Earnings Call Transcript - EXTR Q2 2025

Operator, Conference Operator

Good day. Thank you for standing by and welcome to Extreme Networks Second Quarter Fiscal Year 2025 Financial Results Call. At this time all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please note that today's conference is being recorded. I will now hand the conference over to your speaker host, Stan Kovler, please go ahead.

Stan Kovler, Senior Vice President of Corporate Development and Investor Relations

Thank you, Livia. Good morning and welcome to Extreme Networks second quarter fiscal year 2025 earnings conference call. I'm Stan Kovler, Senior Vice President of Corporate Development and Investor Relations. 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 Networks 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. All financial disclosures made 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 30th, 2024, and the 10-Q report for the period ended September 30th, 2024 filed with the SEC. Any forward-looking statements made on this call 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 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.

Ed Meyercord, President and CEO

Thank you, Stan, and thank you all for joining us this morning. Our results in the second quarter were highlighted by a continued and broad-based recovery in the networking market. We grew revenue sequentially for the third quarter in a row, led by product revenues, and achieved our best quarter of product bookings in five quarters. Our competitive win rates continue to improve, especially with larger enterprise customers. In the quarter, 36 customers spent over $1 million with Extreme, up from 27 last quarter. We're seeing a promising recovery with larger customers, which is creating meaningful share gains across a variety of verticals, including healthcare, manufacturing, and retail. Our EMEA business grew significantly both sequentially and year-over-year. In the Americas, we continued our strong execution. The enterprise vertical's sequential growth in the Americas was impacted by seasonality in the K-12 vertical. From what we see, we believe our customers love the simplicity and feature differentiation of our cloud networking platform. We're the only enterprise player that can deliver end-to-end networking solutions from the campus data center to the edge and across the wide area network from one cloud. In addition, our industry-leading enterprise campus fabric continues to be a significant factor in winning new deals, as it offers zero-touch provisioning, provides the most resilience with sub-second convergence, significantly minimizing or eliminating downtime, and reduces the potential blast radius of lateral cyber attacks on the network. Our competitors simply cannot match these features with their IP fabrics designed for data centers. This quarter, customers such as München Klinik, the largest hospital network in Munich, Philadelphia International Airport, and the City of Temple, Texas, invested in Extreme Fabric for its ability to deliver seamless connectivity, reliability, and rapid recovery, ensuring uninterrupted operations across their high-demand environments. Our competitive displacements span a variety of verticals. We recently secured a multimillion-dollar new logo win with the Pittsburgh Steelers to enhance their fan experience and optimize retail point-of-sale systems for greater stadium-wide efficiency. Taylor Wessing, a large law firm in EMEA, with 28 offices and 1,200 employees, wanted to untangle themselves from the complex licensing structure of our largest competitor to simplify their operations. They chose Extreme for the ease of use and scalability of ExtremeCloud IQ and our industry-leading premier services. We're encouraged by the early traction of our newer commercial models. Bookings for our MSP pilot program have doubled quarter-over-quarter, and we currently have 37 MSP partners. These MSPs love the flexibility of the consumption-based billing program because it lowers their operational overhead and allows their customers to scale at their own pace. This makes our offers sticky with upsell opportunities. We're also expanding our funnel with major customers with our private subscription targeted at large service providers. Last quarter, we secured several large global wins with long-term agreements that will drive high-margin, recurring revenue for Extreme in the coming quarters. ExtremeCloud Universal Zero Trust Network Access, UZTNA, is also gaining momentum. This SaaS solution integrates a mature network access control with Zero Trust remote application access. This quarter, a new aerospace customer upgraded their wired and wireless infrastructure with Extreme and adopted UZTNA for enhanced security. They valued a single policy engine and unified management of application and network access for both onsite and remote workers. Four years ago, we were the first in the industry to announce a universal platform for our unified wired and wireless portfolio. We combined the power of cloud management with next-generation switches and access points that simplify the deployment experience for customers, increases flexibility, and allows customers to gradually adopt new technologies or change their desired use case by changing their OS or management system without a hardware upgrade. In December, we announced our vision for Extreme Platform ONE, an innovative technology platform that integrates Extreme's networking and security solutions by unifying all our applications into a single interface. The core of the platform includes AI models that will drive impactful advances in automation to the networking experience. We previewed the platform with several of our partners and customers, and the response was overwhelmingly positive. They all highlighted the significant time savings their teams would experience by having everything integrated into a single platform powered by AI and with the support of our AI experts. Platform ONE will drive significant productivity gains for IT teams and network design, deployment, management, and virtual operations by reducing complex tasks from days to hours and hours to minutes. Shortly after our launch in December, CRN Magazine named Platform ONE one of the 10 hottest networking products of 2024. We have a lot of exciting plans to expand upon our Platform ONE story and capabilities, which we will demonstrate at Connect, our annual user conference taking place in May in Paris, before it goes GA in our fiscal G1. We anticipate further market share gains and revenue growth for the full year and a better than seasonal third quarter. We expect this growth to be accompanied by increased margins and cash flow for the full year. And with that, I'd like to turn the call over to our CFO, Kevin Rhodes, to walk us through the results and guidance.

Kevin Rhodes, EVP and CFO

Thank you, Ed. Our second quarter marked the third quarter in a row of sequential growth. Our strong gross margin performance and operating expense control demonstrated the strong operating leverage in our model. We achieved earnings per share of $0.21, up 24% from the previous quarter and just above the high end of our guidance range. Customer demand trends continue to improve gradually, particularly with large customers. Second quarter revenue of $279.4 million grew 4% sequentially, based on 6% growth in product sales and attached subscription and support contracts. Professional Services was down slightly year-over-year. On a geographic basis, our EMEA business grew quarter-over-quarter and year-over-year, based on share gains and diversifying our business to enterprise verticals. Americas revenue declined sequentially owing to difficult comparisons of significant deals that we closed earlier than expected in the first quarter. We do expect Americas to grow sequentially in the third quarter, and our APAC region grew 5% sequentially. Overall, this was the best bookings quarter in the last five quarters. Trends were in line with our revenue during the quarter, and the product backlog was once again within our expected range. Channel inventory continued to improve to pre-pandemic levels and sell-out was higher than sell-in. On a product basis, bookings were ahead of the prior four quarters with sequential strength in data center and double-digit growth in wireless. Total subscription and support revenue was $107.1 million consistent with the first quarter. Our recurring revenue growth has been driven by the strength of our cloud subscription revenue. Total recurring revenue was 37% on higher product revenue and a predictable revenue stream for our business. Our subscription deferred revenue was up 18% year-over-year to $290 million, and our total deferred revenue was $589 million, up 7.5% year-over-year. We expect subscription and support revenue to grow sequentially in the second half of the year, reflecting the difficult comparisons to the low product growth we experienced in the second half of fiscal 2024. Gross margin of 63.4% was relatively stable, down 30 basis points sequentially, largely due to product and subscription mix, but it was up 90 basis points year-over-year on improvement in standard costs. The combination of higher product revenue versus subscription and support drove the sequential results. We expect our gross margin to be in the range of 62% to 63% in the second half of fiscal 2025, also owing to mix. Second quarter operating expenses were $136 million, down $2 million sequentially, and down $5 million from the year-ago quarter. We continue to focus on driving improvement in operating margin and higher profitability for the year. We expect our operating expenses to increase to a range of $140 million to $146 million in the second half of the year, slightly better than our previous expectations, despite a consistently positive revenue outlook. Sales productivity and better efficiency from our new commercial models are driving this updated outlook. Operating profit for the second quarter was $41.2 million, a 14.7% margin, up from $33.5 million, or 12.4% of revenue in the prior quarter. Second quarter earnings per share was $0.21 and grew from $0.17 last quarter, all above our guidance range. We ended the quarter with $170.3 million in cash and net debt of $15 million. Our inventory position also improved by $11 million sequentially, and we continue to target an inventory balance closer to $100 million on hand by year-end. $16 million in free cash flow in the quarter reflects higher revenue and solid profitability. We expect a continued recovery in cash flow for the second half of fiscal 2025 as we grow revenue and improve profitability. Now turning to guidance. We're encouraged by the level of customer engagement and growth in the funnel we are seeing, which should bode well for us heading into the second half of the year. As a result of our improved visibility, we are increasing our full-year guidance and providing a slightly narrower revenue range for the next quarter. For the third quarter, we expect guidance as follows: Revenue should be in a range of $276 million to $284 million, gross margin to be in a range of 62% to 63%, operating margin to be in a range of 12% to 13.7%, 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 134.7 million shares. The improving cash generation and profitability we are achieving this year will allow us to restart our practice of offsetting dilution from stock-based compensation. For the full fiscal year 2025, we expect revenue to be in a range of $1,120 million to $1,138 million.

Operator, Conference Operator

Thank you. Please stand by while we compile the Q&A roster. Now, the first question comes from Ryan Koontz with Needham. Your line is open.

Ryan Koontz, Analyst

Great, thanks for the questions. Really nice quarter, guys. With the U.S. being down, you attributed that to K-12, and then EMEA being up. Any particular verticals you'd point to there? And can you expand maybe on those trends and the geographies? Thanks.

Ed Meyercord, President and CEO

Yes, right, Kevin, I'll jump in and then you can come behind. K-12 revenue, Ryan, is usually impacted by E-rate and the general building cycle where K-12 schools don't want to build while kids and classes are in session. So, I think it's a normal seasonality as it relates to K-12 and E-rate. And that's where we felt it. We did see a recovery, and I would say in broader Europe. I will highlight, however, that we are still being negatively impacted by a lack of government in Germany. As many people may be aware, we have a lot of business there. A large percentage of our EMEA business is concentrated in the German market. A lot of those government customers and contracts are on hold while the government sorts itself out. So, when that happens, we expect pent-up demand to release from that market. So yes, it's an encouraging step in the right direction overall in EMEA, but there's more to come there. And then as it relates to K-12 back in the U.S., I think you'll see that recover as well.

Ryan Koontz, Analyst

Got it. Sorry, I didn't read into that, that UK maybe is getting a little better?

Ed Meyercord, President and CEO

Yes, that's right.

Ryan Koontz, Analyst

Got it. And in terms of FX, any impacts from FX, do you guys hedge? Can you remind us?

Kevin Rhodes, EVP and CFO

We do hedge, Ryan, and what we're trying to do is offset any currency fluctuations, which are really minor adjustments from one quarter to another. We don't report anything on an FX-adjusted basis just because we do hedge and we keep it pretty solid, pretty even.

Ryan Koontz, Analyst

Got it. And just in closing up, any thoughts about the latest gyrations in HP Juniper and regulatory approvals there?

Ed Meyercord, President and CEO

I mean, look, I think our view, Ryan, is that combination is one that would be a net beneficiary for us. Our expectation would be long-term that it would happen. Delays create more risk around the transaction. If you're a partner or a customer making a buying decision in the enterprise space, you have to be cautious about the potential risk. We think delays probably help us somewhat. We had heard that the deal was going to close in March. Previously, we had heard it was going to close in December. Now it looks like there's fresh news throwing doubt on the deal. We believe both HP and Juniper want to proceed. There's a hefty breakup fee that HP likely doesn't want to pay. We’ll see — we're also not exactly sure how a change in administration could affect us.

Ryan Koontz, Analyst

Right. Okay, super helpful. Congrats again, I'll pass it.

Kevin Rhodes, EVP and CFO

Thanks, Ryan.

Ed Meyercord, President and CEO

Thanks, Ryan.

Operator, Conference Operator

Thank you. Now our next question coming from the line of Christian Schwab with Craig-Hallum Capital. Your line is now open.

Christian Schwab, Analyst

Great, fantastic quarter, guys. Well, my question has to do with Wi-Fi 7. Can you give us an update when you think that it has the opportunity to have a more meaningful positive impact on your business?

Ed Meyercord, President and CEO

Well, let me jump in, Christian, and thanks for the question. Then I'll let Kevin chime in because he was talking about being more specific than what we're saying. Wi-Fi 7 for us is starting to ramp. I think you’re aware that Wi-Fi 7 brings a lot of benefits in terms of being faster, more bandwidth. In particular, it's about enhanced reliability and the fact that many enterprise customers today who may not have thought about Wi-Fi for certain applications, mission-critical applications, are now feeling more comfortable given the performance of Wi-Fi 7. So, we're expecting strong adoption of Wi-Fi 7. Extreme was one of the first to market with Wi-Fi 7, and we would expect continued ramp as we build out our portfolio of Wi-Fi 7 products. Kevin, do you want to add any more specifics or is there anything else to say?

Kevin Rhodes, EVP and CFO

I think the only thing I would add, Ed, is that Gartner says that nearly half of the APs being sold in 2027 are expected to be Wi-Fi 7. We're seeing some adoption here at about 12% of our access points that we're selling right now are in the Wi-Fi 7 category.

Christian Schwab, Analyst

Great, no other questions. Thank you, guys.

Ed Meyercord, President and CEO

Thanks, Christian.

Operator, Conference Operator

Thank you. Now our next question coming from the line of Timothy Horan with Oppenheimer. Your line is now open.

Timothy Horan, Analyst

Hey, guys, Ed, can you elaborate a bit more on Platform ONE? Just maybe a little more color on how differentiated it is in the market, how much of an improvement it is versus what you had previously, and what you think it means for the business model. Do you think this will start to drive better share gains? How do you think about the TAM or average contract size and what it will do for margins? I know that's a long question, but that's...

Ed Meyercord, President and CEO

It's okay, Tim, and it's top of mind for a lot of people. We came out in December really with our vision for Platform ONE, and there's a huge amount of work going on inside of Extreme right now in developing Platform ONE. If you think about the applications we run supporting our business—everything from wireless and wired—we have something called Site Engine, which gives us the multi-domain capability to manage our competitors' gears. We have SD-WAN and we have UZTNA. So, if you package all of Extreme solutions, you can access them through XIQ through the cloud, but effectively you're going into different applications. The big task being undertaken here is that we're unifying and consolidating all the applications into a single user interface that we call Workspace. For the field and for our partners, a game changer is that our fabric, which is our hottest technology because it's so differentiated and none of our competitors have it for the campus, will allow you to observe from a visibility standpoint, manage and orchestrate fabric from the platform within the cloud. This has been a huge ask from our field and for our partners. There will be this unified solution with common user interfaces, common services, ultimately common data. In addition, we're building in the capability for commercials, so you'll be able to manage licensing and service from the same platform. This is a comprehensive platform that is truly unique in networking and goes beyond just network management. An important thing to mention is that we built AI into the core of the platform, allowing you to query—you can interface with Platform ONE in a way that hasn't been done before. From querying configuration information to assessing client performance or compliance with our SLAs, you'll be able to interface with the platform for these basic functions. It's going to make it much easier to do that. Over time, we plan to add automation to handle common network issues and recommend mitigation, and over time, automate those functions. These are some of the things we're building into the platform that we believe will fundamentally change how people interface with their networks. We're targeting limited availability this quarter and GA in fiscal Q1. We expect to migrate all of our base onto this Extreme Platform ONE over the next three years. All new customers will be signing up and joining the platform. If you take our cloud management platform, which is quite popular, then compare it to what you get from Extreme Platform ONE, everyone in our cloud will want to make that move. Ultimately, we believe there will be greater value, and with greater value, we expect the combination of our service and subscription revenue to grow at a higher rate than today, both in terms of new and renewal rates for subscription licenses. At the end of the day, we want to make it incredibly simple for people to go on this journey and fundamentally change their networking experience.

Kevin Rhodes, EVP and CFO

Yes, Ed, I think you covered it all very well. This is a platform that leapfrogs what we're seeing in the marketplace today. As you said, a lot of customers are eager to jump on it, and AI will bring us to another level we haven't seen. It's not just AI operations; it really allows them to see better into their network and all the activity happening within it. It combines with security as well.

Timothy Horan, Analyst

And will customers, will this cost them more initially, or is the increase in revenue primarily going to come from them adding more products and services already on the platform?

Ed Meyercord, President and CEO

Yes, I think the value is going to come from the new capabilities of the platform and people wanting more value and trading up for that value. So, it’s not a huge step, but we expect incremental revenue from the combined offerings of Platform ONE, which will include service compared to the standard XIQ license and service today.

Timothy Horan, Analyst

Thank you.

Operator, Conference Operator

Thank you. Now our next question coming from the line of Dave Kang with B. Riley. Your line is now open.

Dave Kang, Analyst

Thank you, good morning. First question is just wondering if you can talk about opportunities with your service providers like Verizon. Can we get an update there?

Ed Meyercord, President and CEO

Yes, Dave. As you know, we have targeted opportunities with Verizon and Ericsson. These are our largest service provider customers. We've discussed new commercial models and a private subscription offer, looking to work with them more like an MSP. The MSP platform we're building is meant to support this initiative. We see an opportunity to expand our relationships with these larger service providers. Their relationships with networking providers have been less profitable, and we believe we can unlock profitability with our new platform and commercial model. We view that the economics are significant enough to pull some of them to us. It's a long-term sales process, and we are having productive conversations. We expect to see large wins, which we will start to see in our results as we close out fiscal '25 and enter fiscal '26. Anything else, Kevin?

Kevin Rhodes, EVP and CFO

Yes, Ed, you hit it on the head.

Dave Kang, Analyst

Just wondering if you can kind of make a prediction; how should we think about the trajectory like maybe 10% of revenue? I mean, maybe not this fiscal year, but can we see something like that towards the end of the calendar year or more next calendar year? Any thoughts there?

Kevin Rhodes, EVP and CFO

Yes, Dave, I wouldn’t want to project at this point for '26 or beyond around what that looks like. It's in our pipeline, and as we look at opportunities coming through, we can provide updated guidance on what we think revenue misses will look like in '26 and beyond once we get a little closer to year-end.

Dave Kang, Analyst

Got it. And my second question is, you mentioned data center. How big is it? Are you working with any hyperscalers or is it more with smaller data center operators, and what's driving this trend?

Ed Meyercord, President and CEO

Well, Dave, we have very specific use cases for Ericsson and their platform that supports wireless players. Think about that as an OEM relationship. In the case of Verizon, we're supporting their services platform and their back office, as well as being a direct customer. Those are very specific use cases and where we’re focused. We have not been actively investing in hyperscale data center solutions. The margins in that segment have been getting squeezed, and many larger players are competitively pursuing that market, including white box players. However, with recent announcements, we view them favorably as encouraging; some of these AI workloads could be applied to smaller enterprise customers in an affordable manner. This is still in the early stages, but we are already evaluating how we can best support our customers as AI workloads come back on-premises where our solutions may be more suitable. More details will emerge later. It's a response to the broader question.

Dave Kang, Analyst

Got it. Thank you.

Operator, Conference Operator

Thank you. And our next question, coming from the line of David Belk with UBS. Your line is now open.

David Belk, Analyst

Great. Thanks guys for taking my questions. Maybe Ed, the first one for you. Can you speak to the type of exposure or how you're thinking about the funding of the federal government and how that might filter into your business over the next couple of quarters? Just to get a sense of how we should think about it? And then Kevin, one for you upfront: when I think about your services and subscription business, particularly on the recurring side, if we adjust for product and subtract out professional services, that business has been around a $100 million business. How do we think about that from an attach rate going forward as product revenue growth should continue to grow? Just trying to assess a good algorithm for that going forward or if it’s more complicated than that?

Ed Meyercord, President and CEO

Yes, most of our spend on the government side is in state and local, and in education. At this stage of the game, it is early innings, but we are not aware of any impact on the budgets we support in networking for K-12, higher ed schools, and state/local government customers. Our federal spend customers are well-established government entities, and we do not expect any impact on the projects that we have underway in our funnel.

Kevin Rhodes, EVP and CFO

To respond to the second part of your question regarding subscription support and future outlook, there are four factors influencing this. One, an increase in product sales as we've recovered from Q3 and Q4 last year. Subscription and support function as a lagging indicator against those product sales. Two, Platform ONE and its attachment rate, which has a higher average selling price but promotes renewal at the same time. Three, the Extreme subscription private offer we've discussed that continues to perform well and should generate more subscription revenue. Lastly, our focus on MSPs with 100% attach rates for every deal that closes with them. It's about improved attach rates, stronger product sales, and our new go-to-market motions that we expect to yield results.

David Belk, Analyst

Helpful. Can I slip one more in? Ed, I think I heard you say Q3 would experience better seasonality this year. Can you talk about what's driving that? Is it specific markets, products, or just a general improvement in the networking backdrop?

Ed Meyercord, President and CEO

Yes, exactly. Normally, in our seasonality patterns, we would expect a dip in March, followed by a strong June quarter. However, we're anticipating a flat March quarter and then a pronounced June quarter. We aren't expecting the dip in March that we typically expect due to our positive outlook in the market and the opportunities in our funnel, indicating seasonality for a stronger quarter. Yes, the overall market recovery, commercial models gaining traction, and our favorable competitive position are creating opportunities for Extreme. However, we still see negative impacts on our EMEA business due to a lack of spend in that market, but we anticipate spending to be unlocked with a new government, serving as a tailwind for us.

David Belk, Analyst

Great, thank you.

Operator, Conference Operator

Thank you. And our next question, coming from the line of Eric Martinuzzi with Lake Street Capital Markets. Your line is now open.

Eric Martinuzzi, Analyst

Yes, I'm trying to get a feel for industry growth rates. Given your action over the last 12 months, it’s hard to ascertain the overall industry growth rate. Do you see this industry growing at a high single-digit or mid-single-digit rate, especially with the competitive landscape and your own product launches? What do you think?

Ed Meyercord, President and CEO

Yes, Eric, our view is that the industry is a mid-single-digit grower, and we are positioned to gain share. Long-term, we believe Extreme can trend into high single digits and potentially double digits.

Kevin Rhodes, EVP and CFO

Yes, you're right, Ed. That's exactly what we would say, including larger companies like Cisco showing even low single-digit growth in their networking businesses. We aim to position ourselves for long-term success.

Ed Meyercord, President and CEO

Lastly, I wanted to address the slight drop in our gross margin outlook for Q3 compared to Q4. We ended Q2 with a 63.4% non-GAAP gross margin, and the midpoint for the back half is about 62.5%. I understand it's mix-driven, but could you provide more insight into which specific product is influencing this decline?

Kevin Rhodes, EVP and CFO

Yes, it's driven by product gross margins being lower than subscription and support gross margins. The growth we expect in the latter half of the year will primarily stem from product sales, which results in a lower mix margin. There are some tax adjustments impacting COGS and operating expenses, slightly dragging on gross margins.

Ed Meyercord, President and CEO

We remain confident in the 64% to 66% long-term gross margin range and aim to outperform that in the second half with our expected 62% to 63% gross margin range.

Operator, Conference Operator

Thank you. And I see there are no further questions in the queue at this time. I will now turn the call back over to Mr. Ed Meyercord for any closing remarks.

Ed Meyercord, President and CEO

Okay, Livia, thank you very much. Thanks everybody for joining the call today. We appreciate your support, and we have a lot of exciting things going on at Extreme. As we go through this quarter and head towards May for our User Conference with Connect, I want to thank our employees, customers, and partners who are dialed in. Yes, we're excited about the opportunities that lie ahead. We have opened the door to investors to come to Paris to showcase our new technology, and we look forward to seeing you there. Thanks everybody and have a great day.

Kevin Rhodes, EVP and CFO

Thank you.

Operator, Conference Operator

This concludes today's conference. Thank you for your participation, and you may now disconnect.