Extreme Networks Inc Q1 FY2025 Earnings Call

Thank you, Carmen. Good morning. And welcome to Extreme Networks’ first quarter fiscal year 2025 earnings conference call. With me today are Extreme Networks’ President and CEO, Ed Meyercord; and EVP and CFO, Kevin Rhodes. We just distributed a press release and filed an 8-K detailing Extreme’s financial results for the quarter. For your convenience, a copy of the press release, which includes our GAAP and non-GAAP reconciliations, is available in the Investor Relations section of our website at extremenetworks.com, along with our earnings presentation. Today’s call and our discussion may include certain forward-looking statements based on our current expectations about Extreme’s future business, financial and operational results, growth expectations and strategies. Our financial disclosures on this call will be on a non-GAAP basis, unless stated otherwise. We caution you not to put undue reliance on these forward-looking statements, as they involve risks and uncertainties that can cause actual results to differ materially from those anticipated by these statements. These risks are described in our risk factors in the 10-K report for the period ended June 30, 2024, filed with the SEC. Any forward-looking statements made on this call may reflect our analysis as of today and we have no plans or duty to update them, except as required by law. A reconciliation of our GAAP to non-GAAP results can be found in the press release and financial presentation. Following our prepared remarks, we will take questions. And now I will turn the call over to Extreme’s President and CEO, Ed Meyercord.

Thank you, Stan, and thank you all for joining us this morning. Our results in the first quarter were ahead of plan and reflect what we believe are the early stages of a broad networking market recovery. We also benefited from higher new logo win rates and a few large projects that closed earlier than anticipated. This resulted in sequential growth in what is usually a down quarter. We expect the return of market demand to continue in the second quarter as our funnel of opportunities is growing. SaaS ARR grew 23% year-over-year, demonstrating the value and stickiness of our cloud offering. The differentiation of our enterprise campus solution is the primary driver of our new logo expansion. The combination of our cloud management with integrated AI and security capabilities, campus fabric, licensing simplicity and number one ranked service are significant competitive advantages for Extreme. We’re the only enterprise player that brings end-to-end solutions from the campus data center to the edge across the wide area network from one cloud. We significantly de-risk enterprise customer migration to modern networking infrastructure and offer unmatched premier services to ensure customers get the most out of their investment with Extreme. We have the most simple, resilient and secure enterprise networking solution in the industry. Our end-to-end zero touch provisioning enabled by our campus network fabric is unrivaled by any of our competitors. We eliminate the time-intensive process of configuring virtual LANs to deliver services at the edge of the network. Our network fabric also reduces the risk of cyberattacks by enabling granular micro-segmentation, eliminating lateral movement within campus networks and significantly limiting the blast radius of attacks. When customers see the security benefits of our campus fabric, our win rate drastically increases. And finally, our campus fabric offers unmatched resiliency and sub-second convergence. This means zero downtime during upgrades or maintenance. The network is unbreakable because it heals itself, which means end-users never experience an interruption. None of our competitors can match this. In fact, sub-second convergence was the biggest reason we won a large Fortune 100 Manufacturing Company this quarter, which is slated to be one of the most significant deals in Extreme’s history. This week, we extended our security footprint with the availability of ExtremeCloud Universal zero trust network access, which combines our very mature network access control solution with our zero trust remote application access in a single, easy-to-use SaaS offering. We’re the only networking vendor to offer a single policy engine for cloud-based NAC and ZTNA. This helps boost IT team productivity and reduce troubleshooting time. This quarter, we reinforced our position as an early adopter of the most innovative technology coming from our chipset vendor. We continue to set new standards for innovation and high-performance connectivity and are the first and only player shipping enterprise-grade Wi-Fi 7 Access Points. Wi-Fi 7 delivers substantial benefits, including lower latency, enhanced capacity, better data throughput and reliability. It has crossed the chasm of mission-critical applications. Demand for our AP5020 is being driven from performance improvements across high-density environments and use cases like augmented reality and virtual reality, 4K and 8K streaming, real-time analytics and automation. We’ll continue to expand our Wi-Fi 7 portfolio over the coming months. Finally, our co-pilot AIOps solution is critical for large retailers, universities, manufacturers and healthcare facilities to identify network issues and detect anomalies before they impact uptime or business continuity. It provides proactive recommendations on how to remediate issues, which helps save customers time and money associated with day-to-day network management. This quarter, we have wins at both the National Institutes for Quantum Science and Technology and the Photon Science Innovation Center in Japan. Leveraging Extreme’s Universal switches and Fabric Connect, they’ve built large-scale research facilities with a network that enables users to easily and securely access highly sensitive data and resources. We recently displaced a large competitor at Texas Tech University, where we upgraded their campus data center and edge network with Extreme’s Universal hardware, ExtremeCloud IQ and campus fabric. The university benefits from end-to-end simplified management and enhanced security, which helps them meet the growing demands for online resources, testing and classroom technology. 27 NFL teams, including new deployments with the LA Chargers, Minnesota Vikings, Green Bay Packers and Houston Texans, are leveraging Extreme’s Wi-Fi 6E, ExtremeCloud and Business Insights for venues to deliver seamless connectivity across stadiums and practice facilities. 2024 marks our 12th consecutive season as the league’s official provider of Wi-Fi solutions and Wi-Fi analytics. Finally, we displaced our largest competitor in a deal with one of the chief clinical hospitals in the Netherlands, Hofland Atrium Medisch Centrum. This hospital plans to refresh its aging infrastructure to a more modern cloud-based network and extend the network to one of the new buildings on its campus, an ideal use case for our campus fabric. In addition to our technology innovation, we’re starting to get traction and seeing positive momentum with two new commercial models we’ve been working on for the past 18 months. Extreme subscription private offer gives us the flexibility to be more aggressive in supporting service providers and large customers with scalable technology and flexible pricing models. We closed our first transaction this quarter which included a major European retailer and a Fortune 100 company. Our managed services platform is also resonating. We had 32 MSP partners at the end of the first quarter, up from 27 in Q4, and consumption billings doubled sequentially. Partners love the flexibility of this unique consumption-based billing model and poolable licensing. No one else in the industry offers this level of simplicity and licensing economics. Turning to guidance, we expect continued sequential growth in Q2 based on the size and quality of our funnel. We anticipate further market share gains and revenue growth for the full year and we expect this growth to be accompanied by increased margins and cash flow.

Thank you, Ed. The revenue upside in the first quarter, coupled with the sequential improvement in gross margin, demonstrated the operating leverage in our model. We achieved earnings per share of $0.17, which exceeded the bid point of our initial outlook by $0.05 and exceeded the high end of our guidance range. Customer demand trends continue to improve gradually as we saw in the quarter. First quarter revenue of $269.2 million grew 5% sequentially based on continued recovery and product sales and attached subscription and support contracts. On a geographic basis, Americas revenue grew double digits sequentially this quarter with strength across North America. APAC also grew sequentially and year over year. The protracted recovery in EMEA reflects gradual recovery and government spending, which has been the case for several quarters. We continue to compete well in the region, however, and we are winning our fair share of opportunities. Product revenue of $162.3 million grew 6% sequentially. The sequential improvement reflects stronger growth in data center and campus switching, and our wireless revenue was consistent with the prior two quarters. Overall bookings trends were in line with our revenue during the quarter and product backlog was once again within our expected range. As we continue to gain share with new customers, 27 customers in total spent over $1 million on extreme solutions this quarter. Looking at our customer segments, we’re seeing a more robust recovery in the middle market where we continue to see share gains and net new customer additions. Total subscription and support revenue was $107 million, up 3% sequentially. Our recurring revenue growth has been driven by the strength of our cloud subscription revenue and sequential growth in support and services revenue. Total recurring revenue was 38% of first quarter revenue and it’s a highly visible and predictable revenue stream for our business. Our subscription deferred revenue was up 19% year-over-year to $282 million and our total deferred revenue was $577 million, up 10% year-over-year. We expect subscription and support revenue to continue to grow throughout the rest of this fiscal year. Gross margin moved up again to 63.7%, up another 20 basis points sequentially. The combination of higher product revenue to cover fixed overhead costs and more favorable product mix drove the better sequential results. We expect our gross margin to remain in a similar range or better throughout fiscal 2025. First quarter operating expenses were $138 million, up $10 million sequentially and down $15 million from the year-ago quarter. We continue to focus on driving improvement in our operating margin and higher profitability for the year. We expect operating expenses to increase to a range of $143 million to $147 million per quarter throughout the rest of the year, along with the recovery in our business. Non-GAAP operating profit for the first quarter was $33.5 million or 12.4% of revenue, and first quarter EPS was $0.17. All were above our expected ranges. We ended the quarter with $159.5 million in cash, a net debt of $28 million. The $12 million of free cash flow in the quarter reflects higher revenue and solid profitability. We expect a continued recovery in cash flow in fiscal 2025 as we grow revenue, improve profitability and sell out the inventory we have on hand. Now turning to guidance. We are encouraged by the level of improving customer and new logo activity we are seeing, which should bode well for us heading into the second quarter and the rest of the year. So for the second quarter, we expect guidance as follows: Revenue to be in a range of $273 million to $283 million. Gross margin to be in a range of 63% to 64%. Operating margin to be in a range of 11.3% to 13.4%. And earnings per share to be in a range of $0.16 to $0.20. Our fully diluted share count is expected to be around 133 million shares. For the full fiscal year 2025, we now expect revenue to be in a range of $1,117 million to $1,137 million.

Great. Thanks. Thanks very much. Guys, can you just agree in the U.S. versus EMEA? It sounds like the U.S. is obviously driving things here. But just kind of lay out how the U.S. recovery is progressing and whether the recovery in Europe has started. I just want to get the clear message on what’s going on by geography? Thank you.

Thanks, Mike. This is Ed. I’ll go ahead, and then Kevin and Stan can chime in. You’re right that the U.S. is leading the recovery, and while we’re optimistic about Europe, there are still macro trends causing project delays. This is why we’re taking a cautious approach for Q2. Germany hasn’t officially set a budget yet, and there’s a coalition with a very slim majority. The new government in the U.K. is working on its budget and is presenting it today. Since a significant portion of our business is in the public sector, this means some of our projects, which are set to move forward, are experiencing delays. We’re confident in the opportunities we see in our funnel, but we anticipate that EMEA will shift into the second half of our fiscal year, which is the impact we’re observing. Kevin or Stan, would you like to add anything?

I think you’re right, Ed. We’re seeing some strength in North America, which is good, obviously, as interest rates come down. That’s starting to help CapEx spending in North America and we see some improvement here on IT spending in North America, but EMEA is the one that would help us greatly in the second half and we do believe in the second half it will start to come back.

Thank you. Sure. Mike, when considering share gain, it's essential to analyze the industry's distribution and competitive share. Primarily, we are gaining share from Cisco. Additionally, some of our recent wins are from Juniper and HPE, but most of our gains are from Cisco. With the impending closure of the HPE-Juniper deal, they will face challenging decisions and will need to communicate difficult news to the market regarding their roadmaps and implications for customer investments and partners. We anticipate that this disruption may create opportunities for us, although we don't expect significant changes until the deal is finalized. Our winning strategy hinges on our end-to-end cloud capability that spans from the campus data center to the wireless edge and wide area networks, all integrated into one cloud. This comprehensive visibility of the entire network is a key differentiator for us. Furthermore, we pair this with our unique campus fabric technology, which, while others may claim to have similar technologies, differs significantly from ours. Our technology uses SPB while others rely on IP-based fabrics not designed for campus environments. In a recent Fortune 100 win, we showcased our sub-second convergence capability, which allows for immediate adjustments to the network without disruption. This is crucial for clients, and our largest competitors were unable to match this capability, despite trying on-site for two weeks. Our ability to facilitate hyper-segmentation and create distinct networks within a physical network using our fabric is another competitive advantage that our rivals cannot replicate. Additionally, our zero touch provisioning allows new sites to automatically connect and request services without manual setup, saving considerable time and resources while enhancing security and resiliency. No other company offers a campus fabric that combines these benefits. The synergy of fabric and cloud is what drives our success in the market, and this competitive distribution may shift following the HP-Juniper deal closure.

Fantastic. Thanks so much.

I noted your comment about strong demand or improved recovery in the middle market. I'm curious if this is a short-term trend and whether the full year forecast expects a recovery in the enterprise or larger customer segment.

Thanks, Eric. Thanks for the question. And the answer is yes. Yeah. We are anticipating a return of more larger projects. And our intelligence around that answer is all based on opportunities we have in the funnel and the other competence of the team as we’re scrubbing the timing of projects.

Okay. And then you also talked about still seeing challenges in the European market, particularly on the public sector, Germany and U.K., you mentioned. Just curious to know, like what is the, I guess, the lag time from having a budget to that trickling down to actually impacting procurement processes that would balance out with the guide that you have?

Not all government agencies are the same. In many cases, they need to update their networking technology along with modern security features and tools like AI. They have to make investments; it’s just a matter of timing. In Germany, they have a temporary budget and are expected to finalize it by the end of November, which should release funds. We’ll see how that develops. In the U.K., the Labor Government is preparing their budget, with plans to spend on infrastructure. Their new fiscal year begins on March 1st, but we anticipate that they will start releasing funds before then.

Yeah. Good morning.

Hi, Dave.

The first question is about AI. Some of your competitors have been highlighting their AI capabilities. Can you provide an update on your AI strategy?

Yeah. Dave, thanks. I think that the AI that, what we would call first generation AI, some people would call it precision AI around our ability to harness machine learning to provide intelligent insights to customers in a networking environment. And we are out with our co-pilot product. I mentioned in some of my remarks, some of the capabilities looking at anomalous networking traffic, unusual behavior in the network, predicting network failures, suggesting fixes or remedies or remediations to networking issues. These are the kinds of things that are falling into the category of AIOps and we have our AIOps capabilities. There’s another one of our larger competitors that is really done well, taking share, leveraging and marketing AIOps, which we would call first-generation AIOps. And then I would say, stay tuned. We’re going to be making some announcements in the future about, we’ve talked about platforms and we’ve talked about generative AI, AI experts and the idea of building AI into a platform that effectively you interact with at every step of your networking journey, including all the different types of personas that interface with the network. At Extreme, we’re using AI internally. We have a lot of different applications in terms of sales assistance and accessing information. We’re using it in marketing. We’re using it in service. We’ve seen a lot of efficiency in service. That’s more internal. What you’re going to see and stay tuned and what you’ll hear about is how we’re bringing generative AI and kind of this next-generation AI into our platform that will create a very different experience for users. I think I’m going to hold right here because I don’t want to front-run any future announcements, but suffice it to say that our AI partners are AWS and Microsoft. We have been doing a lot of work with them and we have a very innovative solution to provide very accurate information, knowledge around Extreme, information about your network and enhanced capabilities as far as visibility, reporting, et cetera. So, fundamentally, we think it’s going to change the networking experience.

Got it. And my follow-up is regarding you have some, you have a table regarding major verticals. Just wanted to get an update on your major vertical, the health of your major verticals, starting with government education?

Yeah. Let me, Ed, I’ll comment. They’re very similar. There’s no major shift. And what we’ve seen this quarter versus last quarter. So we just decided David at this point, it’s basically the same percentages that we’ve shown over the last several quarters and so that will probably updated more annually at this point as opposed to quarterly, but it’s very.

Thanks guys. Do you have an idea of when the industry might reach a normal run rate or what the appropriate upgrade rate for the industry is? Do you think budgets are still allocated for AI or are they being redirected to upgrade networks at this time? Also, if I'm an enterprise, why should I upgrade now instead of waiting a year or two for the AI platforms to become more advanced? What’s the rationale for upgrading now versus delaying for a couple of years? Thanks.

Thanks, Tim. Currently, we are observing a merging of networking and security along with the emergence of Gen-1 AI tools for AIOps and network management. Security is fundamental, as it encompasses various elements, whether addressing remote work or campus needs. Therefore, security must be prioritized, regardless of whether you choose a single vendor or multiple vendors. No single vendor excels across all security areas, so we are selective in our partnerships across the entire security stack. Customers do not have the luxury of waiting; aside from budget restrictions, they are taking action. Regarding future AI developments, all existing networks and customer environments will integrate into the evolving platform, benefiting from it. Thus, from a networking standpoint, there isn't a distinct decision to make; timing is key since current investments will naturally contribute to the new platform we are discussing.

Because your platform is backward compatible and it will work with other network.

Exactly. Exactly.

Does anyone else out there have that capability?

No. Not in networking. No.

When do you think the correct run rate for the industry is? Are we below trend or above trend?

I think people are expressing the need to pay attention to the larger players as well. As we approached fiscal 2025, we were anticipating a rebound. We're seeing positive signs from what we refer to as run rate business, which consists of our standard channel contracts and placing orders via distribution. These may be smaller orders, but we've noticed an increase in their volume, indicating overall activity. I mentioned that we are encouraged by several projects we observed in the second quarter of this year, with some extending into the next year. Our perspective is that the first half of 2025 will mark a healthier recovery, and we expect budgets to start returning for some of these governments. This aligns with what our larger competitors are reporting in the market.

Hey. Congrats, Ed and Kevin on good quarterly performance. As we look at your competitive product positioning, gaining share, middle market recovery, positive run rate, budget resolution in EMEA. It seems to me that as we get into fiscal year 2026, someone on the lines of your comment to the last question, we should be operating at kind of the 10% to 12% topline CAGR that you think this business in a normalized market should be running at. Is that fair?

I believe that as we emerge from the challenges of 2024, we're starting to see progress, although EMEA hasn't fully returned to pre-challenge IT spending levels. However, we are confident that once spending normalizes, we have the potential to achieve double-digit growth again, which remains our long-term outlook. We anticipate that the product growth rate could be in the high single digits, while subscription and support revenue might grow at a higher rate, likely in the low teens. This would average out to a low double-digit growth overall, which is our expectation.

Great. And then on the follow-up to that question, should the world and the economy hang in here on a sustainable basis from here? I guess it’s just math, but at a 10% topline growth then in fiscal year 2027, it doesn’t seem heroic to us for you to achieve your long-term target of approaching 20% operating margins. Is that fair?

That’s right, Christian. I mean, I think that we will continue to see leverage in our model. I mean, we saw a little bit of that leverage here just in the first quarter, as I identified, just the overage on the revenue fell to the bottom line. We think we will continue to see that operating leverage tick up over time and that we could get to an operating margin around 20%. We do believe that by the way, even by the fourth quarter of this year, we’re going to get up and improve sequentially throughout the year. And in our fourth quarter, we’re not going to quite be at 20%, but we’re certainly going to continue to drive higher gross operating margins throughout the rest of the year.

Great. And then lastly, I’ll just comment that it was hard not to see your logo inside the dugouts at the World Series yesterday. Congrats on that as well. That’s it.

Thank you.

Thanks, Christian.

Good morning, gentlemen. Thanks for the questions. I was hoping you could update us on some of the progress from your go-to-market motion changes you’ve made over the past few quarters and what impacts you’re seeing on bookings and pipeline from any changes you’ve made in your sales efforts? Thanks.

Thank you, Ryan. We have made several changes over the past year. Norman Rice is now our Chief Commercial Officer, overseeing sales and the sales organization, and we have implemented many adjustments there. We’ve also brought on a new Chief Marketing Officer, resulting in significant improvements in that department and better alignment overall. We have become more detailed in our selling strategies, focusing on our unique offerings related to end-to-end cloud and fabric, and how we present these in the market. There are upcoming disruptions among our second and third competitors that will create opportunities for us, and we plan to be well-organized in addressing this through what we’re calling marketing pods, which focus on specific marketing strategies and sales playbooks in various regions. This year, our teams are targeting funnel creation not just for this quarter or the next but for future quarters as well, which is a new approach for us. We are confident that with our strategic initiatives and differentiation, we can successfully build that funnel. Additionally, we are noticing higher conversion rates, which reinforces our optimism. Overall, the changes we have implemented are enhancing our ability to generate a higher quality and volume of leads. This is a result of our technology differentiation, improved go-to-market strategies, and new channel incentives we are putting in place, leading to increased conversion rates that reflect the adjustments made within the sales organization.

That’s really great. Thank you for that. And just a quick follow-up, I hear your competitive differentiation and your gross margins obviously on a strong trajectory here, but how would you characterize the overall pricing environment right now versus your top tier competitors?

We have been maintaining our gross margin, and this quarter our discounting has improved. Feedback from our distributors indicates that our inventory is in better condition than some of our larger competitors, suggesting there is more inventory available to sell. In our industry, it's common to see larger competitors engaging in unprofitable practices. I believe Extreme is likely in a better position regarding inventory issues compared to some of our competitors, based on what we are hearing from distribution.

And on the largers there, you said they can behave irrationally. You’ve seen a lot of that with this inventory there?

I think that’s a normal part of the industry, depending on the geography, timing, and strategies. If we achieve significant wins in certain markets, we might experience inventory buildup or face pressure, leading to decisions to make statements. However, since Extreme holds a market share of about 5% to 6%, we often operate under the radar and don’t attract as much attention as the larger players who tend to compete openly with each other.

Thanks for the question. This is Brian on for David. So first, can you provide detail on the project that closed earlier? Can you quantify the revenue and gross margin impact of those projects that closed earlier than expected? Then I’ll have a follow-up. Thanks.

I would say that the gross margin profile of the projects that closed a bit earlier than we anticipated was very normal for us. These projects did not significantly increase our revenue from one quarter to the next, so that narrative is inaccurate. We had a few deals in our pipeline that we expected to close in Q2, but they actually closed in Q1, which is where we saw some additional revenue, while the margin profile remained consistent with our usual levels. In terms of size, we recorded 269, which is at the midpoint of our projected range of 260, with the upper end being 265. So, we exceeded expectations by about $4 million to $9 million. Sure. Yeah. I’d say from a balance sheet perspective, first of all, we’ve got good DSO. I think our DSO typically ranges in the 35 days to 40 days range. So we are not concerned at all about what we have from a receivables perspective outstanding right now. We did have a little concentration last year for one of our larger distribution partners just a reminder about 80% of our revenue probably comes from about 10 to 15 large distributors. So that’s not abnormal for us. Our quarter-over-quarter we had $90 million of receivable last quarter, we had $97 million of receivables this quarter. I wouldn’t call it anything different from normal. I think it’s certainly reasonable and we will collect all of that cash on the receivable side probably within the next 90 days. So we feel pretty good.

Thank you, Carmen, and thanks everybody for participating on the call. We appreciate your interest in Extreme. We put up a strong quarter and as always, we want to thank our employees for their hard work and customers, and the channel for their partnership, and we’re really excited about what’s to come here in the future this quarter and into 2025. And we have some exciting news that I mentioned earlier to stay tuned for on the product front and stay tuned for that. Thanks everybody and have a great day.

Thank you all for participating in today’s conference. You may now disconnect.