John T. Kurtzweil - Chief Financial Officer and Senior Vice President Juan Oscar Rodriguez - Chief Executive Officer, President and Director

Jonathan Kees - Capstone Investments, Research Division Christian D. Schwab - Craig-Hallum Capital Group LLC, Research Division Rohit N.

Chopra - Wedbush Securities Inc., Research Division

Thank you. Welcome to the Extreme Networks Fiscal 2013 First 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 the Extreme Networks website for replay shortly after the conclusion of the call, and will remain available for the next 7 days, and is being recorded on behalf of the company.

The presentations and the recording of this call are copyrighted material 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 first quarter of fiscal 2013.

A copy of the release and supporting financial materials are available on the Investor Relations section of the company's website at www.extremenetworks.com. This conference call contains forward-looking statements and 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, and spending patterns in overall trends in economic conditions in the company's markets.

Actual results could differ materially from these projected in the forward-looking statements as a result of certain risk factors, including, but not limited to, a challenging macroeconomic environment worldwide; fluctuations in 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 technology and products; the timing of any recovery in the global economy; risks related to pending or future litigation; and the dependency on third parties for certain components and for the manufacturing of our company's products. The company undertakes no obligation to update information on the conference call.

More information about potential factors that affect our business and financial results is included in the company's filings with the Securities and Exchange Commission. Throughout the conference call, the company will reference some financial metrics that are 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 at www.extremenetworks.com and accompanying our press release.

Non-GAAP results exclude stock-based compensation, restructuring charges and the gain on the sale of the facilities in Santa Clara. After a short review of our fiscal Q1 financial results, I will turn the call over to Oscar for an update on the business and our strategies.

I will return to provide our financial targets for our fiscal Q2, and then we will open the call for Q&A. Q1 fiscal 2013 revenue of $76.1 million was within our target of $75 million to $82 million.

It was down $11.5 million or 13% sequentially from Q4, and down by $2.8 million year-over-year. Product revenue was $61.1 million, a decrease of $11.4 million sequentially, and services revenue was $15 million, a decrease of $0.1 million sequentially.

The Americas revenue was $35 million and is down 9% from Q4 FY '12. The Americas continued to be our strongest performing region despite customer delays in some North American opportunities.

EMEA revenue was $28.5 million, and is down 23% over Q4 FY '12. This seasonally weak period in the EU due to the summer holiday season was taken into account when we provided our targets, as well as the macroeconomic weakness being seen in the region.

Asia-Pacific revenue was $12.6 million and was flat sequentially from Q4 FY '12. The new sales leadership in our Asia-Pacific team has begun to stabilize the region.

Overall GAAP and non-GAAP gross margins were 53%, a decline from the fourth fiscal quarter of 56%. Product gross margins dropped sequentially, primarily due to a $1.5 million excess in obsolete inventory write-off and a one-off strategic deal.

GAAP operating expenses decreased by $17 million in Q1 from Q4, and was favorably impacted by $11.6 million from the sale of the land and buildings in Santa Clara in September. R&D was down $1.2 million due to program timing, and sales and marketing was down related to lower commissions related to the sequential decline in revenue.

SG&A was down due to lower bonus accrual and a one-time property tax refund. Non-GAAP operating expense decreased in Q1 by $5.8 million from Q4 to $36.1 million.

Non-GAAP expenses do not include the gain on the sale of the Santa Clara land and buildings. It does not include $1.3 million of stock-based compensation expense or the restructuring credit.

First quarter GAAP operating income was $13.6 million and non-GAAP operating income was $4.2 million or 5.5% of net revenue. Non-GAAP operating income decreased sequentially from $7.1 million or 8.1% in Q4.

Other income and expense for the first fiscal quarter of 2013 was negatively impacted by $0.3 million due to foreign currency losses, and taxes were $0.6 million, primarily related to our foreign income. GAAP EPS for Q1 was $0.14 per share versus $0.08 per share in the fourth fiscal quarter of 2012, and $0.02 a share from the first quarter of fiscal 2012.

Non-GAAP EPS for Q1 was $0.04 and within our target of $0.02 to $0.05 a share versus $0.08 per share in the fourth fiscal quarter, and $0.05 a share in the first quarter of fiscal 2012. Turning to the balance sheet.

Total cash and investments for the quarter increased $49.1 million to $202.6 million. The cash increase includes $42.7 million from the sale of the Santa Clara land and building, plus $5.5 million of free cash flow.

Earlier this month, we announced a $75 million share repurchase plan, which represents the initial capital authorization for the next 3 years, and will be reviewed at least annually by the Board of Directors. This will be funded from cash on hand.

The share repurchase plan implementation is targeted to maintain the value of our deferred tax assets. Because of this, it is currently expected that purchases will occur unevenly over the 3-year period.

The repurchase program may be suspended or discontinued at any time. Any repurchased shares will be canceled and will not be available for future corporate purposes.

Accounts receivable decreased $6.5 million in Q1 and DSO decreased by 1 day to 41 days from Q4. Inventory decreased by $3.9 million to $22.8 million, and days of inventory decreased by 15 days to 57 days of inventory.

At this point, I'll turn the call over to Oscar.

Thank you, John, and I want to thank all of our investors for joining this call. Over the course of the past 5 quarters, we have taken specific steps which we believe will position Extreme to deliver increased shareholder value.

We have delivered new award-winning products that we believe are best of breed for the markets they serve, 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 vertical markets. In fiscal 2012, we adjusted our cost structures to enable us to deliver increased operating income without revenue growth.

In Q1 of fiscal '13, we took steps to retool our sales force and add new sales leadership, which will result in an increase to our sales expense. As we progress into fiscal 2013, we continue to review our cost structures and align to the current global economic environment.

We are refining our cost structures in Q2, and we expect to reestablish our business model to drive 10% operating income at revenue levels in the low-80s. Beyond the focus on controlling our cost structures, we are focused on driving revenue and market share growth, and we believe that these combined efforts will enable us to drive increased operating income and cash flow.

While we were able to meet our guidance for the first quarter of fiscal 2013, I want all of our investors to know that I am not pleased with our revenue performance, and we are taking steps to improve sales productivity. With new leadership and sales staff in place, we are identifying areas of low performance, and we are taking steps to improve sales velocity and reduce cost where appropriate.

In the quarter, we added new experience and sales leadership to our teams to successfully address larger more complex data center and cloud opportunities. In support of this, during the quarter, we added new data center specific sales staff in North America and Europe, and we hired experienced channel leadership in these geos.

In the last week of the quarter, we added Nancy Shemwell as our new EVP of Global Sales, and she hit the ground running as a key part of our executive team this month. On the product front, Extreme continues to focus our engineering investment in what we believe are key leading market technologies, resulting in increased market share.

As an example, over the past 12 months, our 10 Gigabit Ethernet port bookings increased by 180%, more than double the industry average. The growth in 40-gig port bookings also reflected this trend, and we booked over 1,000 ports for the first time during the quarter, although this is still an early market.

The growth in 10-gig and 40-gig technologies, based on product deployments in mobility, enterprise and cloud customers included shipments of key data center products like our flagship product, the BlackDiamond X8 and the X670 top-of-rack switch. Current Extreme customers deploying the BDX8 for the first time included O'Reilly Auto Parts and e-research [ph], both in North America, and a high-performance computing win at the European Synchrotron Radiation Facility in France.

We also deployed these open fabric products at SRCE which is the computing center at the University of Zagreb in Croatia. The SRCE win was notable in that the customer selected our products for both high-performance computing, as well as cloud services, and in that it was a solid win against established competitors, Cisco and Juniper, and a start up newcomer, Arista.

In Asia, Samsung Electronics, a long time Extreme customer is deploying the BDX8 amongst a host of other equipment as a part of their new RFI research and development facility. To drive increased market awareness and grow sales pipelines, we have launched key marketing programs and expanded our technical industry interoperability.

In both Europe and North America, we have launched lead generation programs designed to drive customer awareness and overall corporate visibility. In North America, we launched a mobile Executive Briefing Center that is partially funded by our select channel partners and will be on the road for the next year bringing products and solutions demonstrations directly to local customer venues.

To further grow our data center business, we are taking solutions-based approaches that includes building interoperability, proven with some the most notable technology leaders in this space. During the quarter, we achieved certification to connect what is known as the Vblock solution, brought to market by VCE, the Virtual Computing Environment.

VCE consists of Cisco, EMC, VMware, and we are the first Ethernet switch that may connect to the Vblock data replication and disaster recovery applications. And in addition to several industry recognitions we received earlier in this year, this week, we announced that CRN Magazine has awarded us the 2012 Tech Innovator of the Year in Enterprise Networking award for the BlackDiamond X8.

We believe the many accolades received this year for our products and innovation will generate increased awareness with channel partners and customers alike. In the quarter, we also announced key offerings to establish our market position in software defined networks.

Our early BDX wins, solutions focus, and our SDN thought leadership is beginning to pay off in the quantity and quality of customer proposals we're requested to bid, and also corresponds to the awareness increase by Fortune 500 CIOs as noted by recent independent surveys. And in our recent report on SDN, Infonetics cited Extreme as one of the top 3 vendors driving SDN solutions awareness for enterprise IT customers, along with Cisco and Dell.

We expect these trends should have a positive impact on our pipelines and revenue in fiscal '13. Also in the United States, we announced a partnership with US-Ignite, a U.S.

global and government initiative, designed to bring new and innovative applications based on high-speed connectivity to communities both large and small. US-Ignite is focusing their work on software defined networking, an area in which we've invested for over the past 18 months, and an architecture which we believe we have a first-mover advantage in based on the flexibility of our XOS network operating system, our unique hardware platform designs, and our focus on interoperability and open standards.

We believe strongly that SDN, rather than completely commoditizing switching, will require high-performance operating systems, a high performance hardware set and even closer links amongst the applications and controllers. In the quarter, we announced SDN partners in this space, including application controller vendors Big Switch and NEC.

We continue to invest approximately 60% of our R&D budget into development of data center and SDN products, and we expect data center sales to increase our average deal size, increase the product margins and drive greater revenue growth. Turning now to geographic performance in what proved to be a challenging quarter in some regions, we were nonetheless able to demonstrate profitability and growth in ports shipped.

Although we are seeing some weakness in Western Europe due to decreased customer demand, both Asia-Pacific and North America delivered year-over-year growth. Eastern Europe, Russia, Latin America all continued to exhibit strength in product sales, and emerging markets have recently been a catalyst for our growth.

Brazil continues to show strength in this quarter as well. We believe the demand for Ethernet infrastructure minimizes customer total cost of ownership and maximizes productivity through services convergence, and is a key ingredient to productivity growth in emerging markets.

On the competitive front, we continue to win against larger competitors. In the quarter, we realized competitive wins in data center and campus deployments.

We are beginning to experience larger deal sizes in the data center, and we expect this trend to continue. In the campus edge, the new SummitX440 product line, which we introduced in the spring, delivers a highly competitive campus edge product set.

These products were recently verified by the Tolly Group as a top performer at the network edge based on key features, including network intelligence and identity management, line break performance and lower power consumption. While we are beginning to see increased price pressure with the traditional premium competitors now aggressively seeking revenue growth, we expect that our continued focus on cost reduction will help us maintain our price competitiveness in the campus edge, while we work to expand our data center revenue sales.

Focusing on vertical markets. In Q1, we won a significant data center deal at Kaisha [ph], one of Brazil's leading financial institutions.

This was a hard won success against Cisco and is a key deployment for our flagship product, BDX8. In the U.K., we deployed for the first time at Infinity STC, another major data center.

We also are beginning a new deployment at a major institution in Japan, in conjunction with a new partner, and we are pleased that our new sales formation in the country is beginning to take hold. Turning to the education vertical, our wins included deployments at Rosemont, Cedar Cliff local schools, and New Ulm Schools all in the United States.

We also had combined wired and wireless LAN wins in EMEA, which included the King's School in the U.K., where the competition included Cisco and HP. Other campus wins included Music, a hospitality deployment in Mexico, and Arctic Cat in the United States.

In Russia, our switches are now -- now support the national blood donation services of the Federal Medical-Biological Agency, and we have also deployed our hardware in Sochi in the support of the 2014 Winter Olympic Games. To further expand our campus and education solutions, we announced the first phase of our physical security initiative during the quarter.

This solution was delivered in conjunction with some of the key technology leaders in this space that include vendors: Axis, for IP cameras; and Milestone, for video management solutions. The use of Ethernet as a common infrastructure for all applications such as video security and building controls expands on our core competencies in delivering highly resilient networking solutions and is applicable to many verticals, including traditional enterprise and education campuses, as well as ports of entry and heavy industry.

In the mobility and service provider vertical, we saw softer demand from our traditional service provider partner base for the quarter. Yet, we continued to expand shipments in support of Korea Telecom's LTE network.

Korea Telecom is one of our largest X670 open fabric deployments to date and provides the switching foundation for the first -- one of the first Voice over LTE deployments in the world. In summary, Extreme is now focused on driving revenue growth for FY '13, while controlling our expense lines.

We have new sales leadership in place, and are working to drive increased sales productivity. We expect to leverage what we believe is a superior product portfolio, increased market awareness and an increasingly refined cost structure to drive revenue growth, which we believe can provide increasing leverage to the bottom line in FY '13.

I look forward to keeping all of you updated on our progress over the coming year. And now I'll turn the call back over to John to discuss guidance for Q2.

John?

Thank you, Oscar. We target our second fiscal quarter 2013 revenue will be in the range of $78 million to $85 million.

This is typically a sequentially up quarter, and we have taken into account the macroeconomic weaknesses being seen in the industry, not only by Extreme Networks, but by our competitors as well. We've also taken a conservative view of Asia-Pacific, given the recent comments coming out regarding China's economy.

We target our GAAP and non-GAAP gross margins to be 55% plus or minus. R&D is targeted to increase by approximately $1 million to $1.5 million.

Sales and marketing is targeted to increase by $1 million to $2 million, primarily related to a full quarter expenses related to the data center sales team, our new head of sales, plus commissions on the targeted revenue. SG&A is targeted to increase slightly less than $1 million.

GAAP net income is targeted to be $2.5 million to $4 million, with non-GAAP net income targeted to be $4 million to $6.5 million. GAAP EPS is targeted to be between $0.02 and $0.05 per diluted share, and non-GAAP EPS is targeted between $0.04 and $0.07 per diluted share, based on 96 million diluted shares outstanding.

For those of you who are building financial models on the company, the company is targeting a quarterly financial model with the goal of achieving non-GAAP gross margin of 56% plus or minus. And for non-GAAP operating income of 10% plus or minus at a revenue level in the low $80 million range by the end of fiscal 2013.

To help achieve this goal, the company intends to focus on growing its revenue with higher performing and lower-cost products, as well as further realigning its operating cost structure around this set of products. We will now open the call for questions.

John, you can start the polling. Thank you.

So I wanted to get some elaboration. Can I get the segmentation information for the verticals, the rolling 4 quarters?

Sure, Jonathan. So for the quarter, we showed 26% of our business in Q1 came from these verticals, and that's as a contrast and slightly weaker than the 35% that we had in Q4.

And we believe that part of that is due to macro weakness in Europe. So we faced some weakness in some of the verticals and also when I look at the service provider verticals, specifically, when we talk about mobility, that was down as well.

So it was mainly Europe, mainly the service provider, the mobility part that [indiscernible]...

And also some education in Europe. Now what's notable here is, just recognizing that a lot of our mobility business comes from work that we do through some of the channel partners that we have in mobility.

In the past, we noted that Ericsson has been a fairly continuous 10% customer, and they were below 10% this quarter.

Okay. All right.

But data center, that trended well, right? I'm not asking for specifics, but the quality part of the data center.

Yes, I'm pleased with the data center momentum that we've got so far. And with our new data center sales teams, my expectation is that, that trend should continue and improve.

All right. Next question would be -- elaboration question would be the 10% customers please?

Sure, the 10% customers in the quarter, we have 3 of them. They were all the distributors that are typically part of a two-tier distribution in the enterprise space.

Okay, Westcon, Scan Source and...

And Tech Data.

And Tech Data, yes, you read it well.

Okay. Now let me go into my actual questions here.

The -- you talked about -- there was some customer delays and non-opportunities. I guess you'd talk about that also last quarter.

Can you elaborate some more in terms of what those are? Is it more, stuff is getting pushed out into the next quarter, the stuff that you talked about were delayed from last quarter is not rolling to this quarter and so on, so on?

Yes, so there are customer delays of deals, and we've seen some of them, where our customers are being cautious about the money that they're spending, and notably, we're seeing a lot of that in Europe as well. What we're also seeing is some of the other competitors getting very aggressive on price.

And so to try to bring deals in at the end of the quarter, we saw some very aggressive pricing from some of our competitors. And so some of those were lost.

And I think that's normal. We win some, we lose some, and when someone goes -- drops price at the end of the quarter, it's expected that we would win some of those, but we would lose some of those.

So I think some of them are delays that are legitimate delays because of customer demand being deferred given the macroeconomic environment, especially in Europe. We also saw some delays, not as many, in North America.

But we also, especially in Europe, saw aggressive competitor pricing.

And that was in the campus products?

Yes, mostly campus products. Thank you, yes.

In the data center products, we really are looking that customers are shopping for value. Those are the places where we go.

And even though we had 1 deal that we identified, that John identified, which was a data center customer that I deemed to be strategic, and I felt that it was a position that we needed in a key country, that aside from that one, the gross margins that we've been noting in data centers are good gross margins and good pricing.

Okay. And I guess that leads to my next question.

And I'll wrap the gross margin and the pricing question together here. Gross margins were down sequentially and year-over-year, and even if I take out the one-time, $1.5 million in obsolescence for the wireless mobility products, that's one-time so I add that back in, gross margins are still down quarter-on-quarter, year-over-year.

I guess most of the pricing pressure is in campus. You're not seeing that in BDX8?

You're not seeing that in the data center? You're not seeing that in the mobility?

And/or are you still doing something like trying to get -- win reference accounts, and that's why you're bringing the pricing down for the BDX8?

Well, what we're seeing when we look at -- this is John, is that in terms of the pricing, you have to take a couple of things into account on the gross margins. One, which you did correctly, you took out the one-time inventory charge of $1.5 million.

There is also almost a point in there, not quite a point, less than a point, in terms of that strategic deal, that brought margins down. And so when we look at it a year ago, quarter, it was 55.5% -- were the non-GAAP gross margins, and when you add the effects of those 2 items in, it's relatively close.

It is down a little bit from last quarter, but we think that as we move forward, we're going to be able to recover back into the 55%-plus range going forward.

That's fairly from the top line growth?

Yes.

Versus cost-cutting.

Right, mainly on the gross margin side, yes. Because we do have -- even though we outsourced a large portion of our -- or all of our manufacturing, we still do have a certain amount of fixed cost that are in the company, in the cost of goods sold in terms of logistics and operations, and procurement and things like that.

So those costs do get leveraged as revenue goes up.

Okay, great. I guess, one last question.

It's very topical, especially considering where I am right now. What kind of disruption do you see from Hurricane Sandy from the Eastern Seaboard?

I guess, Oscar, when you first started, Americas was decreasing, it was kind of a troubled region, and under your leadership, you fixed that. But at that point, one of the problems for the region that was bringing down Americas, was slower sales on the East Coast.

How do you think Hurricane Sandy is going impact and what kind of contingency plans do you have there?

When I look at North America, North America represents about 35%, 37%, looks like in the last quarter. So it's a sizable part of our business.

So I think there's no way for us to tell right now what the aftermath will be of Hurricane Sandy. Whenever there is a problem of this nature, it's going to disrupt business in some way.

I just can't tell how much it's going to be. Of course, the Northeast is 1 of 4 subregions that we have in North America.

So given that it's 1 of 4 regions -- subregions in North America, it's fairly isolated from that standpoint. However, there may be businesses that are impacted outside of the Northeast region based on the business that they have expected to do or have been doing in the Northeast.

So I think it's too soon to tell right now. And I think we need to wait to see what the impact really is to our specific customer base.

Certainly, it's a horrific situation, and we're watching it very carefully.

So -- and then I'll just end it with this, one last question, and then I'll jump out of queue. Can you at least talk in terms of the material amount of impact in Northeast, the subregion and then if you don't want to quantify, just at least speak, is this qualitative?

Is this a good amount of your Americas revenues? Is this near half?

Just some idea there.

No, it's definitely not half. It's -- I would say, less than 30%.

I don't have the actual figures in front of me, but it's definitely not half. It's not the majority of our North America sales.

Oscar, as you look at the next year in order of relative importance, either looking at it from products or technology or target segments, what is the most -- what will drive future revenue strength?

Thank you, Christian, and thanks for coming onto the line here. That question is, I think, rooted in 2 answers.

You have to have product, leading edge products and best-of-breed products, and that's what we've been working on, and we continue to expand our R&D capabilities for the BDX8, for software defined networks and for the places that we believe the customers that we're targeting focus on and what they care about. So I think product is a highly important aspect of this and driving R&D and the deliveries over the course of the next year are important.

On top of that, I also believe that sales coverage and sales productivity both together, are keys to driving revenues for us. And when I look at the data center specifically, I'll mention campus in a moment, but when I look at data center specifically, and that's private clouds as well as public clouds, we can see that our average deal size is beginning to go up.

So we can see deal sizes for the data center to be, initial deal sizes anywhere from $0.5 million and above, and when we're looking at that, that means that when we spend our sales days in those types of accounts, then when it bears fruit, and it does take a little longer to incubate those wins. But when it bears fruit, then it bears higher deal sizes.

So the same sales individual, same sales expense will be able to give you greater revenue. So we focus on 2 things.

Making sure we have the right coverage in sales. So having the right people in the places.

As an example, if you want to sell in Brazil, you have to be in Brazil. And Brazil's been growing well for us.

And I expect it to continue to grow, but you've got to have coverage there. People that speak the language.

People that understand the technology issues there. It's a high-growth market right now still, in spite of the rest of the world.

And my -- a recent keynote address that I gave at Futurecom, which is the main key -- main trade show in Latin America now based in Rio, just reaffirmed for me how important having high productivity is in a high-growth market like that, and we can offer a lot of that. So you've got to have sales coverage, but then your sales teams have got to perform, and we've got to be sure that we're spending our sales dollars in the right places to go get the revenue.

So I think it's sales, and it's R&D, as you what might expect. But in sales specifically, it's coverage and sales productivity.

John, I thought maybe we'd start with some housekeeping questions.

Sure.

Let's start with employees. Do you have that number?

The employee count was close to 690.

690. And then talk about the hiring plans.

You talked a little about expenses going up next quarter. Should we see this sort of wind down in the second half, I know you're trying to build up the team, the sales team, but when do we see that sort of taper off?

You should expect to see it tapering off this coming quarter here. And what we did is that we have the data centers, Oscar mentioned, we added people in data center sales force.

Nancy, a couple of other key hires, for example, the Head of Sales in China. So we think we have the team, the sales team pretty well rounded.

So I wouldn't expect to see that number go up.

And then the question that I wanted to ask you before, and then I had one more after that. But can you take us through the non-GAAP numbers by item or can you give us at least the non-GAAP adjustments?

Sure. Let me give you the non-GAAP adjustments.

If in -- I'd give you a second to see the rundown is that the -- when we look at stock-based comp, the non-GAAP adjustment to the product cost of goods sold is $174,000. For service cost of goods sold, it's $159,000.

In research and development, it's $432,000. Sales and marketing, it's $727,000.

SG&A, it's $676,000. So that's all the stock-based comp.

And then, coming also -- coming out of the operating expense line is the gain on the sale of the building of $11.5 million, and then a small restructuring reversal of $10,000. I hope that helps.

I'll try to fit it all back in. And then I wanted to ask you another question on the strategic sale.

Is that outside the United States, and is that a service provider, can you give a little bit color on the strategic sale?

Yes. Rohit, this is Oscar.

It is definitely in the data center space. It was a key customer that wanted to win in Brazil.

And with -- our feeling was that by winning this customer, we would have a reference account that would be able to influence other like customers as well. So that was the rationale behind it.

And it's not only that, but it's a marquee deployment for a specific type of application for our BDX8 products and some other products along with it.

Is there, I have one other adjustment for, can I ask about, sorry about that, John, tax dollars. Is there an adjustment on tax, from the GAAP tax to the non-GAAP tax?

No, because the stock-based comp is -- and the gain on the sale of facilities and that is basically U.S. So there is no non-GAAP tax adjustment.

Okay. And then, sorry I keep asking questions.

No. That's what this call is for.

Domestic cash and international cash. Probably that's a lot more.

There's less than 5% of the cash is offshore or trapped offshore.

[Operator Instructions] So we'll take our next question from Charles Lesser [ph], who is a private investor.

My name is Charles Lester. I'm a private investor.

I'm a public company CFO. This question is for your CFO.

First of all, congratulations on your move. Second of all, I want to talk about operating expenses, and I must admit I don't know your space, I just happen to have found myself investing in your stock.

You talked about operating expenses going up. I guess it was next quarter, and you're talking about, in the future, kind of getting your operating expenses around the strategic product initiatives.

What opportunities, if any, are there to get operating expenses down, and are you satisfied with the amount of operating expenses as a percentage of revenue for this company versus your previous company and other companies you worked with? I don't sense there's any real incentive to kind of bring them down because you think you're probably going to be ramping revenue up.

But yet for this year, you're running models on approximately $80-odd million per quarter, which is pretty much where you've been the last couple of years.

In our press release, what we have said, and we gave our forward model, is that we expect by the end of this fiscal year, to get to 10% operating income on a non-GAAP basis. We're not there today, and we expect to do that when revenues are in the low-80s.

And that's above where we were in Q1. And to do that, what we're going to need to do is continue to realign the expenses.

Some of it is, when you look at them all, it's project timing in R&D, sales and marketing is going to be -- what do we need to do on marketing if the revenue doesn't come in, we can adjust there. There is commission expense on the sales force.

If they don't hit their numbers, they don't get -- they get their base pay, but they don't get their commission. And we continue to look for efficiencies in terms of trying to do things right the first time.

And we think, through all that, we'll get to an operating model of about 10% operating income which leads you to -- and we put out there an operating goal of gross margins of 56%, which should get you to about a 46% operating expense as a percent of revenue line, so that is below where we're running today.

Okay. Thank you all very much for attending today.

We appreciate your participating in the call. We look forward to talking to you again at the end of next quarter.

Thank you and be careful as your driving around tonight for all those little trick-or-treaters out there. Good night.