Extreme Networks, Inc. (EXTR) Earnings Call Transcript & Summary

Hey, this is Meta Marshall, Head of the Networking Coverage here at Morgan Stanley. We're delighted today to have Extreme Networks with us here. We have the CEO, Ed Meyercord; we also have Stan Kovler, who's on the line as well, who heads up the IR function, and many of you they know him from his past life. I'm going to read a brief disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Ed, thanks so much for being here today. I think this is -- it's great to have you here, especially after the Analyst Day last week.

So can we maybe start off today with an overview of the path that Extreme has taken over the past couple of years? You rolled up a lot of kind of subscale businesses that have very strong technology and installed bases. But maybe they had struggled to find their own traction as stand-alone businesses. How is the portfolio evolved over the past couple of years as you've integrated these companies and moved forward with an integrated strategy?

Meta, well, thank you. First of all, thank you, and thank you for having us. We're pleased to be here. And Extreme is a very different company today than it was several years ago. To your point, we've made a series of acquisitions. If I go back several years, we felt like, look, if we're competing with Cisco and HPE, we need scale. And then we need to get to somewhere around that $1 billion mark in order to play at a level playing field globally. And so we were fortunate to be able to make, what I would call, opportunistic acquisitions along the way. And we made our way up to that $1 billion mark. The initial acquisitions are about scale. And so what we were looking at was we were able to acquire Zebra Wireless LAN assets to build to our wireless portfolio. We got the Avaya Networking business, which has given us our fabric today, which is so important. And then we got the Brocade data center assets that is making up the 5G opportunities that we can talk about. All of this came together a little over a year ago when we acquired Aerohive, and we picked up the industry-leading cloud. And so as we've evolved, we've got end-to-end networking solutions. We've got a few different flavors of wireless. We've got some unique capabilities as it relates to campus and what we can do there and in the core of the network, as well as unique capabilities in data center. And now we can put it all into the cloud, which is where the industry is going. So now when we look at Extreme, and we're pivoting into calendar '21, we're done investing in consolidation. So we have that behind us. Now we have a consolidated road map where we have universal hardware that can run different flavors of operating systems, giving our customers flexibility. And we're moving everything to the cloud, and we have a differentiated cloud offering that we're really excited about. And it's really putting Extreme in a different competitive position than we've ever been in before.

I've got it. And at your Investor Day last week, you discussed how you're targeting kind of specific areas of the market where you can best compete. Obviously, you just noted you compete against some very large competitor. So just kind of what informed the decision of what markets made the most sense and how is that informing kind of the categories that you're approaching?

So we have 2 big opportunities. Probably more than anyone in the space of networking, we're the most heavily concentrated in enterprise. And with cloud, we have a new opportunity, and I'll touch on that. And we have new growth opportunities in 5G that we haven't had before. So when we look at the enterprise, we have a lot of state, local, government, education customers, higher education, K-12, primary. Half of our business is in the Americas, Canada, the U.S. and LATAM and then half is in international markets. So we have what we call SLED. In addition, we have health care, manufacturing, retail, transportation, logistics. And then we also have a sports and entertainment/stadium hospitality business. And obviously, on Investor Day, we were trumpeting our win with Major League Baseball. And then as we look at the 5G side of the equation, we have a unique packet broker solution with a large service provider that we can then bring to other service providers in the marketplace. And then we also have an NFVi solution for one of the world's largest telecom equipment vendors, and we're part of their full stack solution for 5G. So we're going to be deployed out. We're in the early stages of 5G deployments. But we'll be deployed at cell sites throughout the world through that partnership. And so big meaningful growth opportunity from 5G.

Got it. Yes, I see your MLB base in the background. I'm surprised you haven't decided to just kind of move it side-by-side with you. So a big question that we get from investors is just on the campus. And what does it look like in a post-COVID environment? Is it we need better Wi-Fi, but footprints are smaller? Just how are you seeing kind of the interplay between more networking or kind of advanced bandwidth needs with maybe smaller footprints? And just where are customers on solidifying or starting those conversations on what the post-COVID workplace looks like?

Meta, yes. And the answer is yes and yes. I mean, obviously, what happened with COVID is everybody went home, right? So for enterprise customers that pose different challenges for how do we support this distributed enterprise. And the old edge of the network, if you're in a corporate IT department, you might consider the old edge of the network to be a branch office or a corporate office, wherever your employees are, which most are on campus. In this case, employees are now distributed because they're working away from that office and be that at home or wherever they are. Mobility allows you to be in a coffee shop working. So what we like to call is like the new paradigm is what we would call the infinitely distributed enterprise where now we're seeing enterprise customers wanting to deliver the user experience and a consistent user experience to the new edge of the network, which, Meta, is going to be you at your home or wherever you're working for Morgan Stanley, for example. So we see that. We do think in the new normal that we will -- people will go back to work, but they're not going to go back to work in the same way. And we think that enterprises are going to be more flexible about how people come back to work environment. The one thing that we have seen throughout this, the pandemic, and it relates to this distributed network, and you can think about schools, is we've seen the acceleration of digital transformation initiatives. So in the case of schools, where they were looking at arming their students with Chromebooks, iPads, laptops, big independent school district. Well, if that was a 3-year project, they pulled it into 10 months. And then, by the way, they have students that are, say, from -- disadvantaged from an economic perspective, don't really have a connection at home. They have to provide equal footing. So we saw them putting up Wi-Fi around the perimeter of the school. So people could get free Wi-Fi and access to systems that they needed to complete their school work. So these are some of the things that you're seeing and all of it, all the digital transformation initiatives include the network. So when you think about adding every student now has this device, there's consumption of bandwidth and there's connectivity requirements and all of that means investment in networking. And, oh, by the way, that networking requirement, what glues it all together is cloud when you have this distributed environment.

Yes. And that doesn't even kind of talk about all the usage of video, even once you're back into the office and the taxing that puts on the network. So maybe coming back to the MLB deal. This gives you a lot of exposure in the market. I prewrote it gives you a lot of at bats, which is so fun.

Intended.

So -- yes, exactly, intended. What initiatives are you taking to just kind of make sure that such a marquee deal doesn't kind of go without additional levers throughout the enterprise?

Yes. Well, I mean, look, for us, it elevates our status in the industry. When our customers are enterprise customers, they look out and they see Extreme and ballpark and they say, "Wow, it's Major League Baseball grade." The same thing is true with the NFL and the Super Bowl. It helps Extreme elevate our brand. So that's important. The other thing I would say about Major League Baseball is that they play 81 home games. So when there are our partners, then we could leverage our partner community. They're excited because they want to bring end users to the ballpark. And so this will be a great opportunity for our partners. And that's another area where we've been focused is on driving what we would call the channel engine inside of Extreme, where we've been building our base of partners globally. And I think we're attracting more partners because of cloud and then the simplicity of what we're bringing to the enterprise, and I think that's something that's helped. I would say that given what's going on with cloud and just our position in cloud is help put Extreme on the map given the environment. Because people are thinking, we need to take a new approach to networking. We need to consider alternatives. We need to consider cloud. And hey, there's this really differentiated cloud with this company, Extreme Networks. And we should hear you, what you have to say. So there is your at bat. So now all of a sudden, where we might not have gotten that at bat before and our close rates are higher. So these are some of the things that we've done. The other thing I would say, this is more internal to Extreme, we've invested in automating our channel. And so we're making it easier for partners to consume and to buy Extreme products. And what was important around that is how we reorganized our field to keep our strategic sellers going after those big projects and strategic accounts, who are maybe a larger national account. And then not to bog them down with a lower kind of commercial business. And so the automation that we've built into our channel is allowing the field to focus on those opportunities, and we're seeing more and more larger opportunities come to bear. And then we're making it easier for these partners and the new partners to come in and transact where they don't have to bother the field team. So it's basically driving more and more run rate commercial business, and at the same time, we freed up our sellers to go out and to be more productive selling in the field.

Got it. You've mentioned kind of the cloud-based architecture you've built kind of a number of times. And just kind of what are the things that differentiates? A lot of people talk about cloud. So just kind of where do you find that differentiation? And what kind of competitive moat is there in that kind of multi-cloud approach you've taken and built?

Well, at the end of the day, what we're doing, Meta, we're giving more flexibility. Think about it. So if you want to come with Extreme, we're saying, "Hey, you can deploy Extreme cloud on-prem. And we can give you cloud as a service, if you will. We can put you in any of the public cloud. So if it's Major League Baseball and GCP, if it's AWS, if it's Azure, you've got a choice." And it's seamless to the customer, it does -- there's no impact to the user experience. That's the other thing that we're very focused on is the user experience and making it easy. So we believe our cloud is the easiest to use and deploy. And we're creating an intuitive user experience with that cloud. So data is another area that we've differentiated. We think there's valuable information contained in the network. And for the first time, we can tap into that data and make that available. So Extreme is the only one saying, "Look, pool in your data, unlimited data from the network. And it's not limited to 2 weeks or 30 days, you can have data for years. And then even if you don't know how you're going to use that data today, you will figure this out over the future, and you'll be able to go back in time to pull that information." Licensing is really important. When we set out and developing our new licensing platform, we want it to be the simplest in the industry. And we are, by far, the easiest in terms of licenses and how they relate to different devices. The fact that they're poolable, the fact that they're transferable. And the pricing of our licenses is very attractive. And then what we're putting in as far as security end of the platform, first of all, we're the only ISO-certified cloud. We have some unique security characteristics. And then we've got AirDefense, which we acquired through Zebra WiNG acquisition, and that is the leading Wi-Fi security that we've added to CloudIQ. And then we have other security attributes when we look deeper into the network in terms of our fabric. And we're the first cloud provider to put that core-level networking fabric into the cloud. So you can actually manage core of the network all the way out to the edge. It's not just about the edge. You can put everything and have your entire environment from the cloud, and that's what we're enabling. The final point is our ML AI is going to be different. We've been in beta for 9 months with what we'll call autopilot, which is the next level of automation from Extreme Cloud. And we think we will leapfrog the current offering that's out there, and it also gives us an advantage. But we're the largest player in the industry that doesn't have the capabilities. And we think this is really going to be interesting to enterprise customers. And they want to find out what are the capabilities? What can I learn from the network? How can I automate? And what we would say in a explainable way? Some of the AI tools out there are flooding network managers with alarms. That's not -- I mean that's not why they want machine learning and AI tools. They want to solve difficult problems, and they want to leverage data to do that. So as the second largest cloud and the fastest-growing cloud, we have the most data in our machine learning algorithms and tools. And we're looking to build on that to provide differentiated, not just traditional alarms to enterprise customers. And we think they'll pay for that. And that provides us with another license upsell opportunity.

Got it. That's super helpful. I mean in terms of -- there's a lot of competitors kind of talking about the campus market, many of whom who have presented over the past couple of days. Just what are you seeing in the competitive landscape? Is it still largely kind of the Cisco HP environment? Are you starting to see new vendors? Just how is the competitive landscape evolved over the past couple of years? And how do you see that evolving?

I mean our primary competitors remain Cisco, Meraki, HP, Aruba. More recently, we've seen Juniper because Mist -- they've acquired Mist and the Mist has presence in retail. So we've seen -- we run into Mist in the retail landscape. But for the most part, it's -- it would be Cisco, Meraki and HP Aruba. What I would say is last year, when COVID hit, we are the most concentrated in enterprise. And so we were probably impacted the most. And so as we come out of COVID, as you're thinking about enterprise and enterprise exposure, we feel like we're poised to benefit maybe more than our competitors as we come out of COVID. And we're seeing that as we turn the corner as far as our double-digit outlook for the first half of the calendar year, which is the second half of our fiscal. And then as we turn the corner for the rest of calendar '21. So we're -- we see taking a share in the market and it's evidenced by the growth rates that we're calling.

Got it. That's helpful. You touched on security just briefly of putting up solutions that are helpful without kind of flooding them with the large of them. They just turn off and put their -- increase the vulnerability of their network. So security is top of mind for enterprise network customers, particularly with SolarWinds as we saw at the end of last year, it came to the forefront again. This has been an area where you certainly have some offerings. You're partnering in other cases. Just where does security fit within kind of strategic positioning? And how do you determine kind of what to build versus buy in that scenario?

I mean, Meta, security is obviously critical. I mean, it's top of mind for everyone. And so security is part of everything that we do from a networking perspective. We tend to meet in the channel and at customer sites with the firewall provider. So if it's going to be a Fortinet or a Palo Alto, our technologies work very well together. So that's not a space that we're looking to get into, but we do have various different security elements to our offerings. And if we start at the wireless edge, I mentioned AirDefense that we include in CloudIQ. I talked about our fabric. And what we're bringing in terms of a layer 2 technology that really can't be hacked. That brings security into the network. And then we're looking -- and we do extend that all the way out to the edge of the network. And that's another area. The way we think about this expanding enterprise and we look at the new edge, what we're looking at is having cloud capabilities and security capabilities. A lot of our competitors bought what we consider to be old technology, which is SD-WAN 1.0. And we see the industry moving more towards this SASE market where cloud will be in the center, and then we can deliver security from the cloud. And we can partner from within the cloud, and then we could bring this what we would call Zero Trust environment to users at the edge of the network and then have that Zero Trust carry through. This is how we're thinking about it, the evolution of the enterprise, the evolution of the edge and what we can deliver going forward. We were -- we might do tuck-in acquisitions if they're available. Or we would also look potentially at acquiring where we would have the opportunity to cloudify. If there are devices that we could then cloudify and create recurring revenue, we would look there as well. Our cloud is multi-domain. And so we can support more than just Extreme Networking equipment. So then we can monitor it. We can have our eyes on it. We can consume data from other devices in an enterprise environment. And we can do that for the enterprise customers as well as we can do that for partners, looking at delivering managed services.

Got it. That's helpful. We maybe touched on it a little bit in the MLB answer. But clearly, you guys have made some reorganizations to the -- to sales over the past couple of years. You kind of employ more of a direct and channel strategy, just how has that strategy evolved? And kind of what was the impetus of that?

So channels are the extension of our field teams. And it's really -- channels for us, 85% of our business is flowing through our channel partners. And we have an opportunity to grow there. As I mentioned earlier, we weren't always the easiest company to do business with. And if you worked in the channel and you were trying to -- let's say, you're trying to buy networking equipment because you have a project and you're deploying that on-site. The fact that you would have to deal personally an interface with an account executive at Extreme in order to get that, it was somewhat cumbersome. And so what we wanted to do is to free up our salespeople to focus on selling and larger projects. And then we wanted to create a motion for our partners in the field for more of that commercial business to let that flow seamlessly through and to make it easier for them to transact with Extreme. So that's what we've done. And we launched it in August of last year, and it has just taken off. Our partners love it. We're seeing those volumes grow significantly. And as a percentage, it's eclipsed all of our targets for what it would do. And then it's also freed up our salespeople and we'd given them a lot more time to focus on new logos and prospecting and deals. Our team still work with our partners. And our partners still bring us 6-figure, 7-figure deals, 8-figure deals, but it allows our field teams to be more focused on those projects. And as I mentioned earlier, we're seeing our funnel fill up with more and more and more of those. So in general, we have better visibility to the field. We're seeing all these opportunities being created from that channel and from this new commercial motion we set up as well as more opportunities coming from our field. So all of this should drive productivity for us at Extreme.

Got it. And maybe just a side question. Just -- we spent a lot of time talking about how you've evolved the platform, how you've involved the sales model. But you also kind of acquired a lot of technology, where you might have some installed base customers who are just like, "Where is the replacement for product X?" And that could be costly and taxing to an organization when you're trying to just kind of -- to move along. And so where are you on just being able to kind of manage requests there or best manage requests there for kind of how to manage some of that legacy equipment/kind of customer touch method?

Meta, that was like, that's a big issue for us. And I think you know that, that we -- when you're acquiring technologies, and when you think about the assets that we've acquired, Zebra versus Motorola, they've been there for a while. And then it's different technology from the wireless technology that we started with, which is more of the stadium technology, and then we acquired Aerohive technology. So 3 flavors of wireless, how do you bring it all together? And on switching, we had Avaya, and we acquired the networking business there, but we had Extreme, we had Enterasys. How do all those switching platforms can be? So what our teams have done, which I think is -- which is great for us on many fronts, but we created a concept of universal hardware. And the idea that we can create hardware that can run multiple operating systems. And you could pull the flavor of operating system that you want from the cloud. And think about it, this is providing our customers with ultimate flexibility and then they have cloud licenses, which are transferable. So what we're saying is you buy the hardware. The other thing that we've done is we've caught up. We used to be 12 to 18 months behind in terms of being on the latest silicon and latest microchips coming out. We are fully caught up now, and we've upgraded 70% of our portfolio. So now we are more competitive upfront in terms of the solutions that we're offering. And then we have higher gross margins because we're in the latest generation technology. And we've streamlined universal hardware, which means that the multiple operating systems can run on a single piece of hardware, which simplifies our supply chain and consolidate and drains the number of SKUs that we have to support, which is another contributor to gross margin. So all of this has now come together. Everything is now universal hardware. So that has made our life a lot easier. And then everything is going into cloud. And then the software and services that we've acquired is all being cloudified. And so that's creating a much simpler and clearer road map for all of our customers. And all of our customers were focused on bringing them on the cloud journey.

Got it. And it probably makes for a whole lot less calls for you, which I'm sure is -- it is much appreciated. We touched on gross margins. But at the Analyst Day, you were noting, there's potentially kind of some more efficiencies on the sales and marketing line item. How much of that is just kind of the sales motion that we just talked about versus kind of other initiatives you hope to put into place?

It's primarily -- the sales and marketing efficiency is primarily about what I was talking about as far as how we reorganized and then the tools that we put in place. And then as we better leverage the channel, that obviously drives productivity from an Extreme perspective. So, yes, I would say that is the bulk of it from a sales and marketing perspective. We've also -- we are in the process of putting in place what I would say is a more state-of-the-art, lead gen and marketing platform. Historically, we're not very good at translating interest at Extreme and putting it into the hands of our sellers and our partners. That's coming out in real time. And I think that's going to -- that will also have an impact on what we're doing. So there's a pretty big lift in terms of what we're doing in marketing in addition to the automation and then the reorg in sales. So that should help us drive productivity in the field. The final point is with 5G, these are opportunities that are more like kind of the one-to-many that you might see on kind of larger data center-type deals. So the resources required to support, we said $20 million, and then we said, this is going to be -- grow pretty quickly to $50 million to $100 million a year. The productivity from the sellers that are involved in those opportunities, you will wind up being a lot more productive just from an overall sales productivity perspective than the enterprise sellers.

Got it. And maybe just on a last question. Just -- we've kind of alluded to it a couple of times, so we didn't really address it specifically. Just the 5G opportunity. And just where is the opportunity for you? And just how do you see that ramping over the next couple of years?

So we have a -- yes, there's 2 distinct opportunities. And one is with a long-standing service provider customer. It has been one of our largest customers, one of the largest service providers in the world, and the -- in the U.S. And there, as it relates to their wireless infrastructure, we have a packet broker technology. And this is something that we acquired, but we acquired an older generation packet broker technology. And now this is the next generation. So it's really about what we would call fabric automation and the fabric that we build into the solution for packet broker that's unique. So that's really the software that's unique for managing this -- the application that they're using this for us. So this is a big opportunity. That's one of them. The other, I mentioned, is with a telecom equipment vendor, where we're part of a full stack solution when you take NFVi, early stages of 5G. So as they go out and win major carriers throughout the world, in effect, they become our seller as they win business, then our solution gets deployed into all cell sites and service providers around the world as they ramp up 5G. And then we have opportunity to grow to provide other applications with that equipment vendor with a lot of room for growth. And then with our packet broker technology, we can take that to other service providers. So there's different growth vectors from the $50 million to $100 million revenue opportunity we mentioned.

Got it. Well, with that, we're out of time. I could ask you questions for much longer. But unfortunately, we have to go. So Ed, I appreciate you being here so much today. And any questions anybody has, just feed them through myself or through Stan, and we can get you answers. So Ed, thanks so much for being here.

Meta, thanks for having us.

Thanks.