Earnings Call Transcript
Extreme Networks Inc (EXTR)
Earnings Call Transcript - EXTR Q2 2021
Operator, Operator
Thank you for joining us for the Extreme Networks’ Q2 FY ‘21 Financial Results Conference Call. All participants are currently in a listen-only mode. After the presentations, we will have a question-and-answer session. I will now turn the conference over to your host Mr. Stan Kovler. You may begin.
Stan Kovler, Vice President of Corporate Strategy and Investor Relations
Thank you, operator, and welcome to the Extreme Networks Second Fiscal Quarter 2021 Earnings Conference Call. I’m Stan Kovler, Vice President of Corporate Strategy and Investor Relations. With me today are Extreme Networks’ President and CEO, Ed Meyercord; and CFO, Remi Thomas. We just distributed a press release and filed an 8-K detailing Extreme Networks’ preliminary financial results for the quarter. For your convenience, a copy of the press release, which includes our GAAP to non-GAAP reconciliations, is available in the Investor Relations section of our website at extremenetworks.com. I would like to remind you that during today’s call, our discussion may include forward-looking statements about Extreme Networks’ future business, financial and operational results; growth expectations and strategies; the impact of the COVID-19 pandemic, the potential impact of any adjustments to the company’s distributor rebate reserve, changes resulting from the completion of the quarter-end review process, new product introductions, operations, and the impact of tariffs. We caution you not to put undue reliance on these forward-looking statements as they involve risks and uncertainties that could cause actual results to differ materially from those anticipated by these statements as described in our risk factors in our 10-K report for the period ending June 30, 2020, filed with the SEC. Any forward-looking statements made on this call reflect our analysis as of today, and we have no plans or duty to update them, except as required by law. Now, I will turn the call over to Extreme Network’s President and CEO, Ed Meyercord.
Ed Meyercord, President and CEO
Thank you Stan and thank you all for joining us this evening. I want to recognize and acknowledge the efforts of Extreme employees and their families, our valued community and partners, customers, and our investors. The duration of the pandemic continues to impose challenges for everyone. It’s remarkable the efforts that people have put forward and their commitment to Extreme, and we emerge stronger than ever before as a company. Our preliminary Q2 results mark the third consecutive quarter of sequential growth and reflect increased customer demand and continued improvement of our team’s execution across the board. I will have Remi address the potential one-time and non-cash accounting adjustments to our financial statements. In my comments, I will refer to financial results as normalized to address the fact that our accounting adjustments have no impact on our business or our outlook. We outperformed our initial expectations for revenue and earnings, achieved record gross margin and operating profit, and hit double-digit operating margins two quarters ahead of our expectations for fiscal ‘21. These results demonstrate strong cash flow which we used to pay down $40 million of our debt and reduce our leverage. Focusing on our results, cloud has emerged as a critical lifeline for our customers' digital transformation efforts, which have accelerated due to COVID-19. Schools, governments, healthcare organizations, and enterprises are all managing increasingly distributed networks, users, and activities. Students learning from home, the delivery of remote healthcare, and flexible work-from-home models are all here to stay. These trends are driving our new cloud subscription bookings, which grew 140% year-over-year in Q2. We believe the evolution of networking will continue to become more and more distributed, and what we call the infinite enterprise. We are developing innovative next-generation technologies to lead this next market transition. Our competitive differentiation is becoming more pronounced as we are gaining more share than our competitors in cloud-based networking. We currently manage nearly 1.5 million networking elements on our Extreme Cloud IQ platform, marking six straight quarters of sequential growth in the number of customer accounts and managed devices. Digital transformation, and more specifically, network transformation, is driving our customers’ ability to execute in the current environment. Historically, the network has been an untapped resource when it comes to meaningful data that can influence and positively improve business and customer outcomes. One of the strongest differentiators of our platform is access to unlimited customer data for business and technical users to optimize network performance and deliver contextual user experiences. These data insights can be leveraged in real time, and usage trends can be evaluated over prior periods to empower strategic decision-making. We remain the only networking vendor to provide unlimited data to our cloud management subscribers, delivering AI-driven networking insights necessary to compete and advance. Enterprises without clear and realistic plans to support the evolving types of technologies, devices, and applications and people who connect to the network will fall behind. We provide our customers the tools and resources they will need to move on from high-cost and complex infrastructure with our simple, secure, cloud-driven networking solution, making it easier for them to take the next step in their digital transformation journeys. Extreme stands alone in providing unprecedented choice to manage edge-to-edge data center networks, privately on-prem or in any major public cloud. Enterprise customers are all embracing a hybrid cloud environment with different applications running in various public clouds, private clouds, or on-prem. Our ability to support network connections and manage seamlessly in all cloud environments provides unmatched flexibility and effortless experiences. We continually reinvent ourselves to challenge complexity and convention in our quest to make the customer experience effortless. That’s how we do business. We also provide industry-leading customer support and flexible as-a-service subscription options. Our simplified portable cloud licensing and universal hardware platforms can adapt to new use cases at the push of a button, providing much-needed flexibility and investment protection. Our sales growth is being driven by our go-to-market transformation. Our new sales leadership is driving results, yielding more opportunities through the channel. By making our channel strategy the main engine for growth, we increase customer focus and opportunity management. By clarifying and refreshing our portfolio, we have transformed our business. We created more feet on the street with our channel partners and put more trained sellers on the ground. Our cloud channel has contributed over 2.5 times more pipeline and leads than in fiscal 20. This is a fundamental and structural change in our business that we believe will make our growth more sustainable. Our strategic sellers are thus more focused on larger and more strategic opportunities, driving business with new and existing customers. 39 customers spent over a million with Extreme in Q2, about twice the usual number. We expect this growth to spill over into Q3 as we expect better-than-usual seasonality in the March quarter. The automation of our business has helped us drive sales productivity with initiatives like channel self-service. We can add channel partners who transact with us seamlessly, and we are rapidly growing the number of transactions done through self-service. Our distributors and partners are embracing our ability to improve business velocity and deliver an effortless experience. The next steps in our cloud evolution will be to focus on customer success and drive user adoption and the number of devices on our Extreme Cloud IQ platform. The journey of cloud networking for many of our existing customers started with wireless LAN, but with our universal platform for switching, the evolution of our management tools, and in the future our ability to manage third-party devices, we will fulfill our vision of the infinite enterprise. In summary, pivoting to invest in innovation and an effortless experience for employees and customers is now paying dividends and will continue to drive growth going forward. We were especially pleased with the strong sequential growth of our EMEA business this quarter. On a bookings basis, both our Americas and international segments are now back to fiscal ‘20 levels in Q2, and we expect growth to accelerate into the second half of our fiscal year. Q2 also marks the return to sequential growth in wireless, with a 14% quarter-over-quarter unit shipment growth. We expect wireless to once again fuel our growth in the second half of fiscal ‘21 as sports venues and retail verticals begin to recover further over the next several quarters. Our new wired products are seeing increased demand in the marketplace with strong new product revenue from recently released switches such as the 5520 universal platform. Our new products are both more competitive and deliver a higher gross margin. We have a wide range of new product introductions set for the next calendar year to expand our universal product platform with cloud-native management for switches on a truly unified cloud platform. We also saw early orders from some of our largest customers that are global leaders in a service provider ecosystem for 5G. 5G is a substantial growth opportunity for Extreme because of the highly focused investments we have made. First, we are in the early stages of rolling out a next-generation packet broker solution for one of the world’s largest service providers. Second, we’re co-developing an embedded technology into the full stack of a 5G and FDI solution with one of the largest telecom equipment vendors. We expect to see growth begin to ramp in the second half of fiscal ‘21. We’ve created a global go-to-market sales and services team, as well as a focused R&D team of engineers, to specifically address this massive 5G opportunity. In addition to our existing customers, we will also bring our solutions to other large service providers around the world. Heading into the second half of fiscal ‘21, we’re planning to achieve double-digit year-over-year revenue growth, record gross margins, and double-digit operating margins. Our funnel remains strong, and our visibility continues to improve as we emerge as a stronger, more competitive company and take share. With that, I’ll turn the call over to our CFO, Remi Thomas.
Remi Thomas, CFO
Thanks, Ed. As Ed noted, we had a very solid quarter and executed well across the board. As you are aware, upon completing our quarter-end procedures, we identified a potential understatement of the reserve for our distributed rebate program. The review is ongoing, which is why we’re providing a preliminary outlook for our future results. We may make a non-recurring adjustment to contra revenue in our financial statements, which would not impact our reported cash balance as of December 31. We expect to file our financial statements on time and will provide an update if necessary. Based on our preliminary Q2 performance, our results exceeded our outlook across all our financial metrics for the third consecutive quarter. Our updated range for Q2 of $238 million to $248 million is above our prior guidance of $235 million to $245 million. We also anticipate sequential improvements in gross margin for the third consecutive quarter. Our new non-GAAP earnings per share outlook of $0.11 to $0.17 is above the previous range of $0.09 to $0.12. The strong quarter-over-quarter recovery in our bottom line was a function of a higher updated gross margin outlook of 60.7% to 62.1% versus our prior range of 60% to 60.6%. The combination of higher anticipated gross margins and tight expense control results in an operating margin range between 9.5% to 12.2% of revenue, up from a range of 8% to 9.5% implied in our initial guidance. The significant cash flow generation we achieved allowed us to pay down $40 million in debt and strengthen our balance sheets further. New cloud subscription grew 40% sequentially and 140% from the year-ago period. Based on our Q2 bookings, our total cloud managed subscription business reached over $80 million in annualized run rates. The growth of cloud subscription and service renewals resulted in deferred revenue of $309.1 million, up 4% sequentially and quarter-over-quarter. The growth of deferred revenue should sustain our recurring revenue and subscription revenue growth. From a booking’s perspective, the American region grew 2% year-over-year on higher volume and larger deal sales, while continuing to lead the way with above corporate average new cloud subscription growth. Our international business grew 3% year-over-year in bookings across products, services, and subscription. We anticipate year-over-year growth to accelerate during the second half of fiscal ‘21. From a verticals perspective, six out of our eight major verticals were up quarter-over-quarter. We saw sustained demand in government and education spending, a rebound in the healthcare business on both a year-over-year and quarter-over-quarter basis, strong sequential growth in service provider, and another modest sequential recovery in retail and transportation and logistics. Segments of our business, such as sports and entertainment, are set to recover in the second half of fiscal ‘21 based on recent new wins. Our updated non-GAAP gross margin outlook reflects expectations of an improvement in product gross margin driven by higher volume, a greater mix of higher margin new products, and lower freight and tariff costs. As anticipated, the modest sequential increase in operating expenses was due to higher commissions related to revenue growth offset by greater efficiency in our R&D spending. The expected recovery in our operating profit combined with the pre-management of operating working capital resulted in higher cash generation and enabled us to strengthen our balance sheet. After paying down $35 million to complete the repayment of our $55 million in revolving debts and making a principal payment of $4.8 million on our term loan, we ended Q2 with $184 million in cash and equivalents compared to $193 million at the end of Q1. This resulted in a net balance of $172.3 million, down from a net debt balance of $202.9 million in Q1 and $234.9 million in the year-ago quarter. We made sequential progress in reducing our inventory levels to $49.9 million, down from $55.8 million at the end of Q1. The year-over-year and quarter-over-quarter decreases in inventory largely reflect improved demand planning, SKU rationalization, and higher inventory turnover. Now, turning to guidance. We expect Q3 revenue to be in the range of $240 million to $250 million, a better than seasonal quarter. Q3 GAAP gross margin is anticipated to be in the range of 58.4% to 59.5%, and non-GAAP gross margin in the range of 61.5% to 62.5%. Q3 GAAP operating expenses are expected to be in the range of $137.6 million to $139.6 million, and non-GAAP OpEx in the range of $126 million to $128 million. The sequential increase in OpEx is primarily related to higher sales commission we anticipate and higher salary accruals as well as the FICA accrual reset. Q3 GAAP earnings are expected to be a net loss in the range of $5.5 million to a net income of $1.1 million, or a loss of $0.04 to earnings of $0.01 per share. Non-GAAP net income is expected to be in the range of $13.5 million to $20.1 million, or $0.11 to $0.16 per diluted share. In Q3, we expect average shares outstanding to be approximately 124.7 million on a GAAP basis and 126.6 million on a non-GAAP basis. With that, I will now turn it over to the operator to begin the question-and-answer session.
Operator, Operator
Thank you. Our first question comes from Paul Silverstein of Cowen. Your line is open.
Paul Silverstein, Analyst
Thanks. I appreciate you taking the questions. Just a couple from me. First off, Remi, what are the primary drivers of the improving gross margin?
Remi Thomas, CFO
So this quarter was primarily driven by product gross margin. We continue, as you know, to introduce new products that carry a lower bill of material, so that’s helpful. We also had a positive shift in the mix among our products. That basically drove higher gross margin because the products that recovered enjoyed stronger gross margins. We also enjoyed this quarter the benefit of a sequential drop in freight cost. It’s not quite back at the pre-COVID level, but they’re trending down as well as lower tariff costs. So the combination of all these three factors explains why the product gross margin was strong this quarter.
Paul Silverstein, Analyst
All right. Before I ask you about visibility on revenue, on gross margin, I trust there’s not much of any risk of gross margins backsliding below that 60% level. You guys are now nicely above that. It sounds like you’ve already crossed that bridge. But I want to ask you as a question, is there any risk of backsliding?
Remi Thomas, CFO
No, no. If anything, we expect the gross margin to continue to improve. The trends that I just described specifically for tariffs are going to get better in Q3. Overall, you saw that recurring revenue this quarter was 30%. It compared to two quarters ago down a bit because product has been picking up sequentially. But over time, with the $309 million of deferred revenue that I talked about, we should be expecting our subscription and support revenue to increase as a percentage. Structurally, those two activities carry higher gross margins. That should drive our gross margin up. So we’re pretty optimistic about the gross margin trends.
Paul Silverstein, Analyst
Yes, that’s what I figured. I appreciate you anticipated my question, which is, is it possible to quantify at this point now that you crossed the 60% bridge and directionally things are improving, is it possible to quantify over the next year or two what a reasonable best-case gross margin profile could be, if things go right?
Remi Thomas, CFO
We feel comfortable about the ability for us to maintain in the 61 and a half to 62 and a half for the next couple of quarters. As we see the recurring revenue trending higher, that number could go up. But for the, let’s say, the next few quarters, you should be thinking of us as being a 61 and a half to 62 and a half percent gross margin company.
Paul Silverstein, Analyst
All right. I have one last question. Regarding visibility, last quarter you and Ed mentioned that business trends related to the global macroeconomic lockdown were showing constant improvement on a quarterly, monthly, weekly, and almost daily basis. Is that still the case? Are you continuing to see an ongoing increase in business activity, even if it’s not perfectly linear? Additionally, how much of the strength in government and education is associated with E-Rate? I assume there is a connection, but how significant is it? Thank you.
Remi Thomas, CFO
That’s a great question. So I will make two comments. The first one is on what we’ve discussed with you, Paul already, which is what we call the run rate business, sometimes referred to as repeat business, which involves orders less than $50,000 that are really generated by the installed base. In the last three months of 2020, we saw a pickup in that business, which we feel was related to year-end spending, as well as the accumulation of sort of pent-up demand from the month of March to May when not much happened. And so that trend we really saw across the board. As we now enter January and go into the March quarter, obviously, we don’t benefit from the year-end seasonality, but we do see this run rate business continue to be healthy. As for the overall demand, education and government were clearly the strongest verticals. If you think about Q4 fiscal ‘20 and Q1 of fiscal ‘21, what we’ve seen in the last quarter is other segments, which have been subdued, specifically healthcare and service provider and communications equipment, starting to pick up as early as Q2, which bodes well for us. The next sector that we expect to pick up, which has not yet would be sports and entertainment, which is stuck at less than 2% of bookings right now, but we do have those new wins, specifically with MLB. That should allow this vertical to be the sort of the final one to pick up in the quarters to come.
Paul Silverstein, Analyst
Go ahead.
Ed Meyercord, President and CEO
I think you did a great job answering that question, Remi. One important point related to the gross margin question is that we implemented what we call channel self-serve. Our partners are increasingly active and eager to work with Extreme, and they are embracing our cloud offerings. Our partners are driving growth, and we are enhancing our lead generation activities through them. We are also supporting our partner teams differently than before, enabling sellers to reach larger customers. In terms of COVID, we are seeing a return in some sectors like sports venues and retail. The recent economic news indicates that the economy remains strong, and from that perspective, we continue to see strength. Although Extreme is a smaller player compared to some larger companies in the industry, we are gaining market share. For Extreme, even small incremental share gains are significant for our revenue and growth, and we are clearly making strides in that area.
Operator, Operator
Thank you. Our next question comes from Christian Schwab of Craig-Hallum. Your line is open.
Christian Schwab, Analyst
Thank you. My only question is about the 5G opportunity. Ed, you mentioned the words substantial and massive. Should we consider that to imply a $1 billion-plus potential run rate, and should we view it as a $50 million to $100 million revenue opportunity?
Ed Meyercord, President and CEO
Yes, it depends on what period of time we are referring to, Christian. Over the long term, it’s much bigger. We talk about two different growth vectors. One is with a specific next-gen packet broker where we see ourselves being full, I’ll call, 12, 18 months ahead of any other competitor in the industry. We have a very large customer that is a long-standing customer. Our application is well-defined and pretty unique to them. However, the technology could be applied to other service providers around the globe, and the technology differentiation is real. In the second case, we have one of the world’s largest telecom infrastructure providers as we’re built into their solution, and they’re going out to service providers for 5G. We have an opportunity to leverage that relationship to go out to all of the service providers around the world. Based on their competitive position in the market, we see that taking off. In addition to that one opportunity and that one growth vector within that company, there are other growth vectors that are available. We have one of the highest vendor ratings of any of their vendors, and they will open doors for us for new opportunities. I think you’re a little short in terms of how you’re thinking about the market potential for Extreme. We’re taking a long-term approach here in what this could be. Obviously, we’re not providing guidance on a longer term, but I think you’d probably have to take it up a bit.
Christian Schwab, Analyst
Okay. And then would you expect that the majority of that to be shipped? You talked about it ramping in the second half of this fiscal year. Is that something that’s going to be sold for many years or a significant portion of that will be sold within the next year or two, would you imagine?
Ed Meyercord, President and CEO
No, it would be many years. I think this 5G deployment will be the largest investment in telecom infrastructure in history. This is something that we see going on for at least the next 15 years because of the differences in 5G and what it means for last-mile connections. It’s a very different technology, and we’re just excited to have some pretty amazing partners to be going out into the market with. There are different ways to win that are new growth vectors that we haven’t had before. Extreme has never had this kind of a growth opportunity.
Christian Schwab, Analyst
Right. I understand the packet broker business of Brocade and how they were sole-sourced at both 3G and 4G. It seems you think that might be the case at 5G as well?
Ed Meyercord, President and CEO
We do.
Christian Schwab, Analyst
Okay. Yes. Okay, great. I don’t have any other questions.
Ed Meyercord, President and CEO
Thanks, Christian.
Operator, Operator
Thank you. Our next question comes from Alex Henderson of Needham. Your line is open.
Alex Henderson, Analyst
Yes. I just wanted to go back to that last answer. When you say it’s significantly larger than the $50 million to $100 million that Christian threw out, I think you’re referring to over an extended period of time. I think his question was really reflecting, is it potentially $50 million to $100 million in an annual revenue opportunity as opposed to over a long period of time, multiyear opportunity? Can you just clarify that response relative to the scaling as an annual run rate?
Ed Meyercord, President and CEO
Yes. And that’s what I was referring to. That’s I answered the question the way you’re thinking about it, Alex. And what I would say is we have an investor day coming up.
Alex Henderson, Analyst
So that it’s over a long period then, not over?
Ed Meyercord, President and CEO
No. The answer is no.
Alex Henderson, Analyst
You think it could be $50 million to $100 million annually?
Ed Meyercord, President and CEO
Correct. Yes.
Alex Henderson, Analyst
And a final question, go ahead.
Ed Meyercord, President and CEO
Yes. I was just mentioning that we have an investor day coming up, and Nabil Bukhari, our Chief Technology Officer and Chief Product Officer, will provide detailed insights. We will also discuss our new growth vectors related to 5G and their implications. We have hired a new Senior Vice President to manage this initiative, targeting an annual opportunity between $50 million and $100 million. Looking a few years ahead, this goal involves expanding our addressable market to include other service providers who are assembling teams to focus on this new growth area, thanks to the technological differentiation and innovation we are introducing.
Alex Henderson, Analyst
I wanted to ask about the SolarWinds hack instead of clarifying the previous questions. First, I assume you were not affected by it, otherwise, we would have heard something. Have you discussed with executives such as CISOs and CIOs the impact of the SolarWinds hack on spending intentions, especially regarding security-related products or networking budgets? How do you think this will affect spending?
Ed Meyercord, President and CEO
Yes, I can confirm that there was no impact on Extreme from the SolarWinds situation. We managed to avoid any issues and do not anticipate a decline in networking spending. In fact, as networks become more distributed and companies concentrate more on edge computing and providing a consistent user experience, there will be increased investment in networking. The importance of networking has become more apparent, especially in light of the pandemic, which has accelerated this trend. Additionally, the SolarWinds incident has highlighted the critical nature of security. I'm proud to say that we offer the most secure cloud in the industry and hold all necessary security certifications. This assurance of security is likely contributing to our success in capturing market share in cloud services, particularly regarding the protection of customer data within ExtremeCloud IQ.
Alex Henderson, Analyst
Okay. So just to be clear, you haven’t heard anything specific from the C-suite about increasing IT budgets or changes to budget mixes since that’s occurred?
Ed Meyercord, President and CEO
We are very focused on networking, and we are seeing strong demand in this area. There has been an increase in the digital transformation of networking among our enterprise clients.
Operator, Operator
If I could shift gears, can you just give us an update on when you expect, A, to expand the universal product line and B, to be complete on that launch? I think the last time we talked, you said the December quarter would be when the universal line would be fully implemented and fully deployed. Is that still the schedule? And when’s the next set of products coming out to help fill that out?
Ed Meyercord, President and CEO
So we’ve come out with the 5520, and it’s a very healthy switch. But what we’re coming out with in, I would say, the April timeframe, is the next universal switch in the universal switch family, which is a high runner. Later in our calendar third quarter, we expect the next family of switches coming out in the universal family. We’re there on the wireless side as well. So expect to see more wireless products that are coming out of the universal platform, and then early Q4, I think you’ll see an impact from the next family of universal switches coming out.
Alex Henderson, Analyst
If I could just follow up on that question, Remi, considering that your margins have already increased toward the 62% level before the universal products are fully launched, how much growth do you anticipate from these products once they achieve full adoption and availability?
Remi Thomas, CFO
I wish introducing a new product range would have an impact of more than 100 basis points. But typically, the impact that we see, because some of that, obviously, is given back to customers and partners, is in the form of discounts to remain competitive. It’s typically tens of basis points impact, and I would expect that to play out over the next, I would say, four quarters. The majority of the range in edge or aggregation will have been launched by the end of this calendar year. We should be seeing some benefit from that in the first half of fiscal ‘22 for us.
Alex Henderson, Analyst
Thank you very much.
Operator, Operator
Thank you. Our next question comes from Dave Kang of B. Riley. Your line is open.
Dave Kang, Analyst
Thank you. Good afternoon. Nice quarter, gentlemen. My first question is actually a clarification. I may have missed it. Subscription bookings, it was 140% year over year. Did you give a sequential number?
Remi Thomas, CFO
Let me see if I can find it real quick. I remember that it was 100%, but I’m just checking.
Ed Meyercord, President and CEO
It was 40%. Dave, it was a 40% sequential growth.
Dave Kang, Analyst
Got it.
Ed Meyercord, President and CEO
Our field teams have fully adopted the cloud, and customers recognize the need to consider cloud solutions. If you're looking at cloud options, Extreme is a critical consideration. We're observing an increase in this trend, and our teams have integrated cloud technologies more comprehensively. Recently, we've made our management software, XMC, available in the cloud. XMC oversees numerous devices, and we anticipate that migrating XMC to the cloud will further enhance growth in cloud subscriptions due to the extensive range of devices managed by that platform.
Dave Kang, Analyst
Got it. And then regarding recurring revenue, when do you think that will reach your target of 40%? Is that something that can happen maybe next calendar year? And once it does, where does your gross margin go? Perhaps mid-60s?
Remi Thomas, CFO
Yes. We’ll provide more color on that at the analyst day. Dave, it’s going to take longer than calendar ‘22. I think we’re probably two years out before we reach the high 30s. But hopefully, with the deferred revenue balance that I mentioned of $309 million and continuing to grow more than 100% on a year-over-year basis, we see a path to getting there, but we won’t be there for calendar ‘22.
Dave Kang, Analyst
Okay. So maybe calendar ‘23, when you get close to that, where does your gross margin go?
Remi Thomas, CFO
Look at the overall services and subscription gross margin today, which is in the mid-60s, and think about the fact that the subscription margin itself is higher than the services margin. As cloud subscription grows, that 65% should be increasing. I don’t want to provide specific guidance ahead of the analyst day, but I just want to provide some metrics for you to get an idea of where it should be headed.
Dave Kang, Analyst
Sure. I have a couple more questions. Regarding the packet broker, it seems like you shipped it in the December quarter and it's starting to ramp up as we move into this calendar year. Is that correct?
Ed Meyercord, President and CEO
We’re expecting the packet broker product to be more of a Q4 fiscal ‘21 event in terms of its impact on bookings and revenue. I believe it's the other 5G opportunity that is gaining traction and beginning to ramp up in a more significant way.
Dave Kang, Analyst
I thought that was more like a September quarter, but it sounds like it got pulled in then?
Ed Meyercord, President and CEO
Yes. I’m not sure how that was guided previously, but that has been on a very continuous path. How this evolves is that, yes, our customer is selling to large service providers. As they start to embrace the solution, that starts to ramp. I would say we’re at the very early stages of adoption of the solution. It’s a very large service provider. So it’s being successful, and we’re starting to see that ramp. Packet broker, we see coming into our fiscal Q4 and then fiscal Q1 of ‘22.
Dave Kang, Analyst
Got it. Just to be clear on the first one that you talked about, the one that’s currently ramping. I assume that’s the European network equipment vendor. And as Alex was talking about this, you’re talking about $50 million to $100 million annually, just to be clear?
Ed Meyercord, President and CEO
Yes. We’re packaging 5G, yes, all of our 5G opportunities in that bucket.
Dave Kang, Analyst
But $50 million to $100 million annually, though, right?
Ed Meyercord, President and CEO
Yes.
Dave Kang, Analyst
Okay. I have one last question. Actually, a couple more. How might demand dynamics shift in the ORAN, open RAN environment for the European customer? Will they continue to choose your solution, or could that change?
Stan Kovler, Vice President of Corporate Strategy and Investor Relations
Thanks, David, and we’ll have to move on after this one.
Ed Meyercord, President and CEO
Yes. I’m not sure I heard the question, Dave. Sorry.
Dave Kang, Analyst
In the ORAN, open RAN environment, will they continue to choose your solution, or could that change?
Ed Meyercord, President and CEO
No, I mean we’re at the very early stages, David. It’s very, very early. I think we are at the very early stages of a large addressable market for this particular solution. What’s going on with RAN might only enhance the requirement for the full-stack solution we’re a part of.
Stan Kovler, Vice President of Corporate Strategy and Investor Relations
Thanks, operator. Can we move on to the next questions?
Operator, Operator
Our next question comes from Eric Martinuzzi of Lake Street. Your line is open.
Eric Martinuzzi, Analyst
Yes. Maybe I missed it, but what is the deadline for getting the December quarter buttoned up? When are you expecting to have that done by and what’s the deadline?
Remi Thomas, CFO
So the deadline for filing is February 9, and we obviously expect to complete our reviews and file timely.
Eric Martinuzzi, Analyst
Okay. I was impressed by the robust guidance, as it surpassed my expectations and the consensus. However, I anticipated that Q3 would show a sequential decline. What is driving the sequential growth you are experiencing? Could you break it down by specific product categories? Clearly, you have the pipeline to support the $245 million guidance at the midpoint. Please provide more detail.
Remi Thomas, CFO
Yes. Since we have not finished our review of these possible adjustments, we are providing a broad revenue range because we believe there could be an impact or adjustment required. This is why, if you take the midpoint of our range and compare it to our guidance, you will notice a slight increase. Before this adjustment, we would have anticipated a slight decrease. Certain sectors had not recovered by December, particularly sports and entertainment. However, we observed that healthcare has been recovering since last quarter, which will help us lessen the typical seasonal impact expected in March.
Eric Martinuzzi, Analyst
Got it.
Ed Meyercord, President and CEO
I’d like to provide some additional detail on this. We have observed significant pent-up demand after winning Major League Baseball, which is a major achievement with numerous stadiums involved. Having the league gives us a unique opportunity to reach out to each club, and we anticipate a lot of developments taking place as they aim to complete these projects before spring training. We also expect to see increased spending in the NFL and NASCAR, where we have a strong presence and numerous chances to expand. Additionally, we’re noticing a rise in service provider opportunities, as we previously mentioned. Overall, we are seeing heightened interest in our cloud platform from traditional enterprises. This increased cloud adoption and the desire to understand our unique solutions is creating more opportunities, which we are observing in our sales pipeline.
Eric Martinuzzi, Analyst
Thank you.
Operator, Operator
Thank you. Our next question comes from Erik Suppiger of JMP Securities. Your line is open.
Erik Suppiger, Analyst
Thank you for the question. Firstly, regarding Cloud IQ, can you discuss how the product mix is evolving? Is it mainly focused on WiFi products, or are wireline products starting to make up a larger share?
Ed Meyercord, President and CEO
Yes. I would say, today, a high 90% number would be wireless products. We just came out with the 5520 that’s got an embedded Cloud IQ license. We’ve started selling those. As I mentioned in my comments, Erik, we’re really focused on adoption. We’ve sold the switches that have got embedded licenses. Now we’re starting to see the very initial adoption, and then we’re expecting that to ramp very quickly. I also mentioned that our XMC, which is our Extreme Management Center platform, was a perpetual license on-prem software, and we’ve made that part of our cloud offering. You’re going to see a lot of switches coming into our cloud associated with the migration of traditional perpetual software to subscription software from the cloud with the migration of a lot of customers; that’s happening globally.
Erik Suppiger, Analyst
Do you think switches could reach 5% in the next few quarters?
Ed Meyercord, President and CEO
We haven’t really come out with that. But I would say that’s something we should address on investor day coming up. That’s a great topic for investor day.
Erik Suppiger, Analyst
Can you talk a little bit about your supply chain? Are there any component issues, or has the supply chain pretty much eased up at this point?
Ed Meyercord, President and CEO
Yes. I think at this stage, the semiconductor industry is feeling a lot of demand across multiple industries. We compete for our chips, but we have an excellent relationship with Broadcom. We consider them to be strategic partners, and they work with us very closely. So we haven’t really seen supply chain constraints; I think because of the strength of those relationships. But we do understand that it is tight out there. Certain products’ lead times have increased, but for us, it’s not an issue.
Erik Suppiger, Analyst
But there are some related chips that are still pretty long lead times?
Ed Meyercord, President and CEO
Yes. That’s the nature of our business. I would say there’s more pressure now than there has been before, but I think because of the partnership and the relationships we have, we just have to be smarter about how we buy.
Erik Suppiger, Analyst
Do you think some of your competitors are getting hurt by some of the constraints out there?
Ed Meyercord, President and CEO
We wouldn’t be surprised, but I don’t think we have enough knowledge to comment.
Erik Suppiger, Analyst
Okay. And lastly, can we assume tariffs are not a factor for you in light of having moved your supply chain in light of the new administration? I’m just wondering if that will make any difference from a tariff perspective.
Remi Thomas, CFO
Actually, Erik, I was going to say that tariffs, as I mentioned in my preliminary comments, have been a benefit to gross margin in Q2. We expect that to continue to be the case not because they have been removed, not because we have relocated our supply chain, which we still have a mix of China, Taiwan, and Mexico. That mix has not changed, but more because we have implemented a new method in terms of the way we claw back those tariffs. That has been a benefit to us in terms of the cost of the tariff that’s embedded in our cost of goods sold.
Erik Suppiger, Analyst
Is that going to improve if they get away from tariffs?
Remi Thomas, CFO
It would actually improve. We’re going to see the benefit of what I just described in fiscal Q3 and fiscal Q4. If for any reason the new administration were to remove tariffs altogether, then we would reap that improvement to be sustained over time.
Erik Suppiger, Analyst
Okay, very good. Thank you.
Operator, Operator
Thank you. Our next question comes from John Roy of Water Tower Research. Your line is open.
John Roy, Analyst
Great. Thank you very much. So Ed, you were talking about enterprises being interested in your cloud. Maybe you could give us a little color on the larger client and enterprise business last quarter and what you project might be interesting going forward?
Ed Meyercord, President and CEO
I can provide an example of a significant customer and a substantial potential customer where we positioned ourselves favorably against the two largest competitors in our industry. One advantage we have is that our largest competitor faces structural challenges that limit their cloud offerings. When they compete for enterprise clients, it often feels like they operate as two distinct entities. Their capabilities in delivering a comprehensive end-to-end cloud management platform are quite restricted. We have greater coverage in terms of end-to-end cloud services from the edge to the core of the network than any competitor in the industry. Another unique feature we offer is cloud choice. Enterprise customers often work in hybrid environments, utilizing applications across different public clouds, private clouds, or their own hosted clouds. We provide solutions for all three and the ability to manage those environments through ExtremeCloud IQ. No one else can offer that, particularly not our two largest competitors. If you value flexibility in cloud choice, we have a solution that offers flexibility unmatched by others. Data is also a crucial aspect we emphasize. Networking has been the last area to fully leverage data. The intelligence available on a network, including all connected edge devices, users, and the applications they access and when, allows for significant insights. The goal is to centralize the network to collect these insights and have a single point to influence business outcomes. We offer unlimited data collection, and it seems logical to utilize it while our competitors do not. Lastly, security is paramount. We provide the most secure cloud, with ISO and SOC certifications. For those concerned about security—an important consideration for enterprises—you want to ensure that your network data is safe. We are the only ones capable of delivering that level of security. These elements are significant differentiators for us, and they have opened new opportunities. We are succeeding in competitive scenarios because of these advantages.
John Roy, Analyst
Great. Thanks, Ed.
Operator, Operator
Thank you. Our next question comes from Woo Jin Ho of Bloomberg Intelligence. Your line is open.
Woo Jin Ho, Analyst
Great. Thanks for squeezing me in. So Ed, can you just talk about the nature of the RFPs today? Are we starting to get to a point where RFPs are starting to look more like the pre-pandemic era? Or are we still leveraging existing customers and customers are still looking around for upgrades to existing products?
Ed Meyercord, President and CEO
We see it changing. The industry is evolving, and we’re at the right place at the right time. Frankly, we’ve never been in a stronger competitive position because of our cloud. The traditional networking providers and where they have market share are seeing businesses evolving their networks now more than ever, as they consider the new normal, the next normal. People want a different perspective, a different view. That’s part of what’s opening up doors for us at Extreme.
Woo Jin Ho, Analyst
So does that imply that you’re able to adapt?
Ed Meyercord, President and CEO
We do not see the industry going back to the traditional model.
Woo Jin Ho, Analyst
Got it. Okay, and then the technology question, if I may. It looks like Wi-Fi 6e is around the corner, and I know that we're still early in the Wi-Fi 6 upgrade cycle. Does that technology now present a new opportunity to gain share in Wi-Fi as well as drive more Extreme cloud IQ business in the future?
Ed Meyercord, President and CEO
I think it's premature to make that call on Wi-Fi 6e. That said, we'll be right on the early end of the wave as far as the market is concerned.
Woo Jin Ho, Analyst
Great. Thanks a lot.
Operator, Operator
Thank you. I’d like to turn the call back over to Mr. Meyercord for any closing remarks.
Ed Meyercord, President and CEO
Thank you, operator, and I appreciate everyone participating in the call. Extreme is at a pivotal moment after many years of making acquisitions, building scale, and investing in merging our technology, teams, and cultures into one cohesive entity. We are now effectively One Extreme with a universal hardware platform and a shift to the cloud. This positions us to focus on innovation, marking an exciting time for us at Extreme. We believe this is the best time to be a partner or an employee of Extreme. I’d like to take a moment to express my gratitude to all participants on the call and recognize our employees, partners, and customers for their engagement and dedication, especially our employees for their excellent work during this period. I encourage everyone to register for investor day, where we'll share valuable insights and delve deeply into our technology and opportunities. Registration details will be shared soon. Thank you all, and have a pleasant evening.
Operator, Operator
Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you for participating. You may all disconnect. Have a great day.