Good day, ladies and gentlemen, and welcome to the Extreme Networks Third Quarter Fiscal Year 2019 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to introduce your host for today’s conference, Mr. Stan Kovler. Sir, you may begin.

Thank you, operator, and welcome to the Extreme Networks’ third quarter fiscal 2019 earnings conference call. I’m Stan Kovler, Executive Director of Investor Relations and Strategic Development. 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’ third quarter fiscal 2019 financial results. For your convenience, a copy of the press release which includes our GAAP to non-GAAP reconciliations, and our fiscal 2019 Q3 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 and financial results, products, operations, pricing 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 and our reports 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’s President and CEO, Ed Meyercord.

Thank you, Stan, and thank you all for joining us this morning. Today, we announced Q3 results towards the midpoint of our expectations. Revenue was consistent with Q2 despite Q3 being typically a seasonally weak quarter for Extreme. We landed on revenue $251 million versus the guidance of $247 million to $257 million and had non-GAAP earnings of $0.08 per share. Our Agile Data Center and Automated Campus were our best performing solutions pillars and grew quarter-over-quarter, highlighting our improved execution and our previously acquired assets. The results and our outlook for fiscal 2020 validate our acquisition strategy and our team’s ability to execute. While it took us longer than expected to achieve the desired performance metrics with our acquisitions, they are clearly visible today. Revenues corresponding with our Avaya assets within our Automated Campus pillar were at $220 million run rate, the sequential growth for two quarters in a row. When we acquired these assets, we targeted $200 million. So, we’re ahead of that plan and we’ve added 10 gross margin points since the acquisition, which was just shy of our 60% long-term target during the quarter. Customers are embracing our Automated Campus solution because of how easy it is to segment and secure enterprise networks that can’t be hacked with our Layer 2 fabric. When combined with our Smart OmniEdge solution with our XMC single-pane-of-glass software, we deliver our fabric to the edge and provide end-to-end visibility, match analytics and security with a single data base for all devices connected to the network and all network elements. In contrast, our competitor’s solutions run multiple OSs and third-party management software and is very complicated and expensive to deploy. Our field is embracing it, our partners are embracing it and our customers are deploying it. Our teams and partners who…

Thank you. [Operator Instructions] And our first question comes from Mark Kelleher from D.A. Davidson. Your line is open.

Great. Thanks for taking the questions. Let’s start with the June guidance, the weakness there. You indicated that there was some weakness coming out of EMEA and there’s some weakness from some extended sales cycles. Can you kind of size it? One, did I capture that right, are those the two issues? And can you size it between those two issues, and what gives you confidence that those headwinds won’t continue further into the year?

Yes. Thanks, Mark. This is Ed. As we mentioned, there have -- it’s pretty well-documented as far as what’s happening as far as macroeconomic trends in Europe. Specifically, one of our strongest markets is Germany, we have very high market share there. And uncertainty surrounding Brexit is definitely creating -- we’re seeing the impact in terms of particularly manufacturing companies in Germany where the UK is an important export market for them. And so, as we mentioned, we’ve backed off on our forecast, we want to make sure that we’re taking that into consideration as far as what’s going on there. In Q3, we were affected by similar macroeconomic effects in LatAm, we had an impact on the Americas number and we see that carrying through into the next quarter as well. So, that’s been a big piece. Anytime you’re going through a product transition, in this case, WiFi6, this is an adjustment for our customers. As we mentioned, we had some really nice stadium wins that have come through, but a lot of people are taking their time on WiFi6. We’re seeing the opportunities in the pipeline and it’s building, but we’re just not sure of the time. We don’t know when the orders are going to land and ship. And we want to be conservative with our outlook there. We talked about E-Rate. And E-Rate is really a positive note for us, because we were up over 50% in terms of the E-Rate filings, which it’s a real positive for Extreme. And over the course of fiscal 2020, it’s going to help us out. We mentioned K-12 this past quarter being light, and we’ve had softness, really we’ve had softness every quarter this year in that part of our education vertical. From a timing perspective, we’re anticipating this to kick in, in fiscal 2020. And again, we want to be conservative about how aggressive we want to be as far as what gets pulled in on that. In Rémi’s comments, you heard him talk about book-to-bill ratio and the fact that that was below 1 in this quarter and the fact that we expect it to be above 1 in Q4. I talked about operating efficiency and how our teams eliminated product constraints, and that effectively eliminates backlog, which is good for us. We expect that backlog that comes from product constraints to click back up in the quarter and that has a negative effect on revenue. So, it’s truly the four things that we laid out there.

When you talked about operational, Rémi’s mentioned actions to improve operational efficiency, was that specifically what you guys were referring to or are there other actions that you can take maybe in your sales organization to get more robust growth?

Yes. If you do the math and you look at our model for us to achieve that 15% operating income number, we’re going to have to drive -- there’s organic growth that we see in the business, there’s gross margin improvement that we see in the business, but there still has to be operating efficiencies that we drive in the business. And, we are deep in our planning cycle for fiscal 2020, and that has to be part of the equation.

And can you break out the percent of revenue that was wireless in the quarter? Rémi Thomas: That was approximately out of 250 [Technical Difficulty] about 20%. I’m rounding.

Thank you. Our next question comes from Alex Henderson from Needham & Company. Your line is open.

Hey, thanks. This is Roger Boyd on for Alex. Just a quick one for me. You mentioned higher than expected discounting and higher sales and marketing expense. Is that related at all to EMEA? Is that what you’re trying to drive -- kind of offset that weakness in that way, and is there anything else you can do to combat the softness in that geo? Rémi Thomas: We mentioned discounting in our last quarter’s call and highlighting that some of the increase in the list price were unfortunately offset by more discounts in the field. This is not necessarily what we saw this quarter. I would say that our efforts to drive higher discipline in the field paid off. It was just that there was a number of large deals at the end of the quarter where we had to be slightly more aggressive than we would have liked to just to make sure that we were able to secure these orders. So, this was less about the field, offsetting the impact of tariff through greater discount compared to increased list price. This quarter was more about us as a company being slightly aggressive to be able to win the deals that we needed.

Okay. That’s it for me. Thanks. Rémi Thomas: And as far as your second question on the increase in selling and marketing expense, that was for the most part, driven by compensation, benefits, and to a lesser extent by increased sales commission.

Thank you. Our next question comes from Erik Suppiger from JMP. Your line is open.

I want to just follow up on the discounting. Can you discuss the competitive environment? Did it intensify from a pricing perspective? And where did you see the discounting, more pronounced?

Erik, we -- as Rémi mentioned, we saw discounting improvement in the field overall, I would say in our normal course of business. So, the answer to the question would be, no. We’re not seeing anything unusual from a pricing perspective in the market. We did have some large deals toward the end of the quarter that were margin impacting that for us important customers’ strategic business. Maybe we give a little bit away -- more away upfront for business that we get in the future at higher margin and we had to make some strategic decisions and we decided to go on.

Okay. And where did you see these larger deals at the end of the quarter?

I would say, it’s across -- it was across vertical and it was across geo. So, there’s not -- we can’t pinpoint a particular area of the business that drove it.

Okay. Then, last question. So, it sounds like Germany was weak in light of Brexit concerns. Was that incrementally new, or Brexit has been anticipated for some time, did it materialize significantly in the March quarter?

It was new, it was new for us. And I think there’s -- I think you’ve seen it in the press in terms of what’s happening overall in terms of growth rates for Germany as a whole and then what’s happening in EU. For us, it showed up for the first time. And some of our regions that have been very consistent in the past, had to take down the numbers and the view is not that these are lost deals, it’s just deals that are, from a timing perspective, on hold.

And that was not an issue in the UK, this was...

Erik, surprisingly, it really wasn’t. And one of the other things, it’s hard to put your finger on is exactly with the pricing actions that we took in Q2 and we know we had pull in into that quarter. And then, when we were calling this quarter, the question is how much got pulled back into that second quarter. We suspect that there is some early buying that was taking place in Q2. It was tough for us to call. And so, we think that was also somewhat of a factor in the German and EMEA region.

[Operator Instructions] And our next question comes from Christian Schwab from Craig-Hallum. Your line is open.

Are you guys fearful that with refreshing 70% of the products over the next year and a half that that could cause some delays in purchasing of those products until they’re refreshed?

Yes. A lot of -- Christian, a lot of the refresh is coming on, on products in the portfolio that are high runners. So, we think that in terms of what’s coming to market, these are kind of next-generation chipsets that are characterized by higher performance, lower power consumption, the opportunity for us to improve on what we’re delivering from a value perspective to customers. So, I think what we talked about in the past is Extreme historically has been a little bit behind the curve from a timing perspective and leveraging new chipsets and new technology as they come out. And we feel really good about what’s coming to market and what that’s going to mean for our sales teams and our ability to position Extreme.

Okay. Last quarter you guys said that [multiple speakers]. Yes. Last quarter you guys talked about gross margin in Q4 would be at 60-percent-plus, the one you’re just guiding for, because 80% of the tariff impacted manufacturing would be out of China. So, is all the impacted manufacturing not out of China, or why is that so wrong just a few months later? Rémi Thomas: So, it’s a combination a few things. Number one, the plan was to have 80% of the SKUs that account for 80% of our shipments in the U.S. have the manufacturing moved from China to Taiwan, we’re about halfway through. So, right now it’s more like -- I wouldn’t say 10% because it’s not necessarily half, but SKUs that account for about 40% instead of the 80% had been transferred. What we’ve done is to increase the scope, so we’re going to have an even higher coverage than the 80%. The idea is to be closer to 90%. But that effort has been slightly slower than expected. And therefore, it’s going to be done by the end of May. As a result of this, what we’re going to see in Q4 is a combination of the transfer of the manufacturing, which as Ed mentioned is 5% to 6% higher, in addition to the fact that on some of the products that we import in the U.S. will continue to pay tariff. So we’re forecasting an impact of up to 1 percentage point, as I mentioned earlier, just from that, whereas a quarter ago, we felt the impact would start to come down. Secondly, I mentioned the fact that the discounting in Q3 has been higher than expected. It’s hard to say if that’s going to continue into Q4. But certainly, the weakening that we see…

And then, your commentary, large deals in greater discounts at quarter end are nothing new for your business or anybody else who sells enterprise equipment. So, as you guys outlined at your Analyst Day, a lot of conviction of getting to 60% to 62% gross margins, do you still really feel confident in your ability to do that? I mean, the industry is what it is. There is always going to be large deals at quarter-end, whether you want to take them or not. And you’ve seen some big large contract manufacturers all talk about weakness in enterprise networking. So, that would suggest that maybe we’ll hear this from other peers as well, which also typically leads to more discounting in the industry in general. And then, if you’re moving to a next-generation chipset, do you feel confident that a new refresh product line that you’re actually improving the gross margins of those products at list price or not?

Chris, I’ll make a couple of comments and I believe if something Rémi, jump in. Yes. Our teams have done a great job of pulling costs out of the product. And so, we see that continuing. One of the things about the new products coming to market that we’re excited about is higher performance of the new products, but it’s higher performance and it’s also higher margin. So, as we’re coming out with these new products, we’re expecting higher margins based on our normal discounting off the list prices, and at the same time, delivering higher value and higher performance to partners and customers out there. So, that will be a driver for us. And to your comment about enterprise -- being in the enterprise space and having large deals coming in at the end of quarter. Yes, that is something that we’re familiar with. I will say that something that we are calling out in our commentary that we are seeing more big deals than we have historically. And we’re seeing larger opportunities and some of these are kind of break-in opportunities that are different for Extreme in terms of opening the door and getting into an account. Our strategy there is to be a little more aggressive on the front end. And then once we land, we can expand and achieve our targeted margins. Rémi Thomas: If I could just add one more comment. We’re driving a number of gross margin initiatives around what we’ve been mentioning since the start of the call, which is the reduction of cost of goods sold by introducing new, cheaper and faster products, components in our products, but we also have other initiatives around demand planning, supply chain, logistics that we’ve talked about in the past that will also bear fruit in fiscal ‘20. ,So yes, we’re actually very confident that we can achieve a 60% gross margin.

And then, my last question, have seen this in other people who are moving modest scale out of China to Taiwan that some of them are switching contract manufacturers and then dealing with poor yield issues and that’s either led to lost revenue or disruption, inadequate supply of certain products. Your transition from China to Taiwan, did you switch contract manufacturers or are you moving with the same people? Rémi Thomas: No. We’re actually keeping the same people. And one of the reasons we’re not where we wanted to be is that to your point, we’re taking our time to make sure it doesn’t create any disruption.

Christian, just to add. As you know, it’s a pretty fluid conversation in terms of negotiations between U.S. and China. We’re a lot more optimistic today than we were last quarter about potential outcomes. So, in terms of -- we have to balance risk and opportunity. So, we’re tapping on the brake a little bit because if we wake up in a couple of weeks and find out that there’s resolution and the tariff goes away, we’re better off with China and in a meaningful way as our costs in Taiwan are 4% to 6% higher. So, we feel like we’re in a good position, as far as risk and opportunity in terms of how we’re managing the tariff situation. So, it’s a bit of a balancing act there.

And along those lines, if the tariffs are removed here in the next few weeks, we have seen the industry raise prices, given those tariffs. Do you think those price increases then have to go away or they just end up being discounted away?

No. We think it’s status quo. And we don’t see it having an effect.

Thank you. And I am showing no further questions from our phone lines. I’d now like to turn the conference back over to Ed Meyercord, for any closing remarks.

Thank you, operator. And thank you everyone who could join us on the call today. And we always have employees and partners who join and listen in. I just want to thank everybody for everything that was accomplished during the quarter. There is a lot going on still inside Extreme. And we’ve made a significant amount of progress. We’re looking forward to sharing updates about our investments in these new products that are coming to market and software. The Connect Conference for us is a big deal. We had our first user conference last year and the feedback from that conference was overwhelmingly positive. So, we did it again this year and we doubled down. And we’re going to have more than twice the attendance. And it’s going to be a great event. And we’re going to create a lot of buzz about our autonomous enterprise and the solutions coming out of that. So, stay tuned. We are also going to be participating in investor conference coming up, Christian, the Craig-Hallum Conference; Cowen Conference; Stifel and others during the quarter. So, we look forward to getting in front of you. And again, appreciate your time and being on the call. Have a great day.

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