Erik Bylin - Charles W. Berger - Chief Executive Officer, President and Director John T. Kurtzweil - Chief Financial Officer, Principal Accounting Officer and Senior Vice President.

Victor Chiu Christian D. Schwab - Craig-Hallum Capital Group LLC, Research Division Matthew S. Robison - Wunderlich Securities Inc., Research Division Mark Kelleher - D.A. Davidson & Co., Research Division.

Good day, everyone, and welcome to the Extreme Networks Third Quarter 2014 Earnings Results Conference Call. This call is being recorded. With us today from the company is the Chief Executive Officer, Chuck Berger; Chief Financial Officer, John Kurtzweil; and Erik Bylin from Investor Relations. At this time, I would like to turn the call over to Erik.

Please go ahead, sir..

Thank you, Nova, and welcome to the Extreme Networks Third Quarter of Fiscal 2014 Earnings Conference Call. This conference call is being broadcast live over the Internet and is being recorded on behalf of the company.

The recording will be posted on Extreme Networks' website for replay shortly after the conclusion of the call and will remain there for 7 days. The presentations and the recording of this call are copyrighted property of the company, and no other recording or reproduction is permitted unless authorized by the company in writing.

By now, you've had a chance to review the company's earnings press release. For your convenience, a copy of the release and supporting financial materials are available in the Investor Relations section of the company's website at extremenetworks.com.

I'd like to remind you that during today's call, management will be making forward-looking statements within the meaning of the Safe Harbor provision of the federal securities laws regarding business and financial outlook.

These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today, and you should not rely in them as representing our views in the future.

We undertake no obligation to update these statements after this call. For a detailed description of these risks and uncertainties, please refer to our most recent report on Form 10-K filed with the SEC, as well as our most recent Form 10-Q filed with the SEC, in addition to our earnings release posted a few minutes ago on our website.

Throughout the conference call, the company will reference some financial metrics that are derived in accordance with Generally Accepted Accounting Principles, or GAAP. All other metrics are not in accordance with GAAP. This approach is consistent with how management measures the company's results internally.

However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies. Non-GAAP information should be considered as supplement to, and not a substitute for, financial statements prepared in accordance with GAAP.

Reconciliation of the non-GAAP information to corresponding GAAP measures is in the slide presentation under the Investor Relations tab on our website and according -- accompanying our press release.

Our non-GAAP results exclude stock-based compensation, acquisition and integration costs, restructuring charges, amortization of intangibles, purchase accounting adjustments, litigation settlements and the gain on the sale of facilities. Now I'll turn the call over to Chuck Berger for some opening comments..

Thank you, Erik, and thanks to everyone on the call for joining us this afternoon. Let me start with the financial highlights for our third fiscal quarter ended March 31. Non-GAAP revenues were $143.7 million within the guidance range for the fourth successive quarter.

This represents revenue growth of 3% over the prior year's $139.5 million, which we were able to achieve in spite of the seasonal downturn and extensive integration activities during the quarter. The revenue growth was experienced across all 4 of our sales regions.

Non-GAAP earnings per share were $0.02, again, in line with the guidance we provided in February. As we have discussed in past calls, our target for synergy savings as a result of the acquisition of Enterasys continues to be in the range of $30 million to $40 million per year. We are more confident than ever that we will achieve at least that amount.

The bulk of the synergies will be realized once we have completed the integration onto one ERP system that will allow us to truly operate as a single company. We're ahead of schedule for this project, and now I believe we will cut over to a single system early in the first fiscal quarter of 2015.

Overall, the integration of the 2 companies is going well and is on track or ahead of our expectations. We recently launched several important new products into the market, demonstrating our ongoing innovation and continued engineering execution.

Extreme Networks introduced a simple, fast and smart software-defined architecture comprised of unified software and high-performance hardware offerings that enable the IT organization to meet the ever-growing user needs and expectations.

While hardware has been Extreme's mainstay for many years, the software that controls and provides visibility across networks will continue to play an increasingly important role in the future. We had meaningful product releases this quarter that position us well in this evolving market.

It starts with the software-defined architecture, or SDA, that we announced at Interop in April. We have unified our network management to provide simplified operation and optimization through NetSight 6.0 for centralized management, Purview for application analytics and Extreme SDN, or software-defined networking. We released NetSight 6.0 at Interop.

This software unifies Extreme and Enterasys hardware in a single pane of glass network management system that provides visibility and control from the data center all the way to the wireless edge.

The intelligence, automation and integration of NetSight enable IT organizations to optimize the efficiency of network operations and reduce total cost of ownership. This is an important step towards an integrated product line for us as well.

We also released Purview, a software combined with our core flow switches to give the customer extensive application analytics. It is a first-of-kind network-powered analytics and optimization tool that integrates with the network data that carries context of users, devices, locations and the applications that are in use.

Purview captures network data and then aggregates, analyzes and report this -- reports this data. This provides the user an unprecedented insight into how their networks and users are performing. Purview was selected as a finalist for Best of Interop in the management category and what was used by the NFL at Super Bowl XLVIII at MetLife Stadium.

On the hardware side, we continue to develop market-leading products that underpin our software-defined architecture.

We recently announced 2 important new hardware products, aimed at the data center with strong end high-performance computing and IXP environments, the BlackDiamond X8 cloud-scale data center switch provides a low-latency, high-performance switch fabric with high-density wire speed, 10-gig, 40-gig and, now, 100-gig connectivity with up to 20 terabytes of capacity for edge-to-core applications in a compact footprint using only 1/3 of a standard rack.

The X8 was named the Hot Product at Interop, where we announced the availability of our new 100-gig blade. We also introduced our 802.11ac wireless access points, purpose-built for high-density deployments.

These access points are designed to operate in dense user and mission-critical environments, such as health care facilities, universities, conference centers, arenas and stadiums. The IdentiFi wireless LAN system won Network Computing's U.K. Wireless Product of the Year, who touted it as a significant offering in the closely watched mobility space.

During the quarter, we also had a number of key customer wins. Following on our prior successes with the NFL, the Tennessee Titans chose Extreme's IdentiFi solution to equip their stadium with networking and wireless.

Nearly 70,000 fans will enjoy high-capacity wireless through this deployment, and the Titans will use the analytics capability of Extreme NetSight and Purview to understand what applications fans are using, allowing them to maximize the fan experience.

The stadium wins are indicative of the competitive advantage we have when we engineer solutions for a specific venue.

We worked closely with the Titans to perform extensive testing on the interactions of the wireless signals in a venue like a stadium and tailor a solution to meet the requirements of the need -- requirements of the customer, excuse me.

The Titans say that our Wi-Fi performance in high-density environments, as well as a single pane of glass view NetSight provides for both wired and wireless reporting and analytics, as key factors in choosing Extreme. In Incheon, Korea, Extreme was chosen to support the ASEAN Games at -- beginning in September 2014.

Working with SKT, the largest mobile carrier in Korea, we will deploy the BlackDiamond 8000 and Summit series to bolster the IT infrastructure for the games in the city of 3 million people. We also continue to perform well in the education vertical.

In Q3, we had big wins with the University of Tulsa and Troy K-12 Public School System, in each case, displacing Cisco. At the University of Tulsa, we are helping bring the campus mobile, data, voice and video with a suite of switches and IdentiFi APs with software to control all of it.

In the Troy school system, we launched our first K-12 Purview installation, running a broad set of Extreme switches and IdentiFi Wireless APs to handle 24,000 authenticated user.

While there is nothing new to report in our relationships with Ericsson and Lenovo, we continue to invest in these partnerships, which we believe will have a significant impact on revenue in the second half of fiscal 2015, as we have talked about in the past.

Finally, today, we're announcing 2 significant organization changes, which I believe will position us well for ongoing success. Over the past year that I have been in Extreme, it has become increasingly clear that the CEO and CFO need to be in the same location.

As most of you know, I operate out of our San Jose headquarters and John is in our Raleigh, North Carolina facility.

To bring the 2 roles together, we announced today that John Kurtzweil will assume the role of special assistant to the CEO beginning June 2, continuing to assist me in the integration of the 2 companies and other special projects through the end of September.

I'm also very pleased to announce that Ken Arola, most recently CFO at Align Technology, will be joining us in our San Jose headquarters on June 2 as our new CFO.

I want to personally thank John for his many contributions over the past 2 years, not the least of which was playing a major role in the acquisition and the financing needed to complete the acquisition. We are also announcing that Chris Crowell will be leaving the company effective today.

Chris led Enterasys as their CEO for nearly 6 years and has been instrumental in the integration efforts to date. As we move on to the next phase of the integration, I feel it is critical that I stay close to our field organizations, particularly in North America, where we have experienced some integration issues.

The field organizations and corporate marketing will report directly to me effective today.

I want to again reemphasize our plan and our commitment to attain double-digit revenue growth by the second half of 2015 as we complete the integration, realize the benefits of our key partnerships, like Lenovo and Ericsson, and align our efforts between the growth opportunities in the wireless and data center segments.

Over the same period, we're committed to achieve a 10% operating margin on a non-GAAP basis. My belief in our ability to achieve these goals has only strengthened since our last earnings call. Now John will give you the details of the financial performance for the third fiscal quarter and our outlook for Q4.

John?.

the final working capital payment related to the Enterasys acquisition of approximately $5 million; higher inventory payments unanticipated of $80 million, primarily related to the inventory intake during the first few months after the acquisition to ensure we would be able to meet our customer demands; advanced payments on several marketing activities that will benefit the company going forward, this includes such items as our marketing agreement with the NFL that will be amortized over time; integration-related expenses, including consulting and employee severance, of approximately $4 million in cash-related charges; and repayment of term debt according to the schedule and interest of $1.5 million.

For the fourth fiscal quarter, we target to be cash-neutral, including the ongoing integration expenses that we expect to incur. Accounts receivable were flat at $94.2 million with non-GAAP DSO of 59. This is an increase of one day from the prior quarter.

Inventory was up slightly with our non-GAAP days of inventory related to product inventory of product sales of 104 days, an increase of 16 days from the prior quarter. I will now provide guidance for our fourth fiscal quarter. We're targeting GAAP revenue in a range of $143 million to $148 million with non-GAAP revenue $145 million to $150 million.

This is an increase quarter-over-quarter of between 1% and 5%. When we look at the fourth fiscal quarter of 2013, the pro forma revenue would have been $169 million. Year-over-year, revenue is estimated to be down 11% to 14%.

This is primarily due to considerably lower K-12 spending in the U.S., which is related to a lack of E-rate funding, which is expected by many to be restored to previous levels in the next funding year, which begins in October. Last year, we estimate that the fourth fiscal quarter had a positive impact related to E-rate spending in the low teens.

While we expect all geographies to be flat to up year-over-year in our fiscal Q4, execution in North America is the primary driver for the remainder of the year-over-year decline. As previously mentioned, we are investing in our lead generation engine, something that was cut deeply a year ago when we focused on short-term profitability.

GAAP gross margin is targeted to be 50%, and non-GAAP gross margin is targeted to be 55%. GAAP operating expenses are expected to be in a range of $89 million to $92 million.

On a non-GAAP basis, we see expenses increase to between $76 million to $78 million with R&D targeted to come in between $24 million and $25 million, depending on NRE related to various projects hitting certain milestones.

Sales and marketing is targeted to come in between $42 million and $43.5 million, depending on revenue, and G&A is targeted to come near $9.5 million. Interest expense and other is targeted to be approximately $0.7 million. This includes the interest expense related to the debt incurred in relation to the acquisition.

The all-in annual percentage rate of the debt is approximately 3%. Tax expense is targeted to be approximately the same as last quarter at $0.9 million. GAAP net loss is expected to be between $16 million to $19 million or $0.16 to $0.20 per share. Non-GAAP net income is expected to be between $2 million to $4 million or $0.02 to $0.04 per share.

The GAAP and non-GAAP net income targets are based on an estimated 96 million and 100 million average shares, respectively. At this point, I will bring to a close our prepared remarks, and we'll now open the call for questions.

Nova, would you please start the polling?.

[Operator Instructions] Our first question comes from the line of Simon Leopold of Raymond James..

This is Victor Chiu in for Simon Leopold. I'm sorry, I might have missed this when you were speaking about it earlier. Can you just provide some more color around the seasonality in the June quarter and what the impact was? I think I heard something about E-rate spending, but I don't think that I quite got all of that..

Sure, this is Chuck. I'll be happy to comment on that. Against our goal of maintaining revenues flat for the fourth quarter, as you can tell from the forecast, we're actually forecasting down revenues with virtually all of that coming out of the U.S. market.

If you look at last year, both companies, prior to the acquisition, had extremely strong June quarters, a significant amount of which was raised on based on K-12 deals that were related to E-rate funding.

If you're familiar with E-rate, it is a program whereby last year, the federal government would pay up to 90% of qualified network investments by K-12 school districts. That program has completely gone away for this year.

While we expect it to come back, it contributed to revenues last year in the fourth fiscal quarter in the low- to mid-teens of millions of dollars. So the biggest chunk of revenue that we'll be missing versus the prior year is that E-rate business..

Okay.

And you -- so when you say you expect it to come back, you mean -- like what's the timeframe that you expect a kind of recovery in that?.

It's hard to predict the federal government, but they usually make these decisions in the October timeframe. The tax that creates the fund for E-rate continues to be levied. It's a charge on all of our phone bills. So we should see that in that timeframe. That said, our E-rate business definitely spiked to last year, the fourth quarter.

So when you're doing year-over-year comparisons, you won't see nearly as much of it in the September or December quarters..

I mean, it just seems, as I'm going back a few years, it seems like in 2011 and in 2012 the June quarters seem like a sequential increase in the mid- to high-teens. So it seems like it was outside of just last year, too. It just seems like that's kind of a seasonal part of your business.

Was last year weaker then, I guess, if you excluded that business then?.

Well, certainly, we have shown a strong fourth quarter in the past. There are other factors beyond E-rate involved in that. I'd say, it's safe to assume that Enterasys was putting on a more-than-usual full court press as they were in the middle of the process of selling the company.

It, of course, is our fiscal year end as it was last year, and there were a number of salespeople, again, particularly in North America, that were close to hitting accelerators. So we saw a push from that. So I think we had a seasonally strong business in the fourth quarter of 2013.

We just have not done as good a job as I would've like to have seen, which is why I'm going to get much more involve with the North American sales organization in filling the hole created by the E-rate business or the lack of E-rate business..

I'm sorry, did you say it was -- what was the dollar impact last year from that?.

Low- to mid-teens in millions of dollars..

And was this primarily Enterasys or Extreme or kind of what was the split, I guess, between the -- I mean, you just mentioned that Enterasys was doing particularly well. Was it mostly more from Enterasys that we're seeing this impact, or was it kind of split even between the....

It was definitely across both 2 companies, probably slightly weighted towards Extreme, but not by a huge amount..

Our next question comes from the line of Christian Schwab of Craig-Hallum Capital Group..

Just to follow up on the previous set of questions on E-rate funding. Was this legislation supposed to be passed in the last quarter and it was pushed out or delayed? I'm just slightly confused on why this wasn't brought more to everyone's attention last quarter..

This is not new news. As I said, the decision on this is made back in the October, November timeframe. I think until our recent quarterly review -- business review meetings, which we had last week, we hoped we would be able to fill, again, that hole in the revenue. And at least, the current revenue forecast from the region is not showing that.

So that's our challenge for the remaining 2 months of the quarter..

Great and then before I forget, John, thanks for all your service and you will be missed.

As it relates to your confidence in double-digit revenue growth in the second half of '15, is that primarily driven by the competitive nature of your products versus your peers, an expectation on TAM, an acceleration of business profile that, that at that point is better positioned with the likes of Lenovo or Ericsson? I'm just curious what gives you that type of conviction of double-digit revenue growth in the second half of '15, or is that more of something that we should be thinking about as just a management objective or goal?.

Well, it's not only a management objective and goal, but it's one we have a lot of commitment to, and I believe it's absolutely attainable.

And as I said in my prepared remarks, in order of importance, we expect the relationship with Lenovo, in particular, as I've said for the last several calls, to have meaningful revenue impact in the second half of fiscal 2015. We will be certainly through the integration of the sales forces and the channel by that time.

We are well down the path of developing plans, which I've also been talking about, to align the company behind the growth opportunities ahead of us, including wireless and the data center and continue to bring out strong product offerings in both, particularly not just on the hardware side, but on software with products like NetSight.

So I -- those 3 or 4 factors give me a lot of confidence in that forecast..

Great. And then you talked earlier, Chuck, about having some North America integration issues. I'm just wondering what type of integration issues your experiencing or if you could elaborate on that for us? I apologize for the noise in the back..

Well, the North American sales organization is our largest sales organization by far. It probably had the strongest differences in culture that we're working through. And I think that will be -- as we exit the fourth quarter, we should have that in alignment.

But -- again, that's why I'm planning the organization to make sure I get personally involved with what happens..

Great.

And my last question is who is going to be in charge of growing the wireless business? Who within Extreme Networks is now in charge of running the wireless access product division?.

We're finalizing our organization structure for that. It's -- as we get to the end of the year, we've got our business plan reviews coming up with our board, and we'll be able to announce who that is as we exit the fiscal year.

There's a group in Toronto of 100 engineers that handle it from a product side and our product line management group, which is headed up by a gentleman named John Hanahan owns the product marketing piece of this and the product management piece of this. But we'll be more clear on that as we finalize our plan for 2015..

Our next question comes from the line of Matt Robison of Wunderlich..

Chuck, what do you think are the biggest factors that kept you from doing midrange or better on revenue for the quarter?.

I think the biggest factor is we are -- we were still struggling with forecasting. We had just put the 2 sales organizations together at the time we made this forecast. The fact that we did better than last year and were able to show year-over-year growth, I think, is quite an accomplishment.

But again -- and at this point, was consistent across all 4 of our geographies. So as the integration, at least, got started, we were doing well, but we were a couple of million short, as you know, of the consensus on the revenue line..

Were there any particular -- it sounds like regionally, it was a sort of a balanced disappointment, for lack of better words.

Were there any verticals that were particularly conspicuous?.

Not in the third quarter, no..

And what can you tell us about the contribution of wireless and data center?.

Wireless, as we've talked about in the past, continues to be in the neighborhood of about $15 million of revenue a quarter. And data center, which is a little more difficult to track, is in that same neighborhood..

Okay.

So no -- any -- when you look at the pipeline of business, which do you think looks like -- is likely to accelerate more and has shorter sales cycles?.

Wireless is clearly a shorter sales cycle. We're in the process of training as fast as we can, not as fast as we would like. The Extreme partner base and Extreme sales and systems engineers on wireless. There's a -- the upgrade to 802.11ac is in its early stages with another ac 2 upgrade coming shortly behind that.

And there continues to be pretty rapid growth in wireless as BYOD and mobility continue to outstrip existing network's capacity to handle the increased number of devices, as well as the increased richness of content people are accessing on a regular basis..

With Mr.

Crowell gone, who will be looking after Andover?.

We've got a number of senior people there. Our CMO, Vala Afshar, is there. Our Head of Corporate Development, who has been a direct report of mine since the beginning, is there, Norman Rice, who, among other things, is responsible for the NFL successes we've had. We have a number of one tier down from that, VPs and senior directors there.

And we're fortunate that we have Raleigh close by. So Ed Carney, our Head of Engineering, is up there, pretty much on a weekly basis, and I'm out there at least once a month..

So Ed Carney will also be sort of looking after things in Raleigh then?.

He's based in Raleigh, but he's got a large number of engineers from the legacy Enterasys organization that are in Salem. So he's up there nearly every week for a couple of days. He's up there right now, I believe..

Our next question is from Mark Kelleher of D.A. Davidson..

Just as a kind of a follow-up on one of the last questions. You introduced some new products at Interop a little while ago. How is the uptake of those going? I would think those might help give a push into the June quarter.

How's that progressing?.

The market reception has been good. We just introduced them about 3 weeks ago at Interop in Las Vegas. I was actually with 2 of our reps here in Miami where the 3 of us are sitting right now in advance of a investor conference tomorrow, that they are very excited about Purview and NetSight, in particular.

But our sales cycles are generally 90-plus days, and so we haven't seen a huge uptick in orders yet. But we're beginning -- particularly with Purview as well, beginning to see -- as I mentioned, Troy Public School District, our first K-12 Purview sale..

Okay. And on the cost side, you mentioned $5 million of synergies in the June quarter. That's $3 million on top of the $2 million in this quarter.

Is that right, that's the way to look at that?.

Yes. That is -- it's $5 million in total..

$5 million in total.

And that $3 million incremental, is it fair to look at that as being reinvested in other places or should there be a $3 million benefit to cost?.

Well, in our guidance, which you're going to see is that we actually have G&A coming down. So the G&A is coming down, and then there's some NRE programs, some products for engineering that are going to come in during the quarter that will be onetime costs. That will be offsetting a portion of that..

And as we look further out to additional synergies, should we look to the SG&A line? Where would we look for the most bang for the buck there?.

Anywhere you can get the most bang for the buck as we move forward and as the company grows, you'll get it out of COGS and then you'll also get it out of the G&A side, and in particular, after the ERP systems are integrated into one.

And that will be sometime after the end of the first quarter before -- FY '15, before you'll start to see it show up in the P&L..

[Operator Instructions] And I'm showing no further questions in the queue at this time. I would like to turn the call back to Chuck Berger for closing remarks..

Thank you, Nova, and again, thanks, everyone, for your continued interest in Extreme. We are strongly confident of the success of the integration of these 2 companies and the financial results it will produce.

We are moving ahead, ahead of plan on almost every front as we've finally gotten to truly integrating the North American sales forces and allocating quotas and territories, where you've seen an impact, along with the E-rate funding in North America. But we think that is short term.

And you can see that we're taking organization maneuvers, organization changes to make sure we address that, including myself getting much more close to the sales organization.

So our conviction over our goals for the second half and the impact that some of the growth engines, like Lenovo, wireless, data center and completion of the integration will bring to the company, has not weakened at all. In fact, if anything, it's strengthened.

And the fact that we're 2 months ahead on our ERP integration, I take as a very positive sign for that. And that even in the midst of this integration, we were able to show revenue growth in this quarter. So we will keep pushing ahead and look forward to talking to you in 3 months..

And ladies and gentlemen, this does conclude our conference. Thank you for participating. You may now disconnect. Everyone, have a wonderful day..