Extreme Networks, Inc. (NASDAQ:EXTR) reported stronger than expected Q2 2014 results (press release, SEC filings, conference call). The company reported non-GAAP revenue of $156.9M, non-GAAP gross margin of 56.9% and non-GAAP earnings per diluted share of $0.09, which exceeded its own guidance. GAAP revenue was $155.3M and non-GAAP revenue was $156.9M. GAAP net loss was $16.2M, or $0.17 per share. EMEA's quarterly revenue grew by a better-than-expected 4% Q/Q and 5% Y/Y. North America also exceeded expectations driven by three additional NFL stadium wins. As I mentioned in my updated thesis, the E-rate funding will present a great opportunity for EXTR. It was now confirmed that Wi-Fi purchases made on or after April 1, 2015 will be eligible. EXTR is putting programs in place to capitalize on this opportunity.
The Enterasys integration has "significantly exceeded expectations". It is ahead of track in some areas, such as the ERP IT systems integration. The integration challenges experienced earlier in the North American sales and partner organization seem to be successfully resolved now thanks to special attention and focus of the company's CEO on this area. Moreover, EXTR is close to completing the overhaul of its distribution network, focusing on the top-tier distributors which will allow deeper ties and more leverage. As I know from my own managerial experience, reducing the number of distributors can backfire; over time, the top partners gain negotiating strength, so we will see how the this strategy works out for EXTR. The company confirmed its previous guidance, with growth expected to be driven by increased Lenovo business and the renewed E-rate funding program. EXTR plans to continue focusing on efficiency and expects a 10% non-GAAP operating margin going forward.
Overall, EXTR had a very strong quarter and finished a fiscal year of transformation. Synergies from Enterasys acquisition should start flowing in. My original thesis from July 2013 worked very well as the company continued to perform strongly and the stock price doubled within six months. It later retreated but still now trades ~25% above the original price. The stock is also up nicely since my updated recommendation in July. Thanks to another strong quarter and the E-rate program plan working as expected, I reiterate my long thesis and raise my target price slightly to $5.5 per share which offers a ~10% upside within 12 months. However, the stock has been volatile and this will surely continue. As a result, the downside should be protected at 10% below the current price. On the other hand, the stock can easily overshoot my fair value price target and I would recommend keeping most of the position open. Perhaps just trim it.
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