Extreme Networks Inc (EXTR) 2016 Q2 法說會逐字稿

Good morning and welcome to the Extreme Networks second-quarter fiscal 2016 earnings results conference call.

This call is being recorded.

With us today from the Company is Ed Meyercord, the President and Chief Executive Officer; Ken Arola, the Chief Financial Officer; and Frank Yoshino, the Vice President of Treasury, Investor Relations.

At this time, I would like to turn the call over to Frank.

Please go ahead, sir.

Thank you, Chanel, and welcome to the Extreme Networks second-quarter fiscal year 2016 earnings conference call.

This conference call is being broadcast live over the Internet and is being recorded on behalf of the Company.

Should you wish to not be recorded, please do not ask questions during the Q&A.

The recording will be posted on Extreme Networks' website for replay, shortly after the conclusion of the call.

The presentations and the recording of this call are copyrighted property of the Company, and no other recording or reproduction is permitted unless authorized by the Company in writing.

By now you have had a chance to review the Company's earnings press release.

For your convenience, a copy of the release and supporting financial materials are available on the Investor Relations section of the Company's website at ExtremeNetworks.com.

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

These forward-looking statements involve a number of risks and uncertainties which could cause actual results to differ materially from those anticipated by these statements.

You should not place undue reliance on forward-looking statements, which speak only as of the date of -- they are made.

We undertake no obligation to update these statements after this call.

For a detailed description of these risks and uncertainties, please refer to our most recent reports on Form 10-K, Form 10-Q, and Form 8-K, filed with the SEC, in addition to our earnings release posted a few minutes ago our website.

Throughout the conference call, the Company will reference some financial metrics that are derived in accordance with Generally Accepted Accounting Principles, or GAAP, while other metrics are not in accordance with GAAP.

This approach is consistent with how management measures the Company's results internally.

However, our non-GAAP results 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 corresponding GAAP measures is in our earnings press release issued today.

In preparing non-GAAP information, the Company has excluded, where applicable, the impact of acquisition and integration costs, purchase accounting adjustments, amortization of acquired intangibles, restructuring charges, overhead adjustments, litigation expenses, and share-based compensation.

Now I will turn the call the call over to Extreme's Present and CEO, Ed Meyercord, for some opening comments.

Thank you, Frank, and good morning, everyone.

Thank you for joining us to discuss our Q2 results.

Today we are up at our Salem, New Hampshire, office in the greater Boston area, where we've got over 300 employees.

The energy level here is high, as people are excited about the fact that we delivered on three quarters in a row, and we're poised for year-over-year growth in the quarter ending March, our fiscal Q3.

We have a large engineering and technical support presence here along with our sales and marketing teams.

These teams have done great work delivering on our value proposition.

First, creating industry-leading technology, our Wave 2 wireless platform, significant feature innovations in our upcoming software releases, our cloud management platform, our enhanced data center and network orchestration capabilities.

These technology innovations, coupled with our leading service, where analysts confirm time and again that we are the number one service delivery and technical support team in the industry, have us poised to take advantage of upgrade cycles and take share from our competitors.

I'll begin the call with commentary on the quarter; lay out our vision, strategy, and competitive position; review progress with our solution selling vertical go-to-market-strategy; and provide highlights of our technology roadmap and our business outlook.

Then Ken will go through the numbers, and we will open it up for Q&A.

Starting off with the scoreboard, overall it was a strong quarter.

We came in at the high end of our guidance range in revenue and EPS.

Our sales teams have delivered again, just under $140 million in revenue for the quarter, which was up $15 million over fiscal Q1, and right at the top of our guidance range.

We saw strength in each of our geos, led by another consecutive quarter of year-over-year growth in the US, due in part to our success with our K-through-12 education customers, driven by the $1 billion per year E-Rate program that runs through the end of 2019.

We also had a nice recovery in our EMEA region, where we saw a nice sequential revenue increase driven by our strength in manufacturing, healthcare, and education.

We are rebuilding our APAC and LatAm geos, and our new leadership teams are making excellent progress in those markets.

Much improved linearity is giving us stronger visibility into our sales forecasts and predictability into how we convert our growing pipeline of opportunities into sales orders.

And we continue to drive efficiencies in inventory fulfillment and our supply chain operation.

This gives us more confidence in our ability to forecast, and gives us a strong foundation as we build the business toward growth.

Despite the distractions of the holiday season and massive flooding in our Chennai, India, location, where we process all of our service orders, our sales, sales operations, and supply chain teams came through.

We set a Company record for on-time delivery during the quarter, something we measure closely to ensure optimal inventory.

This is great news.

Our run rate gross margins were in line with our 55% target, and I will let Ken address the near-term inventory and warranty items that affected the reported number for this quarter and our Q3 guidance.

From an operating expense perspective, you can clearly see the strengthened financial position and the benefits of the cost-cutting measures we took last May.

When you look at the year-over-year comparisons, we grew our operating income by over 60% on a smaller revenue number.

And our earnings per share grew to $0.09 per share from $0.05 on a non-GAAP basis.

I will note that these numbers include incentive compensation expenses that weren't in the numbers last year.

When we exceed plan, we pay out incentive comp every six months.

This is the first time in many years that this payout has been achieved.

It is well deserved, and great for the morale of the team as we transform into a growth company.

I congratulate our employees on this accomplishment.

At Extreme, we have a clear vision of the networking industry and the competitive landscape, with the costs of bandwidth continuing to fall at a rapid rate; the explosion of devices onto networks, driven by mobility and the Internet of Things; and the proliferation of applications that run on those devices, and connect them to private and public clouds.

All these factors are driving the need for new networking solutions.

For the first time the refresh for wired and wireless are occurring at the same time.

This plays right into our sweet spot at Extreme as an end-to-end provider.

Given the fact that networks have become much more complicated for our customers to manage, and the fact that our customers' IT departments are not able to respond to these new demands by adding staff, they can't afford to double their IT budget.

This, too, is good for Extreme, given our unique software capability and our best-in-class technical service and support.

We see the complexity of these converged wired and wireless networks being simplified with software.

This is where the market is heading.

We believe it's a big opportunity, and it lines up directly with our technology vision, our product roadmap, and our go-to-market strategy.

Our enterprise customers need flexible operating systems; feature-rich management tools; access controls for edge devices; security, application, and device-level policy and quality of service delivery; gateways to private and public clouds; and network analytics.

These will be the drivers of more and more networking decisions in the future.

We have the software, and we are tailoring solutions that make it easier for our target customers in education, healthcare, manufacturing, hospitality, stadium, and government to deploy them.

As most of you are aware, industry analysts tell their clients that Extreme is one of only three networking companies that can deliver wired and wireless end-to-end networking solutions to enterprise customers around the world.

What most people don't know is that we are the only networking company that has what we call a single pane of glass.

This is our unified network management platform that provides complete visibility and control over both wired and wireless environments from our access points, to our access layer switches, to the core of the network into the data center.

This makes it much easier to manage networking environments: one common database for all devices on the network, one database of network equipment and ports, and one user interface with enhanced management capabilities.

In addition, we are the only one of the three end-to-end providers with 100% in-sourced technical support.

Our Extreme team has a tenure of over 8 1/2 years and has more experience than all of our competitors.

When they answer a service call from a customer with a technical issue, they resolve the customer issue over 90% of the time on the very first call.

With networks getting more complicated, with customers being more resource-constrained, this real-time best-in-class support can make a big difference in strengthening our customer relationships.

Earlier this year, we met with the Gartner team and they validated our unique capabilities: end-to-end wired and wireless with a single pane of glass; our elegant SDN solution; and our upcoming May software release, the only solution that extends beyond the data center; our top-ranked service and best value proposition.

This is why Gartner put Extreme in the visionary quadrant for the first time.

The key for us is how we leverage this capability and how we go to market, how we spread the word to the channel community, and how we expand our partner relationships to grow our base of over 22,000 enterprise customers.

We made progress on this front in the second quarter.

Our engineering and product management teams launched our Wave 2 wireless access points in December, on schedule, and in time for the E-Rate buying cycle.

And in connection with this, we will launch our cloud management platform that will become generally available in three weeks, also on schedule.

This is a big deal for our partners and our customers.

The multitenant platform will allow our partners to manage multiple customer networks without the need for a technician to be on site.

It will also allow out enterprise hospital customers -- like the Henry Ford Medical Center in greater Detroit, for example -- to manage a physician's satellite office or an emergency response center, or a community medical center remotely.

Our subsequent cloud 2.0 release in May will expand our cloud management capabilities to cover our wired switch portfolio as well.

The Gartner analysts had said this will provide us with a distinct competitive advantage, and leapfrog our competitors' offerings.

To help illustrate our value proposition, I will highlight a handful of customer successes that were realized in Q2.

In our healthcare vertical, one of our end-to-end enterprise customers, Charlotte Area Medical Center, ordered 2,000 access points as part of their network upgrade.

CAMC is a solutions customer.

They use our switches in their data center out to the edge of their networks, soon to be refreshed with the latest Wave 2 technology.

They use our single pane of glass to assign policy and to manage the complex needs in their healthcare environment, including secure medical records hosted in their data center, quality of service for critical applications in the operating room, and seamless Internet connectivity for guests, a big driver of patient satisfaction.

Net-net, we're delivering a quality experience for users and making it much easier for network administrators to manage.

We put out a press release about another one of our customers in our education vertical, Utica College, where Vijay Sonty, the CIO, stated: with the help of Extreme, we have reduced the complexity of our network.

The gains in efficiency and simplicity alone have had true bottom-line results.

Now, a single network engineer can easily maintain a network that serves 4,000 users, where the customary ratio is one engineer to 200 users.

Overall, Extreme builds a robust network at a savings of close to $1 million over their competitors.

So here, again, our wired and wireless solution managed by our single pane of glass software is integral to delivering value to this customer.

And, finally, we were reworded NRG Stadium in Q2, home of the Houston Texans, and Super Bowl LI.

NRG will be utilizing our entire solution of wired, wireless, and analytics, all managed through our single pane of glass software.

NRG Stadium is one of the most utilized venues in the US, hosting this year's NCAA tournament in addition to other year-round activities.

Here our solutions help deliver game day services, including in-seat ordering, live and replay video footage for multiple camera angles, as well as supporting streaming video and social media apps that are all part of their drive to enhance the fan experience.

We are very proud of our continued success with the NFL, where we now have nearly half the venues leveraging our technology to improve the fan experience, as well as 17 NFL teams utilizing our analytics technology.

And next week, Extreme will be on display as the official Wi-Fi analytics provider of Super Bowl [50], as well as the provider of Wi-Fi to Super Bowl City in downtown San Francisco.

These wins highlight some of our important customer relationships coming on the heels of highly successful training programs that we launched over the summer.

As we move from point product sales of wired switches to a full portfolio of wired, wireless, and software-driven networking solutions, we knew we had to invest in training.

Our field teams embraced these programs: solution selling, technical product education, and wireless certification.

100% of our sales teams have completed our popular 3D solution selling program.

80% have completed tactical training.

And, recall, last June, we only had three wireless certifications in the entire Company.

Now, 85% of our 130 systems engineers are wireless certified, and 50% will receive their advanced wireless certifications in March.

This will make a big difference.

And with this initial training behind us, we can focus on selling.

The transformation won't happen overnight, but will get stronger and stronger each quarter.

We are also investing in our vertical ecosystems.

We're in the process of developing and marketing our suggested reference architectures in each of our key verticals.

And we are refreshing and building out our pool of integration partners in these segments.

This will make it easier for our sales teams and our channel partners to qualify for opportunities.

This, too, will build over time, and it will be customer-driven.

As we gather more and more case studies in reference accounts, we will add new architectures and new integrations.

This will allow us to build strength and momentum each quarter.

As far as guidance, we are projecting year-over-year organic growth for the first time in many years.

This is a direct result of us executing on our strategy and all the tactical initiatives being completed inside of Extreme.

We will remain disciplined on the operating expense side of the equation, which will result in favorable year-over-year comparisons, like you see this quarter, from here on out.

On a personal note, my confidence in Extreme continues to grow, and it's driven on three fronts.

Number one, the quality of our technology and engineering -- our belief that our products and solutions are high-performance and well-engineered are confirmed when sophisticated and incredibly discerning technology buyers validate quality.

Like Intel Corporation, one of our largest customers, which uses our networking solutions from their massive data center out to the access edge.

Number two, the quality of our customer relationships: each time I travel to different locations around the world, I'm always amazed to discover new long-standing Extreme customers like Konica Minolta in Hanover, Germany, where their headquarters and manufacturing facilities; or Bugatti, the maker of the world's fastest car engine; or the Mercedes Formula One team; or Lucasfilms and Skywalker Ranch; or the Louvre in Paris.

The list goes on and on.

Number three, our people: Extreme has a high-caliber team of professionals.

These are A players who make up a strong team.

They want to deliver, and we are starting to demonstrate that, with three consecutive quarters under our belt.

And, most importantly, we are aligned.

We are aligned on our vision, our strategy, and execution initiatives.

And we're committed to winning.

Winning means growth.

Now, let me turn it over to Ken for numbers.

Thanks, Ed.

Before I get to the numbers, I'd like to make a few comments.

To start, I'm very pleased with our financial performance over the past several quarters as we continued to remain focused on delivering on the top line and diligently managing our expenses.

This is the third consecutive quarter that we have delivered on our guidance since our restructuring last May.

Additionally, in Q2, we have realized 100% of the quarterly savings expected from the reduction in headcount in Q4 of 2015.

And, in fact, our non-GAAP operating expenses are down $23 million, or 16%, in the first half of fiscal 2016 compared to fiscal 2015.

And we are clearly on track to realize the $40 million in annualized savings we have mentioned on past calls.

Lastly, when we get to our Q3 guidance, you'll see that we are calling for a growth quarter, on a year-over-year basis.

Now let's review the second-quarter results, starting with revenue.

Q2 GAAP revenue was $139.3 million compared to $124.6 million in quarter one and $147.2 million in Q2 a year ago.

Q2 non-GAAP revenue was $139.7 million compared to $125 million in quarter one and $148 million in Q2 last year.

Geographically, we experienced the largest sequential growth from EMEA, driven by strong results in government and manufacturing.

Strong E-Rate performance drove North America growth.

And APAC and Latin America had solid performance, relative to plan.

The split of revenues were as follows.

North America contributed 47% to total revenue; EMEA contributed 39%; APAC contributed 9%; and Latin America contributed 5%.

Product revenue, both GAAP and non-GAAP, for Q2 was $105.4 million compared to $91.4 million in quarter one and $112.5 million in Q2 last year.

Q2 GAAP service revenue was $34 million compared to $33.2 million in quarter one and $34.7 million in Q2 last year.

Non-GAAP service revenue for quarter two was $34.3 million compared to $33.6 million in quarter one and $35.5 million in Q2 last year.

Moving on to gross margin and operating expenses.

In Q2, GAAP gross margin was 50.4% compared to 52.3% in quarter one and 51.1% in Q2 last year.

Non-GAAP gross margin was 53.6% and compares to 55.2% in quarter one and 54.6% in Q2 of last year.

The sequential decrease in non-GAAP gross margin is largely attributable to two factors.

First, we incurred excess and obsolete charges for older 802.11n access points.

In December, we launched and shipped our new Wave 2 access points, which makes the n product two generations old now.

As such, we began reserving for this older inventory.

Second, we incurred higher warranty reserves, as we are noticing a trend that a greater share of product is shipping with limited lifetime warranties.

These warranties cover a five-year period compared to a one-year period with standard warranties.

Prospectively, we believe that the market will continue to expect limited lifetime warranty products.

Accordingly, our cost to fund these warranties will vary based on shipment volumes and customer returns in any particular quarter.

Combined, the excess and obsolete and warranty charges had approximately a 1% impact on gross margins this quarter.

Q2 operating expense GAAP operating expenses were $75.6 million compared to $75.9 million in quarter one and $86.2 million in Q2 last year.

Q2 GAAP operating expense includes restructuring charges of $3 million related predominantly to the completion of our facilities consolidation following the reduction in workforce in quarter four of 2015.

Recall that GAAP operating expenses in Q1 included restructuring charges of $5.6 million, primarily related to the initial phase of the facilities consolidation.

Q2 non-GAAP operating expenses were $64.1 million and compares to $61.5 million in quarter one and $74.1 million in Q2 FY15.

Sequentially, non-GAAP operating expenses reflect increased sales commissions related to the higher revenue in quarter two, and higher incentive compensation expense related to the Company's performance.

Again this quarter, we realized 100% of the quarterly cost savings associated with the Q4 restructuring.

Second-quarter GAAP operating loss was $5.4 million or negative 3.8% compared to a loss of $10.8 million or negative 8.7% in quarter one and a loss of $11.1 million or 7.5% in Q2 of last year.

Second-quarter non-GAAP operating income was $10.8 million or 7.8% compared to $7.5 million or 6% in quarter one and $6.7 million or 4.5% in Q2 last year.

GAAP net loss for Q2 was $7.2 million or $0.07 per share compared to a net loss of $11.5 million or $0.11 per share in quarter one, and a net loss of $13.1 million or $0.13 per share in quarter two last year.

Non-GAAP net income for the quarter was $9 million or $0.09 per diluted share and compares to net income of $6.7 million or $0.07 per diluted share in quarter one and net income of $4.7 million or $0.05 per diluted share in fiscal Q2 2015.

Turning to the balance sheet, Q2 cash and cash equivalents benefited from strong collections in the quarter, and we ended at $85.9 million, up $3.9 million compared to $82 million at the end of last quarter.

In the quarter, cash flow from operations was $7.4 million compared to $6.5 million in quarter one.

And free cash flow for the quarter was $6.7 million compared to $5.9 million in quarter one.

Accounts receivables were $73.1 million at the end of Q2, up $12.8 million from last quarter, with DSOs increasing slightly to 48 days this quarter from 45 days in quarter one.

Ending inventory was at $56.6 million, down $5.1 million from last quarter.

And total debt outstanding at the end of Q2 was $62 million, and we were in compliance with all debt bank covenants at the end of the quarter.

Now let's move on to the guidance for quarter three.

We expect Q3 GAAP revenue to be in a range of $117.6 million to $127.6 million, and non-GAAP revenue to be in a range of $118 million to $128 million.

At the midpoint, this represents growth over Q3 of last year.

As mentioned, E-Rate funded business contributed nicely to our Q2 results, and we anticipate that to continue into Q3.

Gross margin is anticipated to be in a range -- GAAP gross margin anticipated to be in a range of 49.9% to 51.2%.

And non-GAAP gross margin is anticipated to be in a range of 53.5% to 54.5%.

While we have it initiatives underway to develop programs to sell slower-moving inventory, we are being prudent in our guidance which contemplates anticipated additional inventory reserves in quarter three.

Additionally, keep in mind that our March quarter is a seasonally slower revenue quarter, which has historically had an impact on gross margins, given our relatively fixed manufacturing and service cost structure.

Operating expenses are expected to be in a range of $69.5 million to $72 million on a GAAP basis, and $62 million to $64.5 million on a non-GAAP basis.

The tax expense is expected to be relatively consistent with our Q2 levels.

GAAP net loss is expected to be in a range of $9 million to $13 million, or $0.09 to $0.13 per share.

Non-GAAP earnings are expected to be in a range of a net loss of $1 million to net income of $3 million, or a loss of $0.01 per share to net income of $0.03 per share.

The average shares outstanding are expected to be 103 million on a GAAP basis, and 106 million on a non-GAAP basis.

Now I'll open the call for questions.

(Operator Instructions).

Matt Robison, Wunderlich.

I might have a follow-up question.

But just initially on this gross margin effect from the inventory and warranty reserves, it sounds like the inventory piece wasn't all taken care of in the December quarter.

You've got a little bit of the tail in the March quarter.

I'm hoping you could confirm that.

And then talk a little bit about the warranty reserves.

Should we expect to see an offset to that in the service and maintenance line?

And, presumably, if there was, it would be spread over time.

But can you give a little bit flavor of the timing of that?

You talked about -- Ed, when you mentioned the 55% run rate sustained except for these items -- why wouldn't we expect to see the higher warranty reserves?

Is there -- maybe to [come at it], there's -- what the backdrop is for that being temporary.

Yes, Matt, I'll start here.

So for the access points that I was referring to, we've had those access points for a couple of years, as we've transitioned to 802.11ac and now Wave 2. We had some excess inventory sitting around as customers obviously have moved to the newer versions.

We're in the process right now of developing some programs to move those access points, with marketing programs and some R&D efforts, to add some functionality to the access points.

And I'll leave it at that.

We think we will be able to do that.

But we were in a position, given the aging of the inventory, to take some reserves this quarter on that.

Like I said, we're prudent in our thinking for Q2.

We've built some additional E&O for some access points into our guidance.

The success of the programs that I was referring to could potentially minimize that E&O as we move through Q3.

As far as the limited lifetime warranty, obviously with five years we have a greater liability to cover customers over that five-year period of time, versus the one-year period of time.

We have seen an increasing amount of customers take limited lifetime warranties as an option here.

And you do see an offset there because you don't see the cost in the service line itself over time.

Although, with that said, it will depend on the volume of shipments, the failure rates, returns of products from customers.

I guess [RV also] was that.

With limited lifetime warranty, over time, you'll probably see more warranty requests coming in from customers in the field, given that they can return something at any point in time over a five-year period.

So this -- just to clarify, are you getting a revenue bump for this?

Or are you offering the additional warranty essentially as a discounting mechanism?

Matt, this is Ed.

Good morning.

Thanks for the questions.

This is something that has become market, so we're not doing anything that is really outside the scope of where the market is today.

And when we launched, it was a new program.

We didn't have a lot of history in terms of what to expect.

And then when you see returns come in and you have to make assumptions about how you should be reserving, we've made some changes to that assumption.

And there was a little bit of catch-up that we would expect this quarter and in Q3.

And also we were somewhat victims of our own success with some of the other products, from an E&O perspective, where we came out with our next-generation chipset and the sales have exceeded anything that we've done in our history.

And as you know, when you come out with a new version of technology, everybody wants the new version.

So, we were more successful with our G2 series of products than we had expected.

We have, as Ken mentioned, we've come up with what we think are some creative bundling ideas to bundle those switches with some of the access points to a targeted part of the market to diminish that.

So again, I made the comment about run rate 55%, because we believe that will be the gross margin target.

And we're not moving away from that.

We just had these items that affected that number this quarter, and we built that into our guidance for next quarter.

Yes.

Well, congratulations, by the way, on the product sales volume.

It was significantly higher than I expected, and apparently it's partially because of that launch.

Ken, can you just give us a little sense as to how we get back to the 55%, and maybe the timing of it?

I would say we don't provide guidance out this far, but we see business as usual in the fourth quarter.

Fair enough.

I'll yield the floor for now.

Thanks.

Christian Schwab, Craig-Hallum Capital Group.

Solid results.

As we look to the better quarterly revenue, first I want to get an answer on E-Rate.

Last quarter, we talked about that being $10 million and potentially going to $20 million.

Did we hit that?

Yes, Christian.

We were on the higher end of that $10 million to $20 million range for the quarter, in quarter two.

Right.

Well, we said we would go from $10 million to $20 million, so (multiple speakers).

What we said is we'd be in the high end of that range of $10 million to $20 million, and that's where we ended up.

Okay.

So when we look at the better revenue, I'm just trying to figure out what was the positive surprise.

Was the positive surprise that EMEA acted better than you thought?

Was the positive surprise the decision to move obsolete inventory?

Or is it a collection of a lot of stuff?

Yes, Christian, it's interesting.

I wouldn't characterize it as a surprise.

We came into the quarter with a lot more visibility.

You had mentioned E-Rate.

The funding letters were coming out.

We had an inventory of funding letters, so we had better visibility of how that would play out.

And I mentioned strength in the US, which has continued.

It wasn't just E-Rate, but we've had a lot of success in other verticals, as well.

And we had a nice rebound in EMEA; a good, sequential growth in those markets.

And you're going to see -- we were negatively affected by what was happening in APAC and LatAm in prior quarters.

And I think -- we've got new leadership there.

They are very excited about what they are going to be able to do in their regions.

So, they are pretty aggressive in their outlook.

So I wouldn't characterize it as a surprise.

I would characterize it as us -- the team executing well, and sales going through.

I will also comment that we delivered the results despite -- in a business, you always have puts and takes.

And our sales teams are really focused on execution, and committed to delivering.

And I think there's a lot of things that go on behind the scenes to deliver the numbers.

But really no surprises.

Okay.

As we look to E-Rate, can you give us an update of how much E-Rate-specific revenue, if you can, that you've shipped versus what you previously won?

And when do you expect to ship the last of last year's wins -- what quarter?

So we're looking at -- over the next couple of quarters, still having another, roughly, call it $20 million to $25 million that we're going to be shipping over the next couple of quarters, based on what we said coming into the quarter, or into the year, on what we think we could do for E-Rate.

Again, remember, Christian, that started last Q4.

We got an order in from a school district of about $9 million that extended into quarter -- and you take that into quarter one, and then our results in quarter two.

And then what we will see also, as we move through Q4, is it's likely that we will see next year's cycle starting, and have some orders from next year's cycle hit Q4 as well, on top of us winding down for this year.

Yes, yes, I agree.

How much obsolete inventory of a bunch of old Wi-Fi access points is sitting in inventory?

And we're about to release our next-generation product, so we're about to have another potential product that is on its way to being obsolete.

Is there any way to quantify how much is sitting there that we can keep our gross margins at a more depressed level until they bounce back toward your target?

Yes, so, the access points that we were referring to was the old 11.n access points.

We had less than a quarter's worth of inventory left when we transitioned over.

What Ed was mentioning is with the Wave 2, we shipped a fair amount of access points of Wave 2 in the December quarter here, right as the quarter ended when we released the product.

And that's what we're looking at, going forward.

So, we're putting a program together to be able to push the older n series access points.

Teams are working on that right now.

We think we can minimize that.

Again, we built in some E&O in our Q3 guidance.

But we think we have opportunities to minimize that pretty significantly by the programs that we're going to be running, and doing some bundling with that, and make it more attractive to customers on the low end.

(multiple speakers) Christian, I want to add two comments to that.

One is keep in mind, in terms of the new team and better communications that are -- we're learning each time we go through these cycles.

As we're coming out with Wave 2, you won't catch as with as much inventory of the older access points.

Also, the Wi-Fi market, it's the segment of the market that's growing.

There is high growth.

And we typically play in the high-end enterprise market, in NFL stadiums.

When you are delivering Wi-Fi to the Super Bowl, it's got to be the highest of quality.

There are also parts of the market that are lower-priced, that are the lower-quality markets.

We have opportunities, in terms of service bundling that I mentioned, to create solutions to address what is a really high-growth market with some of the older access points.

So, we have a lot of opportunities here.

We don't expect to see this as an issue, as we project out.

We projected for Q3, and as I mentioned, we see business as usual going into Q4.

Yes.

Here we are, still cleaning up issues of somebody else's previous acquisition; not only fixing operating expenses, but fixing inventory.

So, I don't hold that against you, nor should anybody else.

My last question has to do with year-over-year organic growth statement that I think I heard.

I just want to confirm that I heard it.

Even though at the midpoint, yes, the March quarter is up year-over-year, but you also suggested that that would be the beginning of a Company goal of returning to year-over-year growth.

So I assume that means, this June quarter, you are hoping that you'll again see year-over-year organic growth versus last year.

Did I hear that correctly?

So, yes, I have to say you heard [correctly] if you said hope -- if you said hope, Christian.

But here's what I would say.

I wouldn't count it out.

As you know, we don't forecast out beyond the current quarter.

There's some moving pieces here, as you know.

E-Rate moves around a bit.

So, let's just say we had a very strong E-Rate showing in this quarter that maybe pulls away from Q4.

That could have an impact.

Also remember we had somewhat of a bluebird order of about $8 million in Q4 of last year.

It came in earlier than expected, and raised the revenue number significantly beyond our guidance.

So, I'm not going to tell you to rule it out.

But at the same time, we are not comfortable projecting it on the call today.

No, I understand.

No other questions.

Thanks, guys.

Simon Leopold, Raymond James.

I just want to start with a quick clarification on your gross margin comment.

You indicated, Ken, that there was about a 1 percentage point hit due to the reserve, the two reserves.

Wanted to make sure I understood, was that specific to the product gross margin, or overall gross margin?

So those were more specific to the product gross margin.

And so, when you offered guidance, you talked about the fact that you'd get some of this affecting the March quarter, plus seasonality; lower volume also affecting March quarter.

So you have given us overall gross margin guidance.

But just wondering if I'm thinking about product GAAP gross margin correctly.

If I think about right around a 45% range, slightly lower than what you saw in December, is that what you want us to think of?

You're talking about a GAAP basis?

Yes, I am.

Yes, I think on a GAAP basis, you probably need to be thinking around 50%, 51% gross margin ranges.

So significantly higher than the 45.8% we saw in December?

Oh, you're just talking product gross margin?

Yes, yes.

I'm specifically talking about product, yes.

Yes, so I think that's probably about right, what you are indicating.

Okay.

Okay, great.

Thank you.

Just wanted to make sure I understood what you were saying correctly.

Yes.

So, for Ed, more of a big macro, and obviously as a relatively small company, you're not beholden to the macro.

I understand that.

But in light of what we've read -- obviously all of us seeing the headlines, and I'm thinking about commentary from others in the networking space, as well as large operators.

AT&T and Verizon both commented on enterprise spending, North American enterprise spending, looking a little bit weaker.

And your tone remains somewhat upbeat.

You've got E-Rate certainly in the mix.

I guess I'm trying to understand how the general business -- your general enterprise business, excluding E-Rate -- is holding up.

What you are seeing maybe in some of your verticals; how they may or may not be affected by what we're seeing in the macro environment.

Yes, so thanks, Simon.

I think -- yes, I don't think we could say that, at Extreme, we're immune to what's going on in the larger industry.

So I wouldn't -- yes, I wouldn't ignore it.

And actually, we pay very close attention to what's going on out there as far as what the larger companies are saying.

Obviously, it's important to us.

But what I will say is that -- keep in mind our market share.

And keep in mind what we're doing as far as focus, and looking for share points.

Let's assume that -- I think the industry is looking at -- let's say the industry is flat.

We think we have an -- our opportunity that we're focused on is about taking share.

And if you consider the power of a share point for this company, given the size of the overall market, even if I wanted to look at the larger trends, I still think that we should be able to grow.

And a lot of the issues that we've had as a Company is getting organized in how we go to market, and being really focused in going to market, and highlighting our competitive advantages.

We have distinct competitive advantages.

And it's a function of us being crystal clear in how we educate our own teams internally, how we bring it to market, how we educate our partners.

So that when there are opportunities in healthcare, when there are opportunities in manufacturing, when there are government opportunities, when there are venue opportunities, when there are higher education opportunities, that they know we have unique capabilities and unique solutions, and they should consider Extreme.

And keep in mind that our partners make probably twice as much when they sell Extreme than they make when they sell a Cisco or an HP.

So if you talk to Gartner, they will tell you that there's only three end-to-end competitors.

And if you consider that networks are getting a lot more complicated, and the network managers are having to deal with a much more complex environment with fewer and fewer resources, Extreme provides the best value as far as a one-stop shop, excellent technology, software tools that make it very easy to manage, and then the high quality of service.

I mentioned statistics, but this is really important.

If you are running a network and you have network issue and you pick up the phone, you get a technician at Extreme.

And the number is 94% of the time, he is going to resolve your issue.

If you call one of the larger companies, you're going to get bounced to one or two or maybe three different operators around the globe with different dialects.

And they're going to be trying to triage and figure out where to send you to someone who can answer the question.

Well, it makes a big difference to the enterprise customer that is below, let's call it, the Fortune 300, that doesn't have the direct support, which is the majority of the market, when they get a significant service benefit from someone like Extreme.

Now, everybody says they have good service, so it's hard to market that.

And that's one of the -- I look at it as an opportunity for us.

We're exciting -- you're hearing excitement for me, and you're hearing a lot of excitement from our team because of how, historically, we have all the pieces in place; we built all the pieces; but now we have this opportunity to put it all together, get focused, and bring it to market.

Yes.

Ed, I wanted to follow up on that point about being one of three suppliers able to bundle wireless LAN and switching.

So if you could help us understand roughly what percentage of your product revenue comes from wireless LAN specific products -- access points and controllers, and such.

And then help us understand, if you can quantify what's the dollar value of the switch sales are the result of these wireless LAN execution sales.

So, if you look at our numbers from a macro basis, our numbers are -- we have 10% wireless LAN, 5% software, 85% -- it's going to be in terms of our switched portfolio and services.

About 12% of our overall customers have what we would call our gold standard bundled solution with wired, wireless, and our software portfolio.

If you recall what I mentioned on the call, in June we had three people certified in wireless in the entire Company.

I have to say, I think our team has done an unbelievable job.

And then the field has truly embraced all of the training that's been going on.

And this is a Company that never really had training.

So, now we have literally 80% of our system engineers in the field who are certified in wireless.

And we have half of them who are going to get advanced certifications.

So there's a transition.

I'm excited about what we're going to be able to do in the second half of the year.

Because instead of being in training classes and educational programs, they are going to be out in the field putting their newfound knowledge and skills to work.

And that's going to -- it's going to help us.

And it's going to help us get more focused on the solution.

And the more wins we have, we think it's going to build on itself.

Anyway, I hope that answers your question.

No, that's helpful.

Any chance we can get a dollar value for the wireless LAN in the December quarter?

I don't know if we disclosed --.

We typically have not disclosed that, Simon.

We've talked about it as percentages, about a 10-ish kind of percent number.

(multiple speakers) Is it 10-ish of total revenue, or 10 of product?

Product.

It's been in that 10% to 11% range over the recent several quarters.

Simon, the other thing that we're -- we're not reporting on this, and we're not disclosing metrics around it yet, although it is something we may consider disclosing in the future is -- we're really driving the solutions sale and the bundled solution.

Last year we measured all of our bundled sales.

And in the first six months of this year, we more than surpassed all of the bundled sales from last year.

So, we know that what we're doing, it's working.

We are seeing progress.

There's no silver bullets here.

It's not going to happen overnight.

This is something that's going to be a gradual transition.

But we know that it's working, and we hope to be able to start reporting on it in the future.

Great.

Thank you for taking my questions.

(Operator Instructions).

Alex Henderson, Needham.

I just wanted to continue that conversation we were just having on the bundled.

Obviously moving towards solution selling is your primary focus right now.

And this is an important metric, relative to that.

Thanks for that data point on 1H being up, over all of FY15 bundle.

That's a great data point.

But where do you think you'll take this?

Can you get to a point where it's not just 12% of customers with wireless, wireline, and service bundles, but more like 25% or 30%?

And how long do you think -- can you give us some sense of timelines?

Yes, on the 25%, for sure.

And timeline -- if we aren't at 25% over the next 24 months, 30 months, I'd be disappointed.

If you think about -- we have 22,000 customers, which is a lot of customers, in our installed base.

And most of those customers have a single solution.

That single solution is going to be fixed switching.

So, we have an opportunity to go out and market to those existing customers.

And there's a wireless refresh cycle that's coming up, as far as Wave 2.

When we come out, we're putting our cloud management platform out.

We have been behind.

We're catching up.

In our meetings with the Gartner analysts, they were -- I don't want to say blown away -- but they were really impressed with what we're going to be able to do in the cloud, in terms of managing not only wireless APs, but also the wired switches.

So, as we look at the complete solution, we have -- from a technology perspective, we have the software and the management tools that we're going to be putting in the cloud that are going to provide us with a unique advantage.

We also are one of the few players that is going to have a cohesive wireless access point, Wave 2, and access layer switch solution.

So, if you think about us targeting our base of existing customers, it should be a big opportunity.

So if we're at 12% today, we're talking about 13% over the next 24 months, to bring them up to the solution sell.

It sounds feasible to me.

I don't want to create a new goal for the Company on the conference call, but -- I hope that's helpful.

No, that's helpful.

Let me ask a secondary question, then.

Do you get better margin on your bundled sales than you do on your conventional sales?

We do because of the software.

So if you -- and oftentimes if you're selling a solution, the focus of the sale is less about price and the level of discounting you're getting off of a box.

And it's more about a problem that you're solving.

And as you know, software -- not operating system software, but our network management and our access control and security, network analytics -- these are software products that come with much higher margins.

So, if we're successful selling the solutions bundled, then we should be successful in ultimately growing our margins.

Is it a meaningful delta on gross margin that is then absorbed by higher selling costs, because this is a more complex sell?

Or are the operating margins better as well?

I can't really give you an answer on that one, Alex.

I don't want to make things up on the call.

But I think it's something for us to -- this could be a good follow-up item for us.

So, let me address a somewhat different subject, but still on the operating margin side.

I think you'd talked about getting to 10% operating margins.

And think, at one point or another, I think you suggested that you might be able to do that in the fourth quarter.

But can you give us an update on how you are thinking about attaining that level and whether that's attainable, say, in the next 12 to 18 months?

Or whether that's something that is attained only on a quarterly basis, with the seasonality causing dips below it in some quarters, and just getting to it and they're seasonally strong?

Or will it eventually be able to hit that on average?

Alex, this is Ken.

This is the way I would think about it is we are really focused here on managing our operating expenses to the low- to mid-60 range over the foreseeable future here.

We've been pretty good at that the last three quarters.

We're going to continue that focus.

So let's assume you have -- just pick a number, $65 million in operating expenses on a continuous basis, going forward.

And we run the business at an overall 55% gross margin over the longer term.

With those two metrics, to get to a 10% operating margin, we'd have to generate revenues of $145 million to $150 million a quarter to hit that 10% basis.

We're getting close to that at 8%, so I think we have real opportunity to do that over the next year.

And it's going to depend on us managing our expenses to where they are today, and driving back at that 55% gross margin.

Even if it was at a 54% gross margin, we could probably, at $145 million of revenue, still generate a 10% operating margin.

Okay, one last small question, and then I'll cede the floor.

I'm a little curious why you don't have an adjustment on your income tax rate as a result of the GAAP to non-GAAP adjustments in the rest of the income statement.

Pretty much all we do is pay statutory taxes around the world, mostly internationally.

We have NOLs in North America, Ireland; state NOLs as well.

Very, very significant in nature, hundreds of millions of dollars.

So, we won't be paying any real taxes on a go-forward basis.

So again, it's just the nominal statutory taxes we have around the world, so it's running about $1 million, $1.2 million a quarter.

One other question.

The international side of it -- I know that you've got a lot of programs to expand in Latin America, and are excited about that, and you are also excited about APAC.

The economic conditions in those geographies seem pretty tough.

Can you talk about whether you're seeing that causing hesitation or slowdown in the processing time and the deal sizes in those geographies?

Or whether that is just -- you're just so small that it's all incremental to you, and therefore you're just not seeing that?

Yes, I think it's -- Alex, I think it's the same comment that we had made earlier about the broader market, and how we play relative to the broader market.

It's probably even exaggerated in those markets.

If you were to look at competitors, especially the larger competitors, and if you were to look at their business mix in those markets, they would have a much higher business mix in APAC and LatAm than what we have.

Historically, the Company hasn't executed well in those markets.

As I mentioned, we've hired new leadership.

And the new leadership -- and we've also taken a different approach in some of these markets, where if we're underperforming, we have a large field force with fixed costs.

It's not very efficient.

So in some of these markets we've shifted to drive channel, which is making us more efficient.

Our new leadership is really -- breathe fresh life and a lot of intelligence into the most effective way to grow in the markets.

And they've identified a lot of opportunities.

So, we are not going to be a good macro gauge in these markets.

We are going to be opportunistic, where our solution set, our partners, and our direct teams identify opportunities in those markets.

And they are seeing a lot of opportunities.

I wouldn't say it's not a heavy investment for us.

But there could be some low-hanging fruit for us.

And there's been no competitive price pressure developing as a result of the weakening conditions in these geographies, as well as, for that matter, in the US?

Because of weaker conditions, they are more aggressive on pricing -- you haven't seen any of that?

Well, Alex, I think we see it all the time.

It's not -- it's something that we see -- we see it in the US.

I think it's the nature of the business that we're in.

Let me say that again.

Alex, let me just take a quick step back.

In terms of -- keep in mind, if you look at how we're priced relative to the competition, Cisco provides a nice umbrella in general on a product perspective.

We're probably 20% below Cisco.

And then on a total cost of ownership -- and this is really where there's price creep -- in there we're probably 45% below them.

So we have a nice umbrella, and it gives us a little bit of room.

And we're trying to -- our challenge is to take the discussion away from price.

So, that's part of our ability to succeed, is to take the discussion away from price, like the customer examples that I've given you, and talk more about how we're solving their problems.

And we can do this in our verticals.

The healthcare -- if you look at the healthcare vertical, hospitals and healthcare facilities around the world facing similar challenges.

The same thing is true in manufacturing.

It's similar in education, and government, stadium venues.

So, if we're out there solving problems and selling a solution, it should change the negotiation.

But just to be clear, the question wasn't about what you're doing, but, rather, what they're doing.

Are they responding to the weakening conditions and dropping price, which might compress that umbrella?

Yes, I'd say we're not noticing anything unusual.

Perfect.

That's what I was looking for.

Great, thanks.

Rohit Chopra, Buckingham Research.

I had a couple of questions for you guys.

First thing -- and Simon was asking about wireless LAN.

I just wanted to follow up on that one, just if you don't mind us --.

I'm trying to get a sense of maybe the gross margins relative to switching, and maybe the growth rate relative to switching.

I'm not looking for the exact number again, but just a rough idea.

And the reason I'm asking is because I'm assuming that in the 2015 E-Rate year, you were a little bit more switch focused.

But in 2016, you'll probably be better positioned from a wireless LAN standpoint, given the new product.

So I just want to get a sense of what we should expect.

So that's why I'm asking about gross margins and growth rate there.

And I do appreciate you giving us a sense of how large it is.

And the second question, I just want to get a sense of your thoughts right now on E-Rate.

I know it's early, but the window has opened for the 470s.

I just want to get a sense of what you are seeing out there.

And the reason I'm asking that one very specifically is that it looks like USAC has found an extra $2 billion to throw into the 2016 year, making it closer to $6 billion for E-Rate.

So just trying to get a sense of your thoughts around E-Rate, and then also on wireless LAN, if you don't mind.

Sure.

So I'll start out with the gross margin comment there.

So, wireless and wired -- I'll start off by saying, it depends on the deal.

Generally you would have wireless carrying probably a little bit better gross margin than wired.

But again, it depends on the competitives and the deal, so we see that bounce around a little bit.

With E-Rate deals, those are competitive deals for us, as well, so you have various discounting going on in there.

So, whether it's a more wired versus -- more wireless versus wired, you still have the competitive nature of the business out there.

So, as we're looking at it, we look at it more of a blended gross margins here between both of those product sets, from a product basis, in that kind of 45%, 50% range; and 55% range, I guess, if you aggregate it all.

So, again, even though wireless can carry higher gross margins, with E-Rate we see a lot of competition in these deals when we're going after some of these school districts, especially some of the bigger ones.

And you get into more discounting to win these pieces of business.

So even if we're moving to more of a wireless situation, which could carry higher gross margins, it's the discounting that could play into this.

So it moves around on a quarter-over-quarter basis as you go through time.

But, overall, I would say if you look at wired and wireless over the past near-term history, the overall gross margins are somewhat comparable.

That's very helpful.

And the growth rate, rough, relative to switching -- is there anything that you can provide?

Wireless growth rate?

Yes, wireless growth rate, just relative to switching.

Like I said, I'm not looking for the very specifics, but just a sense (multiple speakers).

If you look at data that we get from the analyst community, they will tell you that wireless is growing around 10% annually over a five-year CAGR.

Wired is probably more flattish, maybe slight growth, if you think about a campus kind of a business.

So yes, wireless is growing very nicely.

And we're looking at taking advantage of that, especially with our Wave 2 access points out.

And as Ed was mentioning, adding to that the wired capabilities and the cloud, I think we have some great opportunities to grow at market rates, hopefully as we go forward.

It's a real opportunity for us in the wireless space.

And just lastly on E-Rate, just some early look, or some early thoughts as you are seeing 470s come in.

I'll comment on this.

We were a lot better positioned this year than we were last year for E-Rate, given the product portfolio and our ability to position and sell wireless, whereas almost all our E-Rate business last year was in our fixed switch product portfolio.

And we have a larger percentage of our sales teams that have embraced the program.

If you're out in the field and you're in sales, and you're seeing people be extremely successful with the program, then you embrace the program.

And so, we have expanded the number of our direct salespeople who are participating in the program.

So I would say the combination of the more participants on our side in the field that are engaged in selling, the volume of proposals, and then the scope of what we're bidding on -- we're enthusiastic.

We're encouraged by what we think our opportunities are.

As you know, when you bid, you don't really know until the final numbers are released.

Sure, absolutely.

I appreciate the answers.

Thanks again (technical difficulty).

Mark Kelleher, D.A. Davidson.

This is Andrew Masuda asking a question on behalf of Mark.

Just one question for Ed.

Geographically, you guys saw a nice sequential increase in EMEA in Q2.

Can you just talk about what drove the strength, and maybe qualitatively speak about your expectations for that region in the second half of the year?

Sure.

I think -- yes, I would describe it as somewhat of a rebound from where we had been historically.

We had said before that we think that the foreign exchange currency issues are behind us.

And I think maybe there's a little of that in the number, in terms of getting back to normal, that the business mix between the US and EMEA still slants toward the US.

Historically, in the Company, it's been slanted to EMEA.

So, we think there's a pretty big opportunity.

What we're doing is we're focused on creating and driving our verticals.

If you look at -- in our [doc] region, which is primarily driven by Germany, we have the highest market share in target markets like manufacturing, healthcare, government, of any country in the world.

And if you look at the opportunity for us to leverage on our existing strengths already, and selling the solutions bundle, that in itself creates an opportunity.

When we say we have a 12% penetration of solutions customers around the world, in that particular region, in Germany, you might look at more of like a 20%, 25%.

So, it's the opportunity for us to focus on our verticals, focus on where we're really successful, build out the reference architectures, get the at-bats with our partners in that territory.

And we think that will drive growth.

We're underweighted in some countries in Europe.

And if we get to where we should be in some of those countries, that, in and of itself, will create growth.

Great.

Thank you so much.

Thank you.

And I'm showing no further questions at this time.

I would now like to turn the call over to Ed Meyercord for closing remarks.

Okay.

Thank you very much.

We appreciate everyone participating on the call, and all the good questions.

We are excited at Extreme.

As I said earlier, there's a lot going on at the Company.

And this idea of year-over-year growth in this quarter, we are laser focused on that.

And we look forward to updating you after we post those results.

So thank you very much.

Ladies and gentlemen, thank you for participating in today's conference.

This concludes today's program.

You may all disconnect.

Everyone, have a great day.