Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Extreme Networks (NASDAQ:EXTR)

Q3 2011 Earnings Call

April 28, 2011 5:00 pm ET

Executives

Oscar Rodriguez - Chief Executive Officer, President and Director

James Judson - Interim Chief Financial Officer

Analysts

Jonathan Kees - Capstone Investments

Brian Horey - Aurelian Management

William John Nasgovitz

Operator

Welcome to the Extreme Networks 2011 Third Quarter Conference Call. [Operator Instructions] On the call today from Extreme Networks are Oscar Rodriguez, President and CEO; and Jim Judson, interim CFO. As a reminder this conference is being recorded today, April 28, 2011.

This afternoon, Extreme Networks issued a press release announcing the company's financial results for the third fiscal quarter of 2011. 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 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 -- expectation regarding the company's performance, strategies, growth of customer bandwidth demand, development of new products, customer acceptance of the company's products, customer buying and spending patterns, overall trends 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, the challenging microeconomic environment worldwide, fluctuations in demand for the company's products and services, a highly competitive business environment for network switching equipment, the company's effectiveness in controlling expenses, the possibility that the company might experience delays in the development of the new technology and products, customer response to its new technology, the timing of any recovery in the global economy, risks related to pending or future litigation, and the dependency of 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 with 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 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 Form 10-Q is filed. I would now like to turn the call over to Mr. Jim Judson, interim CFO of Extreme Networks.

James Judson

Thank you, Sean. Welcome to the Extreme Networks Q3 fiscal 2011 Earnings Conference Call. I'm joined today by Oscar Rodriguez, our President and CEO.

I'll start the call today with a review of our fiscal Q3 results. I'll then turn the call over to Oscar for his comments on our strategy and market dynamics. His comments will describe some key wins during the quarter in the vertical markets where we are focused and how Extreme is able to add value to those customers. He will also comment on our plans and actions related to the execution of our new strategy and discuss how we plan to measure progress against it. After Oscar's comments, I will provide guidance for our Q4 '11 fiscal quarter. We'll then open it up for Q&A. As in previous periods, we have posted slide presentation on our website at www.extremenetworks.com under Investor Relations that I hope you will find useful.

As a reminder, all of my comments will be non-GAAP, except for revenue and the number of common shares. Non-GAAP results exclude stock-based compensation, restructuring charges and litigation settlements. There is a reconciliation from non-GAAP to GAAP financial results in the slide presentation under Investor Relations on our website that I mentioned previously. With regard to our restructuring in Q2, we noted in our Q2 earnings call that we would be reducing our headcount by 5% and taking a charge of between $1 million and $1.5 million. The actual charge was $1 million and is highlighted in that reconciliation of GAAP to non-GAAP results.

During that call, we also noted that we would be taking a charge for the end of sale of our -- one of our Metro/Carrier products, as part of the shift in strategy. The estimated change was given as $4 million to $4.5 million. The actual charge was $5.4 million. This included the write-off of excess inventory, supplier claims, tooling and some modest customer accommodations. This cost is included in the non-GAAP results that I will discuss next.

Q3 was an especially challenging quarter for Extreme in many ways. The company executed a headcount reduction in January to better align our cost structure with the current size of the business. As discussed during the Q2 earnings call, we also made changes in the leadership and structure of our North American field organization. These changes continued to ripple through the organization in Q3, as positions were backfilled. All of these actions are intended to provide better sales efficiency and execution, invest more resources closer to the customer, and to provide more flexibility for the company as we grow.

We also announced our shift in corporate strategy to focus on investing in more robust solutions for several high growth vertical markets, which included an announced end of sale of a key product in the Metro/Carrier space. This was a very tough decision, but a necessary one to align with our target markets. While it has caused some short-term disruptions as the company works through that customer base to understand the transition and support them through it, the ability to lower our cost structure and focus on 1 system architecture across our product lines will improve velocity of innovation within our products and the portability of applications across our product lines to benefit our customers, partners and shareholders.

Turning to our fiscal -- financial results. Q3 is typically a down quarter for Extreme and the trend continued this past quarter. Revenue came in at $75.7 million within our revised guidance of $75.5 million to $76.5 million, but below anything normal fall off from a strong Q2. We believe that the additional weakness can be attributed primarily to the changes we've made implementing our strategy during Q3, some lengthening customer sales cycles and competitive pressure in the high-end enterprise IT market.

Turning to the geo [geography] view, product revenue in North America was $17.9 million, down $1.9 million from Q2 and down $6.1 million from a year ago. On a year-to-date basis, North America is down 4% versus 2010. As mentioned above, the geo is impacted from moving key people into new roles over the last several quarters. We expect that this realignment of resources and responsibilities will be complete during Q4?

In EMEA, our largest geography, product revenue was $28.1 million, down $7.1 million from a strong Q2, but up $1.8 million or 7% from Q3 a year ago. EMEA was the geo most impacted by the product end of sale. On a year-to-date basis, EMEA is up a strong 13% versus 2010.

In Asia Pac, product revenue was $15.1 million, down $200,000 from Q2, but up $2.1 million or 16% from Q3 2010. Over the last year, we have invested aggressively in Asia, particularly in China and India, and are seeing this investment to pay off. On a year-to-date basis, Asia Pacific is up a very strong 30% versus 2010.

Turning to gross margin, our margin in Q3 was 48%, down from 56% in Q2 2011 and 58% in Q3 a year ago. The lower margin in the quarter was primarily due to the previously discussed product end of sale, which reduced margin by 7% or 7 points. Margin was also impacted by spreading our fixed cost of operations over a lower revenue base during the quarter and by the product and geographic mix of sale.

We continue to see erosion of ASPs in the Enterprise Campus space, putting pressure on margins. This trend is one of the primary reasons for our shift in strategy towards high-growth verticals that are more focused on key value features and high performance -- high-priced performance versus a lower-priced commodity-based Enterprise Campus market.

Turning to operating expenses, total op expense came in at $41 million, down $1.7 million from Q2 and essentially flat from Q3 a year ago. Contributing to this was 2 months of benefit from the headcount reduction during Q3 and the reversal of previously recognized expense related to the annual employee bonus plan. Net loss for the quarter came in at $4.6 million or a loss of $0.05 per share. This includes the previously mentioned charge for the end of sale of our Metro/Carrier product of $5.4 million or $0.06 per share.

Turning to the balance sheet, total cash and investments in the quarter increased $5 million, due to a strong collections quarter and a DSO of 42. Inventory declined by $5.4 million to $18.8 million from Q2. $3.1 million of this was from writing-off excess inventory associated with the end of sale of the Metro/Carrier product. The remainder was due to normal transfer of older inventory to service spares and realigning inventory with the lower level of orders during the quarter. Headcount decreased in the quarter to 731 employees from 763 in Q2. This was primarily due to the planned headcount reduction.

I'll now turn the call over to Oscar for his comments regarding our strategy and market dynamics. After that, I'll provide guidance for our Q4 11 fiscal quarter and then we'll open the call up for Q&A. Oscar?

Oscar Rodriguez

Thank you, Jim, and thank you all for joining us on this call. As Jim mentioned, this was a particularly difficult quarter for Extreme. I want all of our investors to know that I'm disappointed in the financial results personally, and my goal is to deliver company results within guidance.

We remain committed to driving value to both our customers and our shareholders and to achieving our target financial model, including revenue growth and a sustainable double-digit operating income. As we discussed in our last call, we are in the process of transforming the company by focusing our resources on select high-growth market verticals. We have taken steps to maximize free use of our technology investments to drive productivity and cost benefits to Extreme and to increase our revenue and customer base over the longer term. This will allow us to realize greater economies of scale, to decrease time-to-market for our products and to increase future velocity.

In our January call, we provided some detailed information regarding the new strategic focus and set a course for transforming the company. To drive revenue growth, we have sharpened our focus to more completely address the high-growth targeted vertical markets within the larger customer base that we already serve. We will continue to serve the broader markets of the enterprises and service providers. And while we are focusing in these high-growth verticals within these wider markets, I am pleased to report that we have already made good progress in the initial steps of this company's transformation.

Since January, we launched our new market positioning at key industry events for specific market verticals. Industry analysts, channel partners and customers have given us positive reviews and confirmed the market relevance of our strategy. We already have traction in these verticals and we expect to continue our success moving forward.

Higher education and the focus on the seamless mobile student experience is one of Extreme's most important and established vertical focus areas in the enterprise market. Hundreds of colleges and universities have already deployed our solutions over the past quarters to enhance campus mobility. In the quarter, we had over 40 new customer wins in this vertical and this complements our over 650 customer wins in this education vertical over the past 30 months.

Tsinghua University represents one of Extreme's latest wins in Taiwan. In the higher education vertical for Q3, this university will leverage the new Summit X460 switches to deploy high-bandwidth, mobile services throughout multiple student dorms. Open standards, ready customization and automation in their network infrastructure are critical to the university. By segmenting the network and integrating its door management software already in place, Tsinghua can control all network points of entry, allowing them to dynamically enable or disable user access and apply necessary quality of service. The result is that students get access to the applications they need, when they need them and how they need them, all while the network remained stable and under control.

In the K-12 segment, Florida's Bay County School District in the U.S. represents another example of our latest wins. With a clear focus on network security and right to access, the Bay County team wanted to ensure that the network remained secure even when students and staff walked away and left their computers or devices unattended. Traditional nack-tight [ph] products were insufficient to enact the speedy response and direct use of controls they needed to avoid a network vulnerability. With Extreme's single network operating system and our ID manager capability, Bay County will leverage advanced awareness on policy control from Extreme to -- across their 40 schools to automatically disable inactive user devices, leaving the school network protected and secure.

These 2 wins, in addition to other new customer wins around the globe, including Abbotsleigh College of Sydney, Australia, Brisbane Sheldon College and the Bay of Plenty Polytechnic, all of these customer wins demonstrate Extreme's concerted traction in the mobile student vertical.

Cloud Service providers are also a key growth vertical for Extreme, and are driven by growing demand for mobile users and devices, connected machines and the mobility of virtual machines within the cloud and enterprise data center networks. One of our newest cloud services customer wins comes from GigeNET, who is an innovative cloud service provider based in Chicago. GigeNET continues to expand its footprint nationally in the United States to major cities around the nation, leveraging Extreme's Summit X650 10-gigabit top-of-rack switches to scale cloud services on demand. This follows our wins with Profitability.net, an innovative cloud services provider based in Ohio and Hypertec of Canada, an emerging service provider in the off-site storage market that offers business continuity disaster recovery services.

In the mobile backhaul vertical, we announced a new E4G family of mobile products, with targeted availability in fiscal '12. These new products are specifically designed to provide mobile operators with the ability to deploy high-performance, wire speed Ethernet mobile backhaul solutions to address the critical timing and data congestion problems associated with 3G networks and the evolution to LTE. Once installed, these same products can be leveraged to provide continued high-performance mobile backhaul solutions to enable operators to deploy reliable, mobile, 4G LTE broadband to wireless services.

To provide a comprehensive 3G to LTE backhaul evolution, we recently completed an alliance with Symmetricom, a company specializing in the synchronization required by mobile operators for Ethernet-based mobile backhaul. In Q3, we continued to drive our channel business in the mobility market vertical, with 4 of the top 6 mobile network equipment providers and saw Ericsson as a greater than 10% customer. For all of these verticals, we are focused on driving revenue growth by winning new customers and delivering the rightful product solutions.

As we work to transform our business, we will track our business by measuring the number of key select customer wins and by measuring the revenue from our identified verticals, as a percentage of our overall revenue. We continue to improve the accuracy of our customer information. And over the past rolling 4 quarters, we estimate that 25% of our revenue has already come from customer wins in these first 3 vertical strategic markets.

While we focus on driving solutions and marketing in these select verticals, we also continue to drive value and serve customers in the wider and enterprise and service provider communications markets. In the quarter, we had customer wins across-the-board in the enterprise market, including the Gerald Champion Regional Medical Center within the healthcare market, and the prestigious new stadium, the Wroclaw, in Poland, a new major sporting venue located in Poland.

Although the competitive market continues to evolve, we are winning new customers in all our geographies in the wider horizontal enterprise market. As a part of our new OEM relationship with NETGEAR, we also received orders and shipped products to this new channel, thereby expanding our market reach and enabling Extreme to serve a portion of the enterprise market that is beyond the reach of our traditional sales channels. We continue to see new customer wins for campus and private data center solutions customers, as customers continue to choose Extreme solutions that are optimized for the new mobile world of people and machines.

In summary, we believe the markets that we serve are strong. And our innovation is real and adds real value to our customers. We are now executing on our new, focused market vertical strategy and on the transformation of the company. And I believe the strategy is on track. We have defined metrics for our business and we have taken the first critical steps to lower cost, define our market position and focused on our product portfolio investments. We will continue to focus on driving a more efficient cost structure to enable us to realize sustainable, double-digit operating income and cash generation. And we are focused on specific high-growth vertical markets to drive revenue growth.

We look forward to having an active and engaged dialogue with all of our investors. And now I'll turn the call back over to Jim who will share some details regarding our guidance for Q4. Jim?

James Judson

Thank you, Oscar. In Q4, we anticipate revenue in the range of $80 million to $85 million. This is a bit wider than the company has provided in the past due to some caution regarding the lingering effects of changes we made in Q3. We anticipate EPS between $0.03 and $0.05 a share.

I'd also like to mention that Q4 will be a 14-week quarter for us, as we better align our quarterly cut-off for the calendar month end. Our Q4 will close on Sunday, July 3, 2011. With that, I'll turn the call back over to Sean for the Q&A session. Sean?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jonathan Kees with Capstone Investment.

Jonathan Kees - Capstone Investments

I wanted to ask about the, I guess, the push out. How much of that was pushed out or can you at least give us an idea, in terms of how much was pushed out versus how much maybe categorized as potentially questionable in terms of getting back from the capacity of activity?

Oscar Rodriguez

So you're referring to push out of revenue that we talked about in the pre-announcement call a few weeks ago?

Jonathan Kees - Capstone Investments

Yes. And also you talked about, at that point, the competitive activities and you mentioned that again in this call. So I guess I want to, eventually, loop back to that. But yes, the push outs.

Oscar Rodriguez

So first of all, I'll mention a couple of things and I'll let Jim take the rest of it. So we did have a $2.6 million deferral that we mentioned last time, and that was due to revenue recognition and making sure that we got sufficient documentation to satisfy ourselves at a customer that we've already delivered some software to actually had accepted all of the components of the software and we got a perfect documentation. So that was revenue to be recognized, and it will be recognized, hopefully, as much as possible in Q4 and then potentially, some in Q1. But it all remains to be seen. It really comes down to the acceptance of the customer of each individual feature with a list of features.

James Judson

And that is part of the reason for the wider range of the guidance.

Jonathan Kees - Capstone Investments

That $2.6 million was, I guess, that's the part that's easy to explain. How about the rest of the gap?

Oscar Rodriguez

Right. So we did have some customer deals that moved from Q3 and Q4. One of them, for example was a customer-readiness deal in EMEA, where effectively it was a building tower in the Middle East that we won. The building did not pass all of the inspections for cabling, et cetera, that were expected by the local partner. Upon not passing inspection, that moved the deal out into Q4, we expect. And so that's about $1 million deal there. So to give you an idea. We had another deal in the United States where the customer we thought was going to make a purchase decision on the PO in Q3. Instead the customer, upon sizing their network and looking at the details, realized that they actually needed a little more equipment. Upon needing a little more equipment, they had to go back through their internal review process, and this is one of the things that we pointed out last time, that we're finding the customers are getting multiple signature levels that maybe a year ago we weren't seeing. And so therefore, that customer by the time they were actually able to get through that process, they effectively -- the time was up on the quarter, so we're expecting that in Q4. That's a sizable deal. I'm mentioning that deal because it's over a $1 million as well.

Jonathan Kees - Capstone Investments

Okay. So that's that $4.6 million so far, roughly. So the rest is still to be, I guess, you have any idea in terms of when that's going to hit or whether that will hit or not?

Oscar Rodriguez

Jonathan, I guess I'm struggling with just what question you're asking.

Jonathan Kees - Capstone Investments

Well, I guess, if you were to add up the numbers that you've provided so far, the $1 million and then the other $1 million and then the $2.6 million, that's still less than the pre-announcement. The math that was pushed out, the midst of the pre-announcement. I guess, the remainder is that stuff that's still under question in terms of whether that's going to hit in a future quarter or not hit at all?

Oscar Rodriguez

So the other sort of big thing we mentioned in the preannounce was the impact that we saw from the end of sale, the one Metro/Carrier product line. I mean, with that product going away, customers who were in the queue to buy that product, as we mentioned during the pre-announcement, we spent a lot of time with those customers, working them through the product line end of sale and trying to get them to move to other products. And we continue to work that. How quickly that may or may not come back with us, remains to be seen. I mean, that's a customer by customer situation.

James Judson

That's right.

Oscar Rodriguez

And what I can say is that there is 1 customer that has elected to go with our new architecture and is already deploying. There's another customer that has elected to, as a part of our end of sale, to buy more of the same product even though it's end of sale to continue the deployments they've already had. So we have -- and then there are still other customer that are still assessing how they want to make a decision going forward, whether they will make a decision with a new architecture or make a decision to continue to expand with the end-of-sale product, or even make a decision to go with a different vendor because that's always a customer decision point that could be had.

Jonathan Kees - Capstone Investments

All right. But what I was just asking about is, this amount that is still up in the air in terms of what's going to happen to it. The other amount you've been pretty clear in terms of saying it more likely to come in the next quarter or 2. Can you talk in terms of -- or I guess, elaborate some more, you've talked about competitive activity both today as well as during the pre-announcement. Can you just talk some more in terms of where you're seeing that and from who?

Oscar Rodriguez

Yes. So really, what I want to point out here is we're not seeing anything that is any different than what we've mentioned 3 weeks ago. What we're really doing is just reiterating that for the purposes of investors, just know that nothing has changed from that perspective. What we're seeing is we're seeing, especially in the horizontal enterprise space, we're seeing aggressive deals that are part and parcel of a lot of the aggression that's going on by the competitor. The other competitors are in that space and some of them are the HPs, the Junipers of the world, et cetera. And of course we're expecting that some of these, even though they may not be targeting Extreme, the tactics are the same tactics they might use against maybe some of the other bigger brands. But they're also bleeding into some of our accounts as well. So I'll give you a couple of examples. So in one example, a network that we had won, we knew that we had won the network. The PO is being walked through on its way to us, but of course, one of our friendly competitors then resubmitted a lower -- an aggressively priced bid that caused the customer to stop, pause and reassess. We've seen that in a few cases, not just in one case. In another case, we've seen in school districts where we've seen protest by competitors, and this is somewhat normal, where a public tender will be protested at the end. And in one case, they actually caused the customer to lose their funding because they were expecting E-rate funding to come in at a certain time period. The protest caused the E-rate funding to evaporate. And so in that particular deal, I would say that there -- it's an open question when the customer would actually get their funding back, but they had already selected Extreme and we had won the deal, but funding was still to come based on their process. So as you can imagine, customers typically are not all too pleased when a competitor does that. But nonetheless, it's part of the open-tender process.

Jonathan Kees - Capstone Investments

Okay. So for those situations where it's in pause and they still have the funding, they haven't lost funding, are they are still in a state pause or have they made decisions yet?

Oscar Rodriguez

No. If they haven't lost their funding, clearly, they're still making their decision or already have made the decision. If they lost their funding, then it's open-ended as to how they get their funding and they may need a different source of funding or they may need to reapply.

Jonathan Kees - Capstone Investments

All right. Lastly, let me ask -- let me take a different tack. Let me ask if I got that right. You had said 25% of the quarter's revenues came from the verticals?

Oscar Rodriguez

Yes. What we did was we looked at the 3 verticals that are strategic verticals, which we see as a strategic part of our business, and we want to be able to track that, as a percentage of our revenue. Clearly we want our revenue to grow, that we also want the percentage of those verticals to grow, as a percentage of our revenue. And so because those verticals ebb and flow from quarter-to-quarter, we feel that the more appropriate way to do it is to use a rolling 4 quarters average. And in looking back over the course of the past 3 years, our rolling average has been about 25%.

Jonathan Kees - Capstone Investments

So you introduced this strategy, this vertical strategy targeting on January, and you've had a quarter of implementing or I guess, working from that strategy. So basically you're still seeing 25% of revenues coming from those verticals?

Oscar Rodriguez

Yes, that's right. I mean, one of the key things I want to emphasize in terms of the strategy, is the strategy is not a radical departure for Extreme. What it is, is a recognition of the places that we've already been strong in and a clear focus on those places that we're already strong, so we can now focus our product investments and continue to drive growth based on where we've already been strong. So I think these are places we know how to win, places where we have channels. The marketplaces where we continue to meet -- drive more channels to market, no doubt about it. So there's investment that we continue to put in place. But by focusing in these specific areas, we believe that we will be able to grow them as a percentage of our revenue and that will give us overall revenue growth as well. The one thing, let me add this as well is that, of the 3 verticals, education, mobility and cloud, cloud is the newest, right? So cloud is the one where we clearly are have a new -- it's a new vertical, I think it's new to a lot of people, not just us. And so that's the one where we're clearly going to be investing in products and investing channels as well.

Operator

[Operator Instructions] I have a question from Brian Horey with Aurelian Management.

Brian Horey - Aurelian Management

In looking at the company's recent history and given your forecast for the June quarter, it looks like the top line revenues for the year are going to be below what they were 2 years ago when the economy bottomed, and which there's been substantial growth both in the economy and the tech space and networking, generally. I think it's great that you guys are trying to focus on a narrower set of targets. But I think it would be very helpful for the investment community if you can give some color on what you think the time frame is in which we're going to see consistent top line growth with margins that would approach other vendors in the enterprise networking space. That would be point one. And point two, the revenue performance and the pressure on margins and the competitive issues that you cited in your narrative all appear to be indications and characteristics of a company that's under considerable competitive pressure, and one which it seems to me ought to be seriously contemplating strategic alternatives to try to rectify that situation. And this is a company that's underperformed the market for some period of time now. It's been through several management teams and several changes in strategy, and I'd like to hear some thoughts on how much longer investors should be expecting to tolerate this set of circumstances and when we can expect to see a change in vector and direction of the company.

Oscar Rodriguez

Okay. This is Oscar. You asked a lot of questions there. Some of them operating, some of them more corporate strategy. Let me try to address the operating ones and then I'll address the corporate strategy ones. So when it comes to the operating pieces, in terms of how we can expect to improve margins, things of that nature, part of the reason that you've seen the moves in our strategy is to be able to move the company and to address verticals that we think will give us better margins. So if you look at the verticals that we are deemphasizing, if you will, or let me say the products we're deemphasizing, part of this is a move to better margins as well. So cost structure clearly is something that's on top of mind for us, not only in standard product, but also in the overall cost structure of the company. And we continue to focus on driving the bottom line and the bottom line is, of course, a consequence of all the different cost lines as they add up. So all of this is part of what we're going after. Yes, we are under competitive pressure when it comes to winning deals. But I don't think there's anyone in the networking space today that's not under competitive pressure. I think everyone is under competitive pressure because it's a competitive environment. So we wake up every day knowing that the competition is tough, expecting them to be tough and yet we are still winning deals and we are still winning new customers because we have real value in our products. It's my belief. So as a result of that, I believe we continue to win deals. We continue to expand our channels to market into places where we are not just competing with our brand, but we're able to also leverage -- establish channels to mark and establish brands out there in different market spaces. I've mentioned the mobility network equipment providers where we go to market, and we have for several years. And I've mentioned the NETGEAR relationship, which takes us to a part of the marketplace in the enterprise space that we don't normally reach because they're smaller enterprises. And so being able to diversify channels to market is also part of this as well. Growth will come, I believe, with the focus on the verticals and adding real value to those customers that are in those demographics rather than chasing the broad horizontal market. I don't profess -- I don't believe that we should be comparing ourselves to the broader horizontal enterprise players because I think that we are a niche player, that's what I see us as. And I believe that as a niche player we need to focus on the market niches where we can be successful. You asked how long? How long for this new strategy? Well, I can't comment and don't think I can comment appropriately on past management teams and what's happened there. But I can tell you that it's my belief, and I've said this on a similar call last quarter, that I believe that this is a 4-6 quarter run for us to be able to demonstrate traction in the strategy. And to me, the good news is, we are not inventing a strategy here. We're really focusing on something, on a lot of things we've already been doing to try to do them a lot better. So it's my belief that as a niche market strategy, we can be successful. It's my belief that we can generate brand in the demographics of customers that we'll see value in the products that we bring. And so therefore, that will drive growth in top line and also growth in bottom line. And if we look at the cost structure of the company, by focusing on the cost structure, I believe that we can drive a double-digit bottom line as well, without needing to grow significantly. And any significant growth gives us leverage. So that's sort of the operating side of it. As far as should the company be looking at strategic alternatives? I can never comment on M&A and I'm not going to try to do that. But I can assure you that the Board of Directors and myself continuously look at what is the best way to drive shareholder value and that's what we keep top of mind. So both from an operating perspective, as well as anything that may come in terms of any future M&A, that you should consider that we are looking at that very carefully and we take it very seriously and shareholder value is what we hold dear.

Brian Horey - Aurelian Management

Okay. Well, just 2 comments, I guess, in response. I think the board should hear loud and clear that the shareholders have suffered with a company that's been losing revenue, losing share and hasn't made any money for over 4 years now. And I think that's more than enough time for patient investors to wait for a company and a board to get their act together and deliver value. So I think time is running out as far as that goes, I think is the message to the board. Number 2. I'm curious what -- 6 quarters is a long time for people to wait for something to turn. What metrics should we judge you by in the interim that show progress towards where you expect to be in 6 quarters? What metrics should we be following that indicate progress on the way to a double-digit bottom line?

Oscar Rodriguez

Okay. Very good. I think part of the metrics clearly are the transformation of our revenue streams coming from these specific verticals that we've defined. So I think that you should see a growing percentage of our revenue coming from these vertical markets. And we've already discussed some of this and how we'll measure it on this call. I also think that you should see a double-digit bottom line getting to double-digit operating income, and we're not there today, clearly. I do want to clarify one thing that we have not been unprofitable and not adding cash for the last 4 years. I think we have. And what we need to do is make sure that this is sustainable. And that our products and our channels really are effectively where we will invest and you will be able to see new products that are focused on these target vertical markets and new channels. And that will enhance our ability to grow the market -- excuse me, to grow our sales.

Brian Horey - Aurelian Management

What percent of the revenue stream would you expect to be coming from these targeted verticals by the end of the 6 quarters?

Oscar Rodriguez

So I haven't released that yet, but that's something I'll need to think about and I'll come back to the investors with that.

Brian Horey - Aurelian Management

Okay. And just to clarify, the company over the last 4 fiscal years has lost almost $10 million cumulatively at the operating line, according to my Bloomberg screen, so we can compare notes on that.

Oscar Rodriguez

From a GAAP perspective, I think you're correct. Yes.

Brian Horey - Aurelian Management

Yes.

Operator

Our next question comes from Bill Nasgovitz from Heartland Fund.

William John Nasgovitz

Could you give us an idea of how much you're going to spend on R&D here going forward with this new strategy on a yearly basis?

Oscar Rodriguez

So we're targeting at this point, 12% to 14% going forward. And we're not necessarily expecting that, that's going to grow linearly with revenue. So as revenue growth comes online, we may grow a bit. But I think that the amount of money that it takes to build adequate products in this space is well understood. And by limiting the demographics of customers we address, we can control the investments in R&D. The other thing that we're doing is that we are expanding our headcount in lower cost venues. So as we expand our headcount in lower cost venues for R&D, we should not see an appreciable change, a commensurate change in growth at the expense line. So we're taking several steps to make sure that we can still deliver products, and we have delivered them in a world-class fashion as we have been. No one has ever questioned our technology. Every customer I talk to tells me that we have as many or more SKUs than our competition. We're able to pump out technologies very effectively and I believe that we can lower the R&D spend that you've seen. And at the same time, be able to deliver great products.

William John Nasgovitz

Okay. You talk optimistically about winning deals, and hopefully we're going to win deals, but what level of profitability do you expect going forward? You talked about -- when the previous question are asked about metrics, what level of profitability do you and the board believe is possible for Extreme in the 6 quarters out?

Oscar Rodriguez

I believe in less than 6 quarters, 10% operating income or better is possible.

William John Nasgovitz

Yes.

James Judson

Sustainable.

Oscar Rodriguez

And sustainable, yes.

William John Nasgovitz

Is the company active in terms of its buyback?

Oscar Rodriguez

We have not done a buyback for -- I believe 2.5 years was the last time we did a buyback. And we have not made any decisions of doing any additional buybacks at this time.

William John Nasgovitz

And what is that cash earning?

Oscar Rodriguez

Do you know what our cash is earning?

James Judson

I don't know at the top of my head, no. But it's a very small percent if that's your point.

William John Nasgovitz

Very small. I guess, it's interesting to note that we're very optimistic here about the future, but we're not as optimistic enough to buyback stocks when cash is earning just about nil. I would like...

Oscar Rodriguez

Do you think that would have a material impact on the valuation of the company?

William John Nasgovitz

Well, periodically, we live in volatile, challenging times, and as a long-term investor in Extreme, I'd love to see management and the board be opportunistic to take advantage of these periodic downturns, and we might just have one tomorrow to perhaps reduce share count and increase per share value.

Oscar Rodriguez

Well, 2 years ago, we did a $100 million buyback. So I don't think that the -- even though I wasn't here, I don't think that the board was completely deaf to those suggestions. So I believe that, that's demonstrated that we have listened in the past. There's no reason to believe that we wouldn't listen in the future, but also there's no guarantee.

William John Nasgovitz

Well, it's disappointing for shareholders, and I recognize, it looks as if it's a very tough marketplace. Just to emphasize, in terms of profitability, the company spent well over $600 million in R&D over the past 10 years and we really have nothing to show for it. We have a negative return over the -- cumulatively over 10 years, we really haven't added any profitability on over $0.5 billion spent. That's very discouraging, and I hope the board certainly spends some time on that. Thank you.

Operator

Our next question comes from Jonathan Kees with Capstone Investments.

Jonathan Kees - Capstone Investments

I just wanted to circle back and just ask about your visibility. Do you see that has improved? Has that stayed the same? How would you characterize that?

Oscar Rodriguez

Well, I think when it comes to visibility of our pipeline, I think that's stayed the same. What's improved is clearly we're not making any strategic -- or product changes this quarter, which doesn't dampen the visibility that was dampened in Q3. So I think that, that's going to help improve our visibility overall. But I think the pipeline visibility as we had it coming into the quarter last quarter is about the same now.

Operator

I'd like to turn the conference back over for closing comments.

Oscar Rodriguez

All right. Very good. So I want to thank all of the investors who have taken their time to be on this call. Clearly, they are long-time investors that would like to see us perform better. Our goal here in this management team is to drive the company into new levels of profitability and growth. We understand fully the potentially long-time frustrations that have been out there. But I also recognize that the marketplace does have a demand for the products and capabilities that we bring to market. I believe that the verticals that we're serving and we're focusing on are strong verticals. We continue to drive customer wins. We continue to see customers realize the value that they get from buying Extreme equipment. And I believe that as a niche market player within this marketplace, not necessarily aligned with the horizontal markets, that we can be successful in the market and drive a double-digit operating income. So I want to thank everyone for joining us, and Jim I'll turn it back over to you for any comments.

James Judson

Yes. Just one last thing that I want to add is that Extreme will be at the Interop conference in Las Vegas the week of May 9, and I will be there and will be available to talk to any investors. And I know some of you have already scheduled time on the schedule. I look forward to meeting you. Any of you that would like to get on the schedule who are not, you can call my office and we'll be happy to arrange that for you or please stop by the Extreme Networks booth at the conference. Thank you all for attending today. Goodbye.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good 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!

Source: Extreme Networks' CEO Discusses Q3 2011 Results - Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts