Extreme Networks (NASDAQ:EXTR), an equipment maker for data center networks, reported second-quarter results after the closing bell on Wednesday that smashed analysts' estimates across the board, largely due to a steady stream of innovative new products.

A hand holds up an Erlenmeyer flask with an icon of a golden money bag inside.

Extreme Networks is making money via research and development. Image source: Getty Images.

Extreme results

Sales in the second quarter of fiscal year 2021 fell approximately 9% year over year to roughly $243 million, according to Wednesday's preliminary earnings report. Adjusted earnings landed near $0.14 per share, up from $0.13 in the year-ago period. The Street consensus called for EPS near $0.11 on revenue in the neighborhood of $241 million.

On the earnings call, CFO Remi Thomas explained that the strong results sprung from widening gross margins, which in turn rested on three key trends:

  • Shipping costs are coming back down from the elevated levels during the onset of the COVID-19 pandemic, when much of the company's product shipments had to be made through alternative channels.
  • Newer products carry a lower bill of material, and that's no accident as Extreme spends more time on developing new designs with cost-saving design choices. Many of the company's newer tools also incorporate a license to Extreme's cloud-based network management tools, which adds a layer of renewable subscription-style payments to each hardware package.
  • A lot of these newer products hit the proverbial store shelf in 2020, and customers were quick to embrace them, shifting Extreme's product mix toward the more cost-effective end of the pool.

Two of these three key growth drivers boil down to Extreme's intense focus on developing a steady stream of high-quality products.

Extreme margin growth

Looking ahead, Thomas expects his company's gross margins to continue marching higher.

"We should be expecting our subscription and support revenue to increase as a percentage [of total revenue]," he said. "And structurally, those two activities carry higher gross margins. So that should be driving our gross margin up. So we're pretty optimistic about the gross margin trends."

This quarter's gross margins will come in at approximately 61%, up from 56% a year ago and 53% in the difficult third quarter of 2020.

These improving gross margins are a crucial component of the company's long-term financial plan, and they have never before crossed the 60% line in Extreme Networks' operating history. These figures are comparable to some of the most generous gross margins in the network equipment industry. Sector leader Cisco Systems (NASDAQ:CSCO) is just a hop, skip, and a jump away, with trailing gross margins of 64.1%.

A stack of 7 magenta-colored data center network switches.

A stack of ExtremeSwitching 5520 network switches, introduced in 2020. Image source: Extreme Networks.

Extreme value

Extreme Networks is on a level playing field with the big boys nowadays. Keep in mind that Cisco also commands a market cap north of $194 billion while Extreme's total market value stops just short of $1 billion. There is a huge opportunity for long-term growth by nibbling at the established market shares of larger rivals such as Cisco. Extreme is also among the more affordable networking stocks on the market today as measured by price to free cash flows or price to forward earnings.

Long story short, Extreme Networks looks like a great buy at today's prices as the business is firing on every cylinder.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.