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spk09: Ladies and gentlemen, thank you for standing by, and welcome to the Xtreme Network Q2 fiscal year 2021 financial results conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question at that time, please press star then 1 on your touch-tone telephone. As a reminder, today's conference call is being recorded. I will now turn the conference over to your host, Ms. Dan Kobler, so you may begin.
spk06: Thank you, Operator, and welcome to the Xtreme Network's second fiscal quarter 2021 earnings conference call. I'm Stan Kovler, Vice President of Corporate Strategy and Investor Relations. With me today are Xtreme Network's President and CEO, Ed Myercord, and CFO, Remy Thomas. We just distributed a press release and filed an 8K detailing Xtreme Network's preliminary financial results for the quarter. For your convenience, a copy of the press release, which includes our gap to non-gap 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 Xtreme Network's 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 can 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 30th, 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 Xtreme Network's President and CEO, Ed Meyerpord.
spk04: Thank you, Stan, and thank you all for joining us this evening. I want to recognize and acknowledge the efforts of Xtreme employees and their families, our extended community of 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 Xtreme to help us emerge stronger than ever before as a company. Our preliminary Q2 results marked the third consecutive quarter of sequential growth and reflects increased customer demand and continued improvement of our team's execution across the board. I will let Remy address the potential one-time non-cash accounting adjustment 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 drove 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 are accelerated by 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 in 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 making six straight quarters of sequential growth 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. In addition, 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 required to compete in advance. Enterprises without a clear and realistic plan to support the evolving types of technologies, devices, and apps 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, We make it easier for them to take the next steps in their digital transformation journeys. Xtreme 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 different public clouds, private clouds, or on-prem. Our ability to support network connections and to 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. It's how we do business. That's why 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 in 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, which increases customer focus and opportunity management, and by cloudifying 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. We flipped the script on funnel creation with cloud channel contributing over two and a half times more pipeline leads creation 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. Thirty-nine customers spent over a million with Xtreme 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 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 fill out our vision of the infinite enterprise. In summary, pivoting to investing 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 by our MIA 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 on 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 venue 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 of recently released switches such as the 5520 universal platform. Our new products are both more competitive and deliver a higher gross margin to extremes. 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 ordering from some of our largest customers that are global leaders in a service provider ecosystem for 5G. 5G is a substantial growth opportunity for Xtreme because of the highly focused investments we have made. First, we're 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 NFDI 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 on plan 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, Remy Thomas. Remy Thomas Thanks, Ed.
spk12: As Ed noted, we had a very solid quarter and executed well across the board. As you're aware, upon completing our quarter-end procedures, we identified a potential understatement of the reserve for our distributor rebate program. The review is ongoing, which is why we're providing a preliminary outlook for our Q2 results. We may make a non-recurring adjustment to contract revenue in our financial statements, which would not impact our reported cash balance as of December 31st. 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 outlook across all our financial metrics to the third consecutive quarter. Our updated range for Q2 of $238 to $248 million is above our prior guidance of $235 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 11 cents to 17 cents is above the previous range of 9 to 12 cents. The strong quarter-over-quarter recovery in our bottom line was a function of 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 debts and strengthen our balance sheet 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 rent rates. The growth of cloud subscription and service renewals resulted in deferred revenue of $309.1 million up 4% sequentially and a quarter of a quarter. The growth of deferred revenue should sustain our recurring revenue and subscription revenue growth. From a bookings perspective, the American region drew 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 product, 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 healthcare business on both the 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 expectation 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 expense was due to higher commissions related to growth in revenue offset by more efficiency in our R&D spending. The expected recovery in our operating profits, combined with the prudent 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 net debt balance down from 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 reflects improved demand planning, skew rationalization, and higher inventory turnover. Now turning to guidance, we expect Q3 revenue to be in the range of $240 to $250 million, a better than seasonal quarter. Q3 gap gross margin is anticipated to be in the range of 58.4% to 59.5% and non-gap gross margin in the range of 61.5% to 62.5%. Q3 gap operating expenses are expected to be in the range of $137.6 to $139.6 million and non-gap OPEX in the range of $126 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 gap earnings are expected to be in the net loss 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 one penny 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.
spk09: Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star then one on your text phone telephone. One moment, please. Our first question comes from Paul Silverstein of Cowan. The line is open.
spk07: Thanks, guys. I appreciate you taking the questions. Just a couple from me. First off, Remy, what are the primary drivers of the improving gross margins?
spk12: 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 amongst our products that basically drove higher gross margin because the products that recovered enjoyed stronger gross margin. And we also enjoyed this quarter the benefits of a sequential drop In freight costs, it's not quite back at the pre-COVID level, but they're trending down, as well as lower tariff costs. And so the combination of all these three factors explain why the product gross margin was strong this quarter.
spk07: Before I ask you, Annette, about visibility and 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?
spk12: No, no. If anything, we expect the gross margin to continue to improve. The trends that I just described specifically for tariff are going to get better in Q3. And overall, you saw that recurring revenue this quarter was 30%. And it's kind of 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, you should be expecting our subscription and support revenue to increase as a percentage. And structurally, those two activities carry higher gross margin. So that should be driving our gross margin up. So we're pretty optimistic about the gross margin transfer.
spk07: Yeah, that's what I figured, and I appreciate you anticipating my question, which is, is it possible to quantify at this point, now that you've 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, what you could attain if things go right?
spk12: We feel comfortable. comfortable about the ability for us to maintain it in the 61.5% to 62.5% for the next couple quarters. As we see the recurring revenue trending higher, that number could go up, but for the next few quarters, you should be thinking of us as being a 61.5% to 62.5% gross margin company.
spk07: One last question for me, if I may. On visibility, I think last quarter you and Ed had commented that business trends relative to global macroeconomic lockdown, that you were seeing constant improvement on a quarterly, monthly, weekly, almost daily basis. Is that continuing? If we think of monthly and weekly progression, are you continuing to see business activity pick up as a general proposition, if not perfectly linear, but on an ongoing basis? And tied to that, how much of the strength is government education tied to E-rate? I assume that's part of it, but how much of the strength is tied to that?
spk12: That's a great question. I would 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 is those orders less than $50,000 that are really being generated by the install base. In the last three months of 2020, we saw a pickup in that business, which we feel was related to year-round 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 going into the March quarter, obviously we don't benefit from the year-round seasonality, but we do see this run-rate business continue to be healthy. That's the overall. And then if I look at the verticals, 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 had been subdued, and I'm thinking specifically of healthcare as well as service provider and communications equipment starting to pick up as early as Q2, which bodes well for us. The next, you know, 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, you know, allow this vertical to be the sort of the final one to pick up in the quarters to come.
spk07: Ed and Remy, if I'm wrong.
spk04: Go ahead.
spk07: I'm sorry.
spk04: I was just going to say, Remy, I think Remy did a great job answering that question. And the one thing that shouldn't be lost, Paul, and it does relate to the gross margin question, is that we implemented what we call channel self-serve, which now our partners, and I think we have to shout out to the partners of Xtreme, we're seeing a lot of activity and growth with partners in the channel that really want to work with Xtreme. They're embracing our cloud. So Our partners are driving growth, and then what we're doing as far as all of our lead gen activities, we're pushing that out through partners, and then we're supporting our partner teams in a different way than we did before. And then we're allowing, as we referenced, sellers to really get out and sell larger customers. So I would say that as it relates to COVID, we're seeing the return of some verticals like sports venue and then also retail coming back. And then I think as everybody understands from the economic news last week, the economy remains strong. And from that standpoint, we continue to see strength. And Xtreme is a smaller player relative to some of the larger players in the industry, and we're taking shares. So for Xtreme, large, very small incremental share gains means a lot to our top line and to growth for Xtreme. And we are clearly taking share here.
spk09: Thank you. Our next question comes from Christian Schwab of Craig Hallam. Your line is open.
spk01: Great. Thank you. My only question has to do with the 5G opportunity. And I know you guys, Ed, you've used the word substantial, and then you used the word massive. Should we be thinking about that as kind of, I guess, at a billion-dollar-plus potential run rate? Should we be thinking about that as like a $50 million to $100 million revenue opportunity?
spk04: It depends over what period of time, Christian. Over the long term, it's much bigger. So we talk about two different growth vectors. One is with a specific company. next-gen packet broker where we see ourselves being the full alcohol 12-18 months ahead of any other competitor in the industry. We have a very large customer that is a long-standing customer and our application is dialed in 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 then they're going out to service providers for 5G. So we have an opportunity, you know, leveraging that relationship to go out to all the service providers around the world. And that could, based on their competitive position in the market, we see that taking off. in addition to that one opportunity and that one growth factor within that company, um, there are other growth factors that are available and we have one of the highest vendor ratings of any of their vendors. Um, and they, they will open doors for us for new opportunities. So I think you're a little short in terms of how you're thinking about the market potential for extreme, um, we're taking a long-term approach here and what this could be. Obviously, we don't provide, we're not providing guidance on a longer term, but I think you'd probably have to take it up a bit.
spk01: Okay. And would you expect that the majority of that to be shipped, you know, you talked about it ramping in the second half of this fiscal year. Is that something that's going to you know, be sold for many years or a significant portion of that will be, you know, sold within the next year or two, would you imagine?
spk04: No, it would be many years. It would be many years. I mean, this 5G deployment, you know, will be the largest investment in telecom infrastructure in history. And this is something that we see going on for at least 15 years. And because of the differences in 5G and then what does it mean for last mile connections and 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 and then different ways to win that are new growth factors that we haven't had before. Extremes never have this kind of a growth opportunity.
spk01: Right. So these are, you know, I understand and remember the packet broker business of Brocade and how they were, I think they were sole sourced at both 3G and 4G. So it sounds like you think that might be the case at 5G as well.
spk04: We do. We do.
spk01: Okay. Great. I don't have any other questions. Thanks, guys.
spk04: Thanks, Christian.
spk09: Thank you.
spk10: I just wanted to go back to that last answer. When you say it's significantly larger than the $50 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 to $100 million in an annual revenue opportunity as opposed to over a long period of time, multi-year opportunity. Can you just clarify that response relative to the scaling as an annual run rate?
spk04: Yeah, and that's what I was referring. I answered the question the way you're thinking about it, Alex. And, you know, what I would do is we have an investor day coming up.
spk10: So the answer was that it's over a long period then, not over an annual?
spk04: No, no, the answer is that it's annual.
spk10: Do you think it could be up to $100 million annually?
spk04: Correct. Yes. Okay.
spk10: The final question, go ahead.
spk04: Yeah, I was going to say, I think, I was just mentioning we have an investor day coming up, and Nabeel Bukhari, who, you know, he is our chief technology officer as well as our chief product officer and runs engineering. You know, you'll have an opportunity to hear him go into great detail, and then we'll also share all of the new growth factors that we have that relate, you know, around 5G and what it means. We've hired a new SVP who's going to be running this and taking, you know, what is, if you frame a $50 to $100 million opportunity on an annualized basis, if you go out, you know, a couple years and have that kind of a target, you know, we're talking about expanding the addressable market through other service providers. We're hiring teams specifically to go focus on this new growth vector given the technology differentiation and the innovation that we're bringing.
spk10: The question I really wanted to ask, as opposed to getting a clarification on the prior questions, was around the solar wind tech. First off, I assume that you guys were not impacted by it. Otherwise, I would have heard, I would assume we would have heard about that. But have you had conversations with C-Suite related people, CISOs, CIOs, about what the impact of the SolarWinds spend or hack was on spending intentions, particularly on either security-related products or on networking-related budgets. How do you see that impacting spending?
spk04: Yeah, I would just say, first of all, From a SolarWinds perspective, no impact at extreme. You know, we dodged that and did not have any issues. We do not see any impact to the downside of networking spend. In fact, you know, as networks become more distributed and as, you know, what we would say is enterprise becoming more of the, you know, more focused on, you know, the edge and delivering the edge and the investment being on delivering the user experience that normally an enterprise employee might have on-prem or on campus or on branch. Now they're going to have it in a more distributed way. If anything, we only see it fueling more investment networking and shining a light on the fact that networking is becoming more strategic today than ever before. So I think people are more aware of that now And what's happened with the pandemic and COVID has only accelerated that. And solar winds only shine the light on how important security is. And, you know, I think we, I will comment and shout out that we have the most secure cloud than any of our competitors in the industry. We're the only ones that have all the security certifications. And so as far as customer data being protected, I do think that's also having an impact as to why we're taking share in cloud because of the, you know, assurance of security within networking data that resides in Extreme Cloud IQ.
spk10: Okay, so just to be clear, you haven't heard anything specific from the C-suite about increasing IT budgets or change in budget mix or anything of that sort since that's occurred?
spk04: I mean, we're seeing, you know, on our side, we're very focused on networking, as you know. And we're seeing very healthy demand for networking. And we've seen an acceleration of the digital transformation of networking with our customers across all of our enterprise customers.
spk10: 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, 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 come out to help fill that out?
spk04: So we've come out on the – you know, we've come out with a 5520. And, you know, I would say that's a very – it's a very healthy switch for But what we're coming out with in the – I would say in the April timeframe is a – I would say the next universal switch in the universal switch family, which is a high runner. And then later in our – in the calendar third quarter, we expect kind of the next family switches coming out in the universal family. So we have – We're there on the wireless side as well, so I think you'd continue to see more wireless products that are coming out that are universal. And then early Q4, I think you'd see an impact from the next family of universal switches coming out.
spk10: If I could just follow up one last extension of that question, then I'll see the floor. Remy, to the extent that your margins have already moved up towards the 52% level before you get those universal products out, how much uplift do you see from those products finally getting to full, you know, full adoption and full availability from the full line so that if we look out beyond that launch, is that another couple hundred basis points or a hundred basis points or, you know, what is the benefit that's still to accrue from integrating all your products with a similar set of functionality, parts and components and all that sort of good stuff.
spk12: 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 and as a 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. To Ed's point, the majority of the range in edge and aggregation will have been launched by the end of this calendar year. So we should be seeing some benefit of that in the first half of fiscal 22 for us. Thank you very much.
spk09: Thank you. Our next question comes from Dave Tang of B Raleigh, your line is open.
spk02: Thank you. Good afternoon. Nice quarter, gentlemen. My first question is actually clarification. I may have missed it. Subscriptions, bookings, it was 140% year over year. Did you give a sequential number?
spk12: Let me see if I can find it real quick. I seem to remember that it was 100%, but I'm just checking.
spk04: It was 40%. Dave, it was a 40% sequential growth. Got it.
spk02: Yeah.
spk04: Yeah, I mean, our cloud, yeah, our field teams, you know, have all embraced the cloud, and, you know, customers know that they have to consider cloud, and if you're considering cloud, you need to consider extreme. So we're seeing, we're getting a lot more at-bats, and our field has embraced the cloud. We are also putting more and more technology into the cloud. Most recently, our management software, XMC, we made available to the cloud. XMC manages a lot of devices, so we're expecting the migration of XMC into the cloud to drive even further growth of cloud subscription because of all the devices that are managed under that management platform.
spk02: Got it. And then regarding recurring revenue, when do you think that 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? Maybe perhaps mid-60s?
spk12: Yeah, so we'll provide more color on that at the analyst day. Dave, it's going to take a little longer than calendar 22. I think we're probably two years out before we reach the high 30s. But hopefully, you know, 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.
spk02: Okay, so maybe calendar 23, when you get close to that, where does your gross margin go?
spk12: So look at the overall services and subscription gross margin today, you know, which is in the mid-60s. and think about the fact that the subscription margin itself, uh, is, is higher than the services margin. Uh, and so as cloud subscription grow, that 65% should be, should be increasing. So I don't want to provide specific guidance ahead of the analyst day, but I just want to provide some, some metrics for you to get an idea of where it should be headed.
spk02: Sure. Uh, just a couple more questions. I'm regarding, um, uh so actually three maybe uh packet broker so it sounds like it shipped uh in the december quarter and uh is starting to ramp heading into the this calendar year is that what's happening so yeah we're expecting packet broker uh to it's that's that's that product is more of a uh q4 fiscal 21 um event as far as impacting
spk04: bookings and revenue. I see. Okay. I would say it's the other 5G opportunity that's got traction and is beginning to ramp in a more meaningful way.
spk02: I thought that was more like a September quarter, but it sounds like it got pulled in then, huh?
spk04: Yeah, I'm not sure how that was guided previously, but that has been on a very a continuous path, and how this evolves is that our customer is selling into large service providers, and as they start to embrace the solution, that starts to ramp. And I would say we're at the very early stages of adoption of the solution to very large service providers. It's being successful and, you know, we're starting to see that ramp. And then, we see coming into the, you know, our fiscal Q4 and then fiscal Q1 of 22. Got it.
spk02: Just to be clear on that, 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, you're talking about $50 to $100 million annually, just to be clear?
spk04: Yeah, we're packaging 5G, all of our 5G opportunities in that bucket.
spk02: $50 to $100 million annually, though, right? Yes. Okay. Okay. Just one final question. Actually, a couple more. Regarding the European customer, so how would demand dynamics change in the O-RAN, open RAN environment? Will they still go with your solution or will actually their customer dictate which switch to use?
spk06: Thanks, David. We'll have to move on after this one.
spk04: Yeah, I'm not sure I heard the question, Dave. Sorry.
spk02: You know, the open RAN where, you know, open architecture, will they still go with your solution or could that change?
spk04: No. I mean, we're at the very early stages, David. It's very, very early. And, you know, I would say we're at the very early stages of a large addressable market for this particular solution. And I think what's going on with RAN might only enhance the requirement for the solution that we're, the full-stack solution that we're a part of.
spk06: Thanks, operator. Can we move on to the next questions?
spk09: Our next question comes from Eric of Lake Street. Your line is open.
spk08: Yeah, maybe I missed it, but what is the deadline for getting the December quarter button up? Just, you know, when should When are you expecting to have that done by and what's the deadline?
spk12: So the deadline filing is February 9th, and we obviously expect to complete our reviews and file timely.
spk08: Okay. And then just understanding the pretty robust guide, certainly it was ahead of me and certainly ahead of consensus, but as I looked at it, I was anticipating Q1, sorry, Q3 to be down sequentially. What's behind that sequential growth that you're seeing here? If you could just, you know, put it into a particular product bucket. Obviously, you've got the pipeline to support that 245 million guide at the midpoint. Take me a layer deeper, please.
spk12: Yeah. So, the fact that we're, because we haven't completed our review of this potential adjustments, we're providing a wide range on the revenue because we assuming that they might be an impact and adjustment that would need to be made. And so that's why you should take the midpoint of the range that we're providing and you take the midpoint of the guidance, you're seeing a slight increase. But I would say that prior to this adjustment, we would have seen a slight decrease. So I'm gonna specify that first of all. As I mentioned in my first answer earlier, there are specific verticals that had not recovered as of December. And I mentioned specifically sports and entertainment. We're seeing also healthcare enjoying a recovery. It started this past quarter. It's going to continue. And so those are helping us sort of mitigate the normal impact of the seasonality that you would typically expect in March.
spk04: Yeah, and just with a little more detail on that, we've seen pent-up demand. We won Major League Baseball. It's a huge win in a lot of stadiums, and with Major League Baseball, we have a league. It's not a hunting license to go after each club. So you'll see a lot of bills happening, and they want to get that done before spring training, et cetera. We'll see that come back, as well as NFL spend and NASCAR spend, where we have significant presence and opportunities. So you see that. We're seeing service provider opportunities take up, as we mentioned before. And in general, what we're seeing is the fact that we're getting a lot of interest in our cloud platform from a traditional enterprise perspective. you know, that cloud adoption and people being more interested in extreme, wanting to hear as people look to cloud, to solving the distributed enterprise, and more and more people want to understand our solution, our differentiation, and it's just opening up more opportunities, and we're seeing it in our funnel.
spk08: Thank you.
spk09: Thank you. Our next question comes from Eric. Do you believe us?
spk05: Yeah, thanks for taking the question. First off, on the Cloud IQ, can you talk about how the mix of products, how that profile is changing? Is it predominantly the Wi-Fi products, and are the wireline products starting to become a bigger piece of that?
spk04: Yes, I would say today, I mean, 90, you know, a high 90% number would be wireless products. We just came in, we came out with a 5520 that's got an embedded Cloud IQ license. And so we've started selling those. And as I mentioned in my comments, Eric, you know, we're really focused on adoption. So, you know, we've sold the switches that have got embedded licenses. And now, you know, we're starting to see the... I would say the very initial adoption, and then we were expecting that to ramp very quickly. I also mentioned that our XMC, which is our Extreme Management Center platform, that was a perpetual license on-prem software, and we made that part of our cloud offering. So I think 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, and that's happening globally.
spk05: Do you think switches could reach 5% in the next few quarters?
spk04: We haven't really come out with that, but you know what I would say is that's something we should address on Investor Day coming up. That's a great topic for Investor Day.
spk05: Okay, fair enough. 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?
spk04: Yeah, I think at this stage, the semiconductor industry is feeling a lot of demand across multiple industries, and so we compete for our chips everywhere. But, you know, 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. And certain products, you know, lead times have, you know, have increased. For us, it's not an issue.
spk05: But there are some related chips that are still pretty long lead times?
spk04: 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.
spk05: Do you think that some of your competitors are getting hurt by some of the constraints out there?
spk04: We wouldn't be surprised, but I don't think we have enough knowledge to comment.
spk05: Okay. And lastly, can we assume tariffs are not a factor for you in light of having moved your supply chain significantly? In light of the new administration, I'm just wondering if that will make any difference from a tariff perspective.
spk12: I was going to say that tariff, as I mentioned in my preliminary comments, has been a benefit to gross margin in Q2. We expect it 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, but that mix has not changed, but more because we have implemented a new method in terms of the way we claw back those tariffs. And that has been a benefit to us in terms of the cost of the tariffs that's embedded in our cost of goods sold.
spk05: Is that going to improve if they get away from tariffs?
spk12: 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 get that improvement to be sustained over time.
spk05: Okay, very good. Thank you.
spk09: Thank you. Our next question comes from John Roy of Water Tower Research. Your line is open.
spk03: 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.
spk04: Yeah, just to say that, um, I just, I missed the front of the question about, you were saying enterprise were interested in your cloud business.
spk02: Yes.
spk03: And I was interested in how the large clients are looking at you guys these days.
spk04: Yeah, and I can give you an example of a very large customer and very large potential customer where we were in a – we displaced, I would say, the two largest competitors in our industry. One of the benefits that we have is that our largest competitor – has got structural impediments and limitations to what they can offer via cloud. And when they compete for enterprise customers, it's almost like they're two separate companies, and they have very limited capabilities in terms of what they can do as far as this ubiquitous end-to-end cloud management platform. That's what we bring. So we have more breadth in terms of end-to-end cloud from the edge into the core of the network than any competitor in the industry. The second thing that we offer that is very differentiated from anyone else in the industry is cloud choice. So enterprise customers, it's a hybrid environment. And so they're multi-cloud because they have applications that are running in multiple different public clouds. They have applications running from cloud service providers and private clouds. And then they'll have their own certain applications that will run in their own hosted cloud. In our environment, we offer all three solutions, and we offer the capability to manage all of those environments from Xtreme Cloud IQ. No one else can do that, especially the two largest competitors that we have. So if you're looking for flexibility in cloud choice, here you have one solution that provides you with the flexibility that no one else can provide, and that That's a meaningful differentiator, and that's something that matters. Data is another thing that we talk about. Networking is the last place to unleash data, if you will. And if you think about all the intelligence that you have from a network, i.e., all edge devices that are connected, all users that are connecting, and then the applications that they're using, when are they using them? there's a lot of insights that can be gained from the network. The idea that you can have a centralized network that gathers all those insights and you have one place to go to change business outcomes. Again, we're offering unlimited data. And why wouldn't you collect that data? Our competitors are not. Finally, security. We have the most secure cloud. We have ISO certification, SOC certification. So if you're worried about security, and I think everyone in the enterprise arena is worried about security, then I think you want to make sure that the data from your network is secure, and we're the only ones that can provide the level of security. So these are all serious differentiators, and it has clearly opened doors for us, and we're winning in competitive situations because of it.
spk03: Great. Thanks, Ed.
spk09: Thank you. Our next question comes from . Oh, great.
spk11: 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?
spk04: We see it changing. We see the industry 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. Because I think the traditional networking providers and where they have market share, I think as people are evolving their networks now more than ever, as people consider the new normal, the next normal, I think people want to get a different perspective, a different view. And so I think that's part of what's opening up doors for us at Xtreme. So does that imply that you're able to... We don't see the industry going back to the traditional model.
spk11: Got it. Okay. And then a technology question, if I may. So 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 node present a new opportunity to gain share in Wi-Fi as well as drive more extreme cloud IQ business in the future?
spk04: I think it's premature to make a call on Wi-Fi 6E. That said, we'll be right out there early. We'll be on the early end of the wave as far as the market's concerned.
spk11: Great. Thanks a lot.
spk09: Thank you. I'd like to turn the call back over to Mr. Myercourt when he closes remarks.
spk04: Okay, thank you, operator, and I want to thank everybody for participating in the call. We have a extreme as in an inflection point where for many years we've made acquisitions, we've built up scale, and we've been investing and consolidating the technology, the teams, the cultures, and everything into extreme at this point. We are one extreme. With the universal hardware platform, with everything moving into the cloud, we are now in a position to invest in innovation, which is an exciting time for us at Xtreme. And we say there's never been a better time to be a partner of Xtreme or to be an employee of Xtreme. So I'll just step back and thank everybody for joining us on the call. I want to recognize our employees, partners, and customers for your engagement and commitment our employees for a job well done in these times. Register for Investment Day. You know, I think there's going to be a huge amount of information that will be valuable. We're going to dive deep into the technology and the opportunity that we've got. So registration information will be coming shortly. Stay tuned. Thanks, everybody, and have a good evening.
spk09: Thank you. Ladies and gentlemen, this is Alison Cicades.
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