Earnings Call: Q4 2019

Jul 31, 2019

Good day, ladies and gentlemen, and welcome to the Extreme Networks Q4 FY19 Financial Results Call. At this time all participants are in a listen only mode. As a reminder, this call is being recorded. I would now like to turn the call over to Stan Koffler, Head of Investor Relations. You may begin. Thank you, operator. Welcome to the Extreme Networks 4th quarter fiscal 2019 earnings conference call. I'm Stan Kovler, Executive Director, Investor Relations And Strategic Development. 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 4th quarter fiscal 2019 financial results. For your convenience, a copy of the press release, which includes our GAAP to 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 Network's future of business, financial operational results, acquired technologies, products, operations, pricing, changes to our supply chain, the impact of tariffs, pending acquisition of Aerohive Networks and digital transformation initiatives. 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 reports filed with the SEC. Any forward statements on this call 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 Networks' President and CEO, Ed Meyercord, Thank you, Stan, and thank you all for joining us this morning. Today, we announced Q4 results at the high end of our expectations, on revenue of $252,000,000, above percent gross margin goal at over 59 percent ahead of the street and non GAAP earnings of $0.06 per share at the high end of our guidance range. For fiscal 2019, we achieved $1,000,000,000 in revenue, improved our gross margin, despite headwinds from tariffs and finished off our year by taking action to improve our cost structure heading into fiscal 2020. We also generated $82,000,000 in free cash flow in fiscal 2019, paid down $20,000,000 of debt and ended the year with $170,000,000 cash balance. We're on track with our pending acquisition of Aerohive having already received U. S. And German antitrust approvals and see clear line of sight towards closing the transaction shortly after our tender offer, which is currently set to expire on August 8th. We reorganized our software engineering team under new leadership to combine with the DevOps cloud management team from Aerohive to hit the ground running. Our intent is to bring cloud management to our entire portfolio of enterprise Wi Fi network switching and software to accelerate feature velocity. We are exiting fiscal 2019 with the knowledge and confidence that our solutions are winning in the marketplace. Last year, we had over customers investing more than $1,000,000 worth of Extreme Products And Services. In Q4 alone, we closed 23 deals of $1,000,000 or more, up from 2017 in Q3. We're winning larger deals and see this trend continuing based on the growth of these large software driven opportunities in our pipeline. That will continue to ramp over the next 9 to 12 months. And 27% quarter over quarter. Specifically, we saw success in education, government, healthcare, retail, and wins in hospitality with Wi Fi Six leading the way, along with our new X Four 65 switch extended edge switching, extreme cloud appliance and associated software. We also released several new products in our automated campus portfolio, such as the 32 by 148 by 25 solutions that drove double digit year over year growth in the Americas. Our agile data center business continued to benefit from strong momentum in our SLX 9640 border routing solution and customers migrating to the SLX platform from the VDx and MLX platforms. Q4 was a difficult comparison quarter outside of our service provider federal and OEM segments, but we finished the year at the high end of our previously guided run rate of 160 to 100 $80,000,000 in revenue for this business. Our software business grew for a 6th quarter in a row of 7% year over year and 20 2% quarter over quarter. We received overwhelmingly positive feedback for all our solutions pillars conference in May in Nashville, where attendance doubled year over year. Last year, customers who attended the conference increased their investments in Extreme by over 10% and those who participated in technical sessions increased their spending with Extreme by 64% education vertical and lots of success in the government and healthcare verticals. In retail, we are seeing lots of large opportunities going into fiscal 2020 that are now focused on switching, validating the strategic rationale of our acquisitions, the biggest customers we picked up from the Zebra acquisition close to 3 years ago, where wireless only and are now embracing our switching portfolio. Heading into fiscal 2020, we continue to expect to see growth in our education vertical based on strong E Rate wins and higher ed coming through and fiscal 2020. Our E Rate bookings grew three times quarter over quarter, while business outside of E Rate such higher ed also grew strongly. In EMEA, service revenue growth drove stability in margins, while challenges in Germany and Southern Europe were offset by strong new logo additions of approximately 20% above corporate average of 15% and year over year growth in wireless. APJC revenue fell 25% year over year on a tough comparison quarter and lumpy deals. However, and regions such as Japan by expanding our enterprise customer base. Our tariff mitigation plans in the U. S. Are on track To date, we moved 90 percent of our product manufacturing to Taiwan and other TAA compliant countries for products bound for the U. S. Our Taiwan standard costs are 4% to 5% higher than in China. We estimate that tariffs added greater than a 1 percentage point headwind to gross margin following the increase from quarter owing to our move to TAA compliant countries. I'd like to elaborate on a few customer wins we highlighted in our press release. Our SLED team in the U. S, which is state, local and education vertical, led the way. In Q4, two top deals in SLED drove $10,000,000 in business alone. We won both of these education and government campus refreshes with integrated solutions across our technology solutions pillars with end to end wireless, campus core and data center switching with XMC riding on top. We won these in head to head competition with Cisco and HPE. Leeds Beckett University, a top university in the UK, is upgrading its campus network with Extreme Smart Omni Edge solutions, serving 25,000 students 3000 and staff across 85 buildings and sports facilities featuring new Wi Fi Six run over our automated campus network, where our Stream Fabric Connect enabled automatic configuration of the new access points. The Extreme Management Center application will provide single pane of glass management across the two networks. And Houston DASH of the National Women's Soccer League to provide high density professional grade Wi Fi connectivity in their home field BBVA Stadium. Stream analytics software. This new network will enable mobile ticketing and improve social media connectivity for fans today. And soon fans will be able to wirelessly order food from concessions and engage in augmented and virtual reality experiences that will bring and productivity in our operations across the board. Our new channel self-service tools like our full solutions catalog came online in May for quoting and configuration by partners. We expect to drive 25% of our business in the form of frictionless transactions within the next for remaining transactions. This means nearly 30% of our transactions were touchless in Q4. Up over two times driving productivity. We initiated a restructuring program at the end of $24,000,000 to $27,000,000 of annualized cost savings, largely in OpEx. We're aligning our cost structure and upgrading our platforms to accommodate significant enthusiasm with our customers, partners and field teams who are interested in cloud managed enterprise. The merger will make Extreme a technology leader in cloud managed Wi Fi with advanced artificial intelligence and machine learning capabilities. This accelerates our strategy of adding more applications in microservices in the cloud to serve our customers. We also aim to technology today. Looking ahead, we are adding conservatism to our forecast to account for customers and partner evaluation of overlapping products in our smart Omni Edge WiFi portfolio and the new cloud managed WiFi from Aerohive. Also, we continue to see challenging macroeconomic trends in both EMEA and typical seasonality in fiscal Q1 results. With that, our outlook for core extreme in fiscal 2020 is to grow in the low single digits to over $1,000,000,000 in revenue and we continue to target and boost gross margins given their mid-sixty percent run rate. We believe the investments we have made in our digital transformation will pave the way for productivity gains and operating efficiency. The combination of growth, increased gross margins and operating efficiencies allows us to target a 15% and gross cash, $181,000,000 in debt for net debt of just $9,000,000. I'm confident in the stream team and our ability to improve execution and operational efficiency as we move forward, especially as we the next chapter CFO, Rami Thomas. Thanks, Ed. As Ed noted, our revenues of $252,400,000 declined 9% year over year and grew 1% quarter over quarter and came in above the high end of our guidance. Non GAAP earnings per share the high end of expenses. Our product revenue of $189,500,000 declined 14% year over year and was down just 1% quarter over quarter. Our book to bill ratio was close to 1.1 with product bookings up 16% quarter over quarter and flat year over year. Our Smart Omni Edge switching business grew year over year quarter over quarter, while our wireless business recovered sequentially, but still faced difficult quarter over quarter. The year over year growth was largely driven by the deferred revenue add back of $5,100,000 from prior acquisitions. On a like for like basis, services revenue grew 2.7% year over year, reflecting the positive impact of continued growth in multiyear bookings we've seen over the past several quarters. Our services bookings grew 6% year over year and 13% quarter over quarter with strength in renewals and new service attach. During the quarter, the Americas contributed 64% to total revenue, EMEA 28% and APAC close out the remaining 8%. Globally, education was our top performing vertical with bookings at the strong 30% year over year and 123 percent quarter over quarter on strength across each of the K through 12 E rates and higher ed subsegments. Government was a close second and grew a healthy 11% year over year, including both state, local and federal government in the U. S. And Internationally. Year over year and to a lesser extent, manufacturing followed by retail to round out the top 5. Non GAAP gross margin was 59.2% compared to 57.6% in the year ago quarter and 57.6% in Q3. The sequential improvement is attributable to the services gross margin, recovering 220 basis point quarter over quarter to 61.6 and product gross margin increasing 130 basis point quarter to quarter to 58.4%. We estimate that tariff had an adverse impact of 110 point on product gross margin, consistent with our estimate entering the quarter. The sequential improvement in our product gross margin can be attributed shift to the U. S. And better pricing, offset by the impact of tariffs. Q4 non GAAP operating expenses $136,800,000 were up from $132,900,000 in the year ago quarter and from $130,600,000 in The sequential increase in non GAAP operating expenses was mainly due to higher sales and marketing expense with higher sales commissions in the U. S. Higher R and D expense was mainly due to work on new product introductions we expect to release in the next 1 to 2 quarters and ahead of our planned restructuring at quarter end. 9% compares to 9.8% in the year ago quarter and 5.6% in Q3. As a reminder, most of the we announced at quarter end related to OpEx cost savings that will flow through to our P and L over the course of fiscal 2020, with a step up in operating margin for the second half of the year. Free cash flow of $18,900,000 from 12,800,000 we generated a total free Our total cash balance at the end of Q4 was $169,900,000, up from $156,800,000 at the end of Q3. DSO of 63 days fell 6 days year over year and grew 8 days quarter over quarter. On a sequential basis, the strong collection drove DSO lower. Our cash conversion cycle stood at 61 days compared to 66 days a year ago. But up only marginally from 60 days in Q3. Now turning to guidance, as Ed mentioned, we're adding conservatism to our forecast to account for overlapping products in our Smart Omni Edge Wi Fi portfolio, continued challenging macroeconomic trends in EMEA, and typical seasonality in our $35,000,000 to $245,000,000. Q1 GAAP gross margin is anticipated to be in the range of 55.1 57.2 percent and non GAAP gross margin in the range of 57.5 percent to 59.5 percent. We estimate that tariffs will of manufacturing to Taiwan. Q1 operating expenses are expected to be in the range of 140.2 $145,800,000 on a GAAP basis and $126,000,000 to $131,600,000 on a non GAAP basis. The sequential decrease in OpEx is primarily related to lower sales commission and OpEx savings as a result of the restructuring actions taken the end of Q4. $1,000,000 or a loss of $0.13 to $0.09 per share. We're still evaluating the impact of our integration costs following the pending acquisition of Aerohive and we'll be in a better position to refine those estimates post closing. Non GAAP net income is expected to be in the range of $4,000,000 to 9,200,000 or $0.03 to $0.07 per diluted share. Assuming a mid quarter close for the Aerohive Networks acquisition, we assume a 5th $1,000,000 contribution to revenue with a 68.6% gross margin on both a GAAP and non GAAP basis from Aerohive. We estimate GAAP Aerohive operating expenses will be $17,700,000 and non GAAP operating expense will be 12 $1,000,000, resulting in a 49.2 percent GAAP operating loss margin and 11.4% non GAAP operating loss share contribution of $0.08 and a non GAAP loss per share contribution of $0.03 to extreme earnings. In Q4, we expect average shares outstanding to be approximately 118,900,000 on a GAAP basis and $121,600,000 on a non GAAP basis excluding the impact of any shares we may repurchase. With that, I will now turn Our first question comes from Eric Martinuzzi of Lake Street. Your line is open. Yes. I was curious to know if you've got any or what your plans are as far as, educating the channel. Obviously, you're looking at some disruption here with the addition of the Aerohive product. But what steps have you taken thus far to that locked and loaded post closed. Okay. So what we're doing right now is there's a lot of work going on as far as our product roadmap going forward. And I think the teams are doing a pretty nice job with that. As I mentioned, And one of the things that we've done is we've reorganized. So our software engineering team is, moving under new leadership. And then we're going to put the, the DevOps cloud team from Aerohive under that same group as we go forward. And we're in the process of mapping out that product roadmap. What we would normally do in this situation, particularly in this quarter is say business as usual, And then, but we will expect some people to sort of pause a bit to evaluate the new technologies. And then, then we'll be providing a very clear guidance. We are enabling both our field as well as our partners on the Aerohive platform. So there is that initiative. And at the same time, we will be enabling and educating the airline partners and field on our switching portfolio. So there's a of demand within our channel for cloud managed platform. Interestingly, a lot of our partners are very familiar with the Aerohive platform. And had some concerns about their viability. So now that they're with Extreme, they're really excited to be able to sell that. There is some overlap in the channel with partners who are selling both. And then on the Aerohive side, there's a very clear opportunity for us to add switching to have a very limited switching portfolio. And obviously, that's one of our Thanks. So right now, the teams are working on clarifying the future roadmap. That'll take us a little bit of time at the same time We have initiatives for both the channel and our field teams to get educated on the, the technologies. Okay. Second question has to do for the fiscal 2020 outlook. Obviously, your guidance here for Q1 on the legacy businesses for relatively flat year on year. And you're talking about full year of low single digits. Does that anticipate a recovery in your European business? It does. A lot of what's happened with the macro issues in Europe and specifically in Germany and what we call our going away, we see them being more delayed. And we fully expect that to come back because there's clearly demand for networking and there's clearly growth in networking with the solutions that we're selling in that market. Okay. And then last question for me. On the anticipated revenue contribution from Aerohive in your fiscal Q1, I think you said $15,000,000, basically a half quarter contribution. Now if I look at their business a year ago in their September quarter, they did $33,000,000. I'm wondering if you could explain that delta there between, because it looks like they're just, they're their June quarter was kind of flat year on year. And yet, based on your implied full quarter kind of distribution, it would seem like they would be down year on year in September. Yes. Why don't I let Rami pick up that one? Yes. So, we're basically obviously looking in detail at the business. One factor that you need to take into account is deferred revenue haircut. And so that's factored in. And then, obviously, when the company is being there's always a bit of transition happening. And then you don't necessarily know the exact number of days we have in the quarter, but when we take their outlook, which is actually north of $33,000,000 for this quarter, factoring the pro rates take into account the deferred revenue haircut. We land on roughly $2,000,000. Understand. Thanks for the explanation and thanks for taking my questions. Our next question comes from Paul Silversteyn of Cowen. Your line is open. Josh, can you hear me? We could hear you. How you doing? Good. Yourself? If I could just take you back to the previous question. So looking at the first quarter guidance organic and taking into account your comments for the year, the discrepancy of growth, is that in highly due to the macro in particular to Europe? Were there any other issues? We're also being a little bit conservative on the Wi Fi business because we're putting together 2 Wi Fi companies and our experience, although we don't see a amount of overlap in the customer base, but there's overlap in the product portfolio. When you combine 2 Wi Fi companies together, you typically would expect a bit of revenue dis synergies. And so the outlook for the year includes the expectation that at least for Q1 and Q2, will not be a recovery in EMEA, and we do expect to see an improvement in the second half. And then around the consolidation of the Wi Fi portfolio, there will be a bit of a revenue dis synergies in Wi Fi revenues. Those are the two factors that we take into account. To guide for this sort of low single digit organic growth for Extreme Corp. But Rami, the discrepancy between the looking at the organic on the quarter for the first quarter versus your growth outlook for the year. If I just think organically, I just want to make sure that that's that's entirely due to the macro or that's also wireless LAN? Because I would think of the wireless LAN side, I appreciate your comments about revenues and synergies, no different than any other deal. But I trust Wi Fi Six should be a rising tide. I recognize products are just coming out from you and others, but I trust that should be a rising tide over the next 12 months that y'all should benefit from no different than your competitors? That's correct. Although the contribution from Wi Fi Six in Q1 would be still a low percentage of total Wi Fi revenue. Right. So again, just focusing on the discrepancy between Q1 guidance relatively flat organically, but $2.35 to $2.45 to $2.40 in the midpoint versus your commentary about the growth for the year, that's all macro or that's also the wireless landed of the synergies or is there other stuff in That's micro, that's the WiFi and that's, the product cycles. So we are seeing already good momentum in Smart Omni Edge switching, which really drove the revenue outperformance in Q4. We do expect to see good momentum in automated campus and data center as we hit and Q3. And specifically in data center, there's a number of releases of SLX, which is the next generation platform that should drive a stronger growth in that specific business compared to what we see in Q1. All right. But at the risk of saving me, obviously, even at our counting on the macro situation in Europe, those pushed out deals, you're counting on those coming in and being able to recognize them throughout the year to hit the guidance. Does that go without saying? Yes, I think that's fair, Paul. The other thing I would mention is, we've made a lot of acquisitions. Our team has done a fabulous job as far as integrating. And we've learned a lot. One of the things we've learned is that there is we will have some of our customers that want to look at the ROI platform And so there could be some delays in some of the opportunities that we're looking at as people want to evaluate the Aerohive platform. The other thing that we commented in this release is the fact it's a great cross selling opportunity and what we're seeing today in retail that we're so encouraged about is the massive switching opportunity that we have with the former Zebra customers, which is that 50% of the Fortune Fifty a lot of the large retailers, transportation logistics companies, you know, the logos, it's just it takes a little bit longer than you might expect. So we want to be conservative on cross sell, but we do believe that there's a pretty significant cross opportunity. Okay. One last question from me. Anna, hopefully I'm not confusing you with someone else. But I think last quarter you had cited the U. K. As well as Germany as being the primary drivers or among the primary drivers of some weakness. I didn't hear you all mention I heard you all mentioned Southern Europe and Germany. I didn't hear any reference to the UK. Did that did the UK resolve itself, in particular, I think you all had referenced U. K. Relative to Brexit, not surprisingly, but was that not an issue this quarter? Yes, it was not an issue. And one of the when we talk about Brexit, Germany, in Europe, their largest export market is the UK. And so the manufacturing sectors in Germany with a slowdown in export business affects the dock region for us. So even though it's a Brexit event, it's really affecting dock more than the U. K. The strength for us in education and healthcare and across our verticals in the U. K. The U. K. The U. K. I and Benelux market for us have been very resilient, particularly at the edge and then our automated campus offerings. Great. I'll pass it on. Thanks guys. Our next question comes from Christian Schwab of Craig Hallum. Your line is open. Great. Thanks for taking my question. So, we did $989,000,000 roughly So we were just in the standalone business, we're not looking for much growth 'nineteen to 'twenty. And now we're going to layer on Aerohive will have some dis synergies and deferred revenue haircut for this year. And then but as we look to let's get beyond 2020, if we can for a minute or I'd like to. We'll have all of our cost savings done in the core business to drive it to 15% operating margin. Remi, I think you've mentioned in the past you would hope to get Aerohive's business to similar margins exiting this year, which sets up really good earnings regardless of any top line growth. The next question I really have though is as you look at your business on a combined business and through a series of of numerous acquisitions to create scale, what are you guys thinking about as far as a top line growth objective on a multiyear basis? Is my question? Yes, I think, look, we've Christian, it's a good question. Longer term, we're not satisfied with low single digit growth. And I would I would gradually step that up for us. And I think it's going to take us a while to see how the portfolio matures. Obviously, cloud managed now working. And then shrink it down to the wireless LAN application, cloud managed wireless LAN is the fastest growing segment of that market place. And we think customer adoption is going to increase where these customers are going to start looking at cloud management as a tool, not just for wireless LAN, but across their switching portfolio. And frankly, across the enterprise, we think we're as well positioned or better positioned than anyone else in the industry to deliver on this. So depending on how that trend in the plays out, we are going to be a very strong competitor to everyone else in the industry. And we think with the 3rd generation cloud that we have, the DevOps team that we're bringing over and the investments that we're going to be making there, we're going to be able to roll out more features, microservices, connect to our switching portfolio and provide that cloud management experience for enterprise better than anyone else. So depending on how this trend catches. And depending on how this plays out, of cross sell and how we do across the cross selling platform, which is obviously another catalyst for growth. And then we just have built in growth from that deferred revenue coming back from a recurring revenue perspective. Right. In 2021, Can you remind us on a combined basis? I think before you talked about roughly 18% of your revenue Wi Fi. So we could just add on Aerohive to come up with a percentage of revenue that could grow very strongly. Is that fair? That is the correct number. Perfect. And then my last question has to do with customer adoption of Wi Fi Six. I understand a pause in the channel or customer base regarding platform comparisons between yours and theirs. But is there any update on the sales cycle of Wi Fi Six? And when would you anticipate that sales cycle to begin to shrink and more meaningful customer adoption to begin. Do you have any thoughts there? Yes. I think we've Wi Fi Six for us was probably one of our most successful new product introductions in the company. A lot of that has to do with how we've changed, that process inside of Extreme and the pre marketing that we're doing and the building of pipeline before the products are G8. So from that standpoint, it's been a very successful product launch. And it's gaining a lot of momentum. And some of the customer highlights that we're pointing out, we're seeing I mentioned leads back at university. I mentioned the stadium win, that the titans, which we didn't talk about in this release, Wi Fi Six, the Houston, the dynamo, Major League Soccer the BBVA Stadium in Houston. So I guess what I would say is we're seeing around the world and within our target markets, we're seeing the adoption of Wi Fi Six game momentum pretty significantly. Great. No other questions. Thanks guys. Hey, Christian, you mentioned our revenue was $9.88. It was $9.96 fees don't take $8,000,000 from us. We work really hard to get that revenue. Sorry, I was just looking at my last note, but thank you for that, Rick. Our next question comes from Paul Silverstein of Cowen. Your line is open. Guys, can you also repeat the bookings numbers on? I think you all gave it regionally. I see from a revenue perspective, EMEA and APAC will both down meaningfully on a year over year and on a sequential basis. I Ed, I think you already addressed immediately in your previous comments Can you talk about what you're seeing from a bookings looking forward in those regions? What the trends are and the issues, if any? Sure. So we don't typically disclose our bookings. So I was happy to give the product book to bill of 1.1 comment on trends, but we're not Yes, well, Remi, just to be clear, so putting aside the exact bookings numbers, what accounts your APAC was down 38% year over year, 39% sequentially. EMEA was down 30% year over year, 22% sequentially. What when you look beyond as opposed to looking backwards, you look forward to what's going on? I'm going to round some of the percentage and give you trends, but The America enjoyed a sequential recovering bookings that was in the mid-thirty, so very strong performance. EMEA was close to 10%. APAC was mid to high single digit recovery. We did see a drop in our service provider fed OEM, which we treat as a 4th region in bookings. That's a more lumpy business because it's essentially driven by agile data centers. So whether we get a big deal, and we got a huge deal in Q3, but we don't, you see lumpiness, that business was down, 15% to 20% in bookings and the overall number was a 16% sequential increase that I mentioned, with book to bill at 1.1. Correct. All right. I'll take the rest offline. I appreciate it. Thank you for that color. Thanks, Paul. There are no further questions. I'd like to turn the call back over to Ed Meyercord for any closing remarks. Okay. Well, thank you, everyone. If you join us on the call today, as always, I want to thank the Extreme employees. It's a very busy time for all of us at Extreme given it's the end of our fiscal year, given the moves that we've taken inside the company to restructure. And then the fact that we're moving so quickly down the path of acquiring Aerohive and, people have been working really hard and we're really excited about what all this brings for the new Extreme. We're looking forward to sharing updates about our investments in the new software platform and cloud platform as well as the upgrade in our new products at several investor conferences We have Oppenheimer, Jeffrey, Citi Global Tech And D. A. Davidson coming up during the quarter, and we hope to see you there. So thanks again and have a great day. 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.