be associated to a user rather than a device and location information can affect change in the environments. Device profiles can be changed to match user specific needs.

Turning now to complete solution announcements; building upon our four pillar vision for the datacenter of the future announced in December 2009, in the past few weeks we announced two innovative capabilities to owners of enterprise and hosted datacenters. 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 datacenter. 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 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 live of the virtualized machine within datacenters. Extreme Networks XNV software modules for both switched based [inaudible] and centralized EPIcenter address the challenges, operational risk and instability created when virtual machines move between servers, switches, racks and between datacenters.

With the ongoing adoption of application and server virtualization, architects and administrators of datacenter networks are facing increased operational complexity as virtual machines continued 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 lifecycle 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 mentioned are being demonstrated at Interop Las Vegas this week. With that, I will turn the call back to Bob.

Robert L. Corey

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 will 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 has benefitting 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 the improving macroeconomic climate and increased sales momentum we anticipate Q4 net revenue to be between $82 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 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 growing 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.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Rohit Chopra – Wedbush Morgan.

Rohit Chopra – Wedbush Morgan

I just wanted to go through a few questions here, maybe you can just update us on the CEO search? I think I asked you that last quarter but it’s been a while now so I just wanted to know where the bored was in getting a leader?

Robert L. Corey

The CEO search continues. The board gives me updates regularly and we have some very qualified candidates. They’re coming principally out of the networking business and that process continues. I can’t give you a hard date as to when the new CEO will be on but I can assure you the board is diligent and continuing to drive that process to select the right candidate. So I am 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.

Rohit Chopra – Wedbush Morgan

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 in the supply chain issues? I know you’ve started to get a little more inventory build here to spend for next quarter but maybe you can talk a little bit more about the supply chain?

Robert L. Corey

The supply chain issues haven’t fully abated for probably most companies in the marketplace because our assessment is that they’re not adding capacity back as fast as they took it out. So I think managing your supply chain is an ongoing continuous effort. We’ve done several things within Extreme to manage that, one is suring 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, etc.

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 to $23 million number is I think where the company has been as we started to approach Q3. But, I think your sense is right, the issue has not gone away you just have to actively work it.

Rohit Chopra – Wedbush Morgan

One more question, 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?

Robert L. Corey

Yes, I think we can count on it. Paul, do you want to go ahead and answer that?

Paul A. Hooper

The relationship we’ve got with Motorola is definitely mainstream at 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 Summit WM portfolio so we’ve got some significant success and it’s 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 solution so a wired switch given the pair of the modular operating system we can then pool on top of it the Motorola software code and turn it in to a converged wired and wireless switch.

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 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 it 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 wireless and wired solution.

Rohit Chopra – Wedbush Morgan

Paul, can I just ask a quick follow up? Does that mean you’d go after a market that for example Meru is in and Aruba in one sense on the wireless side?

Paul A. Hooper

When you say go after it I think our products compete very capably against their portfolio. I’d go so far as to say in many ways they are a stronger portfolio. We see the industry, the edge of the industry transitioning away from the fixed wired to a blend of wired and wireless and we’re absolutely going to play in that market space so certainly we’re going in to that space.

Operator

Your next question comes from Douglas Whitman – Whitman Capital.

Douglas Whitman – Whitman Capital

The shareholders thank you for the great job of leadership that you’ve done for the company. We’re happy with you not rushing to change that leadership position. A question about one of your competitors foundry last quarter had a weak European quarter and partly self inflected 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?

Robert L. Corey

What we saw in Europe was the bookings were a little more back end loaded than what we traditionally would see. It could be just emanates from customer hesitation and finalizing the deals. As you know Greece continues to be a big overhang for the whole European community so I believe there is 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 the east coast and US was shut down for several weeks early on in the winter. That played out a little bit as well. Having said that, we did have a book-to-build 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 other than what I just shared with you why specifically it was a little more backend loaded.

Douglas Whitman – Whitman Capital

On the positive North America was unusually strong particularly for a first quarter. Is there something that you’ve changed, done right? Is it coincidence or can you talk a little bit about the positive there?

Robert L. Corey

Well, I think our leadership team there is doing a great job. It’s been a difficult three to four quarters the last year to year and a half and the US economy is actually starting to show some signs of life reflected in larger deal size. Larger deal size help us being more meat home to the cave so to speak and so you saw larger deal size, expanding of the pipelines in the US, etc. It’s just solid execution in our strong verticals education, healthcare, etc. I think the team is doing a great job there and we’re looking for more contribution from them.

Operator

Your next question comes from John Evans – Edmunds White Partners, LLC.

John Evans – Edmunds White Partners, LLC.

I just had a question for you to understand better, I know you’re trying to drive this bus to operating margins of about 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 non-GAAP and then I think you’re guiding from $0.05 to $0.07 but you have incrementally a lot higher sales sequentially. Is that your spending some money? Is it a mix shift? Are you just being conservative or can you help us understand kind of the dynamic?

Robert L. Corey

Well, we had a couple of benefits in Q3. One, I mentioned calling out my normal comments, was the $1.1 million benefit that came to the gross margin. What that is, is we had an ODM design a product 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 that they reimburse us for these costs.

That reimbursement, $1.1 million benefitted 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 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.

John Evans – Edmunds White Partners, LLC.

Can you talk then just a little bit about I know 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?

Robert L. Corey

I think $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. We’re looking to add teams throughout the fourth quarter to position us to the strength and 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, etc. so we’ve started that process and now those requisitions are open and some of those teams will join us throughout Q4. Our internal estimates say if we get around $90 million we should be getting to that double digit operating income.

John Evans – Edmunds White Partners, LLC.

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

Robert L. Corey

Well the June quarter is our fiscal fourth quarter so you have sales people are always in there, there are accelerators for that type of issue. We normally are up $5 million?

Paul A. Hooper

5% to 7%.

Robert L. Corey

5% to 7%.

Operator

Your next question comes from Rohit Chopra – Wedbush Morgan.

Rohit Chopra – Wedbush Morgan

Bob, I wanted to ask you about the research and development line, I think you’re down about $1 million in that and I’m not, 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?

Robert L. Corey

Yes, we expect R&D to get normalized back up over the $11 million. There was some just timing of projects, etc., hiring of people, that type of stuff. So yes, it should come back up in Q4.

Rohit Chopra – Wedbush Morgan

I just had one question on competition, you said you expected competition to benefit Extreme. You’ve done well I guess 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 an up to 60% off list price sale going on. How competitive is it out there? If you could talk about the competitive environment?

Robert L. Corey

I think you’re talking about our friendly competitor Juniper. We’re very aware of their programs and there are deals where it’s very competitive. In reality, our goal internally is to not lose on price. 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 company so we’re going to continue to look for ways to drive the cost curve in light of a competitive environment. We see competition from CISCO as well, from Foundry, Juniper is in the marketplace, we see all of the above. We think we’re positioned to very aggressively compete with them and we’ll continue to do so.

Operator

I’m not showing any further questions at this time. Would you like to continue with any further remarks?

Robert L. Corey

Yes, why don’t I just make a closing remark. First of all, thank you 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 will be I think end of July. Thank you very much. Cheers.

Operator

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.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!