Ed Meyercord - President and Chief Executive Officer Ken Arola - Chief Financial Officer Frank Yoshino - Vice President of Treasury and Investor Relations

Victor Chu - Raymond James Matt Robison - Wunderlich Christian Schwab - Craig Hallum Capital Group Alex Henderson - Needham & Co.

Good day, everyone. And welcome to the Extreme Networks First Quarter Fiscal 2016 Earnings Results Conference Call. This call is being recorded. With us today from the company is Ed Meyercord, the President and Chief Executive Officer; Ken Arola, the Chief Financial Officer; and Frank Yoshino, the Vice President of Treasury and Investor Relations. At this time, I would like to turn the call over to Frank. Please go ahead, sir.

Thank you, Karen. And welcome to Extreme Networks first quarter fiscal year 2016 earnings conference call. This call is being broadcast live over the Internet. It's being recorded on behalf of the company. Should you wish to not be recorded, please do not ask questions during the Q&A. The recording will be posted on Extreme Networks website or replay shortly after the conclusion of the call. The presentations and the recording of this call are copyrighted property of the company and no other recording or reproduction is permitted unless authorized by the company in writing. By now, you've had a chance to review the company's earnings press release. For your convenience, a copy of the press release and supporting financial materials are available in the Investor Relations section of the Company's website at extremenetworks.com. I would like to remind you that during today's call, management will be making forward-looking statements within the meaning of the Safe Harbor provision of the Federal Securities laws regarding business and financial outlook. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by those statements. These forward-looking statements apply as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after the call. For a detailed description of these risks and uncertainties, please refer to our most recent report on Form 10-K filed with the SEC, as well as our most recent Form 10-Q filed with the SEC, in addition to our earnings release posted a few minutes ago on our website. Throughout the conference call, the company will reference some financial metrics that are derived in accordance with Generally Accepted Accounting Principles or GAAP, while other metrics are not in accordance with GAAP. This approach is consistent with how management measures the company's results internally. Our non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies. Non-GAAP information should be considered a supplement to and not a substitute for financial statements prepared in accordance with GAAP. Reconciliation of the non-GAAP information in accords with GAAP measures is in our earnings press release issued today. In preparing non-GAAP information the company has exclude where applicable the impact of acquisition and integration costs, purchase accounting adjustments, amortization of acquired intangibles, restructuring charges, and share based compensation and overhead adjustments. Now, I'll now turn over the call to Extreme's President and CEO, Ed Meyercord for some opening comments.

Thanks, Frank. And good afternoon, everyone. And thank you for joining us today to discuss our Q1 results. We are at Las Vegas at our Partners Conference and we are with over 450 global partners and what has been a very productive week. The energy level here is high, excitement surrounding our product roadmap, our solution selling strategy and our growth incentives are on display. This is my first Extreme Partner Conference and I must say I am impressed by the strength of our partner relationship, our partners' commitment to grow their Extreme business and the quality of the dialogue is excellent. I'll kick off the call with commentary on the quarter and then talk about our progress with our solution selling strategy, our operating initiatives and our business outlook. Then Ken will go through the numbers and we will open it for Q&A. Let me start off again by saying how pleased I am with the solid execution by our team at Extreme during what is historically been a very soft quarter. I have been in the CEO seat now for six months and I like the way this team is coming together. They have accomplished a lot in a very short period of time. From an operations perspective, tough cost cutting measures we took in Q4 seem like a distant memory with all the growth initiatives we have underway. But from a financial perspective you can certainly see the effects of our cost reductions and our strengthening financial position. But may have been missed by all the attention that the cost value equation, is it we reorganized the function of department at Extreme to establish a customer driven organization structure. Extreme was an engineering led company with engineering controlling all product development, product marketing and customer service. We separated these functions, we now have a single sales and services organization and independent product development and marketing groups. To be clear this is not diminished importance and significance of engineering team and our investment in new products, it is just the opposite. We are providing engineering with much clear direction, less distraction so they can focused on what they do best. With our new leadership team we now have alignment with sales, service, marketing, product development, engineering and our supply chain. We have much improved communications and clear product roadmap and cross functional business initiatives. We are making targeted investments in product development and marketing. We have the right people leading with the right organizational structure that will allow us to be responsive to our customers and partners and ultimately grow. At Extreme we have a clear vision of a networking industry in the competitive landscape. With the cost of bandwidth continuing to fall at a rapid rate and the explosion of devices on networks driven by mobility and the internet of things and the proliferation of applications that run on those devices and connected to cloud, networks are becoming much more valuable and much more complicated for our customers to manage. Our customers IT department can't response to this new demand by adding staff. They can't afford to triple their IT budgets. We see the complexity of these converge wired and wireless network being simplified to software. We think it is a big opportunity and this is why 90% of our engineering resources are currently developing software. Flexible operating systems, feature rich management tools, access control for edge devices, security application, device level policy, quality of service delivery, gateways to private and public clouds, network analytics, these will be the drivers of more and more networking decisions. We have the software and we are tailoring solution to make easier to deploy them for our target customers in education, in healthcare, manufacturing, hospitality, government and our mid level enterprises. The competitiveness of our solutions portfolio will be strengthened when we add our Wave 2 wireless access points which are scheduled to be released this quarter in time for the E-Rate buying cycle. And our plan is to launch our cloud management platform for wireless access in fiscal Q3. The subsequent release expected in mid-2016 will expand our cloud management capabilities to cover our wired switch portfolio as well. We believe this will provide us with the distinct competitive advantage. The response to our new strategy has been very positive. The validation by Gardner Group during the first quarter is a big deal for Extreme. Gardner put Extreme in a visionary quadrant for wired and wireless access layer switching. This was the first time we made it into the visionary quadrant ahead of most of our competitors. By Gardner's definition, it means we have unique capabilities and the ability to differentiate our solutions from the rest of our competitors. This is third party validation of our solutions approach, it is important third party validation and it will help our sales teams as customer rely on Gardner's assessment as part of the decision making process. Our partners in target customers place a high value on magic quadrant, so this is a big deal for us .Our go-to-market strategy is to lead with selling software driven networking solutions that will pull along our high quality wired and wireless hardware. Right now we are very focused on the tactical execution of this strategy. The good news for us is that we already have a large set of reference account of solutions customers in each of our customer groups in most of our geographies. So we are focused on intelligence gathering, developing marketing programs, training and educating our field sales and partners. We completed highly successful training programs during the quarter. Historically in the old engineering led culture, Extreme made very little investment in education and training. Sales were driven by speeds and themes for wired networks. As we move from point product sales wired switches to full portfolio of wired and wireless software driven networking solutions, we have to invest in training of our field teams. All of our sales executives have been trained in solution selling; this was the highest rated training in company history, very well received in the field. In addition, we are in the process of technical training for account execs, our sales and engineers and support teams to become certified in wireless and better understand software portfolio. We have training around industry verticals and competitive positioning as well. Another important initiative along the lines of simplifying and how we go to market was our recent rebranding announcement. Our new tagline, Extreme connects beyond and network conveys the importance of our new customer partner driven strategy. We have excellent relationship at Extreme; we have unique, high touch, high quality customer service that differentiates us in a market. And we want to leverage that. We are also simplifying all of our product names to eliminate some of the confusion of the past. So instead of identify wireless, NetSight, Net purview, we will have Extreme wired and Extreme wireless, Extreme management, Extreme control and Extreme analytics. It is pretty obvious that this is going to simplify our approach to market with our solutions portfolio under a common brand. Turning to our results. Coming after very strong year end Q4, our global sales teams put solid bookings on the board and our fiscal Q1 drive revenue in a mid point of our guidance range. Our U.S. Canada team led the way again with solid performance especially with our education customers and delivered on plan despite lower than expected E-Rate revenue. Other impacts to sales during the quarter that impacted results were shorter selling period post Labor Day just the fact the timing of the calendar and the movement of smaller accounts to inside sales. That didn't happen until late in a quarter. We expect to see a pickup in E-Rate in our fiscal Q2 and see our inside sales recovers well. We had nice friends in the U.S. the Skywalker Sound, a Lucasfilm company, Schneider Electric, Jefferson County Public Schools and the Chicago Cubs. Our EMEA team held to their forecast to strengthen government and manufacturing. At this stage, we do not expect the effects of a dollar euro exchange rate to impact sales in EMEA. In Germany, we have the highest percentage of solutions customers than any other region in the world. And interestingly the two very large orders with both the Turkish and German governments to handle the increased in public Wi-Fi traffic associated with the influx of immigrants from the Middle East. We also have nice wins with the German Tax Office, Queen's University in Southern Europe and the Italian Highway Toll authority. As part of our plan to upgrade our solutions, go-to-market strategy globally, we hired new regional directors in our APAC and Latin regions, both of those regions came in as expected on a reduced forecast and we expect them to build on their successes with growth in future quarters. We've taken up our revenue guidance for Q2 by $10 million over Q1 given our confidence and the strength of our pipeline with both volume of deals and the visibility we have. The name of the game for Extreme is growth and we are driving everyone internally and our partners to achieve this. We have a terrific product portfolio, a great team, strong partners and we are in a huge industry where small share gains will have the big impact on our top line. As we mention in our last call the path to building infrastructure and putting the changes in place to generate solutions selling growth should happen over the next 18 months. During this time, we expect to benefit from four tangible growth initiatives. First is E-Rate. The funding letters from the SEC came in more slowly than we anticipated in Q1 but they picked up and are expected to grow Q2. We are also in the midst to selling for the next round of E-Rate funding where we are continuing our focus to capture increased share of the available funding programs. To help enhance our position for next year's E-Rate season, we are expanding quotable solutions to include our cloud management wireless offering which will be GA in fiscal Q3. Second initiative is our channel realignment. Our partner and distribution team is successfully completed our get-to-get contracts and we expect to deliver new revenue. We still expect these to begin to take hold in our fiscal Q3. We believe this will bring incremental revenue growth but again the timing and hard dollar is to get programs are difficult for us to forecast this time. Our third initiative is to capitalize on the upcoming Wi-Fi upgrade cycle to AC Wave 2, we are right aligned with the market as far as timing is concerned and on track to deliver new APs with Wave 2 technology and enhance firmware that includes our core flow technology this quarter. As I mentioned earlier, our Wave 2 access points are also expected to arrive in time to hit these E-Rate sales cycle this calendar Q4. And we plan to follow this with new 2.5 gig access layer switches after the chipsets become available in fiscal Q4. We will expect to see sales from Wave 2 begin to take hold in our fiscal Q4. Lastly, we view our high touch customer service model as a competitive advantage. Most of our competitors outsource this function to third parties; direct their customer calls to non-technical sales reps, Extreme customers have a totally different experience. With their calls are answered by highly trained technical engineers, immediately begin work to resolve the issue at hand. And our customers and partners place a high value on this aspect of our relationship. Given this value proposition we see opportunities to capture more services revenue and we have several initiatives underway to better monetize this competitive advantage. As far as guidance, we see strength in our top line in Q2, steady gross margins and the benefit from the full effect of our lower operating expense. I'll let Ken provide details on this. On a personal note, my confidence in Extreme continues to grow and it is driven on three fronts. The quality of products and engineering, our belief that our products and solutions are high performance and well engineered, are confirm when sophisticated in discerning technology fire validate quality like Motorola. They are using Extreme switches as the backbone for the New York City and LA police in fire department networks. The second is the quality of our customer relationships. We have a distinct advantage when we sell our full solution portfolio when customers use our Extreme management to control in analytics capabilities across wired and wireless networking infrastructure, they become very sticky. We have many of these excellent relationships around the world in all of our key customers segment who are our strongest advocates. I just returned from a meeting in Germany with the largest hospital in Europe, Charité in Berlin. Their gold status solution customers are using our solutions platform and very creative ways at the forefront of a healthcare industry. They want to showcase this to their partners in a global healthcare consortium. Finally, I have confidence in our people. Extreme has a high caliber team of professionals. A players who make up a strong team and they want to win. And the proof of our team's execution capability is evidence and it was accomplished in beating our earnings targets in Q1. Most importantly, we are aligned, aligned in our vision, strategy and execution initiatives and committed to winning which means growth. Now let me turn it over to Ken for numbers.

Thanks, Ed. Before I jump into the numbers, I want to echo Ed's comments about the team coming together at Extreme. People are excited about the way we have reorganized to become a customer focused company. And the alignment around our software driven networking solutions strategy has created excitement within our company, our partner community and our customers. In addition, the coordination and team work between our sales organization, our supply chain operation, our distributor network and our finance team has improved market lead over the past two quarters. We are getting much stronger as a company and our results reflect it. Now let's review our first quarter results starting with revenue. Q1 GAAP revenue was $124.6 million compared to $149.9 million in quarter four and $136.3 million in Q1 a year ago. Q1 non-GAAP revenue was $125 million compared to $150.6 million in quarter four and $137 million in Q1 of last year. Q1 GAAP and non-GAAP product revenue was $91.4 million compared to $116.3 million in quarter four and $102.7 million in Q1 last year. Q1 GAAP service revenue was $33.2 million compared to $33.5 million in quarter four and $33.6 million in Q1 of last year. Non-GAAP service revenue for Q1 was $33.6 million compared to $34.3 million in quarter four and $34.4 million in Q1 of last year. The geographical split of revenue was comparable to last quarter with North America revenues contributing 50% of total revenue. EMEA revenues 37%, Asia Pacific revenues 9% and Latin America revenue is 4%. Moving on to gross margin and operating expenses. In Q1, GAAP gross margin was 52.3%, compared to 50.9% in quarter four and 51.8% in Q1 last year. Non-GAAP gross margin was 55.2% and compares to 54.4% in quarter four and 55.6% in Q1 last year. The sequential increase in non-GAAP gross margin is mostly attributable to the fact we had a larger percentage of total revenue coming from services in Q1 versus Q4. For services carrying a higher gross margin percent than product and had a favorable impact on overall gross margins. Additionally, we realized some cost savings as a result of the restructuring taken last quarter. Q1 GAAP operating expenses were $75.9 million, compared to $89.8 million in Q4 and $87.7 million in Q1 last year. Q1GAAP operating expense includes restructuring charges of $5.6 million related predominately to facilities consolidations following the reduction of workforce in Q4, 2015. Recall that GAAP operating expense in Q4 included restructuring charges of $9.8 million. In Q1, non-GAAP operating expenses were $61.5 million and compares to $69.6 million in quarter four and $75 million in Q1 FY15. Q1 operating expenses reflect 90% of the quarterly cost savings associated with the Q4 restructuring. We anticipate we will realize 100% with the quarterly savings in Q2, FY16. Additionally, lower than plan headcount attributed to the favorable spend in the quarter. First quarter GAAP operating loss was $10.8 million, compared to a loss of $13.5 million in quarter four and a loss of $17.2 million in Q41 last year. First quarter non-GAAP operating income was $7.5 million, compared to $12.3million in quarter four and $1.2 million in Q1 last year. GAAP net loss for Q1 was $11.5 million or $0.11 per share compared to a net loss of $15.7 million or $0.16 per share in quarter four and the net loss of $19.3 million or $0.20 per share in Q1 last year. Non-GAAP net income for the quarter was $6.7 million or $0.07 per diluted share and compares to a net income of $10.1 million or $0.10 per diluted share in Q4 and a net loss of $1 million or $0.01 per share in quarter one 2015. Turning to the balance sheet. Q1 total cash and cash equivalents were $82 million compared to $76.2 million at the end of last quarter. In the quarter, cash flow from operations was $6.5 million compared to $3.9 million in quarter four and $1.6 million a year ago. Q1 free cash flow was $5.9 million compared to $2.3 million in quarter four and a negative $1.2 million in Q1 of last year. Accounts receivable were $60.3 million at the end of quarter one, down $32.4 million from last quarter with DSOs decreasing to 45 days this quarter from 56 in Q4. The decreases are a result of exceptionally strong collections during the quarter, coupled with lower revenues in Q1 as compared to Q4. Inventory ended at $61.7 million, up $3.7 million from last quarter. And total debt outstanding at the end of the quarter one was $65.3 million. We were in compliance with all bank debt covenants at the end of the quarter. Now let's move on to guidance for Q2. As Ed mentioned earlier E-Rate funding by the SEC was slow out of the gate. Both funding now substantially complete for school projects, we anticipate E-Rate to contribute more in quarter two than over the next several quarters. We expect Q2 GAAP revenue to be in a range of $129.6 million to $139.6 million and non-GAAP revenue to be in a range of $130 million to $140 million. GAAP gross margin anticipated to be in a range of 51% to 52%. With non-GAAP gross margin anticipated to be in a range of 54.7% to 55.7%. Operating expenses are expected to be in a range of $74.5 million to $77 million on a GAAP basis and $62.5 million to $65 million on a non-GAAP basis. On year-over-year basis this reflects a $10 million quarterly savings. Additionally, it reflects 100% of the quarterly saving expected from the reduction of headcount in quarter four. We anticipate the sequential increase in non-GAAP operating expenses to result from catching up on targeted headcount additions that we fell behind on during quarter one. And increase in compensation related expenses including commissions on higher revenues and itinerary expense for product development initiatives. The savings more of facility consolidation of approximately $1 million annually will be reinvested into sales, strategic sales and marketing role. We continue to focus on managing our cost structure and we are on track to realize the $40 million in annualize savings to mention on our Q4 earnings call. Our tax expense is expected to be relatively consistent with our Q1 levels. GAAP net loss is expected to be in a range of $7 million to $11 million or $0.07 to $0.11 per share. Non-GAAP net income is expected to be in the range $6.5 million to $10.5 million or $0.06 to $0.10 per diluted share. The average shares outstanding are expected to be $102 million on a GAAP basis and $104 million on a non-GAAP basis. Now I'll open the call for questions.

[Operator Instructions] Our first question comes from the line of Simon Leopold from Raymond James.

Hi, this is Victor Chu in for Simon Leopold. Could you give us just a little color around E-Rate spending? And your comments around it was slow out of the gate, what's the kind of trajectory that we should kind of expect and how is that impacting kind of what you are hoping for?

Yes, Hi, Victor. This is Ed. What we said about E-Rate were this quarter it came in and the low double digit, we are expecting it to be somewhere between $10 million and $20 million mark. As everybody knows with their funding letter come out of the SEC we have to -- that we are relying on that and then when schools get the letters then we follow through in terms of deployment. So it was little slower that we had projected. So it is going to be little closer to the 10 number than it is to the 20 number. And the second quarter we are going to expect to see that be closer to the 20 number. If that's helpful. As far inside sales, one of the things that we did we restructured our field sales organization. What we did is we took out accounts that are less than 65,000 and we created an inside sales team to cover the accounts. And we did want to do as our field forces making calls to the smaller size customers where it is not economic. But what we -- those who are database create unless it create kind of time negotiate teams and we went to that process, we got a late start. So we didn't start inside selling really earnest so the last the second half and really the last month of the quarter so we -- and we miss the selling opportunity to that base of existing accounts. Now we are running and we will have the full three months, so we will -- that recover as well so those were the headwinds for the quarter for us, it was little later on E-Rate side and slow start in inside sales, other than that things are going great.

Okay, great. Can you -- one last question, can you just give us update on your thoughts for timeline around the WLAN cycles? And how that -- when that -- how that impacts you in kind of the timeline because I guess --

Yes. So AC Wave 2, we mentioned that we are coming out with our new access point this quarter. And we are right in the heart of the E-Rate selling season for the next cycle. We are really excited about the cloud management platform and what that is going to enable us to do and our partners do in wireless and that's going to come out in fiscal Q3. So that's the timing and then following that will be the access layer switching, the hardware deployment that will come out in the middle of the next calendar year. And then we are also going to come out the next version of the software which is really exciting where from a cloud management perspective you are going to be able to manage both wired and wireless switches and that's going to be in the middle part of next year as well, probably the calendar third quarter of the year. That's going to be differentiator for us. Not a lot of people are going to have that capability and we have a lot of partners in distribution system here and we have lot of partners that are really excited about that because cloud management tool allows them to provide managed services which is where the partner community is going. So there is a lot of excitement out here. The partner conference around this cloud management capabilities and we are on track from a development perspective.

Thank you. And our next question comes from the line of Matt Robison from Wunderlich.

Hi, thanks. Congratulation specially getting done without the E-Rate so much. Have you got put the Wave 2 products into beta yet or is that timeframe later this quarter when you get into beta? And you differentiate between them and general availability.

Yes. We've already timed -- we are in beta testing and planning on launching that. So we will be putting that out in the field and it's GA in our fiscal Q3. I am sorry; it is going to be GA in this quarter.

Okay. And can you comment on what verticals were particularly strong and how you are situated with the legacy customers of Enterasys and how is that changed over the last couple of quarters?

Sure. Well, verticals have been -- they have been steady, E-Rate is slowly shine a light on K-312 and overall education for the company. That's an important vertical for us particularly in U.S. We also are very focused on healthcare, that's globally we continue to see strength there. We have manufacturing, we have government accounts, and we have hospitality. We have our stake in venue business, and I would say there is not a lot of change in terms of mix in the quarter with this verticals. What's going on inside the company that we are excited about is the collection of all the information around these accounts, I mentioned Charité which is the largest hospital in Europe. They are doing some very innovative things as far as solutions for hospitals. But it is collecting what our customers are already doing with our technology and our portfolio, organizing this, and having this reference accounts, organizing marketing materials around it, having educational programs to train our field forces, to train our partners. So then they can bring these solutions out to their customers. And we Extreme are now as you know this has been somewhat of decentralized sales and marketing company. The fact that we are centralizing this means we are getting much tighter focus, we are going to have much cleaner execution and this going to be easier for us to accelerate and to invest in growth both with our direct field forces and our partners. As far as the Enterasys question, I know you are familiar with the fact that there was a decision to combine EOS and XOS the operating system and Enterasys and Extreme, we reverse that, we led the face of Enterasys customers know that EOS is alive and well and we are investing in features with that operating system. That had a big impact. We are also doing something in terms of our plans and our roadmap for the Series S modular switch that customers are excited about and so I think with the Enterasys customer base I think the changes we just made recently has created a new excitement that there is a future and they can see the future roadmap and so I think the overall comment would be that, that stabilized.

Ken, a couple of housekeeping questions. Can you give a breakup for depreciation and amortization and then comment at this low level of capital spending is sustainable and what we should expect for the year in that regard?

Yes. Depreciation is roughly about $3 million in the quarter and amortization is about $9 million shows up in cost to good sold, then operating expenses kind of split about 50:50. As far as CapEx is concerned, yes, it was little bit low this quarter at about $600,000 and are typically we are spending a little bit more than that. So I think if you think about as a $1 million or $2 million in a quarter is reasonable.

Thank you. [Operator Instructions] Our next question comes from the line of Christian Schwab from Craig Hallum.

Hi, congrats guys on a great quarter. When you guys look geographically into Q2 would you expect EMEA or Asia Pac to be up on sequential basis? I know you guys talked about increased visibility into that guidance and so we've got some different changes in leadership in those areas. Would you expect that?

Yes. Hi, Christian, this is Ed. Yes, we would. We got a really strong pipeline in EMEA, lot of confidence with that team with in this quarter. And we made leadership changes in APAC. So we have a new regional VP out there who is doing great things. He is come in with lot of industry experience, lot of ideas. I can't share with you his forecast because he is very optimistic and very aggressive. And let's just say we are expecting good things out of that region. And also Latin, we hired a very strong leader in our Latin market thus currently being managed through U.S. Canada, it's going to take time but we've got really solid people on board now and we've got a foundation to build on.

Perfect and then if we just do some basic math, you guys won about $90 million E-Rate, last quarter you had unexpected big deal let's just pretend it was $10 million and then we got another $10 million this quarter so that leaves us like $70 million, some may not get approved and no surprise that the government is behind, so I guess it is fair to say to some degree I would assume E-Rate will linger into Q3.

Yes. That's fair to say. Christian just to elaborate a little bit, what we said we are getting better visibility to around how E-Rate cannibalize normal K-12 business et cetera so as we are piecing together the overall equation what's interesting is math really hasn't changed, what we told people from the beginning which is we see incremental revenue, debt incremental revenue between $30 million and $35 million from E-Rate this year. I can't say we do exactly the algorithm how we got there but it is holding up and it is accurate. So that's still good number and incremental number to think about.

That's wonderful. Do we have as far as the pipeline -- it sounds like you added the comps, congratulation on that, as far as we've looked to stadium work, either in pipeline or potential deal is -- is there any seasonality as we think about your fiscal year where they are ends being more either in major league baseball or the NFL or college stadium as we can think about that.

Yes. I think what you are saying is -- your intuition is correct, the seasonality in terms of what's going to happen in the off season. Yes, I am not sure, we don't really provide specific forecast around it. We don't disclose that to the street, but yes that is correct, your intuition is right.

Thank you. And our next question comes from the line of Alex Henderson from Needham & Co.

Hey, guys. Let me start off with just some housekeeping, can you pick what's in the other expense net line that was pretty considerable number in the quarter, swinging the year-over-year, I just not sure what's cause that.

Yes, Alex, that's where the FX gains and losses show up in our P&L in relation to what we deal from the balance sheet for inter company accounts. So yes the dollar strengthen pretty nicely against the Brazilian Real in particular and that should have the favorable impact in other income expense. That's biggest line time that driving there.

And so if as I am looking forward I should drop that out of the number into December quarter, is that correct?

Well, I think if the dollar continuing doing strong against the Real we will continue to see some may be favorability there. So it depends which direction the exchange rates go. Right now I could say last quarter we've seen some favorable impact with the U.S. dollar strengthening.

Right. I generally try to assume not to try forecast interest rate or exchange rates so based on the current level are you expecting another gain in the December quarter and if so what kind of magnitude we talking about?

Yes. It is really hard to actually give a number on that, Alex. Like I said it depends on where exchange rate go. If you assume exchange rates are staying relatively flat and where they are today then it would be a less of an impact on other income expense and maybe more normalized, but when you see a big movement like we saw this past quarter with the Brazilian Real we got some pickup and FX gain, so depending how you want to look at and model it, if you assume flat rate then nothing is going to change then you can assume that's going to come down to something you have seen in previous quarters.

They pay analysts to forecast the exchange rates more than as quite of them have to sometime -- the second question I had there is some-- I am trying to understand the mechanics around the product gross margin, service gross margin, service gross margin now 68% I believe in the quarter and product was 50% which looks a little bit richer than it had been on the service. Is that a function of restructuring benefits helping that or streamlining of the cost structure?

That realized in the quarter but if you think about with products generally running in the low 50% of margins, 50% to 52% and service is running like 63% or 64% to 67% depending on the quarter, we dropped out $25 million of product revenue in the quarter and rough call it 50% gross margin so you have a more of skewing towards the services revenues in the overall scheme of the business here which drove margin up a bit on a sequential basis.

Yes. I understand the mechanics of the shift between them, I am just trying to look at the individual line items, as I understand it, if I did the math correctly when I was doing the -- offset to non-GAAP I am getting 50% gross margin on product and 68% on services, were seemed a little steeper than it had been running 63%, 64%, 67% even and I am trying to determine is that going to stay up at that 68% level or is that going to come back into the 63% to 67% range.

Well, I guess, let me explain this way. Gross margins were in the low 50% for product this quarter, on the service side of the business it was in the mid-60s not necessarily in the high 60s, I think you will see that kind of range as we go forward in a low 50s and the mid 60s for product and services. And again we saw some statements in relation to the restructuring and cost to good sold this past quarter, we will see a little more next quarter.

Okay. I'll take that offline because obviously I must have put something incorrectly getting 68%. Just to pin down a couple of data points so I think I heard you said that 100% of the restructuring program savings that are going to be showing up in service cost savings as opposed to reinvested are now in the model. Is that correct?

That's correct. If you recall last quarter we said it was going to be -- we are targeting $40 million annualized savings about $10 million per quarter pretty equally through the year with about 10% of that showing up in cost to good sold and 90% of it showing up in OpEx. So at this point in time as we move through Q2, we are expecting that we will realize a 100% of that annualized the quarterly amount of $10 million in the P&L and that's reflected in the guidance that we gave.

And then the second piece of it is, sounds like you are under hired and you expect therefore hiring to help rebuild some of the sales marketing G&A or whatever R&D lines in the OpEx element. So we should be expecting that to be up sequentially in each in the December quarter, will that persist again into the March quarter?

I don't think it will persist in the March quarter. I would think our expenses to be somewhat comparable to what we guided this quarter, for the March quarter, assuming we get all the heads that we wanted to have hired during the quarter here we made some good progress to date so far in the quarter so if we continue with the trajectory we are on we should be on a good pace for that. I guess the other thing to think about as we move through the year payroll taxes, people pay their taxes earlier on the year as you get to the end of the year you have less payroll taxes as company and payroll taxes so we will get a little bit of pickup that as well.

Okay. And I am little confused about some of the comments on E-Rate. I just wanted to make sure I had it correct. Did you say you had $10 million of E-Rate in the September quarter, is that correct?

We said that -- I gave -- Alex gave range and I said, I'd going to say low double digits but that creates a pretty wide range for you. So what I tried to do narrow or just say if you are looking between $10 million and $20 million which is I would just say you provide that as a range for E-Rate, we came in much closer to the 10 side of that scale. We can't disclose the numbers

And then you said I thought that the other side would be closer in the December quarter closer to the upper end in that band.

You got it. You got it.

So I got the math right. So there wasn't any E-Rate in December 2014 correct?

No, pretty normal.

So that would imply if I put about $18 million just to choose a number at the upper end of that band, about 25% decline in product sales, is that right metrics and have we now stabilized that at a growth curve from here?

Your numbers are doubt right we did about $121 million in product sales in quarter four, 2014, I am sorry wrong quarter. $102 million in quarter one of 2015, we did $90 million, $91 million --

Yes. I was just looking at the December quarter front and the mid point of the guide would probably about $102 million in product sales down from $112 million let say $80 million it would right in.

Yes, that's right.

Okay. So we are kind of finish the decline in product associated with the terming of the lines and so forth now we should start to grow and then slip at the end -- from here.

I mean there is a couple of anxiety area Alex which is -- it is K-312 we are talking about and so you have existing K-312 business, your schools, schools going to have fun technology investments whether not the E-Rate program is there or not but there is a lot more incentives to do it if you get E-Rate dollars.

Net number is not as big as the gross number right.

Yes, so there are a few factors moving there. In our guidance we also have the seasonality, we look out there is no seasonally weak Q3 that we look at it in terms of trending but we are with the solution selling and leading the solution selling, we are getting a lot of traction and excitement out in the market place that's building the confidence inside of the company, in our selling organization with our partners. So just how that the positive momentum takes effect and it will hit numbers, we would be guiding on a quarter-on-quarter basis but everyone inside this company believes that we are going to grow. The question is when and this is -- we have a lot of confidence in this second quarter given the strength of our pipeline, the quality of the opportunities and piece of that is going to be what's happening in the E-Rate case and 12 segments.

Just one last question I'll leave the floor. Clearly a big part of the pressure over the last year has been your European business getting hit by a historically huge swing in the European exchange rate, that I believe is now kind of out of the picture on year-over-year basis, that should no longer be much of a factor as we start to go forward and so I would think that your proved economies in Europe would start to be a supporting factor as opposed to a drag the way it has been over the last year. Is that the right way to think about it?

I think that's how you should be thinking about it. That's right.

Yes. I agree with that, Alex.

Thank you. And that concludes our question-and-answer session for today. I'd like to turn the conference back for any closing comments.

Thank you. Yes, I'd like to make a couple closing comments. First, hopefully you are hearing from the colleague that the confidence from the team in terms of the outlook for the company and all the things that are going on. There is a lot of momentum and there is a lot of operating initiatives around our strategy. And leading with software and selling solutions is, we've got third party validation around -- the industry analysts are telling us that this is the way to go, our partners are telling us, our customers are telling us, and we are making great progress and heading in that direction. So there is a lot going on, there is a lot of excitement around that. And as I said earlier, everyone in the company is committed to growth. The other thing is you can see this quarter, we did take tough measures in the fourth quarter and the cost is out. So now that showing up and you will see that going forward in the Q-over-Q comparisons from the cash flow perspective. So we thank everyone for participating on the call. And we are looking forward to Q2 and sharing our results in a few months. Thank you very much. We appreciate your time.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. And you may not disconnect. Everyone have a good day.