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Extreme Networks, Inc. (NASDAQ:EXTR)
Q2 2019 Earnings Conference Call
Jan. 29, 2019, 8:30 a.m. ET

Contents:

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Extreme Networks' Second Quarter Fiscal Year 2019 Financial Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. If anyone should require assistance during the conference, please press "*0" to speak with an operator. As a reminder, this call is being recorded.

I would now like to turn the call over to Stan Kovler. You may begin.

Stan Kovler -- Executive Director of Investor Relations

Thank you, operator, and welcome to the Extreme Networks' Second Quarter Fiscal 2019 Earnings Conference Call. I'm Stan Kovler, Executive Director of Investor Relations. With me today are Extreme Networks' President and CEO, Ed Meyercord; CFO, Remi Thomas, and VP of Finance, Matt Cleaver.

We just distributed a press release and filed an 8-K detailing Extreme Networks' second quarter fiscal 2019 financial results. For your convenience, a copy of the press release, which includes our GAAP to non-GAAP reconciliations, and our fiscal '19 2Q financial results presentation and CFO commentary 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 Network's future business and financial results, products, operations, pricing, 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 reports filed with the SEC. Any forward-looking statements made on this call reflect our analysis as of today and we have no plans or duty to update them except as required by law.

Now, I will turn the call over to Extreme's President and CEO, Ed Meyercord.

Ed Meyercord -- President and Chief Executive Officer

Thank you, Stan, and thank you all for joining us this morning. Welcome to our fiscal Q2 earnings call. Today we announced Q2 results that were better than expected, highlighted by 9% year-over-year and 5% quarter-over-quarter growth in total revenue to $252.7 million, and non-GAAP earnings of $0.13 per share. Our gross margin was the highest in three quarters and we repurchased $15 million worth of our shares during the quarter.

From a bookings perspective, we grew year-over-year and quarter-over-quarter across all our solutions pillars and in all our key industry verticals. We continue to win large deals as customers embrace a broader set of our solutions. During the quarter, we had 18 deals over $1 million, representing software products and services across our solutions pillars. We're growing our total pipeline of large opportunities globally and our total cross-sale pipeline for the next four quarters grew sequentially once again.

I recently came back from meetings with our teams in Asia, where growth has been driven by larger deal sizes and software-driven solution selling. APJC revenue grew 13% year-over-year and 28% quarter-over-quarter.

In the EMEA region, from a competitive standpoint, we believe our story and our product portfolio are resonating well with European customers. European governments are also placing greater scrutiny on the security concerns around Huawei products, which is creating an opportunity for us in the marketplace. We are a trusted provider to many European customers and our secure, automated campus products and various software applications are resonating well in this context. As a result, our revenue in EMEA grew 26% year-over-year and 22% quarter-over-quarter in fiscal Q2 and our pipeline continues to build.

In the Americas, we saw a nice rebound in our service provider vertical and continued growth in our healthcare, transportation logistics, and higher ed verticals. Overall, the revenue for Americas was negatively impacted by distributor consolidation and softness in the K-12 market.

We made key hires to enhance our service provider team and new leadership in our federal team that will strengthen our coverage model for these key verticals. Both our data center business and our automated campus grew sequentially, slightly ahead of expectations.

Our sales teams continue to lead with differentiated software for applications, such as management, control, and analytics, that can manage both Extreme and third-party networking products. Growth in software and cloud-based applications accelerated in the quarter. We posted another quarter of record service bookings, with improvement in our attach rate and growing contribution of multiyear agreements. We increased our overall services backlog and that bodes well for service revenue growth in the future.

Our team has done an excellent job of mitigating the risks of the trade uncertainty between the U.S. and China. In response to the 10% tariff increase in September, which affects most of our hardware products, we implemented price increases on November 1. And as we previously announced, we moved aggressively to move manufacturing to Taiwan and expect 80% of our products that ship into the U.S. to be exempt from this tariff at the end of March. In addition, we benefited from approximately $5 million of forward customer buying during the quarter that came in from Q3.

Last week, we launched our first 802.11ax, or Wi-Fi 6, products. Customer momentum is building, as we have a unique set of high-density Wi-Fi customers who are looking forward to this and additional solutions that we expect to launch throughout calendar '19. We are also the first-to-market with machine learning capabilities on our APs for RF management and artificial intelligence tools that will allow customers to auto-tune their networks without human intervention. Software-programmable radios, upgraded security, and integration with our full software suite of analytics, location, and guest, augmented by our AirDefense wireless intrusion prevention system, creates a truly differentiated and first-to-market solution for customers ranging from stadiums to enterprises. We already have preorders for our Wi-Fi 6 products that will be generally available in April.

In November, we launched new Agile data center products, as we expected, covering the solutions such as border routing, layer to exchange, data center interconnect, and full XMC management integration for single-pane-of-glass visibility. Looking ahead for the rest of calendar '19, we have a multitude of new products coming to market that we believe will drive growth and revenue and margin from our expanded and upgraded product and software portfolio. We're very excited to share many of our new innovations at our Connect Conference in May.

This quarter, we had several exciting wins. A division of a large European auto manufacturer had a requirement for a secure networking solution with future-proof technical capabilities in their assembly plants. The customer implemented our Fabric Connect solutions based on features, security, support, and differentiated technology despite a much lower competitive bid from Huawei.

The city of Memphis, Tennessee is using our augmented campus and XMC management and analytics software as the basis of its smart city implementation for surveillance and digital transformation of the city and its infrastructure. Memphis valued the ease of use of our solutions and the hyper-segmentation features it offers to create distinct networks for its community center, public safety, and transportation departments.

We built on our strength in the sports and entertainment space with wins at MetLife Stadium, home of the Jets and Giants, University of Pittsburgh athletics, and the Chicago Cubs, among others, with our smart, on-the-edge portfolio with strong attach rates of our mobility, analytics, control, and cloud software. Our momentum in this vertical continues to build globally as our teams in EMEA and Asia are winning with our differentiated solutions and strong customer references, like the NFL. The launch of Wi-Fi 6 products will only accelerate this trend.

In the higher education space, the University of Central Arkansas required a strong, secure network infrastructure to fully support its plans for its Arkansas Coding Academy and to achieve their goal of being a technology-first university. UCA selected our automated campus solutions, including Fabric Connect and Cloud Appliance, to implement a complete networking solution for their campus of 124 buildings for over 11,000 students. Extreme management, control, and analytics software has streamlined network management for UCA's IT team, substantially reducing the potential for human errors.

Industry analysts are telling us they are recommending Extreme to their clients based on our software, support, and ease of use. Our differentiation means our true single-pane-of-glass visibility and control software that our largest competitors simply can't replicate. In November, Extreme was named Gardner Peer Insights Customers' Choice for Wired and Wireless LAN and Data Center, highlighting our No. 1 position in customer service.

Our investment in sales enablement and digital transformation is making it easier for our customers and partners to do business with us and we continue to execute on this plan to modernize our go-to-market infrastructure and drive sales productivity. This quarter, we have improved demand, supply, and inventory planning for the entire product portfolio. We started to roll out new automation tools to our field to improve time to market for quotes and pricing and upgraded a number of our internal systems, ranging from finance to HR.

Looking ahead, we expect fiscal Q3 revenue to be consistent with fiscal Q2 despite a seasonally weak March quarter and the $5 million of forward buying from Q3 that came in to Q2. We expect revenue to be in the range of $247 million to $257 million and gross margins to be consistent with Q2. Our gross margin outlook assumes approximately 1% negative impact from transitioning our manufacturing to Taiwan. The resulting expected EPS outlook is in the $0.06 to $0.13 range.

Given some macro concerns investors have about a slowdown in the Chinese economy, I do want to point out that our exposure to China is quite limited, at less than 1% of our revenue. Given our vertical customer exposure, I also don't believe that many of our largest customers have pass-through exposure to China, such as higher ed, healthcare, retail, government, and manufacturing. Our balance among verticals and geos allows us to diversify our risk, as we are not overly reliant on region or vertical as evidenced by the strength of our international business this quarter.

With that, I will turn the call over to our new CFO, Remi Thomas.

Remi Thomas -- Chief Financial Officer

Thanks, Ed. As Ed noted, our revenues of $252.7 million grew 9% year-over-year and 5% quarter-over-quarter and exceed the high end of our guidance. Earnings per share of $0.13 was also at the high end of our guidance range. EPS benefited from similar gross margin with fiscal Q1 but better operating leverage.

Our product revenue of $189.6 million grew 8% year-over-year and 7% quarter-over-quarter. This also reflects the distributor consolidation actions and data center business outlook we previously noted. To that end, we reduced the number of distributors by another 10% in Q2 and will continue to execute on our consolidation plan as previously outlined.

Our services revenue of $63.1 million grew 12% year-over-year and 2% quarter-over-quarter. Attach rates and renewals continued to improve during the quarter and we're seeing increased traction with multiyear offerings on the premier services we rolled out last quarter.

During the quarter, the Americas contributed 45% to total revenue, EMEA 44%, and APAC closed out the remaining 11%. EMEA remained our fastest growing market, where we see customers embracing our differentiated product portfolio very effectively.

Globally, governments was once again our top-performing vertical for the third consecutive quarter. This includes both state, local, and federal governments both in the U.S. and internationally. The next largest verticals were education, manufacturing, service provider, and healthcare to finish out the Top 5.

Non-GAAP gross margin was 58.2% compared to 59.4% in the year-ago quarter and up slightly from 58% even in Q1. Our gross margin was the highest in the last three quarters despite headwinds from higher component costs and tariffs that more than offset the price actions we took in our portfolio on November 1. We estimate that tariffs had a negative impact of approximately 1% to total gross margin in Q2. Our non-GAAP product gross margin of 57% compares to 59.4% in the year-ago quarter and 56.8% in Q1.

Q2 non-GAAP operating expenses of $126.6 million were up from $117 million in the year-ago quarter and from $125.3 million in Q1, increasing at a slower rate than revenue. The sequential increase in non-GAAP operating expense was mainly due to the higher R&D spending as we continue to focus on new product developments and product introductions. On a year-over-year basis, the increase in our operating expenses resulted primarily from the first-time consolidation of the acquired data center assets over the full quarter. As a result, our operating margin of 8% compares to 8.8% in the year-ago quarter and 5.8% in Q1.

Free cash flow of $23.6 million compared to use of cash of $10.3 million in the year-ago quarter. Year-to-date, we generated $15 million in free cash flow compared to less than $1 million in the first half of 2018, which is driven by improved collections and working capital. We expect continued strong cash flow generation into the second half of our fiscal year even as we continue to make capital investments in our own digital transformation.

Our total cash and cash equivalents balance at the end of December was $140.6 million, up slightly from $140.2 million at the end of September. We repurchased $15 million worth of our stock at an average price of $6.33 per share.

DSO of 53 days fell 16 days year-over-year and 10 days quarter-over-quarter. The substantial year-over-year decrease reflects our shift away from the TSA we were on for the period that immediately followed the acquisitions of the campus fabric and data center businesses last year. On a sequential basis, the strong linearity I reference to in our earnings release is what drove DSO lower.

We also made significant progress in growing our deferred revenues to $186 million from $152.4 million in the year-ago quarter and $183.6 million in Q1, on growth of service bookings, including multiyear renewal offerings, and higher software attach rate.

Now, turning to guidance, I want to remind investors that this outlook factors in the $5 million worth of forward buying from customers Ed mentioned that we would have expected for Q3. With that in mind, we expect total Q3 revenue to be in the range of $247 million to $257 million. Q3 GAAP gross margin is anticipated to be in the range of 55.2% to 57.3% and non-GAAP gross margin in the range of 57.5% to 59.5%.

We estimate that tariffs will continue to have up to a negative 100 basis point impact on our overall gross margin for Q3 '19. Overall, we expect our pricing actions will be neutral to accretive related to the slightly lower gross margin outlook we've provided.

Q3 operating expenses are expected to be in the range of $139.7 million to $143 million on a GAAP basis and $129.9 million to $133.2 million on a non-GAAP basis. The sequential increase in OpEx is primarily related to payroll and variable compensation costs.

Q3 GAAP earnings is expected to be in the range of a net loss of $8.3 million to a net income of $0.7 million, or a loss of $0.07 to a net income of $0.01 a share. Non-GAAP net income is expected to be in the range of $7.2 million to $14.9 million or $0.06 to $0.13 per diluted share. In Q3, we expect average shares outstanding to be approximately $117.1 million on a GAAP basis and $119.6 million on a non-GAAP basis, excluding the impact of any shares we may repurchase.

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

Questions and Answers:

Operator

Ladies and gentlemen, if you'd like to ask a question, please press "*1". If your question has been answered and you'd like to remove yourself from the queue, you may press "#". Once again, to ask a question, please press "*1".

Our first question comes from Alex Henderson of Needham. Your line is open.

Alex Henderson -- Needham & Company -- Analyst

Hey, guys. So, there was a couple of pieces that you talked about in the prepared remarks that seem like they're somewhat countervailing. You said, on the one hand that in the most recent quarter, you had a 1% impact from the tariffs. But then you said, in the upcoming quarter, you're expecting to have 80% of that production moved to Taiwan, which should fall out. So, as I look past the current quarter into the June quarter, do I take 80% of the hit from the tariffs plus the 1% hit from the manufacturing move? So I'm improving by 180 basis points? Is that the right way to think about that?

Ed Meyercord -- President and Chief Executive Officer

Hey, Alex. This is Ed. I think the way to think about it is that we still have the impact of the tariffs. Obviously, we're gonna have that in the March quarter. We also have the benefit of the price increase in the March quarter. We are experiencing incremental costs of the manufacturing shifts and that's gonna happen at the end of March. So, we're not gonna have the benefit of the shift of supply chain and products coming from Taiwan versus China until Q4. So, that's when we would expect to receive that benefit and we're guiding that, if the midpoint is a 58.5% gross margin range, we think there's a point attributed to that. So, you can add that point. We have other benefits occurring in Q4 and our expectation is to guide over 60% in our fourth quarter.

Alex Henderson -- Needham & Company -- Analyst

Right. So, just to reiterate what I had said before. So, if I take the tariff impact of 1% which persists into the March quarter but I lose 80% of that because you'll have production moved, in the June quarter that falls out, right?

Ed Meyercord -- President and Chief Executive Officer

That's right. That falls out.

Alex Henderson -- Needham & Company -- Analyst

Then in addition to that, I'm absorbing 1% impact to cost of goods sold for the move and that falls out.

Ed Meyercord -- President and Chief Executive Officer

So, that's correct. There is an offsetting item, which is the fact that costs in Taiwan are more expensive than costs in China. So, overall, we're expecting a 5.5% increase in our costs for products coming in from Taiwan. So, when you consider that, that will provide some offset. Keep in mind there will be 20% of our products that will still come from China and we'll be phasing those out through the September timeframe.

And then we have to be ready to react to what happens with the Trump administration and negotiations with the Chinese government over tariffs and what happens. So, we're ready to respond. Fortunately, now, our team is nimble. We're practiced in this because we've just been through the exercise. So, depending on what comes out, we'll react and either react with more pricing initiatives or not, depending on what happens. But we wanted to mitigate the risk of China all together by shifting to Taiwan and the shift to Taiwan, even though we have a 5% to 5.5% incremental cost on the products, that's obviously less than the 10% cost we have with the tariffs coming from products in China.

Alex Henderson -- Needham & Company -- Analyst

Understand. So, the second question I wanted to ask you was on the pricing initiative. It's my understanding you put it in November 1 but it wasn't immediately effective on all products at that point. There was a portion of your business that was grandfathered as a result of deals that were in the pipeline. So, I guess the question is what percentage of the price increase actually shows up in the December quarter versus how much of an increase will it represent to pricing in the full March quarter? Is it 1% or 2% out of the 7% total?

Ed Meyercord -- President and Chief Executive Officer

Alex, I guess what I would say is that's really the point. It's that timing differential of September 24, 10% tariff, effective immediately. We have to provide 30 days' notice. So then November 1, our pricing takes effect. Meanwhile, we had great linearity in the quarter, where normally we have a small percentage of our orders that would come in in that first month and we had close to 40% of orders in that first month. So, it was a bit lopsided and that timing differential is what caused that margin headwind during the quarter.

Alex Henderson -- Needham & Company -- Analyst

I understand on the margin side. I think I've got that calibrated. What I'm trying to figure out is on the revenue side. So, obviously, if you had a 7% price increase, you had what? One percent or 2% of that actually accrue in the December quarter and then another 5% sequentially? Is that the right mechanics?

Ed Meyercord -- President and Chief Executive Officer

I think you could think about it that way but I think you also have to realize that we put 7% in the U.S., we put 5% rest of world. Given the fact that it's roughly 50/50, I guess you could average that out and say 6%. And I think you have to consider the discounting behaviors in the field. When we raised price rest of world, there was some confusion as to why are we raising price rest of world when the tariffs only affect the U.S. We needed to recover years and years of component cost increase on our products and we decided to do it all at the same time. So, discounting behavior has to be managed and that's deal by deal. As you know, all of our deals have discount authorizations.

The other thing that we have is we have frame contracts. Let's call that 15% -- let's just say roughly 15% of our revenue -- where customers, they have long-term pricing contracts where we can't adjust price. So, that's also somewhat of a limiting factor. So, I guess I'd say there's a lot of different variables that enter into the equation and we have to manage that.

We also have to take care of customers where we may have been negotiating a deal for a long time and the price lands outside of the pricing window and they want a higher discount. And those we view as more near-term pressures. Then over the long-term, we expect our discounting to return to normal levels and that's really where we're going to see the benefit. We really expect to see that pop in Q4.

Alex Henderson -- Needham & Company -- Analyst

Okay. One more question, if I could. The distribution consolidation, obviously there was an impact to that during the period. So, where were you -- I think you were at 250, supposed to be down to 200 by the end of the year, and, if I remember correctly, 150 distributors by the June quarter. Where are you on that and what was the impact of that?

Ed Meyercord -- President and Chief Executive Officer

Yeah. We beat that. At the end of the year, we were down to 180. And so the impact of that kind of affects the book to bill ratio and it was heavier this quarter in the United States. And so, at this point, we're feeling like we're pretty close to complete. If you look at our Top 10 distributors, that's roughly 85% of the products that flow through distribution. So, at this stage of the game, we feel like our teams have done a really good job of that and we're almost at the finish line.

Alex Henderson -- Needham & Company -- Analyst

So, you do sell in recognition of revenue and you said you were going to be bringing down inventories at the discontinued players. Did that have an impact on your sales?

Ed Meyercord -- President and Chief Executive Officer

Yes. That had an impact on our sales, certainly for the second quarter, where the bookings number would be higher than the revenue number that we report, and that was the case.

Alex Henderson -- Needham & Company -- Analyst

Can you quantify it?

Ed Meyercord -- President and Chief Executive Officer

We haven't provided quantification of that, Alex. And a lot of that is just because there are a lot of different moving pieces, globally, with all those distributors. And I guess we don't really want to get caught up in the minutia of diving into all of the different components. But book to bill in the second quarter was definitely over one.

Alex Henderson -- Needham & Company -- Analyst

Okay. I will cede the floor. Thank you.

Ed Meyercord -- President and Chief Executive Officer

Okay. Thanks.

Operator

Our next question comes from Mark Kelleher of D.A. Davidson. Your line is open.

Mark Kelleher -- D.A. Davidson -- Analyst

Great. Thanks for taking the questions. Before we get too far away from gross margins, I wanted to go back to that a little bit. Can you just talk about the impact of different products categories, the product mix, within gross margin? There was an issue a couple of quarters ago with some Brocade, some core switch headwinds to gross margin. Can you just talk about where we stand on that?

Ed Meyercord -- President and Chief Executive Officer

We're really pleased at what we're seeing in the gross margins of the acquired portfolios. If you look at the data center a year ago, I think you'll recall, when we first brought on the SRA assets from Brocade, there was heavy discounting in the field and gross margins were a lot less than we had anticipated. So, we're really pleased to see the recovery of gross margin there.

I mentioned in my comments that we've come out and we've updated our Agile data center products. And so we came out with border routers. We've seen success with Layer 2 exchange, data center interconnect. And we're at the early stages of migrating these customers to our new SLX platform so there's still somewhat of a drag there from the older product portfolio. But as we move to the new SLX platform and we build out the use cases for SLX, we're gonna see continued margin improvement along those product lines.

The same with Avaya fabric and their campus solution. That has been a bright spot. I know we're not technically reporting on Avaya as an entity and we're looking more as our campus fabric, but that business is now up over our acquisition expectations from a quarterly revenue run rate and those margins are up a full 10 percentage points. So, from that standpoint, that's really a driver of the cross-sale pipeline. And on that side, we're feeling very good as well.

So, the improved margins on the acquisitions and really the improved margins across the product portfolio is what's gonna take us to the 60% gross margin in Q4.

Mark Kelleher -- D.A. Davidson -- Analyst

Okay. That's helpful. And you mentioned that the K-12 was still a headwind over on the wireless side. Is that a big headwind? How's the wireless doing? There's some thought that we might be approaching a refresh cycle on K-12.

Ed Meyercord -- President and Chief Executive Officer

Yeah, the wireless is up. And, interestingly, for us, education for us, as a vertical, was up overall because of the strength in higher education. The K-12 vertical, for us, is sensitive to E-Rate. And as you may recall, last year was a rather weak E-Rate spending cycle. This year, we're expecting the opposite, a stronger E-Rate cycle. And we'll find out at the end of March how we do at the next round. So, the weakness in K-12 is still largely a result of that funding cycle that goes back to last March. We are expecting that to pick up. Wireless as a percentage of our total portfolio is approaching 20% of our total product sales. So, wireless is doing very well.

And as you pointed out, we do have a lot of customers. When you think about stadium and you think about healthcare, these are very dense Wi-Fi environments and we have a lot of these customers that are gonna be ripe for Wi-Fi 6, where you have significant density benefits. We have preorders for that product line, maybe a little cannibalization from the existing Wi-Fi lines. As we look out at Q3, we are not gonna be able to ship any of the AX products. So, despite bookings and pipeline that we see today, we can't put that in our Q3 revenue forecast because those products will likely ship in the April timeframe and land in Q4.

Mark Kelleher -- D.A. Davidson -- Analyst

Okay. And last question and then I'll cede the floor. You mentioned Huawei. You were doing well against Huawei in Europe. How much of an impact is that? Is that kind of a one quarter thing or do you think that's something that's gonna help you for several quarters?

Ed Meyercord -- President and Chief Executive Officer

It's hard to tell. Obviously, Huawei, most of the news that you've seen has been around 5G and is less involved with the enterprise. I talked about a win that we had against Huawei with the large auto manufacturer. A lot of that had to do with our fabric and security. And Huawei was still very much in the hunt with that customer but it was really our software and the security and segmentation capabilities of our fabric that allowed us to win. The manufacturer was adamant and fought procurement that wanted to go with a lower Huawei price. So, Huawei is still very much alive in the enterprise space. We do think that there is some trickle-down and we don't know exactly how this is gonna play out but we know that people are starting to think about it. And, for us, it creates an opportunity, if we are in a competitive situation, just to point that out to customers when they're considering their choice of networking vendor.

Mark Kelleher -- D.A. Davidson -- Analyst

Okay. Great. Thanks.

Ed Meyercord -- President and Chief Executive Officer

So, I can't really quantify it for you, Mark.

Mark Kelleher -- D.A. Davidson -- Analyst

All right. Thanks.

Ed Meyercord -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from Christian Schwab of Craig-Hallum. Your line is open.

Christian Schwab -- Craig-Hallum Capital Group -- Analyst

Great. Thanks for taking my call. I just want to follow up on E-Rate in your comments there on education. The number of Form 470s for Category 2 are back off the charts again, something we haven't seen since fiscal year '15, in part because all of those schools who took money in fiscal year '15, as you know, can finally come back after taking three fiscal years off and get it again for funding at the same time that we're transitioning to Wi-Fi 6. In that year, you guys won almost $100 million worth of business. I'm surprised that you're not more optimistic about what you're seeing as far as the initial bidding requests that have already come out, which should accelerate further over the next 90 days. Are you guys not as strongly positioned, as far as a salesforce initiative, there? I'm slightly confused.

Ed Meyercord -- President and Chief Executive Officer

Hey, Christian. No, I would say that we're -- I wouldn't say that. And we should not have left that impression if we did. As you know, this is the last year of the current E-Rate funding cycle and there are a lot of dollars left. And as you point out, there are a lot of people who can come back. When we're talking about guidance, we're obviously talking about Q3, and we'll find out in Q3, but we don't expect a revenue impact in Q3 but we are expecting quite a revenue impact in Q4. If anything, we are probably better positioned than we've ever been to take advantage of E-Rate, with a focused vertical team.

And so this is something we're very much in the hunt and we're very much gonna be involved. Our business has become a lot more diversified across the board so E-Rate makes up a smaller portion of the overall business. And the E-Rate weakness now is really a result of the weaker season last year. But, to your point, I think it's a good comment. We are expecting a much bigger E-Rate cycle this year. Our teams are in place, very busy, very active. And this is gonna be March news for us and it will affect our Q4 and our Q1 coming up.

Christian Schwab -- Craig-Hallum Capital Group -- Analyst

Right. And then last time, in fiscal year '15, you didn't have as broad and maybe as competitive Wi-Fi access point technology as you do cycle and benefited more across the board on your switch platform. So, as you look to this and securing wins and the team is working, do you think that your opportunity is more broad-based and the opportunity to win both switch opportunities as well as wireless access points?

Ed Meyercord -- President and Chief Executive Officer

Yes. I would say that. The other thing I would mention is we also didn't have a cloud platform. And as you know, cloud management is becoming more popular, particularly in K-12 and distributed environments. So, we have a unique offering as it relates to our single pane of glass and managing both an on-prem solution as well as a cloud-managed solution for a remote site with that single pane of glass that our competitors don't have. So, we think there's a feature there that's pretty powerful and differentiating for Extreme when we're out in the market. As you know, the E-Rate dollars aren't applied to software so that software is a differentiating item and that's where we're working to lead with our customers, to focus on that software and spec Extreme in their RFPs.

Christian Schwab -- Craig-Hallum Capital Group -- Analyst

Great. I don't have any other questions. Thank you.

Ed Meyercord -- President and Chief Executive Officer

Thanks, Christian.

Operator

Once again, if you'd like to ask a question, please press "*1". Our next question comes from Paul Silverstein of Cowen. Your line is open.

Paul Silverstein -- Cowen -- Analyst

Thanks. First off, just some clarifications on wireless LAN. You said it's approaching 20% of total product revenue. That would make it about $50 million, if I did the math right, for the quarter. Can you give us what was wireless LAN last quarter and the year-ago quarter?

Ed Meyercord -- President and Chief Executive Officer

I'm gonna say a year-ago quarter, it was probably closer to 15%. And last quarter, it was probably gonna be 18%. Again, that's not a precise number and I think when we get offline, we can follow up with the exact number, but I'm giving you a range which is more or less accurate.

Paul Silverstein -- Cowen -- Analyst

All right. I know you mentioned K-12 is small but can you give us -- can you quantify how small?

Ed Meyercord -- President and Chief Executive Officer

Well, K-12, for us, is now part of the education vertical. Given the growth that we've had in higher education, K-12, for us, is smaller than higher ed. It, historically, has been much higher than higher ed and so it depends on that E-Rate funding cycle. So, overall, if we look at E-Rate exposure for the second quarter and, really, if I have data from a bookings perspective, it's gonna be 3% of revenue, more or less. In that ballpark.

Paul Silverstein -- Cowen -- Analyst

Got it. All right. Let me move on. The pretty broad spread in the guidance, especially on the EPS line, to what extent does that reflect you being appropriately conservative? To what extent does that reflect limited visibility at this point in the quarter, which I assume is not the case? I know it's early but given your comments about the various strengths, what accounts for that pretty broad range? What are the key variables and levers?

Ed Meyercord -- President and Chief Executive Officer

I'm gonna add a couple of high-level points and then I'll let Remi chime in if he wants to kind of supplement the answer. First of all, we did pull in $5 million forward buying, healthcare accounts, other people that knew they were going to be buying Extreme in Q3 took advantage of lower pricing. And we've quantified that at about $5 million. If we pull that out of Q2 and put it into Q3, obviously, that makes a change. We still would have beaten this quarter without the $5 million. But that would have taken the number up quite a bit for Q3.

If we look at our operating expense structure, every year, the calendar year, we automatically have an increase in operating expenses because we restart the clock on different payroll taxes and we have other OpEx expenses that are seasonal that just reset and start in Q1 that create higher OpEx. So, kind of right out of the chute there, if you're just doing the comparative number, you're looking at a revenue headwind and then you're also looking at a seasonal operating expense increase that'll have that effect.

The other comment I'll make is we talked about the 1% headwind as it related to the manufacturing shift. Obviously, that's a one-timer but it does mitigate the risk of China for us. So, it's the right thing for us to do but there's a near-term impact of that shift.

So, obviously, we have a new CFO and I'm gonna let him chime in on the call and add some commentary. This is the second quarter in a row that we've met or exceeded guidance. We obviously want to continue on that path and on that trend so we set our guidance with that in mind and we want to make sure that we have a high degree of confidence of hitting those numbers and that's how we set guidance. And I'll let Remi chime in if you want to add anything.

Paul Silverstein -- Cowen -- Analyst

Before Remi chimes in, I just want to make sure I understood your comments correctly. Everything you cited sounds to me like, while the OpEx apparently resets in calendar Q1, I assume you guys know or should have a pretty good feel for what that reset is. The $5 million pull-in that you've identified, that's not a mystery, apparently. So, the things you identified -- I'm not trying to be argumentative but I'm just pointing out -- those are things you have visibility into. I'm trying to understand what accounts, other than you being appropriately conservative -- and that's fine if that's what it is -- but what are the variables that you don't have such good visibility into that accounts for that degree of spread.

Ed Meyercord -- President and Chief Executive Officer

Yeah. The one item I didn't mention is seasonality. And as you know, historically, there's been a fairly significant falloff from the December quarter into March and then a step up from March into June. And I would say that's the piece where we don't have as much of the visibility as to what is that natural fall off. Now, what I will say is that we have done a lot of work on our pipeline and on enabling our field and on enforcing the field, in terms of the tools that we're using and building a more accurate forecast for our pipeline of opportunities. And I would say that our confidence in that pipeline of opportunities this year versus last year is significantly different. That said, we do have seasonality in the business that we've had historically and obviously we're missing the $5 million. We're still calling a flat number and assuming that we're gonna outpace and outgrow that seasonality.

Remi Thomas -- Chief Financial Officer

Paul, if I could just add, we spent quite a bit of time as a team preparing that guidance and we really looked at three drivers. Obviously, Ed mentioned the revenue based on the pipe that we see. And so we have a range which, as you see, is pretty wide. And we spent a lot of time on the gross margin drivers, the positive aspect as well as, as we mentioned, the impact of tariffs. And then we spent quite a bit of time on the operating expenses. And the math when you have a range of $10 million for revenue, as much as two percentage points on gross margin, and let's call it $5 million for operating expense when you multiply the three, you end up with the range that you see on the EPS. So, one is just math applied to three drivers with a wide range.

The second one, which we haven't mentioned in our initial response, is on the operating expenses. We know, to your point, what the impact of merit is gonna be on compensation. We do, as a company, hire a number of people every quarter and based on how quickly the recs will be built and people will come on board, that will have an impact on our operating expenses. And so that's something to keep in mind to understand revenue times gross margin times a range in OpEx results in this range for EPS.

Paul Silverstein -- Cowen -- Analyst

I get the math. I understand that concept. Let me ask you just one last question on this. On gross margin, in particular, what are the variables that account for that two percentage point spread? What would drive it to the high end? What would cause it to go to the low end?

Remi Thomas -- Chief Financial Officer

There's really, I would say, five factors to keep in mind. On the positive, you've got the list price, which this quarter is going to be effective for the full quarter. And we're counting also on higher expected rate of acceptance in two regions that kind of offset the initial list price increase in Q2 by providing higher discounts, which was EMEA and APAC. And then one factors that's going to kick in this quarter is, every year, we renegotiate procurements with our suppliers. And the benefit of that, given the timing of negotiations, typically comes into Q3. So, those are the two positive things that would drive gross margin up.

The negative ones, one that Ed mentioned is the one-time manufacturing shift to Taiwan from China. That's a 5.5% impact that we're getting compared to the cost of manufacturing in China. We don't expect to receive the financial benefit of the move to Taiwan from the low cost of production until Q4 when that production fully ramps up. And another aspect that we haven't mentioned is that we had a very strong quarter in EMEA last quarter and we don't expect EMEA to be as strong this quarter. And from a geo mix, EMEA tends to be a region where we generate higher gross margins.

So, those are the -- there's obviously others but those are the five that I would isolate as you build your model.

Paul Silverstein -- Cowen -- Analyst

All right. But it sounds like only two or three of those are true variables because you have a pretty good fix about the 5.5% manufacturing hit and the timing. So that's not a variable that I don't think would factor into that two-point spread. Again, not trying to be argumentative. Just trying to understand.

Ed Meyercord -- President and Chief Executive Officer

There's two pieces. There's the run rate once manufacturing is running in Taiwan and we have the increased cost going forward. There's also one-time expenses, which will be expensed in the quarter, for setting up and sort of resetting manufacturing, if you will, in Taiwan. So, there's a one-time effect that we're expecting to be a negative impact this quarter and then we'll have the positive effect in Q4 of having Taiwan manufactured goods that are exempt from the 10% tariff but come at a 5% higher expense.

Paul Silverstein -- Cowen -- Analyst

All right. I'll take the rest of those offline. Let me ask you one last question, if I may. I thought I heard you say that you have higher component costs. I'm not sure if that was particular to the quarter or if it was a more generic statement. I'm hoping to get more insight on that. I get the fact that it's more expensive to manufacture in Taiwan. I assume that purely reflects labor or mostly reflects labor costs but is there something else going on from a component cost perspective? I recognize we've had shortages, certain component shortages. Are those having an adverse impact on costs and is that something you expect to continue? What's going on there?

Ed Meyercord -- President and Chief Executive Officer

Well, that's more of a legacy issue. I would say over the past several years, we've seen things like memory and different component costs because we're in the process of refreshing a big piece of our product portfolio. And there are a lot of products that are in our portfolio that are older. And so the prices for components have gone up over time. And, historically, we've never raised price. We haven't raised list price on our products. And as we contemplated the increase in the U.S., we decided that we should raise price globally and we should take into account the component price increases that have literally happened over the last few years. So, it's more of a decision to raise price and, if we're gonna do it, let's do this all at once and we'll reset the U.S. and rest of world at separate rates but to recover what's happened over the past few years. And I think, going forward, what you'll see us do is have a regular price increase strategy where we will raise price on a more regular basis.

Paul Silverstein -- Cowen -- Analyst

All right. Let me ask you -- I'm sorry. Was there more?

Ed Meyercord -- President and Chief Executive Officer

Well, just that it's consistent with what our competitors do. It's just something that we hadn't done. So, I look at that as an opportunity for us.

Paul Silverstein -- Cowen -- Analyst

Got it. And one last question. My apologies but I want to return to what's going on in the U.S. region. You cited the consolidation of your distribution channel and there was one other factor you mentioned for the weakness. Can you give more insight? Let me ask you the question this way. On a normalized basis, what would U.S. growth look like? Or, alternatively, more importantly, what are expecting in terms of U.S. growth once you've completed the consolidation?

All right. Let me ask you -- I'm sorry. Was there more?

Ed Meyercord -- President and Chief Executive Officer

Well, what I can tell you is that, from a bookings perspective -- and, obviously, when we're saying that this quarter, particularly, in the Americas, we have a book-to-bill ratio higher than one -- we're gonna expect that to level out over time. And if we look at bookings as a leading indicator, obviously our revenue is sales in, we're encouraged by what we're seeing from a bookings perspective. Christian chimed in and he talked about what's going on with E-Rate. E-Rate has been a drag on our numbers this year because of the weak E-Rate season last year. This year, it should be a different story, as we talked about. So, rather than being a drag, it should flip to being a contributor and a growth driver and I think that's gonna help out the Americas quite a bit.

We're really encouraged, Paul, by what we saw across our targeted verticals. Because in each of our verticals, education, overall, grew despite the weakness in K-12 because of our strength in higher ed. Government grew, healthcare grew, manufacturing grew, retail grew, transportation logistics grew. So, all the areas where we're focusing. And in addition to the horizontal solution, delivering vertical solutions and targeting our field, we're seeing growth. And that's true in the Americas as well.

Paul Silverstein -- Cowen -- Analyst

Ed, you mentioned that E-Rate exposure was 3% in the quarter. What was it a year ago?

Ed Meyercord -- President and Chief Executive Officer

A year ago, it would have been twice that.

Paul Silverstein -- Cowen -- Analyst

So, back of the envelope, it looks like your E-Rate business went from $13 million to $14 million a year ago to $8-ish million in Q2 so it was about a $5 million to $6 million delta? $5 million delta? Is that the math?

Ed Meyercord -- President and Chief Executive Officer

You're doing good math, Paul.

Paul Silverstein -- Cowen -- Analyst

I've got an abacus on my desk. All right. I'll pass it on. Thanks, guys.

Ed Meyercord -- President and Chief Executive Officer

Okay, thanks.

Operator

Our next question is a follow-up from Alex Henderson of Needham. Your line is open.

Alex Henderson -- Needham & Company -- Analyst

Great. Thanks. So, a couple of things I wanted to talk about. First one, you threw up a lot of cash. You bought back $15 million in stock. You have put on some debt associated with these acquisitions. Can you talk about your bias to -- say you pull $20 million in cash flow a quarter, how should we think about the split between working down debt versus share repurchases with that available cash flow?

Ed Meyercord -- President and Chief Executive Officer

From a capital allocation policy perspective, under our bank facility, we're allowed to buy down $35 million a year. So, we spent $15 million in the second quarter. We have for the last six months. It means we have $20 million to spend. And we look to be opportunistic and to take advantage of that. We will balance that with M&A, potential M&A opportunities, and keeping powder dry there. But for the most part, we look at our stock as being undervalued and we're gonna continue to look at share repurchases in the second half of the year.

Alex Henderson -- Needham & Company -- Analyst

So, just to be clear, is that a fiscal year or a calendar year that we're talking about?

Ed Meyercord -- President and Chief Executive Officer

Fiscal year.

Alex Henderson -- Needham & Company -- Analyst

Okay. So, you have another $20 million available between now and the end of June and then you reset to having another $35 million each year?

Ed Meyercord -- President and Chief Executive Officer

Yes, it does. So, we have another $20 million and if you look at our cash, we have $183 million of debt, $140 million of cash. So, net debt of $43 million today. We're generating positive cash flow. So, it's something that we're gonna consider. I'm not at liberty to comment on exactly what our intentions are at this point but I'd say we're predisposed toward buying in stock because we believe it's accretive.

Alex Henderson -- Needham & Company -- Analyst

Yeah. The mechanics help. Thanks. Second question. So, you increased price. There's obviously price elasticity in any product. What do you think the net impact of the price increase is to the revenues? If it's a 6% price increase, did it trim volume growth at all? Did it trim it 1%, 2%, or do you think it was immaterial?

Ed Meyercord -- President and Chief Executive Officer

I would say that it was a net neutral in the second quarter and we believe that it should get incrementally positive over the next quarter, although we do have the cost offset. I guess that's more from a margin perspective. We see the full benefit coming in Q4, Alex.

Alex Henderson -- Needham & Company -- Analyst

All right. So, let me just say it again. As we think about it for a multi-quarter period, do you think that there is some negative impact to volumes as a result of the price increases?

Ed Meyercord -- President and Chief Executive Officer

I would say it's less about volumes and I would say it's more about discounting.

Alex Henderson -- Needham & Company -- Analyst

I mean, the net pricing adjustment, I assume, is going up. So, does that have an impact on volumes or not?

Ed Meyercord -- President and Chief Executive Officer

We don't see it. In the U.S., everyone is expecting a price increase because everyone's very familiar with what's going on with the tariffs. It doesn't have an effect on 15% of our customers who have frame agreements or contractual pricing over a longer term. We can't move price on those customers. But the answer to your question is, yes, we do. We do see a benefit of that. We see traction and having benefit on the price increase without affecting volume in the fourth quarter. And this is based on what we see in our current pipeline.

Alex Henderson -- Needham & Company -- Analyst

So, you had said several times that you've had significant improvement in your pipeline. I assume that some of that's in the wireless piece because you called that out. I assume some of that's in E-Rate because you called that out. But are you also seeing it in the data center piece? And what's going on with the service provider acceptance of the new feature set that they were requesting in the fourth quarter calendar that you were supposed to introduce in the fourth quarter? What's the timeline for the acceptance of those feature adjustments?

Ed Meyercord -- President and Chief Executive Officer

Well, this quarter, we saw, as I mentioned, a strong rebound in service provider and we've been hiring and we're excited about the team that we're building in that space and we're excited about some of the customer opportunities, larger customer opportunities that we have in service provider. So, whereas that was a challenge for us when we look at the second half of fiscal '18, we see a rebound and I would say that, from a feature perspective, we are in a much stronger position as we look at the first half of calendar '19.

Alex Henderson -- Needham & Company -- Analyst

So, if I look at the current quarter numbers, you've got guidance that is down year-over-year, roughly, at the midpoint. Flat to down a little bit maybe. So, as I get into the June quarter, with a full acquisition in hand, with all of the impacts falling out with the price and benefits accruing, the service provider kicking in, E-Rate kicking in, the wireless kicking in, should we be looking at a meaningful growth rate in that period or are we just getting back to the flat with fiscal '18 quarter? I know you don't want to give guidance more than one quarter out but could you just give us some sense of direction? Should we be thinking about it as up, down, flat?

Ed Meyercord -- President and Chief Executive Officer

I would have two things I would say. One is I really think you have to adjust our guidance, Alex, for the $5 million. And we had $5 million come in. But you take that out, we still had a strong quarter this quarter. In terms of how we were guiding and how we're setting expectations, our expectation is that $5 million would have been in Q3. So, when you adjust that, it is flat to slightly up and you're getting closer to last year's number. We have not changed the full year guidance here. So, we are expecting a very strong Q4. I can't really comment on and try to provide an exact number.

Alex Henderson -- Needham & Company -- Analyst

Can you explain why the numbers are actually flat to down, given the acquisition closing timing?

Ed Meyercord -- President and Chief Executive Officer

If you remember, we reset. At the end of June, we reset the data center business and we made the decision to consolidate our distributors and, overall, we saw business volumes down quite a bit. So, we are starting at a lower point so even though we may be growing sequentially, we're getting back to where we were. And we're getting back to where we were in a much stronger position.

Alex Henderson -- Needham & Company -- Analyst

Right. Well, that's exactly what I was trying to get at. So, you have two variables here, which are obviously critically important for the reason why you're absorbing in the March and June quarter: the distribution consolidation and the data center realignment. It sounds like, given the strength of the SLX product line launched in the December quarter and the feature adds that the customers were waiting for, that there's an amount of time from the time that feature gets done to the time that they accept it and say, hey, this looks good, I'll accept it. When do we get back to a normalized data center number? And is that business growing off of that base or is it flat?

Ed Meyercord -- President and Chief Executive Officer

Well, we reset the data center expectations for $160 million to $170 million run rate. That business has stabilized and that business is growing. So, we're back to growth in that part of the portfolio and we expect that to continue. If I look at fiscal '18 being -- granted, it wasn't a full quarter in terms of what we had as far as the acquisitions -- but approximately $980 million of revenue and now we're over $1 billion. And as we pivot and go into fiscal '20, we will be projecting growth across the entire portfolio. And that's where we see this and that's why I make the comment about a much stronger foundation from where we're starting.

Alex Henderson -- Needham & Company -- Analyst

I think you'd been talking about the distributors being a $10 million to $15 million hit per quarter until it stabilized. It sounds like you're ahead of trajectory on that. Should we still be thinking about a $5 million to $10 million hit from that in the March and June quarters?

Ed Meyercord -- President and Chief Executive Officer

At this point, Alex, I'd say we're almost done. And so I would say the numbers are probably a little bit smaller in terms of what the effect would be in the quarters in the second half of the year.

Alex Henderson -- Needham & Company -- Analyst

Great. So, those fall out. That would suggest in the back half of the fiscal '19 or fiscal '20 period, when you get into the first half of fiscal '20, that you should be seeing better results in September/December versus traditional seasonality. Is that correct?

Ed Meyercord -- President and Chief Executive Officer

Absolutely.

Alex Henderson -- Needham & Company -- Analyst

Okay. Great. That's what I needed. Thank you.

Ed Meyercord -- President and Chief Executive Officer

Okay.

Remi Thomas -- Chief Financial Officer

Thanks, Alex.

Ed Meyercord -- President and Chief Executive Officer

Thank you.

Operator

There are no further questions. I'd like to turn the call back over to Ed Meyercord for any closing remarks.

Ed Meyercord -- President and Chief Executive Officer

Okay. Well, I'd like to thank everybody for joining us today and all the Extreme employees who were listening in for a job well done. The progress is visible. We're looking forward to sharing a more detailed outlook about our portfolio, our long-term vision, and business model, etc. at the Investor Day that we're having at the Nasdaq Exchange in New York on February 13. So, I would encourage everyone to please consider attending. I think it's going to give you a great look at the progress that we're making and why we're excited about the second half of this year.

We're also having a user conference in May and I would expect people to look at that as well. It' pretty exciting, in terms of what we're coming out with, in terms of our vision across the entire enterprise portfolio and the three solutions pillars. So, thank you all for participating and have a great day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.

Duration: 67 minutes

Call participants:

Stan Kovler -- Executive Director of Investor Relations

Ed Meyercord -- President and Chief Executive Officer

Remi Thomas -- Chief Financial Officer

Alex Henderson -- Needham & Company -- Analyst

Mark Kelleher -- D.A. Davidson -- Analyst

Christian Schwab -- Craig-Hallum Capital Group -- Analyst

Paul Silverstein -- Cowen -- Analyst

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