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

Good afternoon. Thank you for coming to the conference. And I'm Samik Chatterjee. I cover hardware and networking companies at JPMorgan. With me, I have the pleasure of hosting Extreme Networks for the next session. Ed Meyercord, President and CEO of Extreme; and Kevin Rhodes, EVP and CFO. Thank you both for coming to the conference.

I'll start you both off with a question that we've been asking all companies we've talked to today, which is largely to get based on your conversations with customers, what's your thinking, latest thinking in terms of the macro. And really, what we're looking for is investors are clearly very concerned about a slowdown in the second half of the year about potentially going into a recession. And given the visibility you're getting from your customers, how likely do you think that is? How concerned are you? And particularly when you're planning your business for the second half, are you sort of thinking of those possibilities already?

Yes. And the macro as it relates to demand is a little trickier to call. To date, we haven't seen an impact. Initially, there was some concern about the reduction in government spend as it relates to education in our markets. So as an enterprise customer, we're selling to -- into the education market, large campuses, et cetera. I think some of the concerns there were misplaced because a lot of the funding for the K-12 schools and those environments are coming from universal service fund, which is administered by the FCC, which is out from under the Department of Education. We really haven't seen an impact there, and we don't expect to see one. In higher education, there's some impact as it relates to spending, more likely on research projects and joint research projects with the federal government and the universities. And in our case, we're providing that infrastructure that's so important. And so we're not seeing an impact. In fact, if you're extreme and you're 5% market share player, we're actually seeing significant growth opportunities in higher education because of just taking share, and we've been moving upmarket and winning more. So we're seeing an expanding funnel right now. So it's -- we're somewhat maybe of a contrarian in terms of the second half of the year because we're seeing our funnel growing and we're seeing an expansion of opportunities. We play in 19 different markets around the world. And if you look at each of the markets that we're playing in, they have unique characteristics, unique growth characteristics -- and at this stage of the game, we're -- we probably have more tailwinds than headwinds.

Got it. Okay. Fair...

Kevin, do you want to add?

No, I think you cover it well.

Okay.

Yes.

Okay. Moving to tariffs. And one, how is that impacting your supply chain? And more curious to hear how are you managing through this unpredictability of tariffs? Like I'm sure your day looks not very different than what it used to pre-tariffs. So maybe help us understand sort of what goes into the planning process and how you're navigating through that.

Yes. Well, if we go back to the first round of tariffs several years ago, we had to implement operationally a process to reclaim tariffs for goods that come into the United States and out of the United States. And I'll tell you at the time, we weren't prepared for that, but we built out the operating processes. So now we are prepared for that. In the event that tariffs are implemented, we have a way to recover them, first and foremost. So depending on how it plays out, if tariffs are implemented, I'd say we're in a much stronger position today than certainly we were years ago when the first Trump administration. The other thing, our supply chain, we have ODMs that are based in Taiwan, and then their factories and manufacturing were primarily in China, but we moved out, working with our partners. And we moved and our factories moved to Taiwan Vietnam, Philippines, Thailand, all of these countries have been hit with tariffs that have gone away. Our product category was exempt. We don't know if that will remain to be the case. We're also hearing that all these countries are in active negotiations. And so to date, there's basically been no impact on Extreme and our supply chain to date. And we're expecting negotiated settlements with all these countries. So we're going to have to wait and see what happens. If, in fact, there are tariffs, I mentioned the reclamation process that we put in place. And then we also can circumvent by shipping direct into Asia to our distributors as well as into Europe. So we're -- one of the advantages that we have is our size relative to our competitors, and we're able to move quickly. And so we have several plans that were in parallel process to mitigate the impact of tariffs. The last point I'll make as it relates to pricing. As you've seen some of the larger competitors, especially the industry leader, has always been very responsive in raising price and passing through tariffs. And so we and the rest of the industry are fast followers when they take those actions. So we would expect as things settle down, if we wind up in a higher tariff environment, that there would likely be price increases and there would be an umbrella that we could raise price under.

Yes. One thing I would just add to that is that we did communicate out to our resellers that we're going to hold price steady through June 30. And so that was a positive indication that we made to our reseller community. They were very appreciative of that because they weren't hearing a similar message from the rest of the competitive set, it's really unknown right now what will happen with the rest of the competitors, but we came out with that. So we were happy to be able to do that.

Okay. If I can just follow up on that. I mean, a lot of the conversation I've had with some of your peers is them trying to move capacity to countries like Mexico, where there's USMCA compliance that gives you cover. From what I understand in terms of what you're trying to do at this point is wait and see which of the footprint that you have will eventually be under tariff and then potentially take any actions on the manufacturing side. Is that a fair assessment of what your strategy on the supply side is?

Yes. I think that's -- I think it's fair. I would say where we have the highest concentration is in Taiwan and Philippines. I think as we look at the macro landscape and geopolitical environment between the United States and China, those are two very important strategic countries for the U.S. and for the Trump administration. So we know they're in active negotiations, and we would expect resolution to an area that's a tariff level that's reasonable.

Got it. Okay. Great. You reported the best bookings in 6 quarters. Maybe walk us through from your lens, how much of that is a function of customers looking to pull forward some of the demand versus true drivers like real-time deployment from your customers?

So we did not see a lot of pull-in action. I'd say it's less than -- for our bookings number, it's something that's less than, I'd say, 3% overall for the quarter. So a very small, somewhat immaterial number. I think the growth at Extreme is due to improved execution with the team. We've made a lot of changes in upgrading. In the marketing role, I hired amazing Chief Marketing Officer, Monica Kumar. She's come in 1.5 years ago and completely rebuilt our marketing function. We've created -- I mentioned 19 markets, but we've created these pods where we have a very targeted regional director seller combined with a field marketer, combined with a regional channel lead working together to drive funnel in a very verticalized, localized way, taking into consideration distribution, taking into consideration the channel and focusing on verticals where we have differentiation and we can work with partners to drive funnel and convert on the funnel. It's been very successful. It's not a macro horizontal strategy. It's a highly targeted, focused strategy on where we're winning and where we're taking share. We've had tremendous wins, for example, and it's really a design win with the Japanese government, where now we've been spec-ed for GSS contracts for Japanese government agencies, which is creating tremendous growth for us, but it's a very different strategy than, for example, our strategy in the U.K., where we're moving upmarket with partners in health care and higher education, where we have customer wins that we're focusing on those wins with our channel partners and driving more and more opportunities and growth. So it's -- we have 19 distinct strategies where we have our marketing, our sales teams and our channel teams working together to create funnel and then driving activities to close on the funnel. I give credit to Kevin and the teams in terms of developing all the reporting infrastructure and data that gives us complete visibility into the activities and what's working and what's not and understanding what's in our funnel of activities. And so by seeing that and seeing the conversion rates and watching that over time, it's improved. I got a shout out to our new sales lead and new sales leadership and also channel leadership that we brought in. They've been driving very consistent performance that's predictable. So we've been doing a much better job at Extreme of calling a number and executing on the number and then having this collaboration, this cross-collaboration alignment that's building funnel and driving higher conversion and win rates.

And Ed, I would just add to that, we're also going upmarket a bit, right? So we're seeing some good success on over $1 million deals, 29 last year, 39 this year. And so those million-dollar deals allows us to compete against the larger competitor set in a more robust way. It's kind of success begets success as you win a very large logo in a competitive situation that adds more credibility or you can win the next one.

Got it. I'm going to come back to that in 1 minute. But based on the strategy that you outlined where you are focusing on these markets individually, do I take that as naturally an implication that you're very close to the customer? Because when I compare this -- what's going on right now to the post-COVID time frame, where we did have a supply chain crisis, there was a lot of demand pull forward and a digestion after that. Not every company had good visibility into what customer inventory looked like. Given sort of how you're executing now with focus on very sort of very regional level do you have much better visibility in terms of what the inventory in the channel, inventory in the customers looks like? Or how should I interpret sort of visibility today versus what was it post-COVID?

Yes. It's -- we have much better reporting, much better visibility and metrics that we're using to drive the business. As far as inventory in the channel, we've driven to our target levels. So we're where we wanted to be. We were in an oversupply situation and with distribution, with channel and actually with customers that we're buying forward. All of that has been cleaned out. And so we have the visibility. As we look at our bookings and then we look at the pipeline of opportunities that are sitting there, and we look at backlog, backlog is attributed to the next quarter, all of it. So we don't have a backlog, and we measure this, but most of our backlog, you can see being attributed in the near term. So when the orders coming in, they want to ship. If you go back to where we were during the constraints, the lead time was much longer.

Longer.

So you could see -- you look at the bar chart and you look at the quarters of where the customer request date. And so you saw a lot of orders that were out -- 3 quarters, 2 quarters. Now if you look at it, is one color on the bar chart, which is next quarter.

Yes, that's a real distant memory for us now. It's over a year ago that we were kind of managing through higher channel inventories. But at this point, we've really stacked up four sequential quarters in a row of growth. And we've just guided for another quarter of sequential growth. So I think we're well beyond that.

Okay. No, that's interesting. Thank you for sharing that insight. Coming back to, Kevin, what you were mentioning, like the larger deal sizes that you talked about on the call, do you really take that as a function of displacing some of these larger incumbents like Cisco and others? Or are you seeing other drivers within there that's not share related, but your customers just willing to expand more their current footprint that they had with you? Like just help us think about the drivers and how much of this is the competitive landscape itself.

Yes. I think the -- look, moving upmarket for us is about taking share, and it's absolutely about taking share from the larger players. We have highly differentiated technology with the enterprise campus market with our fabric technology. We have unique capabilities that makes it much easier to provision and deploy services on a network. I would say zero-touch provisioning. But when you compare what we can do versus the traditional service provisioning, the old way of doing it is creating VLANs, which are very expensive that have to be delivered right to the port of a switch to the target service area with our fabric, you literally can just plug in an edge device that calls for the service and it gets it. So the ease of provisioning, the automation that we bring in terms of delivering service, the resilience that we have in terms of subsecond conversion, if there's a loop in the network or there's an issue in the network, we can drive performance because of our fabric that none of our competitors can provide. So if we're in a -- we just won John Deere, for example, major global corporation. And in the case of that win, we were the last one in. So the big 3 were there, and there was not high expectations for Extreme Networks. They had questions about the technology. We demonstrated the technology. They use the technology, and then none of our competitors could replicate the performance. So it's the ability to provision, it's the resilience of the network. It's the ability to create a network within a network in terms of segmentation. And this is why we won Wynn Casino and Resorts. We're building out a $5 billion project in UAE. It's the first casino in the Middle East. Yes, they're going with Extreme because they love the Fabric technology and the differentiation. This is opening up a lot of new opportunities. When we win one of these big customers and then they're able to speak on our behalf, they become the voice and they become a very compelling reference for the rest of the market. When we went Washington University and they're leveraging our Fabric technology, well, now it's time for other large universities to refresh and they want to hear from the Washington news of the world. And so our marketing teams are doing a better job of capturing those customers, leveraging kind of the customer relationship to market, and that's what's driving an increased funnel and pipeline. And whether or not it's higher ed in the U.S., whether or not it's hospitality and entertainment in the Middle East or if it's our stadium business here in the U.S. that's spreading over into Europe with exclusive relationships with the NFL, Major League Baseball, NASCAR, Formula One racing, these networks are super high quality, high performance, a lot of people might not be as familiar with the Extreme brand. But when they find out about the brand and they see the technology, we win. So if we get an environment where there's straight up competition, we're doing really well. And then the customers we win will also open up partner relationships because in the case of, for example, John Deere, they need a global partnering network, and they want consistent service and support around the world. So for Extreme, as we're going into markets, we might go to a partner that is a nontypical partner. It's a much larger partner. But if we bring them a customer like John Deere, all of a sudden, we're in. And now we have an opportunity to share our technology, they train up on our technology. They realize what we have and the differentiated solutions that we bring. And so Kevin said, success begets success, and that's kind of how the chain works.

Okay. Staying with the competitive landscape, help me think about like there's -- obviously, with the share gains you're seeing, there is going to be questions about how sort of permanent it is in the sense that is it more a function of some of your larger competitors being distracted at this point when I take like Cisco, HP, Juniper, like [indiscernible] so talk about sort of how permanent do you see some of these share gains being versus what's -- maybe give us a lay of the land of where you see your competitors being in terms of both technology, but also their focus on this part of the market?

So we are incredibly focused on enterprise and the enterprise market. We're particularly strong and competitive on enterprise campuses that are looking for very high-quality, high-performance networking. Every one of our customers in all these industries, what's the question that they're getting? The question they're getting is, hey, how are you leveraging this thing called AI? How are you using AI to drive efficiency, to drive performance, to drive better outcomes? And it's top of mind for everyone. So we decided many years ago that we were not going to try to be the networking solution for AI, okay? And there's a lot of competition for that. The companies have done very well. It's great. Scaling up, scaling out, supporting these large language model sort of deployments, that's great. What we decided we're going to be the leader in AI for networking. And so we're going to be in Paris next week. I'm going to encourage everyone to tune in, at least watch the replay. But we're going to be opening -- it's the largest user conference we've had. We're way oversubscribed, and we're going to be rolling out demoing, not PowerPoint slides. We're going to be demoing new use cases with the first agentic AI platform for networking in the industry. We've been told by our partners that we're way out in front, we're excited. We were a player in first-generation AI, AIOps for networking and basically AIOps for WiFi, which is where the industry was. And now we have a service agent that sits on top of the entire platform. So you've got AI that's not just about AIOps, but it's also the commercials and the operations of the network, licensing, a lot of different personas that we're supporting. But we're going to drive massive efficiency for our customers. So for all the people that are sitting out trying to figure out, hey, how am I leveraging AI in my IT teams, we're going to be providing the most modern, high-quality tools for people to take advantage of driving efficiency in the networking space. And so we're really excited about how we're rolling this out. I mentioned our Fabric. The platform is taking the fabric to a new level with complete visibility from Extreme Platform ONE. And it's going to provide visibility, not only at the physical layer, logical layer, but also the services layer that no one else in the industry can do. It's going to put us way out in front, simplifying networking operations. And so net-net, it's about turning months into weeks and weeks into days and days into hours and hours into minutes, et cetera. And we have thousands of examples of how we're going to do this and how we are doing it with our platform. The platform GAs in the beginning of our first quarter, which is in the month of July. We have 100 customers that are using the platform. We're getting great feedback. All of our system engineers and sellers are using the platform, but we're unveiling some of the capabilities for the very first time on Tuesday. And we're expecting a lot of surprise and a lot of interest in our community of customers.

How long does it take if one of your competitors does want to replicate what you're doing? How long does it take them?

It depends on if you're trying to merge with another big company or it depends on if you're trying to move away from core networking into other markets. And size also matters. So for us, putting this platform together, we had to sort of bring together about 9 applications that were independent. If you look at our wireless, if you look at our wired, if you look at SD-WAN, if you look at ZTNA and network access control and all of these different services. Well, we're pulling all that together. What does AI want? AI wants data. So we're able to pull all these together. So AI has the data and has the data across the entire spectrum. I think it's going to take a long time for our largest competitor to do that. They have a history of not integrating their technologies and their acquisitions. We'll see. We'll see, but it's going to take them, I think, 18 months or so, even though AI moves quickly. I think our other two competitors that are trying to figure out if they're going to get married they have to focus on integrating and delivering a huge amount of synergy to make their deal work. And that's very distracting if you're trying to do what we've just done.

One of the big things we're trying to figure out is when we think about the next sort of campus refresh from enterprise customers, what's going to be the driver for it? What gets the companies to sort of enterprise customers to think that they are ripe for an upgrade at this point? Is it going to be more WiFi led? Is it going to be features on the campus equipment? Or is it going to be AI? Like when you think about the upcoming cycle, what do you think is the trigger to get enterprises to upgrade?

Well, so in the case of Extreme Platform ONE, customers don't necessarily have to upgrade their network from a hardware perspective. okay? So that's what are the benefits in terms of what we're able to do. I just upgraded. I just got out of the platform. I just changed my login, and I was in this incredible user interface, which is super modern and huge improvement over the XIQ cloud platform that we had before. So upgrading is actually quite easy from that standpoint. So I think customers are going to want to do that because they're going to want to use the tools that are allowing them to drive the efficiency and have enhanced visibility, performance, et cetera, across the net. What's going to drive a campus refresh? I think it's the things that always have is we have WiFi 7 now, which has significantly enhanced bandwidth and performance in terms of reliability. And now you're seeing in a manufacturing environment, mission-critical systems being deployed on WiFi. The same thing would be true in a hospital in an operating room. So historically, WiFi, it's crossed over that chasm. So that can drive more usage and more demand. As you upgrade bandwidth at the very edge of the network like WiFi, it filters through the network, then your edge switch requires more demand, et cetera. So that plays in it. I think if you look at different markets, maybe there are different upgrade cycles. I don't think there's one. A lot of people point to COVID and saying people left the office for a couple of years, and now they're being forced to return to office. And it's that return to office that's driving an upgrade cycle. It's hard for us to see that per se because we're taking share in the market. We're a smaller network market share player. And because if we're taking share, maybe it distorts the overall market view because we're seeing growth.

Okay. Coming back to sort of what you're seeing with your customers, and you mentioned the likelihood of price increases by your largest competitor and following suite following on that front, like how do you think about price elasticity of demand at this point for your customers? Like one of the big concerns has been price increases and demand destruction as a result of that. But do you necessarily see the drivers for why enterprises have to upgrade being resilient enough that price elasticity of demand is very limited?

I mean our market is strategic. I mean you think about the network and how important networking infrastructure is to any organization and just daily life and the requirement for high-quality, secure, high-performance networks are critical. So in terms of people deciding and maybe deciding to cancel certain projects, maybe you can hold on a networking project for a year or maybe you can hold on a networking project for 18 months. But over the long run, as you're adding new devices, as you're adding new capabilities and applications and with the growth of data in these networks, you think about the growth of AI, networking infrastructure is absolutely critical. So it's less likely that it's going to be deprioritized than maybe some other investments that are nice to have and not need to have.

And I would just comment in today's world of cybersecurity concerns being probably at the highest at the CIO level, sitting on an old network that you may have to patch and patch and patch and patch and do upgrades to is probably not the best strategy for you to avoid any cybersecurity threats that come to you. At the end of the day, when you've got a fresh network that's got the most latest technology associated with it, you know you're not worried about at some point in the future, having a vulnerability there that you didn't see coming.

Okay. Got it. E-Rate programs, I think you made a comment on the last call about seeing more share gains in the E-Rate programs. Maybe firstly, give us maybe take a step back and give us sort of the background of how relevant these programs are now to Extreme versus maybe sort of a few years ago? And then secondarily, what's driving the share gain?

Sure. Yes, E-Rate is a funding program that's funding kind of K-12 schools. It's very popular in the -- with politicians, giving kind of the state-of-the-art technology for our kids in a learning environment is popular on both sides of the aisle. So it's a program that's in place, and we expect it to continue to be in place. We're at the fifth year funding cycle of the last cycle and then a new program will start. And we -- it's a combination of our cloud. It's a combination of our fabric, and it's a combination of, I think, our overall service and engagement in that community. We have every single school in Palm Beach County, Florida runs on Extreme Networks. And they had our wireless, but then there's an opportunity. They saw our Fabric, they didn't believe it. They couldn't believe it. And now they're rolling out Fabric. So for us, there's opportunities for us to upsell a wireless customer to switching and then -- or a switching customer to the wireless side of the portfolio. So I think it's the differentiation of our technology. And I also think it's the execution of our teams who are doing a great job positioning Extreme and some of the channel programs that we have to drive E-Rate. So it's about 7% of our business.

Okay. Maybe just for the last couple of questions. Kevin, can you please outline the margin drivers that investors should think about for the company? You're already at 62% gross margin, mid-teens operating, I think. Do you see opportunities on both fronts? Or is it really going to be more about operating leverage going forward?

Yes. So our long-range plan would be the 64% to 66% we can do that in a couple of different ways, right? We still see product margin opportunity that we can drive. That's at like 58% today. We could see that getting to 60%. And then I think you're going to see with Platform ONE, as Ed described it, it's going to be this really transitional and transformational, quite frankly, platform that we're putting all of our customers on and selling on to. We're going to get a higher ASP there. We're going to get a higher attach rate there, and we're going to get higher retention rates on Platform ONE in the future. What that's going to do is drive the revenue, the recurring revenue, -- it's got a higher margin profile to it as well. And so as we drive the mix shift of revenue that's higher margin, that's going to help to get us in that 64% to 66% range. And I'm thinking 3 years in that range.

Got it. Okay. Maybe just finishing off here, capital allocation and where does current preference stand between M&A versus the buyback?

So we just authorized -- got a new authorization for a $200 million buyback. We repurchased about 13 million shares last quarter. We're in market purchasing yet again this quarter. So I would say we are very much in the buyback strategy from a capital allocation perspective.

Okay. And any sort of expect in terms of M&A, like is that constant sort of pipeline that you continue to evaluate?

We evaluate it. I, myself, Stan Kovler, our SVP of Finance and corp dev. We evaluate all opportunities for corp dev. We don't have any money burning a hole in our pocket right now. It would have to be strategic. We've got such good momentum going on in the business right now that it feels like that could take us off track. So we look, but at the end of the day, we're very, very focused on executing and continuing to drive the growth that we have today, and it would be a high bar in order for us to go do something that would drive.

Yes, I think that's fair. Today, it's all about the launch of Extreme Platform ONE and the migration of our customers onto the platform, and it drives significant growth in our SaaS, our subscription line and recurring revenue at the company. So we have a lot of growth built into the plan without M&A. But we will always we'll be opportunistic if the right opportunity presents itself.

I mean you talked about higher retention on customers on Platform ONE. Is that just based on the initial feedback you've got? Or is there more of a longer time frame of data that you've collected on that?

Well, what I'm referring to on the retention side is what we sold to customers was on a bespoke basis. You sell the cloud management, then you sell support contracts or SD-WAN. And each one of those is a sales process. And each one of those is a renewal process in and of itself, right? And sometimes a customer based on budget might say, I don't need the support contract this particular time. It's 5 years out. I'm going to let that support contract drop in the Platform ONE world where it's all bundled together, you're going to get a higher retention rate because it's all bundled together and you're renewing the Platform ONE with the Agentic AI and all the value you're getting similar to a SaaS platform, you're creating value over that life cycle as well.

Got it. I'll wrap it up there, but thank you for coming to the conference. Thank you to the audience as well. Thank you.

Thank you.

Thanks, all.