Bob Corey - Chief Financial Officer, Principal Accounting Officer and Executive Vice President
Oscar Rodriguez - Chief Executive Officer, President and Director
Sanjit Singh - Wedbush Morgan
Extreme Networks (EXTR) F1Q11 Earnings Call November 1, 2010 5:00 PM ET
Welcome to the Extreme Networks 2011 First Quarter Conference Call. [Operator Instructions] On the call today, from Extreme Networks, are Oscar Rodriguez, President and CEO; Bob L. Corey, CFO. As a reminder, this conference is being recorded today, November 1, 2010. This afternoon, Extreme Networks issued a press release announcing the company's financial results for the first fiscal quarter of 2011. A copy of this release and 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 replay 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 customers' bandwidth demand, development of new product, customer acceptance of the company's product, customer buying and spending and economic conditions 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: a challenging macroeconomic environment worldwide; 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 and 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 the 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 and the audit of the fiscal year is concluded and/or Form 10-K is filed.
I would now like to turn the call over to Mr. Bob L. Corey, Executive Vice President and CFO of Extreme Networks.
Okay, thank you, Tyrone, and welcome to the Extreme Networks Q1 fiscal 2011 earnings conference call. As I mentioned, I'm joined today by Oscar Rodriguez, our new President and Chief Executive Officer. I'm delighted to have Oscar on board, and I'll turn the call over to Oscar for his comments regarding our focus and strategy and market dynamics. And then I'll follow up brief comments on the quarter and summarize and provide guidance for Q2 of fiscal 2011. We'll then open up for Q&A. So Oscar, welcome, and take it away.
Thank you, Bob. Let me start the call today by first, thanking Bob for his leadership over the course of the last 9 months and by thanking him for his work in driving efficiency, stability within the organization. Under Bob's leadership, Extreme has delivered a series of improving results with greater predictability while also establishing clear guidance. Working together with Bob, I intend to continue these trends and to build upon the momentum that we have established.
By way of a brief introduction, I have now been with Extreme for just over two months, and I'm very pleased to be a part of this team. Prior to Extreme, I had spent all of my 25-year career designing, building, marketing, selling, networking and communications products to both enterprise and carrier markets worldwide. I've held senior Executive positions as part of Alcatel-Lucent's Carrier Ethernet and Enterprise business units. I've held two divisional president positions in Nortel's Data and Enterprise Networking divisions, and I've held president and CEO positions in innovative pure-play communications companies such as Arris Interactive and Riverstone Networks. During my time with these firms, I had the opportunity to build a clear understanding of customer needs in all our core markets, specifically the campus enterprise, data center and Carrier Ethernet markets. Since joining Extreme, I have been conducting a deep and thorough evaluation of the core competencies of the company to better understand our capabilities and to assess any unrealized potential that we may have within the organization. In the next few weeks, we will be finalizing a renewed mission and strategy for the company. I will talk more about the specifics of this strategy on the next call.
Prior to joining Extreme, it was clear to me that the company is operating in a growing and exciting market and that the company has had a very positive reputation for delivering leading-edge technologies at a great price performance. While my evaluation of the company's competencies is not yet complete, I now believe that we have the innovative capacity to create leading-edge products and services that can deliver real customer value, that we have a solid team who are focused on serving our customers well, that our people have the passion and skills needed for the company to succeed. I also have found that in some cases, the company can sharpen its focus on the market it serves, and we can improve our ability to invest in the right products and in the right channels to market to maximize the company's geographic and demographic reach.
I believe that with a renewed strategic and operational focus, Extreme Networks has the potential to deliver higher customer value and stronger financial performance.
Turning to our served markets for a moment. It's no secret that Ethernet is a proven technology. It has become the highly reliable, resilient and cost-effective underlying data infrastructure that enables both high productivity in the enterprise and new revenue streams for carriers. It has a history of delivering increasing performance at prices that have displaced entrenched and less flexible legacy communication technologies. Some of us who have been in the industry for a while have seen this play out many times before. From the edge of the enterprise to the core of carrier networks, this diverse and discrete legacy networks have been merged into Ethernet networks that enable high-value business applications and consumer Internet entertainment services. Ethernet continues to encroach in all these disparate service networks as the infrastructure technology of choice. More recently, we are seeing Ethernet take on new roles. Ethernet is making large strides in the new data center, where discrete networks for server and storage connectivity are increasingly giving way to a more cost-effective, reliable, sustainable and virtualized infrastructure. These new Ethernet data center networks will transform enterprise computing and enable new efficiencies for cloud service providers and private data centers alike.
In the enterprise campus, Ethernet is the predominant infrastructure technology that is the basis for connecting Wi-Fi networks to enable a highly productive and mobile workforce. In addition, we are seeing Ethernet used as the basis for the evolution of 3G and 4G mobile broadband carrier backhaul networks. These new mobile broadband networks need to expand to accommodate the high performance and reliability needed to satisfy the transport needs of the new mobile applications marketplace driven by smart devices. Thus, whether driven by Wi-Fi and the enterprise, or by smartphone applications and the mobile broadband carrier, mobility is increasingly connected and enabled by Ethernet Transport.
But this is not the Ethernet that your father used to use. New applications require Ethernet to take on new roles in the network. They require a focus on Ethernet innovation, a focus on leadership, in new open standards that drive customer choice and a focus on delivering affordable, best-of-breed leading-edge Ethernet products. This evolution of Ethernet Technology requires a new class of product that delivers convergence and performance at an affordable price. This evolution allows Extreme to leverage its core competencies, namely the ability to deliver best-in-class complex network solutions for global carriers and enterprises at an affordable price.
As evidenced by our recent wins with both new and returning customers, we are delivering first-to-market leading-edge technologies that enable affordable high performance and new efficiencies in all our core markets. In September, we announced the deployment of the first European 40 Gigabit Ethernet connection using Extreme products. The combination of our Summit 650 product with 40 Gigabit Ethernet modules was tested by the SARA and CERN research facilities in Holland and Switzerland to provide a long-distance interconnect used to transport video and data for the pursuit of scientific research. This ultra-high-speed network represents the longest and highest performance Ethernet connection deployed to date across the European continent. We believe these ultra-high-speed yet cost-effective 40 Gigabit Ethernet technologies will set the pace for network infrastructure evolution in both the enterprise and cloud services data centers. Together with the coming prevalence of 10 Gigabit Ethernet interfaces at the server, we believe these Ethernet technologies will drive network transformation for the next-generation data centers and enterprises worldwide and will directly impact deployments in carrier networks.
However, our promises don't stop at raw bandwidth or speeds and feeds in our products. We also have focused on delivering network efficiency and intelligence in our products that allowed customers to lower their total cost of operations and manage their networks more efficiently. During the course of the past two quarters, Georgia State University, a longtime Extreme customer, completed a thorough evaluation of our high-performance data centers technologies and decided to expand its commitment to Extreme. The College of Saint Rose in New York also deployed our solutions in their data center as they focus on dramatically improving the overall energy efficiency of their infrastructure.
Last week, we also announced a new Summit X460 family of switch products designed to provide new levels of versatility and performance for both the campus and the data center at an affordable price. This new Summit 460 product line is designed to enable customers, such as the University of Miami, to deploy cross-platform stacking in a Wi-Fi-ready virtual chassis and to offer workgroup flexibility with lower operating cost.
With the pressure to save cost and meet educational demands, local school districts are also seeking ways to improve operational effectiveness and efficiency. The Westminster Essex school district recently completed a network upgrade and implemented Extreme Networks technology throughout their enterprise and data center. Utilizing the design flexibility enabled by the Extreme network architecture, they deployed a more efficient data center architecture with fewer systems and less staff.
As network connectivity continues to enable a highly mobile and dynamic workforce, the integration of mobile and Ethernet technologies drives continued deployment of wireless and wired LAN solutions around the globe. We are currently working with Galaxy Entertainment Group in Macau as they continue to expand their operations through the development of a new Galaxy mega-resort due to open early next year. The resort is expected to offer premier customer services in all of its 2,100 luxury guest rooms and will feature a complete wired and wireless solution from Extreme Networks.
Extreme is also driving network infrastructure efficiency by automating operational functions and activities to improve IT responsiveness and to enable service provider differentiation. essensys, our U.K. provider of managed cloud services, automated their infrastructure management using the native programmability that's available in all Extreme products. By automating their change processes, the essensys team is able to provide one-touch service provisioning and service support delivery, thereby enabling faster customer turnout and enhancing their customer service experience.
Beyond our Extreme technology capability, diversified channels to market are critical to our success. We are focused on driving new business through our traditional enterprise and carrier distribution and reseller channels, with an emphasis on delivering revenue growth. To drive additional growth, we had a clear focus on our strategic alliances and the OEM channels of our business in fiscal 2011. Our focus here is on driving Extreme products through these channels to drive higher volumes and enhance our segment and geographic reach. This is not a new effort for Extreme, and while the Extreme brand is well known in both global enterprise and carrier markets, our go-to-market strategy already includes private label and custom-designed products. These products are sold through our Strategic Alliance and OEM partners, which enable our participation in larger solutions for global markets.
During the quarter, we further expanded our focus here by establishing a new team dedicated to this effort, and we are already seeing positive results. This quarter, we saw revenue growth from our existing OEM partners, and we have also expanded our reach with the addition of other Strategic Alliance partners. This relationship will enable Extreme to deliver products to a sector of the enterprise market that we have not historically addressed, and we anticipate revenue from this relationship over the coming weeks.
You will be hearing more about this new relationship in the coming weeks, and we continue to believe that the combination of traditional channels and our expanded Strategic Alliance and OEM relationships are a powerful and important go-to-market attack combination that can enhance our ability to drive revenue, growth and to grow market share.
In summary, I believe that the markets we serve are strong and our innovation is world-class. With expanding channels to market, I believe we can drive revenue growth needed to increase shareholder returns. Over the next few weeks, I will be finalizing a renewed vision on strategy for the company, and we will then quickly move into execution. I will talk more about the specifics of the strategy on our next call. And at that time, I will also share with you some of the specifics of our execution plan, including how we plan to track and measure our results. I look forward to having an active and engaged dialogue with all of our investors and to driving value for our stockholders. Now I'll turn the call back over to Bob, who will share with you some details on the results of the quarter. Bob?
Okay, thank you, Oscar. As in previous periods, we have posted a slide presentation on our website at www.extremenetworks.com under Investor Relations that we hope you'll find useful. As a reminder, all of my comments will be non-GAAP, except for the revenue and the number of common shares. Non-GAAP results exclude stock-based compensation, restructuring charges and litigation settlements. There's a reconciliation from non-GAAP to GAAP financial results in the slide presentation under Investor Relations at our website that I just mentioned.
Once again, before I go any further, I want to thank every employee in our organization for their dedicated efforts and commitments, which contributed directly to our Q1 performance. Based upon strong sales in Europe and Asia-Pacific, we're reporting total revenue of $83.8 million for the quarter, which is on the high side of our previously issued guidance of $81 million to $84 million. Our revenue of $83.8 million for the quarter were also reporting earnings at the midpoint of our earnings guidance, with net income of $4.8 million or $0.05 earnings per share.
During Q1, we continued to perform and drive operational execution as we reported $83.8 million of net revenue, representing an increase of 26% year-over-year and a small seasonal decrease from Q4 of 2%. With regard to product revenue by geography, the Americas reported $21 million, EMEA reported $32 million and Asia-Pac reported strong performance at $16 million. The product revenue for the Americas represented a 25% decrease from Q4 as the number and size of larger deals in the U.S. were down in the quarter and we saw softness in the Eastern part of the U.S.
At the beginning of the quarter, we executed some changes in the sales organization in the Americas that we believe will create a stronger organization but which we believe effected our ability to perform within the quarter. We promoted our VP of North American sales to lead our focus on Strategic Alliances and OEM relationships and split the Americas into three different territories. Expanding the Alliance and OEM channel to market is strategically important for us, as noted by Oscar in his opening comments.
Mike Seaton, our VP of Worldwide Sales, is managing the organizational change, and we anticipate improved performance from the Americas in Q2. Further, we did see select distributors in the U.S. closely manage their inventories as they continue, we believe, to evaluate a lumpy U.S. economy.
EMEA product revenue was essentially even with Q4 as we saw strong service provider sales. We closed a large government deal in the order in the U.K. and returned to a more normal linearity in the quarter.
Asia-Pacific product revenue increased 55% sequentially. Asia-Pac was driven by record sales in Korea, as the deals we spoke about on the Q4 call closed along with new deals, and we did especially well in the government sales in Korea. These strategic deals were highly competitive. And as a result, the gross margins had a negative effect on our consolidated gross margins. I'll comment more on the gross margin percentage in just a minute.
Across the globe during the quarter, we closed 19 new customers with deal sizes above $100,000. Linearity in the quarter was back-end loaded as the Korean deals closed later in the quarter, and the Americas' performance slowed towards the end of the quarter. Commenting on the mix of enterprise versus service provider revenue, service providers sales in EMEA picked up as a result of increased Alliance and OEM sales by our Strategic Alliance partners, while Asia-Pac and America was slightly lower for service provider revenues.
Consequently, the mix for the quarter was a slight decrease in service provider revenues, representing 24% of revenue. That's changed from 26% in the immediately preceding quarter of Q4. Our mix of stackables to chassis changed from 76% to 24% to 73% to 27% as the content of large deals in Asia have higher chassis content during the quarter. Our book-to-bill for the quarter was slightly below 1, resulting primarily from soft bookings in the Americas. Our reported gross margin percentage for the quarter was 56.3%, a 1.1% decrease from Q4 as large orders in Asia negatively impacted the margin percentage.
As we mentioned on our last earnings call, these orders had slipped contributing to the softness in Asia we reported in Q4 and that we're anticipating closing these orders in Q1, and we did. These were larger strategic deals with lower-than-usual margins. Without the impact of the Korean orders, our gross margin percentage would have been within our guided range of 57% to 59% for the quarter. We continue to target our gross margin percentages as unchanged to between 57% and 59%.
Operating expenses for the quarter were $42.7 million compared to $43.5 million in Q4, a decrease in variable sales compensation with lower litigation costs were partially offset by a performance-based bonus accrual for nonexecutive employees and unfavorable foreign exchange, which impacted sales spending primarily as the U.S. dollar weakened during the quarter.
Operating income was $4.6 million or 5.5% of revenue compared to 6.5% of revenue in Q4 and contrasted to a loss of 6.8% of revenue in Q1 of last year. EBITDA was $6.1 million compared to $6.9 million in Q4 and contrast to a negative EBITDA of $2.9 million in Q1 the last year. Total cash and investments increased to $132.7 million. That's up $300,000 from the prior quarter, and of course, we have no debt. Cash investments were impacted by payment of higher-than-normal sales commissions, resulting from accelerators earned in Q4 and payment of litigation settlements related to the patent litigation that we settled in Q4. Days sales outstanding and accounts receivable improved to 43 days from 45 days in Q4 based upon excellent collection efforts by the organization.
Inventory was down to $20.5 million as we continue to manage our supply chain effectively and utilize inventory in our service businesses. Total deferred revenue was $51.4 million, down from $55.5 million in Q4. This is due to large deals in EMEA being prefilled from disti [distributor] inventories that were held at the end of Q4, coupled with distis in the U.S. holding less stock, as mentioned before, as we believe uncertainty around the economy affected their investment allowance.
Overall, full-time headcount increased to 746 at quarter-end, an increase of six from the prior quarter. Our focus on headcount additions continues to be in sales and engineering. This concludes my comments on results for Q1, and I'll now turn to guidance for Q2.
We anticipate Q2 net revenue to be between $85 million and $88 million, reflecting an increase in product revenue of 9% to 14% over Q2 of last year and an increase of 1% to 5% decrease from Q1. Further, we anticipate earnings per share of $0.05 to $0.07 fully diluted per share. We continue to be focused on making our customers and partners successful and increasing shareholder value. With that, I'll turn it back over to the operator for Q&A session.
[Operator Instructions] We have a question or comment from Rohit Chopra of Wedbush.
Sanjit Singh - Wedbush Morgan
This is actually Sanjit Singh with Wedbush for Rohit Chopra. I had a question on the gross margin. What's your expectation next quarter in terms of competition affecting the gross margin? Do you have larger deals out there where we could see further downsides to gross margins going into next quarter?
Yes, this is Bob. Our thinking, like we said on the call here, is we expected our gross margins to continue to be in our financial guided range of 57% to 59%. The deals in Korea were highly competitive and strategically important to us in that market, so those margins impacted our overall performance, but we're still guiding 57%, 59% going forward.
Sanjit Singh - Wedbush Morgan
And can you talk a little bit about some of the sales force changes that you guys implemented in the U.S.? Were these changes implemented -- how long ago were these changes implemented and was this implied in your original guidance for this quarter?
Well, this is Bob. I'll take a shot and then Oscar may want to comment on it. It was a middle of Q4 in May of last quarter that we announced the change in the overall leadership of the worldwide sales force, along with the combining of management under one executive for sales and the customer services group. And Mike Seaton was promoted to the Worldwide Sales and Service, Vice President at that point. And we finished out the quarter and had what we thought was a pretty strong performance for Q4, and I think exceeded our guidance for the quarter. In the beginning of Q1, we had reassigned the person then who was running VP of North America for Sales to be Alliance and OEM partner group because we believe that's important for the growth of the company, so additional spending, additional sales channel to the market. At the same time, early in the quarter, we split the North Americas into three regions instead of basically two or three territories. So the change was effected late in July, is that right? And we think that the change hampered our ability to execute in the quarter. Clearly, we understand some of the issues. Mike Seaton is on top of the issue. Like I said, we expect to have Q2 performance from North America be a lot better than what we saw in Q1.
Sanjit Singh - Wedbush Morgan
Just to parse it out, do you think the performance of the U.S. this quarter, was that more due to what you guys refer to as some spending cautiousness on the part of distributors and customers? Or was it more the sales force changes?
This is Oscar. I believe it was a combination of -- both of those factors impacted our ability to drive revenue in the Americas region over that. It is a combination of both things. The other thing I will add to what Bob said a little bit earlier about the puts and takes and hows and whys of how the changes were made with the sales management team is that I believe that the Alliances team is now focused to be able to drive better alliances and more focused to drive future revenue based on that. So I think it's a good move from an execution perspective, but it's a question of getting to put through the puts and takes of getting that team up and running and, of course, getting the transition done in the Americas.
[Operator Instructions] And I'm showing no further questions or comments at this time. I would like to turn the conference over to Mr. Oscar Rodriguez for any closing remarks.
Very good. Well, we had only one question this time. It's very much appreciated from the Wedbush team. I look forward to -- and Bob and I both look forward to speaking with you next time. As I said in my prepared statements in the script, I will have a better view of the strategy and be ready to talk to you about, not only the strategy, how we see the new renewed strategy for Extreme as a company, but also points of execution and how we'll be measuring ourselves to that strategy. Thank you very much for joining, everyone, and I look forward to speaking with all of you over the course of the next few months. Thank you.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.