Good day, and thank you for standing by. Welcome to the Extreme Networks Fourth Quarter Fiscal Year 2021 Financial Results Call. 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. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Stan Kovler, Vice President of Corporate Strategy and Investor Relations. Please go ahead.

Thank you, operator. Welcome, everyone, to the Extreme Networks fourth quarter 2021 and year-end 2021 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 at the Investor 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 Extreme's future business, financial and operational results; growth expectations and strategies; the impact of the COVID pandemic; challenges in our supply chain, specifically as they relate to chip shortages; the impact of tariffs, digital transformation initiatives as well. 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 ending June 30, 2020 filed with the SEC and any additional risk factors in subsequent 10-Q filings. Any forward-looking statements made on this call may 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's President and CEO, Ed Meyercord.

Thank you, Stan. And thank you all for joining us this morning. Q4 capped off a record year in our 25-year history as we crossed over the billion dollar revenue mark for the very first time. This is an important milestone and it was a long-term goal of ours. And importantly, the momentum we built throughout the year with 36% overall year-over-year bookings growth that drove 29% revenue growth in the fourth quarter has carried into fiscal 2022. And the strength of our year-end results are understated, given the fact that we tripled our backlog to over $100 million over the course of the year. Our execution has never been sharper. And as a result, Extreme is in the strongest competitive position it's ever been in. This is evident in our industry leadership and significant growth opportunities in two of the fastest growth segments in our industry – cloud-driven enterprise networking and 5G network infrastructure services. The demand for our solutions and the volume of new opportunities are unprecedented. And we're taking share. This is evident in our funnel, our current and projected top line growth forecast, our highest ever full-year gross and operating margins and our record free cash flow generation. The momentum of our cloud-driven business bookings continues to grow. Market share data from 650 Group affirm that Extreme remains the second largest in cloud networking, with 11% share last year. We're outpacing the market with our fourth consecutive quarter of triple-digit growth in new subscriptions bookings and 111% bookings growth during Q4. Our total cloud services business is now on an annualized run rate of over $100 million in bookings and over $70 million in revenue. As the second largest cloud-based networking vendor, we currently manage 1.7 million devices on XIQ, which marks eight straight quarters of…

[Operator Instructions]. Our first question comes from Eric Martinuzzi with Lake Street.

Congratulations on the real strong finish there to FY 2021. That's terrific. And the healthy guide as well. I'm curious to know regarding demand environment, there's definitely – with your enterprise customers, I know a lot of them, at least on the larger side. There was a return to the office. There was a return to the campus. Just curious to know the IT priority they've got because you've got a lot of people that have been gone for a while. I'm just wondering about where you guys, where networking gear and wireless access stands in the pecking order of IT priorities, whether from a budgeting perspective or from a manpower perspective?

It's pretty interesting what's going on in the environment out there. When the pandemic first hit, there was a lot of spend in network peripherals. They had to arm students that were going back to the homes and workers going back to their homes, healthcare workers, et cetera, et cetera. And now what we're seeing is the reimagining of the workplace or the work environment, where enterprise customers are thinking about more of a flexible work environment, a hybrid work environment. And this is why you hear us talk about the distributed enterprise or the infinite enterprise because what it means is that the enterprises are taking responsibility for the new edge of the network. And the new edge of the network is going to be that individual. Eric, wherever you are and whatever device you're on, as opposed to being in a branch of office. And that's why the cloud-enabled networking is the fastest growing segment in the networking industry. And we have the industry's highest quality cloud. And because of our cloud native infrastructure, we're in a position to deliver more services than anyone else. And so, our vision is really catching enterprise customers by surprise. As people rethink their environments, networking has become a higher priority, cloud has become more important. It brings a lot of complexity in terms of a distributed network. And clouds simplifies that. So, all of a sudden, from an Extreme perspective, and that's why we're seeing so much demand. Enterprise customers are contemplating cloud. And then, if they're a Cisco customer, they say, well, I'd like to get another opinion from another competitor. And I should hear from Extreme because they're the number two in terms of size. But our architecture is fundamentally better equipped to provide a cohesive services edge platform than Cisco, for sure, and then all the other competitors. So, now customers are surprised when they're hearing from Extreme. Extreme is moving much further down competitive processes, and our hit rate in terms of batting average is off the charts.

So, you're saying that, given this shift in the – wherever you are – operate from wherever you are, that favors you guys, that is a priority for your enterprise and education accounts?

Oh, absolutely. It's driving cloud. It makes sense, right? You want to have a centralized platform, where you have complete visibility to all of the devices that you're managing in the network, but also to have all the insights to the edge devices that are being supported. And that's what our cloud does better than any other cloud in the industry. And so, it's that, and then it's also future forward in terms of what are the services that are going to come in the future, and we have the most cohesive vision in the industry.

Our next question comes from Alex Kim with Needham.

I was hoping you could talk about your approach and the industry approach to pricing, given what's going on. To what extent you anticipate some increase in prices, when you might be increasing them and what you're seeing from your competitors on that subject? Clearly, there's going to be some pass-throughs here.

Alex, we are seeing – and yeah, we are aware of competitor price increases. Probably the most important move for Extreme is the migration to the Universal platforms that you're aware of. We talked about a 40% migration. But for us, it's the new technology and we caught up. So, we're on the latest wave of Broadcom technology in terms of the latest generation chipsets. And as you just saw with our Wi-Fi 6E announcement, we're first to market. So, I would say that, for us – you're going to see that portfolio completely migrate. And for us, it simplifies our SKUs and simplifies our supply chain. So, in effect, we're going to get a nice gross margin benefit from what is a higher margin – migration to this higher margin Universal platform. And you're going to see that migration happen over the course of this fiscal year. So, that should bring nice margin benefits for us and growth benefits, especially in the second half of the year. As far as the pass through of cost is concerned, the fortunate thing for us, we do have near-term increases in costs, but we've invested – our teams have established a great relationship with Broadcom, and we don't just consider them a vendor. We consider them to be a strategic partner. And they work really well. Our teams work really well together. And so, the good news for us is that we we've secured commitments, and so our fiscal Q2 now, we feel like we've locked that up. And then with the one year lead times, that started a year ago, that really eases and we're going to start unlocking backlog in Q2, and then we feel confident about our allocations and wafer allocations for Q3 and beyond. So, we have to be smart about it. We're looking at potential, more tactical price increases maybe for certain products. At this stage, we don't have a formal plan for it.

So you haven't increased any prices to date?

We're always looking at our portfolio, Alex. So, I would say, you'll always see changes and us elevating prices, particularly on older products, older generation products. It's kind of a normal course of business. The other way we manage it is through discounting control. So, yeah, that's the other way that we manage the margin.

If you were to look at it from the perspective of, on average, your competitors not having a newer product line, not having the ability to benefit from the Universal integration of components, can you quantify or just generally speak to? Is it to 2%? Is it 5%? Is it 8%? What kind of price increases are you seeing from Cisco and Hewlett Packard and others?

I think it's safe to say 5% to 10%.

Our next question comes from Dave Kang with B. Riley.

First of all, just going back to the supply chain challenges, do you think this current quarter – fiscal first quarter will be the bottom in terms of gross margin? How should we think about gross margin going forward?

Yeah, I'll start off and then let Rémi pick it up. But the answer is yes. For us, the September quarter, we have the most pressure on this quarter. And I think the same is true with the rest of the industry. As I mentioned earlier, we've gotten secure shipment dates for what we need in Q2, just given the strength of our teams working with – and the strategic nature of the relationship that we've got with Broadcom. So, we see the lessening happening. And that means that we have commitments, the costs that we incur have to do with expedite fees and trying to pull in product. And then, it's also the timing of how product arrives at our ODMs and then the speed with which we have to turn around into product and direct ship. So, there's a lot of contributing factors. So, across multiple factors, we expect to see the easing start to take place in our Q2 and it's really this quarter will bear the brunt of it. Rémi, I don't know if you want to add to that. Rémi Thomas: If you take the midpoint of our guidance for Q1, Dave, you see that it's 59%. Compare that to where we landed in Q4, it was 60.5%. So, we're looking at a 1.5 percentage point impact, if you take the midpoint. And if you apply the math to the revenue that we're calling out, that really gives you an idea of the size of the impact, and it's really driven by two things. One is the higher cost of components that we're having to pay to secure deliveries. And the second one is higher freight costs. We used to be in an environment where we were able to ship anywhere between 25% and 35% of our shipments from our ODMs to our hub, and from our hub to our distis by sea. And right now, we're pretty much at 95% to 100% by air just to accelerate the delivery time. So, these two components add up to that 1.5 percentage point difference that you see between Q4 and Q1. We think it's probably the highest that we'll see, and things will start to improve as of Q2 and onwards. We'll get also a higher mix of Universal Hardware platforms going forwards, which increasingly carry higher gross margin than [indiscernible] products.

My second question is regarding your fiscal 2022. Outlook, high end of 5% to 9%. Can you just share some key assumptions, such as like a 5G? I think you already talked about $20 million? Could there be some upside to that? And wireless Wi-Fi, other verticals?

We have the benefit of having a funnel. We have a lot of opportunities. We have better visibility. And so, we're seeing this momentum. And I was answering Eric's question before. We're just seeing higher velocity. As we roll into fiscal 2022, the strength that we're seeing in July, the momentum that we felt in June is still right over into July, which is normally a softer month for us. I think it has to do with our position in cloud. Cloud really is the fastest growing segment in the industry. And as people are rethinking and considering cloud, most of the cloud has been wireless. But people are starting to think more broadly about edge switching and migrating other platforms to cloud. And we're in a very strong, probably the most competitive position of all the players in the industry, certainly the strongest position we've been in. And as I said before, our teams are out winning in the market. And I think there's more competitive differentiation at Extreme today, certainly, than since I've been involved with the company for over a decade. So, demand for our solutions is at an all-time high. And I think it's being driven by the competitiveness of our solutions, the innovation that we're bringing, the consistency of our vision, the messaging. We have a smaller market share in the industry relative to a Cisco or an HPE. So, when customers are looking at us, maybe they haven't looked at Extreme in a long time. And they're surprised to find out the quality of the solutions that we can bring and the vision that we have as a potential partner to go forward. This is how we won Major League Baseball, a great example. Some of these casinos, great example. I mentioned, Stanford University right in Palo Alto, they go Extreme. We have a lot of big marquee wins. And then that really stimulates our field and gives them confidence to all of our sellers in the field.

My last question is actually going back to the supply chain issues, talk about the margin impact. What about top line impact on how much revenues are we leaving on the table because of the component shortages? Rémi Thomas: If you remember the prepared remarks from Ed, we talked about a backlog entering Q1 that was $100 million. That's about three times the level that it was entering Q1 of fiscal 2021. So, that gives you an idea of the magnitude of how the backlog is built. So, I would say that if it weren't for product constraints – but we don't like to make those comments because we have product constraints. But if it weren't, our revenue, both for Q4 and Q1 would have been tens of millions of dollars higher.

Our next question comes from Chris Schwab with Craig-Hallum.

Congratulations on a great quarter. Just a whole list of – a litany of wonderful things going for you. I just want to get to gross margins versus the top line growth drivers as you guys have highlighted. With the supply chain issue kind of becoming less of a headwind, it appears, in the second half of your fiscal year, and by that time, I would imagine just about every product you'll be shipped would be on the refreshed Universal platform. And then as we can get some moderation and expedited freight costs and that supply chain of freight kind of normalizes, how good could gross margins be exiting the year if those type of events were to occur? Rémi Thomas: So if you think about the drivers of gross margin, on the downside right now, which is going to impact Q1 and, to a lesser extent, Q2, you have those higher component costs to secure deliveries, then you have the freight costs. And on the upside, you have the introduction of the Universal Hardware. You have our ability to selectively raise price on certain products, and more importantly, to control discounting, which we're doing very effectively. And you have the mix. I talked in my prepared comments about deferred revenue and the fact that we now have $340 million plus of deferred revenue. So, you're going to see the percentage of support and subscription revenue as a percentage of the total pick up over the coming quarters and from the current level of 28%. So, when you factor all that, we should be exiting Q4 fiscal 2022 north of 60%, obviously, and we feel confident about the long term targets that we've established at the Analyst Day. If you recall, we gave a range of 63% to 65%. We think we're still on that trajectory, even though we have the short term impact of the two items that I mentioned earlier.

And then, you add into the fact that you have probably what looks to be the most competitive product lineup for customers. Rémi Thomas: You just said it. Really that statement, but it came from you.

[Operator Instructions]. Our next question comes from Paul Silverstein with Cowen.

A couple from me. First off, Rémi, I don't think I've heard you give – and understand why you won't. But did you give us a number – your expectation for gross margin all-in for fiscal 2022? Or is there – given the higher freight costs the higher component cost at this point, is it just too hard? Rémi Thomas: I didn't. But the goal is to be north of 60% for the full year. So, we'll obviously exit at a higher rate. We're thinking we can be north of 61% by Q4. And when you take the average for the year and take into account the mix of revenue between the various quarters, we feel like we should be above 60% on average for the full year.

And then, the higher freight costs that you and everybody else is saying, is there any concern that freight costs continue to go up? If I heard you correctly, you're already shipping 95% by air. So, it sounds like the mix of sea to air, that can't get any higher. But is there any concern that freight costs will continue to go up and prove a headwind? Rémi Thomas: So there's two factors. The first one is the one you just mentioned, which is that right now we're almost 100% air. And the second one is the actual cost for carrying a ton of product over the Pacific and then over the Atlantic. So, to bring products from China to El Paso, and then ship it out either to the US or to the rest of the world, we tend to use commercial airlines to carry our products. And because capacity has been limited for the past 15 months since COVID started, the rates are up. As commercial traffic starts to pick up, and you can see that airports are getting busier and busier, we expect airlines to add capacity and the unit price for carrying a ton of products to go down. So, to your point, it doesn't get any worse than it currently is. As a matter of fact, when I look at the actual number that we're forecasting for that part of our cost of goods sold, in Q1 versus Q4, it's actually down slightly sequentially. But it's the component costs that are rising.

So, Rémi, to be clear, because it makes perfect sense that as commercial airlines add capacity, you and everybody else should see prices going down. But to be clear, you're already seeing that or that's just… Rémi Thomas: Yes. The price on certain routes are already starting to ease a bit. But it's more than offset by the rising component costs we see from Q4 to Q1.

On that second point about rising component costs, is there any visibility as to incremental increases throughout the year or do you already have prices locked in? Rémi Thomas: No. We basically, to the point I made, have a little long term relationship with Broadcom and the other supplies that we use. And so, we're in constant dialogue to secure commitments for deliveries in Q2 and onwards. And we have good visibility as to how much that will cost us.

On the demand side, what's your historical experience with respect to customer cancellations of the orders and backlog? I assume that's rare.

Paul, that a pretty rare occurrence. And I would say that we have seen a couple of small kind of one-off situations where there's an urgent project or an urgent demand. But what's interesting for us is that – what we were hearing from our distributors is that we're actually – we've asked them to force rank the vendors, and we've got really high ranking. So we're getting – I think, right now, Extreme has had an interesting position of potentially being a go to because of how we manage the supply chain.

Ed, everybody – all the networks are going to be saying they're trustworthy on networking. The silver lining from pandemic has been customers providing extended visibility for beyond the normal book and ship has prevailed for many years now and has given you and your peers far greater visibility into the future than what has been the case historically. That said, investment community is still worried that there's some degree, perhaps meaningful, over-ordering. it What is your visibility as to true demand and the risk that there is a healthy amount – and healthy, obviously, would be the wrong word, but that there's a meaningful amount of over-ordering going on, and so true demand is far less than what your nominal order book and other demand metrics would indicate?

I think you've got think about Extreme and our business mix. And I think I would see from someone like – you might see more of that from like larger service providers. Maybe like the large Fortune 50 type accounts. But we don't see it as much. We might see some stocking orders from distis coming in where we know that they're trying to get ahead of this. But in terms of our backlog, it's a pretty small percentage. When you think about a school district going through, getting [indiscernible] funding and adding to the network or upgrading their network, they're not as sophisticated trying to get ahead of global supply chain clients. So, we just don't see that as much. If you look at our customer profile, most of them are ordering what they need for projects. We have run rate business where they're just ordering, and then there's project business. But in the case of Stanford University Stadium, they have the worst Wi-Fi in their league. Okay? That's embarrassing for a company that's right in the tech center. They need to upgrade. Well, guess what? They've gone to Extreme, big opportunity for us. We won that in the competitive, but they're not pre ordering to get in front of supply chain. They're ordering because they have a problem with the quality of Wi-Fi. And I'd say that is true with almost all the ordering that we're seeing from our customers. Rémi, do you want to add anything? Rémi Thomas: I was going to say, Paul, remember, we operate under two tiered distribution model, where we recognize revenue on the sell-in basis to distis and then distis provide our products to business partners who sell them to end customers. Hypothetically, if an end customer changed their mind and canceled their order, first of all, most of the business partners don't take cancel of orders. But hypothetically, if that happened, what the distis would do is just reallocate those goods because they're short of everything right now to another business partner who would end up selling it to another customer. So, we measure the risk of return through stock rotations, which is an analysis that we did with our distis for the ability to rotate products. And stock rotations right now are at an all-time low because everything they have in their warehouse, they need to be able to deliver to the various business partners that are seeing the strong uptick in demand.

Let me ask one more question on this line. Playing devil's advocate, and correct me if I'm wrong, but I think the last time we saw a meaningful over ordering crisis, if you will, you'd have to go back to the telecom Internet bubble back in the late 90s. Maybe I'm forgetting one or two other times, but I think you'd have to go back 20 plus years. Given how long it's been, and this is obviously not unique to Extreme, but if that is what's going on to one extent or another today, Rémi, I noticed in your comments – and again, I recognize this is not the unique Extreme issue, but just trying to gauge the risk. Everything you just said, would that matter? If it is something that can be late 90s, wouldn't 2there be a collapse across the board of one extent or another? So, your point about reallocation from one customer to another and stocks being very low and that gives you comfort and protection, would that just go away if it is, to some degree, of the late 90s scenario? And I'm not saying it is or isn't.

I was there with you in the late 90s. And this is very – I can tell you, we are in no way in a bubble as far as IT spend. Actually, it's just the opposite. We are on the very front end of this investment in 5G infrastructure that has nothing to do – what we're going to get is – we're at the very, very beginning of deployment of the largest infrastructure investment in our lifetimes. And it's very mature. So. there could be some near term. And again, I think that all the preordering concerns that you're worried about, I think that's more of a service provider phenomenon for larger carriers trying to get ahead. But as far as enterprise customers upgrading their networks, in terms of the idea that we now have this new spectrum band and Wi-Fi in the 6 GHz space and what that means for customers and the capabilities for customers, the edge of the network is going to be changing from the closet in a branch office with a lot of boxes into the cloud, which is driving a greater need for networking. All of these secular trends are going to be around for years and years to come. So, we can't see, we have no visibility to a bubble at this stage of the game.

And this concludes the question-and-answer session. I would now like to turn the call back over to Ed Meyercord court for closing remarks.

Okay. Well, thank you, everybody, for tuning in. I can tell you, we just had all of our global teams together for our sales kickoff meeting and our employees together. And I think consensus on the inside of Extreme is that there's never been a better time to be an Extreme and to be an Extreme seller. We're seeing great demand. Our technology innovation is really coming into the forefront with the strength of our product and engineering teams. And things are looking good. We have great momentum going into this quarter. So, thank all of you for joining us. Thank all the Extreme stakeholders, employees and our partners and customers who are tuning in as well. Have a great day.

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