Ladies and gentlemen thank you for standing by and welcome to the Extreme Networks Quarter One Fiscal Year 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to hand the conference to your speaker today, Stan Kovler. Please go ahead, sir. .

Thanks Richard. Welcome to the Extreme Networks first quarter fiscal 2020 earnings conference call. I'm Stan Kovler, Vice President of Corporate Strategy and Investor Relations. With me today are Extreme Networks' President and CEO, Ed Meyercord and CFO, Remi Thomas.

We just distributed a Press Release and filed an 8-K detailing Extreme Networks' first quarter fiscal 2020 financial results.

For your convenience, a copy of the press release, which includes our GAAP to non-GAAP reconciliations and our financial results presentation 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, financial, operational results, acquired technologies, products, operations, pricing, changes to our supply chain, the impact of tariffs, pending acquisition and integration of Aerohive Networks, 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 10-K reports for the period ending June 30, 2019 filed with the SEC.

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 Networks President and CEO, Ed Meyercord..

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

Today, we announced Q1 non-GAAP results that highlights revenue in-line with our expectations, higher than expected gross margins that we are on the verge of hitting our fiscal 2020 goal of 60% at 59.9% and earnings of $0.08 per share also above the high-end of our guidance range on strong operating expense control and cost synergies with Aerohive.

Overall, Q1 results were driven by strengthen in our cloud managed wireless LAN business and edge switching from our Extreme portfolio, resulting in 7% year-over-year growth. Our acquisition of Aerohive outperformed our guidance as you recognize 25 million of revenue and 64% gross margin during the quarter.

We recognized 230 million from our core extreme business as record gross margins with growth on our edge switching portfolio its several geos. The quarter was negatively impacted by macroeconomics weakness in Germany and a one-time delay in spending by a single large U.S. Federal data center customer that has resumed buying this quarter.

We are more excited today than ever before about our position in the enterprise market with our newly announced extreme cloud IQ platform. The networking industry is at the beginning of a long-term transition to cloud management and what we call cloud driven.

Extreme Cloud IQ is built on a micro services architecture, third generation cloud technology and as the tools that allow us to provide insights and intelligence that are actionable, our gateway to the autonomous network. Extreme Cloud IQ supports wireless today and will be available on our wired switching solutions in January.

Given the higher performance, ease of use, reliability and operating efficiency of running networks from the cloud every enterprise customer has to consider cloud and will need to have a strategy as the industry transitions over the next decade.

Cloud offers speed and continuous delivery of new capabilities, and proven and secure environments that can handle the most risk sensitive customers. Enterprise customers will have access to best-of-breed technologies in the world running on leading edge infrastructure.

On Extreme, we have the number one cloud platform, we will be the first and only cloud driven provider with end-to-end solutions edge to data center. With the only platform that offers customers a choice of public private or local clouds are all of them together on one licensing model.

Its Cisco, its D&A command center solely on premise with a small fraction of paying customers - customers that are actually using it or it is Meraki older generation cloud that is completely separate and incompatible. We also have a largest, highest quality real time MLAI platform that is ISO certified.

Lastly, unlike Meraki we offer diverse consumption licensing models with significant ease of use and will delivered 30% OpEx savings for enterprise customers who choose Extreme. And last week we also announced an expanded strategic partnership with Broadcom at our partner conference.

Senior leadership of Broadcom was there live in Carlsbad to announce that Extreme was their preferred choice for enterprise customers as part of Broadcom's Silicon to Software strategy.

As their preferred provider, we are working together to give enterprise customers and channel partners powerful security, segmentation, resiliency policy, telemetry and performance advantages as they pursue cloud driven digital transformation with a simple, secure and intelligent campus architecture. This is a big endorsement for Extreme.

We are building reference architectures to go to our joint enterprise customer and partner basis as we speak. Gartner once again positioned us as a leader in its Magic Quadrant for wired and wireless LAN access infrastructure. This is the second consecutive year Extreme has been positioned as a leader in this annual report.

It's another strong endorsement of the quality and vision of our solution and is the most important reference we have of enterprise customers. During Q1, we closed 14 deals of $1 million and more, heading into Q2, our pipeline is strengthening a new opportunities across switching wireless cloud and data center.

This is driving our sequential quarter-over-quarter growth. In Q1, our edge switching solutions drove performance on the Extreme side once again, highlighted by the success of our product cycle, it will continue to ramp over the next nine to 12 months.

On the core Extreme side, total edge switching and wireless product revenue grew 9% year-over-year, with edge switching alone up double-digits. Meanwhile, our core wireless revenue declines were moderating, specifically we saw success in [E-rate] (Ph) and education along with our new X465 switch.

These trends were offset by our core wireless business facing difficult year-over-year comparisons and revenues decline mid-single-digits in certain verticals such as retail, transportation logistics where large scale deployments wrapped up.

We benefited from strength and service provider with the SLX platform and our software application revenue grew for a seventh quarter in a row, up 33% year-over-year From a vertical standpoint, E-rate K through 12 business grew double-digit.

Other areas of strength was service provider where bookings grew 11% year-over-year, and sports and entertainment where bookings grew 60% year-over-year, and we won yet another major league baseball stadium during the quarter.

In retail we expect a recovery once our Tri-Radio Wireless Solutions become available towards calendar year end along with lower end switches from our Smart Omni Edge portfolio. We encounter challenges in Germany, Italy and UK high as well due to Brexit uncertainty. Meanwhile, all of our other EMEA regions posted good growth.

Asia Pacific revenue grew 15% year-over-year and 23% quarter-over-quarter organically before the inclusion of HIVE. This comes despite a highly competitive pricing environment as we leverage our value proposition in larger deals.

In North America, we are excited to have a new Senior Vice President of America sales on Board, who came from Cisco after 13 years of enterprise sales leadership at the company, most recently, as their Global Leader of their SD RAM business.

He brings a wealth of knowledge about the enterprise sales strategy, and solutions of our top competitors in the industry to help us architect a plan to win enterprise customers. During Q1, we have reorganized geographic coverage in North America between State Local and Education, what we call SLED and our enterprise sales teams.

This allows a greater focus of these unique accounts that require a different selling motion. Our vertical teams in areas such as sports and entertainment, healthcare, retail remain intact and this aligns with our product strategy to refresh, stratify, verticalize and cloudify our portfolio.

It will also drive better alignment with our channel partners as part of this transformation. Looking ahead, our outlook for Q2 reflect seasonal growth at core Extreme and a full quarters worth of Aerohive contribution factoring in the sluggish EMEA environment.

As customers evaluate our Extreme Cloud IQ solutions, we continue to expect some revenue dis-synergies with our existing wireless business, which we built into our outlook as well. With that, we remain committed to our low single-digit revenue growth, 60% gross margins target and the restructuring actions we took at the end of fiscal 2019.

Strong execution on merger cost synergies put us on-track to higher our operating margins in Q2, and achieving our target 15% non-GAAP operating margin exiting fiscal 2020. And with that, I will turn the call over to our CFO Remi Thomas..

Thanks, Ed. As Ed noted, our revenues of $265.5 million grew 7% year-over-year, grew 1% quarter-over-quarter and came in at the midpoint of our guidance. Non-GAAP earnings per share was $0.08 above the high end of our range. EPS benefited from a gross margin of 59.9% towards the high end of our range and from lower than expected operating expenses.

We completed the acquisition of Aerohive on August 9th, for $267 million, which consisted of $263.6 paid to acquire the outstanding shares of the company and $3.5 million for the acceleration of stock awards. Net of acquisition costs and net of the cash acquired the enterprise value of the transaction was $210 million.

Aerohive contributed approximately $25 million in revenue and $6 million in operating income to Q1 results. On a standalone basis Aerohive revenue would have declined 4% year-over-year with subscription and hosting revenues up over 30% year-over-year partially offsetting a decline in product revenue.

Our combined product revenue of $185.1 million grew 4% year-over-year and decline 2% quarter-over-quarter. On a like-for-like basis, core extreme product revenues declined 6% year-over-year. Our combined product book-to-bill ratio including Aerohive was about one with product bookings up 2% year-over-year.

We refresh over 30% of the core Extreme product before year-to-date up from approximately 25% last quarter. We expect our product refresh to hit between 40% to 60% of our portfolio by the December quarter. Combined services revenue of $70.4 million grew 13% year-over-year and 12% quarter-over-quarter.

On a like-for-like basis for Extreme services revenues grew 2% year-over-year, reflecting the positive impact of continued growth in multiyear bookings we have seen over the past several quarters. Our combined services book-to-bill ratio including Aerohive, but excluding the impacts of the deferred revenue haircut was above one.

Our annualized run rate of Aerohive subscription and services revenue, excluding the impact of the deferred revenue haircuts was $57 million in Q1 versus the $53 million Aerohive recognized in its June quarter. Subscription and services booking for Aerohive grew 5% on a full quarter like-for-like basis, including the legacy Extreme cloud supports.

Our total recurring revenue accounts for nearly 20% of our total revenue, adjusted for full quarter versus just 24% in Q4. During the quarter the America's contributed 55% of total revenue EMEA 36% and APAC close out the remaining amount. Non-GAAP gross margin was 59.9% compared to 58% in a year-ago quarter, and 59.2% in Q4.

The sequential improvements was attributable to a 20 basis points improvement in product gross margin, 40 basis points improvement in services gross margin, as well as a higher contribution from services revenue that is on the core Extreme side.

In addition, gross margin benefited sequentially from the first time consolidation of Aerohive, which carries a higher gross margin than core Extreme.

Finally, we estimate that the net impact of tariffs was a negative 80 basis points to total combined company gross margin in Q1 down from 120 basis points negative impact in Q4 and largely consistent with our guidance.

Q1 non-GAAP opportunity expenses came in at $137.2 million below the low end of our guidance, an increase from $125.3 million in the year-ago quarter and from $136.8 million in Q4 with the consolidation of Aerohive.

The sequential change in non-GAAP operating expenses was mainly due to lower core Extreme selling and marketing expenses as the impact of our restrictions plans flow through the P&L, offset by the inclusion of a partial quarters of Aerohive expenses.

We are on-track to deliver the run rate cost reductions of $24 million to $27 million previously announced on the legacy Extreme side. Our September annualized OpEx run rate for Aerohive was $55 million versus the $93 million reported in Aerohive standalone June quarter.

This is contributing to the higher operating margins we expect in Q2 and another substantial step up to the second half of the year. Free cash flow was a negative $5.4 million down from the positive $18.9 million in Q4 and $26.9 million in the year-ago quarter.

Adjusted for cash merger integration costs, free cash flow would have been a positive $10.6 million. Our total cash and short-term investments balance at the end of Q1 was $161.1 million down from $169.9 million at the end of Q4.

Net debt of $218.9 million increased by $208 million from the $10.9 million in Q4 that was reported in Q4 due to the acquisition of Aerohive. DSO of 55 days, there are eight days from Q4 and from the year-ago quarter, on a sequential basis, the strong collections drove DSO lower.

Our cash conversion cycles stood at 73 days, compared to 61 days in Q4, but down from 76 days in the year-ago quarter. Our inventory balance of $82.4 million through sequentially on 12.2 million of additional Aerohive inventory and six million increase in core Extreme inventories.

Core Extreme inventory rose on pre-buys ahead of additional tariff and as we introduce new products. Now turning to guidance. We expect total Q2 revenues to be in the range of 268 million to 278 million, which represents 7% sequential growth and 3.5% percent growth for core Extreme at the midpoint.

Q2 GAAP gross margin is anticipated to be in the range of 55.2% to 57.4% and non-GAAP gross margin in the range of 59.1% to 61.1%. We estimate that tariffs will have an impact of about 80 basis points on our overall gross margin for fiscal Q2, 2020 given the existing cost of inventory on hand.

Q2 operating expenses are expected to be in the range of $164.2 million to $169.2 million on a GAAP basis and $137.3 million to $142.3 million on the non-GAAP basis. The sequential increase in OpEx is primarily related to a full quarter of Aerohive operations, offset by the restructuring actions taken at the end of Q4 2019.

Q2 GAAP earnings are expected to be in the range of a net loss of $23.2 million to $60.6 million, core loss of $0.18 to $0.14 per share. Non-GAAP net income is expected to be in the range of $13.9 million to $20.5 million or $0.12 to $0.16 per diluted shares.

In Q2, we expect average shares outstanding to be approximately 121.8 million on a GAAP basis and 125 million on a non-GAAP basis, excluding the impact of any shares we may repurchase. With that, I will now turn it over to the operator to begin the question-and-answer session..

Thank you. [Operator Instructions] And our first question will come from the line of Erik Suppiger from JMP Securities. You may begin..

Hi there. So on the tariff.

Can you talk about some of your customer behavior, are they trying to - I don't know manage the timing around tariffs, are they may be delaying any purchasing until tariffs can come down or is there any discussion around what they are - how they are trying to manage that situation?.

Eric, I think when it came into play last year, and the severity of the tariffs were a lot higher in terms of the percentages. We did see a lot of customer activity, particularly in Q2 where there was a lot of early buy-in, given upcoming increases on our side.

Since that time, I think people have become somewhat conditioned to what is going on in the marketplace. And so we are not really seeing the effects as much. And I think our strategy is to balance how we pass through the tariff. We are trying to hold our margins and then do a good job of mitigating the costs. And that is what we are doing.

And I think it is really kind of muted the noise from the field as it relates to this..

Okay, and if tariffs do get reversed, can you comment a little bit about what that would mean from a gross margin perspective? Might we assume that there is an 80 basis points benefit or how should we factor that in?.

Yes. At this point the discussion is around not following through with proposed increases. So that is what we are looking at. We haven't really seen kind of the roll back yet or the proposals of a roll back.

So when Xi Jinping and Trump meet in November in Chile the expectation is on our side, it seems to be consensus in Washington is that new actions will be frozen. And then I think it's going to take some time before we digest, what could happen with tariffs that have already been imposed.

So I think it is going to take some time to play out and at this stage, we have announced a price increase for November which is going to be routine for us, and more or less a nominal price increase that will consider normal course of business going forward. But other than that, I don't think we have any other comments..

Okay. And lastly, on Aerohive.

Can you talk a little bit about how it is working with customers in terms of integration of products or customers looking to transition from traditional Extreme products to Hive products or how are the discussions going since the acquisition closed?.

Yes, look, there is excitement on both sides. I think we just had a partner conference, Aerohive partners are excited about adding our switching portfolio. We have taken the Aerohive cloud team, brought it in and that team has also taken on our software team. We are cloudifying our portfolio very quickly.

And the fact that we are going to have the entire wireless portfolio up into the cloud by the end of the year, and then in January to have our switch portfolio into the cloud has created a lot of excitement with our partner as well as our customer community.

On the Extreme side, there is a lot of interest in cloud there was pent up demand for Extreme, because we didn't have that capability before. And so as we mentioned in our comments, there are a lot of opportunities that we have been looking at where now our customers are taking a step back and they really want to evaluate our Extreme Cloud IQ.

And so, I would just say there is an awful lot of excitement about the platform that we have, the fact that we have the number one cloud, we are not the biggest, but we have the most advanced capabilities and there is a lot of advantages that we bring.

So yes, I would say that the enthusiasm and excitement from existing partners and customers on both sides of the equation is quite high. So we are really optimistic about what this means, as we roll into the first half in calendar 2020..

Very good, thank you..

Thanks Erik..

Thank you. And our next question will come from the line of Alex Henderson from Needham. You may begin. .

Thank you. So I was hoping you could talk a little bit about the restructuring motion. That sounds like you are a little ahead of target so far.

Can you talk about what you are assuming in terms of the cost savings benefit? What portion will be achieved in the December quarter? And how it will progress into the March and June quarters?.

Yes. So I won't let you get into detailed dollar amounts. But I would tell you what we are going to see in the December quarter is the phase two of project times, which was the restructuring on the core Extreme side, with a reduction in engineering headcount and that is largely taking place as we speak.

And what we are going to see in the March quarter is acceleration of synergies on the Aerohive side, as transition employees are employees that were kept because in finance for example, they are required to help us close the books as we transition from NetSuite to Oracle as those employees exit the Company.

So you are going to see step improvements in our operating expenses reduction in the December and the March quarter as a result of these actions..

And if you were to just say percentage complete of the actions, how would it lay out over the four quarters? What is done so far as a percentage of the process?.

I would say 100% of the reduction on the Extreme side will be done by the December quarter. And I would say that 9% of the reduction on the Aerohive side will be done by the March quarter. And so what we will see in Q4, which is our June quarter is really the impact of these seasonality.

But as I look at the operating expenses in that quarter, we will not expect as reduction in the absence - dollar amounts of OpEx..

So in the June quarter, we should be at run rate?.

In the June quarter, we should definitely be at run rate, yes. And then as you know I mean, Aerohive, when, if you look at the last quarter that they reported their OpEx run rate was $93 million and in my opening comments, I stated that, as we exited September, we are already down to $65 million.

And so we have got another few million to ago, but I would say Aerohive is already well advanced..

I see.

Has there been any change in your sales cycles as a result of the macro conditions that we are seeing in the lengthening of sales cycles?.

I think that is fair. Alex, when you talk to our field, the feedback from our field is that your opportunities aren't going away, they are just being delayed. So I think that is a fair assessment on your part. .

And is there any difference in the geographies between those, I mean is it mostly EMEA or we are also seeing a slow - lengthening of the sale cycles in the U.S.?.

It's primarily in EMEA where we have seen the effect. And as you know, we have heavy presence in Germany and there has been a lot of press about the German economy, in terms of what has been going on there. We also felt some pain in Italy and then obviously you have Brexit.

So these are things that are creating disruption and what I would say is that, we are seeing the pipeline build and we are seeing the opportunities as we look out, we feel confident. And a rebound for us, it is just a function of the timing.

As it relates to the Americas, what we did is we have restructured, we had a field team that was more or less generalist focused on a lot of different customer categories. And what we decided to do is to take that SLED team and then have them focus solely on SLED and then create an enterprise team that would be solely focused on enterprise customers.

This is outside the name vertical accounts that we have, as far as healthcare, retail, our stadium transportation logistics. So those clearly defined verticals, now what we have done is created two teams in the Americas to go after that. This past quarter, we completely restructured, we reassigned accounts, we have hired a lot of new people.

So now what we are seeing is we are seeing these teams come in, we are really excited about our new leader that has come in, who has got a lot of experience, and some really clever attack factors on how we go after our competitors, which is going to be great for us.

And we are seeing these teams start to season a bit, and we are seeing the pipeline build as we go forward. So really, that was a structural change we made in the Americas that slowed things down a bit for us, but it's going to accelerate as we go forward..

Okay. One more question if I could.

The conversation around digital transformations are always interesting from your customer perspective, but what about what you are doing? Can you talk a little bit about what you are doing to move your applications to the cloud move the extreme data center into the cloud, or to Azure, where are you in Office 365 and what are you doing on your security posture relative to a perimeter defense model moving to maybe a zero trust model or anything of that sort.

Can you talk about your posture changes in security and digital transformation please?.

Sure. Extreme is going to be the number one spokesperson for all of our customers and at our user conference Extreme on Extreme, we set that program a while ago and we started doing these acquisitions. Our IT teams are mandated and frankly quite excited about our portfolio.

So we have deployed all of our portfolio across the Company and we will be moving very quickly to migrate to the cloud as our portfolio migrates to the cloud and our number one customer is Extreme. So we -..

We are not really talking just about your networking tools, really talking about heavy moved applications to the cloud, are you using Office 365, those pieces of it?.

Absolutely. So, from an ERP perspective, we are at Oracle Cloud, Office 365 Cloud. When we look at sales force, et cetera, we are very much a cloud driven Company. One of the things that we are doing with our Broadcom partnership, remember they acquired CA Technologies.

Symantec is going to close soon, and with his partner what we have talked about doing with them is integrating their solutions, their software solutions into our own environment and likewise, Broadcom is going to be deploying Extreme in their environments.

And we are looking to package all of this together and bring it out into our own enterprise customers on both sides of the equation, as well as to our partner community. Remi, do you want to add something..

Yes, I just want to add as far as being able to offer and support the growth that we expect in subscription revenue, we are also making investments in our production environments, which consist in a license entitlement platform around Gemalto, and the introduction of a subscription billing platform which - Aerohive had a in-house custom built solution running on NetSuite.

As we migrate from NetSuite to Oracle, we decided that where we are going to deploy Azure. So you will see this year, another year of sustained CapEx investment less than last year, but related to these IT investments that we are making..

Thanks..

Thanks Al..

Thank you. And our next question will come from the line of Eric Martinuzzi from Lake Street..

Yes. I would like to focus backward looking just for a moment and then get into some forward-looking questions. But the outperformance as you saw in the first quarter from the Aerohive business.

How much of that was due just to conservatism and then how much of it was due to really unexpected pipeline conversion?.

This was our first quarter when we give guidance then as you know, we had a sub period of 52 days out of 90. So I would say that the guidance that we gave was a best 50/50 percent, yes, that is to the estimate and Aerohive came in substantially higher than what we had seen a 25 versus 50.

But it's also due to the fact that their teams are performing really well, and that they had very strong bookings this quarter. So it was a combination of conservatism and very strong execution in front of the Aerohive salesforce..

But is there an issue here with you know maybe some business that was going to happen in December, happened in September quarter, or is it you continue to expect that good strong pipeline and good strong conversion in December?.

Yes Eric, what I would say is you know following up on what Remi said is. I would say we are probably 50/50 being a little conservative and then outperformance. Some of that we wanted to keep everybody focused on selling cloud and staying in their swim lanes to hit the quarter this quarter.

So we had extra incentives for their team and there is no doubt there was some deals that would get pulled in. That is the nature of our business, every quarter deals get pulled in, deals get pushed out, but you probably saw a little bit more than normal happen there. But as far as their E-rate conversion on the Extreme side.

I would say our E-rate came in a little below plan, HIVE was kind of right there and maybe a little bit better, a little bit better. So I think in general, we feel really good about what we see from a pipeline perspective. And then what we are seeing from the partner behavior and activities in the field around that.

The Extreme teams are chomping it a bit to sell this platform and so you are going to see more of that happen now that we have closed out Q1 and we are on to Q2..

Yes. And that is where I was headed next.

You talk about having the integrated product from the cloud management perspective, having that in January are you able to sell that now or is the channel really looking for more? Look, we will start engaging that once the product is available and not going to touch it until?.

Well, what we are going to do is. We can obviously sell on the Aerohive platform. In January, from a selling perspective, we are going to combine our systems from a sales perspective. So it takes a little while for us to do that. Our teams kind of have joint salesforce, they have an instance salesforce for Extreme and instance salesforce for Aerohive.

All of that combines in January. And then importantly, the licensing and Remi talked about Gemalto, we are going to have probably the most advanced and flexible licensing platforms in the industry.

That is going to come online in April and that is when you we are going to really turn up and we are going to have a real advantage over our competitors - don't have - that have very cumbersome licensing models. So what we are going to do with this strategy is maybe let the teams sell it, effectively we will be giving a lot of it away.

But billing will kick-in in April. .

If I can just add we have distributed to all Extreme sales people a Aerohive quota, and they can't go to Presidents Club unless they get hit that quota and we are deploying specific incentives in the field, so that both Extreme and Aerohive sales people are highly motivated to sell our cloud solutions..

Okay.

And then lastly, obviously just a very meaningful Broadcom partnership expansion, it seems to snatch off points of the relationship there, but I'm just wondering, incrementality what is the low hanging fruit in that tighter Broadcom relationship?.

If you look at where Broadcom has gone now with the CA, the CA acquisition and Remi is in a good position to comment, because that is where he came from. We recruited him from CA. And then, what is going to happen with Symantec. They are in the enterprise software business, and they have all of the top enterprise customers.

The issue for them is most of these customers have Cisco, in their campus environments. And Cisco is not using Broadcom silicon and their strategy is silicon to software. They want their silicon and all these enterprises and they had to pick who do we want to pick to go out with, to how to out make this happen.

And they picked Extremes to go after enterprise customers with our product portfolio. And I think a lot of it has to do with our cloud strategy in driving Broadcom silicon into these environments. So they have an amazing customer list on their side, we have an amazing customer list on our side as it relates to the potential to sell their software.

So that is what we are looking at. Cisco and HP have used similar proprietary silicon and they are on [A6] (Ph) for some of their solutions and Broadcom we believe is superior on many fronts and for many reasons and we want to tell the story together..

Understood. Okay well congratulations, it was a very busy quarter between the acquisition and the restructuring and rejiggering of the vertical. So you definitely kept those in, congrats on the progress thus far..

Thanks Eric..

Thank you. And our next question will come from the line of Christian Schwab from Craig-Hallum. You may begin..

Great, thanks for taking my question. Clearly a fantastic start to right sizing Aerohive on my margins. But my question has to do with top-line growth as we look forward.

I'm wondering, and if you can give us your opinion of what you are most excited about to be a top-line growth driver? I understand, world’s concerns such as tariffs and certain geographies, which we have discussed that everybody knows is somewhat challenged today.

But is there any specific products or maybe the Broadcom relationship or the cloud, E-rate, as you look for the next - over the course of the next year what is the team most excited about to drive top-line growth?.

Well so it's funny to, Chris, you just start answering the question for me, I would say, check, check, check on all the things you were mentioning. But, the overarching excitement is around cloud.

And the reality is, everyone has to consider - if you are an enterprise customer, you have to consider Cloud Now and people are going to move at different paces. Just because of the flexibility that the cloud offers the agility in terms of the speed of new features.

And with our cloud, you don't have to - there are no software upgrades, its continuously upgrading. In terms of having your data in the cloud, it's much more secure as far as data durability. And then you know from the cloud you can pull down best-of-breed technology.

So if you are any enterprise customers, you are going to have to have a cloud strategy. And if you don't have a strategy, that is a strategy in an off itself. So, all enterprise customers are going to start really paying attention.

And by the way, it's not just Extreme, you know competitors are talking about this and trying to figure this out, when you hear people talking about the autonomous enterprise. In our case, so everyone has got to think about cloud and we have got the number one cloud, so if your enterprise customers you have to think about Extreme.

We are the only one that has the end-to-end solution, we are the only ones that are going to be putting that full edge, IoT edge through the data center into the cloud and we are doing it in our own environment at Extreme, but you are going to see that happen, we will be faster than anyone else in the industry.

From a machine learning AI perspective, we have the largest cloud. So in terms of all the devices that are running on our cloud, our cloud learning about device behavior, and then attaching AI and building operational functions and automation functions to that. We are going to take the lead there too.

We are the only one with our third generation, we are going on fourth generation cloud to offer choice. So if you are in Meraki, you are stuck in that old Meraki cloud Mist has got a new high, but they don't have platform flexibility. We are the only one that you can do it your way as an enterprise.

Its public, private, local clouds and then the important thing is on licensing model to get the capability that we have. And then finally, we are going to offer big savings and people care about that. So I would say people are most excited about that and what is going to be happening with the beginning of this wave.

The other thing is, we just hired a head of America's, we have struggled a bit over the last couple of years in terms of driving that growth. And you know we have just brought in a rock star, who really understands I would say the weakness in our competitors offering.

And whereas maybe we have not been quite as technical and our attack as far as going after our competitors. I think we are going to be much stronger out in the field. Everyone in this Company is going to know how to demo our software and we are going to drive home our number one position in cloud.

So I think, our field is going to get excited and our leadership is in a position to drive that. So I would say those are the two big things. It doesn't happen overnight.

We are talking about a multi-year trends, I think you are going to see a lot of momentum in the second half of this year for us, our fiscal first half of calendar and that is really going to build from there..

Great. I know I miss it.

But did you guys give what you believe is a percentage of cloud related revenue percentage in current business today?.

We said that the exit run rate for the September quarter was 57 million from cloud. That is just the HIVE solution. We did have a bit of revenue on the Extreme side, but it was about one million. So let's call it 58 million. And we said that if you add that to our support revenue, as well as our software support revenue.

The total recurring revenue was 28% on a combined basis, taking Aerohive into full quarter, not just the stuff year and that converts to 24%. Our recurring revenue is now close to 30%, which is great news..

Great. Fabulous. No other questions. Thank you..

Thank you..

Thanks Christian..

[Operator Instructions] Our next question will come from the line of Paul Silverstein from Cowen. You may begin..

Thanks guys, I appreciate taking the questions. First is specific and then tow general questions.

Remi, did you see in guidance how much of that is specific to Aerohive?.

I did not. I did not. .

Can you share that with us?.

So you are talking revenue?.

Correct. .

For Q2 we believe Aerohive will contribute about $35 million. You can calculate that with the 3.5% growth that we gave core Extreme and 7% growth that we gave for Aerohive..

I appreciate that. Secondly, let me ask you two broad questions. First of all, now that you are at the 60% gross margin level, picking up I guess was Alex’s question. Where could you - any thoughts on - does it peak out at 62, 63 thoughts on where you could get to from here and in what timeframe? And obviously I'm talking about longer-term not -..

Yes. So, I think the drivers of gross margin, if I think about core Extreme, how the product refresh, we mentioned that we are just a 30%, you can see a step improvements in our December quarter with the launch of a new product, the [465] (Ph), which is an edge product.

And so we would expect that to continue to drive product gross margin on core Extreme. Another factors that is going to play specifically in Q2 to the fact that we are going to consolidate what is a 64% gross margin business over the full quarter instead of this stuff years.

And then as you think further out, as we continue to put actions in place to mitigate the impact of tariffs be in the form of a better mix of our productions between China and TAA compliant countries, as well as some of the price increases that Ed mentioned. That should also help drive margin.

On the Aerohive side, it's really increasing the cloud revenue, which structurally carries margins in the 70s versus the product gross margins that are in the high 50s that is going to be a driver of gross margins going forward.

So, at the Analyst Day, about 10 months ago now, we said that our ambition was to get to 62%, we will not be here there in fiscal 2020. But we will certainly be at or above 60% for the year on average, and then I'm expecting that trend to continue over the next fiscal year where we have the ambition to get to 61%..

I just chime in with a couple of other things Paul. One is, we mentioned Broadcom earlier, so we have a better buying rate and so, high gross margins will benefit from our buying versus silicon at better rates and a better discount. That should help us.

The other thing I will mention is, what has been part of the team in the past has been on the datacenter side, it has taken as longer than we wanted to migrate, our MLX, the routing and BDX switching platforms, older technologies. We are seeing that ramp to SLX.

Now, when we move to SLX, and you know Federal is a great example, a service provider deal that we had this year where we migrated SLX, all of a sudden we are going from margins in the 40s to your margins, literally in the 70s. So we are seeing strength in the data center business, we are projecting growth.

We have got some really interesting federal opportunities. And these are high 60% gross margin business. So new SLX is coming January and then another upgrade in April. It has taking us longer to get here than we wanted to. But it's starting to arrive and I would say that is another factor that could add to gross margins. .

And to the last point, you made the transition in SLX.

That 30%, if I heard the numbers correctly, that 30% is point benefit to gross margin that pertains to how much revenue?.

You know I can't put my finger on it Paul. I mean, there is just a lot of different - it is almost anecdotally telling that deal-by-deal, but there are a lot of - we talked about growth and service provider.

And there is one case, we beat at Juniper a service provider deal, it is more of a regional service provider where we have been selling MLX or BDX, it discounts waiting for this transition to hang on to customers. Well, you know a $1 million [SLX] (Ph) deal comes in and it is a 70% gross margin. That is that 30% swing that you are talking about.

As SLX matures and we see more adoption of data center size. It's going to have an impact and I'm not sure I can quantify that for you right now..

And mathematically wasn’t as simple as you have got X amount of MLX and BDX revenue today and that is the opportunity plus whatever growth you could drive by virtue of SLX being a better platform?.

Yes. You know the transition happens overtime. And it's a lot of deals. So I guess, we could look at that and then I guess we would have to kind of handicap and guess how that is going to happen between now in fiscal 2022 when we end of life the other platforms..

Okay. Let me move on.

Remi the decision 62% surrogate is that - if tariffs get well back - the 62% depending upon - roll back or can you get the 62% in the current [indiscernible] that you mentioned?.

No, we are not making any assumption that the tariff situation gets any worse or any better than it is today. Again, the 62% is an ambition. And I don't think we will get there in fiscal 2021, this is 18 to 24 months ambition that we have. I think we have in a short-term, a clear path to go from 59.9% to 61%.

And that is only driven on the product refresh, discipline in the field in terms of discounting the actions that we are taking to mitigate the current tariff situation. And the impact of the growth in cloud, which as I mentioned is carrying gross margin in the 70s..

Understood. And to the previous question - to an earlier question that was asked. I trust as a given that if tariffs were rolled back in a minimum that makes it easier. And perhaps that accelerates your path to that 62% at a minimum. And maybe even better, it could be incremental to that 62.

I recognize you are talking 18 months to 24 months, not one year, we are just trying to think about what the opportunity is -..

We have had a 120 basis points in Q4, 80 basis points in Q1, we anticipate another 80 basis points, not all of that 80 basis points is related to the actual increase in tariffs that we pay, when products arrive in - some of it is related to the fact that we move production outside of China to either Taiwan or a Mexico for final assembly.

And so unless we have reversed and moved production back to China, we will not get the full benefit of the 80 basis points. But I would say we would probably get 70 basis point out the 80 basis points, because the majority of the impact is really higher tariffs. So your point is absolutely correct..

I appreciate that detail. One last question more, I didn’t want to ask you for the revenue question. You just referenced something I want to come back to. So if I remember several quarters back, Ed had referenced the fact that you were changing discipline among the salesforce from a pricing perspective.

It sounds like from the 59 to - that discipline holding for now and recognize it's still early. It hasn't been a long time since the problem rose.

But any thoughts that you even had concern on that?.

Yes, so what I would say is that some of the regional directors that manage our salesforce are incentivized on their gross margin achievements and so that was a big factor.

And I would say that the second one is, as you move to box selling to solution selling, where you have a combination of software, hardware and now cloud, obviously, you are selling a different value proposition than just competing on speed-to-speed and that also helps drive that discipline..

Right. If I can ask the broader question, heightened to the previous question there was a previous questioner. If I back out to Aerohive, obviously revenue on a year-over-year bass, it was close enough to flat, but it still wasn't - you haven't gone back to growth yet. So you have done is very well conceived acquisitions.

A number that is now the fourth one in the past, I guess four years, you are all very conceived, and they offer significant opportunity. And I recognize that macro was a challenge, whenever you do an acquisition, there is some disruption of revenue for any organization.

So all that been said, looking at this past quarter in terms of why you haven't yet gone back to revenue growth and tying that into the opportunities, you just identified earlier.

Any thoughts that you can share from a high level for what is going on? is just simply, you have got to get this in now that you close the acquisition, it is a matter of blocking, tackling, it is a matter of macro, in Europe, especially the German economy and the Brexit situation, what are the key factors and hierarchical importance in getting back to decent organic revenue growth?.

Yes, so I would say, if you just look at Aerohive isolated, if you remember, before we acquired them, they went through a series of two restructurings. And taking down sales they wanted to focus more on profitability.

And so, before we closed our deal, they had been through two rounds of restructuring, as we concluded the reductions in their sales teams and, on that line. So I think that probably created an impact, there is still a macro issue that we deal with as far as what is happening and as we picked up and acquired the macro issue of EMEA it is still there.

But what I would tell you is that, from an Aerohive perspective, there is a huge amount of excitement around the platform that we have at Extreme and the portfolio. So the Aerohive portfolio is limited and now we are going to significantly expand, and we are going to bring a lot more resources behind cloud driven networking.

And in terms of air cover from marketing, in terms of all the different things that that we are going to be able to do. I would say the most exciting thing for us is the fact that enterprise are going to have to look to cloud. It's just the way cloud management, cloud driven or cloud managed networking is real and it's going to happen.

And we happen to have the number one cloud from a cloud capabilities perspective. And if you are excited, because there has been pent up demand for cloud, we haven't had it. We tried it a couple times. And now we have got the industry's best cloud, and we can pound the table on that. And then if you are coming from the Aerohive side.

Now as I said, you are going to have a much more robust cloud in terms of size and scale, breadth of offerings. And then all the weight and resources that we are poring behind into Extreme. So I guess that is in a very high level. I would go back to cloud driven industry moving to cloud.

Now all of a sudden, Extreme is in the number one position as far as what we can offer enterprise customers..

If I can just add to your specific point about organic, every time we add an acquisition what happens to our organic revenue, I think there is the one thing that we are getting better at factoring is revenue dis-synergy.

So when we acquired Zebra, and the Wing ranger products, obviously that had an impact on Identify, which was the wireless solutions that were brought with the acquisition and tariffs. When we bought Avaya and the Fabric that had an impact on the switches for the campus that were part of the Extreme range.

When we acquired Brocade in Data Center that had an impact on the Extreme data center products - 100. And today, we are acquiring a industry leading cloud solution, which obviously sold with its own access points and that has an impact on the sale of our own access points.

So the revenue dis-synergies systematically explain what you see in terms of the organic decline. Once the portfolio is communized and put together to add points, now we don't have a complete end-to-end solution, including cloud, I think we are in a good position on a go forward basis.

Just one example is our edge switching portfolio, which is benefiting from the refresh grew 14% year-over-year in Q1..

Great. Thanks guys..

Thank you..

Thanks..

I'm not showing any further questions at this time. I would like to turn the call back over to management for closing remarks..

Okay, great. Well, I just like to thank everybody for participating on the call. I always want to reach out and shout out to Extreme employees who are listening in and thank you for all of your hard work and helping us drive the business as we go forward.

Also for Investors, an administrative note, there are a series of investor conferences that we are going to be participating in. We put out a Press Release, you can see the full schedule of those conferences. But between Remi and I, and Stan, we are going to be out and we are really looking forward to sharing the cloud story with you.

We also have the cloud architect, who is going to be presenting about our cloud, who is going to be talking about some of the differentiation of cloud at a conference.

And then what we are also going to do is we are going to host a day, where we are going to take investors through and demo our cloud solutions and we want to take investors through that as well. And Stan will be reaching out on that front. So thank you for participating and we are looking forward to continued dialogue. Have a great day..

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect..