Good day and thank you for standing by. Welcome to the Extreme Networks Fourth Quarter Fiscal Year 2022 Financial Results. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Stan Kovler, Vice President of Investor Relations and Corporate Strategy. Please go ahead.

Thank you, Katherine, and welcome to the Extreme Networks fourth fiscal quarter and year-end 2022 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 Rémi 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 to non-GAAP reconciliations, is available in the Investor Relations section of our Web site 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. 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 ended June 30, 2021 filed with the SEC. Any forward-looking statements made on this call reflect our analysis as of today. 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. We had a strong quarter and year, and I'm pleased with the progress our teams are making. Our results for fiscal '22 highlight unprecedented demand for Extreme solutions and a very vibrant and healthy market for networking. We reported record bookings growth of 24%. This is a clear indication that we're taking share and winning in the market. And our forward-looking funnel for fiscal '23 is up double digits year-over-year. This is a leading indicator of future bookings growth. The differentiation of our Fabric and Cloud solutions for enterprise customers and our targeted solutions for very large service provider customers, combined with the high performance in our global sales and channel teams, gives us the confidence in our outlook for continued growth in demand. Our technology solutions are critical to infrastructure initiatives, underpinning digital transformation for all of our customers around the world. We believe these important projects will continue to remain a priority, irrespective of the changing macroeconomic environment. For the year, our double-digit revenue growth led to an all-time high revenue of 1.1 billion, yet it was understated by the 400 million of incremental backlog we built during the year. Our total Q4 ending backlog was 530 million, thanks to the current supply chain environment. Despite margin pressures, we were also pleased to generate a record 60 million of free cash flow during the quarter, bringing our net debt to EBITDA below 1. The continued improvement in our operating model allowed us to achieve record non-GAAP EPS of $0.70 per share for the year, up 35% year-over-year. We expect these bottom line earnings growth trends to continue. A record 208 customers spent more than $1 million with Extreme during fiscal '22, up 28% from a year…

Thank you. [Operator Instructions]. Our first question comes from Alex Henderson with Needham & Company. Your line is open.

Thank you very much and great job, guys, in a tough environment. I wanted to get a better handle on the bookings in 4Q and the outlook commentary going into the first half of fiscal '23. It sounds like clearly you expect to stay supply constrained through most of the fiscal year. But do you, a, see any improvement in supply in your expectations in the first half of the year? And then second, what's going on in that pipeline as you're looking at that first half outlook? And particularly, if you look at the booking numbers in the fourth quarter, how did that play on geography? And how do you think that looks going into the upcoming quarter, particularly in EMEA? Thanks.

Thanks, Alex. Rémi, why don't you let me jump in and then you can fill in. And so, Alex, you're rightfully pointing out kind of just how we're looking at bookings, which is really our measure of true demand, and then versus revenue and our revenue outlook is really a function of a supply chain and product that we're able to release, given the massive backlog that we built up and the continued strength of bookings. So I'll just start off with supply chain. You've asked about that. What we see is a gradual improvement throughout the year. So think of a step function where we will be stepping our revenue quarter-by-quarter throughout the year based on our outlook of supply chain. And we do have more competence, as we've mentioned before, strong relationships with the likes of Broadcom where we are not constrained. It's more about secondary, tertiary component vendors where we've established direct relationships, normal processes, and have consistency now in our expectations around delivery. And then some of the creative things that our teams are doing around reengineering, et cetera, and then more products showing up on the spot market. So our teams, as I mentioned in my comments, are more competent today than they have been in our ability to step function our supply of products to our customers' partners. So what does that mean? That is how we built the revenue forecast for fiscal '23, which is that step function with the sharper improvement in the second half of the fiscal. As it relates to demand, our demand has been strong, as we've talked about it for the year, 24%. For us, that's record-breaking performance. However, the seasonality for bookings is very different. In an environment where people know that there are long lead times…

EMEA?

Rémi, do you want to comment? Rémi Thomas: No. I think you gave a very detailed view of.

Alex, as it relates to EMEA, we continue to see strength. So we're not seeing -- I know that this is something that you're paying close attention to and if you're concerned about, we can't provide that data point for you. We're not seeing it. We continue to see strength. And the question is whether or not that's because we're taking market share against a macro or if our data point is a valid macro data point.

It's a good result to you either way. Thanks so much for the detail.

Thank you. Our next question comes from Mike Genovese with Rosenblatt Securities. Your line is open.

Thanks very much. Good to be on the call. I guess a little bit of asking that part of the last question a slightly different way, I think you said that by the fourth quarter of the fiscal year you think book to bill will be below 1. And I guess my question there is that more is a function of less confidence in demand when you look that far out or more confidence in the supply chain, allowing you to eat into the backlog and report extraordinary revenue growth in the back half of the year?

Hi, Mike. It's a good question and it's all supply chain. So as I mentioned, we continue to see strength in demand going out for the year and grow. But on the supply chain side, where we are most constrained, and we talked about our components and these are Tier 2, Tier 3 components, where we need every component to make a switch, or to make an access point. And so without it, we can't ship -- we can't produce and we can't ship. So some of our suppliers have fabs that are coming online in the first part of the calendar year, and the fact of the matter is that we have a schedule, we have visibility to how our components will come online, and then we'll see a greater supply of those components. They are ones that are holding us back.

I guess because I'm new to this, I just need some clarification between definitions when we're talking about fiscal years versus calendar years. So we're talking about improvement in every quarter of '23. Is that a fiscal year comment or a calendar year comment? And can you talk about any kind of green shoots -- color on green shoots that you may be seeing or not seeing in the actual calendar second half of '22?

Yes, I think our comments for the fiscal apply to calendar. I think the calendar -- our view of the calendar '23 is the second half of calendar '23, you'll see even a greater inflow of products if you start taking down backlog any time. What we've been talking about is just re-leveling our revenue to real demand, which is resetting this book to bill. And on top of it, we're talking about building backlog where we'll have hundreds and hundreds of millions of backlog of relief. And so that is -- again that will continue and that will only gain velocity in the second half of the calendar.

Sorry to -- I don't know if I'm already beating a dead horse, but can you give us any -- if we think about fiscal 2Q, the December quarter gross margin, I mean, I know you don't normally guide two quarters out, but do you have any color on how we should think about the supply chain versus pricing versus other factors for the sequential gross margin into December? Rémi Thomas: Based on our view of expedite fees of freight costs that are starting to come down as more capacity is being built between Taiwan and Shanghai. In El Paso where we have a main hub, we feel confident that we can improve the gross margin sequentially by close to 1 percentage point so that we now see ourselves in Q2 at around 59%.

Great. Well, I have more questions but I think I'll pass it on to be fair to other people. So thank you. Thank you very much. Rémi Thomas: You're welcome.

Our next question comes from Eric Martinuzzi with Lake Street Capital Markets. Your line is open.

Yes. I wanted to address the FX impact of the strong dollar. I was actually concerned that you guys might be backing away from the 10% to 15% growth in FY '22 based on the strength of the dollar versus the pound and the euro. Could you address that? Rémi Thomas: Sure. There's two aspects, Eric. The first one is the competitiveness of our product. Unless some of our customers are willing to go with Huawei or with Alcatel-Lucent Enterprise, which is a voicemail player, if we're dealing with Juniper, Cisco, HP, Aruba, that has not proven to be a problem. And believe me, I'm asking the questions every Monday on our sales call to our Head of EMEA sales. But so far, customers basically are absorbing the impact of higher product in their local currency, specifically if they're in the Eurozone, because all of our competitors use the dollar as a functional currency with the exception of the two that I mentioned. The second aspect is we have a significant cost base, not so much in terms of R&D, but obviously in sales and marketing with a significant presence in Europe. And as we account for that, it basically has a favorable impact on our OpEx. As a prudent CFO with a very prudent treasurer, we're hedging ourselves against the euro and the Indian rupee to locking some of these rates. So the impact that you'll see on the P&L depends on how smart we've been in terms of hedging, but that second aspect is favorable to the P&L.

Okay. And then you talked about Q4 relief in the supply chain that -- I guess the release of the backlog. Is that consistent with your comments in May at the Investor Day? I could have sworn you were talking about Q3 relief. Rémi Thomas: Go ahead, Ed.

Yes, I was going to say it is consistent. I think not to be confused with how our suppliers begin turning up product and then how that product affects our supply chain. So I think in Norman's commentary, he was talking about suppliers, where we're constrained, turning up and opening up new fabs and then turning up production lines to start releasing products. And so there's an evolution there. That is happening in the first quarter and they're on schedule. That's happening in Q4 and calendar Q1. But then those components have to make it into our supply chain. And so our timetable for that is we're seeing a significant step in our Q4 of those much needed components that we can then turn around and ship product.

Okay. So it was really more of an upstream comment and that the P&L impact is just Q4. Okay. Thanks.

I think keep in mind, we are forecasting a significant step in each quarter going forward. So normally there'd be seasonality in the September quarter and revenue we're guiding to a step up in December, a step up in March, a step up in June. So we're seeing this gradual release with some pretty larger steps happening in the March and then especially in the June timeframe.

Yes, definitely unusual times.

Yes.

Thanks for taking my questions.

Thank you. [Operator Instructions]. We have a follow up from Alex Henderson with Needham & Company. Your line is open.

Great. A double dip, all right. So I wanted to just clarify on the FX and international sales. So do you have any receivables that you have exposure on relative to the FX that could be impacted by the strong dollar, weak currencies in the international markets, particularly Europe, that are either unhedged or would be impacted by further strength in the dollar? Rémi Thomas: The functional currency that we use without the fees [ph] where we basically collect 85% of our receivables happens to be the dollar. So that means that whatever bill was in dollar, they have to come up with the right amounts to meet that bill, so no exposure there.

And relative to the functional currency internationally, and particularly in EMEA, what percentage of your revenues are in dollars versus local currencies? I assume that there are some -- I'm pretty sure that there are some that are in local currencies. Could you just clarify for that percentage since this is such a large factor these days? Rémi Thomas: I don't know the exact percentage but I would assume it's 95%, unless we have guaranteed a net price in the local currency which to my knowledge we don't do. We sometimes will guarantee a net price, so some customers are immune from the price increase we've done until the frame agreement we have with them expires. But in any instance, that price is always set in dollars to my knowledge.

That's higher than I thought it was. So thanks for the clarification. Going back to the environment, it's hard to believe that the Europeans are not seeing some pressure in the pipeline. Can you talk a little bit more about the pipeline relative to Europe? You haven't seen any slowdown or any increase in the number of signatures really, the stretching of lead times, anything on those type of metrics? It seems hard to believe that given massive hits that that economy is taking that there hasn't been any change at all on conditions?

I would add a couple of things to that, Alex. One is it's something that we're looking at very closely and we're watching very closely. And the answer is, no, we really haven't seen that. As I mentioned before is that a function of us taking share. We're seeing with our position in cloud and with our position in fabric and ark [ph], the quality of our story and then the quality of the actual, the implementations, we're getting more fabs. And so is this a function that we're seeing more opportunities from a share gain perspective? That could be part of it. The other thing I would say on an overarching basis is that networking infrastructure is critical, probably more strategic today than it's been. And if you're looking at digital transformation, the connective tissue is the network. And the connective tissue is the cloud. And these are really important complicated projects that we're not seeing these projects being prioritized. And when we look at sort of the difference that new networks can make in terms of driving customer outcomes and business outcomes, these are not the first projects to go. So if things are getting cut, we're -- and it's why I made the comment about the antirecessionary nature of critically important networking projects would either be reinforced. We're not seeing it yet.

That's fabulous. Okay. One more question, except this one on the internal side of things. Have you changed your behavior relative to hiring? What are you seeing in terms of wage inflation? What are you seeing in terms of staffing, churn, any thoughts on those elements to drive OpEx? And when does your annual merit increases, so that we can note them in our model?

So annual merit increases for us are in the second half of the fiscal, so they come into play at January and February timeframe, so in the March quarter. For us, what I will tell you is that our turnover remains unusually low. And I think some of that has to do with our success in the marketplace and the kind of talent that we're attracting right now at Extreme. So from that standpoint, we are out in the market and we are out hiring. We are being very disciplined in our spend, in our investments, because real demand is a lot higher in the market and we're driving a much higher demand than what we're spending for, because revenue is lower. But we've been making some key strategic hires in the channel and in our sales leadership. We're better organized now to support the channel and we see a real channel growth opportunity. And I would say we're hiring. So right now we're in investment mode, but we're constrained because we're governing investment by our revenue. And our revenue is artificially low, because it's not a reflection of real demand because of supply chain, if that makes sense.

So would you then, as supply chain improves, accelerate the hiring to take advantage of your accelerating revenue growth? That sounds like that's the answer to that question.

We would blend our returns to investment in the business and growth that current returns to shareholders.

Make sense. I wanted to just get a little bit more clarity on the embedded backlog in the systems backlog, the stuff that's relevant to service, the stuff that's relevant to subscriptions for software that are tied to actual shipments. If we were to take a ratio of the -- say it's $100 million worth of systems, what would the equivalent portion of software and services be that are embedded in that deferred revenue for systems? Is it 25%, 30%? Is it 50%? How do we think about it? Rémi Thomas: I don't know that we have that kind of metric, because in that 100, you have to see what is our campus portfolio as opposed to our wireless portfolio? I could answer that typically the attach rate that we're now seeing around our wireless portfolio for cloud is around 60%. So every time you sell 100 switches, in 60% of the case the customers will take XIQ to manage that. And the dollar amount related to that is a lower number of that, which we haven't really being disclosed. So I'm not sure we can answer that question, Alex.

Well, the services should be pretty straightforward, right? The services -- Rémi Thomas: Services attach [indiscernible] about $7. So you sell $100 worth of a switch or access point, you typically get $7. But as far as XIQ is concerned --

We should circle back with you on this one.

Okay, great. Thank you very much. I'll cede the floor.

We have a question from Dave Kang with B. Riley. Your line is open.

Yes. Good morning. Nice quarter. First, on clarification, I think, Rémi, you talked about gross margin would have been 600 bips higher. I'm assuming that was for fiscal fourth quarter. Rémi Thomas: No. That was for the full year.

Okay. What was for fiscal fourth quarter. Can I get that number? Rémi Thomas: It was about the same.

Same. Okay, got it. And then regarding -- a lot of that has to do with expedite fees. Have we seen the peak of that, or when do we see that peaking because gross margin obviously declined 1 percentage point sequentially. I'm assuming that was a function of that. Rémi Thomas: Actually, the expedite fees in freight costs in Q4 versus Q3 and versus what we expected didn't really come as a surprise. What really drove that 1% gross margin impact was a mix. We had a significant stronger quarter for wireless and our gross margin on wireless are lower than for our wired products. To your question about, have we seen the peak? The answer is yes. As we look at the expected what we call PPV, purchase price variance, which is really what we pay in addition to the normal invoices to secure supplies from Broadcom and other vendors, we actually see a slight improvement in Q1 and same for freight costs. I mentioned earlier, that there is now more capacity being added back by commercial airlines between Asia and the United States. And we're basically leveraging that commercial airline capacity to carry our products. So that the bill that we expect to pay this quarter is actually going to be down sequentially, which is why we're suggesting a 1 percentage point improvement sequentially.

Got it. And then sticking with wireless, what is the mix between wired versus wireless for product revenue? Rémi Thomas: So this quarter it went back up. It had been depressed because we were delivering more on the wired side. This quarter, we went back up to 28% wireless, 72% wired.

Got it. And then regarding your backlog, I think last quarter you talked about backlog of maybe 500, maybe slightly higher, but clearly you already exceeded that. And you're implying that will continue to go up. So how should we think about the new peak? Are we talking about maybe 600, even higher? And then after peaking, can you maybe talk about the rate of decline? I'm assuming that's going to be more of a fiscal '24? Rémi Thomas: Ed, do you want to comment? So I'll go, Dave, and Ed you can feel free to add.

Yes, I wanted to clarify. I wasn't sure about the question of rate of decline.

The backlog decline.

Yes. So we would expect to see backlog decline. What we imagined is that we would level out and start chipping away at that. And our Q4, we're not expecting a meaningful impact, but it's really in the second half of calendar '23 that you'll start to see us take more meaningful chunks out of that backlog. And again, it will all be based on supply of components and the increased volume. So I think through our fiscal year -- the second half of our fiscal year, you'll see a step up and then throughout fiscal '24 and probably into fiscal 25, you'll see us right size our backlog.

Where do you think it will peak, around 600?

I'm not sure we provided guidance on that. But what we thought would be a -- I think that's a fairly conservative number. I would say that's a safe number based on the strength of bookings that we've got relative to supply, especially if you look at the trend over the last several quarters.

Got it. Just a couple more. Can we get the latest update on SD-WAN and Ipanema, how that's progressing?

Sure. We had our Connect Conference and we announced that we were launching ExtremeCloud SD-WAN. Our teams came in ahead of schedule as far as putting the SD-WAN solution in our cloud. So one of the things you'll hear us talk about is that we have one cloud orchestrating services and we're the only provider in the industry that has a single cloud delivering cloud management on campus as well as wide area network cloud management. So this is how we're differentiated and we're looking at bringing new WAN edge services that we can orchestrate across our cloud. We are building -- this is a 6 to 12-month selling cycle. As we've just launched, what we're seeing is we're seeing the funnel start building of opportunities. And we've already seen -- I mentioned that [indiscernible]. We have sales kickoff meeting with partners, and SD-WAN is going to be a big part of that launch next week. And our teams will have commitments on those numbers. So we're expecting significant growth throughout the course of the year. And then you'll see the funnel build and then you'll see the bookings come for that only in the second half of the year.

Got it. And my last question is on 5G. Clearly, you exceeded 20 million. And then I think before you were expecting 50 million to 100 million. So just wondering if that's the case, still the case for fiscal 23? And then any new customers in the funnel, in the pipeline?

The answer is yes, yes and yes. So we're seeing new opportunities with one of our large global telecom suppliers that we've spoken about. They went from 0 to over 22 proof of concepts, and now the proof of concepts are going into production. So we're going to see a significant ramp as major telcos start deploying this cloud native infrastructure solution where we're the sole source vendor for networking around the major service provider 5G networks around the globe. So we're seeing it happen in real time. And so we're very confident in that forecast. We are also part of the 5G solution. And I know we mentioned Verizon by name, we have a significant business opportunity. We are being certified in Verizon in real time. So the Verizon sellers in the enterprise space can position and they can make a commission and sell Extreme. This is an exciting new opportunity for us. This also expands across the broader portfolio. And then we do -- we are adding new customers because of the work that we've done for these large service providers. There are use cases and very targeted use cases that apply to other service providers, and we're starting to see the funnel build where we open up that portfolio to other service providers, but also say we've also been investing in that field. So this is an area where we see significant growth opportunities.

Got it. Thank you. Rémi Thomas: And Alex, if you're still on the line, we do have an answer to your earlier question. We did some back of the envelope math, but typically when you have $100 worth of backlog that you're not able to deliver between the services and subscription assuming attach rate for service and assuming different attach rate for subscription, you should assume around 15% of that 500 million of backlog gets released, that's potentially $75 million worth of subscription and services business that can be generated over time.

Our next question is a follow up from Mike Genovese with Rosenblatt Securities. Your line is open.

Great. I haven't gotten any long list of follow ups, but then they're mostly just got asked in the last few questions. So I'm just going to end with, for me, Co-Pilot. I know it's early days, but do you have revenues there yet? What's the pipeline like that looking for? How do you sell that product? And what's customer acceptance like? Thank you?

Yes, Mike, it's a great question. It's something we're really excited about. We talked about the next generation as sort of new growth factors for subscription. And clearly SD-WAN, we've gotten a lot of attention around Digital Twin. And then Co-Pilot with AIOps and automation and some of the operational savings that we're going to bring. The launch is really this upcoming week in Boston. So there's a huge amount of training and enablement and an official launch with our own internal sellers, with marketing programs and incentives, as well as for our partners. So more to come on that. We're very excited about the capability and the differentiation on what that can do. So still early, but stay tuned.

Okay. I guess if we take very long term, years down the road, and we kind of dimensionalize the Co-Pilot opportunity versus the core XIQ opportunity, like what percentage would it be?

We haven't guided there yet, Mike, but I think that's something that we can come back. And what we do is we look at customers and we look at their software subscriptions spend. So obviously, the core is a pilot license and then you start layering services on top of that. And so we look at, you can call it, it's an additive strategy where we're looking at adding services on top of that pilot. And I think for us to give you a meaningful answer there, we need to do some modeling for you to try to be responsive and understand what you're trying to build in there. I think it's premature for us to give you an answer on the call today. Rémi Thomas: Mike, you should think of this as an opportunity for us to improve on that retention rate. So if our gross retention rate is in the high 80s, low 90s, when we go back to the customer and renew, we're typically going to upsell them with this type of product and get an additional few percentage points and increase on that retention rate.

Fantastic. Thank you very much.

Thank you. And that's all the time we have for questions. I'd like to turn the call back to management for closing remarks.

Okay. Thank you. Well, we appreciate everyone joining us today. And we appreciate the engagement with the analysts. Great questions. We're very excited as we turn the corner into our fiscal '23. The bookings growth and the demand for Extreme in the market is unprecedented. And I've just say personally, I'm very proud of the team. I know we have a lot of customers, partners, employees who listen in on the call and I would congratulate everyone on a job well done and tremendous momentum that we've got turning the corner, again across the board from the product teams, the sales and marketing teams, our services teams, supply chain ops teams, and then everyone supporting the efforts at Extreme. We're just in a very unique position for top line growth and cash flow and earnings growth, not just the next couple of futures but the next several years. So we're excited about that. Thank you again for joining us and have a great day.

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