Extreme Networks, Inc. (NASDAQ:EXTR) Q3 2024 Earnings Call Transcript May 1, 2024
Extreme Networks, Inc. misses on earnings expectations. Reported EPS is $-0.19 EPS, expectations were $-0.17. EXTR isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by and welcome to the Extreme Networks Third Quarter Fiscal Year 2024 Financial Results. At this time all participants are in listen-only mode. After the speaker’s presentation there will be a question-and-answer session. [Operator Instructions] As a reminder today’s program is being recorded. And now I’d like to introduce your host for today’s program Mr. Stan Kovler, Vice President of Corporate Strategy and Investor Relations. Please go ahead, sir.
Stan Kovler: Thank you, operator. Good morning and welcome to the Extreme Network’s third quarter 2024 earnings conference call. I’m Stan Kovler, Vice President of Corporate Development and Investor Relations. With me today are Extreme’s President and CEO Ed Meyercord and EVP and CFO Kevin Rhodes. We’ve just distributed a press release and filed an 8-K detailing Extreme Network’s financial results for the quarter. For your convenience a copy of the press release which includes our GAAP and non-GAAP reconciliations is available in the investor relations section of our website at ExtremeNetwork.com along with our earnings presentation. Today’s call and our discussion may include certain 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 on a non-GAAP basis unless stated otherwise. We caution you not to put undue reliance on these forward-looking statements. If they involve risk and uncertainty, they can cause actual results to differ materially from those anticipated by these statements. These risks are described in our risk factors in the 10-K report for the period end of June 30, 2023 and subsequent 10-Q 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. Following our prepared remarks, we will take questions. Now I will turn the call over to Extreme’s President and CEO Ed Meyercord.
Ed Meyercord: Thank you, Stan, and thank you all for joining us this morning. Our results were in-line to slightly better than our third quarter outlook. Highlights from Q3 include Net new logo bookings grew double digits globally with particular strength in the US market. Our SaaS ARR grew by 38% year-over-year as we continue to deliver on our value proposition of flexibility and simplicity with our one network, one cloud strategy. And we were successful in reducing channel inventory at the high end of our $40 million to $50 million range, bringing us closer to channel normalization. As expected, we’re calling for meaningful sequential revenue growth heading into our fiscal fourth quarter, but note that industry-wide customer and channel digestion will continue to create a drag on normalized bookings and revenue.
Customers and channel partners continue to work through purchases and orders and we expect demand normalization during the second half of calendar ’24. The expected sequential growth and revenue bookings will help us return to solid profitability and cash flow generation during the fourth quarter. Our funnel of opportunities is up from the prior quarter. We anticipate that the upcoming stage of growth will be driven by an increasing number of deals that exceed a million dollars as we continue to move up market. Last week we hosted our annual Connect user conference in Fort Worth, Texas. It was oversubscribed and our biggest event yet with about 19% growth in customer attendees from a year ago. The event focused on the intersection of networking, security, and AI and we made several announcements relative to those topics.
We demonstrated Extreme Cloud Universal ZTNA, the first network security offering to integrate network application and device security within a single solution. By combining Cloud NAC and ZTNA into a single easy-to-use SaaS offering, we help customers ensure unified observability, frictionless user experiences, and a consistent security policy for applications and devices. As the VPN market transitions to ZTNA, the proliferation of individual applications, each with their own policy and dashboard, is adding complexity and expense for enterprise customers. A vice president of one of our multi-billion-dollar channel partners joined us on the main stage at Connect and said the identity focused approach with a common policy engine is a game changer.
This was further evidenced by the PAC breakout sessions at Connect where discussions on zero trust drew standing room only crowds. When added to our unique enterprise Fabric, this allows us to present a highly differentiated security value proposition to enterprise customers. We also increased the scale of our Fabric solution to extend Fabric over SD-WAN, broadening the reach from the data center to branch. Customers love our Fabric because it’s simple to deploy, highly resilient, makes it easy to segment the network, which dramatically minimizes the blast radius and exposure of cyberattacks. We expect the broadening of our security offerings to drive significant traction for our business with growth opportunities across our top verticals such as higher education, healthcare, retail, manufacturing, transportation, logistics, etc.
Our customers and partners also reacted very favorably to Extreme Labs. A dynamic ecosystem where creativity, collaboration, cutting-edge technology converge to fuel innovation of early stage technologies. We provided a tech preview of AI expert, a generative AI solution that delivers substantial optimizations and cost savings in the design, deployment, and management of enterprise networking and security. Finally, we announced that we are the first vendor to allow Wi-Fi 6E customers such as the San Francisco Giants, Cedar Fair, and BYU to unlock outdoor 6 gigahertz spectrum to experience faster speeds, increased range of coverage, and expanded capacity for outdoor connectivity. There was a lot of discussion at Connect about industry M&A and the disruption that it’s causing.
We feel that lots of questions about Cisco, diversifying away from network, and customers fatigued with a cost, complexity, and lack of flexibility that comes with doing business with them. As it relates to HPE’s acquisition of Juniper, most questions focused on risk and how to protect their technology investments. Customers are worried and don’t have a clear view of technology roadmaps or the potential negative impact the integration they have down the line. We feel confident Extreme’s Pure Play focus on secure network and finding new ways to deliver better outcomes for our customers will remain a competitive advantage. We were named as a leader in the Gartner MQ for the sixth consecutive time. Once again, Cisco moved down in vision and execution and customers are taking notice.
Turning to new wins, we had a strong quarter in higher education. We won Washington University in St. Louis, one of the country’s top universities, which selected Extreme to modernize its networking infrastructure, displacing Cisco. Extreme’s Fabric solutions will help the university create a simple, scalable, and secure network across the campus. And with Extreme Cloud IQ, WashU will be able to manage its entire network, including third-party applications, third-party devices. In EMEA, spending remained challenging across many of our largest verticals and revenue is impacted by channel digestion. However, we continued our success in winning international sports venues, such as Borussia Dortmund, which is one of the largest football clubs in Germany.
They’re deploying Wi-Fi 6E Fabric Extreme Analytics across the stadium to create next-gen experiences like seat and concessions, ARVR, and biometrics. In Asia Pacific, booking trends have been stable for a number of quarters and we’re seeing success, particularly in the hospitality sector, where we’ve added multiple new logos across Asia. In the quarter, we also display Cisco at several major customers, including Korean Airlines, a 30-year customer. We’re deploying across 250 of their sites worldwide, including their global headquarters in Seoul. Our new go-to-market initiatives are helping us grow and gain share as well. We grew our MSP partner base to ’23 during the quarter, with many more in queue. The vast majority of MSP revenue is net new logos.
Our MSP footprint is expanding as partners appreciate the simplicity of one cloud, the flexibility of our unified hardware, and our unique consumption billing model. We make it simple for these service providers to deliver seamless, high-quality networking experiences. As we contemplate our recovery, we’re encouraged by our funnel and believe that customers’ demand for our solutions will continue to improve and we expect a resumption of growth to follow into fiscal ’25. And with that, I’d like to turn the call over to our CFO, Kevin Rhodes, to walk us through the results and guidance. Kevin, are you there?
Kevin Rhodes: Sorry about that. I was on mute. So, thanks, Ed. Sorry about that. And let me get into our results. So, our results were in-line and slightly ahead of our outlook. As we expected entering the quarter, we worked through a significant amount of channel and customer digestion. The overall channel inventory reduction is at the high end of our $40 million to $50 million estimates. We believe this will position us for a return to normalized growth, which will be better aligned to customer demand trends. We also took proactive action at the end of the quarter to right-size our costs, which will enable us to generate profitability again, while continuing to support our strategic and product initiatives. Let me get into some of the numbers.
Revenue of $211 million declined sequentially during the quarter, primarily due to the market dynamics impacting our industry and was slightly above our forecast. Product revenue of $106 million reflected the previously mentioned channel digestion, along with elongated sales cycles, which are also impacting the networking industry. These trends are relatively consistent across both switching and wireless products. The pricing discount rates on product orders was largely intact with prior quarters, and our product backlog was once again at a normalized level and within our expected range. Looking back over the last several quarters, our subscription revenue has been a great success story for us. Since the acquisition of Aerohive in 2019, we’ve gone from annualized revenue of $40 million to $162 million per year.
As our business has shifted to cloud management, it’s important to take both product trends and our recurring subscription and support revenue into account, as this is what customers are buying from Extreme. We expect the strong growth of SaaS ARR to continue. Overall, bookings and most notably product bookings were well above our revenue in the quarter. On a vertical basis, our education business grew double digits year-over-year, led by higher [indiscernible], and our K through 12 business was in-line with our expectations. On a year-over-year basis, health care was up double digits, and we saw sequential growth in retail, service provider, and sports and entertainment, all of which grew double digits. Even in this challenging environment, Extreme is still gaining share by attracting and winning new customers.
SaaS ARR and recurring revenue was once again a bright spot in the quarter, up 38% year-over-year, driven by the strength of our renewals and our activations of previously shipped products. Subscription deferred revenue was up 29% year-over-year to $258 million. Total subscription and support revenue was $105 million, up 14% year-over-year. This growth was largely driven by the strength of cloud subscription revenue. Based on our current outlook, we expect recurring revenue to account for approximately 35% of full year fiscal 2024 revenue. The growth of cloud subscriptions and support drove the total deferred revenue to $558 million, up 20% year-over-year. Gross margin was 57.6%, down 490 basis points in the prior quarter and 150 basis points compared to a year ago quarter.
Our fixed overhead costs were impacted by reduced product revenue and we incurred about an additional $7.5 million of excess raw material costs in the quarter. This occurred as we transitioned one of our primary original design manufacturers out of China and into Vietnam. Without this cost, we would have achieved 61.2% margins in the quarter. We currently expect gross margins to recover back above 60% in the fourth quarter. Our third quarter operating expenses were $147 million, up 3% from the year ago quarter. During the quarter, we did take action to optimize our expense structure to the level of revenue we expect to achieve, including getting back to operating profitability in the fourth quarter and into fiscal year 2025. On a run rate basis, we took out approximately $35 to $40 million of annualized expenses, which will help us drive operating leverage as revenue recovers.
The operating margin in the third quarter was a loss of 12.2%, down from a profit margin of 14.8% last quarter and from a profit margin of 15.6% in the year ago quarter. All in, third quarter non-gap loss per share was $0.19 and in-line with our outlook. This compares to earnings per share of $0.24 in the second quarter and earnings per share of $0.29 in the year ago quarter. We ended the quarter with $151 million of cash and net debt of $42 million. The $74 million usage of free cash flow in the quarter was due to the lower revenue and use of working capital for purchases of raw materials and finished goods inventory based on prior year of purchase commitments. We expect a recovery in cash flow as revenue recovers in the fourth quarter and component purchases become more balanced with normalized sell-through rates.
Now turning to guidance, heading into the fourth quarter, we are expecting improved sequential revenue growth based on our funnel and the seasonality of our business, led by our education vertical. We believe the recovery in revenue and earnings will also drive a recovery in cash flow. However, we are taking a cautious tone to guidance at this time. For the fourth quarter, we expect guidance as follows, revenue to be in a range of $250 million to $260 million. Gross margin to be in a range of 61.6% to 63.6%. Operating margin to be in a range of 9% to 11.5% and earnings per share to be in a range of $0.11 to $0.15. That’s based on fully diluted share count to be expected around 131 million shares. For the full year 2024, we expect as follows.
Revenue to be in a range of $1 billion $110.5 million to $1 billion $120.5 billion. Non-GAAP gross margin to be in a range of 60.9% to 61.4%. Operating margin to be in a range of 9.3% to 9.9%. And earnings per share to be in a range of $0.51 to $0.55. The fully diluted share count is expected to be around 131 to 132 million shares. And with that, I’ll now turn it over to the operator to begin the Q&A session.
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