Good day, ladies and gentlemen and welcome to the Extreme Networks’ Q1 Financial Year 2019 Fiscal Results – Financial Results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Stan Kovler, Executive Director of Investor Relations-Strategic Development. Sir, you may begin.

Thank you, operator and welcome to the Extreme Networks’ first quarter fiscal 2019 earnings conference call. This conference call is being broadcast live over the Internet and is being recorded on behalf of the company. The recording will be posted on Extreme Networks’ website for replay shortly after the conclusion of the call. For your convenience, a copy of the press release and supporting financial materials are available on the Investor Relations section of our 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 federal securities laws. 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. For a detailed description of risks and uncertainties, please refer to our most recent reports on Form 10-K, 10-Q, 8-K filed with the SEC. You should not place undue reliance on forward-looking statements, which speaks only as of today. We take no obligation to update these statements after this call. Throughout this call, we may refer to both GAAP and non-GAAP financial metrics. Non-GAAP information should be considered a supplement to, and not a substitute for, financial statements prepared in accordance with GAAP. Reconciliation of non-GAAP to corresponding GAAP measures can be found in our earnings press release issued today. And now, I will turn the call over to Extremes’ President and CEO, Ed Meyercord, for his opening comments.

Thank you, Stan, and thank you all for joining us this morning. Welcome to our fiscal Q1 earnings call. Today, we announced Q1 results that were better than expected, highlighted by 13% year-over-year growth in total revenue to $239.9 million and non-GAAP earnings of $0.08 per share. We improved our non-GAAP gross margin on a year-over-year basis for the 10th quarter in a row. Our cross-sell pipeline grew to a $166 million at the end of Q1. A product line management and engineering teams have done an excellent job converging four significant product portfolios from our acquisitions into three distinct solutions pillars. Our Smart OmniEdge, Automated Campus and Agile Data Center and our field is beginning to embrace them. We posted another quarter of record service bookings with improvement in our attach rate and growing contribution of multiyear agreements. And we had record cash collections of $300 million in the quarter, strengthening our balance sheet. Customers embraced our new Smart OmniEdge portfolio given the level of intelligence, adaptability and security in our solution. We know from customers and partners alike that our solution is much easier to deploy with faster uptime than our competitors. Our teams can address the top concerns of our enterprise customers. The explosion of devices with the Internet of Things, the need for pervasive and consistent Wi-Fi across campus. The need for protection from increased attacks, the need for increased performance expectations and the requirement to lower expenses. We’re really excited about the product innovations we have coming throughout fiscal 2019, associated with Smart OmniEdge. We have strong customer interests in our IoT Defender product with cloud managed and extreme cloud software along with extreme location upgrades coming in calendar Q4. And we have robust wireless and wired hardware refreshes in connection with the ramp of…

Thanks, Ed. As Ed noted, our revenues of $239.9 million is up 13% year-over-year, generating $0.08 of earnings per share, both above the high end of our guidance range. EPS benefited from strong revenue in both quarter-over-quarter and year-over-year margin performance. Our product revenue of $177.7 million grew 8% year-over-year while addressing the distributor consolidation actions and data center business outlook, we provided during the quarter in typical seasonality. To that end, we reduced the number of distributors by 20% in Q1 and we’ll continue to execute on our consolidation plan as we outlined last quarter. We grew our services business by 32% year-over-year and 9.6% quarter-over-quarter. Our services renewals team is focused on increasing our new attach and maintenance renewal rates. Our success has been enhanced by multiyear offerings, where we are seeing an increase. Earlier this week, we wrote out incremental premier services offerings to provide customers a white glove service and drive standalone value. During the quarter, the Americas contributed 53% to total revenue, EMEA 38% and APAC closed out the remaining 9%. We continued to see particular strengths in EMEA, where we improved on discount discipline. EMEA revenue grew 1% quarter-over-quarter, outperforming typical seasonality and outpaced overall revenue growth at 16% year-over-year. Globally, government was our top-performing vertical for the second consecutive quarter, followed by education, healthcare, manufacturing, and retail to finish out the top five. Non-GAAP gross margin was 58% compared to 57.6 % in Q4 2018 and 56.7 in Q1 last year. Our gross margins increased for the 10th consecutive quarter despite headwinds from one-time wearhouse consolidation expenses and tariffs resulting in an approximately 1% impact to total gross margin in Q1. Our non-GAAP product gross margin of 56.8%, increased from 55.9% year-over-year. Q1 non-GAAP operating expenses were $124.7 million and compared to $132.9…

Thank you. [Operator Instructions]. Our first question comes from Mark Kelleher with D.A. Davidson. Your line is now open.

Great. Thanks for taking the questions. Nice work on the balance sheet. That’s really good. Could you talk a little bit about the core products, the Brocade, acquisition versus your core revenue? I know you struggled – you struggled last quarter with that particular piece of the puzzle and just give us an update on how that is working its way up?

Sure. Thanks, Mark. And yes, we did – there is a lot of work going on, on the data center side. Yes, we have – we’ve made some changes there and in the quarter, we saw some nice customer wins, we see in this stabilization of that business and as we mentioned, we’ve done some hiring in some key segments like service provider in federal that our large pieces of that data center business and we’re really excited about the talent that we’ve brought on and how quickly they’re ramping up. So, we’re already seeing some of these opportunities in the pipeline. From next week, you’re going to see an announcement from us regarding our data center launch if you will, our third pillar we’re calling it our Agile Data Center and we have some real advantages in terms of our cross-domain automation, some of the flexibility. We’ve tied this to Extreme management center and it’s really the adaptability and the agility of these platforms that gives us an advantage. We’ve had some really nice wins with the internet exchange customers and our field is starting to – it’s starting to embrace the opportunities for enterprise customers. Now I’ll be honest and say, it’s taken longer than we’d like. I think that’s always the prerogative of someone in my seat, but the deal is adopting and picking it up, and we’re seeing momentum. So, we think we’ve – a data center was right in line with our expectation and from here, we’re going to – what we expect to see growth.

All right. And how about an update on your distributor reduction program? You said, you were down 20%. So, by my math, you went from 250 to 200, maybe somewhere in that neighborhood. Can you just tell us where you’re headed there?

Yes. That’s about right. We’ve made a lot of progress there. Our distribution team has done an excellent job, supported by our supply chain team and our field. Yes, 20% is about the right number of 40 in terms of the reduction. The other thing is, we’ve also found some opportunities for stocking opportunities in markets like Asia Pacific, where we haven’t had that in the past. We had about 100 of our distributors at present in Prague at our Partner Conference. And about the top 10 of our distributors today are running about 85% of our business. Remember that about 70% of our business runs through distributors and 30% is direct on a product side. So we’ve – we’re making a lot of progress there. The team is doing well. The rationalization, I would say, is right on plan.

Okay, great. Thank you.

Thank you. Our next question comes from Alex Henderson with Needham & Company. Your line is now open.

Hey, guys. Good morning. This is Dan Park on for Alex. So, I was just wondering if you could provide some color on what you’re seeing in terms of competition on the data center side. Have you seen any meaningful changes throughout the quarter?

Not really. Keep in mind that one of the things that – one of the reasons why we are excited about the acquisition was just a huge base of customers that we have. So, a big opportunity that we have is to go back into our base of customers and to sell to our existing base in addition to cross-selling to existing customers that have our deployments in other places in the network. Yes. I would say by and large, the likely and most obvious competitors we’ve run into is Cisco, that hasn’t changed. People often ask us about Arista. We don’t see Arista as much and I think some of that has to do with the verticals, where they’re strong and where they play versus – where we’re strong. We have dominant market share in the internet exchange market. That business continues to be healthy, and we are – there’s a lot of work. The good work being done by our engineering teams and our PLM teams in terms of advancing the capabilities of our new SLX platform. So yes, I guess I would just say that’s – nothing has really changed, the likely suspects are who we’re running into and the opportunity for us, who continue to be this big base of customers that we have to sell into.

Okay, great. Thank you. And just to follow-up on, I know the government vertical was sort of called out on the call. Can you just clarify for us what’s sort of driving the growth there and our customer adoption?

Yes, I think. Again, we have a really large – a large base of government customers and when I would say is, it’s the combination of our Smart OmniEdge and our Automated Campus. What’s happening in our field is people are embracing the fabric, the simplicity and the ease of deployment of that fabric technology is really catching on with our customers globally, with particular strength in EMEA. So, the combination of our policy, our Extreme management center, any efficiencies that we can drive and then the ease of deployment and the security and the hypersegmentation of our fabric, the copy of between our field and our partners really beginning to embrace and understand how these technologies come together. They have been rolling that out – they’ve been rolling that out successfully. So, we have a large base of government customers. If you keep in mind, government can overlap with education. And I guess I would just say that it’s really a byproduct of this large base of customers that we have in the strength of the product portfolio coming together.

Okay, great. Thanks so much for taking my questions.

Thank you. [Operator Instructions]. Our next question comes from Erik Suppiger with JMP. Your line is now open.

Yes. Thanks for taking the question – two questions. One, why are you raising the prices for customers outside of the U.S.? My understanding is that the tariffs are just going to be on the U.S. customers. And then secondly, you had repeated a couple of times that you view yourself as the number one alternative to Cisco. How does HP, how are you viewing their position in the market when you say that? Thank you.

Sure. Well, one of the things that we commented on it that as it relates to the pricing issue is that Extreme and really all of the companies that have come together in the new Extreme. I hadn’t raised list price in a very long time in over four years. And we have been incurring cost increase we talked about the memory prices rising and other elements of our cost structure raising and it was our intention to raise list price this year, and the tariffs kind of created this forcing function, because we had to do it in the U.S. So, we took the opportunity then to raise our list price globally. So, it’s really about our component costs going up and the fact that this is something that we’ve been eating altogether and we need to share some of that with our customers. So that’s what’s going on outside as we look into January and the prospect of a 25% tariff, that pricing actions from that point forward would relate only to U.S. customers. I hope that answers that question.

Yes. A quick one on that one. Do you have any thoughts as to how much you might absorb versus how much you might pass along, particularly given that it sounds like you’re moving fairly quickly to move manufacturing outside of China?

Sure. So, we’re – we have a lot of different mitigation initiatives underway. And at the end of the day, we’re trying to minimize the impact to our customers and our field and our partners. That’s – it’s a top objective at the same time, we’re also thinking about our investors and preserving our gross margin. So we’re balancing that, and we’re balancing that to be gross margin neutral. The good news for us is that our larger competitors, particularly, Cisco, has announced that they’re raising prices and they’re raising prices, more than we are and the fact that our total cost of ownership is already below Cisco. So, they’re giving us an umbrella to operate under, which is a positive for us and we also believe that we’ll be able to move more quickly, because we’re more nimble and moving that manufacturing out of China. So that we’ll be able to mitigate that cost sooner. So, from that standpoint, we think a pricing advantage will only be greater. So, I hope that – I hope that’s helpful.

Yes, great. Yes.

From a competitive perspective, it’s kind of interesting if you look at the Gartner Magic Quadrant, you can see the move that we’ve made over the last five years, each year, the only player moving up into the right while Cisco and HP being the only two in the leadership quadrant had been moving down actually. And so we moved up into the leadership quadrant for the very first time. If you look at the top half of Gartner’s MQ, we’re a challenger in the data center market. So, as it relates to HP, they’re not a great end-to-end story. They have an edge story through a robot that’s quite compelling. But they’ve talked about reselling Arista, those kinds of relationships, always struggle in go-to-market and they don’t really have an end-to-end solution. So, if we think that’s powerful and that’s resonating well with our partners and customers. So we’re the only other player in the top of the MQ next to Cisco. And when you talk to Gartner, they’ll say, look, your solutions, your networking solutions are just as good from a hardware perspective, if you go toe-to-toe, your software is more elegant. You’re a single pane of glass is superior; your total cost of ownership is lower. You’re delivering higher value and your service is superior. So, you’re the premier alternative to Cisco in the marketplace and this is something that’s very embracing, we’re hearing it from partners and I think, this is something that we’re hoping to get leverage from our partners as this message going to galvanize it and resonate. It’s not just extreme pounding the table saying this. It’s third parties saying this.

Very good. Thank you.

Okay.

Thank you. Our next question comes from Christian Schwab with Craig-Hallum Capital group. Your line is now open.

Great. Thanks for taking my call. Good execution. So, as we – can you tell us where you’re going to move the volume two in March when you take it out of China?

Taiwan.

Okay. Thank you. When we look at the non-GAAP gross margins, guidance of 57.5 to 59.5, we’re raising prices and now we kind of expect neutral effects going forward. Is that kind of the – should we kind of assume non-GAAP gross margins for the remainder of the year, stay in that type of range or are there any, puts and takes that could increase gross margins over time this year to have a six handle at that front?

Yes. I mean, our goal, we haven’t given up on the 60% target, Christian. This quarter, the timing of the tariffs caught us a bit. We have to get 30 days’ notice. We got the effective date of the tariffs was September 24. We took a little bit of a hit this quarter and then from a timing perspective, our customers and partners are pretty smart. We’re seeing great linearity this quarter, because people are pulling in orders into the first month of the quarter to benefit from the lower prices if you will, which is how we have good visibility of the quarter based on the linearity that we’re seeing. So, this is somewhat of a one-time impact for this quarter. And then in terms of our pricing strategy, we’re managing our mitigation efforts to be neutral. So, as we go into Q3, as we said earlier, we expect gross margins to step up each quarter of the year, that hasn’t changed. So, we are expecting a step from Q1 to Q2 and then to Q3 and to Q4, and we believe in Q4, we’re going to be over that 60% target.

Okay, fabulous. And as far as operating margin structure, I know you’ve spent some time previously talking about driving to a double digit or a 10% operating margin kind of objective. Is that still – you’re still hoping to operate in that type of business model towards the end of this year, and is there any opportunity to operate that on a yearly basis?

The answer is, yes. That’s where we’re going. That hasn’t changed. As you know, we’ve been talking about this for awhile. It’s taken us a little bit longer and with the reset, we’ve started over again, and we’ll build and we’re – we’ll be guiding there for Q4 of this year, our fiscal Q4. So in June, our plan is for a 60% gross margin and that double-digit operating income margin.

Okay. Fabulous. And then my last question has to do with E-rate. Three years ago, you guys had a very successful run in education as did the industry in the first year of that program. There has been some structural changes at the top that may or may not make it easier for schools to get money. But that being said, there’s a three-year window, I understand, where schools who take money can’t take money. And all of those prosperous schools, if you will, who took money three years ago, we’ll be able to come back in this window and ask for funding again and with the transition to a next generation Wi-Fi architecture, and that being the number one priority of most K-12 schools, are you beginning to see any positive impacts or outlook or dialogue in the education market for a recovery, in the United States, in that market?

Yes. And as you’re highlighting, this was a tough quarter and it’s been a tough year for us in education and given the strength of prior year, it’s given us some headwinds and some tough quarterly comparisons that we’ve had to overcome. This is the last year of the funding program and there are a lot of dollars that are left over and our teams are expecting. They’re expecting E-rate to come back quite a bit in the second half of this year. We don’t expect to see it in Q2, but in Q3 and Q4, we’re expecting a pretty significant return of education customers and spending from that program.

Okay, great. That’s what we’re hearing too. Thanks. No other questions.

Okay.

Thank you. And our next question comes from John Marchetti with Stifel. Your line is now open.

Thanks very much. Good morning guys. Thanks for taking my question. Curious as you talked a little bit about how you – you pulled some orders in or some customers are trying to get ahead of some of this tariff actions, if there’s any risk there as we look out a couple of quarters that you run into a bit of an air pocket if you will on the demand side with some of that stuff being pulled in currently and kind of what your visibility looks like there, so you can mitigate that as we move forward?

John, it’s a great question and it makes a lot of sense. What we’ve seen so far. We saw a little bit of that last quarter, which helped our top line this quarter. We’re seeing stronger linearity, which relates to this global price increase we put in place, and people may be trying to get in front of that. So, we’re seeing this unprecedented linearity as far as Q2 as concerned. We haven’t assumed that we’re pulling anything in from Q3 at this stage. Really what’s been going on? And I talked about $166 million of cross-sell pipeline. Last quarter, we talked about $100 million of cross-sell pipeline that’s what’s giving us the confidence in the second half of the year. And if you talked to our Geo sales leads and you look at the pipeline and the quality of opportunities that we have in the pipeline as we turn the quarter and go into calendar 2019, we’re pretty – we’re feeling confident right now with what we’re seeing. So, I would say, it’s really pipeline driven and at this point our guides we haven’t assumed that there’s a big pool win in Q2.

Great. And then just back on the price raise question a little bit, you had mentioned that that had actually been in the works for a little bit in this kind of with the tariffs up, it sort of gave you the excuse to go ahead and pull the trigger or maybe do that a little bit more broadly. Had that been sort of telegraphed to customers ahead of time, I’m just curious, some seem to be reacting fine in the work that we’ve done, others seem to be pushing back on these increases, and I’m just curious, if we do sort of see the next tranche and things start to climb even higher, how you think that may sort of impact purchasing decisions in demand at least in the sort of intermediate term as they have to grapple with sort of their network demands, and some significant tariff increases if they go that high.

Let me take a shot and then I’ll let matt jump in behind me. First of all, I think everybody understands that when we talk about what’s driving our customers, at the edge with the Internet of Things with new Wi-Fi capabilities, with what’s going on in terms of the requirements for automation, the software tools, what’s happening in data centers, in terms of these complex multi-cloud environments that’s not changing, your networking drive isn’t changing, the need for networking is very strong. So, in terms of market demand, I think we all realize that’s not going to stop and turn around, it’s going to continue to grow. It’s a relative analysis, because you have to look at if people have to make purchases, who do they go to. And keep in mind, we’ve been the beneficiary, but Cisco has been out raising price. So if we’re – if we continue to price below Cisco and on a relative basis, our increases are below theirs, and we can move more quickly to mitigate the expenses that only increases our advantage in the marketplace. The other thing, I would say is that, 85% of our revenue comes from our installed base and these are somewhat captive customers and they’re sticky. We’ve been selling more software. And so to the extent that we are able to continue to drive our solutions, the three pillars we talk about, the pricing impact becomes less meaningful. Matt, do you want to add anything to that?

Yes. Thanks, Ed. So just a couple of other things to add to that associated with our forecasts and expectation around the price changes occurring in the October-November timeframe, the past two years from a services perspective, we have implemented price changes associated with services only, not hardware at all related. And so the timing was to line up with that. When we identify the change in the tariff, we wanted to make sure we were aligned from a cost structure perspective to identify the overall pricing and make one change at the same time associated with both our expected, underlying cost structure change as well as the tariff impact that it was going to have. The concern around the January timeframe from our customers is probably the most notable item. And from an international perspective, we expect that the price changes will only impact the U.S. resulting from the Q3 – our fiscal Q3, the January timeframe price change. And I think the key here is to note that we’re below Cisco before and we continue to be below Cisco, so driving our total cost of ownership at a lower rate.

Helpful. Thank you very much.

Thank you. This concludes today’s Q&A session. I will now like to turn the call back over to Ed Meyercord, President and CEO for closing remarks.

Well, thanks everybody who could join us in the call today. I also want to thank all of our extreme employees, who are listening in for a job well done. I think everybody knows that this is a team that was 11 for 11, running hard. We did something that was very complicated in terms of buying three companies over an 18-month period. Everything is on the extreme platform today. And we are now looking and running and optimizing. During the integration process, we hit some bumps in the road, but we’re back. We’re, one for one now back up on the board and looking forward to executing again on this next quarter. We hope to speak with you at the Needham Conference on November 13th as well as Barclays and Cowen conferences in December. Thanks again for your time and have a great day.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a great day.