Business context and reporting period
Extreme Networks, Inc. provides software-driven wired and wireless networking solutions. This unaudited Form 10-Q covers the fiscal quarter and six months ended December 31, 2016; comparisons are with the corresponding periods ended December 31, 2015, unless noted. On October 28, 2016, Extreme acquired Zebra Technologies’ wireless LAN business for approximately $51.1 million in cash. Its results are included from the acquisition date, so reported growth includes only part of the acquired business’s results.
Financial performance and liquidity
Amounts below are in millions, except per-share data and percentages.
| Metric | Quarter ended Dec. 31, 2016 | Quarter ended Dec. 31, 2015 | Six months ended Dec. 31, 2016 | Six months ended Dec. 31, 2015 |
|---|---|---|---|---|
| Revenue | $148.1 | $139.3 | $270.8 | $263.9 |
| Gross profit / margin | $75.4 / 50.9% | $70.3 / 50.4% | $140.6 / 51.9% | $135.4 / 51.3% |
| Operating loss | $(7.4) | $(5.4) | $(12.1) | $(16.2) |
| Net loss | $(8.6) | $(7.2) | $(15.1) | $(18.8) |
| Net loss per share, basic and diluted | $(0.08) | $(0.07) | $(0.14) | $(0.18) |
- Quarterly product revenue rose 4.2% to $109.8 million and service revenue rose 12.9% to $38.3 million. For the six months, product revenue grew 1.6% and service revenue 5.5%.
- At December 31, cash and cash equivalents were $103.8 million, versus $94.1 million at June 30, 2016, and working capital was $45.9 million versus $17.4 million.
- Six-month operating cash flow was $19.3 million, compared with $14.0 million a year earlier. Investing used $55.8 million, chiefly the $51.1 million WLAN acquisition and $4.7 million of capital expenditures. Financing provided $46.2 million, including $48.3 million of term-loan borrowings.
- Reported debt carrying value was $97.1 million at December 31, compared with $55.1 million at June 30. The company had $23.7 million available on its revolving facility and $0.9 million of letters of credit outstanding.
- Current assets were $283.8 million and current liabilities $237.9 million. Accounts receivable was $117.8 million; deferred revenue, including current and long-term balances, totaled $105.9 million.
Material changes versus the prior comparable period
- Quarterly revenue increased 6.3%, and gross margin improved by 0.5 percentage points. However, operating loss widened to $7.4 million from $5.4 million and net loss widened to $8.6 million from $7.2 million.
- For the six months, revenue increased 2.6%; operating loss narrowed by $4.0 million and net loss narrowed by $3.7 million.
- Management attributed revenue gains in part to the WLAN acquisition and, for product revenue, lower discounting; lower education E-Rate revenue partly offset product growth.
- Quarterly operating expenses increased 9.4% to $82.7 million, including higher R&D, sales and marketing, and acquisition/integration costs. Product gross profit benefited from increased revenue and lower intangible amortization, but was partly offset by $5.1 million of excess inventory charges tied to discontinuing certain product lines following the acquisition.
Outlook, risks, contingencies, and unusual items
- No specific revenue or earnings guidance is provided. Management said cash, operating cash flows, and revolver availability should fund principal cash needs for at least the next 12 months; the company reported compliance with credit-facility covenants at December 31.
- A January 2017 workforce-reduction plan is expected to cost approximately $6.5 million and, if completed as planned, yield approximately $8.0 million of annualized savings. Actual costs and timing may vary.
- The amended five-year credit agreement provides a $90.5 million term loan and a $50.0 million revolver, is secured by substantially all company assets, and contains financial and operating covenants. Management expects interest expense to increase because of higher debt balances.
- Contractual cash obligations totaled $288.1 million, including $93.6 million of non-cancelable inventory commitments, $57.8 million of operating leases, and $13.2 million of estimated debt interest. The company expected to honor inventory commitments within 12 months.
- Major distributors Tech Data, Jenne, and Westcon represented 43% of quarterly revenue combined. Management cites demand volatility, competition and pricing pressure, component and manufacturing dependence, product-development and integration risks, and uncertainty in education funding among material business risks.
- Brazilian tax assessments could involve up to approximately $7.8 million, including interest and penalties; the company recorded a $2.9 million accrual and says it cannot determine the likelihood of an unfavorable outcome. A securities class action remained pending, with damages unspecified; a patent suit was dismissed in December 2016.
- The WLAN purchase-price allocation remains preliminary and may change during the measurement period. Acquisition-related costs were reported as $6.5 million for the six months in the financial statements and acquisition note; the MD&A separately states $1.8 million for that period, an apparent inconsistency to verify.
Important facts for investors to verify
- Separate organic growth from the partial-period contribution of the acquired WLAN business, and assess its future integration costs, margins, and expected benefits.
- Reconcile the acquisition-cost figures in the MD&A with the financial statements and notes.
- Track the preliminary purchase-price allocation, acquired deferred revenue, inventory-related charges, and any subsequent adjustments.
- Monitor debt, variable-rate interest exposure, revolver availability, covenant compliance, and the company’s substantial near-term purchase and lease obligations.
- Follow the workforce-reduction plan’s actual charges and realized savings, as well as developments in the Brazilian tax matter and securities litigation.
- Assess distributor concentration, receivables and deferred distributor revenue, and the sustainability of operating cash flow given the period’s working-capital movements.