Extreme Networks, Inc. (NASDAQ:EXTR) Q1 2024 Earnings Call Transcript

Extreme Networks, Inc. (NASDAQ:EXTR) Q1 2024 Earnings Call Transcript November 1, 2023

Extreme Networks, Inc. beats earnings expectations. Reported EPS is $0.35, expectations were $0.32.

Operator: Good day and thank you for standing by. Welcome to the Extreme Networks’ First Quarter Fiscal Year 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Stan Kovler, Vice President of Corporate Strategy and Investor Relations. Please go ahead.

Stan Kovler: Thank you, Abigail. Good morning, everyone, and welcome to Extreme Networks’ first quarter 2024 earnings conference call. I’m Stan Kovler, Vice President of Corporate Strategy and Investor Relations. With me today are Extreme’s President and CEO, Ed Meyercord; and CFO, Kevin Rhodes. We just distributed a press release and filed an 8-K detailing Extreme Networks’ financial results for the quarter. For your convenience, a copy of the press release, which includes our GAAP to non-GAAP reconciliations, is available in the Investor Relations section of our website at extremenetworks.com along with our earnings presentation. Today’s call and our discussion may include forward-looking statements based on our current expectations about Extreme’s future business, financial and operational results, growth expectations and strategies.

All financial disclosures on this call will be made on a non-GAAP basis unless stated otherwise. 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. These risks are described in our risk factors in our 10-K report for the period ending June 30, 2023 filed with the SEC. And 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. Following our prepared remarks we will take questions. And now I will take the – I will turn the call over to Extreme’s President and CEO, Ed Meyercord.

Ed Meyercord: Thanks, Stan, and thanks to all for joining us this morning. Extreme delivered another strong quarter with revenue growth of 19% and EPS growth of 75%. We continue to move upmarket and the dollar value of deals over $1 million continue to grow quarter-over-quarter. Cloud adoption remains strong on 30% year-over-year ARR growth to $141 million, and SaaS deferred revenue grew 38% year-over-year. Customer retention metrics remain high, a testament to our customers’ loyalty and preference for our industry-leading solutions. We outpaced overall market growth in the quarter and expect continued share gains in fiscal 2024 in our core business. Our new go-to-market initiatives outperformed in the quarter as well. This includes expansion across APAC, certifications in regulated industries like state and federal government, the addition of seven new managed service providers, and a new disruptive whitespace opportunity to sell the enterprise to large service providers with a private subscription offer.

In addition, we have a plan to license all network devices connected to our evolving ExtremeCloud platform. This will deliver even greater simplicity, value, and flexibility beyond the cloud management capabilities we offer today and create more stickiness for our SaaS business. Our strategic initiatives around differentiated zero-trust posture, expanded machine learning and AI capabilities are expected to drive expansion, ARR growth, and average revenue per user. At the end of fiscal Q1, we felt the impact of the macro environment trends in our industry and lowered our outlook for near-term top-line growth. The higher interest rate environment and economic challenges in some of our larger markets, like Germany, lengthened sales cycles and pushed out a larger amount of end-of-quarter orders in Q1 than we would normally expect.

Our channel partners are digesting a large volume of backlog release and focusing on network deployment, slowing down their current ordering. And as a result, we don’t expect run rate business to ramp as quickly as anticipated. In light of what we would call an air pocket of demand and decision-making, leading to our revised growth outlook for the year, we took immediate action to realign resources to drive higher productivity and profitability. As a result, we continue to expect high teens operating margin in fiscal 2024. That will allow us to grow our EPS by over 25% during the year. Our funnel of opportunities continues to grow up double digits on a year-over-year basis as our underlying business and competitive position remain strong. Over the long-term, we expect to return to a mid-teens top-line growth outlook and a mid-20s operating margin.

And here’s why. Customers tell us they’re tired of complexity, inflexibility, and the high costs associated with the old networking models from the larger networking companies. They choose Extreme because we set the bar for modern networking with a combination of innovative and flexible technology, licensing and deployment simplicity, and a focus on driving impactful business outcomes. Customers view their network as a strategic asset to enhance operations, power and scale new services, and reduce business risk, especially cyber security risk. Our customers choose Extreme for three primary reasons. First is operational simplicity. That is driving IT productivity, network availability, ease of use, improving both time to value and total cost of ownership of their networking investment.

We’re the only networking provider that can deploy campus networking fabrics from our cloud. This makes moves, ads, and changes to networks simple and seamless, allows customers to segment networks, and provides unmatched security and resiliency. While fabrics are common in data center environments, we’re the only competitor who can bring these services to the dynamic campus environment orchestrated through our cloud. We create One Network, One Cloud for customers to remove the complexity of managing their entire network infrastructure. Second, we offer unmatched flexibility. We offer cloud choice, public, private, hybrid, and edge cloud deployments that can be managed through a single interface. Our universal switches offer OS choice and deployment options.

We have the industry’s simplest licensing. Unlike competitors, we don’t require customers to hire full-time employees just to manage licenses. And finally, we’re the only networking vendor that can manage a mixed environment without requiring them to rip and replace all their infrastructure at once as they modernize. Third, our cloud solutions offer actionable business insights, security scale, and innovative technologies such as AIOps and automation. Our AIOps solution now cover over 200,000 devices and are gaining traction with large customers as they look for new ways to leverage the network to drive better business outcomes. With our Digital Twin technology, customers can stage and test their network deployment in a digital environment, saving months of actual physical deployment and troubleshooting time.

Our AIOps solutions proactively identify network issues, produce false alarms, and allow IT teams to be proactive instead of reactive. Here are a few examples. We help San Diego Community College connect 80,000 students across multiple campuses with our fabric technology. No other vendor in our industry has the expertise or ability to create a single, secure, hyper-segmented campus network that enables zero-touch provisioning of new locations or moves, ads, and changes to network elements within a matter of minutes. With one network running on one cloud, they decreased OpEx by 50%. Again, none of our competitors can do this. The Dubai World Trade Center recently hosted GITEX, the world’s largest technology trade show, which was powered by Extreme’s wireless, fabric and cloud solutions.

The venue supported more than 180,000 attendees and 6,000 exhibitors at this massive event. They used Extreme Fabric to quickly, simply, and securely segment 3,300 individual networks in a matter of days with an IT staff of two people. Conference attendees thought it was impossible. To accomplish this with our competitors’ solution, it would take weeks with a much larger IT team and introduce a significant margin of error due to their complexity. A global leading fast food chain has selected ExtremeCloud SD-WAN to ensure consistent performance and improve guest experiences at its 1,500 locations across the UK. With Extreme, this industry leader has greater visibility across its network and will be able to simplify network management at all locations, increase overall network security, and optimize operations by improving performance for critical applications.

These large accounts become important references in brand builders to Extreme. Our increasing pool of large, high-profile customers and our technology differentiation is why we continue to see the value of deals over a million dollars grow each quarter. In Q1, we have more than 30 deals over a million dollars. We continue to have a healthy customer order backlog with clear visibility to order with specific customer request dates through the balance of our fiscal year. This quarter, our product lead times normalized, allowing us to continue working down backlog from product constraints. We continue to expect our backlog to settle in a range of $75 million to $100 million by the end of Q4 fiscal 2024. Next week at our Investor Day, we’ll dive into specifics as to why our technology differentiation brings unmatched simplicity, flexibility, and insights that are driving more and more of these high-profile customer wins, and the wins are elevating our brand and driving share gains both in the channel as well as our enterprise customers.

We’ll also share why we’re so excited about new commercial opportunities with our recently launched modern managed services platform, a private subscription offer for very large service providers, our highly targeted certification and security, compliance opportunity, and the elevation of our entire portfolio to subscription licensing. All these factors provide accelerants to the share gains we’re driving in our core business. With that, I’d like to turn the call over to Kevin.

Kevin Rhodes: Thanks, Ed. I’m encouraged not only by our performance in the first quarter, but also our ability to be decisive and take prudent action as we experience shifts in market demand. Let me talk about our first quarter results, and then I’ll move to the outlook. In the first quarter, we again demonstrated strong financial and operational performance. We also showed that we remain committed to continuing that level of performance in the future. Let me get into the numbers. First quarter revenue of $353.1 million grew 19% year-over-year, exceeding the high end of our expectations entering the quarter. Product revenue of $253.5 million grew 23% year-over-year, reflecting continued improvement in our supply chain environment.

We achieved strong double-digit year-over-year growth in campus switching, which grew sequentially as well. SaaS ARR grew 30% year-over-year to $141 million, up from $109 million in the year-ago quarter. Driven by the strength of our renewals, subscription-deferred revenue was up 38% year-over-year to $236 million. Total subscription and support revenue was $99.7 million, up 9% year-over-year. This growth was largely driven by the strength of cloud subscription revenue, up 32% year-over-year. Recurring revenue continues to be a positive story at Extreme. Total recurring revenue of $95 million grew 11% year-over-year, accounting for 27% of overall revenue. Additionally, as we shift products from backlog, it will be a tailwind for our SaaS growth.

Based on our current outlook, we expect recurring revenue to be approximately 30% of our revenue for fiscal 2024. The growth of cloud subscriptions and support drove the total deferred revenue to $525 million, up 24% year-over-year. Our gross margin increased once again, achieving 61.1%, as compared to 60.2% in the fourth quarter and 57.6% in the year-ago quarter. That’s up 90 basis points sequentially and up 350 basis points year-over-year. We attribute our gross margin improvements to the excellent work by our supply chain team, lower overall distribution costs, and a greater mix of high-margin subscription revenue. Our first-quarter operating expenses were $153 million, up from $135 million in the year-ago quarter and down from $156 million in the fourth quarter.

The year-over-year increase reflects increased R&D investment and sales and marketing expenses to support our higher revenue growth plans. Our strong revenue growth, gross margin expansion, and operating expense management contribute to another increase in our operating margin, now at 17.7%, up from 12.1% in the year-ago quarter and up from 17.4% in the prior quarter. To that end first quarter earnings per share was $0.35 above the high end of our guidance range entering the quarter. We finished the first quarter with cash and cash equivalents of $224 million and net cash of $27 million after repurchasing another $25 million worth of shares. We have repurchased $125 million of our shares over the last four quarters and are executing on our commitment to offset dilution from stock awards.

We expect our share count to remain relatively flat for the rest of this year. The $71 million that we generated in free cash flow represents a 20% free cash flow margin above the high end of our long-term model, and we also generated $68 million of adjusted EBITDA. Now turning to guidance. We remain optimistic about the enterprise networking spending environment and our ability to take share. However, looking ahead at the balance of fiscal 2024, we are taking a more cautious tone in light of the current spending environment. Based on changing customer buying patterns and macroeconomic conditions, we are tempering our revenue outlook for this quarter and the balance of the year. We do believe that this is an air pocket as opposed to a more systemic issue within our target markets.

For the second quarter, we expect revenue to be in a range of $312 million to $327 million. Gross margin to be in a range of 60.2% to 62.2%, operating margin to be in a range of 15.4% to 17.3%, and earnings to be in a range of $0.26 to $0.31 per diluted share on a share count of – 134 million shares. Despite expected near term market conditions and lower revenue expectations for the full year fiscal 2024, we expect mid- to high-single digits of revenue growth, which we believe is above industry growth estimates and implies our share gains will continue. We have also taken recent actions to ensure we align our cost structure with the current level of revenue growth that we expect to achieve. As a result, we believe we are well positioned to deliver strong profitability and improved operating margins during the year.

And we expect to generate EPS growth of approximately 25% in fiscal 2024. As Ed noted, we remain committed to long term double digit growth and I see tremendous opportunity for Extreme to grow our business, accelerate our recurring revenue contribution from subscription and support and improve our margins and cash flow. I look forward to laying out some of our long term plans, our new long term plans at our Investor Day next week. And with that, I’ll now turn the call back to the operator to begin the Q&A Session.

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Q&A Session

Operator: Thank you. At this time, we’ll conduct the question-and-answer session. [Operator Instructions] One moment for our first question. Our first question comes from David Will [ph] with UBS. Your line is open.

Unidentified Analyst: Hey, thank you. This is actually Andrew for David. Wanted to ask you one of the big sort of issues looking at this industry for some time now has been the elevated backlog, certainly you’ve had it as well. So what I am wondering is maybe you could help us understand a little bit better how much of the sort of mixed signals that the backlog has been sending to the entire industry is driving your slower outlook versus entirely macro? Can you sort of pull that apart for us and help us understand it?

Ed Meyercord: Yes, Andrew, I’ll jump in and Kevin, you can follow-up. Andrew, I think when we think about the backlog and you think about what’s happened over the course of the last several quarters and it’s not just Extreme it’s the whole industry, there has been a very high level of backlog release into the channel. And so in terms of how it’s affecting current demand, you might say digestion. But effectively we put a lot of product into the channel and so our channel partners are receiving a lot of product and they’re moving forward deploying and they’re very busy deploying networks. And with that focus on receiving an unusually high amount of product and networking gear, they are really active in deployment mode right now.

And I would say – and with some of this, they paused some of their purchasing and some of the drawdown from the channel. So I think that’s how that’s affecting – that’s how you should think about this affecting the current demand equation. As we said, we’re calling it an air pocket this will pass as they deploy the networks, they are going to get back to kind of normal course ordering that will be consistent with kind of normal course demand for networking in the industry. Kevin, do you want to add anything to that? I think you hit it, Ed.

Kevin Rhodes: I think you hit all the points.

Ed Meyercord: Okay.

Unidentified Analyst : And then just my follow-up on that is just obviously you’ve got backlog working down, you expect it now to normalize in Q4, you’ve got some very difficult comps in the back half. What is it that gives you the confidence that you’re going to see a revenue reacceleration in the back half to hit your fiscal 24 revenue targets? Thanks.

Ed Meyercord: Well, Andrew, it’s really about what we see in our funnel. We have a very clear picture of opportunities, and all those opportunities have kind of a timeline next to them. And it’s the quality, and the quantity and volume of our funnel that gives us the confidence to make the call. As we turned into Q2, Kevin mentioned that our teams became more cautious with their call. Some of the bookings that we would normally see at the end of the quarter didn’t happen. And with the slowdown of sales cycle, people became a lot more cautious about the call here. A lot of those opportunities landed in the second half of the year. These are high quality opportunities and so I would say that’s what’s driving the confidence interval. Kevin, I’ll give you a shot to jump in as well.

Kevin Rhodes: Yes, I mean as we as we think about the quarterly revenue throughout the rest of the year and our guidance for the full year, obviously, Q4 is the toughest comp that we have with the $365 million last year. But we’re not calling for accelerating growth over top of that. We think that we’re going to hit about mid teens for the full year compared to the full year, 2023.

Unidentified Analyst : Thanks.

Operator: One moment for our next question. Our next question comes from Alex Henderson with Needham. Your line is open. Great.

Alex Henderson: Great. Just a quick clarification on the guide. So, if I were to look at the guide for the upcoming quarter, I assume that the vast majority of the swing is in product sales and that the strength of software growth plus the normal services growth off of lagging product sales would suggest that overall services quarter-to-quarter and for the year would continue to gradually increase over the course of the next three, four quarters. Is that a fair assessment [indiscernible] product sales.

Kevin Rhodes: That’s right Alex.

Ed Meyercord: For the most part. Obviously, the attach rate with subscription and support is associated with products. So you’ll see a little bit of moderation in the revenue there for subscription and support as it relates to product being lower. But the majority of the reduction in anticipation of revenue for the full year would be on the product side. And that’s just literally the digestion issue, the macroeconomic people are just taking longer to make decisions, and decision cycles are lengthening. And we feel like we’re in this air pocket where we think we will come out of it. The question is the absorption period, if you will, within the market and when does the macro market come back. I think we’re seeing this with many companies across the sector.

Alex Henderson: Just to be clear, the growth in services is generally driven off the last two years worth of product sales. Therefore, it should continue to increase quarter-to-quarter over the course of the 24 period, even if it’s at a very flattish kind of trajectory. So it’s almost all in product sales.

Ed Meyercord: That would be our expectation.

Alex Henderson: Okay, so if that’s the case, in order to hit your guidance as given, it sounds like your product sales literally have to be down in the December quarter and essentially flat for the full year, excluding the just printed quarter. Is that also an accurate read? And if that’s the case, what is the mechanics underneath the surface between the inventory draw down at your channel versus the sell through? So what does the rate of sell through look like if you were to look at it from the customer perspective as opposed to the two tier channel distribution perspective?

Ed Meyercord: I mean, first of all fourth quarter is a long way away right now. We look at just the pipeline. We’ve got a combination of backlog that is expected for customer request dates in the fourth quarter, so we have that information. We’ve got the overall pipeline and we know some of that pipeline relates to existing customers, some of its new logos. We assess that pipeline. Naturally between Q2 and Q3, we’ll build more pipeline for Q4. And so I would say we throw that all through the machine and we look at what we think we are going to achieve for the year. And it’s up, but it’s up on a full year basis. That single to high – mid- to high-single digits for the full year. As it relates to Q4, yes, we’ve got a tough comp there. As I mentioned, that could be flattish in the fourth quarter, but for the full year, still up.