Extreme Networks Inc (EXTR) 2021 Q4 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Extreme Networks Fourth Quarter Fiscal Year 2021 Financial Results Conference Call. (Operator Instructions) Please be advised that this conference is being recorded. (Operator Instructions)

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.

Thank you, operator. Welcome, everyone, to the Extreme Networks Fourth Quarter 2021 and Year-End 2021 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 CFO, Remi Thomas.

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 and non-GAAP reconciliations, is available at 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's future business, financial and operational results, growth expectations and strategies, the impact of the COVID pandemic, challenges in our supply chain, specifically as they relate to chip shortages, the impact of tariffs, digital transformation initiatives as well.

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 10-K report for the period ending June 30, 2020, filed with the SEC and any additional risk factors in subsequent 10-Q filings. Any forward-looking statements made on this call may 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.

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

Q4 capped off a record year in our 25-year history as we crossed over the $1 billion revenue mark for the very first time. This is an important milestone and it was a long-term goal of ours. And importantly, the momentum we've built throughout the year with 36% overall year-over-year bookings growth that drove 29% revenue growth in the fourth quarter has carried into fiscal '22. And the strength of our year-end results are understated given the fact that we tripled our backlog to over $100 million over the course of the year.

Our execution has never been sharper, and as a result, Extreme is in the strongest competitive position it's ever been in. This is evident in our industry leadership and significant growth opportunities in 2 of the fastest growth segments in our industry: cloud-driven enterprise networking and 5G network infrastructure services.

The demand for our solutions and the volume of new opportunities are unprecedented, and we're taking share. This is evident in our funnel, our current and projected top line growth forecast, our highest ever full year gross and operating margins and our record free cash flow generation. The momentum of our cloud-driven business bookings continues to grow. Market share data from 650 Group affirm that Extreme remains the second largest in cloud networking with 11% share last year. We're outpacing the market with our fourth consecutive quarter of triple-digit growth in new subscriptions bookings at 111% bookings growth during Q4. Our total cloud services business is now on an annualized run rate of over a $100 million in bookings and over $70 million in revenue.

As the second-largest cloud-based networking vendor, we currently manage 1.7 million devices on XIQ, which marks 8 straight quarters of rapid growth in customer accounts and managed devices. We continue to innovate with our cloud networking capabilities, making our CoPilot tool available to all users in June. It delivers what we call Explainable AI for a growing list of use cases in the form of next-level analytics and automation. And importantly, we brought our network management software that includes third-party devices with our XIQ Site Engine offering, which opens a seamless path to bring millions of devices managed by our popular and widely deployed XMC on-prem software to the cloud.

The industry is noticing our momentum. CRN named XIQ Product of the Year and CoPilot was named the Coolest New Offering of the Year. We continue to be a leader in the Gartner Magic Quadrant, and we consistently carry the top rankings for customer service in Gartner's peer reviews for the last 4 years. To date, we have upgraded approximately 40% of our portfolio to Universal Hardware, which is the latest generation of chipsets from Broadcom with embedded XIQ licenses. This is on track with our plan we laid out at the beginning of the year.

In fiscal Q3, we noted that the 5520 was the most successful introduction -- product introduction ever, but we broke this record in Q4 with the introduction of the 5420. The 5420 brings higher margins to our value tier with 80 gig stacking, MACsec ready encryption and new multi-rate capabilities, up to 2.5-gigabit speeds, along with up to 90 watts of PoE. We also launched our 9920 next-gen packet broker this quarter. The product was delivered in record time with a product cycle of 1 year on a new hardware platform. This was an amazing feat by our engineering and product teams that is unprecedented.

On the wireless side, we enabled routing capabilities on the AP302W to expand our SD-WAN capabilities. And as we announced earlier this week, we were the first enterprise networking company in the industry to ship Wi-Fi 6E access points to our customers, and that's the AP4000. Wi-Fi 6E brings an unprecedented amount of clean spectrum at the 6 gigahertz band that enables new apps and use cases. It's the first time in more than a decade that a new frequency band has been added to Wi-Fi. This band enables super high multi-gig speeds, and the AP can run on 2.4, 5 and 6 gigahertz frequencies simultaneously with enhanced security on top.

Our target customers are on the front end of an investment cycle and the momentum of large deals and project-based business continues to grow as our large deal funnel is up 50% heading into fiscal '22. Customers are accelerating their return to work environments that are more flexible and hybrid in nature, supporting our Infinite Enterprise vision. The networking industry is set to experience the highest growth in years given this new normal, and global stimulus spending is also fueling growth as we come out of the historic pandemic.

As Remi will discuss, the next wave of recovery and spending is coming from the hospitality sector, and we experienced particular strength with casino and hospitality customers this quarter, such as Wynn Resorts, Shooting Star Casino, Turning Stone Casino, Hard Rock Amsterdam Hotel and others. In the sports and entertainment segment, notable new wins were Stanford University Stadium, where we displaced Cisco in the heart of Silicon Valley.

Government stimulus is also funding part of the recovery with programs across the globe in the education space, such as the FCC's Emergency Connectivity Fund, providing $7 billion to address the Homework Gap; Korea has announced $250 million direct investment in COVID-related education initiatives; the U.K., GBP 1.4 billion Catch-Up Programme. These programs complement existing programs like Digital Pact in Germany and GIGA Schools in Japan. With Extreme's exposure to the education market, we stand to benefit from all these investments globally over the next several years.

So what is Extreme doing to capitalize on this unique opportunity? Having proven out our success with essentially one main SaaS application in XIQ, we're making investments in our business to monetize the secular trend towards more software services with a complete migration to cloud. We are investing in talent and new programs to drive SaaS customer success. This required not only new sales and services expertise, that we have brought in-house, but also focused IT investments to enable a more enhanced SaaS experience. We intend to make the customer experience a core competency, and investing in new IT platforms to deliver these capabilities will be a keen focus for Extreme over the next fiscal year. And on the senior leadership front, we have made new hires from the likes of ServiceNow and other SaaS native companies.

In our service provider business, we recognized initial bookings and revenue of our 5G growth opportunities, and we remain well on our way to over $20 million of 5G business in fiscal '22, in line with our expectations. Both of our 5G solutions, the 9920 platform for services assurance and the cloud-native infrastructure solutions we sell through our OEM partner, are gaining stream in the marketplace. We remain confident in our growth plan for CNIS as the list of service providers around the world testing this solution continues to grow, and we have clear visibility to the ramp in sales.

The funnel of opportunities remain strong across the broad range of verticals and market segments that we serve. The record backlog with which we entered fiscal '22 gives us confidence in our ability to capitalize on our growth objectives. We expect to grow our market share and realize a level of organic growth we have not witnessed for many years.

And with that, I'll turn the call over to our CFO, Remi Thomas.

Thanks, Ed. As Ed noted, we finished fiscal '21 on a very strong note and executed well across the board. Q4 total revenue of $278.1 million were 29% year-over-year and 10% quarter-over-quarter. Strong demand for our wired and wireless portfolios grew 38% year-over-year and 11% quarter-over-quarter product revenue growth. Services revenue grew 11% year-over-year and 7% quarter-over-quarter.

For the fourth quarter in a row, our cloud business exceeded our expectations. New cloud subscription bookings grew 111% year-over-year. Our total cloud-managed subscription business, including renewals, exceeded $100 million in annualized bookings and grew to over $70 million in annualized revenue in Q4. Our recurring revenue, which includes support for both hardware and software, managed services and subscriptions, grew 6%, both sequentially and year-over-year, to $78 million and accounted for 28% of total revenue.

Non-GAAP earnings per share was $0.19, up from $0.03 in the year ago quarter and from $0.16 last quarter, once again, reflecting faster growth in our revenue than in our cost and expenses. For fiscal '21, our non-GAAP EPS grew to $0.57, up from $0.12 in fiscal '20, driven by the combination of top line recovery and improvement in gross margin and a reduction in expenses.

Total product revenue was $195.8 million and our product book-to-bill ratio was 1.18. Wired revenue grew 55% from a year ago and 21% sequentially, led by record edge switching revenue, along with solid performance in campus switching and data center. Although wireless bookings reached an all-time high, wireless revenue was impacted by supply constraints and grew 1% year-over-year and fell 12% quarter-over-quarter.

Total services revenue reached a record $82.3 million, up 11% from the year ago quarter and 7% sequentially, largely driven by the strength of cloud subscriptions. Our total services book-to-bill ratio was 1.34, fueled by growth in subscription bookings. The growth of cloud subscription and service renewals resulted in total deferred revenue of $346 million, up 8% from $294 million in the year ago quarter and up 3% from $318 million in Q3. Deferred revenue related to our cloud subscription was well in excess of $100 million exiting fiscal '21. This will help sustain our recurring services and subscription revenue growth going forward.

From a vertical standpoint, the highest sequential growth came from education on the strength of both K-12 and higher education businesses. Other areas of strength were service provider, where we began to see initial demand for our 5G solutions take off 1 quarter ahead of our expectations; manufacturing; state and federal governments; and transportation and logistics. Our sports and entertainment business was up triple digits year-over-year as venue and hospitality business continue to build. In fact, nearly all verticals were up strong double digits or better from a year ago.

Our non-GAAP gross margin of 60.5% improved 110 basis points from a year ago quarter, but declined from 61.5% in Q3. The year-over-year increase in the company's gross margin was driven for the most part by product, where the very significant increase in volume drove a much higher absorption of the fixed cost components of our COGS. This more than offset the year-over-year decline in our services gross margin. The sequential drop of 1 percentage point in the company's total gross margin was due on the product side by an increasing component and freight cost against the current backdrop of severe shortage of components and on the services side by a high mix of professional services revenue associated with MLB deployments.

Q4 non-GAAP operating expenses were $130.9 million, up from $116.8 million in the year ago quarter and up from $127.3 million in Q3, essentially reflecting higher sales and marketing costs. The net results, a faster top line growth compared to cost and expenses was in non-GAAP Q4 operating margin of 13.4%, a company record, up from just 5.2% in the year ago quarter and 11.3% in Q3. On an annual basis, operating margin of 10.9% marks the first time in company history that Extreme finished the year at double-digit non-GAAP operating margins.

The non-GAAP earnings per share of $0.19 included a tax adjustment of $0.04, primarily due to onetime catch-up modification of the non-GAAP effective tax rate to reflect a greater revenue contribution of the U.S. entity to the company's overall non-GAAP pretax profit. The non-GAAP tax adjustments, which would normally have been attributed to this quarter, was $0.01 and would have resulted in a non-GAAP EPS of $0.22. Going forward, we anticipate the non-GAAP effective tax rate will be approximately 16% for fiscal '22.

The recovery in our operating profit, combined with the good management of operating working capital, resulted in the highest-ever quarterly cash flow from operations of $57 million in Q4 and free cash flow of $52.2 million. In fact, for all of fiscal '21, cash flow from operations was a record $144.5 million and free cash flow was $127.4 million.

Our cash conversion cycle reached historically low levels of 22 days compared to an already low 31 days in Q3, mostly driven by a substantial decrease in our days of inventory. We ended Q4 with $247 million in cash and equivalents compared to $203 million at the end of Q3. Our net debt decreased to just shy of $100 million, down from $148 million in Q3. As a result, our leverage ratio fell to 2. And starting in early August, the interest cost carried on our term loan A debt will drop by another 50 basis points from an all-in rate of 3.19% to 2.69%.

Now turning to guidance. As I noted, entering Q4, demand is outstripping supply for certain products, which led to record backlog for products entering fiscal '22, such as our universal platforms. The supply constraints are leading to further rising component and freight costs as we enter Q1. We continue to proactively manage the supply chain, and our strategic relationship with Broadcom is helping us in this regard. Importantly, we have secured vendor commitments that will allow us to accelerate product delivery and bring down backlog as of Q2 and beyond.

As a result, the combination of our strong results and execution give us greater confidence in our fiscal '22 outlook. We expect fiscal '22 revenue towards the high end of our 5% to 9% long-term growth target with double-digit operating income margin and significant free cash flow growth. For Q1, we expect year-over-year growth to be in line with our full year outlook and expect revenue in the range of $250 million to $265 million.

Q1 non-GAAP gross margin is anticipated to be in the range of 58% to 60%. Q1 non-GAAP operating expenses are expected to be in the range of $121.5 million to $123.5 million. The sequential decrease in OpEx is primarily related to lower sales commission and other sales and marketing costs associated with seasonality and relatively similar R&D and G&A costs compared to Q4 '21. Q1 non-GAAP earnings are expected to be in the range of $16.7 million to $26.7 million or $0.13 to $0.20 per diluted share. In Q1, we expect average shares outstanding to be 133.2 million on a non-GAAP basis.

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

(Operator Instructions) Our first question comes from Eric Martinuzzi with Lake Street.

Congratulations on a real strong finish there to FY '21. That's terrific and the healthy guide as well. I'm curious to know, regarding demand environment, there's -- definitely with your enterprise customers, I know a lot of them, at least on the larger side, there is a return to the office. There is a return to the campus. Just curious to know, the IT priorities they've got because you've got a lot of people that have been gone for a while. And I'm just wondering about where are you guys, where networking gear and wireless access stands in the pecking order of IT priorities, whether from a budgeting perspective or from a manpower perspective.

Thanks, Eric. Yes, great question. I mean it's pretty interesting what's going on in the environment out there. When the pandemic first hit, there was a lot of spend in network peripherals. They had to arm students that were going back to their homes and workers going back to their homes, health care workers, et cetera, et cetera. And now what we're seeing is the reimagining of the workplace or the work environment, where enterprise customers are thinking about more of a flexible work environment, a hybrid work environment. And this is why you hear us talk about the distributed enterprise or the Infinite Enterprise because what it means is that the enterprises are taking responsibility for the new edge of the network. And the new edge of the network is going to be that individual. Eric, it's you, wherever you are and whatever device you're on as opposed to being in a branch office.

And that's why the cloud-enabled networking is the fastest-growing segment in the networking industry. And we have the industry's highest quality cloud. And because of our cloud-native infrastructure, we're in a position to deliver more services than anyone else. And so our vision is really catching enterprise customers by surprise. As people rethink their environments, networking has become a higher priority, cloud has become more important. It brings a lot of complexity in terms of a distributed network and cloud simplifies that. So all of a sudden, from an Extreme perspective, and that's why we're seeing so much demand, enterprise customers are contemplating cloud. And then if they're a Cisco customer, they say, "Well, I'd like to get another opinion from another competitor and I should hear from Extreme because they're the #2 in terms of size." But our architecture is fundamentally better equipped to provide a cohesive services edge platform than Cisco, for sure, and than all the other competitors.

So now customers are surprised when they're hearing from Extreme. Extreme is moving much further down competitive processes, and our hit rate in terms of batting average is off the charts.

Okay. So you're saying that given this shift in the -- wherever you are, operate from wherever you are, that favors you guys, that is a priority for your enterprise and education accounts?

Absolutely. I mean it's driving cloud. It makes sense, right? You want to have a centralized platform where you have complete visibility to all the devices that you're managing in the network, but also to have all the insights to the edge devices that are being supported. And that's what our cloud does better than any other cloud in the industry. And so it's that. And then it's also future forward in terms of what are the services that are going to come in the future, and we have the most cohesive vision in the industry.

Good luck in Q1.

Our next question comes from Alex Henderson with Needham.

I was hoping you could talk about your approach and the industry approach to pricing given what's going on. To what extent you anticipate some increase in prices, when you might be increasing them and what you're seeing from your competitors on that subject? I mean, clearly, there's going to be some pass-throughs here.

Sure. Alex, we are seeing and we are aware of competitor price increases. Probably, the most important move for Extreme is the migration to the universal platforms that you're aware of. We talked about a 40% migration. But for us, it's the new technology. And we caught up, so we're on the latest wave of Broadcom technology in terms of the latest generation chipsets. And as you just saw with our Wi-Fi 6E announcement, we're first to market. So I would say that for us, you're going to see that portfolio completely migrate. And for us, it simplifies our SKUs and simplifies our supply chain. So in effect, we're going to get a nice gross margin benefit from what is a higher margin -- a migration to this higher margin universal platform.

As it relates to -- and that's happening, and you're going to see that migration happen over the course of this fiscal year. So that should bring nice margin benefits for us and growth benefits, especially in the second half of the year. As far as the pass-through of cost is concerned, the fortunate thing for us, we do have near-term increases in cost. But we've invested -- our teams have established a great relationship with Broadcom. And we don't just consider them a vendor, we consider them to be a strategic partner. And they work really well and our teams work really well together. And so the good news for us is that we've secured commitments.

And so our fiscal Q2 now, we feel like we've locked that up. And then with the 1-year lead times that started a year ago, that really eases, and we're going to start unlocking backlog in Q2. And then we feel confident about our allocations and wafer allocations for Q3 and beyond. So we have to be smart about it. We're looking at potential more tactical price increases maybe for certain products. At this stage, we don't have a formal plan for it.

So you haven't increased any prices to date?

On some of the -- we're always looking at our portfolio, Alex. So I mean, I would say, we're always -- you'll always see changes in us elevating prices, particularly on older products, older generation products. It's kind of a normal course of business.

If you would characterize the...

The other way we manage it is through discounting control. So yes, that's the other way that we would -- we manage the margin.

If you were to look at it from the perspective of, on average, your competitors not having a newer product line, not having the ability to benefit from the universal integration of components, can you quantify or just generally speak to, is it 2%, is it 5%, is it 8%? What kind of price increases are you seeing from Cisco and Hewlett Packard and others?

I think it's safe to say 5% to 10%.

Our next question comes from Dave Kang with B. Riley.

First of all, just going back to the supply chain challenges. Do you think this current quarter, fiscal first quarter will be the bottom in terms of gross margin? How should we think about gross margin going forward?

Yes. I'll start off and then let Remi pick it up. But the answer is yes. I mean, for us, the September quarter, we have the most pressure on this quarter. And I think that the same is true with the rest of the industry. As I mentioned earlier, we've gotten secured shipment dates for what we need in Q2, just given the strength of our teams working with -- and the strategic nature of the relationship that we've got with Broadcom. So we see the lessening happening and that means that we have commitments. The costs that we incur have to do with expedite fees [and] trying to pull in product. And then it's also the timing of how product arrives at our ODMs and then the speed with which we have to turn around into product and direct ship. So there's a lot of contributing factors.

So across multiple factors, we expect to see the easing start to take place in our Q2, and it's really this quarter where we'll bear the brunt of it. Remi, I don't know if you want to add to that.

Yes. If you take the midpoint of our guidance for Q1, Dave, you see that it's 59%. Compare that to where we landed in Q4, it was 60.5%. So we're looking at a 1.5 percentage point impact if you take the midpoint. And if you apply the math to the revenue that we're calling out, that really gives you an idea of the size of the impact. And it's really driven by 2 things: one is the higher cost of components that we're having to pay to secure deliveries and the second one is higher freight cost. We used to be in an environment where we were able to ship anywhere between 25% and 35% of our shipments from our ODMs to our hub and from our hub to our distis by sea. And right now, we're pretty much at 95% to 100% by air just to accelerate the delivery time.

So these 2 components add up to that 1.5 percentage point difference that you see between Q4 and Q1. We think it's probably the highest that we'll see, and things will start to improve as of Q2 and onward. And then last point, we'll get also a high mix of universal hardware platforms going forward, which intrinsically carry higher gross margin than our [gen 2] products.

Got it. And then my second question is regarding your fiscal '22 outlook of high end of 5% to 9%. Can you just share some key assumptions, such as like your 5G, I think you already talked about $20 million, could there be some upside to that? And wireless, Wi-Fi, other verticals?

Yes. Well, we have the benefit of having a funnel, and we have a lot of opportunities. We have better visibility. And so we're seeing this momentum. And I was answering Eric's question before, we're just seeing higher velocity. As we roll into fiscal '22, the strength that we're seeing in July, the momentum that we felt in June is spilled right over into July, which is normally a softer month for us. And I think it has to do with our position in cloud. Cloud really is the fastest-growing segment in the industry. And people are rethinking and considering cloud, most of cloud has been wireless. But people are starting to think more broadly about edge switching and migrating other platforms to cloud.

And we're in a very strong, probably the most competitive position of all the players in the industry, certainly the strongest position we've been in. And as I said before, our teams are out winning in the market. And I think there's more competitive differentiation at Extreme today certainly than since I've been involved with the company for over a decade. So demand for our solutions is at an all-time high, and I think it's being driven by the competitiveness of our solutions, the innovation that we're bringing, the consistency of our vision, the messaging. We have a smaller market share in the industry relative to a Cisco or an HPE. So when customers are looking at us, maybe they haven't looked at Extreme in a long time, and they're surprised to find out the quality of the solutions that we can bring and the vision that we have as a potential partner to go forward.

I mean this is how we won Major League Baseball, a great example. Some of these casinos, great example. I mentioned Stanford University, right in Palo Alto, they go Extreme. We have a lot of big marquee wins, and then that really stimulates our field and gives them confidence -- to all of our sellers in the field.

Got it. And my last question is actually going back to the supply chain issues. You talked about the margin impact. What about top line impact? How much revenues are we leaving on the table because of the component shortages?

If you remember the prepared remarks from Ed, we talked about a backlog entering Q1 that was $100 million. That's about 3x the level that it was entering Q1 of fiscal '21. So that gives you an idea of the magnitude of how the backlog has built. So I would say that if it weren't for product constraints -- but we don't like to make those comments because we have product constraints. But if it weren't, our revenue both for Q4 and Q1 would have been tens of millions of dollars higher.

Our next question comes from Christian Schwab with Craig-Hallum.

Congratulations on the great quarter. And we just got, wow, a whole list of, litany of wonderful things going for you. I just want to get to gross margins versus the top line growth drivers that you guys have highlighted. With the supply chain issue kind of becoming less of a headwind, it appears, in the second half of your fiscal year; and by that time, I would imagine just about every product you'll be shipped would be on the refreshed universal platform; and then if we can get some moderation in expedited freight costs and the supply chain of freight kind of normalizes, how good could gross margins be exiting the year if those type of events were to occur?

So if you think about the drivers of gross margin on the downside right now, which is going to impact Q1 and to a lesser extent Q2, you have those higher component costs to secure deliveries and you have the freight costs. And on the upside, you have the introduction of the universal hardware, you have our ability to selectively raise price on certain products, and more importantly, to control discounting, which we're doing very effectively and you have the mix. I talked in my prepared comments about deferred revenue and the fact that we now have $340 million-plus of deferred revenues. So you're going to see the percentage of support and subscription revenue as a percentage of the total pickup over the coming quarters and from the current level of 28%.

So when you factor all that, we should be exiting Q4 fiscal '22 north of 60%, obviously. And we feel confident about the long-term target that we've established at the Analyst Day. If you recall, we gave a range of 63% to 65%. We think we're still on that trajectory, even though we have the short-term impact of the 2 items that I mentioned earlier.

And then you add into the fact that you have probably what looks to be the most competitive product lineup for customers, at least...

You just said it. We agree with that statement, but it came from you.

Yes. You can quote me on it.

(Operator Instructions) Our next question comes from Paul Silverstein with Cowen.

A couple from me. First off, Remi, did -- I don't think I heard you give it, and I understand why you won't, but did you give us a number, your expectation for gross margin, for -- all-in for fiscal '22? Or is there -- given the higher freight costs, higher component costs at this point, is it just too hard to...

I didn't, but the goal is to be north of 60% for the full year. So we'll obviously exit at a higher rate. We're thinking it could be north of 61% by Q4. And when you take the average for the year and take into account the mix of revenue between the various quarters, we feel like we should be above 60% on average for the full year.

All right. And then the higher freight costs that you and everybody else is seeing, is there any concern that freight costs continue to go up? If I heard you correctly, you're already shipping 95% by air. So it sounds like the mix of sea to air, that can't get any higher. But is there any concern that freight costs will continue to go up and prove a headwind?

So there's 2 factors. The first one is the one you just mentioned, which is that right now, we're almost a 100% air. And the second one is the actual cost for carrying a ton of product over the Pacific and then over the Atlantic, so to bring products from China to El Paso and then ship it out either to the U.S. or to the rest of the world. We tend to use commercial airlines to carry our products. And because capacity has been limited for the past 15 months since COVID started, the rates are up. As commercial traffic starts to pick up, and you can see that airports are getting busier and busier, we expect airlines to add capacity and the unit price for carrying a ton of product to go down.

So to your point, it doesn't get any worse than it currently is. As a matter of fact, when I look at the actual number that we're forecasting for that part of our cost of goods sold in Q1 versus Q4, it's actually down slightly sequentially, but it's the component costs that are rising.

So Remi, to be clear because it makes perfect sense that as commercial airlines add capacity, you and everybody else should see prices going down. But to be clear, you're already seeing that? Or that's just common sense?

Yes. The price on certain routes are already starting to ease a bit, but it's more than offset by the rising component costs we see from Q4 to Q1.

And then on that second point about rising component costs, is there any visibility as to incremental increases throughout the year? Or do you already have prices locked in?

No, we basically, to the point I made, have a long-term relationship with Broadcom and the other suppliers that we use. And so we're in constant dialogue to secure commitments for deliveries in Q2 and onwards, and we have good visibility as to how much that will cost us.

All right. And then on the demand side, what's your historical experience with respect to customer cancellations of the orders [in] backlog? I assume that's rare.

Yes. Paul, that's a pretty rare occurrence. And I would say that we have seen a couple of small kind of one-off situations where there's an urgent project or an urgent demand. But what's interesting for us is that what we are hearing from our distributors is that we've asked them to force rank the vendors, and we've got really high ranking. So we're getting -- I think right now, Extreme is kind of in an interesting position of potentially being a go-to because of how we manage the supply chain.

Ed, everybody, all the networking companies [that I trust] will be on networking, the silver lining from the pandemic has been customers providing extended visibility far beyond the normal book and ship that's prevailed for many years now. And that's given you and your peers far greater visibility into the future than what has been the case historically.

That said, the investment community still worries that there's some degree of perhaps meaningful over-ordering. What is your visibility as to true demand [and] the risk that there is a healthy amount -- and healthy, obviously, would be the wrong word, but that there's a meaningful amount of over ordering going on, and so true demand is far less than what your nominal order book and other demand metrics would indicate?

Yes. It's a great question, Paul. I think you got to think about Extreme and our business mix. And I think I would see from someone like -- you might see more of that from like larger service providers, maybe like the large Fortune 50 type accounts, et cetera, but we don't see as much. I mean we might see some stocking orders from distis coming in where we know that they're trying to get ahead of this. But in terms of our backlog, it's a pretty small percentage.

When you think about a school district going through, getting e-rate funding and adding to their network or upgrading their network, they're not as sophisticated trying to get ahead of a global supply chain crunch. So we just don't see that as much. If you look at our customer profile, most of them are ordering what they need for projects. We have run rate business where they're just ordering and then there's project business. But in the case of Stanford University Stadium, they have the worst Wi-Fi in their league, okay? That's embarrassing for a company that's right in the tech center. They need to upgrade. Well, guess what? They've gone to Extreme, big opportunity for us. We won that in a competitive. But they're not preordering to get in front of a supply chain. They're ordering because they have a problem with the quality of Wi-Fi. And I'd say that is true with almost all the ordering that we're seeing from our customers. Remi, do you want to add anything?

Yes. I was going to say, Paul, remember, we operate under a 2-tier distribution model where we recognize revenue on a sell-in basis to distis, and then distis provides our products to business partners who sell them to end customers. Hypothetically, if an end customer changed their mind and canceled their order, first of all, most of the business partners don't take cancelable orders. But hypothetically, if that happened, what the distis would do is just reallocate those goods, because they're short of everything right now, to another business partner who would end up selling it to another customer.

So we measure the risk of return through stock rotations, which is an allowance that we give our distis for their ability to rotate products. And stock rotations right now are at an all-time low because everything they have in their warehouse, they need to be able to deliver to the various business partners that are seeing this strong uptick in demand.

Guys, let me ask one more question on this line. Playing devil's advocate, and correct me if I'm wrong, but I think the last time we saw a meaningful over ordering crisis, if you will, you'd have to go back to the telecom Internet bubble back in the late '90s. Maybe there was -- maybe I'm forgetting 1 or 2 other times, but I think you'd have to go back 20-plus years. Given how long it's been, and this is obviously not unique to Extreme, but if that is what's going on, to one extent or another, today, Remi -- and notwithstanding your comments. And again, I recognize this would not be a unique Extreme issue. I'm just trying to gauge the risk. Everything you just said, would that matter?

I mean we'd see -- if it is something akin to late '90s, won't there be a collapse across the board of one extent or another? So your point about the reallocation from one customer to another and stocks being very low, and that gives you comfort and protection, wouldn't that just go away if it is, to some degree, the late '90s scenario? And I'm not saying it is or isn't. But that -- would (inaudible)...

Yes, Paul -- yes. I was there with you in the late '90s. And this is very -- I mean this is a very -- I can tell you, we are in no way in a bubble as far as spending -- IT spend. We're -- actually, it's just the opposite. We are on the very front end of this investment in 5G infrastructure. It has nothing to do -- I mean what we're going to get, we're at the very, very beginning of deployment of the largest infrastructure investment in our lifetimes. And it's very mature. So there could be some near term -- and again, I think all the preordering concerns that you're worried about, I think that's more of a service provider phenomenon for larger carriers trying to get ahead.

But as far as enterprise customers upgrading their networks in terms of the idea that we now have this new spectrum band and Wi-Fi in the 6 gigahertz space and what that means for customers and the capabilities for customers, the edge of the network is going to be changing from the closet in a branch office with a lot of boxes into the cloud, which is driving a greater need for networking. All of these secular trends are going to be around for years and years to come. So we have -- we can't see -- we have no visibility to a bubble at this stage of the game.

And this concludes the question-and-answer session. I would now like to turn the call back over to Ed Meyercord for closing remarks.

Okay. Well, thank you, everybody, for tuning in. I can tell you, we just had all of our global teams together for our sales kickoff meeting and our employees together. And I think consensus on the inside of Extreme is that there's never been a better time to be at Extreme and to be an Extreme seller. We're seeing great demand. Our technology innovation is really coming into the forefront with the strength of our product and engineering teams. And things are looking good. We have great momentum going into this quarter.

So thank all of you for joining us. Thank all the Extreme stakeholders, employees and our partners and customers who are tuning in as well. Have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.