Description
Extreme Networks, Inc. Director EDWARD TERINO bought 100,000 shares on 10-01-2012 at $ 3.38
BUSINESS OVERVIEW
Overview
Extreme Networks, Inc., together with its subsidiaries, (collectively referred to as Extreme and as we , us and our ) is a leading provider of network infrastructure equipment and services for enterprises, data centers, and service providers. Our customers include businesses, hospitals, schools, hotels, telecommunications companies and government agencies around the world. Since our founding in 1996, our vision has been a world enabled by a unified network based upon Ethernet that simplifies each element and component of the network, and through simplification, provides services at a lower cost. As networks internal to businesses, between businesses and the Internet itself become more pervasive and critical to a wide variety of business and social communications, the volume and the demands of applications, data, users and devices on networks continue to increase. Our vision focuses on the design and delivery of easily deployable, highly scalable, secure and comprehensively managed networks which are reliable, fast, flexible and cost-effective. We primarily sell our products through an ecosystem of our channel partners who combine our Ethernet products with their offerings to create compelling information technology solutions for end user customers.
Industry Background
The networking industry has undergone significant changes in the last few years. With the mobilization of the workforce, the virtualization of the data center, and the demand for anywhere, anytime connectivity, across any device, Ethernet is the common technology across both enterprises and service providers. Extreme Networks' strategy, product portfolio, and research and development are aligned with the following trends:
•Ethernet. Through its scalability, adaptability, and cost-effectiveness, has solidified its role as the basis for both public and private networks. At the same time, the enterprises and service providers expect the technology to follow a price-performance curve that mandates continued innovation by Ethernet vendors.
•Mobile Workforce . Employees expect high-quality and secure access to corporate resources in a Bring Your Own Device (“BYOD”) world across a diversity of endpoints such as laptops, tablets, and smart phones, whether they are within the corporate firewall or on-the-go. IT departments focus their investment decisions on this mobile workforce, taking a unified view of wireless access, the campus core, and the data center. Networking vendors offer end-to-end solutions that permit IT managers to meet employee expectations and to maximize IT return on investment.
•The Cloud. Data center architectures are influenced by the cloud and by the deployment of server virtualization. Enterprises have migrated applications and services to either private clouds, or public clouds offered by 3 rd parties. In either case, the network infrastructure must adapt to this new dynamic environment. Intelligence and automation are key if enterprises are to derive maximum benefit from their cloud deployments. Ethernet, scaling from 10 Gigabits (G) to 40G and even 100G, provides the infrastructure for both private and public clouds. In addition, there is growing interest in Software Defined Network (SDN) approaches that may include technologies such as OpenFlow, OpenStack, and CloudStack.
•Public Network Evolution . 3G and 4G mobile networks now provide the necessary capacity and reach to enable employees to be productive away from the office and away from fixed networks. Mobile operators continue to invest in their next-generation networks, and Ethernet is the technology often used for their access networks, referred to as Mobile Backhaul.
•Vendor Consolidation . Consolidation of vendors within the Ethernet networking market and between adjacent markets (storage, security, wireless & voice applications) continues to gain momentum. We believe that the underpinning technology for all of these adjacent markets is Ethernet. As a result, we believe that there will be continued mergers between adjacent market vendors to enable them to deliver complete and broad solutions to customers.
The Extreme Networks Strategy
With the proliferation of mobile users and their devices, within a campus or across continents, the challenges of operating and managing a network have changed. IT has rapidly evolved from a world of fixed to a new world of mobility where everything-people, devices, machines, and applications-are in motion. IT now has to support end users with smart phones, tablets, laptops and other wireless peripherals as well as their wired workstations. Users are beginning to define the services that IT must offer as they adopt tablets and their applications, and work on the go. Users know what they need to be productive, and they expect the network to help them achieve productivity.
Extreme Networks provides networks designed for mobility. Customers deploying our technology can know what resources are using the network, what they are requesting and where they are located, and can provide customized access to approved resources and content.
Our networks help enable granular visibility and control, higher performance and resource security.
Extreme Networks strategy is to offer sophisticated, open, and cost effective scalable networks, an alternative to single-sourced, highly proprietary networking equipment from other companies. Our commitment to open standards is manifested by demonstrated interoperability within both enterprise and service provider networks, and the active participation in key industry and standards associations.
Sales, Marketing and Distribution
We conduct our sales and marketing activities on a worldwide basis through a distribution channel utilizing distributors, resellers and our field sales organization. We primarily sell our products through an ecosystem of channel partners who combine our Ethernet products with their offerings to create compelling information technology solutions for end user customers. We utilize our field sales organization to support our channel partners and to sell direct to end-user customers, including some large global accounts.
Strategic Relationships. We have strategic relationships with Ericsson Enterprise AB, Motorola Inc., Netgear, Inc., Nokia Siemens Networks and others who sell our products as part of an overall solution.
Distributors . We have established several key relationships with leading distributors in the electronics and computer networking industries. Each of our distributors primarily resells our products to resellers. The distributors enhance our ability to sell and provide support to resellers, who may benefit from the broad service and product fulfillment capabilities offered by these distributors. One distributor, Westcon Group, Inc., accounted for 19%, 16%, and 16% of our net revenue in fiscal years 2012 , 2011 and 2010 , respectively. Distributors are generally given the right to return a portion of inventory to us for the purpose of stock rotation, to claim rebates for competitive discounts and participate in various cooperative marketing programs to promote the sale of our products and services. We defer recognition of revenue on all sales to distributors who maintain inventory of our products until the distributors sell the product, as evidenced by monthly “sales-out” reports that the distributors provide to us, provided other revenue recognition criteria are met. (See “Revenue Recognition” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations .)
Resellers. We rely on many resellers worldwide that sell directly to end-user customer. Our resellers include regional networking system resellers, resellers who focus on specific vertical markets, value added resellers, network integrators and wholesale resellers. We provide training and support to our resellers and our resellers generally provide the first level of contact to end-users of our products. Our relationships with resellers are on a non-exclusive basis. Our resellers are not given rights to return inventory and do not automatically participate in any cooperative marketing programs. We generally recognize product revenue from our reseller and end-user customers at the time of shipment, provided other revenue recognition criteria are met. When significant obligations or contingencies remain after products are delivered, such as installation or customer acceptance, revenue and related costs are deferred until such obligations or contingencies are satisfied.
International sales
International sales are an important portion of our business. In fiscal 2012 , sales to customers outside of the United States accounted for 67% of our consolidated net revenue, compared to 68% in fiscal 2011 and 63% in fiscal 2010 . These sales are conducted primarily through foreign-based distributors and resellers managed by our worldwide sales organization. In addition, we have direct sales to end-user customers, including large global accounts. The primary markets for sales outside of the United States are countries in Europe and Asia, as well as Canada, Mexico, Central America and South America. (See “Net Revenue” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations .)
Long-Lived Assets
See Note 2 of our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K for more information regarding our long-lived assets.
Marketing
We continue to develop and execute on a number of marketing programs to support the sale and distribution of our products by communicating the value of our solutions to our existing and potential customers, our distribution channels and our resellers. Our marketing efforts include participation in industry tradeshows, conferences and seminars, publication of technical and educational articles in industry journals, frequent updates to our publicly available website, promotions, web-based training courses, advertising and public relations. We also submit our products for independent product testing and evaluation.
Backlog
Our product backlog at June 30, 2012, the last day of our 2012 fiscal year, net of anticipated back end rebates for distributor sales, was approximately $10.6 million, compared with product backlog of approximately $12.7 million at July 3, 2011, the last day of our 2011 fiscal year. Our products are often sold on the basis of standard purchase orders that are cancelable prior to shipment without significant penalties. In addition, purchase orders are subject to changes in quantities of products and delivery schedules in order to reflect changes in customer requirements and manufacturing capacity. Our business is characterized by seasonal variability in demand and short lead-time orders and delivery schedules. Actual shipments depend on the then-current capacity of our contract manufacturers and the availability of materials and components from our vendors. Although the Company believes that the orders included in the backlog are firm, all orders are subject to possible rescheduling by customers, cancellations by customers which the Company may elect to allow without penalty to customer, and further pricing adjustments on orders from distributors. Therefore, the Company does not believe that its backlog, as of any particular date is necessarily indicative of actual revenue for any future period.
Seasonality
Like many of our competitors, we historically have experienced seasonal fluctuations in customer spending patterns, which generally adversely affect our first and third fiscal quarters. This pattern should not be relied upon, however, as it has varied in the past.
Customer Service and Support
Our customers seek high reliability and maximum uptime for their networks. To that extent, we provide the following service offerings:
•Support services for end-users, resellers and distributors. We meet the service requirements of our customers and channel partners through our Technical Assistance Centers, or TACs, located in Utrecht, Netherlands; Research Triangle Park, North Carolina; and Chennai, India. Our TAC engineers and technicians assist in diagnosing and troubleshooting technical issues regarding customer networks. Development engineers work with the TACs to resolve product functionality issues specific to each customer.
•Professional services . We provide consultative services to improve customer productivity in all phases of the network lifecycle – planning, design, implementation, operations and optimization management. Our network architects develop and execute customized hardware deployment plans to meet individualized network strategies. These activities may include the management and coordination of the design and network configuration, resource planning, staging, logistics, migration and deployment. We also provide customized training and operational best practices manuals to assist customers in the transition and sustenance of their networks.
•Education . Our classes cover a wide range of topics such as installation, configuration, operation, management and optimization – providing customers with the necessary knowledge and experience to successfully deploy and manage our products in various networking environments. Classes may be scheduled and available at numerous locations worldwide. We deliver training using our staff, on-line training classes and authorized training partners. In addition, we make much of our training materials accessible free-of-charge on our internet site for customers and partners to use in self-education. We believe this approach enhances the market’s ability to learn and understand the broad array of advantages of our products.
Manufacturing
We outsource the majority of our manufacturing and supply chain management operations as part of our strategy to maintain global manufacturing capabilities and to reduce our costs. We conduct quality assurance, manufacturing engineering, document control and test development at our main campus in Santa Clara, California. This approach enables us to reduce fixed costs and to flexibly respond to changes in market demand. Our end-to-end supply chain, including our three engineering facilities at Santa Clara, RTP, and Chennai, India, are all ISO 9001 certified.
We use Alpha Networks, Inc. headquartered in Hsinchu, Taiwan to design and build some of our products. Alpha Networks is a global networking Original Design Manufacturer ("ODM") leader with core competencies in areas such as Ethernet, LAN/MAN, Wireless, Broadband and VoIP. Alpha Networks, Inc.’s manufacturing processes and procedures are ISO 9001 certified.
Our wireless products are supplied under an Original Equipment Manufacturer ("OEM") supply agreement with Symbol Technologies, Inc., a subsidiary of Motorola, Inc. (“Motorola”). Motorola rebrands and customizes the wireless products for us to resell to customers. Motorola’s manufacturing processes and procedures are ISO 9001 certified. Motorola has made ongoing supply and support commitments during the term of the agreement and is required to provide support for a defined period of time after any termination of the agreement.
Research and Development
The success of our products to date is due in large part to our focus on research and development. We believe that continued success in the marketplace will depend on our ability to develop new and enhanced products employing leading-edge technology. Accordingly, we are undertaking development efforts with an emphasis on increasing the reliability, performance and features of our family of products, and designing innovative products to reduce the overall network operating costs of customers.
Our product development activities focus on solving the needs of enterprises, data centers, and service providers. Current activities include the continuing development of our innovative switching technology aimed at extending the capabilities of our products. Our ongoing research activities cover a broad range of areas, including, in particular, 40G and 100G Ethernet, routing, timing and resiliency protocols, network security, identity management, data center fabrics, and wireless networking.
We continue to enhance the functionality of our modular operating system (ExtremeXOS) which has been designed to provide high reliability and availability. This allows us to leverage a common operating system across different hardware and network chipsets.
As of June 30, 2012 , our research and development organization consisted of 210 employees. Research and development efforts are conducted in several locations, including Santa Clara, California; Raleigh, North Carolina; and Chennai, India. Our research and development expenses in fiscal years 2012 , 2011 and 2010 were $45.6 million , $49.3 million and $49.4 million , respectively.
Intellectual Property
We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. As of June 30, 2012 , the Company has 158 issued patents in the United States and 33 patents outside of the United States. The expiration dates of the Company's issued patents in the United States range from 2017 to approximately 2032 . Although the Company has patent applications pending, there can be no assurance that patents will be issued from pending applications or that claims allowed on any future patents will be sufficiently broad to protect the Company's technology. With respect to trademarks, we have a number of pending and registered trademarks in the United States and abroad.
We enter into confidentiality or license agreements with our employees, consultants and corporate partners, and control access to, and distribution of, our software, documentation and other proprietary information. In addition, we provide our software products to end-user customers primarily under “shrink-wrap” license agreements. These agreements are not negotiated with or signed by the licensee, and thus these agreements may not be enforceable in some jurisdictions. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States.
Environment
We are committed to energy efficiency in our product lines. For example, some of our products consume less power than offerings from our major competitors under normal operations. Accordingly, we believe this is an area that affords us a competitive advantage for our products in the marketplace. We maintain compliance with various regulations related to the environment, including the Waste Electrical and Electronic Equipment and Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment regulations adopted by the European Union. To date, our compliance efforts with various U.S. and foreign regulations related to the environment has not had a material effect on our operating results.
Employees
As of June 30, 2012 , we employed 668 people, including 266 in sales and marketing, 210 in research and development, 74 in operations, 63 in customer support and service, and 55 in finance and administration. We have never had a work stoppage and no U.S. personnel are represented under collective bargaining agreements. We consider our employee relations to be good.
We believe that our future success depends on our continued ability to attract, integrate, retain, train and motivate highly qualified personnel, and upon the continued service of our senior management and key personnel. None of our executive officers or key employees is bound by an employment agreement which mandates that the employee render services for any specific term. The market for qualified personnel is competitive.
Organization
We were incorporated in California in May 1996 and reincorporated in Delaware in March 1999. Our corporate headquarters are located at 3585 Monroe Street, Santa Clara, CA 95051 and our telephone number is (408) 579-2800 . We electronically file our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 with the Securities Exchange Commission. The public can obtain copies of our SEC filings from our website found at www.extremenetworks.com free of charge, or on the Securities Exchange Commission’s website at www.sec.gov. The public may also read or copy any materials we file with the Securities Exchange Commission at the Securities Exchange Commission’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the Securities Exchange Commission at 1-800-SEC-0330 .
Our corporate governance guidelines, the charters of our audit committee, our compensation committee and our nominating and corporate governance committee and our code of ethics policy (including code of ethics provisions that apply to our principal executive officer, principal financial officers, controller and senior financial officers) are available on our website at www.extremenetworks.com under “Corporate Governance.” These items are also available to any stockholder who requests them by calling (408) 579-2800 .
CEO BACKGROUND
Maury Austin . Mr. Austin serves as a strategic advisor for technology-oriented businesses. From March 2008 to December 2011, Mr. Austin served as Chief Financial Officer of MIPS Technologies, Inc., a publicly traded provider of processor architectures and cores for digital home, networking and mobile applications. Mr. Austin previously served as Senior Vice President and Chief Financial Officer of Portal Software, Inc. from June 2005 until its acquisition and integration into Oracle Corporation in November 2006. From 2004 to 2005, Mr. Austin served as Senior Vice President and Chief Financial Officer for Southwall Technologies. Prior to his employment with Southwall Technologies, Inc., Mr. Austin was Senior Vice President and Chief Financial Officer for Vicinity Corporation from 2000 until its acquisition by Microsoft Corporation in 2003. Mr. Austin also has held executive positions at Apple Inc., Symmetricom, Inc., FlashPoint and General Electric Co. Mr. Austin holds a B.S. in Business Administration (Finance & Marketing) from the University of California, Berkeley and an MBA from Santa Clara University.
Mr. Austin, who has more than 25 years of corporate finance experience in senior executive positions at established technology companies, will provide our Board with financial expertise and effective insight into our company and its business.
Oscar Rodriguez . Mr. Rodriguez has served as our President and Chief Executive Officer since August 2010 and as one of our directors since October 2010. From April 2007 to August 2010, Mr. Rodriguez served as a director and the Chief Executive Officer and President of Movius Interactive Corporation, a privately held leader in messaging, collaboration and mobile media solutions for service providers worldwide. Prior to joining Movius, beginning in April 2006, Mr. Rodriguez served as the Vice President of the Carrier Ethernet business and the Chief Marketing Officer of Alcatel-Lucent’s Enterprise Business Group. From August 2003 until April 2006, Mr. Rodriguez served as Chief Executive Officer, President and a director of Riverstone Networks, Inc., a provider of carrier ethernet infrastructure solutions for business and residential communications services, until it was acquired by Lucent Technologies in April 2006. From October 2000 to August 2003, Mr. Rodriguez held various positions at Nortel Networks Corporation, a telecommunications systems company, including as Divisional President, Enterprise Solutions Business; Divisional President, Intelligent Internet Business; and Vice President Portfolio & Operations, Local Internet Business. Mr. Rodriguez sits on the Dean’s Board of Advisors for the College of Engineering at the University of Central Florida. Mr. Rodriguez holds a B.S. in computer engineering from the University of Central Florida and an MBA from the Kenan-Flagler Business School at the University of North Carolina, Chapel Hill.
Mr. Rodriguez has extensive executive experience in the communications technology industry and provides strong financial and operational expertise to our Board. As our current President and Chief Executive Officer, Mr. Rodriguez also provides our Board with important insights about our company and its operations.
Edward B. Meyercord, III . Mr. Meyercord has served as the Chairman of the Board of Directors since March 8, 2011, and as one of directors since October 2009. Mr. Meyercord currently serves as Chief Executive Officer and Director of Critical Alert Systems LLC, a private company that provides wireless communications services, where he has served since July 2010. Prior to Critical Alert Systems, he was the founder and President of Council Rock Advisors LLC, a private company that provides advisory services. From December 2006 until January 2009, Mr. Meyercord served as Chief Executive Officer of Cavalier Telephone & TV, a privately held voice and data services. Prior to the sale to Cavalier Telephone & TV in December 2006, Mr. Meyercord served as Chief Executive Officer and a member of the board of directors of Talk America, Inc., a publicly traded provider of phone and internet services to consumers and small businesses. Mr. Meyercord also serves on the board of directors of Tollgrade. Mr. Meyercord received his bachelor’s degree in Economics from Trinity College in Hartford, CT and his MBA from New York University.
Mr. Meyercord has extensive executive experience in corporate finance, risk assessment and management. His background in the telecommunications industry provides our Board with valuable industry expertise in one of our key markets.
John H. Kispert. Mr. Kispert has served as one of our directors since May 2009. In February 2009, Mr. Kispert was hired to serve as President and Chief Executive Officer of Spansion, Inc., a publicly-traded manufacturer of flash memory products, to oversee that company’s reorganization of its business and is a director of Spansion. From 1995 to February 2009, Mr. Kispert held various executive management positions at KLA-Tencor Corporation, including President and Chief Operation Officer, Executive Vice President and Chief Financial Officer and Vice President, Finance and Accounting. Previously, Mr. Kispert served in a number of positions with the IBM Corporation. Mr. Kispert received his bachelor’s degree in Political Science from Grinnell College and his MBA from the University of California, Los Angeles.
Mr. Kispert has extensive management and leadership experience and provides our Board with technology, leadership and financial expertise that aids our Board in understanding corporate needs and strategic opportunities.
Harry Silverglide . Mr. Silverglide has served as one of our directors since June 2004. From January 1997 to July 2002, Mr. Silverglide served as our Vice President of Sales. From May 1995 to January 1997, he served as Vice President of Western Region Sales for Bay Networks. From July 1994 to May 1995, he served as Vice President of Sales for Centillion Networks, a provider of LAN switching products which was acquired by Bay Networks in 1995.
Mr. Silverglide’s experience, and particularly his extensive experience in sales and sales organizations, including his experience with our sales organization and distribution channels, provides our Board with valuable insight regarding sales management and sales strategy.
MANAGEMENT DISCUSSION FROM LATEST 10K
Business Overview
We develop and sell network infrastructure equipment and offer related services contracts for extended warranty and maintenance to our enterprise, data center and metropolitan telecommunications service provider customers. Substantially all of our revenue is derived from the sale of our networking equipment and related service contracts. In our fiscal year ended June 30, 2012 , our revenue decreased $11.7 million , gross profit decreased $0.1 million , operating profit increased $10.8 million and net income increased $13.2 million as compared to fiscal 2011 .
We believe that understanding the following key developments is helpful to an understanding of our operating results for the fiscal year ended June 30, 2012 .
Impact of the Global Economic Developments
Although our net income and earnings per share both increased in fiscal 2012 , we believe that the credit market crisis, slow economic recovery in the United States, and other challenges affecting global economic conditions placed significant limitations on our financial performance. We operate in three regions: Americas, which includes the United States, Canada, Mexico, Central America and South America; EMEA, which includes Europe, Middle East, and Africa; and APAC which includes Asia Pacific, South Asia and Japan. Sales in the APAC and some European countries were most impacted as a result of the soft global economy and the global credit crisis in the financial market and certain European countries. We believe that limited access to credit, conservative purchasing patterns and delays or cancellation of IT infrastructure plans in the face of continued uncertainty regarding the global economy, may continue to negatively impact overall demand for networking solutions, including Ethernet equipment.
We have taken and plan to continue to take other steps to manage our business in the current economic environment. For example, we have managed from time to time our contingent work force, reduced travel and other discretionary spending, realigned our product portfolio and organization to grow revenue and operating income, and controlled all hiring activities.
Increasing Demand for Bandwidth
We believe that the continued increase in demand for bandwidth will over time drive future demand for high performance Ethernet solutions. Wide-spread adoption of electronic communications in all aspects of our lives, proliferation of next generation converged mobile devices and deployment of triple-play services to residences and businesses alike, continues to generate demand for greater network performance across broader geographic locations. In parallel to these transformational forces within society and the community at large, the accelerating adoption of internet and intranet “cloud” solutions within business enterprises is enabling organizations to offer greater business scalability to improve efficiency and through more effective operations, improve profitability. In order to realize the benefits of these developments, customers require additional bandwidth and high performance from their network infrastructure at affordable prices. We are seeing the initial indications that the Ethernet segment of the networking equipment market will return to growth as enterprise, data center and carrier customers continue to recognize the performance and operating cost benefits of Ethernet technology.
Expanding Product Portfolio
We believe that continued success in our marketplace is dependent upon a variety of factors that includes, but is not limited to, our ability to design, develop and distribute new and enhanced products employing leading-edge technology. During the past year we further extended our Ethernet product portfolio through the addition of the BlackDiamond BD-X, a highly-scalable core switch for IT and cloud data centers, the Summit X440 for the intelligent edge, the Summit X670 for data center top-of-rack deployments, the E4G Cell Site Router family for mobile backhaul, and a revamp of our RidgeLine network management platform
Industry Developments
The market for network infrastructure equipment is highly competitive and dominated by a few large companies. The current economic climate has further driven consolidation of vendors within the Ethernet networking market and with vendors from adjacent markets, including storage, security, wireless and voice applications. We believe that the underpinning technology for all of these adjacent markets is Ethernet. As a result, independent Ethernet switch vendors are being acquired or merged with larger, adjacent market vendors to enable them to deliver complete and broad solutions. As an independent Ethernet switch vendor, we must provide products that, when combined with the products of our large strategic partners, create compelling solutions for end user customers. Our approach is to focus on the intelligence and automation layer that spans our hardware products and that facilitates end-to-end solutions, as opposed to positioning Extreme Networks as a low-cost-vendor with point products. Lower overall market growth has also created an environment of declining margins due to increased competition between the remaining vendors in this space. During the last year, overall Ethernet port counts have grown, while industry revenues have decreased, signaling a decline in average selling price. Our product life cycle and operational cost reduction efforts are therefore even more critical for margin preservation.
Realignment of Corporate Strategies
In fiscal 2011, we commenced a strategy to focus on growing revenue in specific market verticals and on improving operational effectiveness. As part of this corporate realignment we recorded a charge of $1.6 million during the fiscal year ended June 30, 2012.
Amendment to Rights Agreement
On April 26, 2012, our Board of Directors of the Company adopted an Amended and Restated Rights Agreement between Extreme Networks and Computershare Shareholder Services LLC as the rights agent. The Restated Rights Plan governs the terms of each right ( “Right” ) that has been issued with respect to each share of Common Stock of Extreme Networks. Each Right initially represents the right to purchase one one-thousandth of a share of Series A Preferred Stock of Extreme Networks. The Restated Rights Plan replaces in its entirety the Rights Agreement, dated as of April 27, 2001, as amended on June 30, 2010 and April 26, 2011, between Extreme Networks and Mellon Investor services LLC (the “Prior Rights Plan”).
The Board reviewed the necessity of the provision of the Prior Rights Plan adopted to preserve the value of Extreme Networks' deferred tax assets, including its net operating loss carry forwards, with respect to its ability to fully use its tax benefits to offset future income may be limited if it experiences an “ownership change” for purposes of Section 382 of the Internal Revenue Code of 1986 as a result of ordinary buying and selling of Extreme Networks' common stock. Following its review, the Board decided it was necessary and in the best interests of Extreme Networks and its stockholders to enter into the Restated Rights Plan The Restated Rights Plan incorporates the Prior Rights Plan and the amendments thereto into a single agreement and extends the term of the Prior Rights Plan from April 30, 2012 to April 30, 2013.
Sales and Marketing Expenses
Sales and marketing expenses consist of salaries, commissions and related expenses for personnel engaged in marketing and sales functions, as well as trade shows and promotional expenses. Sales and marketing expenses decreased in fiscal 2012 as compared to fiscal 2011 primarily due to $4.5 million reduction in salaries and benefits, $3.5 million reduction in commissions due to lower revenue, $1.7 million less professional fees due to utilization of in-house services, and $1.4 million lesser travel expenses resulting from the reduction in headcount at the beginning of fiscal 2012.
Sales and marketing expenses increased in fiscal 2011 as compared to fiscal 2010 primarily due to $3.2 million higher salary and benefits expense resulting from increased headcount, $2.3 million higher commissions due to increased revenue, and $0.6 million increase in new marketing initiatives to improve brand awareness.
Research and Development Expenses
Research and development expenses consist primarily of salaries and related personnel expenses, consultant fees and prototype expenses related to the design, development, and testing of our products. Research and development expenses decreased in fiscal 2012 as compared to fiscal 2011 primarily due to $3.5 million less in salaries and benefits expense due to a reduction in headcount and a transfer of resources to lower cost regions and $0.9 million less in small equipment expenses due to better utilization of existing test equipment, offset by $0.6 million increase in professional fees related to new product launches.
Research and development expenses remained flat in fiscal 2011 as compared to fiscal 2010 primarily due to a $3.5 million increase in engineering project expenses offset by a $2.4 million decrease in salaries and benefits due to a reduction in headcount, a $0.5 million decrease in professional fees related to development work, and a $0.6 million decrease in stock-based compensation expense.
General and Administrative Expenses
General and administrative expenses increased in fiscal 2012 as compared to fiscal 2011 primarily due to increased legal expense of $2.0 million, increased contract labor expense for accounting and finance of $1.0 million, increased stock based compensation expense of $0.8 million, increased international accounting fees of $0.8 million offset by lower salaries and benefits expense of $0.8 million due to fewer headcount.
General and administrative expenses decreased in fiscal 2011 as compared to fiscal 2010 primarily due to a $1.7 million decrease in litigation expenses.
Restructuring Charge, Net of Reversal
During the fiscal 2012 , 2011 and 2010 , we recorded restructuring charges of $1.6 million , $3.8 million , and $4.2 million , respectively.
Fiscal 2012 Restructuring
During fiscal 2012, we incurred total charges of $2.2 million, including $1.8 million related to severance, $0.1 million of contract termination fees, and $0.2 million other charges. A portion of this restructuring activity is related to the liquidation of our Japan subsidiary with a cost of $0.5 million at June 30, 2012. We substantially liquidated the subsidiary in Japan in the fourth quarter or fiscal 2012, as part of our broad restructuring effort. We will dispose the remaining immaterial assets and liabilities and complete the liquidation process by the end of fiscal 2013.
Fiscal 2011 Restructuring
During fiscal 2011, we commenced a strategy to focus on growing revenue in specific market verticals and on improving operational effectiveness. As part of the strategy, we reduced headcount and incurred total restructuring charges of $4.2 million , of which $1.0 million and $3.2 million were recognized in the third and fourth quarter of fiscal 2011, respectively. During the fourth quarter of fiscal 2011, the lease term for the excess leased facilities ended. We recognized a restructuring reversal of $0.4 million related to the true up of operating and rent expenses.
Fiscal 2010 Restructuring
During fiscal 2010, we incurred charges of $4.6 million related to the restructuring or the organization from a business unit organization to a functional organization. Total termination benefits were $4.1 million. We incurred $0.2 million increase in facilities operating expenses related to one of the facilities; $0.5 million reversal of restructuring expense due to higher projected sublease receipt from sublease renewal arrangement. $0.1 million reversal of restructuring expense related to the settlement of employment termination benefits incurred in the third fiscal quarter of 2009.
Litigation Settlement
During the fourth quarter of fiscal 2012, from a judgment related to our lawsuit with Enterasys Networks for patent infringement, we received $0.6 million from Enterasys including a first trial damage award of $0.2 million, reimbursement of legal costs from the first trial of $0.4 million, and interest.
Interest Income
Interest income was $1.2 million in fiscal 2012 , $1.3 million in fiscal 2011 and $1.5 million in fiscal 2010 , representing a decrease of $0.1 million in fiscal 2012 from fiscal 2011 , and a decrease of $0.2 million in fiscal 2011 from fiscal 2010 . The decrease in interest income in fiscal 2012 from fiscal 2011 was due to a decrease in the average interest yield from 1.2% in fiscal 2011 to 0.95% in fiscal 2012. The decrease in interest income in fiscal 2011 from fiscal 2010 was due to a decrease in the average interest yield from 1.6% in fiscal 2010 to 1.2% in fiscal 2011.
Interest Expense
Interest expense was $0.1 million for each fiscal year 2012 , 2011 and 2010 . Interest expense in fiscal 2012 and fiscal 2011 were primarily related to interest amortization of technology agreements.
Other Income (Expense), net
Other income (expense) net, was income of $2.0 million in fiscal 2012 , expense of $0.6 million in fiscal 2011 and expense of $0.1 million in fiscal 2010 . Other income in fiscal 2012 was primarily comprised of $1.9 million in foreign currency translation gains that were reclassified from other comprehensive income (loss) due to the substantial liquidation of our Japan subsidiary.
Provision (Benefit) for Income Taxes
We recorded an income tax provision of $1.2 million for fiscal 2012. The effective tax rate in fiscal 2012 was 7.0% which differs from the federal statutory tax rate of 35% due primarily to the tax impact of income from foreign operations and the change in valuation allowance. We recorded an income tax provision of $1.2 million for fiscal 2012 due to profits in our foreign subsidiaries, utilization of the US entity's net operating losses, and the release of foreign tax reserves.
The income tax provision of $1.0 million and income tax benefit of $0.4 million for fiscal 2011 and 2010, respectively, were recorded for taxes due on income generated in U.S federal, certain states and foreign tax jurisdictions. The effective tax rate was 26.9% for fiscal 2011 which differs from the federal statutory tax rate of 35% due primarily to the tax impact of income from foreign operations and the change in valuation allowance. The effective tax rate was 223.6% for fiscal 2010 which differs from the federal statutory tax rate of 35% due primarily to the benefit of U.S. net operating losses carry-forwards and the tax impact of income from foreign operations.
Critical Accounting Policies and Estimates
Our significant accounting policies are more fully described in Note 2 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. The preparation of consolidated financial statements in accordance with generally accepted accounting principles requires management to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the period reported. By their nature, these estimates, assumptions and judgments are subject to an inherent degree of uncertainty. We base our estimates, assumptions and judgments on historical experience, market trends and other factors that are believed to be reasonable under the circumstances. Estimates, assumptions and judgments are reviewed on an ongoing basis and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Actual results may differ from these estimates under different assumptions or conditions. We believe the critical accounting policies stated below, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Share-based Payments
We use the Black-Scholes option-pricing model to determine the fair value of option awards, and share purchase options under our Employee Stock Purchase Plan (“ ESPP ”) on the date of grant with the weighted average assumptions. The expected term of options granted is derived from historical data on employee exercise and post-vesting employment termination behavior. The expected term of purchase options under our ESPP represents the contractual life of the ESPP purchase period. The risk-free rate based upon the estimated life of the option and ESPP award is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on both the implied volatilities from traded options on our stock and historical volatility on our stock. We do not currently pay cash dividends on our common stock and do not anticipate doing so in the foreseeable future. Accordingly, our expected dividend yield is zero. We are required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. In fiscal 2012, our estimated forfeiture rates based on historical forfeiture experiences are 7% for executives and 9% for non-executive employees. We use the straight-line method for expense attribution, and we estimate forfeitures and only recognize expense for those shares expected to vest.
Revenue Recognition
We derive the majority of our revenue from sales of our networking equipment, with the remaining revenue generated from service fees relating to maintenance service contracts, professional services, and training for our products. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price of the product is fixed or determinable, and the collection of the sales proceeds is reasonably assured. In instances where any of the criteria for revenue recognition are not met, we defer revenue until all criteria have been met.
Product revenue from our value-added resellers, non-stocking distributors and end-user customers is recognized at the time of shipment, provided that all of the foregoing revenue recognition requirements have been satisfied. We generally do not grant return privileges, except for defective products during the warranty period, nor do we grant pricing credits. Accordingly, we recognize revenue upon transfer of title and risk of loss to the customer, which is generally upon shipment. We maintain estimated accruals and allowances for sales incentives and other programs that we may make available to our partners, based on historical experience or applicable contractual terms. Shipping costs are included in cost of product revenues. Sales taxes collected from customers are excluded from revenues.
We also sell our products to distributors that stock inventory and sell to resellers. We defer recognition of revenue on all sales to our stocking distributors until the distributors have sold the products, as evidenced by sales data that the distributors provide to us. We grant stocking distributors certain price protection rights and the right to return a portion of unsold inventory for the purpose of stock rotation. The distributor-related deferred revenue and receivables are adjusted at the time of the stock rotation return or price reduction. We also provide stocking distributors with credits for changes in selling prices based on competitive conditions, and provide funding for our distributors and their resellers to perform marketing development activities. We maintain estimated accruals and allowances for these exposures based upon our contractual obligations. Our marketing development channel programs do not meet the criteria for recognizing the costs as marketing expenses and therefore these costs are accrued as a reduction to revenue in the same period that the products are sold.
Revenue from service contracts is deferred and recognized ratably over the contractual service period, which is typically from one to two years. Professional service revenue is recognized upon delivery or completion of performance.
Our networking products are tangible products that contain software and non-software components that function together to deliver the tangible product's essential functionality. Our sales arrangements may contain multiple deliverables comprised of our tangible products, standalone software licenses, and service offerings depending on the distribution sales channel through which the products are sold and the requirements of our customers. We recognize revenue for our multiple deliverable arrangements in accordance with the accounting standard for multiple deliverable revenue arrangements, which provides guidance on whether multiple deliverables exist, how deliverables in an arrangement should be separated, and how consideration should be allocated. The industry-specific software revenue recognition guidance generally does not apply to the sales of our tangible products. Software revenue guidance is applied to sales of our standalone software products, including software upgrades and software that is not essential to the functionality of the hardware with which it is sold.
Pursuant to the guidance of the accounting standard for multiple-deliverable revenue arrangements, we allocate the total arrangement consideration to each separable element of an arrangement based on the relative selling price of each element. We determine the standalone selling price for each element based on a selling price hierarchy. Under the selling price hierarchy, the selling price for each deliverable is based on our vendor-specific objective evidence of selling price (“VSOE”), which is determined by a substantial majority of our historical standalone sales transactions for a product or service falling within a reasonable range. If VSOE is not available due to a lack of standalone sales transactions or lack of pricing within a narrow range, then third party evidence (“ TPE ”), as determined by the standalone pricing of competitive vendor products in similar markets, is used. TPE typically is difficult to establish due to the proprietary differences of competitive products and difficulty in obtaining reliable competitive standalone pricing information. When neither VSOE nor TPE is available, we determine the best estimate of standalone selling price (“ ESP ”) for a product or service by considering several factors including, but not limited to, the 12-month historical median sales price, sales channels, geography, gross margin consistency, competitive product pricing, and product life cycle. In consideration of all relevant pricing factors, we apply management judgment to determine the best estimate of selling price through consultation with and formal approval by our management for all products and services for which neither VSOE nor TPE is available. Generally the standalone selling price of services is determined using VSOE and the standalone selling price of all other deliverables is determined by using ESP. We regularly review VSOE, TPE and ESP for all of our products and services and maintain internal controls over the establishment and updates of these estimates.
Pursuant to the software revenue recognition accounting standard, we continue to recognize revenue for software using the residual method for our sales of standalone software products, including optional software upgrades, and other software that is not essential to the functionality of the hardware with which it is sold. After allocation of the relative selling price to each element of the multiple deliverable arrangement, we recognize revenue in accordance with our policies for product, software, and service revenue recognition.
Our total deferred product revenue from customers other than distributors was $2.2 million and $2.0 million as of June 30, 2012 and July 3, 2011 , respectively. Our total deferred revenue for services, primarily from service contracts, was $37.7 million as of June 30, 2012 and $36.0 million as of July 3, 2011 . Service contracts typically range from one to two years. Shipping costs are included in cost of product revenues.
We provide an allowance for sales returns based on our historical returns, analysis of credit memo data and our return policies. The allowance for sales returns was $1.3 million and $0.6 million as of June 30, 2012 and July 3, 2011 , respectively, for estimated future returns that were recorded as a reduction of our accounts receivable. If the historical data that we use to calculate the estimated sales returns and allowances does not properly reflect future levels of product returns, these estimates will be revised, thus resulting in an impact on future net revenue. We estimate and adjust this allowance at each balance sheet date.
Inventory Valuation
Our inventory balance was $26.6 million as of June 30, 2012 , compared with $21.6 million as of July 3, 2011 . We value our inventory at lower of cost or market. Cost is computed using standard cost, which approximates actual cost, on a first-in, first-out basis. We provide inventory allowances based on excess and obsolete inventories determined primarily by the age of inventory. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Any written down or obsolete inventory subsequently sold has not had a material impact on gross margin for any of the periods disclosed. Inventory write-downs charged to cost of product revenue were $1.1 million in fiscal 2012 , $2.2 million in fiscal 2011 and $1.9 million in fiscal 2010 .
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Business Overview
We are a leading provider of network infrastructure equipment and services for enterprises, data centers, and service providers. We were incorporated in California in May 1996 and reincorporated in Delaware in March 1999. Our corporate headquarters are located in Santa Clara, California. We develop and sell network infrastructure equipment to our enterprise, data center and telecommunications service provider customers.
We conduct our sales and marketing activities on a worldwide basis through a distribution channel utilizing distributors, resellers and our field sales organization. We primarily sell our products through an ecosystem of channel partners who combine our Ethernet products with their offerings to create compelling information technology solutions for end user customers. We utilize our field sales organization to support our channel partners and to sell direct to end-user customers, including some large global accounts. Our customers include businesses, hospitals, schools, hotels, telecommunications companies and government agencies around the world.
We outsource the majority of our manufacturing and supply chain management operations as part of our strategy to maintain global manufacturing capabilities and to reduce our costs. We conduct quality assurance, manufacturing engineering, document control and test development at our main campus in Santa Clara, California. This approach enables us to reduce fixed costs and to flexibly respond to changes in market demand
The market for network infrastructure equipment is highly competitive and dominated by a few large companies. The current economic climate has further driven consolidation of vendors within the Ethernet networking market and with vendors from adjacent markets, including storage, security, wireless and voice applications. We believe that the underpinning technology for all of these adjacent markets is Ethernet. As a result, independent Ethernet switch vendors are being acquired or merged with larger, adjacent market vendors to enable them to deliver complete and broad solutions. As a result, we believe that, as an independent Ethernet switch vendor, we must provide products that, when combined with the products of our large strategic partners, create compelling solutions for end user customers. Our approach is to focus on the intelligence and automation layer that spans our hardware products and that facilitates end-to-end solutions, as opposed to positioning Extreme Networks as a low-cost-vendor with point products.
We believe that continued success in our marketplace is dependent upon a variety of factors that includes, but is not limited to, our ability to design, develop and distribute new and enhanced products employing leading-edge technology. In the third quarter of fiscal 2012, we saw the first revenue shipments of the BD-X, the E4G and our Summit X-440 product line. All three of these product lines are based on our new Extreme XOS 15.1 operating system.
Sales and Marketing Expenses
Sales and marketing expenses consist of salaries, commissions and related expenses for personnel engaged in marketing and sales functions, as well as trade shows and promotional expenses. Sales and marketing expenses in the three months ended April 1, 2012 decreased by $4.2 million , or 17% , compared to the corresponding period of fiscal 2011. The decrease in sales and marketing expenses was primarily due to a decrease of $1.1 million in employee-related expenses and a decrease of $1.4 million in commission expense. Other significant decreases in the third quarter primarily reflected the effects of cost-cutting measures, including a decrease of $0.4 million in IT expenses and a combined decrease of approximately $1.0 million in professional services, supplies, and travel expenses.
Sales and marketing expenses for the nine months ended April 1, 2012 decreased by $9.3 million , or 12% , compared to the corresponding period of fiscal 2011. The decrease in sales and marketing expenses was primarily due to a decrease of $2.6 million in employee-related expenses resulting from headcount reduction and a decrease of $2.4 million in commission expense due to the combined impact of headcount reduction and lower revenue. Other significant decreases in sales and marketing expenses in the nine months April 1, 2012, included a decrease of $1.3 million in professional fees, a decrease of $1.0 million in IT expenses, and a decrease of $0.9 million in both travel supplies expenses.
Research and Development Expenses
Research and development expenses consist primarily of salaries and related personnel expenses, consultant fees and prototype expenses related to the design, development, and testing of our products. Research and development expenses for the three months ended April 1, 2012 decreased by $0.9 million , or 8% , compared to the corresponding period of fiscal 2011. The decrease in research and development expenses was primarily due to a decrease in employee-related costs resulting from headcount reduction.
Research and development expenses for the nine months ended April 1, 2012 decreased by $2.3 million , or 6% , compared to the corresponding period of fiscal 2011. The decrease in research and development expenses was primarily due to a decrease of $2.8 million in employee-related costs, partially offset by increases in various other expenses, the most significant of which was a combined decrease of approximately $1.0 million in engineering project expenses and professional fees.
General and Administrative Expenses
General and administrative expenses for the three months ended April 1, 2012 increased by $1.5 million , or 25% , compared to the corresponding period of fiscal 2011. The increase in general and administrative expenses was primarily due to a combined increase of $1.5 million in legal expenses and professional fees.
General and administrative expenses for the nine months ended April 1, 2012 increased by $3.2 million , or 17% , compared to the corresponding period of fiscal 2011. The increase in general and administrative expenses was primarily due to an increase of $1.6 million in professional fees, and an increase of $2.3 million in legal-related expenses, partially offset by a net decrease of $1.2 million in employee costs.
Restructuring, Net
Beginning in the third quarter of fiscal 2011, we implemented several restructuring initiative, involving among other things, a reduction of our worldwide workforce. The associated restructuring costs primarily consisted of cash severance, contract termination costs and other termination benefits. Restructuring charges was insignificant in the three months ended April 1, 2012 and $1.4 million in the first nine months of fiscal 2012. In connection with the ongoing restructuring activities, we are in the process of closing certain of our foreign offices which may result in a decision to eliminate certain legal entities. To the extent we liquidate or substantially liquidate those entities, any amount of foreign currency cumulative translation adjustments recognized in accumulated other comprehensive income (loss) would be required to be recognized in our statement of operations. As of April 1, 2012, the amount of that potential gain recognition is approximately $1.6 million. As of April 1, 2012, we had $0.7 million of restructuring liabilities remaining, which we anticipate paying by the first quarter of fiscal 2013.
Interest Income
The change in interest income in the three and nine months ended April 1, 2012 , compared to the corresponding period of fiscal 2011 was insignificant.
Interest Expense
The decrease in interest expense in both the three and nine months ended April 1, 2012 , compared to the corresponding period of fiscal 2011 was insignificant.
Other Income / (Expense), Net
Other expense, net decreased by approximately $0.1 million in the third quarter of fiscal 2012, and decreased by $0.3 million in the nine months ended April 1, 2012 compared to the corresponding periods of fiscal 2011. The changes in other income and expense primarily resulted from net realized and unrealized gains and losses from the revaluation of certain assets and liabilities denominated in foreign currencies into U.S. dollars.
Provision (Benefit) for Income Taxes
We recorded an income tax provision of $0.5 million and $0.4 million for the three months ended April 1, 2012 and March 27, 2011, respectively. We recorded an income tax provision of $1.2 million and $0.8 million for the nine months ended April 1, 2012 and March 27, 2011, respectively. The income tax provision for the three months ended April 1, 2012 consisted primarily of taxes on foreign income and U.S. state income taxes. The income tax provision for the three months ended March 27, 2011 consisted primarily of taxes on foreign income and U.S. state income taxes. The income tax provision for the nine months ended April 1, 2012 consisted primarily of taxes on foreign income and U.S. state income taxes, partially offset by a benefit for the release of an unrecognized tax benefit due to the expiration of the statute of limitations. The income tax provision for the nine months ended March 27, 2011 consisted primarily of taxes on foreign income and U.S. state income taxes, partially offset by a reversal of previously recorded deferred tax liabilities. The income tax provisions for both fiscal years were calculated based on the results of operations for the three and nine month periods ended April 1, 2012 and March 27, 2011, and may not reflect the annual effective rate.
We have provided a full valuation allowance for our U.S. net deferred tax assets after assessing both negative and positive evidence when measuring the need for a valuation allowance. For the current quarter, evidence such as operating losses during the most recent three-year period was given more weight than our expectations of future profitability which are inherently uncertain. Accordingly, we believe that there is sufficient negative evidence to maintain a full valuation allowance against our U.S. federal and state net deferred tax assets. This valuation allowance will be evaluated periodically and can be reversed partially or totally if business results have sufficiently improved to support realization of our U.S. deferred tax assets.
Critical Accounting Policies and Estimates
Our unaudited condensed consolidated financial statements and the related notes included elsewhere in this report are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these unaudited condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. On an ongoing basis, we evaluate our estimates and assumptions. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.
CONF CALL
John T. Kurtzweil - Chief Financial Officer and Senior Vice President
Thank you, Michelle. Welcome to the Extreme Networks 2012 Fourth Quarter Conference Call. On the call with me today, from Extreme Networks, is Oscar Rodriguez, President and CEO. This conference call is being broadcast live over the Internet and will be posted on Extreme Networks' website for replay shortly after the conclusion of the call, and will remain available through August 10, 2012, and is being recorded on behalf of the company. 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.
This afternoon, Extreme Networks issued a press release announcing the company's financial results for the fourth quarter and total year of fiscal 2012. A copy of the release and the slide presentation of the supporting financial materials are available in the Investor Relations section of the company's website at www.extremenetworks.com.
This conference call contains forward-looking statements that involve risks and uncertainties, including statements regarding the company's expectations regarding its financial performance, strategies, growth of customer demand, development of new products, customer acceptance of the company's products, customer buying patterns, spending patterns, and overall trends in the economic conditions in the company's markets.
Actual results could differ materially from these projected and in the forward-looking statements as a result of certain risk factors, including, but not limited to, a challenging macroeconomic 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, including the company's cost restructuring efforts; the possibility that the company might experience delays in the development of new technologies and products; customer response to its new technologies and products; the timing of any recovery in the global economy; risks related to pending or future of 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.
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 some financial metrics that were derived in accordance with Generally Accepted Accounting Principles or GAAP, while 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 a supplement to, and not a substitute for, financial statements prepared in accordance with GAAP. A reconciliation of the non-GAAP information to the corresponding GAAP measures is in the slide presentation under the Investor Relations tab on our website and accompanying our press release.
Non-GAAP results exclude stock-based compensation, restructuring charges and litigation settlements.
After I review our fiscal Q4 financial results, I will turn the call over to Oscar for an update on the business and our strategy. We will then open up the call for Q&A.
Q4 fiscal 2012 revenue was $87.6 million, which was up $14.3 million or 19% sequentially from Q3, and within the guidance provided early in the quarter of $82 million to $90 million. Product revenue was $72.5 million, an increase of $14.5 million sequentially, and service revenue was $15.1 million, a decrease of $0.3 million sequentially.
The Americas revenue was $38.2 million and is down 10% from Q4 FY '11. Sequentially, The Americas increased 29%, more than making back the decline in Q3 from Q2. The Americas were our strongest performing region this fiscal year despite customer delays in some North American opportunities.
EMEA revenue was $36.9 million, which grew 13% over Q4 FY '11. On a quarter-over-quarter basis, EMEA increased by 17%.
Asia Pacific revenue was $12.5 million and decreased by 16% compared to the year-ago quarter. Asia Pacific revenue increased sequentially from Q3 FY '12 by 3%. During the quarter, we added new sales leadership in our Asia Pacific team, and we are hiring new account managers and sales engineers in various locations in the region and are already seeing increased quoting activity.
Overall GAAP and non-GAAP gross margins were 56%, a slight decline from the third fiscal quarter of 56.4%. Product gross margin percentage dropped slightly sequentially, primarily due to a higher mix of campus edge products in a one-off strategic deal. We believe our new products for the data center and supply chain cost reductions will positively impact gross margins moving forward.
GAAP operating expenses increased by $4.8 million in Q4 from Q3, and non-GAAP operating expenses increased in Q4 by $4.6 million from Q3 FY '12 to $41.9 million. The 2 primary areas that contributed to this increase in expenses were: Higher sales commissions expense in that sales area related to increased revenue; and higher R&D program expense related to the release of some of our new products that Oscar will talk about in a few minutes.
Litigation expense was essentially flat and the remainder of G&A was down approximately $0.7 million.
Fourth quarter GAAP operating income was $5.4 million and non-GAAP operating income was $7.1 million or 8.1% of net revenue. Non-GAAP operating income increased sequentially from $4.1 million or 5.6% in Q3 FY '12. This was a result of the leverage in the P&L due to cost reduction efforts and the variable component of expenses that scaled with revenue.
GAAP EPS for Q4 FY '12 was $0.08 per share versus $0.03 per share in the third fiscal quarter, and a loss of $0.02 a share in the fourth quarter of fiscal 2011. Non-GAAP EPS for Q4 FY '12 was $0.08 a share versus $0.04 per share in the third fiscal quarter, and $0.02 a share in the fourth quarter of fiscal 2011.
We have now achieved 5 consecutive quarters of positive non-GAAP earnings per share, due primarily to our improvement in operational efficiencies and cost reductions.
Turning to the balance sheet. Total cash and investments for the quarter increased $6.3 million to $153.5 million. Accounts receivable decreased $4.5 million in Q4 and DSO decreased from 57 days in Q3 to 42 days in Q4. Inventory increased by $3.3 million to $26.6 million as we added inventory related to the product launches of the BDX8, E4G and Summit X440 products. Despite the increase in inventory, days of inventory decreased by 6 days to 72 days of inventory.
At this point, I'll turn the call over to Oscar for his comments on recent customer wins with our new products and other market highlights. Oscar?
Juan Oscar Rodriguez - Chief Executive Officer, President and Director
Thank you, John, and I want to thank all our investors for joining this call.
Fiscal 2012 has been a significant transformation year for Extreme. We have adjusted our cost structures with the expectations of increasing operating income as we grow revenue, and we have focused our marketing to drive higher levels of customer and market awareness to position Extreme as a leading competitor in specific high-growth market verticals.
We've delivered a new award-winning products that we believe are best of breed for the markets that they serve. We believe that the combination -- a combined effects of our refreshed products, increased awareness and reduced cost structure, combined with more recent efforts to retool our sales force to attack new and larger opportunities, will enable Extreme to drive revenue and market share growth and increasing free cash flow.
We have now delivered on 5 quarters of non-GAAP operating profitability, with year-over-year growth of approximately 190% in EPS and FY '12. We're now focused on adding new experience and skill to our sales teams worldwide to successfully address larger, more complex data center and cloud opportunities.
In support of this, the quarter -- in the quarter, we added new sales leadership in our Asia Pacific team, and we are hiring additional account managers and sales engineers in various locations in the region. We have also established a data center sales team in North America and are in the process of adding a similar team in EMEA. We hired an experienced leader of global channels and have now consolidated our global channel attack to drive better partner intimacy and focus. We have also adjusted our sales commission and compensation structure to drive a clear focus on increasing new customer wins, and we expect this to increase our ability to gain market share.
Finally, we're in the process of hiring a new head of worldwide sales and we expect this role to be filled by the end of the current quarter.
During the last 2 quarters, we successfully delivered the BlackDiamond X8 switch, which is part of our open fabric product family and is the highest density cloud scale data center aggregation chassis available in the market. We have delivered a 4G-ready cell site router with the E4G product line and delivered a new line of intelligent mobile had stackable switches with the Summit X440 portfolio. These products were all introduced on time and are exhibiting high quality and performance, and we are pleased with the initial market traction they are receiving.
In FY '12, we experienced growth in 10-gig ports of 146% over FY '11. With the market for 10-gig Ethernet estimated by Dell'Oro to grow at 66% in calendar '12, we believe we are growing significantly faster than the market for 10 gigabit technology. With this new product portfolio, we expect to grow both the 10 gig and the 40-gig markets are faster than the market in FY '13.
During our -- turning now to our vertical market attack, we continue to see our focused market attack to drive increased penetration in our selected market verticals payout. During Q4, the rolling 4 quarter percentage of sales into our targeted market verticals is 30% on the strength of strong education and mobile service provider sales.
In the data center and cloud vertical, we continue to gain initial traction for the BlackDiamond X8 across key markets that included both Internet exchanges and high-performance computing.
As I mentioned last quarter, we recently deployed the BDX8 at the London Internet Exchange, which is the fourth largest IXP in the world, and which are significantly -- recently upgraded their network with the BDX8 product in preparation for the Olympic Games. In addition, we're in the process of deploying the BDX8 products at 2 other Tier 1 Internet exchanges in Europe.
High-performance computing is in adjacent market with requirements that demand cloud-scale networking solutions. In Q4, HPC wins included one of the largest global reserve oil companies located in the Middle East, which deployed their first fully loaded 40-gig BDX8 open fabric solution. We also deployed of a BDX8 at a large U.S.-based international semiconductor manufacturer and Extreme switching is now deployed in critical networks in 23 of the top 25 semiconductor companies in the world.
We also had a major financial institution in Brazil select the BDX8 for their sizeable network data center deployment. This is the key data center win against some of our largest competitors and reaffirms the competitiveness of our open fabric solution. Other data center wins also included multi-tenant cloud deployments at Uber, a leading cloud hosting services company in Australia, and a private data center deployment at O'Reilly Auto Parts here in the U.S.
During the quarter, we also introduced our software-defined network strategy, building upon our open fabric data center architecture and our Extreme XOS network operating system. Extreme has been delivered SDN-like solutions for over 5 years, leveraging Extreme XOS programmability. We view SDN as a key long-term investment and expect SDN solutions will be deployed in phases based on customer business requirements. We intend to take a leading role in the SDN market and we have augmented our investments in open flow and open stack to set the stage for future deployments. The investment protection and interoperability offered by our SDN approach has received positive coverage by the analyst community.
During the quarter, we announced key ecosystem relationships designed to enable us to realize increasing market and customer access for the data center and cloud vertical. The first 2 announcements in this space include a joint marketing and technology interoperability agreement with Fortinet for deployment of cloud-scale virtualized firewalls in support of managed multi-tenant data centers, and a similar agreement with QLogic, a leader in fiber channel technology, which provides us with new key Ethernet to fiber channel storage area gateway to functionality.
We also announced investments in our interoperability with NEC in support of their SDN open flow-based controller products. We anticipate expanding our ecosystem architectures in the coming quarters and expand upon this.
Our focused data center investments are continuing to gain traction and industry's recognition. In May, a 2012 Infonetics report placed Extreme Networks as a top 5 vendor in the 10 gigabit Ethernet market along with Cisco, HP, Dell and IBM. In the 40-gig market, we are ranked as the top 4 vendor along with Cisco, IBM and Juniper.
Analyst firm Crehan Research has placed Extreme as the #1 vendor in 40-gig modular shipments and revenue, and noted that Extreme had experienced the highest growth rate for 10 gigabit Top of Rack switch adoption during the quarter ending March 2012.
In April, a Morgan Stanley report recognized our growing momentum in Ethernet switching, and in the same month, Info-Tech Research rated Extreme as a differentiated campus innovator.
Our new BlackDiamond X8 has now received awards from ZDNet in China and also from Network Computing in the U.K.
Turning now to the education market, we experienced solid growth in education momentum, both in support of K-2 to 12 in higher education, where we grew revenues by 50% in Q4 as compared to our Q3 quarter.
During -- our new Summit X440 products, which became available in Q3 and Q4, saw significant campus education sales momentum above our initial projections. The very quick adoption of the X440 reaffirms our belief that this portfolio offers a key price performance advantage at the new mobile edge and will serve to improve company product margins in the coming quarters.
Notable education wins included Xanka [ph] University in China, which is using our switches for their new 10 gigabit backbone, the Instituto Salvadoreño de Bien in El Salvador, and the Institute of Chartered Financial Analysts in India, and the new College of Durham in the United Kingdom, which was a competitive win against the incumbent Cisco. And in Russia, we began a combined wired and wireless LAN deployment at the Kazan Federal University. Other campus wins included Imagination Technologies in the U.K., which is a chip designer for mobile devices, where we won a LAN refresh versus Cisco and HP based on long-term CCO value, as well as performance, scalability and redundancy. And in Belarus, a network upgrade at the Belarusian Potash Company also was won against Cisco and HP.
Setting the stage for future enterprise growth at the recent Communication Trade Show in Singapore, we launched the next phase of our "Bring Your Own Device" or BYOD strategy, which builds upon our Intelligent Mobile Edge announcement of the previous quarter. We also recently deployed a complete wired and wireless solution at JW Pharmaceutical, which is one of the top 3 pharmaceutical companies in Korea. Extending our campus portfolio, we recently conducted a major interoperability demonstration of the new Audio Video Bridging standard. The new AVB protocol sets the stage for professional audio/video markets to adopt Ethernet as a common transport much like what is already happening with data and storage in the data center.
At a recent InfoComm industry trade show, Extreme switches were used to interconnect Pro A/V vendors including Bosch, Harman and Yamaha. And the Extreme AVB switch solution leverages our network timing and resiliency expertise, and we believe we'll position Extreme to gain market share in this high-growth market. In the mobility vertical, we continue to experience strong mobile service provider traction during the quarter through our NEP partners based on continued global 3G and LTE deployments.
During Q3, we began shipping our E4G Cell Site Router, and in May, we announced deployment at PEG Bandwidth, a leading national provider of 4G mobile backhaul infrastructure services for carriers, which offers wholesale cell site backhaul services, metro transport solutions and long-haul transport services to multiple carriers in the U.S. This solution, based on the combined Extreme Networks and Equinix optical offering, provides PEG with a cost-effective and high-performance mobility backhaul and connectivity service network.
In addition, we also deployed mobility solutions at the service provider Ufanet in Russia, who are using our switching products for 10 gigabit aggregation, and we expanded our deployments of Tier 1 service provider SingTel for their carrier service network deployments in Singapore.
In summary, Extreme has now completed the company-wide transformational cost structure changes we planned for FY '12. We've released new award-winning products with features that address our targeted market verticals in large high-growth markets, and we continue to build the customer awareness needed to enable our increased participation in customer deals for key vertical markets. We are now focusing our sales attack for revenue growth, which we believe we can increase leverage to the bottom line and the drive free cash flow in FY '13. I look forward to updating you all in our progress over the coming year.
And now I'll turn the call back over to John for guidance in Q1. John?
John T. Kurtzweil - Chief Financial Officer and Senior Vice President
Thank you, Oscar. We target our first fiscal quarter of 2013 revenue will be in the range of $75 million to $82 million. This is a sequentially down quarter, and we have taken into account the seasonally weak period, the macroeconomic weakness being seen in the industry, as well as the fact that EMEA is now in the midst of their summer holiday season. We have also taken the conservative view of Asia Pacific given the recent management changes in that expected time for new staff to join and ramp to full productivity.
We also target that our GAAP EPS will be breakeven to $0.03 a share and non-GAAP EPS for Q4 will be in the range of $0.01 to $0.05 per share. As a reminder, non-GAAP results exclude stock-based compensation, restructuring charges and litigation settlements. We will now open the call for questions. Michelle, you can start the polling, please.
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Fund Letters
