Jean Young - The Piacente Group, IR Edward Meyercord - President and Chief Executive Officer Drew Davies - Chief Financial Officer.

Paul Silverstein - Cowen & Co., LLC Michael Berg - JMP Securities LLC Alex Henderson - Needham & Company Simon Leopold - Raymond James & Associates, Inc. Christian Schwab - Craig-Hallum Capital Group LLC.

Good day, ladies and gentlemen, and welcome to the Extreme Networks' Second Quarter Fiscal Year 2018 Financial Results Conference Call. 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 call maybe recorded. I would now like to introduce your host for today’s conference, Ms. Jean Young. Ma’am you may begin..

Thank you, Skyler, and welcome to the Extreme Networks' second quarter fiscal 2018 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.

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

These risks include our ability to successfully integrate the recently acquired assets, technologies and operations from Avaya and Brocade into our business and operations, including, but not limited to, the following risks; difficulties we may experience in the retention, assimilation and successful integration of employees and teams, acquired operations, technologies and/or products, unanticipated costs, litigation or other contingent liabilities associated with the acquisitions that could negatively impact our operating results and financial condition, adverse effects on existing business relationships with suppliers and customers, and difficulties we may experience in reaching our aspirational goals related to the acquisitions.

For a detailed description of risks and uncertainties, please refer to our most recent reports on Form 10-K, 10-Q and 8-K filed with the SEC. You should not place undue reliance on forward-looking statements, which speak only as of today. We undertake no obligation to update these statements after this call.

Throughout this call, we may reference 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.

For your convenience, a copy of the release and supporting financial materials are available on the Investor Relations section of the Company's website at extremenetworks.com. Now, I will turn the call over to Extreme's President and CEO, Ed Meyercord, for his opening comments..

Thank you, Jean, and thank you all for joining us this afternoon. Welcome to Extreme's Q2 earnings call.

Today, we are pleased to announce financial results for fiscal Q2 highlighted by 48% growth in total revenue and gross margin expansion ahead of plan which we believe has it own track to exceed our 60% gross margin target and 15% operating income target in our fiscal June quarter.

We have taken share to become the number three firm at our target enterprise market with over 30,000 customers and over $1 billion in annualized revenue, recent acquisitions and our expanded product portfolio to cover the entire enterprise from the wireless access edge to the cloud have created a heightened awareness of Extreme in the industry, elevated our brand, and are generating a significantly increased level of new opportunities for us.

We are seeing the pace of digital transformation gain momentum for enterprise customers across our industry verticals. Mobility and the Internet of Things are driving rapid growth of network devices with new demands for easy deployment, intelligence, visibility and security. Today, enterprise data centers are all about cloud services.

Multi-cloud and hybrid cloud environments, giving Extreme more ways to support our customers with our next generation technology. These changes in the market are happening at a time when IP budgets are shrinking.

The only way to solve for the growth and complexity is to leverage software-driven solutions that automate provisioning of devices at the edge and the deployment of cloud services across multiple platforms.

Extreme is well positioned as the premier alternative to the larger competitors in our market who are less focused and playing in many different market segments like server, storage, security and hyper converged platforms. We believe we have better and differentiated technology to support our enterprise customers at all places for the network.

At the wireless edge, we have the leading dens Wi-Fi and distributed Wi-Fi solutions and we are the only competitor with unified architecture for both cloud-managed and on-premise solutions.

We have unique fabric technology that makes it easy to automate to secure campus environments that is complemented by our software that provides complete visibility and control of the enterprise environment.

And finally, our portfolio of next-generation cloud Data Center solutions complemented with our Workflow Composer deliver cross-domain automation and agility for enterprise and cloud service providers alike.

We’re the only networking vendor exclusively focused on delivering end-to-end software-driven networking solutions from the wireless edge to the cloud, and our 100% in-source technical support is also a differentiator with our customers. Q2 results for fiscal 2018 highlight our progress.

We delivered 48% revenue growth, gross margin expansion, and non-GAAP earnings per share of $0.14 marking the 11 consecutive quarters Extreme has met or exceeded our earnings guidance target.

Growth in the quarter was driven by the addition of a full quarter of our Campus Fabric business and a partial quarter of the Data Center business acquired from Brocade.

In our core Extreme portfolio, we see continued strength in wireless and software-driven sales that pull through our fixed switching portfolio offset by the runoff of modular switching which is now a much smaller portion of our revenue mix.

We’re developing more prescriptive solutions for our customers in the field and our Secure Automated Campus launch is also been well received. In Q2, we turned away a considerable amount of low margin business particularly in the campus market.

Our core Extreme portfolio which now includes Zebra grew at 1%, and our core gross margins ran up to 59.9% as the result of pursuing higher quality business. In addition, we are expecting higher distributor inventory in our sales-in model that we adopted in July versus sales-out accounting.

With the acquisitions, we increased the number of distributors threefold and began the process to rationalize and consolidate them. We had a set of target inventory level and overestimated that level, which caused a one-time reduction and our reported sales numbers relative to sales-out.

Today, we believe we are at the right inventory levels heading into our fiscal Q3 and expect our sales-in to be consistent with sales-out going forward.

Given the strength of our pipeline and visibility we have for the March quarter in our $262 million to $272 million revenue guidance, we are projecting higher organic growth in our core Extreme portfolio to our low to mid single-digit target.

The pipeline is diverse across all of our geos and target verticals and includes significant growth in cross-sell opportunities. We have a large health system in London with six hospitals who have selected our Fabric technology and want to replace one of our larger competitors with Extreme. We are a very large Cloud Service provider in the U.S.

that is a household name and likely to be a breakthrough for a new use case for our cloud offerings with SLX technology. These are just a couple of examples that was in our pipeline. And in second quarter, we are very successful on our continued efforts to clean up the discounting behavior in the field with a former Avaya portfolio.

We push back on high discount requests relating to what it historically been bundled unified communications sales or residual deals affected by the bankruptcy process.

While this had a one-time effect on revenue during the quarter, it was offset by an 800 basis points sequential improvement and our Campus Fabric gross margins from Avaya from 48% to 56%. We are seeing a very healthy pipeline in our Avaya Campus business being generated by strong demand for our fabric solution.

These deployments, the ability to segment networks across the enterprise and the high level of security at our Layer 2, what we call stealth networking is driving a healthy pipeline and demand for our solutions.

We expect that business to return to our $200 million annual run rate target in the second half of our fiscal year at the higher run rate gross margin level that we saw in Q2. We are pleased with the help of the Data Center business acquired for Brocade.

We benefited from a partial quarter of revenue that exceeded our expectations, strength in the SLX, VDX, and MLX switching and routing platforms, along with our automated deployment tools is driving revenue.

There's excitement in the field and with our customers as we build out the use cases with our next-generation SLX combined switching and routing platform. Our validated designs and reference architectures for specific use cases are making it easy to sell and deploy our cloud solutions.

When combined with our Workflow Composer and its cross domain deployment capability, we can support our customers in delivering very agile enterprise cloud solutions. At our upcoming March quarter, it will be the first full quarter results with our data center assets.

And our revenue guide, we are including data center revenue that is ahead of our $230 million annual revenue target and generating margins in the low-60% range. We completed the migration of Brocade data and IT systems into the Extreme platform, as scheduled on January 15 and have good visibility into that business.

Net-net, when we combine revenue for the acquired assets at Brocade and Avaya were projecting to be slightly better than the $430 million revenue run rate for the acquired asset. And with core growth and our core Extreme business, we are comfortable with our revenue outlook of $262 million to $272 million with continued improvement in gross margin.

We are encouraged by the growth of our cross-selling opportunities. We already booked cross-selling revenue in all of our product families, which amounted to approximately $3 million in Q2.

Recall that a buyer had differentiated fabric technology, but they didn't have software or access control, management, analytics, and they’ve sold wireless in an OEM relationship. Extreme has a full suite of software and competitive wireless, but not the fabric.

This past quarter, a large German university from legacy of Avaya deployed Extreme wireless and our Extreme Management Center software, a large retailer in Europe from legacy Zebra deployed Extreme switching and products from the legacy of Avaya portfolio.

One of our large manufacturing customers and our APAC region deployed our switching and routing products from former Brocade and their data center. Our pipeline has grown over $20 million for these kinds of opportunities. We are three quarters of the way through Extreme now.

Our world tour to bring our leadership directly to customers to 55 cities in 22 countries, feedback has been very encouraging and we've received significant press in local markets. Our customers and partners are usually surprised and encouraged by the depth of our portfolio when our technical teams take everyone through each plate in the network.

Our initial goal is to attract over 3,000 customers to these global events and we've blown through that target. Our customer outreach efforts for the new Extreme will culminate with our user conference in April.

The benefits of higher quality solution sales are evident in our second quarter non-GAAP gross margins that jump 220 basis points year-over-year when we had a full quarter of the new Extreme Data Center business, this will bring a very close to our 60% target for the new Extreme in fiscal Q3 and we believe we're on track to achieve the 60% non-GAAP gross margin target at our fiscal Q4 quarter at June 2018.

Our teams continue to execute well, despite the extra time and resources required to integrate that on board, our employees, our customers and our partners, develop our combined product roadmaps, build out our engineering labs and resources combine the data and systems that support the business.

As I mentioned earlier, we see upside to our combined network and both on revenue and cash flow perspective. With that, I'll turn it over to Drew to review our results and guidance in detail..

Thanks Ed. I will get started with a few highlights from our second quarter of fiscal 2018. In Q2, our non-GAAP gross margin increased 220 basis points to 59.4%. We have now increased our non-GAAP gross margin every quarter compared to the same quarter year-over-year since fiscal Q3 2016.

This is before judgments made of prior year’s financial statements as a result of our adoption of the new ASC 606 revenue recognition guidance.

Our margins benefited from the addition of the acquired Data Center business starting in November and a strong 800 basis point quarter-over-quarter improvement in the margin for the acquired Campus Fabric business as well as continuing improvements in our core business from reduced discounting and supply chain cost improvements.

Next, I’ll turn of revenue. Q2 revenue was $231.1 million compared to $211.7 million in Q1 and $156.4 million in Q2 a year-ago. Revenue increase quarter-over-quarter and year-over-year by 9.2% and 48% respectively, although our Q2 revenue was 2.1% less than the lower end of our previous guidance.

During the second quarter we focused on improving the quality of revenues and gross margins for the Campus Fabric business, which had an impact on our revenues. We also anticipated better grow driven by higher level of distributor stocking orders in our Extreme core business in the quarter that did not occur.

The geographic split of revenues was as follows; The Americas contributed 51% of total revenue, EMEA contributed 39% and APAC contributed 10%. Product revenue for Q2 was $174.8 million, compared to $164.8 in Q1 and $119.1 million in Q2 last year. Q2 service revenue was $56.3 million compared to $46.9 million in Q1 and $38.3 million in Q2 last year.

Moving on to gross margin and operating expenses. In Q2, GAAP gross margin was 55.8% compared to 53.1% in Q1 and 50.9% in Q2 last year. Non-GAAP gross margin was 59.4% which compares to 56.7% in Q1 and 57.2% in Q2 last year. Q2 GAAP operating expenses were $160.1 million compared to $107.9 million in Q1 and $82.6 million in Q2 last year.

Q2 GAAP operating expense includes amortization of intangibles of $2.7 million, stock-based compensation charges of $6.6 million a litigation and settlement proceeds of $0.4 million and acquisition related expenses of $34.1 million. Q2 non-GAAP operating expenses were $117 million compared to $97.5 million in Q1 and $71.2 million in Q2 of 2017.

The sequential increase in non-GAAP operating expenses was mainly attributable to the addition of two months of expense from the Brocade Data Center business. Second quarter GAAP operating loss was $31.1 million compared to operating income of $4.5 million in Q1 and a loss of $3 million in Q2 last year.

Second quarter non-GAAP operating income was $20.3 million were 8.8% of total revenue, compared to $22.5 million or 10.6% of total revenue in Q1 and $18.4 million or 11.7% of total revenue in Q2 last year.

GAAP net loss for Q2 was $31.9 million or $0.28 per share compared to net income of $4.4 million or $0.04 per diluted share in Q1 and a net loss of $4.2 million or $0.04 per share in Q2 last year.

The GAAP net loss includes the $25 million payment to Broadcom for a consent to purchase Brocade’s Data Center business of $4.9 million gain on the purchase of Brocade’s capital finance business and $2.5 million tax credit resulting from recent changes in the tax law.

The $25 million payment was pat of regionally agreement upon price further business, but was treated as an expense for GAAP purposes. Non-GAAP net income for the quarter was $16.4 million or $0.14 per diluted share and compares to net income of $18.6 million or $0.16 per share in Q1 and $17.1 million or $0.16 per share in Q2 of 2017.

Turning to the balance sheet. Q2 total cash and cash equivalents ended the quarter at $127.1 million, down $25.9 million from the end of last quarter, and up $23.3 million from the end of Q2 of FY 2017.

Payment for the data center acquisition and build up of working capital mainly for the investment of inventory for the acquired businesses attributed to the decline in cash in Q2. During the quarter, cash flow from operations was an outflow of $4.4 million compared to inflows of $18.6 million in Q1 and $9.7 million in Q2 last year.

Free cash flow was an outflow of $10.2 million compared to inflows of $11.2 million in Q1 and $6.7 million in Q2 last year.

Accounts receivables were $154.9 million at the end of Q2, up $38.4 million from the end of Q1 on higher sales, and up $64.6 million from the end of Q2 of FY 2017 with the addition of the acquired Data Center and Campus Fabric businesses. DSO increased by 11 days to 62 days this quarter compared to Q1 and increased compared to 53 days in Q2 of 2017.

Inventory ended at $83.4 million, up $25.3 million from last quarter, and up $33.9 million from Q2 of fiscal 2017 with the addition of acquired inventories. Total debt outstanding net of loan fees at the end of Q2 was $183.1 million compared to $97.1 million at the end of Q2 last year.

The increase is attributable to the amended term loan for the purchase of the Campus Fabric and Data Center acquisitions. Now let’s move to the guidance for Q3. We expect total Q3 revenue to be in the range of $262 million to $272 million.

Q3 GAAP gross margin is anticipated to be in the range of 56.1% to 58.4% and non-GAAP gross margin is estimated to be in a range of 58.9% to 61.1%. Our anticipated increase in gross margin in Q3 is driven by a full quarter of the data center business and the benefit of our gross margin initiatives.

Q3 operating expense is expected to be in the range of $153.5 million to $156.5 million on a GAAP basis and $130 million to $133 million on a non-GAAP basis. Tax expense is expected to be $1.8 million to $2.6 million, up from previous quarters on higher revenue. We are continuing to evaluate the recently enacted U.S.

tax legislation and the impact to our income statement and balance sheet, and pursuant to SEC guidance, we have recorded provisional amounts in our Q2 financial results.

For the second quarter, we have estimated that there will be no tax impact relating to the deemed repatriation of previously untaxed foreign earnings based on our ability to utilize existing tax attributes. The revaluation of our net U.S. deferred tax liabilities at the new lower U.S.

tax rate of 21% resulted in an estimated tax benefit of $2.5 million to our second quarter GAAP net income. You have not been a U.S. taxpayer in recent years due to the level of accumulated tax attributes we are carrying forward.

We believe changes in the tax laws including the addition of a new minimum tax on a portion of our foreign earnings, limitations on certain U.S. deductions and anti-base erosion provisions will likely cause us to utilize those U.S. operating losses on an accelerated basis, and we will be subject to the full U.S. tax rate in two to three years.

Q3 GAAP net income is expected to be in a range of a loss of $1.6 million to $10.4 million or a loss of $0.01 to $0.09 per share. Non-GAAP net income is expected to be in a range of a loss of $1.6 million to $10.4 million or a loss of $0.01 to $0.09 per share.

Non-GAAP net income is expected to be in a range of $20.4 million to $29.2 million or $0.17 to $0.24 per diluted share. In Q3, we expect average shares outstanding to be approximately $115 million on a GAAP basis and $120 million on a non-GAAP basis. This concludes our prepared remarks. We will now open it up to questions..

[Operator Instructions] Our first question comes from Paul Silverstein with Cowen & Co. Your line is now open..

Thanks Ed and Drew for taking the question. Two or three if I may.

First off, at what revenue levels can you guys drive 20% plus operating margin?.

Hey, Paul. It's Ed. I think you're looking at a number that's north of $1.2 billion. If you look at our base assumption and we talk about – okay, Extreme, base Extreme is $650 million or $430 million of acquired revenues, you're looking at [10.80].

If you look at organic growth on top of that, the marginal profitability of that organic growth is quite high and will contribute a lot to that operating income. So if we tag Q4, we hit our 15% operating income number. You'd be looking – based on that level, you're looking at – you need another $55 million.

So it could be north of $1.2 billion, unless I mean that's a ballpark. That’s full-year..

I appreciate that.

And Drew, on OpEx, if we look beyond March and as you look out some longer term business, what are you thinking about in terms of OpEx growth on a normalized basis in terms of organic growth?.

Yes. We think as we get into Q3 here that we can hold our OpEx fairly steady. We will have some increases for sales compensation. We’ll have some variability there. We will have our annual pay increases. We’ll have some there.

So you can see kind of from the midpoint of our guidance here kind of in the – the mid $130 million range, $133 million to $135 million-ish and we think we can kind of continue to hold it there with the exception of the annual pay increases and some variable sales comp..

Any sense for how much growth, the annual pay increases and variable sales comp that would drive in terms of growth, if that – if those are the only driver?.

We target – we usually target 3% to 4% pay increase each year. And then the sales can vary $2 million to $4 million. The variable expense could go up $2 million to $4 million per quarter..

All right.

One last question for me, if you already provided, my apologies, but did you all give a breakout of the revenue from each of the Avaya and Brocade acquisitions?.

The breakout for this quarter, we didn’t give the exact breakout this quarter..

Are you willing to give that?.

Well, kind of what we’ve put into our guidance is or into our release is that Avaya was below our expectation. We had an expectation in $50 million there. Avaya was below that. On Brocade, we had said that they would do about 40% to 45% of revenues in a typical quarter. So 40% to 45% of $57.5 million, which is fourth of the $230 million that we gave.

We thought that they would do about $25 million in the quarter and they did better than that. And then on the Extreme Zebra piece, we had low – we had single-digit like 1% organic growth year-over-year..

All right. And again my apologies, because I think you actually said this in the call.

But the Avaya weakness was a function of – or the weakness relative to your original expectations, as the function of what?.

Yes, and I mean, I’ll let Ed chime in too, but really we were working hard on improving the quality of that revenue this quarter and turning down deals was really low margins.

I think they were – that business was coming out of bankruptcy and there was a lot of really heavy discounting to kind of maintain where they were and I think some of the customers are kind of been conditioned to being able to get very low or very large discounts and low gross margins and we really focused on that business this quarter and we improves the gross margin by 800 basis points, we went from 48% to 56% on that piece of business alone..

The other piece you mentioned Paul as to do [disti]. We picked up several hundred globally and brought them on board and began that the integration and rationalization process with our disti.

We had picked an inventory level not that were sales in versus the sales out, we pegged in an inventory level for what that sales and would be disti and we round that below that tag and a lot of that has to do it how disti is by globally and also their perception of their business with Extreme as we go forward.

So there were – there is a lack of visibility there and moving pieces. But we've done a lot of work there, but we feel good now about the visibility, the reporting, and the clarity we had about going forward.

And we believe we're at a level now where that sales in number is going to be close to the sales out number .So it should be in sync there and we have plans with our distis in terms of how they're buying and inventory levels and modified agreement so that we have clarity on both sides of that.

So yes, that was another element that affected us in Avaya, and then it also in Extreme..

And again, my apologies if you already said at this, but that looking at the revenue stream you are expecting going forward on the Avaya piece. Given that you understand we walked away from the low margin business.

When you look at that outlook and I assume that wasn’t one-time low margin business, or maybe it may be it does come back as people willing to payoff, but when you look at the revenue stream going forward given the business you’re walking away from what is that look like relative to original communications of the investment?.

So we're projecting and this is based on pipeline and what we are seeing in the field and the opportunities that are being created in the field and we had much better visibility today.

We are expecting a rebound and rebound with the higher level other Avaya and whether or not we hit the 50 in Q3 or Q4, we're confident that we're going to get there by the end of our fiscal.

It’s amazing what’s going on with their fabric, it’s really driving the Campus sale particularly in some of our verticals like in healthcare also an education and manufacturing. It’s been a big driver of demand in our pipeline.

And we know that some of the partners and some of the customers have been on the sideline there and looking for our suite of software. And they want to know that we’re committed to the portfolio. And they're seeing that by – the secure automated campus release where we attached Extreme management and our software suite of to the Avaya portfolio.

We gone deeper with more management tools and analytics and the release it’s coming on next week and by the end of the quarter it can be fully features of the entire of Avaya portfolio.

So the feedback and we are getting from partners and customers and evidence of the pipeline, I mean we are projecting that to come back and either Q3 or Q4 hit the 50 bogie.

That is being more that offset by strength of Data Center and the good news as far as the business model is concern that Data Center revenue is a higher margin business and carries higher gross margin. So to the extent that we are offsetting higher Brocade with lower Avaya were net-net is a positive into the model..

Got it. I’ve got other questions, but I respect for all those on the call I’ll take them offline. I’ll pass it on. Thanks guys..

Thanks Paul..

Our next question comes from Erik Suppiger with JMP Securities. Your line is now open..

Hi guys. Congratulations on it. Good quarter. This is actually Michael Berg in for Erik Suppiger today. I don't want to beat the drum, but for revenue I just want some clarity.

So I mean, obviously it was a mess, but the mess in the guide up was a function of sales-in and versus sales-out dynamics, combined with in and off, then the weakness in Avaya that was offset by the strength in the Brocade.

Is that a good way of looking at it? And then are you guys still on target hit the $1 billion mark in revenue in fiscal 2018?.

And Michael I’ll jump in and then Drew could follow me. Yes, I think that's a good way to look at it. The other thing to consider is the 800 basis point improvement in gross margin and we did turn away a lot of business and it was global in many different geos.

Some of this has to do with the former deals where they were highly discounted because maybe they were part of a unified communications sale or bundled with the Avaya or because it's a legacy pipeline opportunity from when Avaya was going to bankruptcy and these kinds of things.

So I would say that’s more of the one-time nature of this, but we were very disciplined and we’re reconditioning the field, our field and our partners in terms of what kind of discounts that we are going to deliver. And we are seeing growth in the pipeline and we are expecting growth in that business at the higher margin range. .

Yes. And kind of the second half of your question here, so based on the midpoint of our guidance and where we think we can come in for Q4, we do still think that will be above a $1 billion for the full-year..

Okay. And just a follow-up on that. I mean it sounds like things are going well both in the Avaya overall and Brocade, would you say given the one-time, I guess revenue mess or what everyone call for this quarter, what would you say is driving the extra strength from the second half of this year.

Would you say it's expecting a higher growth in Avaya or Brocade or anything in particular you can point to?.

Well I'll start. We're seeing strength in the Brocade portfolio, in the Brocade business, so that’s been very strong. And the adoption of the next-gen data center platform which is the SLX platform which is the combined switching and routing platform with the automation tools, cross-domain automation provide agility for data center.

We have a really interesting looking pipeline for that portfolio in the data center side and differentiated technology. On the Avaya side, we think people have been looking. There's an overlap between Avaya and Extreme in terms of having Campus portfolios.

People have been watching, but it's the things like the release of our next version of our software that now opens up all of the features and capabilities of Extreme Management Center to the Avaya portfolio. And it's also on the Extreme side where we're bringing wireless.

There's a lot of cross-sell deals in the pipeline where you're seeing Avaya customers with ExtremeWireless, which is creating opportunities for growth. And Drew I don't know if you want to add anything to that..

The other thing on Avaya that makes us feel better is the visibility that we have. We've gotten a lot closer to the customers we’ve had. We've got works with Avaya. We're still on TSA, the transition services agreement where we're using their systems for one more quarter, where we're going to be off their systems at the end of March.

But we've improved the management of the pipeline in the sales force tool that they use there and the visibility that our sales team has in that tool. We've also improved. We got all the historical service revenue opportunities.

It took us awhile to get that and we've got good visibility to that, so that we can go after additional service renewals and target those customers. So, just our overall visibility has improved on the Avaya business..

Got it. Thank you for that. One last question and I'll sweep the floor.

Would you be able to quantify the miss in revenue guidance in terms of the one-time and inventory change for the sales and versus something like would be Avaya weakness?.

Yes, well so we didn't give an exact number on that. But the Avaya piece is the majority of the miss. And the inventory issue, it makes up the balance. So it was primarily on the Avaya side..

Okay, but overall you're feeling very strong about the business, given all the factors you listed earlier..

Yes..

Okay, awesome. Well all right, I’ll see it before. Thank you very much..

Thank you..

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

Thanks.

So how long do you think it will take you to get the salespeople moving to Avaya products? To be on board with the proper discounting structures, so that you're not turning away deals and to get the customers who might have been hesitant to buy products when they were in bankruptcy, now that you've got the company in-house to step up to the plate and up their product purchases.

When do you see the business accelerated and so you start beating numbers within the Avaya footprint?.

Hey, Alex, this is Ed. We see that happening in real time. We're in the second half of the year and we see it in our pipeline and we're where we expect to be there by the end of our fiscal year, a lot of the discounting that that we saw was clean up and we are calling some of that one time. We think it was.

Some of the inventory issues with disti is tied to the Avaya portfolio as well. That gets cleaned up. The thing I'd like to highlight is that the technologies are truly complimentary and if you look at what's come in, Avaya had this fabric technology that is unique and it’s layered to. It got differentiated security element, security features.

It's very easy to deploy, segmenting networks and complex, enterprise, environments. It has unique capabilities that we didn't have at Extreme, that we didn’t have this in Campus. So the fabric is truly differentiated. There's a lot of interest in the field with that fabric. Remember that Avaya didn't have our software.

Well that’s our bread and butter on the Extreme side. This is where we have technology differentiation and we can reference the Gartner reports with the single pane of glass and the visibility and the control, and common database for every device that’s running on an enterprise network at all the different network elements.

Well, they didn't have that technology. So Avaya customers in the field have been looking at this and they’re saying well, this is great technology.

How it’s going to come together? Are they protecting my investment and they are seeing that because we're putting our money where our mouth is in terms of where we're investing and the lab piece was wireless and this was another opportunity for margins from us because the resold [Zirius] OEM wireless solution with a very low margin for the Avaya business.

Now we have higher quality wireless solutions that are going to come at higher margins that are also tied into the fabric technology and tied into our software. So if you look at it from an agile campus perspective, the technologies are very complimentary.

We're expecting what we're seeing in the pipeline is growth and its growth based on this combined technology roadmap that we've put out there..

Couple of questions if I could on the competitive front, clearly you guys are now $1 billion company and I would assume you've popping up a little bit more on Cisco's radar screen, even though it's probably still low and on their hit list.

But has there been any competitive response or any change in their behavior in the marketplace as they pushed on pricing or other variables to keep you out of accounts or to take accounts way from you?.

Nothing is really change there Alex. From our perspective, I've personally have been involved with some meetings where customers have not been thrilled with the packaging of security for a combined package….

Separate question that was my next one actually..

Yes, just given that Cisco’s kind of coming at it from a data center or from the core of the network out. And we're looking at the portfolio of security that there packaging and selling and the way that they're changing the pricing around this.

It’s creating a lot of expense and a lot of complexity whereas we're coming out of the opposite way we're coming out with simplicity and we're coming out with an open framework where we want our customers to continue to use their preferred security vendor for example. If they like Palo Alto, if they like Fortinet, if they like Checkpoint.

And so our strategies are all about enabling flexibility for our enterprise customers and I'm sure that there 's going to be a lot of customers out there that like Cisco's, the solution if they want to just deal with one vendor.

But there's a big piece of the market that is less enamored there and we actually see that creating opportunities for us which is why it's important for us to pull our portfolio together with our Secure Automated Campus, we think is a much better solution..

Can you give us any scaling on how much of the opportunity in your pipeline might reflect on people's discontent with the intuitive networking, blocking around security and networking plus a requirement to move to a licensing model? So that there's a lot of it with that but if you look at your pipeline how big a net is there a couple percentage points of opportunity for that or for more?.

It's really hard for us to call that. Because we go up against Cisco all the time and we go up with Aruba and HP all the time we see them.

Aruba is really coming out from the other edge, they’re really starting the wireless and moving their way and Cisco’s kind of moving out to the edge with DNA, but don’t have an integrated or unified architecture for cloud base or on-prime wireless.

So there will just join it on the wireless side, but it would be really - it would be kind of a big guess to try to pin to that. .

So when you look at that product the intuitive networking have you had any - have you done a tear down, if you look at the way the various software elements of the security pieces are integrated into it. I know you said that Meraki is not integrated in it.

But any sense of the competitive nature of that product?.

Well, I think there are standalone elements of the product that may be compelling what we've heard – our experts have ripped it apart and our analysis is that there's really nothing new from a switching perspective is nothing new coming out. So from that perspective it’s older technology they're bundling and a portfolio of security.

The problem is to actually deploy it an enterprise is really complicated, really complicated. So they want to sell managed services so they can deploy it for you which starts to get really expensive.

Now all of a sudden you’re putting all your eggs in one basket and a solution that’s very expensive and you're giving up a future flexibility and that's the question if you want to be handcrafted to them going forward. And that’s where we see ourselves having a big opportunity..

So one last question, and I'll sweep the floor.

When you look at the OpEx number going from March to June and then back to September and then back up to December should – how much seasonality should we be baking into the newly structured company on the OpEx line between them? Is it a situation where March is generally somewhat lower, June is a little higher, September is a little lower, December is more like June.

How do we think about display between those seasonal quarters?.

Yes, the June quarter is still going to be kind of out highest quarter I think it's going to be the highest quarter in terms of revenue and then the OpEx will kind of follow that with the variable sales tax that we have.

Typically for us Q1 would come down it's going to be a little bit different next year just because of the seasonality Avaya and Brocade they typically had a fairly busy September – it was September for Avaya and it was October for the Brocade business. Because they had fair amount of total business and the year ends were at that time.

So we anticipate that September row be a little stronger than it has in the past and then the December quarter and the March quarter will be more somewhat to each other for the quarter. So more and more flat. Q1 was typically been down and Q2 also that changes a little bit with the new business..

Great.

Is there a location for finding me non-GAAP R&D sales and marketing in G&A breakout which I don't think is in a press release or the slide deck?.

Yes. Well I think we have it. Do we have it in the slide deck? We're checking..

Yes. I don't see it in the slide deck. I was looking at it. It's a similar. It's broken out at the OpEx line not at the individual granularity..

Yes. We’ll get back to you. Thanks..

Our next question comes from Simon Leopold with Raymond James. Your line is now open..

Great. Thanks. And I just want to follow-up on one of the prior questions. Understanding June is typically a peak quarter, it does seem that you’ve had some revenue maybe slide from December and to March, so I guess I'm looking for a little bit finer detail on the June prospect.

So certainly the highest quarter, but historically you've had kind of a team sequential growth in your June quarter.

Are you still calling for that kind of sequential growth rate in June?.

Yes.

You are talking about on revenue deal or on OpEx?.

No revenue specifically..

Yes. We do. We've got a kind of a low – it's really just a low double-digit percent – growth percentage from Q4 to Q3 or Q3 to Q4..

Okay. And I guess the other thing I was trying to get a better understanding of in terms of the strength in gross margin in the December quarter, and I think there are maybe two questions here.

How much of this was related to mix and I tend to assume that the wireless LAN access point products are better than average and just wondering how that plays into the overall gross margin story here?.

Wireless LAN now is – now that we are getting on the combined run rate here. Wireless LAN is going to be about 15% to 20% of our overall product revenues and it's not as high as the Brocade data center gross margin, it's about the same as our switching line of products which it's been in kind of now it's in the mid to high 50s..

Okay. Great. Thanks. And then given that you generally have had decently high exposure to EMEA and considering the shift in foreign exchange rates, basically your products seem to be cheaper to European customers buying in dollars, converting from euros.

Can you comment on what if anything you've seen in terms of forex related benefits?.

Yes. I'll chime in here. What we've seen is an overall strength in the European economies, and we’ve seen strength in EMEA in terms of what's driving a big driver of organic growth for us.

We have it in our core market, if you recall if Germany and the [indiscernible] region has always been our largest region and maybe even skewed more towards that in terms of the distribution of GDP or economy in EMEA.

But the other, we're seeing a healthy business there and then we're also seeing recovery in markets like UK, Benelux, France, Spain, Italy, the Southern Cal markets. At Middle East across the board we're seeing a nice growth numbers as those economies rebound. I don’t think we have a number for you from a forex perspective..

Okay. One last one. I don't think you really talk too much about specific market verticals and I do recall the strategy previous acquisitions was to focus on select verticals not to be everything to every enterprise opportunity, so you’ve had strength particularly in education, hospitality.

Any variances in terms of the vertical behaviors or any shift in the strategy of focusing on select verticals? Thank you..

What we're doing is we're developing use cases and we're looking at use cases that are horizontal and then we're going to drop them into our verticals.

So if you take our Secure Automated Campus and if we look at how that would fall into for example manufacturing, it's going to be tweaked a little bit from how it drop down into healthcare or how that drops down into manufacturing.

I mean one thing that did happen to the quarter, our reliance on K-12 or our exposure to K-12 which is a market which has been more susceptible to public bidding and more aggressive pricing and lower, and margin pressure.

That’s vertical that has come down a bit for us, so we have lower exposure and that's also been contributing to our higher gross margins..

Great. Thanks for taking my questions..

Thank you..

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

Great, I only have one question. What do we grow at now? So for $1 billion business and we’re walking away from some value business, which makes perfect sense.

What is the targeted growth rate for the three years that you would be targeting as an average CAGR following this June?.

We’re not putting guidance out that far. I appreciate the question. What we said is that we're acquiring these businesses. We sort of laid out the core Extreme to mid to low single-digit. The companies that have come in, that have been acquired at that $430 million revenue run rate.

Those we expect to grow and to grow beyond that into the future and we'll be putting together as we projected – as we go through Q4 our outlook. We are seeing – when you look at the first quarter projection, we’re projecting in a healthy organic growth in the core Extreme, which is now includes Zebra business.

So as we're projecting sequential growth and the Avaya, the Data Center business. So as it all comes together, we're going to have to figure out how we modify the guide. But we're saying the low to mid single-digits now and I think we’ll hold there..

Okay. Yes, so we still feel even with the Avaya, just walking away from business, you'd have to walk away from some of that lower margin business whether other people on the call new or not.

So your topline growth expectations of low to mid single-digits on the combined company hasn't changed, correct?.

Correct..

That's all I got..

Okay..

And our next question comes from Alex Henderson with Needham & Company. Your line is now open..

Yes, I just wanted to go back to the – actually similar to what was just passed on the current quarter that was just reported.

Can you try to give us a little bit better sense of what was going on with the organic growth? I mean I think you said it was 1% in the quarter at Extreme per se, is that…?.

Extreme and Zebra combined..

Yes, Extreme and Zebra combined right..

Yes..

Is that what we should be using is the organic growth for the quarter because everything else was non-organic?.

Yes, I think that’s how we’re kind of looking at. That’s how we're looking at it for this quarter, but we're expecting that number to go up – jump going into the March quarter..

So the increase from the 1% to the low to mid single-digit organic growth is driven by the cross-selling predominantly and to some extent the opportunities within the installed base of where customers might have been reluctant in the past to buy for a variety of reasons?.

I mean Extreme this quarter. We had issues related to disti that was part of the distributor issue that I mentioned before. The pushback from a discounting perspective, there's also happening within the Extreme portfolio and….

I’m sorry.

I thought the pushback on discounting was in predominately in the Avaya portfolio, which would not be in the easy piece?.

It was in the Avaya portfolio predominantly, but there is also – we’re also getting more stringent on discounting in the core Extreme portfolio. So it's a combination of both Alex.

So and I think with what we're looking at in terms of how the product roadmaps are coming together and the opportunities that we see in the pipeline, we have a good visibility and we’re quite confident on – and our forecast for the March quarter..

Okay, so the mechanics to get to the higher growth is predominately coming from what…?.

Yes, what we’ve said and I think had to think about is that we are going to be – on the $430 million of acquired revenue. We're going to be a little bit ahead there and you're going to see a nice step in the organic growth of core Extreme, which core Extreme is the Extreme and Zebra combined business..

Okay. I’ll sweep the floor. Thanks. End of Q&A.

At this time, I’m showing no further question. I’d like to turn the call back over to Mr. Ed Meyercord for closing remarks..

Okay. Well, we appreciate all the questions. We thank everybody who could join us on the call today. I do want to shout out to all of the employees at Extreme. There has been a lot of extra lifting going on as we integrate these businesses while driving the train.

And so we’re collectively really looking forward to the putting up the March numbers when we have combined – all the assets combined into one and having our first full quarter as a combined new Extreme. So thank you and have a great evening..

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day..