Extreme Networks Inc (EXTR) 2019 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Extreme Networks Second Quarter Fiscal Year 2019 Financial Results Call.

(Operator Instructions) As a reminder, this call is being recorded.

I would like to turn the call over to Stan Kovler.

You may begin.

Thank you, operator, and welcome to the Extreme Networks Second Quarter Fiscal 2019 Earnings Conference Call.

I am Stan Kovler, Executive Director of Investor Relations.

With me today are Extreme Networks' President and CEO, Ed Meyercord; CFO, Rémi Thomas; and VP of Finance, Matt Cleaver.

We just distributed a press release and filed an 8-K detailing Extreme Networks' second quarter fiscal 2019 financial results.

For your convenience, a copy of the press release, which includes our GAAP to non-GAAP reconciliations and our fiscal '19 Q2 financial results presentation and CFO commentary are both available in the Investor Relations section of our website at extremenetworks.com.

I would like to remind you that during today's call our discussion may include forward-looking statements about Extreme Networks' future business and financial results, products, operations, pricing and digital transformation initiatives.

We caution you not to put undue reliance on these forward-looking statements as they involve risks and uncertainties that can cause actual results to differ materially from those anticipated by these statements, as described in our risk factors in our reports filed with the SEC.

For any forward-looking statements made on this call reflect our analysis as of today, and we have no plans or duty to update them except as required by law.

Now I will turn the call over to Extreme's President and CEO, Ed Meyercord.

Thank you, Stan, and thank you all for joining us this morning.

Welcome to our fiscal Q2 earnings call.

Today, we announced Q2 results that were better than expected highlighted by 9% year-over-year and 5% quarter-over-quarter growth in total revenue to $252.7 million and non-GAAP earnings of $0.13 per share.

Our gross margin was the highest in 3 quarters, and we repurchased $15 million worth of our shares during the quarter.

From a bookings perspective, we grew year-over-year and quarter-over-quarter across all our solutions pillars and in all our key industry verticals.

We continue to win large deals as customers embrace a broader set of our solutions.

During the quarter, we had 18 deals over $1 million, representing software, products and services across our solutions pillars.

We're growing our total pipeline of large opportunities globally and our total cross-sell pipeline for the next 4 quarters grew sequentially once again.

I recently came back from meetings with our teams in Asia where our growth has been driven by larger deal sizes and software-driven solutions selling.

APJC revenue grew 13% year-over-year and 28% quarter-over-quarter.

In the EMEA region, from a competitive standpoint, we believe our story and our product portfolio are resonating well with European customers.

European governments are also placing greater scrutiny on the security concerns around Huawei products, which is creating an opportunity for us in the marketplace.

We are a trusted provider to many European customers and our secure automated campus products and various software applications are resonating well in this context.

As a result, our revenue in EMEA grew 26% year-over-year and 22% quarter-over-quarter in fiscal Q2 and our pipeline continues to build.

In the Americas, we saw a nice rebound in our service provider vertical and continued growth in our health care, transportation, logistics and higher ed verticals.

Overall, the revenue for Americas was negatively impacted by distributor consolidation and softness in the K-12 market.

We made key hires to enhance our service provider team and new leadership in our federal team that will strengthen our coverage model for these key verticals.

Both in our Data Center business and our Automated Campus grew sequentially, slightly ahead of expectations.

Our sales teams continue to lead with differentiated software for applications, such as management, control and analytics that can manage both Extreme and third-party networking products.

Growth in software and cloud-based applications accelerated in the quarter.

We posted another quarter of record service bookings with improvement in our attach rate and growing contribution of multiyear agreements.

We increased our overall services backlog and that bodes well for service revenue growth in the future.

Our team has done an excellent job of mitigating the risks of the trade uncertainty between the U.S. and China.

In response to the 10% tariff increase in September, which affects most of our hardware products, we implemented price increases on November 1. And as we previously announced, we moved aggressively to move manufacturing to Taiwan and expect 80% of our products that ship into the U.S. to be exempt from this tariff at the end of March.

In addition, we have benefited from approximately $5 million of forward customer buying during the quarter that came in from Q3.

Last week, we launched our first 802.11ax or Wi-Fi 6 products.

Customer momentum is building as we have a unique set of high-density Wi-Fi customers who are looking forward to this and additional solutions that we expect to launch throughout calendar '19.

We are also the first to market with machine learning capabilities on our APs for RF management and artificial intelligence tools that will allow customers to auto-tune their networks without human intervention.

Software programmable radios, upgraded security and integration with our full software suite of analytics, location and guest augmented by our air defense, wireless intrusion prevention system creates a truly differentiated and first-to-market solution for customers ranging from stadiums to enterprises.

We already have pre-orders for our Wi-Fi 6 products that will be generally available in April.

In November, we launched new Agile Data Center products, as we expected, covering the solutions such as border routing, Layer 2 exchange, data center interconnect and full XMC management integration for single pane of glass visibility.

Looking ahead, for the rest of calendar '19, we have a multitude of new products coming to market that we believe will drive growth in revenue and margin from our expanded and upgraded product and software portfolio.

We're very excited to share many of our new innovations at our Connect Conference in May.

This quarter, we had several exciting wins.

A division of a large European auto manufacturer had a requirement for a secure networking solution with future-proof technical capabilities in their assembly plants.

The customer implemented our Fabric Connect solutions based on features, security, support and differentiated technology despite a much lower competitive bid from Huawei.

The City of Memphis, Tennessee, is using our Automated Campus, an XMC management and analytics software as the basis of its Smart City implementation for surveillance and digital transformation of the city and its infrastructure.

Memphis valued the ease of use of our solution and the hyper-segmentation features it offers to create distinct networks for its community center, public safety and transportation departments.

We built on our strength in the sports and entertainment space with wins at MetLife Stadium, home of the Jets and Giants, University of Pittsburgh Athletics and the Chicago Cubs, among others, with our Smart OmniEdge portfolio with strong attach rates of our mobility, analytics, control and cloud software.

Our momentum in this vertical continues to grow globally as our teams in EMEA and Asia are winning with our differentiated solutions and strong customer references like the NFL.

The launch of Wi-Fi 6 products will only accelerate this trend.

In the higher education space, the University of Central Arkansas required a strong secured network infrastructure to fully support its plans for its Arkansas Coding Academy and to achieve their goal of being a Technology First University.

UCA selected our automated campus solutions, including Fabric Connect and Cloud Appliance to implement a complete networking solution for their campus of 124 buildings for over 11,000 students.

Extreme Management, Control, and Analytics software have streamlined network management for UCA IT team substantially reducing the potential for human errors.

Industry analysts are telling us, they are recommending Extreme to their clients based on our software, support and ease of use, our differentiation being our true single pane of glass visibility and control software that our largest competitor simply can't replicate.

In November, Extreme was named Gartner Peer Insights Customers' Choice for Wired and Wireless LAN and Data Center highlighting our #1 position in customer service.

Our investment in sales enablement and digital transformation is making it easier for our customers and partners to do business with us, and we continue to execute on this plan to modernize our go-to-market infrastructure and drive sales productivity.

This quarter, we have improved demand, supply and inventory planning for the entire product portfolio.

We started to roll out new automation tools to our field to improve time-to-market for quotes and pricing and upgraded a number of our internal systems, ranging from finance to HR.

Looking ahead, we expect fiscal Q3 revenue to be consistent with fiscal Q2 despite a seasonally weak March quarter and the $5 million of forward buying from Q3 that came into Q2.

We expect revenue to be in the range of $247 million to $257 million and gross margins to be consistent with Q2.

Our gross margin outlook assumes approximately 1% negative impact from transitioning our manufacturing to Taiwan.

The resulting expected EPS outlook is in the $0.06 to $0.13 range.

Given some macro concerns investors had about a slowdown in the Chinese economy, I do want to point out that our exposure to China is quite limited at less than 1% of our revenue.

Given our vertical customer exposure (technical difficulty) still believe many of our largest customers have pass-through exposure to China, such as higher ed, health care, retail, government and manufacturing.

Our balance among verticals and geos allows us to diversify our risk as we are not overly reliant on region or vertical as evidenced by the strength of our international business this quarter.

With that, I will turn the call over to our new CFO, Rémi Thomas.

Thanks, Ed.

As Ed noted, our revenues of $252.7 million grew 9% year-over-year and 5% quarter-over-quarter and exceeded the high end of our guidance.

Earnings per share of $0.13 was also at the high end of our guidance range.

EPS benefited from similar gross margin with fiscal Q1, but better operating leverage.

Our product revenue of $189.6 million grew 8% year-over-year and 7% quarter-over-quarter.

This also reflects the distributor consolidation actions and Data Center business outlook we've previously noted.

To that end, we reduced the number of distributors by another 10% in Q2 and will continue to execute on our consolidation plan as previously outlined.

Our services revenue of $63.1 million were 12% year-over-year and 2% quarter-over-quarter.

Attach rates and renewals continued to improve during the quarter.

And we're seeing increased traction with multiyear offerings on the premier services we rolled out last quarter.

During the quarter, the Americas contributed 45% to total revenue, EMEA 44%, and APAC closed out the remaining 11%.

EMEA remain our fastest-growing market, where we see customers embracing our differentiated product portfolio very effectively.

Globally, government was once again our top-performing vertical for the third consecutive quarter.

This includes both state, local and federal governments, both in the U.S. and internationally.

The next largest verticals were education, manufacturing, service provider and health care to finish out the top 5.

Non-GAAP gross margin was 58.2% compared to 59.4% in the year-ago quarter and up slightly from 58% even in Q1.

Our gross margin was the highest in the last 3 quarters, despite headwinds from higher component costs and tariffs that more than offset the price actions we took in our portfolio on November 1. We estimate that tariffs had a negative impact of approximately 1 percentage point to total gross margin in Q2.

Our non-GAAP product gross margin of 57% compares to 59.4% in the year-ago quarter and 56.8% in Q1.

Q2 non-GAAP operating expenses of $126.6 million were up from $117 million in the year-ago quarter and from $125.3 million in Q1, increasing at a slower rate than revenue.

The sequential increase in non-GAAP operating expense was mainly due to the higher R&D spending, as we continue to focus on new product developments and product introduction.

On a year-over-year basis, increasing operating expenses resulted primarily from the first time consolidation of the acquired Data Center assets over the full quarter.

As a result, operating margin of 8% compares to 8.8% in the year-ago quarter and 5.8% in Q1.

Free cash flow of $23.6 million compared to use of cash of $10.3 million in the year-ago quarter.

Year-to-date, we generated $50 million in free cash flow compared to less than $1 million in the first half of 2018, which is driven by improved collections and working capital.

We expect continued strong cash flow generation into the second half of our fiscal year, even as we continue to make capital investment in our own digital transformation.

Our total cash and cash equivalents balance at the end of September was $140.6 million -- sorry, end of December, up slightly from $140.2 million at the end of September.

We repurchased $15 million worth of our stock at an average price of $6.33 a share.

DSO of 53 days fell 16 days year-over-year and 10 days quarter-over-quarter.

The substantially year-over-year decrease reflects our shift away from the TSA we were on for the period that immediately followed the acquisition of the Campus Fabric and Data Center businesses last year.

On a sequential basis, the strong linearity I referenced to in our earnings release is what drove DSO lower.

We also made significant progress in growing our deferred revenues to $186 million from $152.4 million in the year-ago quarter and $183.6 million in Q1 on growth of service bookings, including multiyear renewal offerings and higher software attach rates.

Now turning to guidance.

I want to remind investors that this outlook factors in the $5 million worth of forward buying from customers Ed mentioned that we would have expected for Q3.

With that in mind, we expect total Q3 revenue to be in the range of $247 million to $257 million.

Q3 GAAP gross margin is anticipated to be in the range of 55.2% to 57.3% and non-GAAP gross margin in the range of 57.5% to 59.5%.

We estimate that tariffs will continue to have up to a negative 100 basis point impact on our overall gross margin for Q3 '19.

Overall, we expect our pricing actions will be neutral to accretive related to the slightly lower gross margin outlook we provided.

Q3 operating expenses are expected to be in the range of $139.7 million to $143 million on a GAAP basis and $129.9 million to $133.2 million on a non-GAAP basis.

The sequential increase in OpEx is primarily related to payroll and variable compensation cost.

Q3 GAAP earnings is expected to be in the range of a net loss of $8.3 million to a net income of $0.7 million or a loss of $0.07 to a net income of $0.01 a share.

Non-GAAP net income is expected to be in the range of $7.2 million to $14.9 million or $0.06 to $0.13 per diluted share.

In Q3, we expect average shares outstanding to be approximately $117.1 million on a GAAP basis and $119.6 million on a non-GAAP basis, excluding the impact of any shares we may repurchase.

With that, I would like to now turn it over to the operator and begin the question-and-answer session.

(Operator Instructions) Our first question comes from Alex Henderson of Needham.

So there was a couple of pieces that you talked about in the prepared remarks that seem like they're somewhat countervailing.

You said on the one hand that in the most recent quarter, you added 1% impact from the tariffs, but then you said, in the upcoming quarter, you are expecting to have 80% of that production move to Taiwan, which should fall out.

So as I look past the current quarter into the June quarter, do I take 80% of the -- hit from the tariffs plus the 1% hit from the manufacturing move, so I'm improving by 180 basis points, is that the right way to think about that?

Alex, this is Ed.

I think the way to think about it is that we still have the impact of the tariffs.

Obviously, we're going to have that in the March quarter.

We also have the benefit of the price increase in the March quarter.

We are experiencing incremental costs of the manufacturing shifts, and that's going to happen at the end of March.

So we're not going to have the benefit of the shift of supply chain and products coming from Taiwan versus China until Q4.

So that's when we would expect to receive that benefit.

And we're guiding that if the midpoint is a 58.5% gross margin range, we think there is a point attributed to that, so you can add that point.

We have other benefits occurring in Q4, and our expectation is to guide over 60% in our fourth quarter.

Right.

So just to be -- to reiterate what I had said before.

So if I take the currency -- excuse me, the tariff impact 1%, which persists into the March quarter, but I lose 80% of that because you'll have production moved, in the June quarter that falls out, right?

That's right.

That falls out...

And then in addition to that, I'm absorbing 1% impact to cost of goods sold for the move and that falls out?

So there is a -- that's correct.

There is an offsetting item, which is the fact that costs in Taiwan are more expensive than costs in China.

So overall, we're expecting a 5.5% increase in our costs for products coming in from Taiwan.

So when you consider that, that will provide some offset.

But keep in mind, there will be 20% of our products that will still come from China and we'll be phasing those out through the September time frame.

And then we have to be ready to react to what happens with the Trump administration and negotiations with the Chinese government over tariffs and what happens.

So we're ready to respond.

Fortunately, now our team is nimble.

We're practiced in this because we've just been through the exercise.

So depending on what comes out, we will react and either react with more pricing initiatives or not, depending on what happens.

But we wanted to mitigate the risk of China altogether by shifting to Taiwan.

And the shift to Taiwan, even though we have a 5%, 5.5% incremental cost on the products, it's -- that's obviously less than the 10% cost we have with the tariffs coming from products in China.

Understand.

So the second question I wanted to ask you is on the pricing initiative.

It's my understanding you put it in November 1, but it wasn't immediately effective on all products at that point.

There was a portion of your business that was grandfathered as a result of deals that were in the pipeline.

So I guess, the question is, what percentage of the price increase actually shows up in the December quarter versus how much of an increase will it represent to pricing in the full March quarter?

In other words, is it 1% or 2% out of the 7% total?

Well, Alex, I guess, what I would say is that's really the point, is that timing differential of September 24, 10% tariff effective immediately.

We have to provide 30 days' notice.

So then November 1, our pricing takes effect.

Meanwhile, we have great linearity in the quarter, where normally we have a small percentage of our orders that would come in, in that first month, and we had close to 40% of orders in that first month.

So it was a bit lopsided and that timing differential is what caused that margin headwind during the...

I understand on the margin side.

I think I've got that calibrated.

What I'm trying to figure out is on the revenue side.

So obviously, if you had only -- you had a 7% price increase.

You had, what, 1% or 2% of that actually accrue in the December quarter, and then another 5% sequentially, is that the right mechanics?

I think you can think about it that way.

But I think you also have to realize that it's -- we put 7% in the U.S., we put 5% rest of world.

Given the fact that it is roughly 50-50, I guess, you could average that out and say, 6%.

And I think you have to consider the discounting behaviors in the field.

When we raised price rest of world, there was some confusion as to why are we raising price rest of world when the tariffs only affect the U.S. We needed to recover years and years of component cost increase on our products, and we decided to do it all at the same time.

So there was -- so discounting behavior has to be managed and that is deal by deal.

As you know, all of our deals have discount authorizations.

The other thing that we have is we have frame contracts, let's call that 15% to -- let's just say roughly 15% of our revenue where customers are, we -- they have long-term pricing contracts, where we can't adjust price.

So that's also somewhat of a limiting factor.

So I guess what I'm saying is there is a lot of different variables that enter into the equation, and we have to manage that.

We also have to take care of customers, where we may have been negotiating a deal for a long time and the price lands outside of the pricing window, and they want a higher discount.

So -- and those we view as more near-term pressures.

And over the long term, we expect our discounting to return to normal levels and that's really where we're going to see the benefit, and we expect -- we really expect to see that pop in Q4.

One more question, if I could.

The distribution consolidation.

Obviously, there was an impact to that during the period.

So where were you?

I think you were at 250, close to be down to 200 by the end of the year?

And if I remember correctly, 150 distributors by or buyers by the June quarter.

What was -- where are you on that, And what was the impact of that?

Yes.

We beat that at the end of the year.

We were down to 180.

And so, the impact of that, it affects the book-to-bill ratio and it was heavier in this quarter in the United States.

And so at this point, we're feeling like we're pretty close to complete.

If you look at our top 10 distributors, that's roughly 85% of the products that flow through distribution.

So at this stage of the game, our -- we feel like our teams have done a really good job of that, and we're almost at the finish line.

So you do sell-in recognition of revenue.

And you said you're going to be bringing down inventories at the discontinued players.

Did that have an impact on your sales?

Yes.

That had an impact -- that had an impact on our sales, certainly for the second quarter, where the bookings -- the bookings number would be higher than the revenue number that we report, and that was the case.

Can you quantify it?

We haven't provided quantification to that, Alex, and a lot of that is just because of there are a lot of different moving pieces globally with all those distributors.

And, I guess, we don't really want to get caught up in the minutia of diving into the -- all of the different components.

But book-to-bill in the second quarter was definitely over 1.

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

Before we get too far away from gross margins, I want to go back to that a little bit.

Can you just talk about the impact of different product categories, the product mix within gross margin?

There was an issue a couple of quarters ago with some Brocade, some core switch headwinds to gross margin.

Can you just talk about where we stand on that?

Yes.

We're really pleased at what we're seeing in the gross margins of the acquired portfolios.

If you look at the Data Center a year ago, I think you'll recall, we -- when we first brought on the SRA assets from Brocade, there was heavy discounting in the field and gross margins were a lot less than we had anticipated.

So we're really pleased to see the recovery of gross margin there.

I mentioned in my comments, we've come out and we've updated our Agile Data Center products.

And so we came out with border routers.

We've seen success with Layer 2 exchange, Data Center Interconnect.

And we're at the early stages of migrating these customers to our new SLX platform, so there is still somewhat of a drag there from the older product portfolio.

But as we move to the new SLX platform, and we build out the use cases for SLX, we're going to see continued margin improvement along those product lines, the same with Avaya fabric and their campus solution.

That has been a bright spot.

I know we're not technically reporting on Avaya as an entity, and we're looking more as our Campus Fabric.

But that business is now up over our acquisition expectations from a revenue -- a quarterly revenue run rate and those margins are up a full 10 percentage points.

So from that standpoint, that's really a driver of the cross-sell pipeline and on that side, we're feeling very good as well.

So these -- the improved margins on the acquisitions and really the improved margins across the product portfolio is what's going to take us to 60% gross margin in Q4.

Okay.

And -- that's helpful.

And you mentioned that the K-12 was still a headwind over on the wireless side.

Is that a big headwind?

How's the wireless doing?

There's a thought that we might be approaching a refresh cycle on the K-12?

Yes.

The wireless is up.

And interestingly for us, education for us as a vertical was up overall because of the strength in higher education.

The K-12 vertical is -- for us is sensitive to E-Rate.

And as you may recall, last year was rather weak E-Rate spending cycle.

This year, we're expecting the opposite, a stronger E-Rate cycle, and we'll find out at the end of March how we do with the next round.

So the weakness in K-12 is still largely a result of that funding cycle that goes back to last March.

We are expecting that to pick up.

Wireless as a percentage of our total portfolio, is approaching 20% of our total product sales.

So wireless is doing very well.

And as you pointed out, we do have a lot of customers when you think about stadium and you think about health care, these are very dense Wi-Fi environments.

And we have a lot of these customers that are going to be ripe for Wi-Fi 6, where you have significant density benefits.

We have pre-orders for that product line, maybe a little cannibalization from the existing Wi-Fi lines.

As we look out at Q3, we're not going to be able to ship any of the ax products.

So despite bookings and pipeline that we see today, we can't put that in our Q3 revenue forecast because those products will likely ship in the April time frame and land in Q4.

Okay.

And last question, and then I'll cede the floor.

You mentioned Huawei, you were doing well against Huawei in Europe.

How much of an impact is that?

Is that kind of a 1 quarter thing?

Or do you think that's something that's going to help you for several quarters?

It's hard to tell.

Obviously, the -- Huawei, most of the news that you have seen has been around 5G and is less involved with the enterprise.

I talked about a win that we had against Huawei with a large auto manufacturer.

A lot of that had to do with our fabric and security, and Huawei was still very much in the hunt with that customer.

But it was really our software and the security and segmentation capabilities of our fabric that allowed us to win.

The manufacturer was adamant and fought procurement that wanted to go with a lower Huawei price.

So Huawei is still very much alive in the enterprise space.

We do think that there is some trickle-down, and we don't know exactly how this is going to play out.

But we know that it is -- people are starting to think about it.

And for us, it creates an opportunity if we are in a competitive situation to -- just to point that out to customers when they are considering their choice of networking vendor.

So I can't really quantify it for you, Mark.

Our next question comes from Christian Schwab of Craig-Hallum.

I just wanted to follow up on E-Rate in your comments there on education.

The number of forms, 470s for Category 2 are back off the charts again, something we haven't seen since fiscal year '15.

In part because all of those schools who took money in fiscal year '15, as you know, can finally come back after taking 3 fiscal years off and get it again for funding at the same time that we are transitioning to Wi-Fi 6. In that year, you guys won almost $100 million worth of business.

I'm surprised that you're not more optimistic about what you're seeing as far as the initial bidding requests that have already come out, which should accelerate further over the next 90 days.

Are you guys not as strongly positioned as far as a sales force initiative there?

I'm slightly confused.

Christian, no, I would say that we're -- I wouldn't say that, and we should not have left that impression if we did.

As you know, in your point, this is the last year of the E-Rate -- the current E-Rate funding cycle, and there are a lot of dollars left.

And as you pointed out, there a lot of people who can come back.

When we're talking about guidance we are obviously talking about Q3, and we will find out in Q3, but we don't expect a revenue impact in Q3, but we are expecting quite a revenue impact in Q4.

We are -- if anything, we are probably better positioned than we have ever been to take advantage of E-Rate with a focused vertical team.

And so this is something that we're very much in the hunt, and we're very much going to be involved.

Our business has become a lot more diversified across the board.

So E-Rate makes up a smaller portion of the overall business, and the E-Rate weakness now is really a result of the weaker season last year.

But to your point, I think it's a good comment that -- is that we are expecting a much bigger E-Rate cycle this year.

Our teams are in place, very busy, very active.

And we're -- this is going to be March news for us and it will affect our Q4 and our Q1 coming up.

Right.

And then last time in fiscal year '15, you didn't have as broad and maybe as a competitive Wi-Fi access point technology as you do this cycle and benefited more across the board on your switch platform.

So as you look to this, and securing wins and the team is working, do you think that your opportunity is more broad-based than the opportunity to win both switch opportunities as well as wireless access points?

Yes.

I would say that.

The other thing I would mention is, we also didn't have a cloud platform.

And as you know, cloud management is becoming more popular particularly in K-12 in distributed environments.

So we have a unique offering as it relates to our single pane of glass and managing both an on-prem solution as well as a cloud-managed solution for a remote site with that single pane of glass that our competitors don't have.

So we think there is a feature there that is pretty powerful and differentiating for Extreme when we are out in the market.

As you know that the E-Rate dollars aren't applied to software, so that software is a differentiating item, and that's where we're working to lead with our customers to focus on that software and spec Extreme in their RFPs.

(Operator Instructions) Our next question comes from Paul Silverstein of Cowen.

First off, just some clarifications on wireless LAN, and you said it's approaching 20% of total product revenue.

That would be make it about $50 million, if I did the math right, in the quarter.

Can you give us what was wireless LAN last quarter and the year-ago quarter?

I'm going to say a year ago quarter, it's probably closer to 15%, and last quarter, it's probably going to be 18%.

Again, that's not a precise number.

I think when we get offline we can follow up with the exact number, but I'm giving you a range, which is more or less accurate.

All right.

And you mentioned K-12 is small, but can you give us -- can you quantify how small?

Well, K-12 for us is now a part of the education vertical.

Given the growth that we've had in higher education, K-12 for us is smaller than higher ed.

It historically has been much higher than higher ed.

And so it depends on that E-Rate funding cycle.

So overall, if we look at E-Rate exposure for the second quarter, and really if I add data from a bookings perspective, it's going to be like 3% of revenue, more or less in that ballpark.

Got it.

Let me move on.

The pretty broad spread in the guidance, especially the EPS line, does that reflect -- to what extent does that reflect you being appropriately conservative?

To what extent does that reflect limited visibility at this point in the quarter, which I assume is not the case given -- I know it's early, but given your comments about various strengths, what accounts for that pretty broad range?

What are the key variables, levers?

I'm going to add a couple of high-level points and I'll let Rémi chime in, if he wants to kind of supplement the answer.

First of all, we did pull in $5 million, forward buying health care accounts.

Other people that knew they were going to be buying Extreme in Q3, took advantage of lower pricing, and we've quantified that at about $5 million.

If we pull that out of Q2 and put it into Q3, obviously, that makes a change.

We still would have beaten this quarter without the $5 million, but that would have taken the number up quite a bit for Q3.

If we look at our operating expense structure, every year, the calendar year, we automatically have an increase in operating expenses because we restart the clock on different payroll taxes, and we have other OpEx expenses that are seasonal, they just reset and start in Q1, that create higher OpEx.

So kind of right out of the chute there, if you're just doing a comparative number, you're looking at a revenue headwind and then you're also looking at a seasonal operating expense increase that will have that effect.

The other comment I'll make is, we talked about the 1% headwind as it related to the manufacturing shift.

Obviously, that's a one-timer, but it does mitigate the risk of China for us.

So it's the right thing for us to do, but there is a near-term impact of that shift.

So obviously, the way -- we have a new CFO, and I'm going to let him chime in on the call, and add some commentary.

This is the second quarter in a row that we've met or exceeded guidance.

We obviously want to continue on that path and on that trend.

So we set our guidance with that in mind and we want to make sure that we have a high degree of confidence of hitting those numbers and that's how we set guidance.

And I'll let Rémi chime in, if you want to add anything.

Before Rémi chimes in, I just wanted to make sure I understood your comments correctly.

Everything you cited sounds to me like, while the OpEx apparently we set the counter in Q1, I assume you guys know or should have a pretty good feel for what that reset is.

The $5 million pull-in you've identified, it's not a mystery, apparently.

So the things you identified -- I'm not trying to be argumentative, but I'm just pointing out those are things you have visibility into.

I'm trying to understand what accounts -- other than you being appropriately conservative, and that's fine if that's what it is.

But what are the variables that you don't have such good visibility into that accounts for that degree of spread?

The 1 item that I didn't mention is seasonality.

And as you know, historically, there's been a fairly significant falloff from the December quarter into March and then a step-up from March into June.

And I would say that is the piece where we don't have as much of the visibility as to kind of what is that natural falloff.

Now what I will say is that we have done a lot of work on our pipeline and on enabling our field and on enforcing the field in terms of the tools that we're using and building a more accurate forecast for our pipeline of opportunities.

And I would say that our confidence in that pipeline of opportunities this year versus last year is significant -- significantly different.

That said, we do have seasonality in the business that we've had historically and obviously, we are missing the $5 million.

We are still calling a flat number and -- we're calling a flat number and assuming that we're going to outpace and outgrow that seasonality.

Paul, if I can just add.

We spent quite a bit of a time as a team preparing that guidance, and we really looked at 3 drivers.

Obviously, Ed mentioned the revenue based on the pipe that we see, and so we have a range, which as you see is pretty wide.

And we spent a lot of time on the gross margin drivers, the positive aspect as well as we mentioned that we have the impact of tariffs.

And then we've spent quite a bit of time on the operating expenses.

And the math when you have a range of $10 million for revenue, as much as 2 percentage points on gross margin and let's call it $5 million for operating expense, when you multiply the 3, you end up with a range that you see on the EPS.

So one is just math applied to 3 drivers with wide range.

The second one, which we haven't mentioned in our initial response is on the operating expenses, and we know, to your point, quite well what the impact of Merit is going to be on compensation.

We do as a company hire a number of people every quarter.

And based on how quickly the recs will be filled and people will come on board, that will have an impact on our operating expenses.

And so that's something to keep in mind to understand why revenue times gross margin times a range in OpEx result in this range for EPS.

I did the math.

I understand that concept.

Let me ask you just one last question on this.

On gross margin in particular, what are the variables that account for that 2 percentage point spread?

What would drive it to the high end or cause you to be on the low end?

There is really, I would say, 5 factors to keep in mind.

On the positive, you've got the list price, which this quarter is going to be effective for the full quarter.

And we're counting also on higher expected rate of acceptance in 2 regions that kind of offset the initial list price increase in Q2 by providing higher discounts, which was EMEA and APAC.

And then 1 factor that's going to kick in this quarter is, every year we renegotiate in procurement with our suppliers and the benefit of that given the timing of negotiations typically comes into Q3.

So those are the 2 positive things that will drive gross margin up.

The negative ones, one that Ed mentioned is the onetime manufacturing shift to Taiwan from China.

That's a 5.5% impact that we're getting compared to the cost of manufacturing in China.

We don't expect to receive the financial benefit of the move to Taiwan from the low cost of production until Q4 when that production fully ramps up.

And another aspect that we haven't mentioned is that we had a very strong quarter in EMEA last quarter, and we don't expect EMEA to be as strong this quarter.

And from a geo mix, EMEA tends to be a region where we generate higher gross margin.

So those are the -- there's obviously others, but those are the 5 that I would isolate as you build your model.

All right.

But it sounds like only 2 or 3 of those are true variables because you have a pretty good fix about the 5.5% manufacturing and in the timing, so that's not a variable that would -- I don't think, wouldn't think would factor into that 2 point spread.

Still, not trying to be argumentative, just trying to understand.

There's 2 pieces.

There's the run rate once manufacturing is running in Taiwan and we have the increased cost going forward.

There's also onetime expenses, which will be expensed in the quarter for setting up and sort of resetting manufacturing, if you will, in Taiwan.

So there's a onetime effect that we're expecting to be a negative impact this quarter, and then we'll have the positive effect in Q4 of having Taiwan manufacturer's goods that are exempt from the 10% tariff, would come at a 5% higher expense.

All right.

I'll take the rest of this offline.

Let me ask one last question, if I may.

I thought I heard you say that you have higher component cost.

I'm not sure if that was particular to the quarter or if it was a more generic statement.

I'm hoping you'd give more insight on that.

I get the fact that it's more expensive manufacturing in Taiwan.

I assume that purely reflects labor -- or mostly reflects labor costs, but is there something else going on from a component cost perspective?

I recognize we've had shortages, certain component shortages.

Are those having an adverse impact on costs and is that something you expect to continue?

What's going on there?

That's more of a legacy issue.

And I would say, over the past several years, we've seen things like memory and then different component costs because we are in the process of refreshing a big piece of our product portfolio.

And there are a lot of products that are in our portfolio that are older.

And so -- the prices for components have gone up over time.

And historically, we've never raised price.

We haven't raised list price on our products.

And as we contemplated the increase in the U.S., we decided that we should raise price globally and we should take into account the component price increases that have literally happened over the last few years.

So it's more of a decision to raise price and if we're going to do it, let's do this all at once.

And we'll reset the U.S. and the rest of the world at separate rates, but to recover what's happened over the past few years.

And I think going forward, what you'll see us do is have a regular price increase strategy, where we will raise price on a more regular basis, and it's consistent...

Let me ask you -- I'm sorry, was there more?

Well, I just said it's consistent with what our competitors do, it's just something that we haven't done.

So it's an -- I look at that as an opportunity for us.

Got it.

One last question.

My apologies, but I want to return to what's going on in the U.S. region.

You say with the consolidation of your distribution channel and I -- there was one other factor you mentioned for the weakness.

So can you give you more insight?

Let me ask you the question this way.

On a normalized basis, what would U.S. growth look like, or alternatively, more importantly, what do you expect in terms of U.S. growth once you've completed the consolidation?

Well, what I can tell you is that from a bookings perspective, and obviously, when we are saying that this quarter particularly in the Americas, we have a book-to-bill ratio higher than 1. We're going to expect that to level out over time and that if we look at bookings as a leading indicator, obviously, our revenue is sales in, we are seeing -- we're encouraged by what we're seeing from a bookings perspective.

Christian chimed in and he talked about what's going on with E-Rate.

E-Rate has been a drag on our numbers this year because of the weak E-Rate season last year.

This year it should be a different story as we talked about.

And so rather than being a drag, it would flip to being a contributor and a growth driver.

And I think that's going to help out the Americas quite a bit.

We're really encouraged, Paul, by what we saw across our targeted verticals because in each of our verticals, education overall grew despite the weakness in K-12 because of our strength in higher ed.

Government grew, health care grew, manufacturing grew, retail grew, transportation logistics grew.

So all the areas where we're focusing, and in addition to the horizontal solution, delivering vertical solutions and targeting our field, we're seeing growth, and that's true in the Americas as well.

Ed, you mentioned E-Rate, you mentioned that E-Rate exposure was 3% in the quarter.

What was it a year ago?

Year ago, it would have been twice that.

So back of the envelope, it looks like your E-Rate business went from $13 million, $14 million a year ago to $8-ish million in Q5.

So it was about $5 million, $6 million delta -- $5 million delta?

Is that your math?

You're doing good math, Paul.

Our next question is a follow-up from Alex Henderson of Needham.

So a couple of things I wanted to talk about.

First one, you threw off a lot of cash, you bought back $15 million in stock.

You have put on some debt associated with these acquisitions.

Can you talk about your bias to, say, you pull $20 million in cash flow a quarter, what -- how should we think about the split between working down debt versus share repurchases with that available cash flow?

From a capital allocation policy perspective, under our bank facility, we're allowed to buy down $35 million a year.

So we spent $15 million in the second quarter.

We have -- for the last 6 months, it means we have $20 million to spend.

And we look to be opportunistic and to take advantage of that.

We will balance that with M&A, potential M&A opportunities and keeping powder dry there, but for the most part, we look at our stock as being undervalued and we're going to continue to look at share repurchases the second half of the year.

So just to be clear, is that a fiscal year or calendar year that we're talking about the $15 million?

Fiscal year.

Okay.

So you have another $20 million -- some-odd $25 million or $20 million available between now and the end of June?

And then you reset to having another $35 million each year?

We -- yes, it does.

So, we have another $20 million, and if you look at the -- our cash, we have $183 million of debt, $140 million of cash.

So net debt of $43 million today.

We're generating positive cash flow.

So it's something that we are going to -- it's something that we're going to consider.

I can't -- I'm not at liberty to comment on exactly kind of what our intentions are at this point.

But I'd say, we're predisposed towards buying in stock because we believe it's accretive.

The mechanics help.

Second question, so you increased price.

There is obviously price elasticity in any product.

What do you think the net impact of the price increases is to the revenues?

Is it -- if it is a 6% price increase, did it trim volume growth at all?

Did it trim it 1%, 2%, or do you think it was immaterial?

I would say that it was a net neutral in the second quarter.

And we believe that it should get incrementally positive over the next quarter, although we do have the cost offset, I guess, that's more from a margin perspective.

We see the full benefit coming in Q4, Alex.

Right.

So let me just say it again.

As we think about it for multi-quarter period, do you think that there is some negative impact to volumes as a result of the price increases?

I would say, it's less about volumes, and I would say it's more about discounting.

I mean, the net pricing adjustment, I assume, is going up.

So does that have an impact on volumes or not?

We don't see it.

In the U.S., everyone is expecting a price increase because everyone is very familiar with what's going on with the tariffs.

It doesn't have an effect on 15% of our customers, who have frame agreements or contractual pricing over a longer term.

We can't move price on those customers.

But the answer to your question is, yes.

We do.

We do see a benefit of that.

We see traction and having benefit on the price increase without affecting volume in the fourth quarter.

And this is based on what we see in our current pipeline.

So you'd said several times that you've had significant improvement in your pipeline.

I assume that some of that's in the wireless piece, because you've call that out.

I assume some of that's in E-Rate, because you've call that out.

But are you also seeing it in the Data Center piece and what's going on with the service provider acceptance of the new feature set that they were requesting in the fourth quarter calendar that you were supposed to introduce in the fourth quarter?

Does that -- what's the time line for the acceptance of those feature adjustments?

Well, this quarter, we saw, as I mentioned, a strong rebound in service provider.

And we've been hiring and we're excited about the team that we are building in that space and we're excited about some of the customer opportunities -- larger customer opportunities that we have in service provider.

So whereas that was a -- that was a challenge for us.

When we look at the second half of fiscal '18, we see a rebound.

And I would say that from a feature perspective, we are in a much stronger position as we look at the first half of calendar '19.

So if I look at the current quarter numbers, you've got a guidance that is down year-over-year, roughly at the midpoint, flat to down a little bit maybe.

So as I get into the June quarter, with a full acquisition in hand with all of the impacts falling out, with the pricing benefits accruing, the service provider kicking in, E-Rate kicking in, the wireless kicking in, should we be looking at a meaningful growth rate in that period?

Or are we just getting back to the flat with fiscal '18 quarter?

I know you don't want to give guidance more than 1 quarter out.

But could you just give us some sense of direction, should we be thinking about it as up, down, flat?

I would say, I would have 2 things I would say.

One is, I really think you have to adjust our guidance out for the $5 million, and we've $5 million come in, but you take that out, we still had a strong quarter this quarter.

And it's really in terms of how we were guiding and how we're setting expectations, there is the -- our expectation is that $5 million would have been in Q3.

So when you adjust that, it is flat to slightly up and you're getting closer to last year's number.

We have not changed our full year -- we haven't changed the full year guidance here.

So we are expecting a very strong Q4.

I can't really comment on trying to provide an exact number.

Could you explain why the numbers are actually flat to down given the acquisition closing timing?

Well, if you remember, we reset -- at the end of June, we reset the Data Center business, and we made the decision to consolidate our distributors and overall, we saw business volumes down quite a bit.

So we are starting at a lower point.

So even though we may be growing sequentially, we're getting back to where we were.

And we are getting back to where we were in a much stronger position.

Right, that's exactly what I was trying to get at.

So you have 2 variables here, which are obviously critically important for the reason why you're absorbing in the March and June quarter, the distribution, consolidation and the Data Center realignment.

It sounds like given the strength of the SLX product line launched in the December quarter and the feature adds that the customers were waiting for that there is a amount of time from the time that feature gets done to the time that they accept it and say, "Hey, this looks good, I'll accept it." When do we get back to a normalized Data Center number?

And is that business growing off of that base, or is it flat?

We reset the Data Center expectations for $160 million to $170 million run rate.

That business is stabilized, and we -- and that business is growing.

So we are back to growth in that part of the portfolio, and we expect that to continue.

If I look at -- fiscal '18 being -- granted it wasn't a full quarter in terms of what we had as far as the acquisitions, but approximately $980 million of revenue, and now we're over $1 billion.

And as we pivot and go into fiscal '20, we will be projecting growth across the entire portfolio.

And that's where we see this, and that's why I make the comment about a much stronger foundation from where we're starting.

I think you'd been talking about the distributors being a $10 million to $15 million hit per quarter until it stabilized.

It sounds like you're ahead of trajectory on that.

Should we still be thinking about $5 million to $10 million hit from that in the March and June quarters?

Yes.

I'd say, at this point, Alex, I would say we're almost -- we're almost done, and so I would say the numbers are probably a little bit smaller more in terms of what the effect would be in the quarters in the second half of the year.

Great.

So those fall out.

That would suggest in the back half of fiscal '19 -- or fiscal '20 period, when you get into the first half of the fiscal '20, that you should be seeing better results in September, December versus traditional seasonality, is that correct?

Absolutely.

There are no further questions.

I'd like to turn the call back over to Ed Meyercord for any closing remarks.

Okay.

I'd like to thank everybody for joining us today and all the Extreme employees who are listening in for a job well done.

The progress is visible.

We're looking forward to sharing a more detailed outlook about our portfolio, our long-term vision, business model, et cetera, at the Investor Day that we're having at the NASDAQ Exchange in New York on February 13.

So I would encourage everyone to please consider attending.

I think it's going to give you a great look at the progress that we're making, and why we're excited about the second half of this year.

We're also having a user conference in May, and I would expect -- ask people to look at that as well.

It's pretty exciting in terms of what we're coming out with in terms of our vision across the entire enterprise portfolio and the 3 solutions pillars.

So thank you all for participating and have a great day.

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

This does conclude the program, and you may all disconnect.

Everyone, have a great day.