Extreme Networks, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Extreme Networks, Inc. is a networking solutions provider, offering software, hardware, and services, primarily focused on cloud networking. Their solutions are targeted at enterprise customers seeking to modernize and secure their networks, offering both wired and wireless connectivity options, and are increasingly moving towards a subscription-based revenue model.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Extreme Networks provides a range of networking solutions including Wi-Fi access points, Ethernet switches, and related management software for various industries, with a strong focus on education, government, and healthcare sectors. Extreme’s core business is providing cloud-driven, end-to-end networking solutions that enable a more efficient and reliable flow of data.

Extreme Networks is transitioning their focus from product to outcome-based solutions.

Revenue Distribution: * Product: Primarily consists of the sale of their networking equipment which include wired switches and wireless access points. Product revenues decreased to $325.1 million in the first 9 months of fiscal year 2023 as compared to $393.7 million in the same period of 2022.

The majority of the revenue is still coming from products but they have seen a significant decrease in product revenue. * Subscription and support: Recurring revenues generated from subscriptions for cloud-based products. This is a growing source of revenue which reached $530 million in revenues in the first 9 months of fiscal year 2023, compared to $432.3 million in the same period of 2022.

Subscription based revenue continues to grow steadily. * Service and Subscription: They offer services including design, installation, and technical support, this segment accounts for $98.1 million in the first 9 months of fiscal year 2023, compared to $87.3 million in the same period of 2022.

A smaller part of the business but it also continues to grow.

Industry Trends: * Cloud Networking Adoption: Increased adoption of cloud-based networking solutions and the rising trend of hybrid work environments are making companies shift to the cloud for their networking needs. Companies like Extreme Networks are trying to capitalize on this demand. * Growing Need for Security: As cybersecurity threats are growing, organizations are demanding secure network infrastructure and companies have to address it. This means new networking solutions need to be designed and implemented to address these threats. * Shift to Subscription Model: The preference among companies to opt for recurring subscription services is causing changes in the ways companies in the networking industry recognize revenues. This is a global phenomenon as a lot of companies are changing from a one-time sale of equipment or license, to a recurring subscription model. * Demand for Faster Speeds and Bandwidth: As the number of devices and data consumption has been increasing, they need faster network connection. And that is where companies that offer faster speeds and more capacity will thrive. * Convergence of Network Technologies: There is an increasing tendency for companies to offer integrated network technologies. That is, combining networking equipment with cloud services and analytics into one integrated product.

Competitive Landscape: * The market is competitive with established players such as Cisco, Juniper, HPE, and newer entrants focusing on specific niches. * A big threat is that companies might choose to buy their networking solutions from large technology players (hyperscalers) who are also offering network solutions.

What Makes Extreme Networks Different: * They focus on providing end-to-end solutions, integrating their hardware, software, and cloud platforms. The value proposition is to provide an integrated and easy to manage system, instead of having multiple systems. * They are pushing towards subscription model which can ensure recurring revenues. * Their focus on analytics to provide insight for their customers is also seen as a value proposition. * They also focus on providing end-to-end support for their customers.

Financials in-depth:

The company’s revenues are showing a positive uptrend. In the nine-month period for fiscal 2023, total revenue reached $950.1 million, compared to $929.8 million during the same period in 2022.
They are gradually changing their revenue model towards subscription based, resulting in an increase in recurring revenue. Subscription and support revenues rose to $530 million for the first 9 months of fiscal 2023 from $432.3 million in the same period last year.

This is very important for long term profitability and stability of the company.

The company is increasing its investments in research and development (R&D), with R&D expense increasing by 14.9% in 2023 (first nine months), to ensure it maintains its edge over competitors.
Sales and marketing expenses increased by 14.3% in 2023 (first nine months) as the company is focused on capturing more market share.

These rising costs in R&D and Sales and marketing can affect profits in the near term but will ensure sustainable growth in the future * The company reported an operating profit of $130.2 million in 2023 (first 9 months), compared to $148.2 in the same period last year. Operating margin has decreased from 16% to 13%. The company’s net income has decreased in the latest 9 months by 11 million year on year.

Decreasing profitability and net income are a concerning area for the company. * The company’s balance sheet shows it has $223.7 million in cash and short term investments at the end of September 2023. With a total liabilities of $1.13B and equity of $1B.

This is a relatively healthy balance sheet. With good liquidity (cash + short term investment > short term liability)

Moat Rating: 2/5 * Although they have some level of brand recognition and are transitioning towards more recurring revenue, the competition in the market is very high, with established giants like Cisco and Juniper. The products they provide can not be called unique, as they are provided by the competition as well. So, at the moment, they only have a narrow moat based on brand recognition and high switching costs. A higher rating is not possible due to high competition.

Legitimate Risks that Could Harm the Moat and Business Resilience:

Intense Competition: The networking solutions market is very competitive, requiring continuous innovation and differentiation. New entrants, or aggressive pricing from existing competitors can pose a threat to EXTR’s profitability. * Technological Obsolescence: The fast-paced technological advancements could make their existing products and services obsolete faster. If the company fails to innovate at the pace that is required, they will lose their market share quickly.
- Cybersecurity Threats: With networks being connected more than ever, security is of prime importance. Failure in addressing or preventing cybersecurity issues may result in the company losing customers or market share.
Acquisition challenges: The company makes many acquisitions to expand its products. The integration of new acquisitions with existing operations might present difficulties, and they can fail to achieve predicted synergies. Also, some acquisitions might prove not as successful as anticipated, which in return could have a negative impact on their financials. * Supply chain volatility: The company is exposed to risk from supply chain disruptions. Global events, trade policies and component shortages might hamper the ability of the company to procure the needed parts in a reasonable timeframe and with reasonable prices.

Understandability Rating: 3 / 5

While the products of the company (networking solutions, switches, access points) are easy to understand, the inner workings and dynamics of the industry are a bit complex. It is not as straightforward as a simple retail or service business and therefore they receive a 3 in understandability. A person with background in tech can easily understand this business.

Balance Sheet Health Rating: 4 / 5 * Extreme Networks maintains a relatively healthy balance sheet. With a good liquidity position as their cash plus short term investments are more than their short term liabilities. However, their long term debt still requires attention, which is why they can’t receive a 5 rating.

Recent Concerns/Controversies: * During the recent earnings call, it was noted that the company is facing declining profitability and net income, which were also previously mentioned above. They have also announced higher prices in order to maintain their profits. They are also struggling with costs related to the ongoing inflation. * The company has had high spending on acquisitions to expand its business, and it’s not known when their profitability will return back to their desired levels. It is still unclear how they will get back on their “long-term profit” growth plan.

These concerns need to be kept in mind as an investor.