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

Good morning, everyone. I'm Samik Chatterjee. I cover hardware and networking companies at JPMorgan. For the next fireside chat, I have the pleasure of hosting Extreme Networks. And with us is Ed Meyercord, President and CEO; and Kevin Rhodes, CFO of Extreme Networks. Ed, Kevin, thank you for taking the time to attend the conference. Stan Kovler, Investor Relations, thank you for taking the time as well.

Ed, I'm really starting off asking all of our companies to share what they think about the end markets in 12 months from now. So we all realize where the end markets are today. There are cyclical headwinds that we are seeing, but maybe take a long view 12 months out and tell us how do you think about where we will be 12 months from now.

Sure. And thank you for having us, Samik, I appreciate it. We are -- if you look at Extreme, we're in the enterprise space. So we play across many industry verticals. We are currently feeling the effects of somewhat of a slowdown in macro public sector spend in some of our markets. So I would say from -- 12 months from today, we're hoping that we see a rebound in EMEA, for example, where we've seen the cycle of public spending slow down quite a bit. And we feel like we're sort of at the bottom of that cycle. Then in other verticals such as health care, manufacturing, retail, other verticals, we're seeing strength. Overall, the macro issue affecting our environment has been supply chain oriented and a lot of supply in the channel, and we're seeing that clear up quite a bit. So hopefully -- and the way we see it, that we're at the bottom here, and we're coming out. We'll see more strength in the industry verticals where we play in the public sector in Europe specifically.

Okay. So maybe flesh that out a bit more in terms of the inventory digestion, which you've highlighted for a few quarters. One, sort of where do things stand right now? And let's say we get past the inventory digestion. How does the rebound look? Is it an immediate sort of snap back because of the absence of that inventory digestion headwind? Or how are you thinking about the recovery beyond that?

Yes. For us, inventory peaked in September of last year. This is really where supply -- not only with our distributors, but also with our channel partners and also our end-user customers, for example, were stocking Extreme equipment. And that is a highly unusual phenomenon. We realize that in the middle of September of last year, and this is all the while where our distributors are still placing orders. So we have to work our way through that. We made the decision to clean out the channel as much as we could in this March quarter, which is clearly the bottom for us. And then what we're calling is a step out, a gradual step out where we're markedly up about 20% seasonality from the March quarter to June. Normally, you'd see a downtick from a seasonal perspective going into September. We think we're going to grow through that as the cycle -- as we come out of the cycle. And then December is always a strong quarter for us, end of year government spend. And so we're expecting to step out for the next 3 quarters, sequential growth. So at the end of the day, for us, we look at this, say what's the path? We want to get back to this $300 million a quarter of revenue. There is the growth of subscription, which is 30 -- high 30% growth rates for us, which is helping us out of this. And then with the channel digestion behind us, it's not such a huge lift to get back to that level.

Okay. Relative to the industry, there is some M&A that's sort of playing out. How are you thinking about the opportunity that's offered to Extreme from the consolidation of 2 big competitors? How do you think about like the addressable market you can go after? What are the tier of customers that you can sort of target to directly gain share?

Well, yes, there's a lot of disruption with the largest players in our industry today, which is creating opportunities for Extreme. We provide a very attractive alternative. And you can't just think about the end users, you also have to think about the channel, okay? And there's 2 very different dynamics there. In the case of Cisco, this is the place where all the competitors normally feed to take share. Cisco tends to be the highest price player in the market. I think everyone is well aware of their acquisition strategy. They make a lot of acquisitions. There's a huge challenge trying to integrate all the technologies they put in their portfolio. It winds up being very complicated. So we come in and we represent simplicity, and we also represent value, and we also represent high quality. So as we come in with our 1 network, 1 Extreme, 1 cloud strategy, we become a very attractive alternative, and this is why we won Korean Air Lines, big enterprise customer, 30-year Cisco customer. They needed a change. They wanted modern networking tools, technology and a fresh start. Extreme became that choice. We won Kroger, the world's largest grocer. We're in the process of deploying 2,800 locations managed from a single cloud platform. Again, this is an alternative to the largest player in the industry, where we show very well there. Cisco acquired Splunk. They have a lot of work to do on that asset. Splunk is not real-time. It's old technology. And so there's a massive investment that's required by them to effectively sort of catch up. They took down their earnings. From our perspective, as Cisco being the price setter in our industry, this is good for us because it means that they have pressure not to drop price, which is what they've done historically. So we feel like the pricing environment in the industry is going to be fairly stable, thanks to Cisco and the fact that we're still priced below them. The big news, obviously, is HPE buying Juniper, the #2, #3 players where we play. Here again, we think this is a big opportunity for Extreme as a great alternative to either one of those players. Keep in mind, we go head-to-head with these players every single day in the marketplace, and there's a lot of disruption. If you go back to our history and you look at how Extreme evolved over time, we made a lot of acquisitions. We acquired a lot of companies with complementary technology, very hard. Very hard. Teams come together, you have to decide which way are we going, what path are we going to take in terms of the portfolio and how are we going to make it work together and how are we going to communicate this to the channel and how we're going to communicate this to our end-user customers. It's complicated. It takes a long time. So as we look at it, first of all, the deal has to close. I would say between the ask and where they're trading, it's an unusually wide margin, which means some people don't think the deal is going to even happen. But when the deal happens, they have to put together a road map that's compelling, and they also have to sell their channel and their partners. So we had our user conference a couple of weeks ago, and we had a very large university with 40,000 students, contemplating Extreme as an alternative to both HPE and Juniper. The teams from both companies came in and pitched and said their technology was a surviving technology. Okay. Well, we know that's not the case. And it can't be the case. So there's a lot of mistrust and a lot of concern. They're going Extreme. The same thing in the channel, if you're a Juniper partner, you probably don't want to be part of the commodity base of HPE's partners and their partner programs, et cetera, okay, that creates a disruption, that creates an opportunity. So we're looking at all this with very specific playbooks around how we approach the end-user customer as well as how we approach the channel where there -- we become, in our view, a much better alternative. There's certainty around the future technology and the product road map with Extreme, and there's simplicity in our commercial model that we think is going to allow us to take share from both players.

Like the example you gave of a university moving over from the competitors to using Extreme, any more sort of details you can share in terms of which are the pure -- or the verticals that HPE and Juniper do well in when you run into them in the markets that you play in? Where would you sort of be on a vertical basis, where would you really target to take sort of incremental share?

Yes. I think if you look at where we traditionally played, it's in the SLED market. So state, local government, education, HPE has been a strong player there. This is a tough DOJ, and I think that's probably where their focus is, on SLED and they're probably concerned about what happens when these 2 get together. Juniper has made a huge push in the SLED. And so right now, they're looking at -- I know they're looking at market share data. I wouldn't be surprised if that's an area that's creating some concern, as far as where they have stronger market share.

The cloud-enabled platform. So going back to the product road map, the cloud-enabled platforms in relation to WiFi, Campus that Extreme has had driven a lot of the share gains for Extreme in the past. What are you hearing from customers in relation to drivers of the share gain and now sort of the differentiation that your product portfolio has given that it's been a while since you sort of talked about the cloud story and that resonated with customers. But is that still holding as a differentiation? Or do you see any other reason that customers are coming up and saying, "This is the reason we want to use Extreme versus the others?"

I mean the -- I mean cloud managed networking is clearly one of the fastest-growing segments in the industry, and that's not going -- that's going to continue. I just talked about Kroger, the fact in Cincinnati, the team -- and when IT could look at 2,800 stores, they can look at every single IoT device, every network element from a performance perspective and a connectivity perspective, they can look at every client that's attached to every network element. They could look at application performance, all of these tools that are available from a cloud instance. This is powerful, and the world is not going back. I mentioned Korean Air Lines, same thing. Everyone is interested in cloud. One of the places where Extreme is differentiated is with a unique networking fabric that we have. It's a Layer 2 fabric. It can't be hacked. It's super, super simple for the Campus. If you ever hear about network fabrics, a lot of people say, "Oh, I remember those. Like, it's old networking technology. It's for the data center, but it's not designed for the Campus." So we have a Layer 2 Campus purpose-built fabric that literally no one else has. So what it allows you to do is, from a security standpoint -- by the way, this is one of the reasons why we won Washington University, another prominent university, again, taking it away from the larger players is the fact that they can create -- within a physical networking infrastructure, you can create a network within a network very easily. What does it mean from a security perspective? It means you minimize the blast radius. University of Pennsylvania and Philadelphia, their 1.5 million square foot medical complex that they've just built state-of-the-art. They love our fabric because they can literally create the 47 operating rooms in that hospital. Each operating room has its own effective network. Each room in the hospital has its own effective network. So when they get hacked, because the network interconnection device on an MRI technology or some like new -- the biomed team puts in, like a new equipment, that has a hole where someone can get in, the blast radius is confined to a single room or a single system, depending on how you configure it. Security is like top of mind for everyone. So this is a technology that we have. There are also things that you can do with our fabric in terms of ease of provisioning. The theme at Extreme is going to be simplicity, ease of use, driving operational efficiencies. So this is another key area for us today that is very popular. And I could go on and on about all these customer use cases where we're winning in the marketplace, but it's a significant differentiator for Extreme today.

Got it. Let's talk about WiFi 6E and WiFi 7, whether you still expect WiFi to be in a material upgrade cycle driver. I mean we used to see in the past, WiFi was a reason for enterprises to upgrade. As you look at WiFi 7 and beyond, is there enough of an incentive for enterprises to upgrade for the new WiFi technology? Or is it more let the replacement cycle run out and when the asset is up for renewal, then sort of go?

Well, I would say absolutely. Going from WiFi 6 to 6E was a big change because you open up 6 gigahertz spectrum. So you have 2.4 and 5 kind of built into WiFi 6. When you add 6E, you open up the 6 gigahertz spectrum, which massively, massively increases capacity. So that moved from 6 to 6E then takes a WiFi environment and then allows you to be much more robust in terms of what you can cover. WiFi 7 is all about performance. And what you're going to see is mission-critical applications running on WiFi, where historically, you might not have seen that people be reticent. It's like a best efforts basis over a WiFi network. People are concerned about maybe in a health care environment maybe people are concerned in a manufacturing environment. When you think about robotics, you think about important systems that are running. And that really was a compelling case for private 5G. The quality that is going to come with WiFi 7 makes it mission-critical grade. I think it's going to raise the bar even further for private 5G. It's going to be harder to make that case given the favorable economics that you've got with WiFi. We dominate in the stadium space. I think about Gillette Stadium here of the Kraft family, 20 of the 30 NFL stadiums run on Extreme. We got Manchester United. Our partners in these deals are the service providers like Verizon is our partner because of the massive savings they have in terms of the economics. People seamlessly flow onto the WiFi network and it saves them a ton of money, not to mention all the visibility that they get in the stadium. So again, when on an ethernet network, you have complete visibility into all the connected devices, all the data, application performance. So all the teams use our stadium analytics and you're not getting that from the private 5G network. So there's a lot of advantages. I think WiFi 7, again, is going to be about the quality of connectivity and the fact that enterprise customers can now kind of make that bet on reliability and mission-critical services.

Good. Let's transition to more sort of AI relevant topics. But before we get to products and revenue drivers, just more curious since we're asking all of our companies to comment on how do you see adopting AI internally? And do you see any tangible improvements that you can make in terms of either processes or any other areas where it is more of an impact on the operations of the company?

Sure. I mean there are obvious cases for us, especially considering that we're running a services organization in terms of GTAC. So we have a huge knowledge base of cases where there's an issue in the network and our teams have solved it. We create a knowledge base. Well, access to the knowledge base using generative AI becomes a much more powerful tool. Self-service for customers, in addition to our own teams solving problems faster when something comes across the bow. Extreme focuses on quality of customer service. We always have the highest rating from Gartner. This only enhances our capability there. Look, there are other areas in terms of responding to RFPs where we can adopt like we have the ability to streamline and automate some of the functionality. Marketing, we're selling in 80 countries and many different languages. This historically has been pretty expensive as we convert things in other languages. Here again, pretty simple opportunity. Our HR teams, how we deal with HR benefits, questions. Yes, Kevin, I don't know if you want to add anything from an IT perspective.

I mean, we're looking at it operationally across the board internally and like you said, trying to drive more efficiency organizationally. We're also looking at it from a product perspective as well. And I think that's some of the most exciting opportunities we have ahead of us.

Okay. So let's transition to discussing products. How do you see AI on the product side impacting your technology road map? How do you think about sort of what the timing of that demand looks for you?

So look, the first generation of AI was important from a performance in what we would call AIOps perspective of the network, where literally, we have millions of devices that are connected to the network to our cloud. We have visibility to those devices and how they perform and then different characteristics when something happens in the network. So from a network performance perspective, FedEx, every time you get a FedEx package, it's come across an Extreme Networks' network because their distribution runs on Extreme. Well, in their massive distribution center, if we notice that there's a channel that's sort of kind of fluttering, turning off -- on and off for an access point, we can identify that with our AI, right? And with that, we can notify FedEx, and we could say, look, we're sending you in an access point, change it. They don't need a network technician. They just have to change out the access point, send in the old one. The network never goes down, we save them a ton of money, performance is higher. That's kind of Gen 1 machine learning algorithms for our AI, which still is intact today. The same thing with network behavior. Samik, we noticed like all of a sudden, you have very bizarre traffic patterns in terms of what's coming out of your machines. We notify you of these things because there's anomalous behavior in a network. So that's sort of your traditional AI, if you will. So those capabilities still exist, but they're enhanced by the next-generation AI. So we're looking at it really 3 categories. There's knowledge. We have about 1 million pages of product and support and tool information, if you will. All of that's been loaded into our private database, if you will, that gets married with a public database and now becomes very easy to find out how do I configure a network? How do I configure this access point? How do I respond when I'm getting these kinds of indicators from the network? How do I configure a fabric? So there's just all kinds of information that literally from a knowledge perspective, you just asked. Then there's enhancements around performance and reporting of performance where going back to the AIOps type examples I'm using, you use this to drive performance. So there's information, real-time information from the network that you can glean to track what's happening in real time. I'll go back to -- you're in a hospital environment and someone's complaining because Biomed has bought a new fancy piece of health care equipment, it's moving around the environment, and there's a problem with it. And mean time to resolution is incredibly important if you're in the networking industry because everyone blames the network or mean time innocence because it's always a network fault, right? And in this case, you can just ask for a report what's happened to this client, this device, what is its history across the network over the past 2 hours? You have a report. This would take teams -- health care teams in tech weeks to walk around with the device, try to figure out what's going on. Well, now all of a sudden, you have an instantaneous fix to your problem. So here's another example where it applies to your network in real time for real-time issues that you're trying to solve for. This is, I think, could be very powerful for people running networks, and it's going to save a lot of time and a lot of money. The last element is we consider scenarios, what if scenarios, if you will, around I'm in a Gillette Stadium. I run football games. I know the traffic behavior of what's going on in the stadium. Now Taylor Swift is coming to the stadium. All right. What happens if Taylor Swift comes to the stadium? I can run, okay, a scenario that says, "This is what we predict will happen to the network. And this is where you may want to enhance the network or this is where you're going to fail. This is where you're going to have a problem." This is much more complicated. It's much more complex, but you can do -- retail can do this on Black Friday. You can do this. There's a lot of different scenarios that you can run. But here, this is more advanced. The point I will make is that I don't even think -- I think we're just starting to scratch the surface of the use cases here. So what we know today is going to change in the next 6 months, and it has changed in the last 6 months. So I think there's a -- this is going to continue to evolve. In our case, we're looking at developing this platform. It's already developed. So we're already in beta with many of our customers. We're coming out in the fall with what we believe will be the first secure networking platform with embedded and built in AI. We're partnered with Microsoft. We just had our user conference, the head of their data AI environment was up on stage with our CTO and Chief Product Officer as well as the network interconnection lead at Intel. We are excited about where we are there. We have very practical use cases and what we believe are opportunities to be the first to have a platform where there's one network element of hardware. Everything is attached to a subscription, which is also attached to service and support on a single license. And you've got built in AI across the board. And then we have a metering around AI queries from knowledge, information, performance and what-if scenarios.

That's a lot of AIOps. When you think about does it directly impact demand for data center switches in terms of your portfolio? How do you think about the implications for the amount of investments that you need to do in terms of the data center switch portfolio? And how much of a demand do you foresee there from enterprise customers?