Frank Yoshino - VP Treasury, IR Ed Meyercord - President, CEO Ken Arola - EVP, CFO

Matt Robison - Wunderlich Christian Schwab - Craig-Hallum Capital Group Simon Leopold - Raymond James Alex Henderson - Needham Rohit Chopra - Buckingham Research Andrew Masuda - DA Davidson

Good morning. And welcome to the Extreme Networks Second 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, Investor Relations. At this time, I would like to turn the call over to Frank. Please go ahead, sir.

Thank you, Chanel. And welcome to Extreme Networks second quarter fiscal year 2016 earnings conference call. This conference 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 Web site 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 release and supporting financial materials are available on the Investor Relations section of the company's Web site 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, which could cause actual results to differ materially from those anticipated by these statements. You should not place undue reliance on forward-looking statements which speaks only as of the date they are made. We undertake no obligation to update these statements after this call. For a detailed description of these risks and uncertainties, please refer to our most recent reports on Form 10-K, Form 10-Q and Form 8-K filed with the SEC in addition to our earnings release posted a few minutes ago on our Web site. 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. However, our non-GAAP results 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 to corresponding GAAP measures is in our earnings press release issued today. In preparing non-GAAP information the company has excluded where applicable the impact of acquisition and integration costs, purchase accounting adjustments, amortization of acquired intangibles, restructuring charges, overhead adjustments, litigation expenses and share-based compensation. Now, I'll turn the call over to Extreme's President and CEO, Ed Meyercord for some opening comments.

Thank you, Frank, and good morning everyone. Thank you for joining us to discuss to our Q2 results. Today, we are up in our Salem, New Hampshire office in the Greater Boston area where we've got over 300 employees. The energy level here is high as people are excited about the fact that we delivered on three quarters in a row. And we're poised for year-over-year growth in the quarter ending March, our fiscal Q3. We have a large engineering and technical support presence here along with our sales and marketing teams. These teams have done great work delivering on our value proposition. First creating industry leading technology, our Wave 2 wireless platform, significant feature innovations in our upcoming software releases, our cloud management platform, our enhanced data center and network orchestration capabilities. These technology innovations coupled with our leading service where analyst confirm time and again, that we are the number one service delivery and technical support team in the industry have us poised to take advantage of upgrades cycles and take share from our competitors. I will begin the call with commentary on the quarter lay out our vision, strategy and competitive position, review progress with our solution selling, vertical go-to-market strategy and provide highlights of our technology roadmap and our business outlook. Then Ken will go through the numbers and will open it up for Q&A. Starting off with the score board, overall, it was a strong quarter. We came in at a high-end of our guidance range in revenue and EPS. Our sales teams have delivered again just under $140 million of revenue for the quarter which was up $15 million over fiscal Q1 and right at the top of our guidance range. We saw strength in each of our geos led by another consecutive quarter of year-over-year growth in the U.S., do in part due to our success with our K-12 education customers driven by the 1 billion per year E-Rate program that runs through the end of 2019. We also had a nice recovery in our EMEA region where we saw a nice sequential revenue increase driven by our strength in manufacturing, healthcare and education. We are rebuilding our APAC and LatAm geos and our new leadership teams are making excellent progress in those markets. Much improved linearity is giving a stronger visibility into our sales forecast and predictability into how we convert our growing pipeline of opportunities into sales orders. And we continue to drive efficiencies and inventory fulfillment and our supply chain operation. This gives us more confidence in our ability to forecast and gives us a strong foundation as we build the business toward growth. Despite the distractions of the holiday season and massive flooding in our Chennai, India location where we process all of our service orders, our sales, sales operations and supply chain teams came through. We set a company record for on-time delivery during the quarter something we measure closely to ensure optimal inventory. This is great news. Our run rate gross margins were inline with our 55% target, and I will let Ken address the near term inventory and warranty items that affected the reported number for this quarter and our Q3 guidance. From an operating expense perspective, you can clearly see the strength in financial position and the benefits of the cost cutting measures we took last May. When you look at the year-over-year comparisons we grew our operating income by over 60% on a smaller revenue number and our earnings per share grew to $0.09 per share from $0.05 on a non-GAAP basis. I will note that these numbers include incentive compensation expenses that weren't in the numbers last year when we exceed plan, we payout incentive comp every six months. This is the first time in many years that this payout has been achieved. It is well reserved and great for the morale of the team as we transform into a growth company. I congratulate our employees on this accomplishment. At Extreme we have a clear vision of the networking industry and the competitive landscape. With the cost of bandwidth continuing to fall at a rapid rate. The explosion of devices onto networks driven by mobility and the Internet of Things and the proliferation of applications that run on those devices and connect them to private and public clouds. All these factors are driving the need for new networking solutions. For the first time the refresh for wired and wireless are occurring at the same time. This plays right into sweet spot at Extreme as an end-to-end provider. Given the fact that networks have become much more complicated for our customers to manage and the fact that our customers IT departments are not able to respond to these new demand by adding staff. They can't afford to double their IT budgets. This too is good for Extreme given our unique software capability and our best in class technical service and support. We see the complexity of these converts, wired and wireless networks being simplified with software. This is where the market is heading. We believe it's a big opportunity and it lines up directly with our technology vision, our product roadmap and our go-to-market strategy. Our enterprise customers need flexible operating systems, feature rich management tools, access controls for Edge devices, security, application and device level policy and quality service delivery, gateways to private and public clouds and network analytics. These will be the drivers of more and more networking decisions in the future. We have the software and we are tailoring solutions that make it easier for our target customers and education, healthcare, manufacturing, hospitality, stadium and government to deploy them. As most of you’re aware, industry analyst tell their clients that Extreme is one of only three networking companies that can deliver, wired and wireless end-to-end networking solutions to enterprise customers around the world. What most people don't know is that we are the only networking company that as what we call a single pane of glass. This is our unified network management platform that provides complete visibility and control over both wired and wireless environments from our access points to our access layer switches, to the core the network into the data center. This makes it much easier to manage networking environments one common database for all devices on the network, one database of network equipment and ports and one user interface with enhanced management capabilities. In addition, we are the only one of the three end-to-end providers with 100% in-source technical support. Our Extreme team has a tenure of over 8.5 years and as more experience than all of our competitors. When they answer a service call from a customer with a technical issue, they resolve the customer issue over 90% of the time on the very first call with networks getting more complicated with customers being more resource constrained, this real-time best in class support can make a big difference in strengthening our customer relationship. Earlier this year, we met with the Gartner team and they evaluated our unique capabilities, end to end wired and wireless for the single pane of glass, our elegant SDN solution and our upcoming May software release, the only solution that extends beyond the data center. Our top ranked service and best value proposition. This is why Gartner put Extreme in a visionary quadrant for the first time. The key for us is how we leverage this capability and how we go-to-market, how we spread the word to the channel community and how we expand our partner relationships to grow our base of over 22,000 enterprise customers. We made progress on this front in the second quarter. Our engineering and product management team launched our Wave 2 wireless access points in December on schedule and in time for the E-Rate buying cycle. And in connection with this, we will launch our cloud management platform that will become generally available in three weeks also on schedule. This is a big deal for our partners and customers, the multi-tenant platform will allow our partners to manage multiple customer networks without the need for technician to be onsite. It will also allow our enterprise hospital customers like the Henry Ford Medical Center in Greater Detroit for example to manage a physician satellite office or emergency response center or a community medical center remotely. Our subsequent cloud 2.0 release in May will expand our cloud management capabilities to cover our wired switch portfolio as well. The Gartner analyst had said this will provide us with a distinct competitive advantage and leapfrog our competitors' offerings. To help illustrate our value proposition, I will highlight a handful of customer success that were realized in Q2. In our healthcare vertical, one of our end-to-end enterprise customers Charlotte Area Medical Center ordered 2000 access points as part of their network upgrade. CAMC is a solutions customer. They use our switches in their data center out to the edge of their networks soon to be refreshed with the latest Wave 2 technology. They used our single pane of glass to a sign policy and to manage the complex needs and their healthcare environment including secured medical records hosted in their data center, quality of service for critical applications in the operating room and seamless Internet connectivity for guests a big driver of patients satisfaction. Net-net we are delivering a quality experience for users and making it much easier for network administrators to manage. We put out a press release about another one of our customers in our education vertical Utica College where Vijay Sonty, the CIO stated "With the help of Extreme, we've reduced the complexity of our networks," the gains and efficiency and simplicity alone have had true bottom-line results, now a single network engineer can easily maintain a network and service 4000 users where the customary ratio is one engineer to 200 users. Overall, Extreme does a robust network at savings of close to $1 million over their competitors. So here again, our wired and wireless solution managed by our single pane of glass software is integral to delivering value to this customer. And finally, we were rewarded NRG stadium in Q2 home of the Houston Texans and Super Bowl 51. NRG will be utilizing our higher solution of wired, wireless and analytics all managed through a single pane of glass software. NRG stadium is one of the most utilized venues in the U.S. hosting this year's NCAA tournament in addition to other year round activities. Here our solutions helped to deliver game day services including NC's ordering, live and replay video footage for multiple camera angles as well as supporting streaming video and social media apps that are all part of their drive to enhance the fan experience. We are very proud of our continued success with the NFL where we now have nearly half the venues leveraging our technology to improve the fan experience as well as 17 NFL teams utilizing our analytics technology. And next week, Extreme will be on display as the official Wi-Fi analytics provider of Super Bowl 50 as well as the provider of Wi-Fi to Super Bowl City in downtown San Francisco. These wins highlight some of our important customer relationships coming on the heels of highly successful training programs that we launched over the summer. As we move from point product sales of wired switches to a full portfolio of wired, wireless and software driven networking solutions, we knew we had to invest in training. Our field teams embraced these programs, solution selling, technical product education and wireless certification. A 100% of our sales teams have completed our popular 3D solution selling program, 80% have completed technical training and recall last June we only had three wireless certifications in the entire company. Now, 85% of our 130 systems engineers are wireless certified and 50% will receive their advanced wireless certifications in March. This will make a big difference and with this initial training behind us, we could focus on selling. The transformation won't happen overnight but we will get stronger and stronger each quarter. We are also investing in our vertical ecosystems, we are in the process of developing and marketing our suggested reference architectures in each of our key verticals and we are refreshing and building out our pool of integration partners in these segments. This will make it easier for our sales teams and channel partners to qualify for opportunities. This two will build over time and it will be customer driven as we gather more and more case studies and reference accounts, we will add new architectures and new integrations. This will allow us to build strength and momentum each quarter. As far as guidance, we are projecting year-over-year organic growth for the first time in many years, this was a direct result of us executing on our strategy and all the tactical initiatives being completed inside of Extreme. We will remain disciplined on the operating expense side of the equation which will result in favorable year-over-year comparison like you see this quarter from year and out. On a personal note, my confidence in Extreme continues to grow and it's driven on three fronts. Number one, the quality of our technology and engineering, our belief that our products and solutions are high performance and well engineered are confirmed when sophisticated an incredibly discerning technology buyers valuing quality. Like Intel Corporation, one of our largest customers which uses our networking solutions from their massive data center out to the access edge. Number two, the quality of our customer relationships, each time I travel to different locations around the world, I'm always amazed to discover new longstanding Extreme customers like Konica Minolta in Hanover, Germany where their headquarters and manufacturing facilities, or Bugatti, the maker of the world fastest car engine or the Mercedes Formula One team or Lucas Films and Skywalker Ranch or the Louvre Paris, the list goes on and on. Number three, our people. Extreme has a high caliber team of professionals, these are A players who make up a strong team, they want to deliver and we are starting to demonstrate that with three consecutive quarters under our belt. And most importantly, we are aligned -- we are aligned in our vision, our strategy and execution initiatives and we are committed to winning -- winning means growth. Now, let turn it over to Ken for numbers.

Thanks Ed. Before I get to the numbers, I would like to make a few comments. To start I'm very pleased with our financial performance over the past several quarters as we continue to remain focused on delivering on the top-line and diligently managing our expenses. This is a third consecutive quarter that we have delivered on our guidance since our restructuring last May. Additionally, in Q2, we have realized 100% of the quarterly savings expected from the reduction in headcount in Q4 2015, and in fact, our non-GAAP operating expenses are down $23 million or 16% in the first half of fiscal 2016 compared to fiscal 2015 and we are clearly on track to realize the $40 million in annualized savings, we have mentioned on past calls. Lastly, we get to our Q3 guidance; you will see that we are calling for growth quarter on a year-over-year basis. Now, let's review the second quarter results starting with revenue. Q2 GAAP revenue was $139.3 million compared to $124.6 million in quarter one and $147.2 million in Q2 a year ago. Q2 non-GAAP revenue was $139.7 million compared to $125 million in quarter one and $148 million in Q2 last year. Geographically, we experienced the largest sequential growth from EMEA driven by strong results in government and manufacturing. Strong E-Rate performance drove North America growth and APAC and Latin America had solid performance relative to plan. The split of revenues were as follow. North America contributed to 47% to total revenue, EMEA contributed 39%, APAC contributed 9% and Latin America contributed 5%. Product revenue both GAAP and non-GAAP for Q2 was $105.4 million compared to $91.4 million in quarter one and $112.5 million in Q2 last year. Q2 GAAP service revenue was $34 million compared to $33.2 million in quarter one and $34.7 million in Q2 last year. Non-GAAP service revenue for quarter two was $34.3 million compared to $33.6 million in quarter one and $35.5 million in Q2 last year. Moving on to gross margin and operating expenses. In Q2, GAAP gross margin was 50.4%, compared to 52.3% in quarter one and 51.1% in Q2 last year. Non-GAAP gross margin was 53.6% and compares to 55.2% in quarter one and 54.6% in Q2 of last year. The sequential decrease in non-GAAP gross margin is largely attributable to two factors. First, we incurred excess and obsolete charges for older 802.11 n access points. In December, we launched and shipped our new Wave 2 access points which makes the 802.11 n product two generations old now. As such we begin reserving for this older inventory. Second, we improved higher warranty reserves as we are noticing a trend that a greater share of product is shipping with limited lifetime warranties. These warranties cover a 5-year period compared to 1-year period was standard warranties. Prospectively, we believe that the market will continue to expect limited lifetime warranty products. Accordingly, our cost to fund these warranties will vary based on shipment volumes and customer returns in any particular quarter. Combined the excess and obsolete and warranty charges at approximately 1% impact on gross margin this quarter. Q2 operating expense, GAAP operating expenses was $75.6 million compared to $75.9 million in quarter one and $86.2 million in Q2 last year. Q2 GAAP operating expense includes restructuring charges of $3 million related predominantly to the completion of our facilities consolidation following reduction in work force in quarter four 2015. Recall that GAAP operating expenses in Q1 included restructuring charges of $5.6 million primarily related to the initial phase of the facilities consolidation. Q2 non-GAAP operating expenses was $64.1 million and compared to $61.5 million in quarter one and $74.1 million in Q2 of FY 2015. Sequentially non-GAAP operating expenses reflect increased sales commissions related to the higher revenue in quarter two and higher incentive compensation expense related to the company's performance. Again, this quarter we realized 100% of the quarterly cost savings associated with the Q4 restructuring. Second quarter GAAP operating loss was $5.4 million or negative 3.8% compared to a loss of $10.8 million or a negative 8.7% in quarter one and a loss of $11.1 million or 7.5% in Q2 of last year. Second quarter non-GAAP operating income was $10.8 million or 7.8% compared to $7.5 million or 6% in quarter one and $6.7 million or 4.5% in Q2 last year. GAAP net loss for Q2 was $7.2 million or $0.07 per share compared to a net loss of $11.5 million or $0.11 per share in quarter one and the net loss of $13.1 million or $0.13 per share in quarter two last year. Non-GAAP net income for the quarter was $9 million or $0.09 per diluted share and compares to a net income of $6.7 million or $0.07 per diluted share in quarter one and a net income of $4.7 million or $0.05 per diluted share in fiscal Q2 of 2015. Turning to the balance sheet. Q2 cash and cash equivalents benefited from strong collections in the quarter and we ended at $85.9 million up $3.9 million compared to $82 million at the end of last quarter. In the quarter, cash flow from operations was $7.4 million compared to $6.5 million in quarter one and free cash flow for the quarter was $6.7 million compared to $5.9 million in quarter one. Accounts receivables was $73.1 million at the end of Q2 up $12.8 million from last quarter with DSOs increasingly slightly to 48 days this quarter from 45 days in quarter one. Ending inventory was at $56.6 million down $5.1 million from last quarter and total debt outstanding at the end of Q2 was $52 million and we were in compliance with all debt bank covenants at the end of the quarter. Now let's move on to guidance for quarter three. We expect Q3 GAAP revenue to be in a range of $117.6 million to $127.6 million and non-GAAP revenue to be in a range of $118 million to $128 million. At the midpoint, this represents growth over Q3 of last year. As mentioned, E-Rate funded business contributed nicely to our Q2 results and we anticipate that to continue into Q3. Gross margin is anticipated to be in a range GAAP gross margin anticipated to be in a range of 49.9% to 51.2% and non-GAAP gross margin is anticipated to be in a range of 53.5% to 54.5%. While we have initiatives underway to develop programs to sell slower moving inventory, we are being prudent in our guidance which contemplates, anticipated additional inventory reserves in quarter three. Additionally, keep in mind, that our March quarter is a seasonally slower revenue quarter which has historically had an impact on gross margins given our relatively fixed manufacturing and service cost structure. Operating expenses are expected to be in a range of $69.5 million to $72 million on a GAAP basis and $62 million to $64.5 million on a non-GAAP basis. The tax expense is expected to be relatively consistent with our Q2 levels. GAAP net loss is expected to be in a range of $9 million to $13 million or $0.09 to $0.13 per share. Non-GAAP earnings are expected to be in a range of a net loss of $1 million to net income of $3 million or a loss of $0.01 per share to net income of $0.03 per share. The average shares outstanding are expected to be $103 million on a GAAP basis and $106 million on a non-GAAP basis. Now I'll open the call for questions.

[Operator Instructions] And our first question comes from Matt Robison of Wunderlich. Your line is now open. Please go ahead.

Hi, just -- I might have a follow-up question. But just initially on this gross margin effect from the inventory and warranty reserves, it sounds like the inventory piece wasn't all taken care of in the December quarter. You've got a little bit of the tail in the March quarter. I'm hoping you could confirm that. And then talk a little bit about the warranty reserves. Should we expect to see an offset to that in the service and maintenance line? And presumably, if there was, it would be spread over time. But can you give a little bit flavor of the timing of that? You talked about -- Ed, when you mentioned the 55% run rate sustained except for these items -- why wouldn't we expect to see the higher warranty reserves? Is there -- maybe to comment at, there's -- what the backdrop is for that being temporary.

Matt, I will start here. So for the access points I was referring to, those -- we have had those access points for a couple of years as we transitioned to 802.11ac and now Wave 2. We had some excess inventory sitting around as customers obviously have moved to the newer versions. We are in a process right now of developing some programs to move those access points with marketing programs and some R&D efforts to -- add some functionality to the access point. And I will leave it at that. We think we will be able to do that but we weren't in a position given the aging of the inventory to take some reserves this quarter on that. Like I said, we are prudent in our thinking for Q2 we built some additional E&O for some access points into our guidance. The success of the programs that I was referring to could potentially minimize that E&O as moving through Q3. As far as the limited lifetime warranty, obviously with five years, we have a greater liability to cover customers over that five year period of time versus the one year period of time. We have seen an increasing amount of customers take limited lifetime warranties as an option here. And you do see an offset there because you don't see the cost in the service line itself over time. Although with that said, it will depend on the volume and shipments, the failure rate return to product and customers. I guess our view also was that with limited lifetime warranty over time, you will probably see more warranty request coming in from customers in the field given that -- they can return something at any point in time over a five year period.

So this -- are you -- just to clarify, are you getting a revenue bump for this or is it or you offering the additional warranty essentially as a discount -- discounting mechanism?

Matt, this is Ed. Good morning thanks for the -- thanks for the questions. This is something that has become market, so we are not doing anything that's really outside of the scope of where the market is today. And when we launched it was a new program, we didn't have a lot of history in terms of what to expect. And then, when you see returns come in and you have to make assumptions about how you should be reserving. We've -- we made some changes to that assumption and we are -- there was a little bit of catch up that we expect this quarter and in Q3. And also, we were somewhat victims of our own success with some of the other products from an E&O perspective where we came out with our next generation chip set. And the sales have exceeded anything that we have done in our history and as you know when you come out with a new version of technology everybody want a new version. So we are -- we were more successful with our G2 series products than we had expected. We have as Ken mentioned, we've come up with what we think are some creative bundling ideas to bundle those switches with some of the access points to a targeted part of the market to diminish that. So again, I made the comment about run rate 55% because we believe that will be the gross margin target and we are not moving away from that. We just have these items that affected that number this quarter we built that into our guidance for next quarter.

Well, congratulations by the way on the product sales volume those significantly higher than I expected and apparently it's partially weaker than the launch. Can you just give us a little sense as to how we get back to the 55% maybe the timing of it?

I mean, I would say we don't provide guidance out this far, but we've -- we see business as usual in the fourth quarter.

Fair enough. I will leave the floor for now. Thanks.

Okay. Thanks Matt.

Thank you. And our next question comes from Christian Schwab of Craig-Hallum Capital Group. Your line is now open. Please go ahead.

Great. Thanks for taking my question. Solid results. As we look to the better quarterly revenue, first I want to get on the entrant E-Rate, last quarter we talked about that being $10 million and potentially going to $20 million did we hit that?

Yes, Christian. We were on the higher end of that $10 million to $20 million range for the quarter in quarter two.

Right. When we said we would go from $10 million to $20 million so would that be --

What we said, as we'll be in the high end of that range of $10 million to $20 million and that's where we ended up.

Okay. So when we look at the better revenue I'm just trying to figure out, you know, what was the positive surprise, was the positive surprise that EMEA acted better than you thought? Was the positive surprise decision to move obsolete inventory or is it a collection of a lot of stuff?

Christian, I wouldn't characterize it as a surprise. We came into the quarter with a lot -- a lot more visibility. You mentioned E-Rate; the funding letters were coming out. We had an inventory of funding letters, so we had better visibility of how that would play out. And I mentioned strength in the U.S. which is continued, it wasn't just E-Rate, but we have had a lot of success in other verticals as well. And we had a nice rebound in EMEA, a good sequential growth in those markets. So and you are going to see, we were negatively affected by what was happening in APAC and LatAm in prior quarters. And I think we got new leadership there. They are very excited about what they are going to be able to do in their regions. So they are pretty aggressive in their outlook. So I wouldn't characterize it as a surprise, I would characterize it as us -- the team executing well and sales going through. I will also comment that we delivered the results despite -- in a business you always have puts and takes and -- our sales teams are really focused on execution and committed to delivering and I think there is a lot of things going behind the scenes to deliver the numbers but really no surprises.

Okay. As we look at the E-Rate, can you give us an update on how much E-Rate specific revenue if you can that you shipped versus what you previously won and when do you expect to ship the last -- of last year's wins, what quarter?

So we are looking at over the next couple of quarters still having another roughly call it $20 million to $25 million that we are going to be shipping over the next couple of quarters based on what we said coming into the quarter, we are into the year on what we think we can do for E-Rate. Again remember Christian, it started last Q4 we got an order in from the school district about $9 million that extended into quarter -- and you take that into quarter one. And then, our results in quarter two and then what we will see also as we move through Q4 is, is lightly that we will see next year's cycle starting and have some orders from next cycle again in Q4 as well on top of us winding down for this year.

Yes. I agree. How much of obsolete inventory of bunch of old Wi-Fi access points is sitting in inventory and we are about to release our next generation product, so we are about to have another potential product that is on its way to being obsolete, Ken is there anyway to quantify how much is sitting there that we can keep our gross margins at kind of a more depressed level until they bounced back towards your target?

So the access point that we were referring to was the old 11.n access point. We had a less than a quarter's worth of inventory left when we transitioned -- what Ed was mentioning with the Wave 2, we shipped a fair amount of access points of Wave 2 in the December quarter here that is the quarter end when we released the product. And that's what we are looking at going forward. So we are putting the program together to be able to push the older n series access points. Teams are working on that right now. We think we can minimize that. Again, we built in some E&O in our Q3 guidance but we think we have opportunities to minimize that pretty significantly by the programs that we are going to be running and doing some bundling with that and make it more attractive to customers on the low-end.

Yes. Okay, great.

Christian, let me add -- I will add two comments to that. One is, keep in mind, in terms of the new team and better communications that we are learning each time we go through these cycles. So as we are coming out of Wave 2, you won't catch us with as much inventory of the older access points. Also the Wi-Fi market, it's the segment of the market it's growing. There is high growth and we typically play in the high-end -- high-end enterprise market in NFL stadium, when you are delivering Wi-Fi there is a Super Bowl. It got to be the highest of quality. There are also parts of the market that are lowered price -- they are the lower quality markets. We have opportunities in terms of service bundling that I mentioned to create solutions to address what is really high growth market with some of the older access point. So there -- we have a lot of opportunities here. We don't expect to see this is an issue as we project out. We project it for Q3 as I mentioned we see business as usual going into Q4.

Yes. That mean this is -- here we are ended up -- cleaning up issues of somebody else's previous acquisition not only fixing the operating expenses but fixing inventory. So I don't hold that against you nor should anybody else? My last question has to do with year-over-year organic growth statement that I think I heard, I just want to confirm that I heard it. Even though at the mid-point, yes, the March quarter is up year-over-year, but you also suggested that that would be the beginning and the company goal of returning to year-over-year growth. So I assume that means this June quarter you're hoping that you will again see year-over-year organic growth versus last year. Did I hear that correctly?

So, I have to say you're great, you said hope. If you said hope Christian. But here is what I would say, I wouldn't count it out as you know we don't forecast out beyond the current quarter. There is the moving pieces here as you know, E-Rate moves around a bit. So let's just we had a very strong E-Rate showing in this quarter that maybe pulls away from Q4 that could have an impact. And also remember we had somewhat of a blue bird order of that $8 million in Q4 of last year. It came in earlier than expected and raised the revenue number significantly beyond our guidance. So I'm not going to tell you to rule it out but at the same time, we -- we are not comfortable projecting it on the call today.

Understand. No other questions. Thanks guys.

Thanks Christian.

Thanks Christian.

Thank you. And our next question comes from Simon Leopold of Raymond James. Your line is now open. Please go ahead.

Great. Thank you taking my question. I just want to start with a quick clarification on your gross margin comment. You indicated Ken that there was about a 1 percentage point hit due to the reserve -- the two reserves. Wanted to make sure, I understood was that specific to the product gross margin or overall gross margin?

Yes. Those were more specific to the product gross margin.

And so when you offered guidance, you talked about the fact that that you would get some of this affecting the March quarter plus seasonality lower volume also affecting March quarter. So you've given us overall gross margin guidance, but just wondering if I'm thinking about product GAAP gross margin correctly if I think about kind of right around a 45% range, slightly lower than what you saw in December, is that what you wanted to think of?

You are talking about it in GAAP basis?

Yes, I'm.

Yes. I think on a GAAP basis, you probably need to be thinking around 50%, 51% kind of gross margin ranges.

So significantly higher than the 45.8% we saw in December?

Are you just talking product gross margin?

Yes, yes. I'm specifically talking about product, yes.

Yes. So I think that's probably about right, which you indicated.

Okay, okay. Great. Thank you just wanted to make sure I understood when you are saying correctly.

Yes.

So for Ed, more kind of a big macro and obviously as a relatively small company you are not beholding to the macro, I understand that. But in light of what we've read obviously all of us seeing the headlines and I'm thinking about commentary from others in the networking space as well as large operators AT&T and Verizon both commented on enterprise spending, North American enterprise spending looking a little bit weaker. And your tone remains somewhat upbeat you got E-Rates certainly in the mix. I guess I'm trying to understand how sort of the general business -- your general enterprise business excluding E-Rate is holding up, what you are seeing maybe in some of your verticals, how they may or may not be affected by what we are seeing in the macro environment.

So, yes. Thanks Simon. I think -- I don't think we could say that at Extreme we are immune to what's going on and the larger industry. So I wouldn't -- yes, I wouldn't ignore and actually we pay very close attention to what's going on out there as far as what the large companies are saying. Obviously, it's important to us. But, what I will say is that, you keep in mind our market share and keep in mind what we are doing as far as focus and looking for share points. So even let's assume that I think the industry is looking, let's say the industry is flat. We think we have -- our opportunity that we are focused on is about taking share. And if you consider the power of a share point for this company given the size of the overall market, it's -- even if I wanted to look at the larger trend I still think that we should be able to grow. And a lot of it -- a lot of the issues that we've had as a company is getting organized and how we go-to-market and being really focused in going to market and highlighting our competitive advantages. We have distinct competitive advantages. And it's a function of us being crystal clear and how we educate our own teams internally, how we bring it to market, how we educate our partners. So that, when there are opportunities in healthcare, when there are opportunities in manufacturing, when there are government opportunities, when there are venue opportunities, when there are higher education opportunities that they know we have unique capabilities and unique solutions and they should consider Extreme. And keep in mind that our partners make probably twice as much when they sell Extreme than they make when they sell a Cisco or an HP. So if you talk to Gartner, they would tell you that there is only three end-to-end competitors and if you consider that networks are getting a lot more complicated and the network managers are having to deal with a much more complex environment with fewer and fewer resources. Extreme provides the best value as far as one stop shop excellent technology, software tools that may get very easy to manage. And then the high quality of service, it went -- I mentioned statistics but this is really important. If you are running a network and you have a network issue and you pick up the phone, you get a technician at Extreme and that the number is 94% of the time, he is going to resolve your issue. If you call one of the larger companies, you're going to get bounced to one or two or maybe three different operators around the globe with different dialects. And they are going to be trying to triage and figure out where to send you to someone who can answer the question. Well, it makes a big difference to the enterprise customer that is below, let's call it the fortune 300. It doesn't have the direct support, which is the majority of the market when they get significant service benefit from someone like -- from someone like Extreme that everybody says they have good service so it's hard to market that. But that's one of the -- it's one of the -- I look at it as an opportunity for us. But we are excited, you are hearing excitement from me and you're hearing a lot of excitement from our team because of how we -- how historically we have all the pieces in place, we built all the pieces but now we have this opportunity to put it altogether to get focused and bring it to market.

And I wanted to follow-up on that point being one of three suppliers able to bundle wireless LAN and switching. So if you could help us understand roughly what percentage of your product revenue comes from wireless LAN specific products access points and controllers and such. And then, help us understand, if you can quantify what sort of the dollar value of the switch sales are the result of these wireless LAN, execution sales?

So if you look at our numbers even from a macro basis, our numbers are -- we have 10% wireless LAN, 5% software and 85%, it's going to be in terms of our switch portfolio and services. About 12% of our overall customers of what we would call, our gold standard bundle solution, wired, wireless and our software portfolio. If you recall what I mentioned on the call, in June, we had three people certified in wireless, I mean entire company. I had to say I think our team has done an unbelievable job and then the field as truly embraced all the training it's been going on. And this is company that never really had training. So now, we have literally 80% of our system engineers in the field who are certified in wireless. And we have half of them who are going to get advance certifications. So it's a transition, I'm excited about what we are going to be able to do with the second half of the year because instead of being in training classes and educational programs. They are going to be out in the field putting their new found knowledge and skills to work. And that's going to -- it's going to help us. And it's going to help us get more focused on the solution. And the more wins we have, we think it's going to build on itself. And anyway, I hope that answers -- I hope that answers your question.

No, that's helpful. Any chance we can get a dollar value for the wireless LAN in the December quarter?

I don't know if we are to --

We typically have not disclosed that Simon. We talked about it as a percentage number.

And is that total revenue or 10 product?

Product. It's been that 10% to 11% range over the recent several quarters.

Simon the other thing we are not reporting on this, if we are not disclosing metrics around it, yet, although it's something we may consider disclosing in the future is, we are really driving the solution sale and the bundle solution, last year we measured all of our bundle sales. And in the first six months of this year, we more than surpassed all of the bundle sales from last year. So we know that we are -- what we are doing, it's working -- we are seeing progress, there is no silver bullets here. It's not going to happen over night. If it's something it's going to be a gradual transition but we know that it's working and we hope to be able to start reporting on in the future.

Great. Thank you for taking my questions.

Thanks Simon.

Take care, Simon.

Thank you. [Operator Instructions] Our next question comes from Alex Henderson of Needham. Your line is now open. Please go ahead.

Yes. I just wanted to continue that conversation we are just having on the bundled, obviously, moving towards solution selling is your primary focus right now. And this is an important metric relative to that. Thanks for that data point on 1H being up over all of FY 2015 bundle that's a great data point. But where do you think you will take this? Can you get to a point where it's not just 12% of customers with the wireless, wireline and service bundles but more like 25% or 30%. And how long do you think, can you give us some sense of timelines?

Yes, for the 25% for sure. And the timeline, if we are in a 25% over the next 24 to -- over the next 24 months, 30 months, I would be disappointed. If we think about we have 22,000 customers, which is a lot of customers in our installed base. And most of those customers have a single solution that single solution is going to be fixed switching. So we have an opportunity to go out of market to those existing customers. And there is a wireless refresh cycle that's coming up and as far as Wave 2, when we come out -- we are putting our cloud management platform out. We have been behind we are catching up in our meetings with the Gartner analyst. They were analyst, they have blown away. But they were really impressed with what we are going to be able to do in a cloud in terms of managing not only wireless APs but also the wired switches. So as we look at the complete solution, we have from a technology perspective, we have the software and the management tools that we are going to be putting in the cloud, they are going to provide with the unique advantage. We also are one of the few players that is going to have a cohesive wireless access point Wave 2 and access layer switch solution. So if you think about us targeting our base in existing customers, it should be a big opportunity. So if we are 12% today, we are talking about 13% over the next 24 months to bring them up to the solution itself. It sounds feasible to me. I don't want to create a new goal for the company on a conference call but I hope that's helpful.

No, that's helpful. Let me ask a secondary question. Do you get better margin on your bundle sales than you do on your conventional sales?

We do because of the software. So if you -- often times if you are selling a solution, the focus of the sale is less about price and the level of discount you are getting off of a box. And it's more about a problem that you are solving. And as you know, software not operating system software, but our network management and our access control and security, network analytics, these are software products that come with much higher margins. So if we are successful selling the solutions bundled in then we should be successful and ultimately growing our margins.

Is it a meaningful delta on gross margin that is then absorbed by higher selling cost because this is more complex or the operating margins better as well?

I don't -- I can't really give you an answer on that one, Alex. I try to be -- I don't want to make things up on the call. But I think it's something for us to -- this could be a good follow-up by and forth.

And so, let me address somewhat different subject but still on the operating margin side. I think you talked about getting to 10% operating margin. And I think one point or another, I think suggested that you might be able to do in the fourth quarter. But, can you give us an update on, how you are thinking about attaining that level and whether that's attainable and say in the next 12 to 18 months or whether that's something that's obtained only in a quarterly basis with the seasonality causing dips below it in some quarters and just getting to it and they are seasonally strong, or will it eventually be able to hit that on average?

This is Ken. This is the way I would think about it. We are really focused on managing our operating expenses to a low to mid-60 range over the foreseeable future here. We have been pretty good at the -- the last three quarters we're going to continue that focus. So let's assume you have -- just pick a number $65 million is an operating expenses on a continuous basis going forward. And we run the business at overall 55% gross margin over the long-term. With those two metrics to get to 10% operating margin, we had to generate revenues of $145 million to $150 million a quarter to hit that 10% basis. We are getting close to that at 8%. So we think we have real opportunities to do that over the next year. And it's going to depend on us managing our expenses to where they are today and driving back at that 54% gross margin even if it was at a 54% gross margin, we could probably at a $145 million of revenue still generate a 10% operating margin.

Okay. One last small question then I will see the floor. I'm little curious why you don't have an adjustment on your income tax rate as a result of the GAAP to non-GAAP adjustments in the rest of the income statement.

Pretty much what we do is pay statutory taxes around the world mostly internationally. We have NOLs in North America, Ireland, state NOLs as well very, very significant in nature, hundreds and millions of dollars. So we won't be paying any real taxes on a go forward basis. So again, it's just a nominal statutory tax that we have around the world. So it's running about a $1 million or $1.2 million a quarter.

One other question, the international side of it, I know that you've got a lot of programs to expand in Latin America and they are excited about that. And you're also excited about APAC, but the economic conditions in those geographies seemed pretty tough. Can you talk about whether you are seeing that causing hesitation or slowdown in, in the processing time and the -- the deal sizes in those geographies or whether that is just, you are just so small that it's all incremental to you and therefore, you are not -- just not seeing that.

Yes. I think its -- Alex, I think it's the same -- same comment that we made earlier about the broader market and how we play relative to the broader market. Its probably be even exaggerated in those markets. If you were to look at -- if you were to look at competitors especially the larger competitors, if you were to look at their business mix in those markets, they could have a much higher business mix in APAC and LatAm than what we have. We historically the company hasn't executed well in those markets. As I mentioned, we hired new leadership and the new leadership we've also taken a different approach in some of these markets where if we are underperforming we have a large field force of fixed cost, it's not very efficient. And so, in some of these markets we shifted to drive channel, which is making us more efficient. Our new leadership is really -- is pretty fresh life and a lot of intelligence into the most effective way to grow in a market. And they have identified a lot of opportunity. So I -- we are not going to be a good macro gauge in these markets. We are going to be opportunistic. We are the solution set. Our partners and our direct teams identify opportunities in those markets. And they are seeing a lot of opportunities. So that's -- I wouldn't say it's not heavy investment for us. But there is -- there could be some low hanging fruit for us.

And there has been no competitive price pressure developing as a result of the weakening conditions in these geographies as well as for the matter in the U.S. because of weaker conditions there more aggressive on pricing, you haven't seen any of that?

Well, I think Alex, we see it all the time. It's not -- it's something that we see -- we see it in the U.S. I mean I think it's the nature of the business that we are in.

Let me say that again.

Alex maybe just take a quick step back. In terms of keep in mind, if you look at how we are priced relative to competition, Cisco provides a nice umbrella in general on a product perspective, we are probably 20% below fiscal and then on a total cost of ownership and this is really where there the price creep and we are probably 45% below them. So we have a nice umbrella and it gives us a little bit of room. And we are trying to -- our challenge it to take the discussion away from price. So that's part of our ability to succeed is to take the discussion away from price like the customer examples I have given you. And talk more about on resolving their problems. And these -- we can do this in our verticals. The healthcare, if you look at the healthcare vertical, hospitals and healthcare facilities around the world facing similar challenges. Same thing is to our manufacturing, similar in education and government, stadium venues. So if we are out there solving problems installing solution it should change the negotiation.

But just to be clear, the question wasn't about what you're doing but rather what they are doing. Are they responding to the weakening conditions and drop in price which might compress that umbrella?

I would say, we are not noticing anything unusual.

Perfect. That's what I was looking for. Great, thanks.

Okay.

Thank you. And our next question comes from Rohit Chopra of Buckingham Research. Your line is now open. Please go ahead.

Thanks very much. I had a couple of questions for you guys. First thing, and Simon was asking about wireless LAN, I just want to follow-up on that one just if you don't mind, I'm trying to get a sense of maybe the gross margins relative to switching and maybe the growth rate relative to switching. I'm not looking for the exact number Ken. But just a rough idea and the reason I'm asking is because I'm assuming that in the 2015 year-over-year you were a little more switch focus. But in 2016, you are probably the better positioned from a wireless LAN standpoint and given the new product. So I just want to get a sense of what we should expect. That's why I'm asking about gross margins and growth rate there. I do appreciate you giving us a sense of how large it is. And the second question, I just want to get a sense of your thoughts right now on E-Rate, just I know it's early but the window has opened for the 4.70s, so I just want to get a sense of what you are seeing out there. And the reason I'm asking that one very specifically is that, it looks like USAC has found an extra $2 billion to throw into the 2016 year, making it closer to $6 billion for E-Rate. So I'm just trying to get a sense of your thoughts around E-Rate and then also on wireless LAN if you don't mind.

Sure. I will start out with the gross margin comment there. So wireless and wired, I will start up by saying it depends on the deal. I mean you can generally -- you would have wireless carrying probably a little bit better gross margin than wired. But again, it depends on the competitiveness and the deals, so we see that bounce around a little bit. With E-Rate deals, those are competitive deals for us as well. So you have various discounting going on in there, so whether it's more wired versus -- more wireless versus wired. You still have the competitive nature of the business out there. So as we are looking at it, we look at it kind of more of a blended gross margins here between both of those products -- product sets -- from a product basis and that's kind of 45% to 50% range. And 55% range I guess, if you kind of aggregate at all. So again, even though wired can carry higher -- wireless can carry gross margin. With E-Rate, we see a lot of competition in these deals when we're going after some of these school districts, especially some of the bigger one and you get into more discount, when these pieces of business. So if you are moving some more of a wireless situation which could carry higher gross margins. It's the discounting you could play into this. So it kind of -- kind of moves around on a quarter-over-quarter basis as you to join. But overall, I would say if you look at wired and wireless over the past near term history, overall gross margins are somewhat comparable.

And that's very helpful. And the growth rate rough relative to switching, is that anything that you can provide?

Wireless growth rate?

Yes, wireless growth rate just relative to switching, I mean like is said I'm not looking for the very specifics. But just a sense, pretty much --

If you look at data that we get from the analyst community, they will tell you that wireless is growing around 10% annually, over a 5-year CAGR. Wired is probably more flattish, may be slight growth, if you think about a campus kind of a business. Yes, wireless is growing very nicely and we are looking to taking advantage of that especially with our Wave 2 access points out and as Ed mentioning adding to that the wired capabilities in the cloud. I think we have some great opportunities to grow at market rates. Hopefully, as we go forward, I mean it's a real opportunity for us in the wireless space.

And then just lastly on E-Rate, just some early look or some early thoughts as you are seeing 470s come in?

We are a lot better positioned this year than we were last year for E-Rate given the product portfolio and our ability to position and sell wireless where as almost all of our E-Rate business last year was at our fixed switch product portfolio. So and we have a large percentage of our sales teams that have embraced the program if you are out in the field and you're in sales and you're seeing people be extremely successful with the program than you embrace the program. So we have expanded the number of our direct sales people who are participating in a program. So I would say the combination of the more participants on our side and the field that are engaged and selling the volume of proposals and then the scope of what we are bidding on. We are enthusiastic. We are encouraged by what we think our opportunities are. As you know, you don't really know until the -- until their final numbers are released.

Sure, sure. Absolutely. I appreciate the answers. Thanks again.

Thank you.

Okay. Take care.

Thank you. And our next question comes from Mark Kelleher of DA Davidson. Your line is now open. Please go ahead.

Hi, guys. This is Andrew Masuda asking a question on behalf of Mark. Just one question from Ed, geographically you guys saw a nice sequential increase in EMEA in Q2. Can you just talk about what drove the strength and maybe qualitatively speak about your expectations for that region in the second half of the year?

Sure, I think -- I would describe it as somewhat of a rebound from where we had been historically. And we had said before that we think that the foreign exchange currency issues are behind us. And I think maybe there is a little of that in the number in terms of getting back to normal. The business mix between the U.S. and EMEA is still slant towards the U.S. historically the company has been slanted to EMEA. So we think there is a pretty big opportunity, what we are doing is, we are focused on creating and driving our verticals. And if you look at in our [dark] [ph] region, which is primarily driven by Germany. We have the highest market share and target markets like manufacturing, healthcare, government of any country in the world. And if you look at the opportunity for us to leverage on our existing strength already and selling the solutions bundle. That in itself creates an opportunity. We have -- when we say we have 12% penetration of solutions customers around the world in that particular region in Germany, you might look at more like 20%, 25%. So if the opportunity for us to focus on our verticals focused on where we are really successful build out the reference architecture, get the at-bats with our partners in that territory. And we think that will drive growth. we are underweighted in some countries in Europe and if we get to where we should be in some of those countries that in itself will create growth.

Thank you so much.

Thank you.

All right. Thank you.

Thank you. And I'm showing no further questions at this time. I would now like to turn the call over to Ed Meyercord for closing remarks.

Okay. Thank you very much. We appreciate everyone participating on the call and all the good questions. We are excited at Extreme. As I said earlier, there is a lot going on at the company and this idea of year-over-year growth in this quarter; we are lazar focused on that. And we look forward to updating you after we post those results. So thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great.