Ladies and gentlemen, thank you for standing by and welcome to the Extreme Networks Q1 FY '23 Financial Results Conference Call. [Operator Instructions] I would now like to turn the call over to your host, Stan Kovler, you may begin..

Thank you, Kevin. Welcome to Extreme Networks first quarter in 2023 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, Rémi Thomas.

We just distributed a press release and filed an 8-K detailing Extreme Networks' financial results for the quarter. For your convenience, a copy of the press release which includes our GAAP to non-GAAP reconciliations is 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's future business, financial and operational results, growth expectations and strategies. All financial disclosures on this call will be on a non-GAAP basis, unless stated otherwise.

We caution you not put [indiscernible] 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 of described in our risk factors in our 10-K report for the period ended June 30, 2022, as 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 as required except as required by law. Now, I will turn the call over to Extreme’s President and Chief Executive Officer, Ed Meyercord..

Thank you, Stan and thank you all for joining us this morning. We had a record quarter as demand for cloud-driven networking and for Extreme Solutions has never been stronger. Again, our share gains are evident by double-digit revenue growth, record revenue and continued growth of backlog which now sits at $555 million.

The sequential increase in revenue and margins led to continued improvement in our operating model and we achieved EPS of $0.20 in Q1, up from $0.15 in Q4. We expect these bottom line earning trends to continue. The combination of our fabric and cloud solutions are driving significant differentiation for Extreme.

Our fabric technology deployed in over 7,500 campus networks globally delivers network automation, hyper-segmentation and unmatched security. Today, our fabric provides simplicity and ease of use for local area network deployments from the campus core to the wireless edge.

In calendar Q1, we're extending our fabric across the wide area network, bringing new features and security to our enhanced SD-WAN solution. With ExtremeCloud IQ, our customers have complete visibility and management of network devices and connected clients throughout the entire enterprise, end-to-end across local and wide area networks.

The intelligence and automation tools we bring in our CoPilot license, such as digital twin and AIOps are game changers.

Highlighting the value of our CoPilot solution, one of our customers is on record saying, with CoPilot I'm finding problems in the network that I didn't know existed and now I have readily available solutions that I didn't have without the tool.

Both our fabric and cloud solutions stole the show at our oversubscribed sales kickoff event for direct sellers and channel partners where we hosted over 1,000 people in Boston in August. At Extreme, we have a unique focus in finding new ways for our customers to deliver better outcomes, leveraging the most advanced cloud and fabric technologies.

During the quarter, 37 customers spent more than $1 million with Extreme.

Some of our top wins for the quarter include household names such as the third largest cruise line in the world, where we beat out a large incumbent and we'll be deploying our wired wireless CloudIQ and fabric solution, a 4,000-room luxury hotel going up in Las Vegas that will showcase our fabric along with our CloudIQ site engine.

Third largest bank in South Korea is deploying our data center switching and fabric to protect sensitive customer information and ensure uninterrupted operations. And the world's third largest energy company based in Europe, a global leader in smart grid technology that added more than 2,000 Extreme access points are switching solutions and CloudIQ.

Our sales productivity continues to run at historically high levels and this will only increase over the next few years given the rightsizing of book-to-bill and the release of backlog. There has never been a better time to be a salesperson in Extreme. And our competitive position has never been stronger.

In such a large industry, small share gains have a large impact on Extreme's top line, making us the fastest-growing networking company. Third-party analysts, industry press and partner community have taken notice demonstrated by accolades and awards for our solutions and service.

For example, this is the fifth year in a row that Extreme was named Gartner's Choice for Wired and Wireless land access infrastructure based on peer insights. We achieved subscription bookings growth of 60% and annualized cloud SaaS bookings of close to $190 million exiting Q1.

Strong demand for our innovative cloud solutions is also pulling through product sales and we believe the level of organic subscription growth we're seeing today is sustainable.

In addition, the improvement in supply chain and our ability to deliver products, most notably wireless LAN this quarter supported a strong pull-through of software subscription. On the supply chain side, we continue to be laser-focused on tactical execution to meet our customers' needs.

Our distributors give us the highest rank in the networking industry for delivering on our commit dates and this is driving demand and has become a source of new customer logos and partners for Extreme. This quarter alone, we qualified an additional 50 component suppliers and reduced our part shortages.

Our success in reengineering products has also helped ease constraints. Based on all the actions we've taken with our supply chain over the past year, we now have better visibility and confidence in the ramp of our product deliveries.

With a strong outlook for bookings growth and the gradual improvement in supply, we expect to build backlog through the end of the fiscal year. We anticipate neutral book-to-bill or release of backlog in our fiscal Q1 of '24.

Once backlog begins to release, it will unlock an accelerated wave of product shipments and revenue growth over multiple quarters. We have complete visibility into our product backlog, the vast majority of which is comprised of orders with current delivery request dates.

Our orders are part of essential IT projects that have been carefully designed and planned for customer environments such as stadiums, college campuses, hospitals and manufacturing facilities. This is why cancellations remain negligible at a fraction of 1%.

About half of our backlog consists of the latest-generation universal products that pull through subscription and services. So when our backlog shifts, it will also unleash subscription and maintenance services revenue.

Our recently introduced Universal Switch5720, designed to support products with higher data throughput such as our Wi-Fi 6E access points, we'll be launching later this year. We also launched new outdoor APs, building on our first-to-market status in Wi-Fi 6E.

The transition to universal products continues with nearly 60% of our bookings now on universal platforms for wired and wireless products. Our sales funnel, our AI tools and our field forecast all point to healthy bookings trends for the next 12 months.

This is a combination of Extreme taking market share and the resiliency of cloud-based networking in this environment.

I'm excited about the strength and favorable outlook of the networking industry, our growing market share, gains from larger competitors, cloud-driven networking has never been more important in our competitive position with the highest quality cloud in the industry, combined with unique simplicity and security of our Extreme Fabric has never been more impactful.

We're poised for accelerated top line growth and margin increases that will drive unprecedented cash flow and earnings growth in future quarters and years to come. And with that, I'll turn the call over to our CFO, Rémi Thomas..

Thanks, Ed. Q1 results highlight the strength of execution of our go-to-market and supply chain teams. Our direct sellers and channel partners achieved near record bookings for both products and cloud subscriptions. Our global operations team delivered strong shipments that resulted in record revenue and we're reaching new milestone for SaaS ARR.

At the same time, we improved our margin sequentially and continued to generate strong cash flow. Our first quarter revenue of $297.7 million grew 11% year-over-year and 7% quarter-over-quarter which was once again above the high end of our expectations entering the quarter.

With a product book-to-bill ratio of 1.3 for the quarter, we added $42 million to backlog from the prior quarter. We now have nearly 3 full quarters of product revenue in backlog.

Wireless LAN revenue grew sharply on a quarter-over-quarter and year-over-year basis and now accounts for 30% of product revenue due to the loosening supply of access points in the quarter. We grew our SaaS subscription bookings by 60% in Q1, accelerating from the prior quarter's growth rate of 61%.

This was fueled by the sequential recovery in our wireless LAN business which has an extremely high attach rate of cloud services. Our SaaS ARR grew to $111 million, up from $103 million in Q4 for a growth of 41% year-over-year and 8% quarter-over-quarter. We remain confident in our long-term subscription revenue growth outlook of 35% to 45%.

SaaS deferred revenue was $171 million, up 40% year-over-year and 9% quarter-over-quarter. Q1 earnings per share was $0.20 at the high end of our guidance entering the quarter. Revenue on a geographic basis has been impacted by the timing of product shipments to our distributors.

With that in mind, the difference in performance between the Americas compared to EMEA and APAC is not a good indicator of demand. Bookings by geography is a better representation of end-user demand. To that point, the Americas reflected the highest growth up over 20% year-over-year.

EMEA grew mid-single digits year-over-year which is a solid performance considering that last year EMEA had an over 70% growth rate versus the prior year. Finally, APAC bookings also grew mid-single digits, also a good performance considering the strength of last year's bookings.

The APAC region was also impacted by currency devaluations which are making our dollar-denominated products more expensive in region, particularly in Japan.

Product bookings grew mid- to high single digits from the previous year, with similar performance in our wired and wireless products, campus switching growth outpaced overall product bookings growth for the quarter.

From a vertical standpoint, our mix did not change meaningfully during the quarter with government and education accounting for roughly 40% of the total, manufacturing at about 10%, health care at about 10%; and retail, transportation and logistics also at about 10%. Services and subscription revenue of $91.4 million in Q1 was up 11% year-over-year.

This growth was largely driven by the strength of cloud subscriptions, up 39% year-over-year. Total Q1 recurring revenue, including maintenance, managed services and subscription was at $86.8 million or 29% of total company revenue on the strength of product revenue.

The growth of cloud subscription and service renewals drove the total deferred revenue to $424 million, up 19% from the year ago quarter and 6% sequentially. Our gross margin came in at 57.6%, up 60 basis points sequentially and down 2.8 percentage points from the year ago quarter, driven by lower product gross margin.

On a sequential basis, the improvement in gross margin is attributed to an improvement in supply chain and freight costs and offset slightly by changes in the mix of products and services.

Services and subscription gross margin of 67.5% grew 3.8 percentage points from the year ago quarter on higher subscription mix but fell 3.2 percentage points sequentially, driven by higher professional services revenue and slight decline in maintenance.

Q1 operating expenses were $135 million, up from $125 million in the year ago quarter and from $132 million in Q4 '22, reflecting higher R&D expenses and year-over-year increase in sales and marketing to support higher revenue growth.

The year-over-year increase in sales and marketing spend relates to the reintroduction of in-person corporate events we hosted in Q1. Total operating expenses as a percentage of revenue overall dropped to 45.4%. All in all, our operating margin was 12.1%, down from 13.8% in the year ago quarter and up from 9.6% in Q4 of '22.

Net debt was reduced by $41 million sequentially to $73.2 million, driven by the strong increase in our EBITDA as well as a reduction in operating working capital, resulting for the most part from strong collections. Our cash conversion cycle dropped by 8 days sequentially and now sits at 19 days.

This quarter, we made a principal repayment of $37 million to our Term Loan A, enabling us to reduce our covenant leverage ratio to less than 1.25 and in turn, reduced the carrying interest rate on the loan by 50 basis points.

At the current 3 month LIBOR rate, the annual carrying interest rate on our debt will be approximately 5% to 5.5% effective November 9. Now turning to guidance. Our confidence in our outlook is further solidified by $555 million worth of product backlog exiting Q1. For Q2, we expect revenue to be in the range of $299 million to $309 million.

Q2 gross margin is anticipated to be in the range of 57.5% to 59.5%. Q2 operating expenses are expected to be in the range of $133 million to $138 million. Q2 earnings are anticipated to be in the range of $28 million to $35 million or $0.21 to $0.26 per diluted share.

We continue to expect that the reduction in expedite and shipping fees, combined with the full impact of our recent pricing actions will lead to a progressive recovery in gross margin throughout fiscal year '23. So for the year, we expect 10% to 15% revenue growth.

For the second half, we expect to cross the 60% gross margin threshold and achieve an operating margin in the mid-teens. With that, I will now turn it over to the operator to begin the question-and-answer session..

[Operator Instructions] Our first question comes from Alex Henderson with Needham. Your line is open..

Thanks. I’m going to break that a little bit because I wanted to get some clarification on some of the numbers which are just pretty straightforward. Can you give us some guide on the interest line since you obviously have a lot of things moving around in there? And did you say the book-to-bill was 1.3, I’m getting 1.23 when I calculate it..

Product looks to be a little at 1.3, Alex..

It was 1.3%, okay..

Yes, it was 1.4%. So the average is slightly higher..

I see, I see.

And the interest line?.

Hold on, let me just bring that up. It keeps moving with 1-month LIBOR rate. You should assume about $5 million a quarter..

The LIBOR rate going up 75 basis points this morning impacted you guys or ECB did?.

We do the reset on a monthly basis. So today's rate may not necessarily be the one that we'll have after November 9. But currently, it would be 330 plus 125 would be 455 [ph] if we use the last 1 month LIBOR reset that we have..

Okay. If I could ask a couple of questions. Just -- those were just technical details. The first one is, I didn’t hear any mention of pricing. And I know pricing has gone up in the industry. I know you guys have increased price.

Can you talk about where you are in terms of actually getting the price in the numbers this quarter as well as where you expect the pricing to look like? And one other clarification, you said you wanted to -- you thought your backlog would increase by year end.

Do you mean increase from the start of the fiscal year? Or do you mean increase from the 555 [ph]?.

Alex, I'll jump in and then, Rémi, you can back me up here. Alex, we expect backlog to increase each quarter throughout the remainder of our fiscal year. So we're expecting increases in December, March and June..

Perfect..

As it relates to pricing, we had a very modest and targeted price increase effective October 1. On the bookings side, we did see some pull-ins but it was much more muted than what we had last year. If you recall last year, we had a 12% price increase as of October 1 and that drove significant bookings.

Rémi referenced that, over 70% growth in product bookings in EMEA which it is -- we were really excited to see that we were able to grow organically on top of that kind of comparable. So in general, we are in a -- we feel like we're in a strong position. Cisco has announced price increases. We remain under their umbrella.

And then we've seen our other competitors follow suit. So we like where we are in terms of seeing the price increase in numbers. You'll see the most recent price increase, a small impact this quarter and then a larger impact in the following quarter. Rémi, I don't know if you want to add anything to that..

I was just going to add that with the exceptions of certain country where currency devaluations have impacted our ability for our customers to meet their budget, our price increase are holding edge.

So we're not having to raise discounts to offset the price increase and so they really translated into an improvement in the overall net selling price of the company..

So just to be clear, in the quarter, the price benefit was low single digits and you expect it to be what by the fourth quarter or fiscal year?.

There was -- I mean, there was an impact this quarter of the price increase that we made on April 1. However, the impact of the October 1 price increase was not felt in the September quarter..

Clearly.

But my point -- my question is what was the real impact of price increases in the quarter? Was it low single digit contribution to your revenue growth or some other number?.

Yes, low single digit coming from prior price increases, correct..

And you expect by the June quarter it will be 5%, 6%, 8%, 1%? What are your expectations for the realization of that when you talk about building backlog through the end of the year and the like?.

[Indiscernible] discount trends don't change, it would be low to mid-single digits..

Low to mid-single digits. Thank you..

Thanks, Alex..

One moment for our next question. Our next question comes from Eric Martinuzzi with Lake Street Capital. Your line is open..

I’m going to assume that to me. It’s Eric from Lake Street Capital Markets. Just wanted to follow-up on the geographic commentary that you gave. You talked about bookings by geo with the Americas being up 20% and then mid-single digits for EMEA and APAC against a tough comp.

Where should we think about that for fiscal year ‘23, given the revenue guide of 10% to 15%.

How do you see the bookings growth across geographies for FY ‘23?.

Total bookings growth across all geographies and products, services and subscription is expected to be in the high single digit..

Okay. And then combined with what's coming off the backlog, that's how we get to the revenue number of business..

Okay..

I would say, Eric, we're not expecting -- we're expecting to grow backlog during the year. So in terms of how we get to our fiscal year growth, the expectation is that we are not reducing backlog but we're growing backlog. I just want to clarify that..

Yes. Okay. And then as far as the release in the gross margins, we’re seeing relief, you’ve qualified more component suppliers, you’ve got a little bit of breathing room on the expedite fee. But what’s really the -- it’s -- I’m looking for what’s the biggest contributor to the gross margin expansion as we go quarter-by-quarter..

Eric, that would be the reduction in expedite fees based on what we paid to our key suppliers of semiconductors and components as well as the reduction of freight cost which is still elevated today because most of the products that are produced out of China and Taiwan are shipped by air directly to El Paso which is our main hub.

So the reduction of these two that are currently hurting gross margin is really what's going to drive the improvement over time..

Got it. Thanks for taking my questions..

One moment for our next question. Our next question comes from Paul Silverstein with Cowen. Your line is open..

Thanks, guys. Two questions, if I may. One, on macro, it sure doesn’t sounded from the numbers in your commentary but I’ve got to ask. Last -- the other day we had F5 in Juniper with 2 very different messages. In F5s case, there was about cancellations, delays, downsizing increased budget scrutiny, especially overseas, in particular overseas.

Are you not seeing any of that, especially in light of FX and energy prices in Europe, etcetera?.

Paul, it's something that we -- obviously, is something that we keep a very close eye on. And we're not seeing it. We have a lot of different variables that we look at, specifically as we look forward, we look at opportunities that we have in the funnel that are -- and we're scrubbing those regularly.

We have feedback from our direct sellers in field and what they're rolling up and calling. And as you're aware, we have an AI tool that sits on top of Salesforce that comes up with a call. So we kind of have kind of 3 legs to our outlook and we're just not seeing it. There's 2 things that are in play here. One is the resiliency of networking.

One way to offset inflation is productivity and -- and what's driving productivity are improvements in technology and all the digital transformation projects that you see today, the glue to everything is the network. And so we're not seeing networking initiatives being deprioritized.

And in our backlog, the fact that we have a backlog of complicated networking systems, not commodity products, we're not seeing -- we're not seeing the books. And so that's why we say it's a fraction of 1% because it truly is. So if enterprise customers are having to cut back spend, we're not seeing them prioritize networking.

We're seeing other items in the budget being cut in front of networking. So that's one thing. The other thing is our relative size and we mentioned that we're taking share. The fact of the matter is we are taking share against much larger players. So these small share gains for us can cloud what may be happening in the larger market.

So the -- our ability to continue to drive bookings even in these challenged markets like in the EMEA market or currency challenged markets in APAC, we still see healthy growth in bookings and some of that is going to be from market share gains.

And the other is, as I mentioned, is just the resiliency of these networking projects which in our mind to become more strategic for enterprise customers..

And I just thought you just pushed through, you’re not even seeing elongated sales cycles..

No, we're not. I would say it's actually the opposite, Paul, we're seeing. If anything and this goes back to supply chain, if anything, we may see people that are anticipating lead times and ordering early so that they can establish their position as it relates to supply chain. So we're not seeing it. And in our case, we're asking the questions.

We're all over it. Obviously, given everything that's going on in the world and the news, there's this expectation. So we're very sensitive to it. What I would say is we're just -- we're not seeing it..

That pegs the question. Do you -- I assume the answer is no but has there been any communication view or anything that would argue that the supply chain constraints are keeping customers in line and that may be why you and others haven’t seen any weakness yet relative to macro. Again, I assume for when….

Paul, I think it's fair that, that could be a factor.

So in the case of Extreme, there's the overall significance of networking initiatives for our enterprise customers which underlie all of their digital transformation and productivity and sort of -- it's all about how they're driving their business and so we're just -- we're not seeing that get deprioritized.

I think there is a supply chain element that you mentioned. There's also an element. Our story hangs together with our fabric and with our cloud, with our end-to-end enterprise solution and the recognition that Extreme is getting in the marketplace today. We are getting -- we're seeing more opportunities.

And I think some of our larger competitors are creating these opportunities because of a disjointed vision of how to leverage cloud, how to have this single pane of glass, a single view of all your network elements end-to-end across the enterprise, the orchestration of services from one cloud, future proof in your investment and with the latest technology, we have the cleanest story out in the marketplace today when you combine that with our fabric technology.

And it's resonating. And so we're taking share and we do have a different story and we're getting more looks. And I think some of that is -- we're the beneficiary of some of the issues out in the market with some of our larger competitors..

One last question on this. Ed, correct me if I’m wrong. Historically, when there were downturns, especially significant downturns, the typical customer behavior in that environment had been to stay with the incumbent and not to switch vendors.

It was only in better environments when they were more willing by away from whoever their increment was HP, Cisco level.

Do I have that right?.

I'm not sure -- I'm not sure I can validate that for you, Paul. I think in this environment what we're seeing is maybe the opposite. Their supply chain strategies in some of the larger players have pursued that are creating opportunities, as I mentioned, for us, especially our enterprise customers.

And then there's a lack of a cohesive solution for customers where it's very expensive for them. So it's almost more expensive for them to stay with some of the legacy larger vendors in a sense more risky because of the lack of a cohesive end-to-end strategy, especially as it relates to cloud.

And that's something that's creating more opportunities for us rather than less. And that may be different than maybe what you saw in the traditional recessionary type or a downturn scenario in the market..

One moment for our next question. Our next question comes from Mike Genovese with Rosenblatt Securities. Your line is open..

Great. Thanks. So, guys, really good report. I mean, I don’t see anything not great here except for, I guess, the gross margins your building up sequentially, the gross margin was in the quarter and the guide were just very slightly less than what we were looking for.

And I guess my question is, is that more a function of the supply chain and expedite fees? Or is that more of a function of the mix shift to wireless? And where do we think that’s going to look like in future quarters, particularly in the back half of the year? Do we expect a mix shift away from wireless? Or will that ground for a while?.

I would say that the latter because the amount of expedite fees and the freight costs that we paid in the quarter were in line with our expectations. The shift to wireless was more pronounced than we expected entering the quarter.

And that's really what drive the difference between the 57.6 [ph] that we reported and the 58 [ph] that we were getting for at the start of the quarter..

And do we think the mix will change? Or this is a -- I think that happened last quarter too. So is this kind of the two quarter….

The loosening of supply chain combined with the historical very high level of backlog for wireless products means that, that the 30%-70%, 30% wireless 70% wired is going to stay for the next few quarters.

However, the reason we mentioned in our introductory comments that we feel confident we can cross the 60% gross margin mark is that we now have visibility as to the reduction of expedite fees and freight costs.

So although that mix is not going to change, we do see progressive reduction in expedite fees and freight costs that will drive a higher gross margin, especially in the second half when we expected higher volumes of shipments that lead to a better absorption of the fixed costs that are in our cost of goods sold..

Rémi, I can add one other variable here which is if you recall a year ago, we did not have these direct relationships with secondary and tertiary component vendors. And today we do, we meet regularly and we have confidence in what they're delivering because they are delivering on what they say they're going to deliver.

And they've given us the commitment of the ramp. When we don't have the direct commitment and we're not getting the shipments, we also have to go out in the secondary markets to find product. And so that also leads to increased prices when we're having to go out and buy components in the secondary market.

So as we have and we see the commit from the secondary and tertiary component vendors step up, this is what's giving us the confidence in the forecast. At the same time, it will reduce our reliance on secondary markets where we're paying up, also the expedite fees that Rémi is talking about as well as the freight components..

Okay. Great. Perfect. I guess, back on the macro, you guys gave a very direct, I thought clear answer on particularly around Europe, you are not seeing macro weakness. You did mention in the prepared remarks though, about some, I guess, currency-related weakness in Asia Pacific.

So I guess, is that the macro effect that you’re seeing? And what do you think the -- I mean, the solution to that is. Is this customers’ willingness to pay? Or expectations of the currency will change? Or is there any thought of repricing any of the backlog if it gets worse? Just your thoughts on those issues, please..

Yes. I would say, Mike, I would say it's less of an issue with backlog. It's more of an issue with new bookings and a timing issue on these important projects. I mean, I'll reiterate that networking projects are underpinning the really important initiatives. And there's not really another alternative for them other than a timing decision.

And in that market, I will say we have upgraded our team significantly. We are excited about the team and new channel relationships that we have, more than any other market in the world we have smallest markets there in that market.

So the opportunity to take share, small little share bites in that market can help us offset the reticence of certain buyers, particularly in Japan, for example, where they've seen a currency devaluation of 40%. So that's -- at the high level. Rémi, I don't know if you want to add anything to that..

No, I just want to say that for deals that we deem to be strategic if the customer is struggling basically to meet their budget, given the currency devaluation, it's a question for us of do we want to leave that deal or go ahead and grab it.

And so in certain specific deals that are strategic to us, we're willing to be slightly more aggressive to meet the customers' budget requirements and take the deal up the street..

Okay. Fantastic. Last question. I know I’m going to ask the same, I guess, numbers everybody asked. But fiscal ‘24, I guess, where we’re still looking, I just want to confirm, first of all, that we’re still looking for acceleration in the 13% to 17% revenue growth.

But I guess we would expect the book-to-bill to be below 1 that year because we releasing so much backlog but I don’t know if you can see this far out.

But kind of sequentially year-over-year, ‘24 orders versus ‘23 orders, do you think that they could be flat to up? Or do you think that they’ll be down? If you can have any view this early on that?.

Well, Mike, I'll jump out first here. As I was mentioning before, we have a very strong focus on our funnel and we look bottoms-up at each of the opportunities. We do it by geo. We do it by our regional directors and the regional directors are in the details down to the account executive level.

We also have a separate partner forecast as part of our quarterly business reviews with our partners. So all this comes together and all this feeds the opportunities that we see for the next 12 months. That's really the way that we look at it.

And we're seeing very healthy demand, organic bookings demand for the next 12 months year-over-year based on what we see in our funnel. So we see this continuing. We don't see [indiscernible] it pulling back currently.

So as we contemplate rolling into our fiscal '24, you would expect -- we are expecting to see continued growth in demand and bookings and then the releveling of book-to-bill. Keep in mind, we're not showing all of our revenue because we're still building backlog this year.

So we're going to have the benefit of just the releveling of book-to-bill to the current demand levels and then the release of backlog which today is 3 quarters worth of backlog but we think that will grow. And so that's what you're going to see going into fiscal '21. That's our best guess today.

And so our expectation would be that we would see a book-to-bill drop below 1 but that's going to be a significant driver of revenue growth..

And our current working assumption, Mike, is that top line will grow between 15% and 17% next year..

Great. Well, congratulations on the results and the momentum and keep up the great work..

Thank you..

One moment for our next question. Our next question comes from Dave Kang with B. Riley. Your line is open..

Hi, yes. Thank you. Good morning.

Just wanted to -- can you repeat, Rémi, the backlog mix between wired versus wireless?.

We have not split the backlog between wired and wireless, Dave. The comment I made, the 30%-70% was for revenue this quarter. And just to give you an idea, a year ago it was 21%-79%. So on a year-over-year basis, there's been a dramatic shift in the wired to wireless revenue ratio. But we're not communicating the split.

I did mention that there's a significant amount of backlog for wireless but I didn't give a percentage..

Got it. And then in your presentation I noticed that regarding the verticals, there are no plus and minus signs.

Can you kind of go over those key verticals, what you’re seeing and whether it’s a plus or somewhat turning equal or negative?.

Yes, we haven't seen -- and that's why I made the comments that I made about the split as a percentage of total bookings is we haven't seen any dramatic shift.

So in other words, the large, the top 4 segments which are government, education, health care, manufacturing, retail, transportation, logistics still account for roughly the same percentage point.

We did see a sequential improvement in our bookings in sports and entertainment and that really came off of the fact that we had a low quarter in Q4, so that we saw a significant recovery in there. But we're not seeing any major trend. The funding in education and government remains very healthy. Healthcare business remains pretty healthy.

Manufacturing, where you'd see -- you would expect to see signs of a slowdown because of the macro environment has actually behaved quite well. The year-over-year increase in bookings in manufacturing was double digits.

And then retail, transportation, logistics which also could be sensitive to change in the macro environment is also enjoying healthy trends..

Got it. And then I may have missed this but then did you talk about the supply chain impact on your margins? I think last quarter it was about 600 bps.

What was it this quarter?.

So the comment I made about 600 bps is I was comparing the purchase price variance that we pay which really are expedite fees and us going out to the secondary market, as Ed mentioned. And I was adding that with the freight costs and comparing it to fiscal '21.

We're not really breaking it down by quarter but just to give you an indication, purchase price variance which really reflect those expedite fees, have reached an elevated amount of about $15 million per quarter. They're back to $11 million. So there's a $4 million improvement there.

As far as freight costs are concerned, they just roughly are expected to improve by $1 million in Q2 versus Q1. So if you think of the improvement that we're seeing today, it's about $5 million overall versus the peak that we reached at one point in time.

And then you can divide that $5 million by the revenue this quarter of $297.7 million to get a feel for the improvement that we're seeing in gross margin as a percentage of revenue..

Got it. And my last question is on seasonality. I mean, typically I think in the past, fiscal first quarter is seasonally weak versus second quarter and yet you grew about 7% sequentially in the first quarter and you’re only guiding to about 2% sequential growth in second quarter.

Just wondering how much of that is conservatism versus is there something else that we are missing?.

And that's purely driven by supply chain. We get a weekly reads from my supply chain teams as to what they're able to ship this quarter.

The services and subscription revenue, as you can imagine, is largely coming off the balance sheet from deferred revenue that's sitting there and that 2% sequential growth that we're guiding for is based on these 2 factors. And we don't feel like we've been particularly conservative. We try to be as accurate as possible..

Got it. Thank you..

One moment for our next question. Our next question comes from Christian Schwab with Craig-Hallum. Your line is open..

Hey, congrats on the great results. So Rémi, as we think about backlog, when is that going to normalize? Or I know there are certain components and we know there’s thousands of different ones in the switch. So that’s because one area of silicon might be opening up, others still are not.

Are we going to run with a bigger backlog business war much more -- what do you -- I guess what I’m really asking is, when is backlog going to normalize? When does it go back to historical levels? Or do you believe until we have full access to -- or oversupply of semiconductor components that, that is not likely..

Christian, I'll let Ed chime in as well because we're both very close to the topic but we believe it's going to be fiscal '26 when it really goes back to normal. And we'd expect our backlog to be anywhere between $50 million to $100 million at that point in time.

But based on what we see in the semiconductor industry with obviously new capacity being added but at the same time, some of the large semiconductor makers revising their plans, we will also see demand dropping in other industry segments that are heavy consumers of chipsets and competed with us and now see slower demand.

The combination of these 2 factors tell us that it's going to be a while before things fully go back to normal. So based on our delivery plans, we think it's really -- it takes 2 fiscal year -- I mean, fiscal '23, what's left is it fiscal '24, fiscal '25. And then maybe at the start of fiscal '26, we drop back to below $100 million.

That's our current scenario..

Fantastic. No other questions. Thank you..

One moment for our next question. Our next question is the follow-up from Alex Henderson with Needham. Your line is open..

Great. Thanks. So in looking at the mix assumptions through to the fourth quarter and thinking about your gross margins, can you talk a little bit about the impact on gross margins of; one, the fall of expedite fees and costs associated with the procurement.

Two, the mix to Universal and the impact that, that has versus your historical products, where I think the margins are quite a bit better.

And then third, what kind of improvements you’re getting off of the redesign process? How do we allocate between those various factors, the improvement in margins?.

I'm not sure I want to get into that level of detail. But I'd say the combination are the factors that you mentioned, Alex, should be driving an improvement in gross margin sequentially for products of about 1 to 1.5 percentage points in Q2 versus Q1 and then Q3 versus Q2.

Again, these 3 factors combined together would drive an improvement of about 2 percentage points. And then Q4 versus Q1, we're looking at roughly 1 percentage point.

One factor that you have not mentioned which we're also looking at because it did impact our gross margin in the quarter with the mix of professional services versus subscription and classic services -- by classic service, I mean, maintenance in Q1 that drove our services gross margin down to 67.5% versus 70.7% in Q4 fiscal '22.

We do expect the services and subscription gross margin to go back to 68.5% by Q4 because we will not see the same way of professional services. And those were essentially related to MLB deployment..

So that actually was the second question I wanted to ask. So I’m looking at the revenue growth rate guidance for FY ‘23. Can you -- clearly, as you’re working some of these larger product sales that does drive adoption of services and subscriptions.

So can you break out a little bit between the implied growth in the product line versus the services line in that guidance assumption?.

Yes. So we would expect -- as you saw, both grew and I'm combining services and subscribe into one bucket but both grew at around 11%. I would expect that in Q2 we'll see a higher growth for products will be closer to 10% than services and subscription which will be in the mid- to high single digits.

And then in Q3, we actually expect based on our current delivery plans, the growth in services to be higher -- services and subscription to be higher than product. And then Q4 is when we really see a step function improvement in supply chain.

And then you're going to see a very strong growth in product, whereas our services and subscription growth will be close to 10%..

That’s very helpful. And then so I guess in -- as we move out into ‘24, the product would continue to be much higher based off of the fact that you’re getting meaningful improvement in supply availability.

Is that the right logic?.

That's correct. And then services and subscription continues to grow at a steady rate of anywhere between 8% and 10% depending on the quarters..

What are you factoring in, in terms of Broadcom price increases I’ve heard that they’re going to increase pricing in the January time frame.

Does that show up in that quarter? Or does that show up with some delay? How do we think about their price increases?.

We're basically today placing orders with Broadcom a year in advance in order for us to secure the current pricing..

Okay. So you would be protected for a considerable amount of time then because of that procurement -- advanced procurement. Yes. Okay. That’s really interesting. I wouldn’t have expected that. The other question….

The other thing to mention is that in addition to list price and price increases, there are expedite fees. And one of the things that we see happen with Broadcom and some of this has to do with our relationship with them. Some of the price increases will be mitigated by a reduction in expedite fees..

Right, right. The other question I had is on the decommits comments you made, it sounded like decommits are declining but still happening.

Is that accurate? Or have the decommits basically stopped at this point?.

Alex, decommits are just -- it would be a normal part of the business. These are one-offs. And I can tell you right now because of our scrutiny around this, each and every decommit, to the extent there is one, gets a lot of scrutiny from us. And there's no consistency around it. So the example I might give would be a government agency that has budget.

They can't get supply by the end of the year, it's use it or lose it. So they want to reprioritize another spend. So they might cancel an order or and maybe that comes into the budget for the following year based on that dynamic. But these are things that are not really supply chain.

I guess you could say that supply chain related but these are more one-offs. And so we're not really seeing a change in the one-offs and they remain at a fraction of 1%..

Alex, was your question on decommits related to customers or suppliers?.

His line -- actually left the queue..

Okay..

So we're going to move on to our last question as a follow-up from, one moment. So a follow-up question from Paul Silverstein with Cowen. Your line is open..

And Rémi, I apologize if I missed it but can you give us an update on the Arsen [ph] relationship and what you’re seeing with respect to future revenue outlook and current revenue contribution from that product?.

I will actually let Ed comment on that..

Paul, we have an excellent relationship with them. We just met with senior leadership in Stockholm. I -- we are in a very good position with that account. And in addition to C&IS which is really a function of 5G rollouts from carriers and each of the carriers is kind of at their own stage of life cycle.

So we're seeing we're seeing a couple of the larger carriers move from proof of concept into deployment modes. So that's -- we're excited because we're the sole source vendor for that application which we expect to roll out over the next 5-plus years.

The -- we are looking at other opportunities with Ericsson that I would say are longer term in nature. But we have new growth opportunities within that account..

Ed, on the 5G products in general, because I believe you’ve referenced another relationship previously won directly with a specific carrier.

What’s the current revenue run rate from that and what’s the potential going forward?.

I don't know what we've disclosed. Rémi, I'm going to rely on you for what we've disclosed or communicated around service provider. And we have 2 very significant relationships, Paul, that you're referencing. And then we have other service provider customers that I would say are less strategic but nonetheless fall into that service provider bucket.

We see -- in terms of the other -- the direct service provider customer account, we see a significant opportunity, not just with sell-to and supporting what I would call their 4G and 5G back office as well as the carpeted enterprise and sell to. We also partner with them in stadium deployments and we sell with them.

But now we've just been approved for their enterprise teams to sell Extreme, retire quota, get paid commission and we have sellers on our side that are actively working with their sellers which is a new growth vector with that account.

So from the SP side, we see new opportunities with the Swedish company as well as new growth opportunities inside the large carrier in the U.S..

Ed, we haven't really communicated but we did mention that both of them were several tens of million dollars in annual bookings. And I can say that the combination of these 2 is between 50 and $100 million in annual bookings..

Okay. Thanks, guys..

Thank, Paul..

And I'd like to turn the call back over to Ed for any closing remarks..

Yes. Well, thank you. Great questions. We appreciate participation in the call and the engagement with the analysts and people who are participating on the call. It was obviously a strong quarter for us at Extreme.

We’re -- it’s been a cross-functional effort across the board and really proud of the caliber of execution of all of our teams at Extreme across the board as well as the partnership we have with our channel community. We’ve got a lot of momentum. As we’ve said, we’re taking share.

And it’s really a function today of us releasing supply chain and we’ve got better visibility to that as we step through the year. So I’d say we have more and more confidence in our outlook as we go forward.

So as we say this, there’s never been a better time to be at Extreme and that’s true for our employees, partners, customers and I think it’s also true for investors. We encourage everybody that we have upcoming investor conferences. We encourage people to participate. I know with Needham, Raymond James, Oppenheimer and Cowen.

So, we look forward to being with you live and have any opportunity to share the story in more detail. Thanks, everybody and have a great day..

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day..