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Edited Transcript of EXTR.OQ earnings conference call or presentation 11-May-20 9:00pm GMT

Q3 2020 Extreme Networks Inc Earnings Call

SANTA CLARA Jun 15, 2020 (Thomson StreetEvents) -- Edited Transcript of Extreme Networks Inc earnings conference call or presentation Monday, May 11, 2020 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Edward B. Meyercord

Extreme Networks, Inc. - President, CEO & Executive Director

* Rémi Thomas

Extreme Networks, Inc. - Executive VP & CFO

* Stan Kovler

Extreme Networks, Inc. - VP of Corporate Strategy & IR

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Conference Call Participants

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* Alexander Henderson

Needham & Company, LLC, Research Division - Senior Analyst

* Christian David Schwab

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Partner

* Eric Martinuzzi

Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst

* Erik Loren Suppiger

JMP Securities LLC, Research Division - MD & Senior Research Analyst

* Samik Chatterjee

JP Morgan Chase & Co, Research Division - Analyst

* Woo Jin Ho

Bloomberg Intelligence - Senior Technology Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Extreme Networks' Q3 FY '20 Financial Results Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to our speaker today, Mr. Stan Kovler. Thank you. Please go ahead, sir.

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Stan Kovler, Extreme Networks, Inc. - VP of Corporate Strategy & IR [2]

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Thanks, Federica. Welcome to the Extreme Networks Third Quarter Fiscal 2020 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, Rémi Thomas.

We just distributed a press release and filed an 8-K detailing Extreme Networks' third quarter fiscal 2020 financial results. For your convenience, a copy of the press release, which includes our GAAP and non-GAAP reconciliations and our financial results presentation, are both available in the Investor Relations section of our website at extremenetworks.com.

I would like to remind you that during today's call, our discussion may include forward-looking statements about Extreme Networks' future business, financial and operational results, growth expectations and strategies, acquired technologies, products, operations, pricing, changes to our supply chain, the impact of tariffs, acquisition and integration of Aerohive Networks and digital transformation initiatives. We caution you not to put undue reliance on these forward-looking statements, as they involve risks and uncertainties that can cause actual results to differ materially from those anticipated by these statements as described in our risk factors in our 10-K report for the period ending June 30, 2019, filed with the SEC, and in our most recent 8-K and 10-Q filings. 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 Networks' President and CEO, Ed Meyercord.

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [3]

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Thank you, Stan, and thank you all for joining us this evening. Our teams have been working closely with our customers and partners impacted by COVID-19, and the stories and positive outcomes are heartwarming. We are living in unprecedented times, and I want to thank our customers and partners for their resilience and support. I also want to thank our employees for their dedication and continued focus, while working from home. We were fortunate to be early adopters of Microsoft Teams in the Zoom collaboration platform, enabling 97% of our employees to transition seamlessly to work-from-home environments. The resulting economic fallout of COVID-19 remains an unparalleled headwind. We began to encounter the resulting spending delays from the pandemic in March, extending into April when most of our largest markets and active quarantine and social distancing protocols pushing out deals in our pipeline. Supply constraints, along with additional logistics-related challenges in certain countries, due to border closures, also contributed to the shortfall. Despite the challenges we are all experiencing with the pandemic, we continue to close large deals. All in all, we had 22 customers that spent over $1 million with us during the quarter similar to Q2. However, it's taking longer to close because of a number of COVID-19 issues. Rémi will discuss the quarter in more detail, but we are building on a base of strong recurring revenue, and we continue to take actions to further strengthen our balance sheet. We feel that we are well positioned to weather the macroeconomic impact of COVID-19.

Key highlights during the quarter were completing the integration of Aerohive on April 6 and migrating all systems and processes to Extreme systems, while operating remotely across most of our locations, executing on a new R&D model to drive feature and solution velocity that has been in the works since we reorganized engineering leadership at the end of Q1. The proof points around this were highlighted by cloudifying the edge switching portfolio ahead of schedule with the launch of ExtremeCloud IQ pilot, offering device agnostic license portability and a simplified licensing and pricing model. By July, our copilot automation software suite will be rolled out and management of our fabric portfolio by ExtremeCloud IQ will be added.

We made significant progress in our 70% portfolio refresh that is approaching completion. In fact, during Q3, new product revenue remained more stable than revenue from our older products. We upgraded most of our network operations locations for ExtremeCloud IQ to our fourth-gen cloud that has 100% uptime, no need to count the 9s for reliability. Our ExtremeCloud IQ application continues to experience growth, and we added over 5,000 new customer accounts on the platform with over 40,000 new devices under management. In April alone, we added over 20,000 new devices under management, and daily traffic has grown 50% in our management application since the pandemic began and 60% since last quarter, reducing OpEx with a strategic realignment of both our R&D and our go-to-market organizations and in order to lower our net income breakeven point to $220 million in revenue. Our finance team has moved very quickly to secure preliminary and then longer-term covenant waivers from our bank syndicate through March 31, 2021, thereby, avoiding potential dilution and/or higher-priced subordinated debt.

We continue to see that networking remains vital for our customers despite the virus, and demand remains strong. We continue to book very large deals across the product portfolio, including health care, government, education, service provider, enterprise and other segments. But they are taking somewhat longer to close. In response to our customer needs, we've rolled out a rapid outdoor connectivity kit to help hospitals and other organizations swiftly extend secure wireless connectivity to pop-up sites in support of quarantine, testing and patient care. We work closely with our customers to help them set up remote working and learning environments with portable branch kits, and we launched a flexible financing plan to support our customers that are most in need.

Our technology allows distributed campuses to be centrally managed from the cloud. As campuses reopened post-COVID-19, we can help customers through that process. Our new-normal work and school environment will be a distributed enterprise with requirements for secure tunneling, remote kits for home and ad hoc work locations, automated provisioning, fabric attach capabilities for extending networks and effortless management.

In acquiring Aerohive in August, we took the next step in our strategy, and we are seeing the proof points of that with an inflection in the market of customers wanting to move to cloud-based networking. According to a recent Gartner survey, some of the top CIO priorities in today's environment are IoT, cloud and employee workforce enablement. Cloud and security are 2 areas IDC identified as key areas of sustained crisis response. As customers take a more holistic view of a unified work-from-home wired and wireless environment, the type of networking approach Extreme can offer managed from either the cloud or on-premise will proliferate. Extreme has blended a dynamic fabric attach architecture that delivers simplicity for moves and changes at the edge of the network, together with corporate-wide, role-based policy. This enables customers to migrate to new cloud-managed switching and WiFi agnostic of the existing networking or wireless equipment they already have installed.

In the end, these customers will see lower CapEx, lower subscription costs, lower cost of ownership and get higher flexibility, along with a more resilient network. This is an example of where COVID-19 offers Extreme future opportunities.

Networking is essential technology. And while there could be a temporary slowdown in buying, we know that the market will come back. Our customers are experiencing a shift in use cases. Schools are adding APs to their parking lots. Grocery and retail stores will add more in-store pickup capabilities. Sports is cyclical and will come back as it is highly experiential. Public spaces and retail will add more IoT for sensors and other factors. Although many carpeted enterprise customers are likely to consider shrinking their real estate footprint and shifting investment to improve their work-from-home and Zoom footprint, campus investments and edge for IoT, edge computing and security are likely to increase and drive growth for networking. Moreover, the post-COVID-19 buying criteria for networking will also change. We believe that it will be less influenced by legacy history considerations and become more influenced by the flexibility for one solution set that can work on the enterprise campus and with a large number of distributed work-from-home workers, all managed from one user interface. Status quo vendors are not offering this solution, but Extreme is uniquely positioned in this regard.

In realigning our go-to-market organization, we have taken down silos, and we are fostering teamwork in the field where all commission salespeople will have a targeted number and a common goal. We're also automating capabilities of partners and cloud users to manage the network for ordering and licensing, expanding touchless orders that aligns with more of our volume motion, particularly around cloud-based networking. These changes will drive improved sales productivity, and we believe, this customer-centric approach will also create more run rate business and stable business for Extreme and our partners as well. We are excited to announce we hired Wes Durow as our new Chief Marketing Officer. Wes brings new ideas and will drive a more efficient handoff between marketing and sales with higher quality leads and will introduce new processes to shrink our response time, running at cloud speed.

Key customer wins during the quarter included the School District of Manatee County in Florida that deployed Extreme wireless access points in the parking lots of 52 elementary, middle and high schools to allow students who may not have sufficient Internet at home to download remote learning assignments. This is how Extreme is working with its customers in the new-normal environment. Several large-scale, cross-sale wins includes state and local government win, deploying Extreme fabric at 200 courthouses, underpinned by 4,500 switches and soon-to-be 4,000 APs to add WiFi capacity for lawyers, judges in the public and supporting AV technologies, such as broadcast and multicast. A large medical center is unveiling a state-of-the-art 1.5 million square foot, 17-story hospital with 500 private patient rooms and 47 operating suites. This customer will extend and integrate its fabric deployment to this new facility and recently purchased a variety of Extreme switching solutions and XMC for this new building. Even as we talk about ExtremeCloud IQ, our XMC on-premise management suite continues to be adopted by customers. A global infrastructure-as-a-service provider offers compute, storage and data centers located in the U.S., Europe, Hong Kong and Singapore, continue to invest in Extreme data center products, reducing provisioning times from hours to minutes as well as support OpenStack development and SDN initiatives.

Through the first month of Q4, our bookings are tracking slightly above our internal expectations and are running at a slightly higher level than the first month of Q3. However, the current market environment is fluid for everyone, and Extreme Networks quarterly business is typically back-end loaded, with the June being a key month in our fiscal Q4 2020 forecast. Because of these factors, we are temporarily suspending our Q4 2020 outlook. We will reassess providing quarterly guidance based on the clarity of macroeconomic recovery at the end of the fourth fiscal quarter. I am confident that Extreme will weather this challenge and emerge from this as a stronger and more cohesive company.

And with that, I'll turn the call over to our CFO, Rémi Thomas.

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [4]

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Thanks, Ed. Revenue of $209.5 million was in line with our preannouncement. We're building on a base of strong recurring revenue, and this component remained relatively stable on a dollar basis, contributing 34% of revenue, up from 28% in Q2. Non-GAAP earnings per share was a loss of $0.14, impacted by the revenue shortfall as well as a non-GAAP gross margin of 56.7%, low relative to our recent performance, only partially offset by tight control of operating expenses.

In response to weaker demand owing to the macroeconomic impact of COVID-19, we'd promptly implemented a number of liquidity and cost control measures during Q3, including: tightening control on discretionary spending, hiring and working capital; drawing down $55 million of our $75 million revolving credit facility; implementing interest rate swap contracts on slightly more than half of the outstanding Term Loan A debt principle; securing a waiver of the covenants pertaining to our Term Loan A due 2024 through March 31, 2021, an extension from the previously negotiated July 31, 2020 time frame; and finally, accelerating actions the company was planning to take to improve R&D and sales productivity, along with cost reductions in supply chain and operations. This has enabled us to lower our quarterly non-GAAP net income breakeven points to approximately $220 million in revenue as early as fiscal Q4 2020, all while further enhancing our financial flexibility.

With $196 million of cash on hand at the end of Q3, we're well funded and have ample liquidity to work through these challenging times. To help our partners and customers, Extreme introduce LEAP, the Lending Enablement & Assistance Program, to provide preferential financial terms for qualified channel partners across the Americas and Europe through September 30, 2020. LEAP offers flexible, low-interest financing, deferred payments and free training as well as reduced growth rebate targets, extended partner leveling requirements and training. This program is enabled by financial solutions partner, leaving credit risk off Extreme's balance sheet.

Total product revenue in Q3 was $136.5 million, and our total product book-to-bill ratio was approximately 1.2. In cloud, new subscription bookings grew 7% year-over-year but were flat quarter-over-quarter, owing to seasonality and the impact of COVID. We were 70% complete with our product refresh as of the March quarter, in line with our expectations. However, due to some of the ongoing cost reduction actions, we now expect this refresh program to be completed during the second quarter instead of the first quarter of fiscal 2021, as previously discussed. Total services revenue of $73 million grew 21% year-over-year but fell 5% quarter-over-quarter, largely on a sequential decrease in maintenance. Our total services book-to-bill ratio was slightly below 1. During the quarter, the Americas contributed 50% to total revenue; EMEA, 40%; and APJC close out the remaining 10%. Although revenue declined across our regions, we did experience year-over-year bookings growth in cloud subscription and services in both EMEA and APJC on an apples-to-apples basis.

Following Q3, our trends in Northern Asia appear back on track in regions, such as Korea and Japan. Yet, harsh lockdowns in India, Philippines and other markets are offsetting factors. In Europe, France, Italy and Spain are over the worst of the impact. Germany is getting back to work and is aided by strong stimulus package and easing of procurement requirements of public sector. The U.K. is somewhat behind the curve. In our international markets, lockdowns are easing for schools, construction and manufacturing, while nongrocery retail and other verticals are delayed. Finally, we're now participating in both the Japanese and German versions of E-Rate type program for schools and are making good progress. In the U.S., verticals such as stadiums, casinos, nonfood retail stores and large public venue spending paused. This was partially offset by positive momentum in government, education of what we call overall SLED, state, local and education as well as logistics. Several large deals we had expected pushed to the right, as Ed mentioned.

In Q3, non-GAAP gross margin was 56.7% compared to 57.6% in the year ago quarter and 60% in Q2. The sequential decrease was attributable to lower volume, higher product overhead and a $4.5 million write-down of obsolete inventory. Finally, we estimate that the net impact of tariff was a negative 210 basis points, up from 150 basis points last quarter as much of our inventory sold during the quarter was purchased under 15% List 4A tariffs prior to the mid-February reduction to 7.5% on wireless access points and optics.

Q3 non-GAAP operating expenses came in at $129.3 million at the low end of our guidance, a decrease from $136.3 million in Q2 based on the actions we took during the quarter. This resulted in an operating margin loss of 5.1%, down from an operating margin of 9% in Q2. Free cash flow was $2 million, down from $17.9 million in Q2 and $12.7 million in the year ago quarter. DSO 42 days fell from 55 days in Q2 and from 51 days in the year ago quarter. Our cash conversion cycle stood at 59 days, down from 69 days in Q2 and similar to the 60 days in the year ago quarter. Q3 ending inventory of $66.2 million fell $13.5 million from Q2 and grew $8.6 million from the year ago quarter. The quarter-over-quarter decrease reflects supply constraints and demand planning considerations.

Now turning to guidance. As Ed noted, we're temporarily suspending our Q4 2020 outlook. However, we will reassess providing quarterly guidance based on the clarity of macroeconomic recovery at the end of our fiscal fourth quarter.

With that, I will now turn it over to the operator to begin the question-and-answer session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Samik Chatterjee with JPMorgan.

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Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [2]

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Maybe if I can just start off, you mentioned kind of the strength you're seeing in the cloud IQ business, which clearly indicates there's still interest from the enterprise customers in pursuing some strategic projects that they had thought of pre-COVID, but if you can just broadly kind of outline what you're seeing across the customer base? Is there still a lot of interest in continuing with the strategic projects? Or is it more about just kind of doing the high priority, kind of, keeping the lights on kind of projects? And what are you seeing on that front? And I have a follow-up.

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [3]

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Sure. I'll take a shot and then, Rémi, I'll let you -- you can come in behind me. But in our IR package, we highlight vertical trends. And the response is different depending on the vertical. So we've still seen strength in our government education business, which -- that's our largest vertical. And so from a demand perspective, that hasn't changed. Some people are taking advantage of this environment, where they might have empty schools or empty courthouses, like the example that I used, to actually undertake a network upgrade because it's a good time to upgrade your network. We have hospitals and health care, which is an important vertical. That, too, has been growing, and demand has been strong. There's been a negative impact on sports and entertainment and hospitality. That's smaller as a percentage of our overall business. But nonetheless, high-profile NFL teams, things like that, these kinds of customers are -- have paused to take a look at whether or not they're going to have a season and what that might look like.

Manufacturing has been somewhat neutral. We are seeing people return to work. And large customers of ours, like Volkswagen, et cetera, are sending people back to factories, and we're seeing people return to work. And that's happening more outside the U.S. than in the U.S., but it's starting to happen. Retail, transportation, logistics, there, it's been somewhat mixed for us. Obviously, grocers, these kinds of retailers are still strong. The likes of our customers like FedEx, they are doing very well. And so ordering remains strong. Obviously, looking at the likes of Macy's or Sears, those kinds of retailers, it's a little bit different. And service provider has been strong. So we have lower exposure to the service provider side. But nonetheless, we still have service provider customers, and they're seeing growth and expansion in their networks. So that's kind of an overlay of our different verticals and where we're playing from a customer perspective. I hope that's helpful.

I don't know if, Rémi, you want to come back in or, Stan, you want to come back in with…

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [4]

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No. Ed I would just add on E-Rates, specifically in -- if you look at the past year's attribution, we saw that getting funding or getting the approval from USAC for certain larger project was somewhat getting delayed in some of our districts, where we're strong. We feel like with all of the stimulus package that's been introduced, we might see accelerated funding. So that some schools that we're planning on deploying next quarter in our fiscal Q1, which is our September quarter under the current ease of getting funding approved, might end up having to do it -- being in a position to do it earlier. So anything that really is related to government funding might be a little easier as we approach Q4 and Q1 of next year.

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Samik Chatterjee, JP Morgan Chase & Co, Research Division - Analyst [5]

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All right. And if I can just follow up, you mentioned you've kind of taken cost actions to lower the breakeven to $220 million. Is that is -- the best way to think about that, that's kind of where you want to position your business and you see demand coming back to that level at a minimum? Or is that a moving target and you kind of going to evaluate that on a go-forward basis and take more actions if required?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [6]

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No. No. That's specific to Q4. This is what we see based on a combination of some of the temporary measures that we've taken as well as the more structural measures, of which full benefit will not reach until fiscal Q1 of 2021. So our breakeven in Q4 is $220 million on a net income basis, non-GAAP, and that's not necessarily that we aim to be at $220 million. We're not providing guidance for the quarter, but we would need to be at $220 million to breakeven. And it would -- to your point about moving target, that will evolve as we enter in Q1 because we'll get the full benefit of some of the cost reduction actions that we're taking today.

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [7]

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I would just -- I would add one point to that, which is we've run a variety of different scenarios. And what we've done is we've left -- from a sales perspective and go-to-market perspective, we've left our teams in place where I would say with average productivity as we come back, we would see upside based on a productive sales force in a post-COVID, more normal environment.

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Operator [8]

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And your next question comes from the line of Eric Martinuzzi with Lake Street.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [9]

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Yes. Just a clarification on the nonguidance business outlook. Is the implication here -- you talk about April versus January. I would expect April is typically up versus January. But being up when a lot of people are still shelter in place, I would see that as a definite positive. But is that to say that if the trends sustain here in Q4 that we would be up sequentially on the revenue versus Q3?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [10]

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I'll take this one. If you recall, the normal seasonal pattern, the way the bookings come in, is 20% month 1, 30% month 2 and 50% month 3. So as much as I wish, I could say because our April bookings are slightly up versus that January booking and we feel good about this, but it's hard for us to draw a conclusion on the trend. Hence, the fact that we're not willing to provide guidance. It's just a data point that we want to show you because bookings were down 20% or up 20%. Obviously, you guys would be driving to a different conclusion.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [11]

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Okay. And then on the debt, you talked about getting relief on the covenants. Now it's not July 31, it's March 31, 2021. Is that to say that the existing debt arrangement is no longer being amended? Or are we still kind of midstream on the amendment to the existing agreement?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [12]

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No. No. It's been amended already, and we came to a successful conclusion last Friday with the unanimous approval from all of the banks in the lending group. And so we will continue to operate under these extended terms, but until the end of March of 2021 as opposed to the prior amendment that took us just to the end of July.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [13]

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Got you. Okay. And then last question for me on the operating expense. Where do we -- given the cuts that we've made, and I realize it's a moving target here, but the measures that we have taken, let's say, normalized, what's your operating expense expectation for Q4?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [14]

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So we see ourselves between $115 million to $120 million.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [15]

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Okay. And is the bulk of that coming from sales and marketing? Or is that a mix across the 3 buckets?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [16]

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We see savings coming from both R&D and sales and marketing, that would be the bulk of it. And I will split it 50-50 between the 2. And then we do see some savings as well in G&A, but much, much lower.

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Operator [17]

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And your next question comes from the line of Erik Suppiger with JMP.

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Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [18]

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So what is the situation with your supply chain at this point? Are you at capacity now? Or what is the health of the supply chain?

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [19]

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Yes. Erik, this is Ed. So when we went into this, we had concerns about China and what was going on over there, and it wasn't just our primary ODMs, but it was secondary and tertiary suppliers. And the -- they've come back. So we're encouraged because as far as China and Taiwan, we are at -- back to 100%, and that's a huge part of our supply chain. We did -- in connection with the tariffs between U.S. and China, we did move production into Mexico. And Mexico is a little later on the curve. And so they're down to 50% to 60% capacity right now, but they're saying they'll come back to 100% by June.

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Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [20]

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So is that to say that your June quarter should not be adversely affected by the supply chain?

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [21]

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We think that there may be some effect, but less than this last quarter, I would say.

Rémi, do you want to comment?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [22]

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Yes, yes. Much less in terms of our ability to deliver. What I would highlight, Ed, is that we're seeing increased freight cost because there is obviously less capacity. We typically leverage commercial airlines to ship goods from our El Paso warehouse to the rest of the world. And the flight availability is much reduced, as you can imagine. And so the available capacity is costing us a little more. So that's an impact that we factor in, in our cost of goods sold. But as far as not being able to ship products, we will be limited to those products that are coming out of our factory in Mexico.

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Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [23]

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And then you talked about your cloud service. Is it -- is the vast majority of those devices, is it WiFi access points that you're managing or is there much switches or other devices at this point?

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [24]

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It's primarily access points today, Erik. It's the former Aerohive portfolio. And then our teams have been really productive working from home, and we moved ahead of schedule. Our WiNG wireless portfolio into the cloud, that happened. And then we pulled in from July to April our edge switching platform. So now you have what we would call XOS edge switching that can be managed from the cloud. And then from October, we pulled in VOS, which is that fabric campus core technology, that's been pulled into June as well as copilot, which has automation built in. So we now have edge switching in the cloud, and then we will have core switching. So we will be able to manage end-to-end from wireless access points, IoT, edge, all the way through the core of a network from our ExtremeCloud IQ. And I could tell you, it's incredibly easy to manage. We're all about effortless and making it easy. We developed a very simple licensing model, and it's the simplest in the industry. And we think that's going to help us scale and then drive adoption of management in the cloud. So we're moving very quickly, very rapidly in cloudifying our portfolio. So it's happening -- within this quarter, we'll be edged to core from ExtremeCloud IQ.

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Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [25]

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Okay. And then lastly, I just wanted to clarify. You are still making cuts during the fourth quarter. Your breakeven is going to be at $220 million if you get to that revenue in the fourth quarter? Or does that $220 million breakeven level? Does that apply to the first quarter because that's when you get the full benefit of the cuts?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [26]

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No. If we generated $220 million in Q4 fiscal 2020, we would be at breakeven on a net income basis, on a non-GAAP basis.

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Erik Loren Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [27]

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Okay. So are you seeing the full benefit of your cuts in the fourth quarter? Or will there be further…

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [28]

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So the issue with that question is we have a combination of temporary actions, and then we have more structural actions. We will get the full benefit of our structural actions in Q1. However, when that is the case, the temporary actions, such as like, right now, nobody is traveling, we do expect people to start traveling in. So some of the cost benefits that we're getting on a temporary basis won't happen again in Q1. However, in Q1 of fiscal 2021, we get the full benefits of our cost reduction actions. So that if you think about our operating expenses in Q1 -- I gave an indication that in Q4, they'd be somewhere between $115 million and $120 million. In Q1 of fiscal '21, they will be up very modestly from that number. But obviously, we're counting on a pickup in revenue at that point in time.

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Operator [29]

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(Operator Instructions) Your next question comes from the line of Alex Henderson with Needham.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [30]

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I got a couple of questions. I wanted to ask some clarifications as well, if I could. But the first question I wanted to ask is you guys are on a sell-in model to your channel. Can you talk a little bit about what they're seeing in terms of their inventory? Are they seeing any backup in their ability to pass-through the equipment to customers? And to what extent is the channel also seeing any fallout that might back up into your results that you might not have anticipated?

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [31]

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I can jump in first, Rémi, and then you can provide comments afterwards. So as far as the channel is concerned, our channel is actually quite healthy. And a lot of -- we obviously represent the networking space. But their -- as far as their server and their storage businesses have been doing well, security is another one, so they've actually been very robust. And so any -- as far as any kind of concerns from a health perspective, they've been quite healthy. And we've obviously been in very close contact with our distributors. And we have been in a position for us to shrink our inventory with our distributors.

And Rémi, I don't know if you want to provide any additional color on that front.

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [32]

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No. I would just add, Alex, that historically, distributors tend to anticipate on a future quarter and typically, at the end of Q3, they will look at Q4, which is supposed to be a stronger seasonal quarter. Because of the impact of COVID-19, they're more basically playing it by ear. So that means that you should be expecting our sales-in and sales-out revenue to be tightly correlated, i.e. when a disti gets an order, they immediately pass it on to us, but probably won't be building any buffer. As far as their financial health is concerned, Ed mentioned that they're doing well in certain specific segments of the market, like PC peripherals, et cetera. And so what we're seeing is that their ability to continue to pay us on a timely basis has remained intact.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [33]

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Second question, if I could. Your product book-to-bill at 1.2 partly to do with, obviously, the impact of your supply chain. But if you were able to supply that going forward, it would imply sequential improvement in revenues, obviously, COVID offsetting, but I mean is it reasonable to think that now that you're no longer constrained that you should at least be at the current level of revenues or maybe the hair above that in the June quarter? Or is that too much extrapolation off the book-to-bill number?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [34]

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Yes. I wouldn't deduct from that 1.2 that we would see a sequential uptick because the 1.2 really relates to what I just said about the lack of willingness of our distis to build inventory ahead of Q4 and the closer correlation between sales in and sales out. So if anything that would support that the business should be sort of stable going forward but certainly not picking up strongly in Q4.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [35]

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Okay. A couple of clarifications. The comment you made about the tariff of 210 basis point hit because you were working through older inventory, what would be the sequential hit in the upcoming quarter now that, that inventory has been churn through? Is it half of that?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [36]

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Yes. Roughly.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [37]

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Okay. And then very difficult for us to forecast the interest line -- the interest expense line here. $4.4 million expense in the June quarter. You've got a whole bunch of moving pieces here relative to 0 interest rates on cash balances, new credit agreements, which have different terms. You pulled down $55 million in cash. I have no idea how to forecast that line…

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [38]

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Yes. Well, at a high level, when you get a sense to read out 10-Q, which has just been posted about half an hour ago, you'll see that as part of the amendment we agreed to LIBOR plus 450 basis points. There's no minimal floor. I mean the floor is effectively 0. And then it's really hard -- and that is -- should be applying to $425 million in gross debt, which is the $370 million outstanding on the Term Loan A close to $55 that we drew down. So that's the high level answer. Having said that, you can't really factor in the impact of the swaps that we did. So we're happy in a follow-up call to help out fine-tune this number. But LIBOR plus 450 is a good start.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [39]

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Is it reasonable to think that, that number is going to be higher back up to the $6.5 million type level in the June quarter? Is that the kind of ballpark what we should be thinking about?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [40]

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We see it slightly less than that in the June quarter.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [41]

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Interested in just ballpark. Great. And just one last question, and then I'll see the floor. What's your big brother in the space doing Cisco changing behavior at all, pricing behavior, going downstream into more aggressively into smaller accounts? What are you seeing on the competitive front because you haven't mentioned anything on that front so far?

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [42]

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Yes. Alex, what I can share is that we haven't seen unusual behavior from them. I would say, as far as our competitive landscape, we continue -- we go head-to-head with Cisco and HPE. And those are 2 kind of primary competitors that we run into. And I would say, nothing unusual or nothing out of the ordinary as far as the competitive landscape from that standpoint. What we have commented on is the fact that we are seeing this move to the cloud, and that's the fast-growing segment here, predicted to go from $3 billion to $7 billion. But having the flexibility and the versatility of this platform, we think that this is going to drive adoption. And so from our standpoint, we have a much simpler licensing platform, and we think we're going to be able to make it easier for people to move to our cloud than the Meraki cloud. But nothing unusual from a pricing perspective. We're not seeing anything that what I would describe as a normal competitive behavior.

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Operator [43]

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And your next question comes from the line of Christian Schwab with Craig-Hallum Capital Group.

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Partner [44]

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Rémi, can you give us -- would you be willing to share how much revenue you actually did in the month of March?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [45]

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First of all, we typically don't disclose revenue on a monthly basis. Second of all, I mentioned earlier that the inventory in the channel was typically not as strong as you would expect at the end of March because of distis playing it by ear. And that means that going forward, our sales in and sales out are more closely correlated. So based on that, the trend for revenue on a sales-in basis is positive if I look at March versus January, but I'm not willing to highlight much more than that. And this is, again, on a one month basis, and need to think about the fourth quarter and not just the month of April.

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst & Partner [46]

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Right. Right. Right. Understood. Just when the pre-release and where revenue came in, I thought some color might be helpful there. Number two, regarding gross margins. Can you help us understand either from a mix standpoint or a revenue standpoint what it would take for us to be at 60% plus type of gross margins?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [47]

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It's really -- if we assume that -- as Ed mentioned, we're not seeing any major change in competitive behavior from our competitors. So we don't see accelerated price pressure. We do expect the benefits of reaching the end of our product refresh. It's going to happen a quarter later than what we had assumed. So it's going to happen in December, but that's ongoing benefit. And so really, for us to go back to the 60% that we achieved in Q2 of fiscal 2020, we need to get volumes up because that will help us absorb basically the fixed cost that we carry in our cost of goods sold related to the cost of our supply chain, the tariffs, excess in obsoletes, et cetera. And so as you build the revenue and that we get closer to $240 million to $250 million a quarter, which are at the historical level, there's absolutely no reason for our gross margin, on a non-GAAP basis, not to get back to 60%. So it's really entirely driven by how quickly you will assume in our model a top line recovery.

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Operator [48]

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And your next question comes from the line of Woo Jin Ho with Bloomberg Intelligence.

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Woo Jin Ho, Bloomberg Intelligence - Senior Technology Analyst [49]

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Great. Just a couple of environment or sales environment questions. Now does sales activity for you have to -- well, I guess, does business activity have to return for your sales activity to improve? So for example, if the NFL or the hospitality does not start ramping up in the near future, does that correlate yourselves in any way?

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [50]

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Well, yes. So the answer is -- and we put on the slides where we have our sports and entertainment, we call it hospitality, is like 5% of revenue number. And obviously, these customers have been hard hit. So we do have a lot of projects, for example, with casinos, for example, that are the purchasing decisions that have been on hold. And they're focusing on how to bring people back into their environment. So there's a -- I would say there's a lot of pent-up demand that would take place with retail, sports and entertainment, these kinds of customers that we have where they've paused or they've pushed out to the right, if you will, the opportunities. So we do think that we will benefit when it comes back.

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Woo Jin Ho, Bloomberg Intelligence - Senior Technology Analyst [51]

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Got it. And then in your prepared remarks, you had mentioned something along the lines of the potential for a shrinking carpeted enterprise still being an opportunity for the campus switching market. I'm assuming it's also a WiFi commentary as well. Could you expand upon that a bit because that doesn't make sense to me given that you have a smaller footprint? And do you find it to be a bigger opportunity going forward?

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [52]

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Well, it depends. I mean if you listened to -- Eric Schmidt was quoted today by saying that the carpeted enterprise is going to have to grow for social distancing. You can't put people back in the work environments where they were as maybe a different or an alternative point of view. In our end, what we're looking at is something that -- what we talk about is a more distributed workplace and maybe a more flexible environment. I know that's how we're thinking about going back to work in a more flexible way, but you still -- you'll still require networking in your environment. And from a distributed point of view, you're going to have workers working from home or working from different locations. And that's where we think that having an enterprise-grade network and supporting flexible work and work-from-home is an opportunity for us, and it's a particular opportunity for our cloud because our cloud is very easy to manage, and it's a single view of your entire network. So you can have a distributed network in multiple locations that you can manage from our ExtremeCloud IQ. So that's what we're talking about, which is a new kind of enterprise that is more distributed and that we have a platform and we have the software and the platform to support that solution.

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Woo Jin Ho, Bloomberg Intelligence - Senior Technology Analyst [53]

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Got it. And then just a follow-up on that, and this may be premature, but has the nature of the conversations changed in favor of your enterprise -- I'm sorry, your Cloud IQ solution given what may be the future enterprise?

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [54]

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The answer is yes, and I gave some examples of that. And your -- we think that this is something that will be an accelerant to migration to cloud. And industry analysts are already calling that migration, but we think that what's going on here has been an accelerant.

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Operator [55]

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(Operator Instructions) And you have a follow-up with Alex Henderson with Needham.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [56]

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Great. I just wanted to -- I didn't see anything in the materials that talking to the service provider percentage, enterprise percentage, government percentages…

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [57]

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You were breaking up, Alex, but let me switch to the verticals. I'll just give you at a high level, and I can only give you a range. We've not formally disclosed it. But I would say that education and higher education together accounted for, let's call it, 16% to 18% of the first 9-month revenue. Governments, both Fed and local, accounted for 14% to 16% of first 9-month revenue. Health care was 10% to 12%. Manufacturing was 9% to 11%. Retail has dropped as a result of some of the trends that Ed talked about. It's now accounting for 5% to 7% of our total revenue. Service provider has picked up. For the first 9 months, it's accounting for 7% to 9% of our total revenue. Sports and entertainment is for -- sorry, 2% to 4%. And finally, transportation and logistics is 4% to 6%. And with that, you should be covering the first 10 verticals, which is about 75% of our overall revenue.

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Alexander Henderson, Needham & Company, LLC, Research Division - Senior Analyst [58]

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Great. That's helpful. I was hoping we could just go back to one more question. The $220 million breakeven, what assumption are you making on gross margins with that $220 million number?

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Rémi Thomas, Extreme Networks, Inc. - Executive VP & CFO [59]

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Again, you're trying to get me to provide guidance. And the name of the game today was not to be cornered and provide you with guidance. But we do expect -- but certainly, the nonrecurrence of that $4.5 million excess in obsolete inventory write-down to help us. So we finished the quarter at 56.7%. If you were to see somewhere up from that level, I think you'd be in the right direction. And just to quantify, I would expect that number to be perhaps up 1.5 points versus that level. But it's just because of the nonrecurrence of that impact that we just talked about.

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Operator [60]

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And we have no questions in queue at this time. Okay.

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Edward B. Meyercord, Extreme Networks, Inc. - President, CEO & Executive Director [61]

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Okay. Thank you, operator. Thanks, everybody, who could join us on the call today. And I also want to shout out to Extreme employees, who are listening in for what was an incredible and is an ongoing incredible effort during these times. It's been a challenging time for all of us as individuals, as organizations, as we adapt to the COVID-19 environment, and we figure out and navigate the future of work and what the new normal is going to look like. So as I said earlier, now more than ever, we're here for customers, and we're in a unique position to provide resources, solutions and flexibility to navigate this distributed enterprise environment. So that's it. Thank you very much, and have a great day.

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Operator [62]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.