TMCnet News
EXTREME NETWORKS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This quarterly report on Form 10-Q, including the following sections, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including in particular, our expectations regarding market demands, customer requirements and the general economic environment, future results of operations, and other statements that include words such as "may" "expect" or "believe" . These forward-looking statements involve risks and uncertainties. We caution investors that actual results may differ materially from those projected in the forward-looking statements as a result of certain risk factors identified in the section entitled "Risk Factors" in this Report, our Quarterly Report on Form 10-Q for the first quarter of fiscal 2015, our Annual Report on Form 10-K for the fiscal year ended June 30, 2014, and other filings we have made with the Securities and Exchange Commission. These risk factors, include, but are not limited to: fluctuations in demand for our products and services; a highly competitive business environment for network switching equipment; our effectiveness in controlling expenses; the possibility that we might experience delays in the development or introduction of new technology and products; customer response to our new technology and products; the timing of any recovery in the global economy; risks related to pending or future litigation; a dependency on third parties for certain components and for the manufacturing of our products; and our ability to receive the anticipated benefits of the acquisition of Enterasys. Business Overview We are a leading provider of network infrastructure equipment and services for enterprises, data centers, and service providers. We were incorporated in California in May 1996 and reincorporated in Delaware in March 1999. The shares of Extreme Networks, Inc. (EXTR) began trading on NASDAQ in April 1999. Our corporate headquarters are located in San Jose, California. We develop and sell network infrastructure equipment to our enterprise, data center and telecommunications service provider customers. On October 31, 2013 (the "Acquisition Date"), we completed the acquisition of Enterasys Networks, Inc. ("Enterasys"), a privately held provider of wired and wireless network infrastructure and security solutions, for $180.0 million, net of cash acquired, whereby Enterasys became our wholly-owned subsidiary. The combined entity immediately became a networking industry leader with more than 12,000 customers. As a combined Company, we believe we will set the standard for the networking industry with a strategic focus on three principles: Highly scaled and differentiated products and solutions: Our combined product portfolio spans data center networking, switching and routing, Software-Defined Networking (SDN), wired and wireless LAN access, network management with analytics and integrated security features. This broader solutions portfolio can be leveraged to better serve existing and new customers. We will continue to enhance and support the product roadmaps of both companies going forward to protect the investments of customers and avoid any disruption to their businesses. We intend to increase research and development to accelerate our vision for high-performance, modular, open networking. Leading customer service and support: We are working to augment our current outsourced support model by integrating Enterasys' in-sourced expertise, building on Enterasys' award-winning heritage and strong commitment to exceptional customer experience. The Company's expanded global network of channel partners and distributors will benefit from expanded services and support capabilities. Strong Channels and Strategic Partners: Our focus is to leverage the capabilities of the combined Company and expand existing partnerships with Ericsson and the developing partnership with Lenovo as well as continue to add new strategic partnerships in the future. Additionally, we will increase our focus on partnering with distributors and channel partners globally. The goal is to develop and enhance relationships that grow revenue and profits for the Company and our alliance and channel partners. At the same time, we are investing in infrastructure to make doing business with the Company easier and more efficient. We conduct our sales and marketing activities on a worldwide basis through a distribution channel utilizing distributors, resellers and our field sales organization. We primarily sell our products through an ecosystem of channel partners who combine our Ethernet, wireless and software analytics products with their offerings to create compelling information technology solutions for end-user customers. We utilize our field sales organization to support our channel partners and to sell direct to end-user customers, including some large global accounts. Our customers include businesses, hospitals, hotels, universities, sports venues, telecommunications companies and government agencies around the world. 19-------------------------------------------------------------------------------- Table of Contents We outsource the majority of our manufacturing and supply chain management operations as part of our strategy to maintain global manufacturing capabilities and to reduce our costs. We conduct quality assurance, manufacturing engineering, document control and test development at engineering facilities in San Jose, California, RTP, North Carolina, Salem, New Hampshire, Toronto, Canada and Chennai, India. This approach enables us to reduce fixed costs and to flexibly respond to changes in market demand. The market for network infrastructure equipment is highly competitive and dominated by a few large companies. The current economic climate has further driven consolidation of vendors within the Ethernet networking market and with vendors from adjacent markets, including storage, security, wireless and voice applications. We believe that the underpinning technology for all of these adjacent markets is Ethernet. As a result, we believe that, as an independent Ethernet switch vendor, we must provide products that, when combined with the products of our large strategic partners, create compelling solutions for end user customers. Our approach is to focus on the intelligence and automation layer that spans our hardware and software products that facilitates end-to-end solutions, as opposed to positioning Extreme Networks as a low-cost-vendor with point products. We believe that continued success in our marketplace is dependent upon a variety of factors that includes, but is not limited to, our ability to design, develop and distribute new and enhanced products employing leading-edge technology. Results of Operations During the first quarter of fiscal 2015, we achieved the following results: • Net revenues of $136.3 million compared to net revenues of $75.9 million in the first quarter of fiscal 2014. • Product revenues of $102.7 million compared to product revenues of $61.0 million in the first quarter of fiscal 2014. • Service revenues of $33.6 million compared to service revenues of $14.9 million in the first quarter of fiscal 2014. • Total gross margin of 52% of net revenues compared to total gross margin of 58% of net revenues in the first quarter of fiscal 2014. • Operating loss of $17.2 million compared to operating income of $0.4 million in the first quarter of fiscal 2014. • Net loss of $19.3 million compared to net loss of $35.0 thousand in the first quarter of fiscal 2014. • Cash flow provided by operating activities of $1.6 million in the three months ended September 30, 2014 compared to cash flow provided by operating activities of $1.9 million in the three months ended September 30, 2013. • Cash and cash equivalents, short-term investments and marketable securities decreased by $1.4 million to $104.5 million as of September 30, 2014 from $105.9 million as of June 30, 2014, primarily due to less proceeds from cash used in operations. We operate in three regions: Americas, which includes the United States, Canada, Mexico, Central America and South America; EMEA, which includes Europe, Russia, Middle East, and Africa; and APAC which includes Asia Pacific, South Asia, India, and Australia. The following table presents the total net revenue geographically for the three months ended September 30, 2014 and September 30, 2013, respectively (dollars in thousands): Three Months Ended September 30, September 30, $ % Net Revenues 2014 2013 Change Change Americas: United States $ 58,488 $ 25,389 $ 33,099 130.4 % Other 7,341 6,301 1,040 16.5 % Total Americas 65,829 31,690 34,139 107.7 % Percentage of net revenue 48.0 % 41.7 % EMEA 53,934 30,842 23,092 74.9 % Percentage of net revenue 39.6 % 40.6 % APAC 16,511 13,384 3,127 23.4 % Percentage of net revenue 12.1 % 17.6 % Total net revenues $ 136,274 $ 75,916 $ 60,358 79.5 % 20-------------------------------------------------------------------------------- Table of Contents Net Revenues The following table presents net product and service revenue for the three months ended September 30, 2014 and September 30, 2013, respectively (dollars in thousands): Three Months Ended September 30, September 30, $ % 2014 2013 Change Change Net Revenues: Product $ 102,672 $ 61,045 $ 41,627 68.2 % Percentage of net revenue 75.3 % 80.4 % Service 33,602 14,871 18,731 126.0 % Percentage of net revenue 24.7 % 19.6 % Total net revenues $ 136,274 $ 75,916 $ 60,358 79.5 % Product revenue increased $41.6 million or 68.2% in the first quarter of fiscal 2015 compared to the corresponding period of fiscal 2014. In the three months ending September 30, 2014, there was a significant increase in the number of customers and products sold during the period due to our acquisition of Enterasys in the second quarter of fiscal 2014. This resulted in a significant increase in our product revenue in all regions. Such increase from the acquisition was offset by lower revenue in EMEA region during the quarter due to political and economic conditions and the weakening of the Euro and British Pound Sterling against the United States Dollar which dampened the demand for product sales in EMEA. Service revenue increased $18.7 million or 126.0% in the first quarter of fiscal 2015 and $18.7 million compared to the corresponding period of fiscal 2014. The increase in service revenue for the three months ended September 30, 2014 was due to an increase in service maintenance contracts and professional service and training revenues due to our acquisition of Enterasys in the second quarter of fiscal 2014 partially offset by purchase price accounting adjustments of $0.8 million. Cost of Revenue and Gross Profit The following table presents the gross profit on product and service revenue and the gross profit percentage of product and service revenue for the three months ended September 30, 2014 and 2013 (in thousands): Three Months Ended September 30, September 30, $ % 2014 2013 Change Change Gross profit: Product $ 48,647 $ 33,529 $ 15,118 45.1 % Percentage of product revenue 47.4 % 54.9 % Service 21,880 10,178 11,702 115.0 % Percentage of service revenue 65.1 % 68.4 % Total gross profit $ 70,527 $ 43,707 $ 26,820 61.4 % Percentage of net revenue 51.8 % 57.6 % Cost of product revenue includes costs of materials, amounts paid to third-party contract manufacturers, costs related to warranty obligations, charges for excess and obsolete inventory, amortization expense for developed technology, royalties under technology license agreements, and internal costs associated with manufacturing overhead, including management, manufacturing engineering, quality assurance, development of test plans, and document control. We outsource substantially all of our manufacturing and supply chain management operations, and we conduct quality assurance, manufacturing engineering, document control and distribution in San Jose, California; Salem, New Hampshire; China, and Taiwan. Product gross margin percentage decreased to 47.4% in the first quarter of fiscal 2015 from 54.9% in the first quarter of fiscal 2014. The decrease in product gross margin percentage for the three months ended September 30, 2014 was primarily due to $4.3 million increase in the amortization of the developed technology intangibles from the acquisition of Enterasys during the second quarter of fiscal 2014, increase in excess and obsolete inventory charges of $1.4 million and higher warranty costs for the products from the acquisition of Enterasys for the quarter ended September 30, 2014 as compared to the corresponding periods of fiscal 2014. 21-------------------------------------------------------------------------------- Table of Contents Our cost of service revenue consists primarily of personnel, overhead, repair and freight costs and the cost of spares used in providing support under customer service contracts. Service gross margin percentage decreased to 65.1% from 68.4% in the first quarter of fiscal 2015. The service gross margin percentage for the three ended September 30, 2014 decreased primarily due to higher personnel, overhead and travel cost as well as purchase accounting adjustments as a result of our acquisition of Enterasys during the second quarter of fiscal 2014. Operating Expenses The following table presents operating expenses and operating income (in thousands, except percentages): Three Months Ended September 30, September 30, $ % 2014 2013 Change Change Research and development $ 23,347 $ 9,937 $ 13,410 135.0 % Sales and marketing 44,779 22,694 22,085 97.3 % General and administrative 11,074 6,934 4,140 59.7 % Acquisition and integration costs 4,058 3,695 363 9.8 % Restructuring charge, net of reversals - 75 (75 ) (100.0 )% Amortization of intangibles 4,467 - 4,467 100.0 % Total operating expenses $ 87,725 $ 43,335 $ 44,390 102.4 % Operating income (loss) $ (17,198 ) $ 372 $ (17,570 ) (4,723.1 )% Research and Development Expenses Research and development expenses consist primarily of salaries and related personnel expenses, consultant fees and prototype expenses related to the design, development, and testing of our products. Research and development expenses increased by $13.4 million, or 135.0% in the first quarter of fiscal 2015 as compared to the corresponding period of fiscal 2014. The increase in research and development expenses for the three months ended September 30, 2014 was primarily due to increased personnel costs due to increase in headcount of approximately 300 employees and higher occupancy costs due to additional facilities primarily in Salem, New Hampshire and Toronto, Canada, as a result of our acquisition of Enterasys in the second quarter of fiscal 2014. Sales and Marketing Expenses Sales and marketing expenses consist of salaries, commissions and related expenses for personnel engaged in marketing and sales functions, as well as trade shows and promotional expenses. Sales and marketing expenses increased by $22.1 million, or 97.3% in the first quarter of fiscal 2015 as compared to the corresponding period of fiscal 2014. The increase in sales and marketing expenses for the three months ended September 30, 2014 was primarily due to increased personnel costs as a result of an increase in headcount of approximately 330 employees as a result of our acquisition of Enterasys in the second quarter of fiscal 2014 as well as additional spending on sales and marketing programs as compared to first quarter of fiscal 2014. General and Administrative Expenses General and administrative expenses increased by $4.1 million, or 59.7% in the first quarter of fiscal 2015 compared to the corresponding period of fiscal 2014. The increase in general and administrative expenses during the three months ending September 30, 2014, compared to the corresponding period of fiscal 2014, was primarily due to higher personnel and travel costs due to an increase in headcount of approximately 100 employees, and higher occupancy costs due to additional facilities in Salem, New Hampshire and Shannon, Ireland as a result of our acquisition of Enterasys in the second quarter of fiscal 2014 and an increase in bad debt expense as compared to the corresponding period of fiscal 2014. Acquisition and Integration Costs As a result of our acquisition of Enterasys, we incurred $4.1 million of integration costs during the first quarter of fiscal 2015 primarily for IT integration and severance costs. The Company expects to incur integration costs through fiscal 2015. The Company incurred $3.7 million of acquisition-related costs during the quarter ended September 30, 2013. 22-------------------------------------------------------------------------------- Table of Contents Restructuring Charge, Net of Reversals During the second quarter of fiscal 2013, we initiated a plan to reduce our worldwide headcount by 13%, consolidate specific global administrative functions, and shift certain operating costs to lower cost regions, among other actions. The Company has substantially expensed all of the costs associated with this initiative. As of September 30, 2014, we had restructuring liabilities of $0.2 million, which we anticipate paying by the end of fiscal 2015. Amortization of intangibles During the three months ended September 30, 2014, we recorded $4.5 million of amortization, primarily for certain intangibles related to the acquisition of Enterasys. Interest Expense During the three months ended September 30, 2014 we recorded $0.8 million interest expense related to the Credit Facility that the Company entered into on October 31, 2013. Other Expense, Net Other expense, net increased by $0.2 million in the first quarter of fiscal 2015 compared to the corresponding period of fiscal 2014. The increase in other expense, net was primarily due to losses from the revaluation of certain assets and liabilities denominated in foreign currencies into U.S. dollars. Provision for Income Taxes For the three months ended September 30, 2014 and September 30, 2013, we recorded an income tax provision of $1.0 million and $0.4 million, respectively. The income tax provisions for the three months ended September 30, 2014 and 2013 consisted primarily of taxes on the income of our foreign subsidiaries as well as tax expense associated with the establishment of a U.S. deferred tax liability for amortizable goodwill resulting from the acquisition of Enterasys Networks, Inc. Critical Accounting Policies and Estimates Our unaudited condensed consolidated financial statements and the related notes included elsewhere in this report are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these unaudited condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could have reasonably used different accounting estimates, and in other instances changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. On an ongoing basis, we evaluate our estimates and assumptions. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. As discussed in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year ended June 30, 2014, we consider the following accounting policies to be the most critical in understanding the judgments that are involved in preparing our consolidated financial statements: • Revenue Recognition • Business Combinations • Goodwill • Share-based Payments • Deferred Tax Valuation Allowance • Accounting for Uncertainty in Income Taxes There have been no changes to our critical accounting policies since the filing of our last Annual Report on Form 10-K. 23-------------------------------------------------------------------------------- Table of Contents New Accounting Pronouncements See Note 2 of the accompanying condensed consolidated financial statements for a full description of new accounting pronouncements, including the respective expected dates of adoption and effects on results of operations and financial condition. Liquidity and Capital Resources The following summarizes information regarding our cash, investments, and working capital (in thousands): September 30, June 30, 2014 2014 Cash and cash equivalent $ 74,067 $ 73,190 Short-term investments 30,395 32,692 Total cash and investments $ 104,462 $ 105,882 Working capital $ 49,630 $ 96,279 As of September 30, 2014, our principal sources of liquidity consisted of cash, cash equivalents and investments of $104.5 million, net accounts receivable of $100.0 million and $0.9 million of letters of credit and borrowings from the Revolving Facility under which the Company had $0.1 million of availability at September 30, 2014. Our principal uses of cash will include purchase of finished goods inventory from our contract manufacturers, payroll, restructuring expenses and other operating expenses related to the development, marketing of our products, purchases of property and equipment, repayments of debt and related interest. We believe that our $104.5 million of cash and cash equivalents and investments at September 30, 2014 along with the availability of borrowings from the Revolving Facility will be sufficient to fund our principal uses of cash for at least the next 12 months including the repayment of the additional borrowings of $24 million from the Revolving Facility as of the filing date of this report. Our Credit Agreement contains financial covenants that require us to maintain a minimum Consolidated Fixed Charge Coverage Ratio and Consolidated Quick Ratio and a maximum a Consolidated Leverage Ratio and several other covenants and restrictions that limit our ability to incur additional indebtedness, create liens upon any of our property, merge, consolidate or sell all or substantially all of our assets, etc. The Credit Agreement also includes customary events of default, including failure to pay principal, interest or fees when due, failure to comply with covenants, if any representation or warranty made by us is false or misleading in any material respect, certain insolvency or receivership events affecting Extreme and its subsidiaries, the occurrence of certain material judgments, the occurrence of certain ERISA events, the invalidity of the loan documents or a change in control of our Company. The amounts outstanding under the Credit Agreement may be accelerated upon certain events of default. We believe we are in compliance and expect to remain in compliance with our Credit Agreement covenants and they are not expected to impact our liquidity or capital resources. Key Components of Cash Flows and Liquidity A summary of the sources and uses of cash and cash equivalents is as follows (in thousands): Three Months Ended September 30, September 30, 2014 2013 Net cash provided by operating activities $ 1,632 $ 1,925 Net cash (used in) provided by investing activities $ (1,036 ) $ 3,254 Net cash provided by financing activities $ 925 $ 1,799 Foreign currency effect on cash $ (644 ) $ 227 Net increase in cash and cash equivalents $ 877 $ 7,205 Net Cash Provided by Operating Activities Cash flows provided by operations was $1.6 million in the three months ending September 30, 2014. Current year's net loss was primarily offset by non-cash expenses such as amortization of intangibles, stock-based compensation expense and 24-------------------------------------------------------------------------------- Table of Contents depreciation. Accounts receivables decreased primarily due to lower revenue during the quarter and higher collections. Inventories decreased primarily due to the timing of inventory receipts to bring the inventory levels in line with the near term demand. Such increases in cash inflows were offset by decrease in accounts payable due to timing of payments. Cash flows provided by operations was $1.9 million for the three months ended September 30, 2013. Net loss for the quarter ended September 30, 2013 was primarily offset by non-cash expenses such as stock-based compensation expense and depreciation. Inventories increased primarily due to the timing of inventory receipts to bring the inventory levels in line with the near term demand and an increase in accounts payable balance due to the timing of payments. Net Cash (Used In) Provided by Investing Activities Cash flow used in investing activities in the three months ending September 30, 2014 was $1.0 million, primarily comprised of $2.8 million used to purchase property and equipment offset by proceeds of $2.0 million from the maturities of investments. Cash flow provided by investing activities in the three months ending September 30, 2013 was $3.3 million, comprised of proceeds of $13.1 million from the maturities of investments, offset by $9.8 million used to purchase property and equipment. Net Cash Provided by Financing Activities Cash flow provided by financing activities in the three months ending September 30, 2014 was $0.9 million, comprised of a draw on the Revolving Facility of $24 million during the quarter ended September 30, 2014 for working capital requirements, $1.7 million proceeds from the exercise of stock options and issuance of shares of our common stock under the ESPP, net of taxes paid on vested and released stock awards offset by $24.8 million of cash used for repayment of debt. Cash flow provided by financing activities in the three months ending September 30, 2013 was $1.8 million, comprised of proceeds from the exercise of stock options and issuance of shares of our common stock under the ESPP, net of taxes paid on vested and released stock awards. Contractual Obligations The following summarizes our contractual obligations at September 30, 2014, and the effect such obligations are expected to have on our liquidity and cash flow in future periods (in thousands): Less than 1 More than 5 Total Year 1-3 years 3-5 years years Contractual Obligations: Debt obligations $ 120,750 $ 30,500 $ 32,500 $ 57,750 $ - Interest on debt obligations 8,131 2,543 4,167 1,421 - Non-cancellable inventory purchase commitments 90,737 90,737 - - - Non-cancellable operating lease obligations 58,920 9,600 15,961 13,933 19,426 Other liabilities 7,032 4,468 2,433 131 - Total contractual cash obligations $ 285,570 $ 137,848 $ 55,061 $ 73,235 $ 19,426 Non-cancelable inventory purchase commitments represent the purchase of long lead-time component inventory that our contract manufacturers procure in accordance with our forecast. Inventory purchase commitments were $90.7 million as of September 30, 2014. We expect to honor the inventory purchase commitments within the next 12 months. Non-cancelable operating lease obligations represent base rents and operating expense obligations to landlords for facilities we occupy at various locations. Other liabilities include the Company's commitments towards debt related fees and specific arrangements other than inventory. The amounts in the table above exclude immaterial income tax liabilities related to uncertain tax positions as we are unable to reasonably estimate the timing of settlement. We did not have any material commitments for capital expenditures as of September 30, 2014. 25-------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of September 30, 2014. |