Extreme Networks Inc (EXTR) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Extreme Networks Q3 FY '18 Financial Results Conference Call.

(Operator Instructions) As a reminder, this conference may be recorded.

I would now like to introduce your host for today's conference, Stan Kovler, Senior Director, Investor Relations and Finance.

Sir, you may begin.

Thank you, Amani.

And welcome to the Extreme Networks Third Quarter Fiscal 2018 Earnings Conference Call.

This conference call is being broadcast live over the Internet and is being recorded on behalf of the company.

The recording will be posted on Extreme Networks' website for replay shortly after the conclusion of the call.

By now, you've had a chance to review the company's earnings press release.

I would like to remind you that during today's call, management will be making forward-looking statements within the meaning of the safe harbor provision of federal securities laws.

These forward-looking statements involve a number of risks and uncertainties which could cause actual results to differ materially from those anticipated by these statements.

These risks include possible adjustments in tax calculations arising from further assessment of the impact of the recent changes to U.S. tax laws and our ability to successfully integrate the acquired asset technologies and operations from Avaya and Brocade into our business and operations including, but not limited, to the following risks: Difficulties we may experience in the retention, assimilation and successful integration of employees and teams' sales functions acquired operations technologies and/or products; unanticipated costs, litigation or other contingent liabilities associated with the acquisitions that could negatively impact our operating results and financial conditions; adverse effects on existing business relationships with suppliers and customers; and difficulties we may experience in reaching our aspirational goals related to these acquisitions.

For a detailed description of risks and uncertainties, please refer to our most recent reports on Form 10-K, 10-Q, 8-K filed with the SEC.

You should not place undue reliance on forward-looking statements which speak only as of today.

We undertake no obligation to update these statements after this call.

Throughout this call, we may reference both GAAP and non-GAAP financial metrics.

Non-GAAP information should be considered a supplement to, and not a substitute for, financial statements prepared in advance in accordance with GAAP.

Reconciliation of non-GAAP to the corresponding GAAP measures can be found in our earnings press release issued today.

For your convenience, a copy of the release and supporting financial materials are available on the Investor Relations section of the company's website at extremenetworks.com.

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

Thank you, Stan, and thank you all for joining us this afternoon.

Welcome to Extreme's Q3 earnings call.

Today, we announced Q3 results highlighted by 76% growth in total revenue year-over-year.

A few key successes.

First, we were pleased with our fourth consecutive quarter of organic growth within the core Extreme portfolio excluding acquisitions.

Core Extreme experienced 8% year-over-year organic growth on strength in our wireless business, particularly in North America.

Second, Avaya experienced strong sequential growth at 10% as we continue to focus on disciplined go to market and success in cross-selling the layer 2 fabric, particularly in Europe.

Third, quarter-over-quarter improvement in sales during a typically seasonally weak quarter for us.

However, in our first full quarter with Brocade, our data center revenue was impacted by 2 primary factors: A $5 million purchase accounting adjustment with Brocade, and discounts built into the pipeline we acquired on a few deals.

We also built backlog of $7 million during the quarter.

We started Q3 with 3 separate versions of Salesforce, 2 versions of Oracle and 1 version of SAP.

Now the entire business runs on 1 Extreme system, 1 instance of Salesforce, and all our bookings are in 1 Oracle system.

Entering Q3, we said we had better visibility and that it would take some time to transition.

But now, heading into Q4, we believe we have complete visibility of our business from a systems perspective.

And for our third consecutive systems migration, we booked, shipped and billed orders on the first day of the cutover with excellent performance by our IT and business integration teams.

Beyond organic growth of 8% core Extreme year-over-year, the acquired Avaya revenue also grew 10% sequentially to $44 million, while Brocade's first full quarter revenue totaled $53 million, $58 million post purchase accounting adjustment.

All in, our acquired run rate remains in line with our $230 million guidance.

Our non-GAAP gross margin came in at 57.9%, affected by a few large Brocade deals early in the quarter.

Although we were targeting to reach our long-term goal of 60% gross margins and 15% operating income by Q4 '18, we now expect to achieve them in fiscal '19.

Our Q3 results for fiscal '18 highlight our progress despite some integration challenges we worked through during the quarter.

We delivered $0.16 of non-GAAP earnings just below our guidance range.

Our Extreme Connect user conference in Phoenix, Arizona in late April attracted a large audience of customers and partners that are now Extreme-certified inside our community members.

Attendees at Connect received technical training across all of Extreme's solutions, along with dedicated training for key verticals such as education, retail and hospitality.

Feedback continues to be very encouraging and we received very favorable press.

Our customers and partners are usually surprised and encouraged by the depth of our new portfolio when our technical teams take everyone through each place in the network.

With the IT systems integration of our acquisitions behind us, we are taking a unified approach in our new go-to-market focus centered around the smart edge automated campus and agile data centers.

We bring together applications, services and support for our customers that truly highlights our end-to-end networking focus.

Our customers across our target verticals continued to embrace digital transformation and consider Extreme as a partner on this journey.

At the beginning of Q4, we rolled out the unified branding message to our employees and partners, focused on software-driven solutions.

These solutions, driven by the agile, adaptive and secure infrastructure and a variety of software applications, deliver intelligence across smart edge, automated campus and agile data center solutions.

Our customers are telling us their businesses demand that they shift from managing the network to managing the business.

Smart edge supports campus distributed in cloud wireless architectures from precedented choice and adapts to diverse technical requirements.

Our customers can manage smart edge from Extreme cloud-as-a-service, and from our smart edge management application, on-prem or private cloud, allowing multiple consumption models.

You'll be hearing a lot of our smart edge this summer and fall as we introduce a broad range of products including 802.

11ax wireless and extended edge switching products.

Our secure automated campus launch continues to make headway in the marketplace as campus upgrades are a key priority for a significant number of our customers.

Automated campus redefines networking to match the expectations of a digital business.

Designed for agile simple and intelligent networking, this policy-based, fabric-enabled architecture is unrivaled in its simplicity and manageability.

Our customers tell us that, on average, automated campus makes adds and changes 11x faster than prior generations.

We continue to enhance automated campus solution.

Our whole campus portfolio is already supported in XMC, and by summer, we will have ExtremeAnalytics support across the portfolio as well.

In this area of cloud networking, agility at the speed of business is critical for maintaining competitive advantage.

Extreme's agile data center solution is optimized to help enterprises and cloud organizations meet these challenges.

Our agile data center solution is built on programmable switching and routing platforms, providing pervasive network visibility and cross-domain network lifecycle automation.

In April of this year, we introduced OptiScale For Internet Routing which enables customers to easily utilize the programmability built into the platforms.

We continue to enhance OptiScale to include other use cases and features.

Our end markets are undergoing tremendous change that is happening at a time when IT budgets have been under pressure.

However, recent CIO surveys show budgets are actually improving in calendar 2018 relative to their 2017 views.

This gives us confidence in the demand environment as we refresh and homogenize our product portfolio under one Extreme.

Campus upgrades are an essential priority for a significant portion of our customers with a key focus on using more software solutions.

The only way to solve for this growth in complexity is to leverage software-driven solutions that automate provisioning of devices at the edge and the deployment of cloud services across multiple platforms.

Extreme is well positioned as the premier alternative to the larger competitors in our market who are less focused and playing in many different market segments like servers, storage, security and hyperconverged platforms.

In our core Extreme portfolio, we see continued strength in wireless and software-driven sales that pull through our fixed switching portfolio, offset by the runoff of modular switching which is now a much smaller portion of our revenue mix.

We are developing more prescriptive solutions for our customers in the field.

Our secure automated campus launch continues to make headway in the marketplace.

Having completed the systems migration from the Avaya TSA agreement early in Q4, we are unencumbered to grow into our run rate for this business and expect sequential growth in our Avaya business once again in the June quarter.

We entered the March quarter with a pipeline of cross-selling deals of $20 million, up from $8 million in December, of which we recognized $2.5 million in the December quarter.

During the March quarter, we recognized $10.5 million in cross-sell revenue and grew our June quarter cross-selling pipeline to $38 million, with particular strength in both the U.S. and EMEA.

I want to highlight a few examples of what these opportunities were.

First, a large university health care center implemented our complete hardware and software solution suite, deploying ExtremeWireless analytics and switches to create unique and engaging user experiences for their patients physicians and staff.

Second, in the hospitality vertical, we expanded our engagement with existing customers beyond analytics and deployed exhaust switches and Extreme's management center solution for new application.

We also deepened our relationships with several key Fortune 50 customers and became even more strategic to their network edge and core efforts.

Combining Avaya's differentiated fabric technology with Extreme's full suite of software and competitive wireless continues to yield dividends from a cross-selling perspective.

We are now rebuilding our pipeline of business in our Avaya campus business which is being generated by strong demand for our fabric solution.

The ease of deployment, the ability to segment networks across the enterprise and a high level of security in our layer 2 fabric is driving a healthy pipeline and demand for our solutions.

We continue to target a $200 million annual run rate in Q4 and growth in fiscal '19 at a higher gross margin level than what we saw in Q3.

While there's excitement in the field about our data center business as we build out the use cases with our next generation SLX combined switching and routing platform, we were impacted by residual challenges in Brocade's pipeline that we are now rebuilding.

Our VDX and MLX switching and routing platforms, along with our automated deployment tools, are driving revenue and customer engagements.

We continue to make progress with customer such as the U.S. government agency that deployed our VDX solution.

The key components to their continued business is unbeatable support, in addition to higher-performing products from an uptime and thermal efficiency perspective.

We are introducing Extreme validated designs across the entire portfolio, bringing true solution bundles of hardware and software to our enterprise and cloud service customers.

On the data center side, our validated designs and reference architectures for specific-use cases are making it easier to sell and deploy our cloud solutions and are being embraced by our customers.

When combined with our workflow composer and its cross-domain deployment capability, we can support our customers in delivering very agile enterprise cloud solutions.

A few lower margin Brocade deals early in the quarter impacted our gross margin by about 100 basis points.

As we continue to impart our discipline on our acquired businesses, we expect gross margins to reach our long-term 60% target in early fiscal year '19.

Our third quarter non-GAAP gross margins grew 70 basis points year-over-year.

As we look out into the June quarter, we project Q4 revenue to improve to a range of $277 million to $287 million.

The improved visibility into our business should allow us to rebuild the pipeline across all our geos and target verticals and include significant growth and cross-sell opportunities into fiscal '19.

One focus point I wanted to reiterate heading into June is on our data center business.

We expect data center revenue to remain at our $230 million annual revenue target, adjusted for purchase accounting and generate gross margins in the low 60% range going forward.

We continue to work with our teams to build out Brocade's pipeline following a period when this business was going to a sales process and we remain confident in the business.

Net-net, taking our second half fiscal '18 run rate yields $1.08 billion of revenue on an annualized basis.

Our recently acquired assets, Brocade and Avaya, are on a $430 million run rate that we expect to grow 3% to 5% in fiscal '19.

Our core Extreme business exits fiscal '18 on a $650 million run rate and we expect this business domain to maintain a similar growth rate into next year.

Our teams continue to execute well despite the extra time and resources required to integrate and onboard our employees, customers and partners, develop our combined product road maps, build out our engineering labs and resources, move our employees into our facilities and combine the data and systems that support the businesses.

With all our acquisitions now under one roof, we expect improved execution and 3% to 5% normalized annual revenue growth heading into fiscal '19 that we continue to believe is appropriate for our combined businesses on a like-for-like basis.

With that, I'd like to turn it over to Drew to review our results and guidance in detail.

Thanks, Ed.

Let's get started with a few highlights from our third quarter of fiscal 2018.

In Q3, we had our first full quarter of the combined revenues of our recent acquisitions, and as a result, our revenue grew $113 million or 76% year-over-year, and $31 million or 13% from the previous quarter.

Also, I'm pleased to report organic revenue growth in the preacquisition Extreme business of 8% and 3% year-over-year and quarter-over-quarter.

Our non-GAAP gross margin increased 70 basis points in Q3 from fiscal 2017 to 57.9%.

This makes 8 consecutive quarters.

We have now increased our non-GAAP gross margin compared to the same quarter year-over-year.

Quarter-over-quarter, from Q2, our gross margin declined from 59.4% to 57.9%.

Next turning to revenue.

Q3 revenue was $262 million compared to $231.1 million in Q2 and $149.2 million in Q3 a year ago.

Revenue increased quarter-over-quarter and year-over-year by $30.9 million and $112.8 million, respectively.

I would also like to note that we did not recognize $5.1 million of service revenues in Q3 and $3.4 million last quarter from our campus fabric and data center acquisitions as a result of purchase accounting adjustments.

The geographical split of revenues was as follows:

The Americas contributed 55% to total revenue.

EMEA contributed 36%.

APAC contributed 9%.

The order of our top 5 verticals in Q3 was: Education, communications, government, manufacturing and health care; compared to government, education, manufacturing, communications and retail in fiscal Q2 of '18.

Product revenue for Q3 was $203.5 million compared to $174.8 million in Q2 and $111.3 million in Q3 last year.

Q3 service revenue was $58.5 million compared to $56.3 million in Q2 and $37.9 million in Q3 last year.

Moving on to gross margin and operating expenses.

In Q3, GAAP gross margin was 54.6% compared to 55.8% in Q2 and 55.5% in Q3 last year.

Non-GAAP gross margin was 57.9% which compares to 59.4% in Q2 and 57% in Q3 last year.

Q3 GAAP operating expenses were $151.2 million compared to $160.1 million in Q2 and $85.4 million in Q3 last year.

Q3 GAAP operating expense includes amortization of intangibles of $2.1 million, stock-based compensation charges of $7.3 million, a litigation settlement expense of $200,000, restructuring charges of $4.9 million and acquisition-related expenses of $9.3 million.

We had stock compensation expenses of $700,000 in cost of goods sold; $2.4 million in R&D; $2.8 million in sales and marketing; and $2.2 million in G&A.

Q3 non-GAAP operating expenses were $127.4 million compared to $117 million in Q2 and $70.8 million in Q3 of '17.

The sequential increase in non-GAAP operating expenses was mainly attributable to the addition of 1 month of expenses from the Brocade data center business.

Third quarter GAAP operating loss was $8.2 million compared to an operating loss of $31.1 million in Q2 and a loss of $2.6 million in Q3 last year.

Third quarter non-GAAP operating income was $24.4 million or 9.3% of total revenue compared to $20.3 million or 8.8% of total revenue in Q2, and $14.6 million or 9.8% of total revenue in Q3 last year.

GAAP net loss for Q3 was $13.6 million or $0.12 per share, compared to a net loss of $31.9 million or $0.28 per share in Q2, and a net loss of $5 million or $0.05 per share in Q3 last year.

Non-GAAP net income for the quarter was $19 million or $0.16 per diluted share, and compares to net income of $16.4 million or $0.14 per diluted share in Q2 and $12.2 million or $0.11 per share in Q3 of '17.

Turning to the balance sheet.

Q3 total cash and cash equivalents ended the quarter at $103 million, down $24 million from the end of last quarter and down $14 million from the end of Q3 in fiscal '17.

Our cash balance declined in Q2 and Q3 due to acquisition and integration-related spending for CapEx, mainly for facilities and IT systems and infrastructure, transition services, IT integration consulting, restructuring and other spending that we do not expect to incur beyond Q4.

For illustration, we've included Slide #10 in our earnings release presentation posted on the Investor Relations section of our website to show these payments compared to what we view as our typical capital spending.

During the quarter, cash flow from operations was an outflow of $16 million compared to an outflow of $4 million in Q2 and an inflow of $25 million in Q3 last year.

Free cash flow was an outflow of $25 million compared to an outflow of $41 million in Q2 and an inflow of $22 million in Q3 last year.

Accounts receivables were $188 million at the end of Q3, up $34 million from the end of Q2 on higher sales, and up $116 million from the end of Q3 of fiscal '17 with the addition of the acquired data center and campus fabric businesses.

DSO increased by 3 days to 65 days this quarter compared to 62 days in Q2, and increased 21 days compared to 44 days outstanding in Q3 of '17.

Our DSO for the last 3 quarters has been impacted by the transition services agreements from the Campus Fabric and data center acquisitions.

Under these TSAs, Avaya and Brocade collected accounts receivable on behalf of Extreme over the standard customer payment terms, typically 30 to 45 days, and then remitted the collections after 45 days.

This temporarily built additional days into our collections cycle, inflating our DSO.

The impact of the TSA on our DSO will end in our fiscal Q4.

Inventory ended at $78 million, down $6 million from last quarter and up $28 million from Q3 of '17, with the addition of the acquired inventories.

Total debt outstanding, net of loan fees at the end of Q3 was $179 million compared to $95 million at the end of Q3 last year.

The increase is attributed to the amended term loan for the Campus Fabric and data center acquisitions.

On May 1, we closed a new term loan and revolving line of credit that repaid our outstanding debt.

The outstanding amount of the new term loan is $190 million and there is $10 million outstanding on the revolver out of a total available $40 million.

The interest rate on the new term loan will initially be 100 basis points less than the rate on the previous term loan.

This will result in approximately $200,000 less interest expense in Q4 and $0.5 million in Q1 of fiscal '19, the first full quarter that the loan will be outstanding.

Now let's move on to the guidance for Q4.

We expect total Q4 revenue to be in the range of $277 million to $287 million.

Q4 GAAP gross margin is anticipated to be in the range of 56% to 58.1%, and non-GAAP gross margin is estimated to be in the range of 58% to 60%.

Q4 operating expenses are expected to be in a range of $148.6 million to $152.2 million on a GAAP basis, and $136.5 million to $139.5 million on a non-GAAP basis.

Tax expense is expected to be $2 million to $2.4 million in Q3 -- in Q4, up from the previous quarters due to higher revenue and increased activity in our foreign jurisdictions.

We are continuing to evaluate the recent reenacted U.S. tax legislation and the impact to our income statement and balance sheet.

And pursuant to the SEC guidance, we have recorded provisional amounts in our Q3 year-to-date financial results.

We have not been a tax -- U.S. taxpayer in recent years due to the level of accumulated tax attributes we are carrying forward.

We believe changes in the tax laws, including the addition of a new minimum tax on a portion of our foreign earnings, limitations on certain U.S. deductions and anti-base erosion provisions will likely cause us to utilize those U.S. operating losses on an accelerated basis and will be subject to the full U.S. tax rate in 2 to 3 years.

Q4 GAAP net income is expected to be in a range of $1.5 million to $9.6 million, or $0.01 to $0.08 per share.

Non-GAAP net income is expected to be in the range of $19.2 million to $27.9 million, or $0.16 to $0.23 per diluted share.

In Q4, we expect average shares outstanding to be approximately 121.5 million shares outstanding.

This concludes our prepared remarks.

We will now open the call up for questions.

(Operator Instructions) And our first question comes from Erik Suppiger with JMP Securities.

First off, can you just clarify, on the Brocade revenue restatement, was that a surprise to you during the quarter?

Or was that already factored into your guidance?

And then I've got a...

Yes.

Sorry, Erik.

Yes, So part of it was we had a $1 million adjustment that we had to make during the quarter.

And then the other part is the deferred revenue that you lose when you have an acquisition, and that accounted for about $4 million of the $5 million.

Were both of those or one of those already assumed in your guidance?

Yes.

Yes.

We had assumed the $4 million in our guidance but the $1 million was a surprise.

Okay.

And then secondly, how were your Brocade sales to Brocade campus customers during the quarter?

And similarly, how was your Avaya sales to Avaya wireless customers in the quarter?

Yes, Erik.

Let me take that.

We have several initiatives underway, and we have a pipeline of ICX customers, the campus customers from Brocade.

But at this point, we don't have a sales number to comment on for the call.

But we are building up quite a pipeline there.

So it's taking -- it takes a little bit of time but we do see opportunities there.

On the Avaya side, that's really been a big driver of the cross sell.

We talked about the pipeline growth and commented that the growth in pipeline being driven largely by Avaya Campus Fabric wireless, the opportunity for us to sell ExtremeWireless into their fabric customers, and then also, the fabric technology that we're selling along with Extreme technology.

And this is happening across our geos in Europe and the U.S. But if we talked about the fact that we went into the December quarter and we had a pipeline of $8 million and then it grew to $20 million, and now, it's grown to $38 million, and a lot of that is driven by wireless.

(Operator Instructions) This concludes today's Q&A session.

I would now like to turn the call back over to Ed Meyercord for closing remarks.

Okay.

Thank you, Amani.

I appreciate that.

And thank you, everybody, who could join us on the call today.

And I want to thank all the Extreme employees who are listening in.

We are looking forward to improving our execution in the pipeline of the June quarter, which is going to set us up for a strong fiscal '19.

We hope to speak to you.

We have a Craig-Hallum conference on May 30, coming up as well as at the Cowen Company Technology Media and Telecom Conference on May 31.

So we thank you for your participation and we'll catch up with you next quarter.

Thank you.

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.