Stan Kovler – Senior Director-Investor Relations and Finance Ed Meyercord – President and Chief Executive Officer Drew Davies – Chief Financial Officer.

Erik Suppiger – JMP Securities.

Good day, ladies and gentlemen and welcome to the Extreme Networks Q3 FY18 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 conference maybe recorded.

I would now like to introduce your host for today’s conference, Stan Kovler, Senior Director of Investor Relations and Finance. Sir, you may begin..

Thank you, Amani, and welcome to the Extreme Networks third 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 Network’s 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 includes possible adjustments in tax calculations arising from further assessment of the impact of the recent changes to U.S.

tax laws, and our ability to successfully integrate the 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, sales functions, 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 these 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 advance in accordance with GAAP. Reconciliation of non-GAAP to the 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, Stan, and thank you all for joining us this afternoon. Welcome to Extreme’s Q3 earnings call. Today we announced Q3 results highlighted by 76% growth in total revenue year-over-year. A few key successes; first, we were pleased with our fourth consecutive quarter of organic growth within the core Extreme portfolio, excluding acquisitions.

Core Extreme experienced 8% year-over-year organic growth on strength in our wireless business particularly in North America. Second, Avaya experienced strong sequential growth of 10% as we continue to focus on disciplined go-to-market and success in cross-selling the Layer 2 fabric, particularly in Europe.

Third, quarter-over-quarter improvement in sales during a typically seasonally weak quarter for us; however, in our first full quarter with Brocade, our data center revenue was impacted by two primary factors; a $5 million purchase accounting adjustment with Brocade, and discounts built into the pipeline we acquired on a few deals.

We also built backlog of $7 million during the quarter. We started Q3 with three separate versions of the sales force; two versions of Oracle and one version of SAP. Now the entire business runs on one Extreme system, one instance of sales force and all our bookings are in one Oracle system.

Entering Q3, we said we had better visibility and that it would take some time to transition. But now heading into Q4, we believe we have complete visibility of our business from a systems perspective.

And for our third consecutive systems migration, we booked shift and built orders on the first day of the cut-over with excellent performance by our IT and business integration teams.

Beyond organic growth of 8% core Extreme year-over-year, the acquired Avaya revenue also grew 10% sequentially to $44 million, while Brocade’s first full quarter revenue totaled $53 million, $58 million post purchase accounting adjustment. All-in, our acquired run rate remains in line with our $230 million guidance.

Our non-GAAP gross margin came in at 57.9% affected by a few large Brocade deals early in the quarter. Although, we were targeting to reach our long-term goal of 60% gross margins and 15% operating income by Q4 2018, we now expect to achieve them in fiscal 2019.

Our Q3 results for fiscal 2018 highlight our progress despite some integration challenges we worked through during the quarter. We delivered $0.16 of non-GAAP earnings just below our guidance range.

Our Extreme Connect user conference in Phoenix, Arizona in late April attracted a large audience of customers and partners that are now Extreme Certified Insider community members.

Attendees at Connect received technical training across all of Extreme solutions, along with dedicated training for key verticals such as education, retail and hospitality. Feedback continues to be very encouraging and we’ve received very favorable press.

Our customers and partners are usually surprised and encouraged by the depth of our new portfolio when our technical teams take everyone through each place in the network.

With the IT systems integration of our acquisitions behind us, we’re taking a unified approach in our new go-to-market focus centered around the smart edge automated campus and agile data centers. We bring together applications, services and support for our customers that truly highlights our end-to-end networking focus.

Our customers across our target verticals continue to embrace digital transformation and consider Extreme as a partner on this journey. At the beginning of Q4, we’ve rolled out a unified branding message to our employees and partners, focused on software driven solutions.

These solutions driven by the agile adaptive and secure infrastructure in a variety of software applications deliver intelligence across smart edge automated campus and agile data center solutions. Our customers are telling us their businesses demand that they shift from managing the network to managing the business.

Smart edge supports campus distributed in cloud wireless architectures from precedented choice and adapts to diverse technical requirements. Our customers can manage smart edge from Extreme cloud as a service, and from our smart edge management application on-prem or private cloud allowing multiple consumption models.

You’ll be hearing a lot about smart edge this summer and fall as we introduce a broad range of products, including 802.11ax wireless and extended edge switching products. Our secure automated campus launch continues to make headway in the marketplace as campus upgrades our key priority for a significant number of our customers.

Automated campus redefines networking to match the expectations of a digital business. Designed for agile, simple and intelligent networking, this policy based fabric-enabled architecture is unrivaled in its simplicity and manageability. Our customers tell us on average automated campus makes adds and changes 11 times faster than prior generations.

We continue to enhance automated campus solution. Our whole campus portfolio is already supported in XMC, and by summer we will have Extreme analytics support across the portfolio as well. In this area of cloud networking, agility at the speed of business is critical for maintaining competitive advantage.

Extreme’s agile data center solution is optimized to help enterprises and cloud organizations meet these challenges. Our agile data center solution is built on programmable switching and routing platforms, providing pervasive network visibility and cross-domain network lifecycle automation.

In April of this year we introduced OptiScale for internet routing, which enables customers to easily utilize the programmability builds into the platforms. We continue to enhance OptiScale to include other use cases and features. Our end markets are undergoing tremendous change that is happening at a time when IT budgets have been under pressure.

However, recent CIO survey show budgets are actually improving in calendar 2018 relative to their 2017 views. This gives us confidence in the demand environment as we refresh and marginalize our product portfolio under one Extreme.

Campus upgrades are an essential priority for a significant portion of our customers with a key focus on using more software solutions. The only way to solve for this growth in 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 servers, storage, security and hyper-converged platforms.

At our core Extreme portfolio, we see continued strength in wireless and software driven sales that pull through our fixed switching portfolio offset by the run-off 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.

Our secure automated campus launch continues to make headway in the marketplace. Having completed the systems migration from the Avaya TSA agreement early in Q4, we are unencumbered to grow into our run rate for this business and expect sequential growth in our Avaya business once again in the June quarter.

We entered the March quarter with a pipeline of cross-selling deals of $20 million, up from $8 million in December, which we recognized $2.5 million in the December quarter.

During the March quarter we’ve recognized $10.5 million in cross-sell revenue, and grew our June quarter cross-selling pipeline to $38 million with particular strength in both the U.S. and EMEA. I want to highlight a few examples of what these opportunities were.

First, a large university healthcare center implemented our complete hardware and software solution suite, deploying ExtremeWireless, analytics and switches to create unique and engaging user experiences for their patients, physicians and staff.

Second, in the hospitality vertical, we expanded our engagement with existing customers beyond analytics and deployed exhaust switches and Extreme’s management center solution for new application. We also deepened our relationships with several key Fortune 50 customers and became even more strategic to their network edge and core efforts.

Combining Avaya’s differentiated fabric technology with Extreme’s full suite of software and competitive wireless, continues to yield dividends from a cross-selling perspective. We are now rebuilding our pipeline of business in our Avaya campus business, which is being generated by strong demand for our fabric solution.

The ease of deployment, the ability to segment networks across the enterprise and a high level of security in our Layer 2 fabric is driving a healthy pipeline of demand for our solutions. We continue to target a $200 million annual run rate in Q4 and growth in fiscal 2019 at a higher gross margin level than what we saw in Q3.

While there is excitement in the field about our data center business, as we build out the use cases with our next generation SLX combined switching and routing platform, we were impacted by residual challenges in Brocade’s pipeline that we are now rebuilding.

Our VDX and MLX switching and routing platforms along with our automated deployment tools are driving revenue and customer engagements. We continue to make progress with customers such as the U.S. government agency that deployed our VDX solution.

The key components to their continued business is unbeatable support in addition to high performing products from an uptime and thermal efficiency perspective. We’re introducing Extreme validated designs across the entire portfolio bringing true solution bundles of hardware and software to our enterprise and cloud service customers.

On the data center side, our validated designs and reference architectures for specific use cases are making it easier to sell and deploy our cloud solutions that are being embraced by our customers.

When combined with our workflow composer and its cross-domain deployment capability, we can support our customers in delivering very agile enterprise cloud solutions. A few lower margin Brocade deals early in the quarter impacted our gross margin by about 100 basis points.

As we continue to impart our discipline on our acquired businesses, we expect gross margins to reach our long-term 60% target in early fiscal year 2019. Our third quarter non-GAAP gross margins grew 70 basis points year-over-year. As we look out into the June quarter, we project Q4 revenue to improve to a range of $277 million to $287 million.

The improved visibility into our business should allow us to rebuild the pipeline across all our geos and target verticals, and include significant growth in cross-sell opportunities in the fiscal 2019. One focus point, I wanted to reiterate heading into June is on our data center business.

We expect data center revenue to remain at our $230 million annual revenue target adjusted for purchase accounting and generate gross margins in the low 60% range going forward.

We continue to work with our teams to build out Brocade’s pipeline following a period when this business was going through a sales process and we remain confident in the business. Net-net, taking our second half fiscal 2018 run rate yields $1.08 billion of revenue on an annualized basis.

Our recently acquired assets Brocade and Avaya are on a $430 million run rate that we expect to grow 3% to 5% in fiscal 2019. Our core Extreme business exits fiscal 2018 on a $650 million run rate and we expect this business to maintain a similar growth rate into next year.

Our teams continue to execute well despite the extra time and resources required to integrate and onboard our employees, customers and partners, develop our combined product road maps, build out our engineering labs, and resources, move our employees into our facilities and combine the data and systems that support the businesses.

With all our acquisitions now under one roof, we expect improved execution and 3% to 5% normalized annual revenue growth heading into fiscal 2019 that we continue to believe is appropriate for our combined businesses on a like-for-like basis. With that, I’d like to turn it over to Drew to review our results and guidance in detail..

Thanks, Ed. Let’s get started with few highlights from our third quarter of fiscal 2018. In Q3, we had our first full quarter of the combined revenues of our recent acquisitions. And as a result, our revenues grew $113 million or 76% year-over-year and $31 million or 13% from the previous quarter.

Also I’m pleased to report organic revenue growth in the pre-acquisition Extreme business of 8% and 3% year-over-year and quarter-over-quarter. Our non-GAAP gross margin increased 70 basis points in Q3 from fiscal 2017 to 57.9%. This makes eight consecutive quarters.

We have now increased our non-GAAP gross margin compared to the same quarter year-over-year. Quarter-over-quarter from Q2 our gross margin declined from 39.4% to 57.9%. Next turning to revenue, Q3 revenue was $262 million compared to $231.1 million in Q2 and $149.2 million in Q3 a year ago.

Revenue increased quarter-over-quarter and year-over-year by $30.9 million and $112.8 million, respectively. I would also like to note that we did not recognize $5.1 million of service revenues in Q3, and $3.4 million last quarter from our campus fabric and data center acquisitions as of result purchase accounting adjustments.

The geographical split of revenues was as follows; the Americas contributed 55% to total revenue, EMEA contributed 36%, APAC contributed 9%. The order of our top five verticals in Q3 was education, communications, government, manufacturing and healthcare, compared to government, education, manufacturing, communications and retail in fiscal of 2018.

Product revenue for Q3 was $203.5 million compared to $174.8 million in Q2 and $111.3 million in Q3 last year. Q3 service revenue was $58.5 million compared to $56.3 million in Q2, and $37.9 million in Q3 last year. Moving on to gross margin and operating expenses, in Q3 GAAP gross margin was 54.6% compared to 55.8% in Q2 and 55.5% in Q3 last year.

Non-GAAP gross margin was 57.9% which compares to 59.4% in Q2 and 57% in Q3 last year. Q3 GAAP operating expenses were $151.2 million compared to $160.1 million in Q2 and $85.4 million in Q3 last year.

Q3 GAAP operating expense includes amortization of intangibles of $2.1 million, stock-based compensation charges of $7.3 million, litigation settlement expense of $200,000, restructuring charges of $4.9 million and acquisition related expenses of $9.3 million.

We had stock compensation expenses of $700,000 in cost of goods sold, $2.4 million in R&D, $2.8 million in sales and marketing, and $2.2 million in G&A. Q3 non-GAAP operating expenses were $127.4 million, and compared to $117 million in Q2, and $70.8 million in Q3 of 2017.

The sequential increase in non-GAAP operating expenses was mainly attributable to the addition of one-month of expenses from the Brocade data center business. Third quarter GAAP operating loss was $8.2 million, compared to an operating loss of $31.1 million in Q2, and a loss of $2.6 million in Q3 last year.

Third quarter non-GAAP operating income was $24.4 million or 9.3% of total revenue compared to $20.3 million or 8.8% of total revenue in Q2 and $14.6 million or 9.8% of total revenue in Q3 last year.

GAAP net loss for Q3 was $13.6 million or $0.12 per share, compared to a net loss of $31.9 million or $0.28 per share in Q2, and a net loss of $5 million or $0.05 per share in Q3 last year.

Non-GAAP net income for the quarter was $19 million or $0.16 per diluted share and compares to net income of $16.4 million or $0.14 per diluted share in Q2, and $12.2 million or $0.11 per share in Q3 of 2017.

Turning to the balance sheet, Q3 total cash and cash equivalents ended the quarter at $103 million, down $24 million from the end of last quarter and down $14 million from the end of Q3 in fiscal 2017.

Our cash balance declined in Q2 and Q3 due to acquisition and integration related spending for CapEx, mainly for facilities and IT systems and infrastructure, transition services, IT integration consulting, restructuring and other spending that we do not expect to incur beyond Q4.

For illustration, we’ve added – we’ve included Slide number 10 in our earnings release presentation posted on the Investor Relations section of our website to show these payments compared to what we view as our typical capital spending.

During the quarter, cash flow from operations was an outflow of $16 million compared to an outflow of $4 million in Q2, and an inflow of $25 million in Q3 last year. Free cash flow was an outflow of $25 million compared to an outflow of $41 million in Q2 and inflow of $22 million in Q3 last year.

Accounts receivables were $188 million at the end of Q3, up $34 million from the end of Q2 on higher sales and up $116 million from the end of Q3 of fiscal 2017 with the addition of the acquired data center and campus fabric businesses.

DSO increased by 3 days to 65 days this quarter compared to 62 days in Q2 and increased 21 days compared to 44 days outstanding in Q3 of 2017. Our DSO for the last three quarters has been impacted by the Transition Services Agreement from campus – from the campus fabric and data center acquisitions.

Under these TSAs, Avaya and Brocade collected accounts receivable on behalf of Extreme over the standard customer payment terms typically 30 days to 45 days, and then remitted the collections after 45 days. This temporarily built additional days into our collection cycle inflating our DSO. The impact of the TSA on our DSO will end in our fiscal Q4.

Inventory ended at $78 million, down $6 million from last quarter, and up $28 million from Q3 of 2017 with the addition of the acquired inventories. Total debt outstanding net of loan fees at the end of Q3 was $179 million compared to $95 million at the end of Q3 last year.

The increase is attributed to the amended term loan for the campus fabric and data center acquisitions. On May 1, we closed a new term loan and revolving line of credit that repaid our outstanding debt.

The outstanding amount of the new term loan is $190 million and there is $10 million outstanding on the revolver out of a total available of $40 million. The interest rate on the new term loan will initially be 100 basis points less than the rate on the previous term.

This will result in approximately $200,000 less interest expense in Q4 and $0.5 million in Q1 of fiscal 2019, the first full quarter that the load will be outstanding. Now let’s move on to the guidance for Q4. We expect total Q4 revenue to be in the range of $277 million to $287 million.

Q4 GAAP gross margin is in participated to be in a range of 56% to 58.1%. And non-GAAP gross margin is estimated to be in a range of 58% to 60%. Q4 operating expenses are expected to be in a range of $148.6 million to $152.2 million on a GAAP basis; and $136.5 million to $139.5 million on non-GAAP basis.

Tax expense is expected to be $2 million to $2.4 million in Q3 – in Q4, up from the previous quarters due to higher revenue and increased activity in our foreign jurisdictions. 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 the SEC guidance, we have recorded provisional amounts in our Q3 year-to-date financial results. We have not been a tax – a U.S. taxpayer in recent years due to the level of accumulated tax attributes we’re 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 years to three years.

Q4 GAAP net income is expected to be in a range of $1.5 million to $9.6 million or $0.01 to $0.08 per share. Non-GAAP net income is expected to be in a range of $19.2 million to $27.9 million or $0.16 to $0.23 per diluted share. In Q4, we expect average shares outstanding to be approximately 121.5 million shares outstanding.

This concludes our prepared remarks. We will now open the call up for questions..

[Operator Instructions] And our first question comes from Erik Suppiger with JMP Securities. Your line is now open..

Thanks for taking the question. First off, can you just clarify on the Brocade revenue or restatement, was that a surprise to you during the quarter or was that already factored into your guidance? And then I’ve got –.

Yes, sorry, Erik. So part of it was we had $1 million adjustment that we had to make during the quarter. And then another part is the deferred revenue that you lose when you have an acquisition, and that accounted for about $4 million to $5 million..

Were both of those or one of those already assumed in your guidance?.

Yes. We had assumed the $4 million in our guidance, but the $1 million was a surprise..

Okay.

And then secondly, how were your Brocade sales to Brocade campus customers during the quarter? And similarly, how was your Avaya sales to Avaya wireless customers in the quarter?.

Yes Erik, let me take that. We have several initiatives underway and we have a pipeline of ICX customers, the campus customers from Brocade, but at this point we don’t have a sales number to comment on for the call, but we are building up quite a pipeline there, so it’s taking – it takes a little bit of time, but we do see opportunities there.

On the Avaya side, that’s really been a big driver of cross-sell.

We talked about the pipeline growth and commented that the growth in pipeline being driven largely by Avaya campus fabric wireless, the opportunity for us to sell ExtremeWireless into the fabric customers and then also, the fabric technology that we are selling along with Extreme technology.

And this is happening across our geos, in Europe and in the U.S. But we talked about the fact that we went into the December quarter, we had a $5.8 million, and then it grew to $20 million, and now it’s grown to $38 million and a lot of that is driven by wireless..

Very good. Thank you..

Thank you. [Operator Instructions] This concludes today’s Q&A session. I’d now like to turn the call back over to Ed Meyercord for closing remarks..

Okay, thank you, Amani, I appreciate that, and thank you everybody who could join us on the call today. And I want to thank all the Extreme employees who are listening in. We’re looking forward to improving our execution in the pipeline of the June quarter, which is going to set us up for a strong fiscal 2019. We hope to speak to you.

We have a Craig-Hallum Conference on May 30, coming up, as well at the Cowen Company Technology, Media & Telecom Conference on May 31. So we thank you for your participation, and we’ll catch up with you next quarter. Thank you..

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