Earnings Call: Q2 2019

Jan 29, 2019

Good day, ladies and gentlemen, and welcome to the Extreme Networks Second Quarter Fiscal Year 2019 Financial Results Call. At this time, As a reminder, this call is being recorded. I would now 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'm State Kovler, Executive Director of Investor Relations. With me today are Extreme Networks' President CEO Ed Meyercord, CFO, Remi Thomas and VP of Finance Matt Cleaver. We just distributed a press release and filed an 8 K detailing Extreme Networks 2nd quarter fiscal 2019 financial results. For your convenience, a copy of the press release, which includes our GAAP to non GAAP reconciliations in our fiscal 2019 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 $252,700,000 and non GAAP earnings of $0.13 per share. Our gross margin was the highest in 3 quarters, and we repurchased $15,000,000 worth of our shares during the quarter. From a bookings perspective, We grew year over We continue to adding 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 four quarters grew sequentially once again. I recently came back for meetings with our teams in Asia, where growth has been driven by 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 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 transportation logistics and higher ed verticals. Overall, the revenue for Americas was negatively impacted by distributor consolidation softness in the K-twelve 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 met 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, implemented price increases on November 1st. And as we previously announced, we moved aggressively to move manufacturing to Taiwan and expect 80% of our products to ship into the U. S. To be exempt from this tariff at the end of March. In addition, we benefited from approximately 5,000,000 of forward customer buying during the quarter that came in from Q3. Last week, we launched our first 802.11ax or Wi Fi Six 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 2019. We are also 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 preorders for our WiFi six 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 to exchange, Data Center interconnect and full XMC management integration for single pane of glass visibility. Looking ahead for the rest of calendar 2019, 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 augmented campus and 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 value 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 Omni Edge portfolio, with strong attach rates of our mobility, analytics, control and cloud software. Our momentum in this vertical continues to go globally as our teams in EMEA and Asia are winning with our differentiated solutions and strong customer references like the NFL. The launch of WiFi six products will only accelerate this trend. In the higher education space, the University of Central Arkansas required a strong secure 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 gains, our true single pane of glass visibility, and control software that our largest competitors simply can't replicate. In November, Extreme was named Gartner Peer Insights customer's choice for wired and wireless LAN and data center, highlighting our number one 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 $5,000,000 of forward buying from Q3 that came into Q2. We expect revenue to be in the range of $247,000,000 to $257,000,000 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 have 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, I don't believe many of our largest customers have passed through exposure to China, such as higher ed, healthcare, 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 Thanks, Ed. As Ed noted, our revenues of $252,700,000 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 $189,600,000 grew 8% year over year and 7% quarter over quarter. This also reflects the distributor consolidation actions and data center business outlook we previously noted. To that end, we've reduced the number of distributors by another 10% in Q2 and we'll continue to execute on our consolidation plan as previously outlined. Our services revenue of $63,100,000 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 multi year offerings and the premier services we rolled out last quarter. During the quarter, the Americas contributed 45 percent to total revenue, EMEA, 44%, and APAC closed out the remaining 11%. EMEA remain our fastest growing market, but we see customers embracing our differentiated product portfolio very effectively. Globally, governments was once again our top performing vertical for the 3rd consecutive quarter. This includes both state, local and federal governments, both in the U. S. And Internationally. Next largest verticals were education, manufacturing, service providers 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 three 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 Our non GAAP product gross margin of 57% compared to 59.4% in the year ago quarter and 56.8% in Q1. Q22 non GAAP operating expenses of $126,600,000 were up from $117,000,000 in the year ago quarter and from $125,300,000 in Q1, increasing at a slower rate than revenue. The sequential increase in non GAAP operating expense was mainly due to the higher R and D spending as we continue to focus on new product development and product introductions. On a year over year basis, the increase in operating expenses resulted primarily from the first time consolidation operating margin of 8% compares to 8.8% in the year ago quarter and 5.8% in Q1. Free cash flow of $23,600,000 compared to use of cash of 10.3 in the year ago quarter Year to date, we generated $50,000,000 in free cash flow compared to less than $1,000,000 in the first half of twenty eighteen, 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 investments in our own digital transformation. Our total cash and cash equivalent balance at the end of September was $140,600,000, sorry, end of December, up slightly from $140,200,000 at the end of September. We repurchased $15,000,000 worth of our stock at an average price of $6.33 a share. DSO of 53 days fell 16 days year over year 10 days quarter over quarter. The substantial year over year decrease reflects our shift away from the TSA we were on for the period that immediately followed the acquisitions 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 $186,000,000 from 152.4 in the year ago quarter, and 183.6 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 $5,000,000 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 247,000,000 to $257,000,000. Q3 GAAP gross margin is anticipated to be in the range of 55.2 to 57.3 percent and non GAAP gross margin in the range of 57.5 percent to 59.5 percent. We estimate that tariffs will continue to have up to a negative 100 basis point impact on our overall gross margin for 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 $139,700,000 to $143,000,000 on a GAAP basis and 129.9 to 133.2 on a non GAAP basis. The sequential increase in OpEx is primarily related to payroll and variable compensation costs. Q3 GAAP earnings is expected to be in the range of a net loss of $8,300,000 to a net income of 700,000 or a loss of $0.07 to a net income of a $0.01 a share. Non GAAP net income is expected to be in the range of $7,200,000 to $14,900,000 or $0.06 to $0.13 per diluted share. In Q3, We expect average shares outstanding to be approximately 117,100,000 and $119,600,000 on a non GAAP basis, excluding the impact of any shares we may repurchase. With that, I would like to now turn the Our first question comes from Alex Henderson of Needham. Your line is open. Hey, guys. 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 had a 1% impact from the tariffs But then you said in the upcoming quarter, you're expecting to have 80% of that production moved Taiwan, which should fall out. So as I look past the current quarter into the June quarter, do I take 80% of the benefit hit from the tariffs plus the 1% hit from the manufacturing move? So I'm improving by 100 and 80 basis points. Is that the right way to think about that? Hey, Alex. This is Ed. I think the way to think about it is that we 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 shift 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 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's a point attributed to that. So you can have that point. We have other benefits occurring in Q4. And our expectation is to guide over 60% in our 4th quarter. Right. So just to me, to reiterate what I had said before. So if I take the currency, I'd say the tariff impact 1%, which persistent to 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's more of that. Then I get it. Then in addition to that, I'm absorbing 1% impact to cost of goods sold. For the move and that falls out. So there's 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. 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 timeframe 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'll 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, 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 you is on the pricing initiative. It's my understanding you put it in November 1st, but it wasn't immediately effective on all product at that point, there was a portion of your business that was, grandfathered as a result of deals that were in the actually shows up in the December quarter versus, how much of an increase will it represent to pricing in the full March quarter. And I would say it's 1% or 2% out of the 7% total? Alex, I guess what I would say is that's really the point It's 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 had great linearity in the quarter where Normally, we have a small percentage of our orders that would come in that 1st month, and we had close to 40% of orders in that 1st month. So it was a bit lopsided and that timing differential is what is what caused that margin headwind. I understand on the margin side, I think I've got that calibrated 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 could think about it that way, but I think you also have to realize that it's, it's a we put 7% in the U. S. We put 5% rest of world, given the fact that it's roughly fifty-fifty, I guess you could 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 tariff only affect the U. S. We needed to recover years and years of component cost increase, at our products, and we decided to do it all the same time. So there was so discounting behavior has to be managed and that's 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 they have long term pricing contracts where we can adjust price. So that's that's also somewhat of a limiting factor. So I guess what I'm saying is that there's 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. 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 2 50s supposed to be down 200 by the end of the year. And if I remember correctly, 150 distributors by or VARs 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 kind of affects that, the book to bill ratio, And it was heavier in this quarter in the United States. And so at this point, we're 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. At this stage of the game, we feel like our teams have done a really good job of that. And we're almost at the finish line. So do you do sell in recognition of revenue? And you said you were going to be bringing down inventories at the discontinued players, did that have an impact on your sales? Yes. That had an impact that 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 you 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. Okay. I will see the floor. Thank you. Okay. Thanks. Our next question comes from Mark Kelleheller of D. A. Davidson. Your line is open. Great. Thanks for taking the questions. Before we get too far away from gross margins, I wanted to go back to that a little bit. Can you talk about the impact of different product categories, the product mix within gross margin is There was an issue a couple of quarters ago with some brokeades, some core switch headwinds to gross margin. Can you just talk about where we stand on that? 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 discountings in the field and gross margins were a lot less than we had anticipated. So we're really pleased see the recovery of gross margin there. I mentioned in my comments that 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's still somewhat of a drag there from the older product portfolio, but as we move to product lines. The same with Avaya Fabric and their campus solution, that has been a 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 It was now up over our acquisition expectations from a revenue or 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 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-twelve was still a headwind over on the wireless side. Is that big headwind? How's the wireless doing? There's some thought that we might be approaching a refresh cycle on the K through 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-twelve 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 of stronger E rate cycle and we'll find out at the end of March, kind of how we do it the next round. So the weakness in case 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 Six, where you have significant density benefits. We have pre orders for that product line, maybe a little cannibalization from the existing WiFi lines as we look at it 3, we are 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 timeframe and land in Q4. Okay. And last question, and then I'll see 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've 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 that 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, just to point that out to customers when they're 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. Your line is open. I just want 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 2015, in part because all of those schools took money in fiscal year 2015, as you know, can finally come back after taking 3 fiscal years off and get it again for funding. At the same time, transitioning to Wi Fi Six. In that year, you guys won almost $100,000,000 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 should accelerate further over the next 90 days. Are you guys not as strongly positioned as far as a Salesforce initiative there? I'm slightly confused. Hey, 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 point out, there are a lot of people who can come back. When we're talking about guidance, we're obviously talking about Q3. And we'll 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've 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 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 2015, you didn't have, as broad and maybe as 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 the team is working, do you think that your opportunity is more broad based and 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-twelve in distributed environment. 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 remote site with that single pane of glass that our competitors don't have. So we think there's a feature there that's pretty powerful and differentiating for Extreme when we're 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 we're working to lead with our customers to focus on that software and spec Extreme and there are fees. Great. I don't have any other questions. Thank you. Our next question comes from Paul Silverstein of Cowen. Your line is open. Thanks. First, I'll just some clarifications wireless link. You said it's approaching 20 percent of total product revenue that will make it about $50,000,000, if I did the math right, 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 is probably closer to 15%. And last quarter is probably going to be 18% Again, that's not a precise number. And 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. I know you mentioned K-twelve was small, but can you give us can you quantify how small? Well, K-twelve for us is now as part of the education vertical, given the growth that we've had in higher education, K through 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 have data from a bookings perspective, it's going to be like 3% of revenue, more or less in that ballpark. Got it. All right. Let me move on. The pretty broad spread in the guidance, especially on 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. I know it's early, but given your comments about the 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 then I'll let Remy chime in if he wants to kind of supplement the answer. First of all, we did pull in $5,000,000, you're forward buying, healthcare 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 $5,000,000. If we pull that out of Q2 and put it into Q3, obviously that that makes a change. We still would have beaten this quarter without the $5,000,000, but that would have taken the number up quite a bit for 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 that just reset and start in Q1 that create higher OpEx. So kind of right out of the chute there, if you're just doing the 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 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 2nd 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 Remi chime in if you want to add. Before Remi chimes in, I just want to make sure I understood your comments correctly. Everything you cited sounds to me like while the OpEx apparently resetting calendar Q1, I would I assume you guys know or should have a pretty good feel for what that reset is. The $5,000,000 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 one 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's the piece where we don't have the 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 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're missing the $5,000,000. We're still calling a flat number, And we're calling a flat number and assuming that we're going to outpace and outgrow that seasonality. Yes, Paul, if I can just add, we spent quite a bit of time as a team preparing that guidance and we really looked at 3 drivers. See 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 as the mentioned that we have to the impact of tariffs. And then we spent quite a bit of time on the operating expenses. And the math, when you have a range of $10,000,000 for revenue as much as two percentage points on gross margin and let's call it $5,000,000 for opportunity spend when you multiply the 3, you end up with the 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. We note your point fine well what the impact of merits is going to be on compensation. We do as a company hire a number of people every quarter. And based on how quickly the wreck will be filled and people will come on board that, that will have an impact on 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 get the math. I understand that concept, but 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 points spread? What would drive it to the high end? What will cause it to go to the low end? There's 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 two regions that kind of offset the initial list price increase in Q2 by providing higher discounts. Which was EMEA and APAC. And then one factor that's going to kick in this quarter is every year, we renegotiate, in procurement, without suppliers. And the benefit of that, given the timing of negotiations typically comes into Q3. So those are the two positive things that would drive gross margin up. The negative ones one that Ed mentioned is the one time 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 margins. 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 going 2 or 3 of those are true variables because you have a pretty good fix about the 5.5% manufacturing unit of the timing. So that's not a variable that would factor I don't think would wouldn't think would factor into that 2 point spread. Again, that's trying to be argumentative, just trying to understand. There's two pieces. There's the run rate once manufacturing is running in Taiwan and we have the increased costs going forward. There's also one time 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 one time 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 manufacturers goods that are exempt from the 10% tariff would come at a 5% higher expense. All right. I'll take the rest of those offline. Let me ask you one last question, if I may. I thought I heard you say that you have higher component costs. I'm not sure if that was particular to the quarter 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 manufactured 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? Well, 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're 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 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 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. All right. Let me ask you, I'm sorry, was it more? 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 cited the consolidation of your distribution channel. And I think there was one other factor you mentioned for the weakness can you give 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 are you expecting 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're saying that this quarter, particularly in the Americas, you 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're 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 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 should be a different story as we talked about. And so rather than being a drag, it should 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-twelve because of our strength in higher ed. Government grew, healthcare 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 3% in the quarter. What was it a year ago? A year ago, it would have been twice that. So in fact, in the envelope, it looks like your E Rate business went from $13,000,000 to $14,000,000 a year ago. To $8 ish 1,000,000 in Q5. So it was about a $5,000,000, $6,000,000 delta. Is that the math? You're doing good math, Paul. Got an average for my desk. All right. I'll pass it on. Thanks guys. Okay. Thanks. Our next question is a follow-up from Alex Henderson of Needham. Your line is open. Great. Thanks. So, a couple of things I wanted to talk about First one, you threw off a lot of cash. You bought back $15,000,000 in stock. You have put on some debt associated with these acquisitions. Can you talk about your bias to, say you pulled $20,000,000 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? Yes, from a capital allocation, policy perspective, under our bank facility, we're allowed to buy down $35,000,000 a year. So we spent $15,000,000 in the second quarter. We have, for the last 6 months, it means we have $20,000,000 to spend. And we look to be opportunistic and to take advantage of that. We will balance that with M and A, potential M and A opportunities in keeping powder dry there. But for the 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 a calendar year that we're talking about the fiscal year? Okay. So you have another 20 some odd 25,000,000 or 20,000,000 available between now and the end of June. And then you reset to having another 35 each year? Yes, it does. So we have another We have another $20,000,000. And if you look at the, our cash have $183,000,000 of debt, $140,000,000 of cash. So net debt of $43,000,000 today, we're generating positive cash flow. So it's something that we're going to it's something that we're going to consider. Avi, 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. That mechanics help. Thanks. 2nd question, so you increased price. There's obviously price elasticity in product. What do you think the net impact of the price increases is, to the revenues? Is it if it's a 6% price increase, did it trim volume growth at all? Did it trim at 1%, 2%, or do you think it was immaterial? I would say that it was a net neutral in the second quarter. And And we believe that it should get incrementally positive over the next quarter, although we do have the the cost offset, I guess, that's more from a margin perspective. We we see the full benefit coming in 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 than I'd 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 was expecting a price increase because everyone's 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 in having benefit on the price increase without affecting volume in the fourth quarter. So you think And this is based on what we see in our current pipeline. So you'd said several times that you've had significant an improvement in your pipeline, I assume that some of that's in the wireless piece because you've called that out. I assume some of that's knee rate because you've called 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, that they were requesting in the 4th quarter calendar that, you were supposed to introduce in the fourth quarter. Is that what's the timeline for the acceptance of those feature adjustment 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're building in that space and we're excited about some of the customer opportunities, larger customer opportunities we have in service provider. So whereas that was a challenge for us, when we look at the second half of fiscal 'eighteen, 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 twenty nineteen. 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 price 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 2018 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, Alex, for the 5,000,000 And we have $5,000,000 come in. I mean, but you take that out, we still had a strong quarter this quarter and it's really terms of how we were guiding and how we're setting expectations, there is the that our expectation is that $5,000,000 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 your 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're getting back to where we were in a much stronger position. Right. Well, 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 June quarter, the distribution consolidation and the data center, realignment, 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's 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 flat? Well, we reset the data center expectations for $160,000,000 to $170,000,000 run rate. That business is stabilized and we and that business is growing. So we were back to growth in that part of the portfolio, and we expect that to continue. If I look at Fiscal 2018 being granted, it wasn't a full quarter in terms of what we had as far as the acquisitions, but approximately $980,000,000 of revenue and now we're over $1,000,000,000. And as we pivot and go into fiscal 'twenty, and we will be projecting growth across the entire portfolio. And that's 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 $10,000,000 to $15,000,000 hit per quarter, until it stabilized. It sounds like you're ahead of trajectory on that. Should we still be thinking about $5,000,000 to $10,000,000 hit from that in the March June quarters? Yes, I'd say at this point, Alex, I would say we're we're almost done And so I would say the numbers are probably a little bit smaller 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 the fiscal 'nineteen or our fiscal 'twenty period when you get into the first half of their fiscal 'twenty, that you should be seeing better results in September, December versus to traditional seasonality. Is that correct? Absolutely. There are no further questions. I'd like to turn the call back over to Ed Meicore for any closing remarks. Okay. Well, 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 more detailed outlook about our portfolio, our long term vision business model, etcetera, at the Investor Day that we're having at the NASDAQ exchange in New York. On February 13th. 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 to ask people to, 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 in 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.