Extreme Networks, Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended December 31, 2019 (the second quarter of fiscal 2020). Amounts are in U.S. dollars; financial statement amounts below are in millions unless otherwise noted.
Business context and reporting period
Extreme Networks provides wired and wireless networking equipment, software, cloud networking solutions, and related services. The quarter includes Aerohive Networks’ results following its acquisition on August 9, 2019. Aerohive contributed $41.9 million of revenue in the quarter and $67.3 million in the six-month period.
Financial performance and position
| Metric | Three months ended Dec. 31, 2019 | Prior-year quarter | Six months ended Dec. 31, 2019 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $267.5 | $252.7 | $523.0 | $492.6 |
| Gross profit | $148.7 | $141.3 | $285.9 | $273.4 |
| Gross margin | 55.6% | 55.9% | 54.7% | 55.5% |
| Operating income (loss) | $(15.2) | $4.8 | $(47.4) | $(0.3) |
| Net income (loss) | $(23.5) | $7.2 | $(61.3) | $(1.9) |
| Diluted earnings (loss) per share | $(0.20) | $0.06 | $(0.51) | $(0.02) |
| Cash provided by operating activities | — | $21.9 | $61.6 |
Quarterly revenue increased 5.9%; product revenue rose 0.5% to $190.5 million, while service revenue rose 22.0% to $77.0 million. Six-month revenue increased 6.2%. Service growth reflected Aerohive and higher legacy maintenance revenue; product growth was attributed to Aerohive, partly offset by lower legacy revenue.
Quarterly product gross margin fell to 52.0% from 54.4%; service gross margin improved to 64.4% from 60.6%. Management cited acquired-inventory fair-value step-up costs, higher distribution charges, and acquired-intangible amortization as pressures on product gross profit. Total operating expenses rose 20.0% in the quarter, including higher acquisition/integration and restructuring costs.
At December 31, 2019, cash was $140.4 million, down from $169.6 million at June 30, 2019. Working capital was a deficit of $5.3 million, compared with positive working capital of $86.0 million at fiscal year-end. Total assets were $1,014.7 million and stockholders’ equity was $50.9 million.
Debt had a $375.3 million principal balance ($365.7 million net carrying amount), compared with $180.5 million principal at June 30, 2019. The company reported $60.3 million available under its $75 million revolving facility, with $7.7 million of letters of credit outstanding. The term loan’s stated interest rate was 5.0% at quarter-end. The company reported compliance with its credit covenants.
For the six months, investing cash outflow was $183.6 million, principally reflecting $219.5 million net cash paid for Aerohive, partly offset by $45.2 million from investment maturities and sales. Financing cash inflow was $132.7 million, including $199.5 million of term-loan borrowings; uses included $25.0 million of debt repayments, $10.5 million of loan fees, and $25.2 million of share repurchases.
Material changes versus comparable periods
- Revenue growth was driven mainly by service revenue; product revenue growth was modest. The acquisition contributed to both reported revenue and expense changes.
- The company moved from quarterly operating and net income to losses. Higher operating expenses and interest expense contributed; quarterly interest expense rose to $6.2 million from $3.1 million.
- Six-month operating cash flow declined to $21.9 million from $61.6 million, while cash declined by $29.2 million over the current six-month period.
- Goodwill increased to $330.2 million from $138.6 million, primarily due to Aerohive; the preliminary acquisition allocation included $191.6 million of goodwill and $53.4 million of identifiable intangible assets.
- Debt increased following the August 2019 refinancing and acquisition financing. The company also adopted lease accounting, recording operating lease right-of-use assets and liabilities; lease liabilities totaled $76.5 million at December 31, 2019.
Outlook, commentary, risks, and unusual items
Management stated that cash and revolver availability should be sufficient for principal cash needs for at least the next 12 months. The filing does not provide a clear formal revenue or earnings guidance range. Remaining performance obligations were $277.8 million, primarily deferred maintenance and SaaS revenue; the company expected to recognize approximately 42% of deferred revenue in fiscal 2020, 34% in fiscal 2021, and the remainder thereafter.
Unusual and acquisition-related costs included $9.0 million of acquisition and integration expense in the quarter and $24.9 million for six months. The six-month amount included a $6.8 million accelerated stock-award compensation charge. Restructuring charges were $6.6 million for the quarter and $12.8 million for six months, including facility impairments and severance. Product costs also included acquired-inventory fair-value step-up expense of $3.4 million in the quarter and $7.3 million for six months.
The company identified risks including demand fluctuations, intense competition, product development and customer adoption, global economic conditions, third-party component and manufacturing dependence, acquisition integration and benefits, and litigation. It disclosed several patent disputes in the United States, Germany, and China; for certain matters, the possible loss or range of loss could not be estimated. A Brazilian tax assessment was settled for approximately $2.2 million, with about $0.2 million of government legal fees accrued.
Customer concentration is notable: Tech Data, Jenne, and Westcon each represented at least 10% of quarterly revenue. The company also disclosed $47.7 million of inventory and service purchase commitments. Management reported disclosure controls were effective; no material changes to previously disclosed risk factors were reported.
Most important facts for investors to verify
- Whether Aerohive’s revenue growth and expected integration benefits translate into sustainable organic growth and improved operating performance.
- How quickly acquisition, restructuring, inventory step-up, and amortization costs decline, and the resulting effect on product margins and profitability.
- Debt service capacity, variable-rate exposure, covenant headroom, and liquidity given the working-capital deficit and lower operating cash flow.
- Final Aerohive purchase-price allocation and any resulting changes to goodwill, intangible assets, or tax accounting.
- Developments in disclosed patent litigation and other contingencies for which losses are not currently estimable.
- Customer and distributor concentration, deferred-revenue conversion, and the fulfillment of purchase commitments.