Welcome to the Extreme Networks Q3 FY '17 Financial Results Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Ms. Laurie Little. Please go ahead.

Thank you, Heidi and welcome to Extreme Networks' Third Quarter Fiscal Year 2017 Earnings Conference Call. This conference call is being broadcast live over the Internet and is being recorded on behalf of the company. The recording will be posted on Extreme Networks' website for replay shortly after the conclusion of the call. By now you've had a chance to review the company's earnings press release. I'd like to remind you that during today's call, management will be making forward-looking statements within the meaning of the safe harbor provision of the federal securities laws. These forward-looking statements involve a number of risks and uncertainties which could cause actual results to differ materially from those anticipated by these statements. These risks include our ability to successfully close the Avaya and Brocade transactions and to successfully integrate the acquired technology and operations into our business and operations, including, but not limited to, the following risks, difficulties we may experience in the retention, assimilation and successful integration of employees and teams, acquired operations, technologies and/or products; unanticipated costs of litigation or other contingent liabilities associated with the acquisitions that could negatively impact our operating results and financial condition; adverse effects on existing business relationships to suppliers and customers; and difficulties we may experience in reaching our aspirational goals related to the acquisitions. For a detailed descriptions of risks and uncertainties, please refer to our most recent reports on Form 10-K, 10-Q and 8-K filed with the SEC. You should not place undue reliance on forward-looking statements which speak only as of today. We undertake no obligation to update these statements after this call. Throughout this call, we may reference both GAAP and non-GAAP financial metrics. Non-GAAP information should be considered a supplement to and not a substitute for, financial statements prepared in accordance with GAAP. Reconciliation of non-GAAP to corresponding GAAP measures can be found in our earnings press release issued today. For your convenience, a copy of the release and supporting financial materials are available on the Investor Relations section of the company's website at extremenetworks.com. With that, I will turn the call over to Extreme's President and CEO, Ed Meyercord, for his opening comments.

Thank you, Laurie and thank you all for joining us this afternoon. Today, we're pleased to announce solid third quarter results that beat our earnings per share guidance of $0.08 by 25% and more than tripled our earnings per share from the March quarter a year ago. The results underscore the success of our accretive acquisition of the WiNG wireless business from Zebra which drove 19% year-over-year top line growth and significantly increased cash flow during the quarter. The results also reflect the improved profitability and quality of our core Extreme networking business. This makes 8 consecutive quarters that our Extreme team has met or exceeded our earnings guidance. We came up short of where we wanted to be on the revenue side, but we more than made up for it with higher-quality solution sales, stronger gross margins and aggressive cost controls. The March quarter was an unusually busy quarter for us, with many projects taking place behind the scenes. In addition to the integration of the Zebra Wireless LAN assets that are now consolidated into our normal business operations, we realigned our workforce to take advantage of expanding wireless opportunities and new geographies and to accelerate the achievement of our target operating income margins. And we went live with a major IT conversion to a new platform supporting our global service sales and service delivery operations, retiring a 12-year-old civil system. The project with our new master data management system lays important groundwork for scaled operations in the future. In addition to this, we announced the Avaya and Brocade deals during the quarter which I'll provide more detail on later in the call. We believe the result of all the recent initiatives will be transformative. Extreme will be a clear leader in the enterprise networking industry with the #1…

Thanks, Ed. First, I would like to start with a few financial highlights from our third fiscal quarter of 2017, specifically the increase in our gross margin and the strong growth in our earnings and free cash flow as compared to the same period last year. Discounting improvements, enhanced operational efficiencies and contributions from the acquired wireless LAN business from Zebra drove the increases in our gross margin and earnings. Free cash flow growth benefited from profitability and accretion and accounts receivable collections from the wireless LAN business. These are all strong indications that we're on our way to achieving our margin target numbers. I would like to now briefly cover the financial highlights of the quarter and encourage you to refer to our earnings presentation that has been posted on our IR website for more details. Now let's move to the third fiscal quarter results, starting with revenue. Q3 '17 revenue was $148.7 million compared to $148.1 million in Q2 and $124.9 million in Q3 a year ago. Our revenue increased 19% year-over-year, was driven by the additional revenue from the acquired wireless LAN business, partially offset by back-end linearity of the quarter and discipline over discounting. The geographic split of our revenues were as follows, North America contributed 15 -- 52% to total revenue; EMEA contributed 35%; Asia Pacific contributed 10%; and Latin America contributed 3%. Product revenue for Q3 was $110.8 million compared to $109.8 million in Q2 and $92.7 million in Q3 last year. Q3 service revenue was $37.9 million compared to $38.3 million in Q2 and $32.2 million in Q3 last year. Moving on to gross margin and operating expenses. In Q3, GAAP gross margin was 55.3% compared to 50.9% in Q2 and 50.2% in Q3 last year. Non-GAAP gross margin was 57% and compares…

[Operator Instructions]. And your first question comes from the line of Matt Robison with Wunderlich.

Yes, just, I guess, obvious question is maybe you could help us understand a little bit more about the revenue story coming in under your expectations and what you've learned that gives you confidence that you'll be able to achieve the guidance you've given for the current quarter.

Thanks, Matt. This is Ed. Yes, for some reason, it was a very back-end-loaded quarter. We had really high percentage of the orders that came in right at the bitter end. It put pressure on supply chain and getting product out the door. And I commented earlier that I don't want to get into deal-by-deal specifics, but that was clearly a factor. And so some of that will spill over into Q4 and that's one of the reasons why we have confidence. The other thing going on is that we're being more stingy out in the field. We're selling more solutions and we're being more disciplined around lower margin opportunities that are going our way. And so we're turning away a fair number of deals and I'd say we probably turned away a bit more than we expected.

Okay. So why -- so if you hadn't been so stingy, you would have been at the bottom of your range? Or obviously, it worked. You got to the bottom line number and the margins were nice, but...

Yes, [indiscernible] going through different deals and we could recreate our revenue and gross margin or better. Look, at the end of the day, I think if we weren't as back-end loaded, that alone would have put us right up where we needed to be. And then I think there's just additional pressure because of the discipline on the sales side.

Were there any -- how does that map in the verticals or regions, the back-end-loadedness?

Yes, the Americas was strong, a little softness in EMEA on a relative basis. APAC, steady over last year. We're seeing -- we have new leadership there. We're expecting a pretty nice rebound in that region. We're also expecting EMEA -- the teams in all of our geos have a lot of confidence in their commit levels and the pipeline we've got. And we've built in a little extra conservativism in our methodologies around how we're forecasting. So I hope that's helpful.

Your next question comes from the line of Mark Kelleher with D.A. Davidson.

Just as a quick follow-up to that, because of the back-end loading, does that mean you've got greater backlog going into the June quarter? Does that give you some better confidence in that quarter?

Mark, this is Ed. Yes, it does.

Okay. And then on the -- is there a way you can size up the Zebra contribution? Or maybe give us some feel for what the organic growth would have been without Zebra?

Yes, so I -- with respect to Zebra. Zebra came in, in line with our expectations, maybe even slightly ahead. The big plus from Zebra is that the gross margins were better than we had expected. So that contributed to gross margin strength. I think we've guided previously to say that we're at $28 million to...

$29 million to $35 million is what we guided before.

$29 million to $35 million.

Yes. And we were in that range, even a little better than our forecast.

Okay. And with regard to the acquisitions, I assume it's still too early to be having any communication with either of those groups, right? There's no way to kind of coordinate. And I'm just thinking that Brocade is a [indiscernible].

No, that's [indiscernible] that's not the case. We actively working...

Oh, you are. Okay.

Actively working cross functionally with both Avaya and Brocade teams. We have a cross functions. And we've been doing a lot of work. Our teams have been working collaboratively, where we have conference rooms filled with Brocade, Avaya and Extreme teams, hammering through our vision, our technology vision, our product roadmap and how this is all going to come together over the next 3 years. Our teams are working on business integration, technology integration from an operating platform perspective when we look at quote-to-cash cycles. And we're actively working. As I mentioned before, we're not aware of any other bidders in the Avaya process. I should also say we think we would know. We're pretty certain that we would know if there were bidders. So at this point, we're locked and loaded and we're already working on combining the companies. The same thing with Brocade. We have a signed deal with Brocade and Broadcom. So as soon as that deal closes, then we're going to be positioned to close within 30 days of that. We're actively working on the combination of the 3 companies, very excited about the amazing customers that these companies have and how they're going to fold in and how it fits into our enterprise vision. The talented people, there are some terrific resources that we're picking up. And as the CEO of the company, the chemistry of the teams and the enthusiasm and energy around pure-play networking, it's fun to be around. So the teams are really excited and it's going to be a busy summer.

Your next question comes from the line of Alex Henderson with Needham.

So a couple of quick questions. First one, I just wanted to go back to the organic growth of Extreme versus the acquisition. I think if I back that out, you were 1% or 2% organic growth, excluding the acquisition. And I know that's a little bit of a mixed calculation because you merged 2 teams and, obviously, there's some cross-selling going on in there. So is that a correct estimate, roughly?

Alex, I -- let me comment. And I could let Drew jump in if he wants to. Because of the back-ended nature and what we pushed, we were down probably 3%, 4% year-over-year on the Extreme side. I think we would have been right there. We would have been flat. As I mentioned before, we're projecting modest organic growth in the Extreme business in Q4.

Okay, so second question is going at these deals where you've decided to be more aggressive about getting your price as opposed to giving discounts which is a great thing to do and I'm totally for it. But the question is, are you losing those customers? Or are they just saying, "Well, I'm not going to buy it if I'm not going to get a discount," and they're still sitting out there with the older equipment, having not replaced it or somebody else getting in and putting gear in. Is it a competitive situation? Or are you, in fact, just not getting the deal because I wanted a discount or I'm not going to do it.

Alex, I'm not sure you're going to like the answer. It's a combination of both. We've got -- we have 10,000 -- 6,000 orders in the quarter approximately and then when we're looking at discount authorizations, there's tens and tens and tens of different deals that come through. In some cases, it's business that we probably don't want and we're going to let that go. In other cases, maybe deals get pushed out or maybe the purchase decision is delayed.

The reason I asked the question is a lot of people won't buy a deal, buy something that they want until the sale's on. And if -- it often happens is that they'll wait and they'll think, "Well, I'll get it next quarter at the end of the quarter." And then that doesn't happen, then after a couple of quarters of waiting, they finally say, "I really do need the equipment," and step up. Is there some pent-up demand, do you think, as a result of this approach, that sitting there going, "I'd like to buy it, but I'm not getting the price," and eventually, they'll cave?

Alex, it's a tough call. I'd hope that, that's the case, but it's really hard for us to say. What I will say is we have held the line on discounting right up through the end of the quarter. So historically, you might have seen some gross margin degradation or discount increases towards the end of the quarter. And our teams are doing a terrific job of holding the line. We really -- we give a lot of credit to the field and the new approach and the leadership team and how they're running the business.

The other question on conditions. Clearly, Europe is a little bit soft. It's pretty much every company that's reported so far. Can you talk to what percentage of your European business is related to U.K. which is going through some transitional issues, as well as France which has got an election going on that was scaring people. Is that part of what's causing some of the flux there? Or is it just execution in the environment ambiently? Is it similar in Germany, for instance, as it would be in those other two?

It is. For us, Germany is our strongest market in EMEA and the -- that team continues to perform well and we see the market remaining strong for Extreme. We have seen some disruption in the U.K. It's hard to call how Brexit-related it is or to put our finger on exactly what's going on there. We have a lot of initiatives underway to turn that around. We also have strong market position in Middle East and some markets like Turkey, for example, where there's been a lot of unrest and a lot of things going on in that market and -- that we've seen some business slide there. But overall, we're bullish on EMEA and the -- some of the softness we had this quarter, our teams think that they're going to get it back in the fourth.

We also had some softness in oil-dependent countries as well, so kind of the whole EMEA and Middle East.

Yes.

So it sounds like the pretty broad mix of areas that had some pressure. One last question and I'll cede the floor. As you're thinking about being a $1 billion-plus revenue company post these deals, obviously, I would think you would benefit enormously on the purchasing scale. Have you had any discussions with your suppliers on what the benefit of that might look like and what kind of margin improvement you could get as a result of volume discounts as you aggregate these product lines? And any thought on how much of the product purchasing you're doing can actually be aggregated without having to redesign the parts so that they're common?

Yes and this goes back to Mark's question. We're -- our teams are actively working this and the answer is yes. We see a lot of opportunities. We have opportunities to leverage our relationship with Broadcom, our largest vendor or supplier. And then with our manufacturers, we're seeing a lot of opportunities. So it's a work in process. It'd be premature for me to try to provide specific guidance, but we do expect it to get to our 60% gross margin objective next year and we think that's only going to be accelerated with these acquisitions. Obviously, from an operating income perspective, there's operating leverage with the businesses that we're bringing over. So there's a fair amount of synergies. So we will expect to see leverage on the operating income line as well.

Can you at least address what portion of the parts are common and what portion of the parts would need to be redesigned in order to get commonality to get this -- the volume benefits?

Yes, I mean, we're all -- we're using the merchant silicon. There's overlap in some of our suppliers and there're some new opportunities. It's -- it would be a bit premature for me to comment specifically on that. Maybe we can take it off-line after the call.

Your next question comes from the line of Simon Leopold with Raymond James.

Great. A couple of things I just want to follow up on. One was maybe, rather than focusing on the organic, inorganic, if we could get a sense of what portion of total product revenue was directly related to wireless LAN.

Sure. Wireless LAN was over 30% for the quarter. That's helpful. I don't know if there's any other comments that you want to add, Drew. That's the number.

Yes. No, that's it. It's growing, yes.

Okay. And then, I guess, the other thing I want to come back to is, within your prepared remarks, you sounded more constructive on your own high-end Ethernet switching elements and then with the acquisition from Brocade, Avago, you'd be picking up some other data center higher-performance Ethernet switches. That puts you into a somewhat different competitive environment than you've been traditionally. That's going to put more weight of you facing off with companies like Juniper and Arista and not just Cisco and HP. Can you talk a little bit about how that shift in the competitive landscape affects your strategy?

Sure. Interestingly, it doesn't really change our strategy, Simon. It just gives us more ways to sell into existing customers. You might be surprised to learn how many Fortune 100 customers we have that are using -- that we acquired through Zebra and that Extreme supports anyway. We have -- I gave an example of a very large Fortune 20 logistics company that is -- we're a very strategic supplier of that company and they really like the quality of service that they're getting for us, the level of attention that we're providing out of the edge. They want to expand our presence at the edge and they've invited in and now we're having discussions with their data center teams about fabric and our switching technologies now. It's the higher end of the enterprise. So we're still focused on the enterprise. We're end-to-end, wired, wireless, from the wired and wireless edge, all the way through the data center. Now with Brocade, you're right. We're a much larger data center. We really see the competition there being Cisco, HP and that market is buying through Arista. Arista has been very vertically focused. We're not sure if we're overlapped now with Arista, but we may see more of them. It's really going to be a continued competition with Cisco and HP.

[Operator Instructions]. And your next question comes from the line of Al Tobia with Sidus.

Ed, I've a couple of questions. First was the large deals from the Zebra side of things. I know that there were some 8-figure deals that were out there. Have any closed? Or do you expect any in June?

Yes. The answer -- Zebra has very large customers, retail, transportation, logistics and typically, the order sizes are a lot larger. We're looking -- in terms of the pipeline, there's a lot of big deals out there with these kinds of customers. And as I mentioned to Simon before, what we're excited about is the fact that there are opportunities to sell other products into these customers and we're excited about those opportunities.

Just this quarter, Al, 4 of our top 10 deals came on the Zebra side.

Okay. But I think, when we spoke, you said that there were about 3 to 5 of these sort of needle-moving deals that were around and you hadn't forecasted and they hadn't materialized. So did any really large deals close in the quarter or no?

No.

Okay. Second thing is the back-end loading. Regarding the June linearities, just what you've seen so far through April, did you -- was April above normal linearity?

Yes.

Okay. Then the 10% operating margin target that was given, if I remember correctly, before the Brocade and the Avaya deals, it was said that, based on Zebra, that you would be able to do 10% in the September quarter. So is that still the case? Will you be able to do double-digit margins without the impact of those deals in September?

Well, we got pretty close to it this quarter. We're not going to...

We're forecasting in next quarter, but you're talking about the September quarter, right?

[Indiscernible] the September quarter, I don't think we're going to forecast Q1 at this time, Al, but I think...

I thought the statement was you guys were going to be able to do double-digit margins even in the seasonally weak quarters of 2018. Is that -- am I [indiscernible]

Yes, we just -- I mean, we just haven't guided there yet and we're very close. I mean, we're 9.4% this quarter and last quarter and we'll be very close. We just haven't given guidance for Q1 yet. And by the time we do, it's going to be -- it's going to have revenues from both the Avaya and Brocade deals.

Right, okay. And then just assuming those deals close on that time line, the funding for them and the time at which you kind of pay down that debt to where you're sort of cash-neutral on the balance sheet, what are we looking at there, roughly? And then I'm done with my questions.

Yes. So kind of what we have left or what we have to borrow here is we have -- well, what we have left to pay. So we paid a $10 million deposit on the Avaya deal. So we've got about $70 million left to pay on the Avaya deal and $35 million on day 1 for the Brocade deal. So we need about $105 million. We're going to take about that much. We're still working on the final amendment to our credit agreement, but we'll take roughly that amount. It could be a little more, a little less, depending on our cash flows in Q4 and our cash flow forecast for Q1. And we're expecting the cash flows from the new deals to really pay for the incremental debt within 4 to 5 quarters.

I'm showing no further questions at this time. I would now like to turn the conference back to Mr. Ed Meyercord.

Thank you. Well, in closing, I'd like to say I'm pleased with the progress that our team is making. We're executing well on our operating plan, highlighted by 8 quarters in a row of delivering on our earnings guidance. We've got exciting new growth opportunities that lie ahead with our new wireless LAN customers, innovative new product releases and the exciting expansion of our business once we close Avaya and Brocade which we expect will bring in, in excess of $430 million of revenue and put us north of $1 billion, an important milestone for Extreme. So I'd like to thank shareholders and customers for their continued support and all of our employees for all their hard work. Thank you and I look forward to seeing many of you at our June 2 Investor Day.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.