Extreme Networks, Inc. (NASDAQ:EXTR) Q2 2024 Earnings Call Transcript
Extreme Networks, Inc. (NASDAQ:EXTR) Q2 2024 Earnings Call Transcript January 31, 2024
Extreme Networks, Inc. misses on earnings expectations. Reported EPS is $0.24 EPS, expectations were $0.27. 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: Good day, and thank you for standing by. Welcome to Extreme Networks' Second Quarter Fiscal Year 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please note that today's conference is being recorded. I’ll now hand the conference over to your speaker host, Stan Kovler, Vice President of Corporate Strategy and Investor Relations. Please go ahead.
Stan Kovler: Thank you, Olivia and good morning, everyone, and welcome to Extreme Networks' second quarter 2024 earnings conference call. I’m Stan Kovler, Vice President of Corporate Strategy and Investor Relations. With me today are Extreme Networks' President and CEO, Ed Meyercord; and Executive Vice President 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 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 remarks we will take questions. Now I will take the – 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 second quarter results were in line with our previously announced revised Q2 outlook. We did have some highlights in the quarter. SaaS ARR grew 37%, which reinforces the value of our differentiated cloud platform. We have 44 customers who spent over $1 million on Extreme Solutions demonstrating both customer retention and our ability to take new logos from our larger competitors and gross profit is 62.5% showing continued improvements and the benefit of a higher mix of high margin recurring revenue. At a high level, the networking industry is exiting the final stage of the COVID-induced era of supply chain constraints, which has significantly impacted our business.
We've made the conscious decision to put channel digestion behind us in the March quarter. Our distributors and partners have lowered inventory purchases, which we expect to accelerate in the third quarter. We expect to emerge in the fourth quarter at a much more normalized level of revenue and earnings. Our bookings trends and funnel of new opportunities are strong indicators of customer demand. While larger deals are still experiencing elongated sales cycles, particularly in North America, we continue to win against the competition on a bookings basis, with an uptick in new logos. Our EMEA business has stabilized and grew from the prior year and APAC bookings continue to grow over the prior year. In addition to sequential and year-on-year funnel growth, we grew the number of transacting partners accounts and deal volume during the quarter.
These trends and the expanded go-to-market opportunities give us confidence that we are positioned for a return to meaningful growth of fiscal ‘25. We've attracted a growing list of 14 managed service provider partners exiting the second quarter with seven already driving transactions. We're positioned to expand our MSP footprint as partners are drawn to 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 experience to their customers. We've also made inroads establishing a private subscription offer through a highly-targeted list of large service providers, as noted at our November Investor Day this market segment opens a $5 billion addressable market.
In November, we introduced Extreme Cloud Universal ZTNA, the first network security offering to integrate network application and device access within a single solution. This helps move organizations to a zero trust policy for all devices across the network. This, combined with our industry-leading campus fabric solution, extends our value proposition in helping customers both manage and secure their networks. Yesterday, we launched new Wi-Fi 7 access points and the 4000 Series Universal Switches designed to help highly distributed enterprise organizations, create improved network connectivity, security and application performance. Both of these new cloud-managed platforms leverage AI-ops and machine learning to deliver faster remediation and enhance network visibility.
These new products also integrate well with ExtremeCloud Universal ZTNA to enhance network security posture. The integration of AI, security and analytics into a single platform is a key differentiator for Extreme as it allows us to bring greater simplicity and flexibility for customers. This is why we continue to enlarge deals with manufacturers, like, LG Energy Solutions, leading healthcare facilities like NHS Trust Hospitals in the UK, educational institutions like, London South Bank University, Leeds Beckett and Kingston Universities, and large venues, like, Wells Fargo Center and Canada Life Centre. I've made previously announced leadership changes to streamline and strengthen our go-to-market capabilities. Earlier this month, Norman Rice was appointed as our Chief Commercial Officer and is now focused on driving revenue growth and leading the company's sales, partner, and services organizations.
He's successfully built our go-to-market sales motions in stadiums and venues, driving large opportunities with Verizon and Kroger, and has been at the forefront of driving our new commercial opportunities with large service providers. He has valuable experience managing revenue operations with deep knowledge of our complex supply chain environment. Our Chief Product and Technology Officer, Nabil Bukhari is focused on increasing our SaaS revenue, in his newly mentioned role as our GM of our Subscription business. We've also deepened our bench of SaaS expertise on the executive team over the past six months with the additions of our new Chief Marketing Officer, Monica Kumar in December; and CFO Kevin Rhodes last May. The alignment of the team is crucial to helping accelerate growth and capture more share.
The Extreme brand continues to get elevated in the marketplace through our customer wins and differentiated technology that creates more simplicity and flexibility across complex networking environments. Our promise of One Network, One Cloud remains a competitive differentiator. One Network is underpinned by our universal hardware highlighted by campus fabric, which has unparalleled campus security benefits and allows users to segment networks 10 times faster than any competitor. One Cloud offers customers modern networking tools with built-in AI-ops. And we're unique because we're the only provider to offer cloud choice whether that's public, private, hybrid or edge. We're winning deals based on helping customers find new ways to deliver better outcomes such as increased IT productivity, reduced OpEx or securing their business.
The simplicity and flexibility of One Network, One Cloud remains a competitive differentiator, particularly in a time when major competitors have created complexity with disjointed solutions, and uncertainty in their long-term rationalization of products and solutions. We remain the only pure play networking company with a differentiated and integrated portfolio and a clear roadmap. We believe our exposure to the fastest-growing areas of the networking market, share gains and new go-to-market partnerships provide ample growth opportunities to drive double-digit growth in the long-term. We're forecasting market share gains with targeted partners leveraging the strength of our unique solutions for the enterprise. 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 Rhodes: Thanks, Ed. Despite lower revenue in the second quarter, we improved our gross margins sequentially, and optimized our operating expenses to maintain a healthy operating margin profile. Our EPS was therefore impacted less than our revenue shortfall end of quarter. In the second quarter, we took proactive action that enabled us to protect our profitability, while continuing to invest in our strategic initiatives. We will continue to focus on aligning our cost structure accordingly, as we navigate the second half of our fiscal year. Let me get into the numbers. Second quarter revenue of $296.4 million, fell 7% year-over-year and was in line with our revised outlook. Product revenue of $186.6 million, fell 16.5% year-over-year, reflecting continued channel digestion and elongated sale cycles that are impacting the networking industry.
These trends are consistent across both switching and wireless products. Our product backlog has normalized this quarter earlier than we initially anticipated and our bookings approximated our product revenue for the first time in four quarters. In fact, our bookings trends were positive in both EMEA and APAC where each grew double-digits year-over-year. From a vertical perspective, while total bookings fell slightly both quarter-over-quarter and from the prior year, our healthcare, education, manufacturing, and transportation/logistics vertical markets grew from the prior year. We are encouraged by this level of customer activity which informs our view that we will be able to get channel digestion phase behind us as quickly as possible. SaaS ARR and recurring revenue was a bright spot in our quarter.
SaaS ARR grew 37% year-over-year to $158 million, driven by the strength of our renewals and activations of previously shipped products. Subscription deferred revenue was up 32% year-over-year to $246 million. As we ship products and backlog, it's generating a tailwind for SaaS growth. Total subscription and support revenue was $110 million, up 16% year-over-year. This growth was largely driven by the strength of our Cloud subscription revenue, up 39% year-over-year. Recurring revenue continues to be a positive at Extreme. Total recurring revenue of $101 million grew 14% year-over-year and 6% sequentially, to now 34% of total revenue. Based on our current outlook, we expect recurring revenue to account for approximately 35% of the full fiscal 2024 year revenue.
The growth of cloud subscriptions and maintenance drove the total deferred revenue to $549 million, up 23% year-over-year, and 5% sequentially. Gross margin was 62.5% up 140 basis points from the prior quarter and up 400 basis points compared to the prior year ago quarter. This is the third quarter in a row that we've achieved 60% plus gross margin, which is proven to be an achievable level for Extreme at normalized scale. We attribute this to improvements and mix due to the higher contribution of subscription and support revenue, and an improvement in supply chain and distribution related cost. Our second quarter operating expenses were $141 million down $12 million from a $153 million in the first quarter, and up slightly from $139 million in the year ago quarter.
We plan to take additional actions to further optimize our operating expenses to the level of revenue we expect to achieve in the second half of fiscal 2024, in order to preserve our margin structure in the fourth quarter and into fiscal 2025. Operating margin for the second quarter was 14.8%, down from 17.7% and similar to 14.9% in the prior year quarter. This is the sixth quarter in a row of double-digit operating margins, also an achievable level for the company at normalized scale. All-in second quarter non-GAAP earnings per share was $0.24, down from $0.25 in the first quarter and $0.27 in the year-ago quarter. We finished the quarter with $221 million in cash and net cash of $26 million after repurchasing another $25 million of our shares.
We've repurchased $153 million worth of our shares over the past five quarters. The $28.6 million of free cash flow we generated in the quarter was impacted by lower revenue and the use of working capital for purchases of raw materials and inventory, based on our prior year purchase commitments. We expected recovery in cash flow as revenue recovers and component purchases become more balanced with normalized sell-through rates. Now turning to guidance. This quarter, we expect sell-through to be significantly higher than sell-in, which we believe will have a meaningful impact on our operating results. To quantify this impact, we expect a $40 million to $50 million reduction in channel inventory in the third quarter, which will allow us to cover to a more normalized level of revenue in the fourth quarter.
As a result, we plan to take further cost actions to drive the recovery in earnings per share and cash flow. 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 our proactive approach to managing through this industry challenge will enable us to deliver improved growth and profitability in fiscal year 2025. For the third quarter, we expect as follows: revenue to be in a range of $200 million to $210 million; gross margin to be in a range of 59.5% to 61.5%; operating loss to be in a range of 12.4% to 8.8%; and loss per basic share in the range of $0.22 to $0.17. A basic share count is expected to be around 129 million shares.
Looking further ahead into our fourth quarter, we expect revenue to be in a range of $265 million to $275 million, gross margins to be flat to slightly up from the third quarter, non-GAAP operating margin to be in a range of 10% to 13%, GAAP operating margin to be 1% to 4%, and fully diluted share count of 131 million to 132 million shares. With that, I'll now turn the call over to the operator to begin the question-and-answer session.
Operator: Thank you. [Operator Instructions] And our first question coming from the line of Eric Martinuzzi from Lake Street Capital Market. Your line is open.
Eric Martinuzzi: Yeah. I wanted to address the leadership change here and the -- how we're going to be approaching the channel differently than we were before. If you could talk a little bit about what Norman Rice is going to be doing? I guess, we sort of lost touch with the channel demand, those are my words not yours, but what are we doing to help improve that channel monitoring? What processes or is Norman putting in place?
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