Extreme Networks, Inc.
Q2 2009 Earnings Call Transcript

Published: 29 Jan 2009

[Operator:]

Good afternoon ladies and gentlemen and welcome to the Extreme Network’s 2009 second quarter conference call. At this time all participants are in a listen-only mode. Following today’s presentation, instructions will be given for the question-and-answer session. (Operator Instructions) On the call today from Extreme Networks are Mark Canepa, President and Chief Executive Officer; and Karen Rogge, Senior Vice President and Chief Financial Officer. As a reminder, this conference is being recorded today, Wednesday, January 28, 2009. This afternoon Extreme Networks issued a press release announcing the company’s financial results for the second fiscal quarter of 2009. A copy of this release is available at the company’s website at www.extremenetworks.com. This call is being broadcast live over the internet and will be posted on the Extreme Network’s website for a replay shortly after the conclusion of this call. The company has asked me to remind you that this conference call contains forward-looking statements that involve risks and uncertainties, including statements regarding the company’s expectations, regarding its strategy, growth of customer bandwidth demands, development of new products, customer acceptance of the company’s products, customer 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 fluctuations and demand for the company’s products and services, the highly competitive business environment for network switching equipment, it’s effectiveness and control expenses, the possibility that the company might experience delays to make development of new technology and products, customer response to it’s new technology and products, the timing of any recovery in the global economy, risks related to pending or future litigation and a dependency on third parties for certain components, and for the manufacturing of the company’s products. The company undertakes no obligation to update the information on this conference call. More information about potential factors that affect our business and financial results is included in the company’s filings with the Securities and Exchange Commission, including without limitations under the captions, management’s discussion and analysis of financial conditions and results of operations and risk factors which is on the file for Securities and Exchange Commission. Throughout the conference call the company will reference to both GAAP and non-GAAP financial results. The company has provided a reconciliation table of GAAP to non-GAAP 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 maybe subject to change when the review of the fiscal quarter is concluded and/or a Form 10-Q is filed. I would now like to turn the call over to Mr. Mark Canepa, President and CEO of Extreme Networks; please go ahead sir.

[Mark Canepa:]

Thank you, Mary and thank you all for joining us today. I would like to cover three points with you

[Karen Rogge:]

Our second quarter results reflected the difficult macro-economic climate in the U.S. Despite this backdrop, we managed our operating expenses in the quarter to deliver a profit and increase our cash and investments. Overall, revenue for the quarter was down 2% from the year ago quarter. Pro forma gross margin declined 1.7 percentage points compared to the year ago quarter and cash and investments increased $900,000 from the prior quarter. Product revenue was $72.6 million, which compares to $77.4 million a year ago. Once again, EMEA revenue grew stronger, increasing 18% from a year ago. Our product book-to-bill ratio was one for the quarter. Service revenue was $15 million and inline with the prior year’s results. We continue to see further progress in our services business. The ratio of enterprise to service provider sales was 71% to 29%, which compares to our historical pattern of 74% and 26% respectively. The decreased percentage of enterprise sales was primarily due to the lower proportion of sales in the Americas region. Sales of new products introduced to market in the past 24 months were 37% compared to 41% in the prior quarter, primarily due to the maturing of our Summit 450 product family. We believe this ratio will increase as the recently introduced BlackDiamond 20-K and Summit 650 product lines begin ramping during the coming quarters. The ratio of stackable and modular product sales was 67% and 33% respectively and inline with our historical pattern. Looking at revenues by geography for the quarter; revenue in North America was $33.4 million which compares to $35.7 million in Q1 and $40.5 million in the year ago quarter. We continue to see a slowing of business in North America, as a result of the ongoing macro-economic downturn in the United States. Product and services revenue in the region declined 20% and 9% respectively from the year-ago quarter. EMEA continued to grow stronger, with revenues of $42.2 million, up from $41.6 million in Q1 and $35.7 million in the year-ago quarter. This represents the fifth consecutive quarter of growth in the region, primarily driven by an increase in service provider sales in Eastern Europe. Product sales increased 17% and service revenue increased 27% compared to the year-ago quarter. Revenue in Asia Pacific was $11.9 million, down from $16.3 million in the year ago quarter. Products and services revenue in APAC declined 29% and 14% respectively from the year ago. We believe the company’s growth in Asia is limited primarily by our execution, as opposed to the broader macro-economic climate and we are in the process of rebuilding the management team and partner relationships in the region. We continue to perform well in selected markets, including Korea and India. Let’s now turn to non-GAAP gross margin results, which exclude the effect of stock-based compensation. As a percent of revenue, total non-GAAP gross margin was 55.8%, down 1.7% points from the year-ago quarter. Product non-GAAP gross margin as a percent of revenue was 56.8%, down 3.2% points from a year ago. The decrease in product gross margin was primarily driven by the decrease in revenue, product mix and increased distribution costs of $0.5 million, partially offset by a decrease in warranty costs of $0.4 million due to improvements in quality. Service non-GAAP gross margin was 50.7%, an increase of 7 percentage points from the year ago quarter, primarily due to the change in the amortization of our spares inventory of $0.6 million and a decrease in service overhead spending of $0.4 million. Non-GAAP operating expenses were $46.2 million, which is down $4.2 million from the prior quarter. The decline in operating expenses compared to the first quarter was primarily due to the reduction of $1.8 million in variable compensation, $0.75 million related to the December shutdown and $0.65 million in other expense controls, including the reduction of our contingent work force. In comparison to the year ago quarter, expenses were down $3.3 million, primarily due to the reduction of variable compensation expense of $4.1 million, decreased R&D project spending of $0.6 million, offset by an increase of $1.2 million in general sales and marketing expenses. Other income was $0.8 million, which primarily includes foreign exchange gains. Non-GAAP net income was $3.5 million or $0.04 per diluted share, which compares to $5.5 million or $0.05 per diluted share in the year ago quarter. In summary, revenue and gross margins declined from the second fiscal quarter of last year, partially offset by reduced operating costs. Turning to the balance sheet; at the end of December, cash equivalents and investments increased $900,000 from the September quarter, ending the quarter at $143.5 million. Cash flow used in operations was $2.8 million, primarily due to a decrease in deferred revenue of $6.9 million, increased inventory of $6.6 million, as a result of lower sales than forecasted, offset by a decrease of $9.1 million in accounts receivable. At the end of the second fiscal quarter, regular employees were 863 and in line with Q1. As a part of our effort to align operating expense with anticipated revenue, we reduced our contingent work force in Q2 by 37 people or 47%. We are continuing our practice of not providing specific guidance for the coming quarter. Against the backdrop of uncertain macro economic conditions, we are focused on the need for fiscal discipline and executing on the areas we can control, to maximize our profitability and cash flow from operations. During Q2, we took measures to reduce our work force, executed the December shutdown and reduced discretionary spending levels including travel. Looking forward given the continuing weakness in the worldwide economy and what has historically been a seasonally down quarter in Q3; to further manage our cost structure, we are focused on reducing inventory levels to be in line with our current operating needs, aligning operating expenses with anticipated revenues and ensuring adequate cash flow to protect the business. Specifically in Q3, we have already announced a one week shutdown for our US operations and reduced executive compensation. While we are tightly managing our expenses, we are continuing to invest strategically in technology, products and partnerships to bring our new solutions to market. With that, I will now turn the call back over to Mark.

[Mark Canepa:]

Thank you, Karen. This concludes our prepared remarks and we are now ready to take your questions.

[Operator:]

(Operator Instructions) Your first question comes from Samuel Wilson - JMP Securities.

[Doug Ireland:]

Hello, this is Doug Ireland for Sam Wilson. I was wondering if you have considered a reverse stock split, as your stock is down between $1 and $2?

[Mark Canepa:]

Yes, good question. These are all pieces of the planning process. Those kinds of things, stock buybacks and so on that the Board considers from time-to-time and these are discussions that I and the Board have on a regular basis. For now, we felt that we are in the correct position. If the Board were to arrive at a different conclusion, obviously we would take action.

[Doug Ireland:]

Do you consider the Dutch tender that you carried out in the quarter successful?

[Mark Canepa:]

Well, certainly the Dutch tender achieved its goal. We wanted to retire a $100 million worth of stock at that point in time and we were able to reduce our outstanding shares by something close to 25%. So from that point of view, it met the needs.

[Operator:]

(Operator Instructions) Your next question comes from Rohit Chopra - Wedbush Morgan.

[Sam:]

This is actually [Sam] for Rohit Chopra. On the European service provider sales, we asked this question last quarter, but could you give us an update on where we are in the implementation cycle?

[Mark Canepa:]

That’s right, the question was asked last quarter. We have a lot of service providers in various parts of the world and all in different stages of where their life cycles might be. So we don’t have obviously precise data for any one. We believe that they are continuing their implementations and we continue to work with them on an ongoing basis.

[Sam:]

I mean, but overall generally do you feel like we are still in the beginning phases or we’re mid-cycle?

[Mark Canepa:]

Well, it depends on the particular carrier. I mean, some of them are just beginning deployments. For example, the Moscow government one, we put it under the enterprise category. It’s really very much of a carrier kind of deployment. Those are long ways to go there and some of them are a little further down the line. You’ve seen that over the last few quarters our Carrier business continues to be pretty healthy. We believe we’ve got good products and not only are we continuing with the deployment of these carriers, but we are continuing to work and find other carriers that over time will begin to begin new deployments.

[Sam:]

Great and then Karen maybe just a follow-up on service gross margin; there’s a nice bump-up there. Now, how sustainable is that going to be to get to north of 50% gross margins on the services side?

[Karen Rogge:]

Well, we’ve been looking at our service provider business quite some time and we’ve have been talking about that. In looking at that business over the last few quarters, it has stabilized I would say in the low 50’s range.

[Sam:]

Great and one final question on R&D, that was down; you mentioned last quarter that it probably would be down. It was a little bit more than I was expecting. Is there anything else in that number that’s maybe like one time?

[Mark Canepa:]

R&D bounces around. It was up kind of last time because as I was telling you we were sort of in the final phases two of major problems, the X650 and the BD 20K. We are winding down a little bit of those and we are a bit in a lull and I’m sure there’ll be other programs that are going to be coming along. Now all that said, we are watching our R&D expenses very carefully like all of the other expenses in the company and we continue to focus our resources where they need to be.

[Operator:]

(Operator Instructions) and management, I am showing that there are no further questions. I’ll turn it back to you for closing comments.

[Mark Canepa:]

Well, thank you Mary. Thank you all for joining us this afternoon. I want to thank all of our employees for their dedication and effort, especially during these challenging times. We look forward to speaking with all of you again at our next conference call. Thank you.

[Operator:]

Thank you. Ladies and gentlemen that will conclude today’s teleconference. If you would like to listen to a replay of today’s conference, please dial into 303-590-3000 or 1800-405-2236 and enter the access code of 11124856#. We thank you again for your participation and at this time you may disconnect.