Extreme Networks, Inc. (NASDAQ:EXTR) Q1 2024 Earnings Call Transcript

Extreme Networks, Inc. (NASDAQ:EXTR) Q1 2024 Earnings Call Transcript November 1, 2023

Extreme Networks, Inc. beats earnings expectations. Reported EPS is $0.35, expectations were $0.32.

Operator: Good day and thank you for standing by. Welcome to the Extreme Networks’ First Quarter Fiscal Year 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Stan Kovler, Vice President of Corporate Strategy and Investor Relations. Please go ahead.

Stan Kovler: Thank you, Abigail. Good morning, everyone, and welcome to Extreme Networks’ first quarter 2024 earnings conference call. I’m Stan Kovler, Vice President of Corporate Strategy and Investor Relations. With me today are Extreme’s President and CEO, Ed Meyercord; 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 to 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 forward-looking statements based on our current expectations about Extreme’s future business, financial and operational results, growth expectations and strategies.

An overhead view of a modern networking technology suite in a data center.

All financial disclosures on this call will be made 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 our 10-K report for the period ending June 30, 2023 filed with the SEC. And 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. Following our prepared remarks we will take questions. And now I will take the – I will turn the call over to Extreme’s President and CEO, Ed Meyercord.

Ed Meyercord: Thanks, Stan, and thanks to all for joining us this morning. Extreme delivered another strong quarter with revenue growth of 19% and EPS growth of 75%. We continue to move upmarket and the dollar value of deals over $1 million continue to grow quarter-over-quarter. Cloud adoption remains strong on 30% year-over-year ARR growth to $141 million, and SaaS deferred revenue grew 38% year-over-year. Customer retention metrics remain high, a testament to our customers’ loyalty and preference for our industry-leading solutions. We outpaced overall market growth in the quarter and expect continued share gains in fiscal 2024 in our core business. Our new go-to-market initiatives outperformed in the quarter as well. This includes expansion across APAC, certifications in regulated industries like state and federal government, the addition of seven new managed service providers, and a new disruptive whitespace opportunity to sell the enterprise to large service providers with a private subscription offer.

In addition, we have a plan to license all network devices connected to our evolving ExtremeCloud platform. This will deliver even greater simplicity, value, and flexibility beyond the cloud management capabilities we offer today and create more stickiness for our SaaS business. Our strategic initiatives around differentiated zero-trust posture, expanded machine learning and AI capabilities are expected to drive expansion, ARR growth, and average revenue per user. At the end of fiscal Q1, we felt the impact of the macro environment trends in our industry and lowered our outlook for near-term top-line growth. The higher interest rate environment and economic challenges in some of our larger markets, like Germany, lengthened sales cycles and pushed out a larger amount of end-of-quarter orders in Q1 than we would normally expect.

Our channel partners are digesting a large volume of backlog release and focusing on network deployment, slowing down their current ordering. And as a result, we don’t expect run rate business to ramp as quickly as anticipated. In light of what we would call an air pocket of demand and decision-making, leading to our revised growth outlook for the year, we took immediate action to realign resources to drive higher productivity and profitability. As a result, we continue to expect high teens operating margin in fiscal 2024. That will allow us to grow our EPS by over 25% during the year. Our funnel of opportunities continues to grow up double digits on a year-over-year basis as our underlying business and competitive position remain strong. Over the long-term, we expect to return to a mid-teens top-line growth outlook and a mid-20s operating margin.

And here’s why. Customers tell us they’re tired of complexity, inflexibility, and the high costs associated with the old networking models from the larger networking companies. They choose Extreme because we set the bar for modern networking with a combination of innovative and flexible technology, licensing and deployment simplicity, and a focus on driving impactful business outcomes. Customers view their network as a strategic asset to enhance operations, power and scale new services, and reduce business risk, especially cyber security risk. Our customers choose Extreme for three primary reasons. First is operational simplicity. That is driving IT productivity, network availability, ease of use, improving both time to value and total cost of ownership of their networking investment.

We’re the only networking provider that can deploy campus networking fabrics from our cloud. This makes moves, ads, and changes to networks simple and seamless, allows customers to segment networks, and provides unmatched security and resiliency. While fabrics are common in data center environments, we’re the only competitor who can bring these services to the dynamic campus environment orchestrated through our cloud. We create One Network, One Cloud for customers to remove the complexity of managing their entire network infrastructure. Second, we offer unmatched flexibility. We offer cloud choice, public, private, hybrid, and edge cloud deployments that can be managed through a single interface. Our universal switches offer OS choice and deployment options.

We have the industry’s simplest licensing. Unlike competitors, we don’t require customers to hire full-time employees just to manage licenses. And finally, we’re the only networking vendor that can manage a mixed environment without requiring them to rip and replace all their infrastructure at once as they modernize. Third, our cloud solutions offer actionable business insights, security scale, and innovative technologies such as AIOps and automation. Our AIOps solution now cover over 200,000 devices and are gaining traction with large customers as they look for new ways to leverage the network to drive better business outcomes. With our Digital Twin technology, customers can stage and test their network deployment in a digital environment, saving months of actual physical deployment and troubleshooting time.

Our AIOps solutions proactively identify network issues, produce false alarms, and allow IT teams to be proactive instead of reactive. Here are a few examples. We help San Diego Community College connect 80,000 students across multiple campuses with our fabric technology. No other vendor in our industry has the expertise or ability to create a single, secure, hyper-segmented campus network that enables zero-touch provisioning of new locations or moves, ads, and changes to network elements within a matter of minutes. With one network running on one cloud, they decreased OpEx by 50%. Again, none of our competitors can do this. The Dubai World Trade Center recently hosted GITEX, the world’s largest technology trade show, which was powered by Extreme’s wireless, fabric and cloud solutions.

The venue supported more than 180,000 attendees and 6,000 exhibitors at this massive event. They used Extreme Fabric to quickly, simply, and securely segment 3,300 individual networks in a matter of days with an IT staff of two people. Conference attendees thought it was impossible. To accomplish this with our competitors’ solution, it would take weeks with a much larger IT team and introduce a significant margin of error due to their complexity. A global leading fast food chain has selected ExtremeCloud SD-WAN to ensure consistent performance and improve guest experiences at its 1,500 locations across the UK. With Extreme, this industry leader has greater visibility across its network and will be able to simplify network management at all locations, increase overall network security, and optimize operations by improving performance for critical applications.

These large accounts become important references in brand builders to Extreme. Our increasing pool of large, high-profile customers and our technology differentiation is why we continue to see the value of deals over a million dollars grow each quarter. In Q1, we have more than 30 deals over a million dollars. We continue to have a healthy customer order backlog with clear visibility to order with specific customer request dates through the balance of our fiscal year. This quarter, our product lead times normalized, allowing us to continue working down backlog from product constraints. We continue to expect our backlog to settle in a range of $75 million to $100 million by the end of Q4 fiscal 2024. Next week at our Investor Day, we’ll dive into specifics as to why our technology differentiation brings unmatched simplicity, flexibility, and insights that are driving more and more of these high-profile customer wins, and the wins are elevating our brand and driving share gains both in the channel as well as our enterprise customers.

We’ll also share why we’re so excited about new commercial opportunities with our recently launched modern managed services platform, a private subscription offer for very large service providers, our highly targeted certification and security, compliance opportunity, and the elevation of our entire portfolio to subscription licensing. All these factors provide accelerants to the share gains we’re driving in our core business. With that, I’d like to turn the call over to Kevin.

Kevin Rhodes: Thanks, Ed. I’m encouraged not only by our performance in the first quarter, but also our ability to be decisive and take prudent action as we experience shifts in market demand. Let me talk about our first quarter results, and then I’ll move to the outlook. In the first quarter, we again demonstrated strong financial and operational performance. We also showed that we remain committed to continuing that level of performance in the future. Let me get into the numbers. First quarter revenue of $353.1 million grew 19% year-over-year, exceeding the high end of our expectations entering the quarter. Product revenue of $253.5 million grew 23% year-over-year, reflecting continued improvement in our supply chain environment.

We achieved strong double-digit year-over-year growth in campus switching, which grew sequentially as well. SaaS ARR grew 30% year-over-year to $141 million, up from $109 million in the year-ago quarter. Driven by the strength of our renewals, subscription-deferred revenue was up 38% year-over-year to $236 million. Total subscription and support revenue was $99.7 million, up 9% year-over-year. This growth was largely driven by the strength of cloud subscription revenue, up 32% year-over-year. Recurring revenue continues to be a positive story at Extreme. Total recurring revenue of $95 million grew 11% year-over-year, accounting for 27% of overall revenue. Additionally, as we shift products from backlog, it will be a tailwind for our SaaS growth.

Based on our current outlook, we expect recurring revenue to be approximately 30% of our revenue for fiscal 2024. The growth of cloud subscriptions and support drove the total deferred revenue to $525 million, up 24% year-over-year. Our gross margin increased once again, achieving 61.1%, as compared to 60.2% in the fourth quarter and 57.6% in the year-ago quarter. That’s up 90 basis points sequentially and up 350 basis points year-over-year. We attribute our gross margin improvements to the excellent work by our supply chain team, lower overall distribution costs, and a greater mix of high-margin subscription revenue. Our first-quarter operating expenses were $153 million, up from $135 million in the year-ago quarter and down from $156 million in the fourth quarter.

The year-over-year increase reflects increased R&D investment and sales and marketing expenses to support our higher revenue growth plans. Our strong revenue growth, gross margin expansion, and operating expense management contribute to another increase in our operating margin, now at 17.7%, up from 12.1% in the year-ago quarter and up from 17.4% in the prior quarter. To that end first quarter earnings per share was $0.35 above the high end of our guidance range entering the quarter. We finished the first quarter with cash and cash equivalents of $224 million and net cash of $27 million after repurchasing another $25 million worth of shares. We have repurchased $125 million of our shares over the last four quarters and are executing on our commitment to offset dilution from stock awards.

We expect our share count to remain relatively flat for the rest of this year. The $71 million that we generated in free cash flow represents a 20% free cash flow margin above the high end of our long-term model, and we also generated $68 million of adjusted EBITDA. Now turning to guidance. We remain optimistic about the enterprise networking spending environment and our ability to take share. However, looking ahead at the balance of fiscal 2024, we are taking a more cautious tone in light of the current spending environment. Based on changing customer buying patterns and macroeconomic conditions, we are tempering our revenue outlook for this quarter and the balance of the year. We do believe that this is an air pocket as opposed to a more systemic issue within our target markets.

For the second quarter, we expect revenue to be in a range of $312 million to $327 million. Gross margin to be in a range of 60.2% to 62.2%, operating margin to be in a range of 15.4% to 17.3%, and earnings to be in a range of $0.26 to $0.31 per diluted share on a share count of – 134 million shares. Despite expected near term market conditions and lower revenue expectations for the full year fiscal 2024, we expect mid- to high-single digits of revenue growth, which we believe is above industry growth estimates and implies our share gains will continue. We have also taken recent actions to ensure we align our cost structure with the current level of revenue growth that we expect to achieve. As a result, we believe we are well positioned to deliver strong profitability and improved operating margins during the year.

And we expect to generate EPS growth of approximately 25% in fiscal 2024. As Ed noted, we remain committed to long term double digit growth and I see tremendous opportunity for Extreme to grow our business, accelerate our recurring revenue contribution from subscription and support and improve our margins and cash flow. I look forward to laying out some of our long term plans, our new long term plans at our Investor Day next week. And with that, I’ll now turn the call back to the operator to begin the Q&A Session.

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Q&A Session

Operator: Thank you. At this time, we’ll conduct the question-and-answer session. [Operator Instructions] One moment for our first question. Our first question comes from David Will [ph] with UBS. Your line is open.

Unidentified Analyst: Hey, thank you. This is actually Andrew for David. Wanted to ask you one of the big sort of issues looking at this industry for some time now has been the elevated backlog, certainly you’ve had it as well. So what I am wondering is maybe you could help us understand a little bit better how much of the sort of mixed signals that the backlog has been sending to the entire industry is driving your slower outlook versus entirely macro? Can you sort of pull that apart for us and help us understand it?

Ed Meyercord: Yes, Andrew, I’ll jump in and Kevin, you can follow-up. Andrew, I think when we think about the backlog and you think about what’s happened over the course of the last several quarters and it’s not just Extreme it’s the whole industry, there has been a very high level of backlog release into the channel. And so in terms of how it’s affecting current demand, you might say digestion. But effectively we put a lot of product into the channel and so our channel partners are receiving a lot of product and they’re moving forward deploying and they’re very busy deploying networks. And with that focus on receiving an unusually high amount of product and networking gear, they are really active in deployment mode right now.

And I would say – and with some of this, they paused some of their purchasing and some of the drawdown from the channel. So I think that’s how that’s affecting – that’s how you should think about this affecting the current demand equation. As we said, we’re calling it an air pocket this will pass as they deploy the networks, they are going to get back to kind of normal course ordering that will be consistent with kind of normal course demand for networking in the industry. Kevin, do you want to add anything to that? I think you hit it, Ed.

Kevin Rhodes: I think you hit all the points.

Ed Meyercord: Okay.

Unidentified Analyst : And then just my follow-up on that is just obviously you’ve got backlog working down, you expect it now to normalize in Q4, you’ve got some very difficult comps in the back half. What is it that gives you the confidence that you’re going to see a revenue reacceleration in the back half to hit your fiscal 24 revenue targets? Thanks.

Ed Meyercord: Well, Andrew, it’s really about what we see in our funnel. We have a very clear picture of opportunities, and all those opportunities have kind of a timeline next to them. And it’s the quality, and the quantity and volume of our funnel that gives us the confidence to make the call. As we turned into Q2, Kevin mentioned that our teams became more cautious with their call. Some of the bookings that we would normally see at the end of the quarter didn’t happen. And with the slowdown of sales cycle, people became a lot more cautious about the call here. A lot of those opportunities landed in the second half of the year. These are high quality opportunities and so I would say that’s what’s driving the confidence interval. Kevin, I’ll give you a shot to jump in as well.

Kevin Rhodes: Yes, I mean as we as we think about the quarterly revenue throughout the rest of the year and our guidance for the full year, obviously, Q4 is the toughest comp that we have with the $365 million last year. But we’re not calling for accelerating growth over top of that. We think that we’re going to hit about mid teens for the full year compared to the full year, 2023.

Unidentified Analyst : Thanks.

Operator: One moment for our next question. Our next question comes from Alex Henderson with Needham. Your line is open. Great.

Alex Henderson: Great. Just a quick clarification on the guide. So, if I were to look at the guide for the upcoming quarter, I assume that the vast majority of the swing is in product sales and that the strength of software growth plus the normal services growth off of lagging product sales would suggest that overall services quarter-to-quarter and for the year would continue to gradually increase over the course of the next three, four quarters. Is that a fair assessment [indiscernible] product sales.

Kevin Rhodes: That’s right Alex.

Ed Meyercord: For the most part. Obviously, the attach rate with subscription and support is associated with products. So you’ll see a little bit of moderation in the revenue there for subscription and support as it relates to product being lower. But the majority of the reduction in anticipation of revenue for the full year would be on the product side. And that’s just literally the digestion issue, the macroeconomic people are just taking longer to make decisions, and decision cycles are lengthening. And we feel like we’re in this air pocket where we think we will come out of it. The question is the absorption period, if you will, within the market and when does the macro market come back. I think we’re seeing this with many companies across the sector.

Alex Henderson: Just to be clear, the growth in services is generally driven off the last two years worth of product sales. Therefore, it should continue to increase quarter-to-quarter over the course of the 24 period, even if it’s at a very flattish kind of trajectory. So it’s almost all in product sales.

Ed Meyercord: That would be our expectation.

Alex Henderson: Okay, so if that’s the case, in order to hit your guidance as given, it sounds like your product sales literally have to be down in the December quarter and essentially flat for the full year, excluding the just printed quarter. Is that also an accurate read? And if that’s the case, what is the mechanics underneath the surface between the inventory draw down at your channel versus the sell through? So what does the rate of sell through look like if you were to look at it from the customer perspective as opposed to the two tier channel distribution perspective?

Ed Meyercord: I mean, first of all fourth quarter is a long way away right now. We look at just the pipeline. We’ve got a combination of backlog that is expected for customer request dates in the fourth quarter, so we have that information. We’ve got the overall pipeline and we know some of that pipeline relates to existing customers, some of its new logos. We assess that pipeline. Naturally between Q2 and Q3, we’ll build more pipeline for Q4. And so I would say we throw that all through the machine and we look at what we think we are going to achieve for the year. And it’s up, but it’s up on a full year basis. That single to high – mid- to high-single digits for the full year. As it relates to Q4, yes, we’ve got a tough comp there. As I mentioned, that could be flattish in the fourth quarter, but for the full year, still up.

Alex Henderson: Yes, the question really was what’s the difference between sell through to customers and i.e. what is the underlying customer growth rate in terms of buying product from your channel as opposed to the work down of inventory in your two-tier distribution channel? So, if you were to look underneath the surface here, yes, there’s flat product sales, but that is reflective of underlying sell through of what percentage of your revenues coming out of the two-tier distribution. So how much of this is the channel distribution inventory destocking and how much of this is a weakness in underlying demand?

Ed Meyercord: I mean, it’s hard to cheese that and pull that apart naturally Alex, we don’t have perfect visibility into all that. I would say that our two-tier reseller and distribution program, it’s relatively healthy is what I would say. They have got healthy now, fully normalized inventory levels that they have. We don’t have too much necessarily in the distribution level and we’ve got our own healthy amount that we have on our own in warehouse. We’re looking at more end customer demand challenges right now. This air pocket is more of an end customer demand. I mean, you got two wars going on right now, et cetera, et cetera. So we’re just seeing Europe being this more sluggish, I would say, area of any we commented, particularly in Germany, that’s the area that’s really I’ll call causing the slowdown is mostly in the European area. We’re doing well in APAC and U.S. still continues to be strong, but if there is any area, it’s that.

Alex Henderson: Thanks.

Operator: One moment for our next question. Our next question comes from Eric Martinuzzi with Lake Street Capital Markets. Your line is open.

Eric Martinuzzi: Yes, I was hoping to. Just a clarification first on the guide for FY’24, that mid- to high-single digits, are we talking 4% to 9%?

Kevin Rhodes: I guess you would, yes.

Eric Martinuzzi: Okay. And then I guess the change in demand environment, it seems like up until about maybe six weeks ago, we were still pretty confidently talking about a mid teens growth rate, not only for FY’24, but for FY’25. Was there a particular event or two that you guys can point back to as the market shifting kind of all at once?

Kevin Rhodes: Yes, Ed, you want to cover that?

Ed Meyercord: Yes. Eric it really happens if you look at the way our business flows from an ordering standpoint and it’s the entire industry. There is a build up towards the end of the quarter where most of the orders come in, in the last month of the quarter. And literally, I would say the last two weeks of the quarter when we have a huge pipeline of deals and committed deals, our sellers and then the alarm started coming back that, hey, this is going to push. The decision by – and it’s really across geographies, across industries, across verticals, where there was this wave of messaging coming from our field that deals were going to slip and push at an unusually high level. And it caught us off guard because no one really saw that coming.

We’ve heard about it, but that happened. And so it started slipping at the end of the quarter and then as we look forward, our teams just got a lot more cautious with their call, given the environment. And what we’re hearing is that there’s more scrutiny over budgets, more people are getting involved in the purchasing process. The projects are still good, the projects are still going to happen, maybe there is a prioritization issue that takes place, but you’re seeing more purchasing, more financial types a lot of different players come into the decision making process. They just slowed things down. We weren’t in a situation where we lost business. We were in a situation where our opportunities just moved out to the right. And that happened literally the last two weeks of the quarter.

A lot of those orders don’t really affect the quarter because now we’re getting close to a point where what we book in a quarter is what we ship. And at the end of the quarter, when orders come in, you don’t turn around. That would be kind of more normal backlog with what happens at the end of the quarter. The orders come in and they turn into your revenue and your shipments for the next quarter. And so it was that softness at the very end of the quarter that caused us to look at Q2 to be more cautious and conservative. And our field teams, on the heels of what had happened at the end of the quarter felt they should be more cautious with their calls. So, that’s really – it’s kind of the combination of those two things that happened.

Kevin Rhodes: And Ed, I would even comment that beyond September 30, like even to October, we were still seeing some of the same buying pattern issues in the last 30 days that caused us to also assess what our Q2 revenue would look like leading up to today.

Eric Martinuzzi: Got it. Thanks for taking my question.

Ed Meyercord: Thanks, Eric.

Operator: One moment for our next question. Our next question comes from Timothy Horan with Oppenheimer. Your line is open.

Timothy Horan: Thanks guys. Ed, when you study past periods of slowdown may be talking to the channel, I mean, in this last six months, 18 months can these networks just run hotter for a little bit longer? And I know you’ve been asked a few times, but can you just maybe give us a rough guesstimate of what percentage of the lower guide comes from just working down inventory at the channel versus end user demand? Just kind of hearing mixed signals. Yes, I know it’s very hard to quantify, but just a little bit more color. Thanks.

Ed Meyercord: Yes. It is hard to quantify Tim. And thanks for the question. And I’ll give an example with some of our largest partners and I’ll use – I’ll pick on EMEA and I’ll pick on Germany specifically. They’re having a fantastic year. They’ve gotten all of this product that’s been released from backlog, and they are solely – they’re focused and super active in deploying networks for their customers on our behalf. They are fully consumed and you see their business is way off year-over-year with us. These are an example of a strategic partner with really healthy business and amazing customers. However, their focus right now is on deploying all that equipment. And so their business is off. They fully expect business to return.

And so that’s why, as we look at with our outlook, we know it’s coming back. It’s just – there’s a near term. And we’re calling it an air pocket for the channel to deploy. If I had to put it – if I had to just make up a number and place a guess on how much I would allocate to the slowdown of decision making, more people coming into the decision making process, budgetary constraints, pushing versus channel digestion. Kevin, you can jump in, but if I had to give it a finger, like I’d probably say half and half.

Kevin Rhodes: Yes, I was thinking 60 macro, 40 digestion, but somewhere in that.

Ed Meyercord: Okay. Yes. And Tim, the other piece is there historically has been a run rate business and that run rate business is not insignificant. And we knew that run rate is starting to come back, which is encouraging to us. Our anticipation is that there would be a step function in run rate throughout the course of this fiscal year. And I think it’s – that run rate is happening more slowly. We think that’s also a byproduct of what’s going on in the channel.

Timothy Horan: Yes, that’s great color. So, I mean, basically you can look at the distribution is full out at this point. They can’t handle any more capacity is maybe half to slow down…

Ed Meyercord: There’s the distribution side, okay, and distribution has inventory, and then, there are channel partners themselves and they’re busy and they’re saying, okay, distributors don’t ship me that product yet because I need to finish this project, and then I’ll take delivery for the next project. So the – and that slows down distributor buying as well because they’re waiting for what we call POS. But they’re waiting for our channel partners to draw down on their inventory. So it’s kind of, it’s just gotten backed up a little bit which is why we’re calling it digestion, but it will pass.

Timothy Horan: Very helpful. Thank you.

Ed Meyercord: And I was thinking we’ve been here before. We’ve seen this happen before. It’s a quarter – a quarter two, a few quarter phenomenon, but it will pass. We’ve factored all this into our revised outlook for the year and for the quarter.

Timothy Horan: Thank you.

Operator: One moment for our next question. Our next question comes from Dave Kang with B. Riley. Your line is open.

Dave Kang: Thank you. Good morning. I may have missed it, but were product orders up or down or any color on that?

Kevin Rhodes: So Dave, we haven’t really quoted any dollar amount for orders from one quarter to another. We have tended to say that orders have been up sequentially or down sequentially, et cetera. And in our second quarter, we had a softer quarter because of what we just discussed around the pushing out of some of those orders. And as you think about it, a first quarter order that pushes out, you’re obviously not shipping it. And it may get done in Q2. So I would say yes we had a softer orders quarter in Q1 than we expected, and that’s it reflected in our Q2 guidance.

Dave Kang: And do you expect similar trends in fiscal second quarter, or you think they’re going to rebound?

Kevin Rhodes: We’re – we right now, I would say our visibility into the second quarter is stronger than it was in the first quarter from a orders perspective. But we’re not done with the quarter yet. And so, I don’t know whether at the end of the year, we’ll have the same phenomenon that we had in September with orders pushing again. So that’s the challenge, if you will we have right now from a visibility perspective, the macroeconomic is, are these sales cycles going to continue to elongate? Are things going to continue to push where you can’t ship it in the quarter? That’s the phenomenon.

Ed Meyercord: Yes, Kevin, I’ll jump in and say that from a revenue perspective the impact on revenue, we feel like we hit bottom in the December quarter with product orders being up – with being up slightly. But again, a lot of those orders now in our environment, will spill into the March quarter orders that they come in at the end of the quarter usually don’t get shipped and wind up shipping in the following quarter. So that – does that answer your question, Dave?

Dave Kang: Yes. Yes. And my follow-up is regarding your competitors, previously you said you don’t typically run into Juniper and Arista. Juniper and Arista seems like their enterprise business has been growing nicely in recent quarters. Are you seeing them more in your end markets?

Kevin Rhodes: Yes. We see – we never see Arista. Their enterprise market is very different than our enterprise market. I think that’s an extension of maybe the large financials and some of the other larger, an extension of their cloud data center business with larger customers. But in our market it would be very unusual for us to see Arista. As it relates to Juniper, we see them more frequently. And Juniper is investing in the enterprise market, I think more heavily in the verticals where we play. I think if you read the tea leaves [ph] on what Juniper said, I think they’re calling the same high single digit growth from a demand perspective that we are in the near term. From a revenue perspective, they’re still unloading a lot of backlog.

Dave Kang: Got it. Thank you.

Operator: One moment for our next question. Our next question comes from Christian Schwab with Craig-Hallum. Your line is open.

Christian Schwab: Hey, great. Thanks for taking my question. So the – is it safe to assume that backlog is probably almost back to a somewhat normalized level since the conversation is returning to kind of pre-COVID conversation, talking about a funnel and a pipeline versus previous conversations of a backlog driving material growth for a material period of time. Is that fair?

Ed Meyercord: Christian, I think it’s fair to say that the – our backlog as it relates to distribution is normalized. But we still have a fair amount of customer backlog that’s out there. And yes, I can give an example of like Kroger, we had a very large win with Kroger. They’re deploying to all their stores. They don’t necessarily want all the equipment upfront at once. They want to time that with their deployment. So we have customer request dates, very specific customer request dates. That is one of – from one example of many. And what we’ve said and what continues to be the case is that we see the normalization of our backlog at the end of fiscal – Q4 of this fiscal year.

Christian Schwab: That’s right. That’s right. Yes. And just to follow up on that, the push outs that you were talking about at quarter end, is that direct customer push outs or was that unanticipated distribution channel push outs? Those are customer…

Ed Meyercord: Those are customer, yes.

Christian Schwab: That’s what I thought. Okay. Great. And then my last question, a return to 15% top line growth in 2025 with 30% of your revenue recurring seems like a really strong growth rate for products. So I’m trying to figure out or back into, what you guys’ growth assumptions for industry growth is versus market share gains to attain that growth objective?

Kevin Rhodes: Well, a couple things. I mean, one, we’ll go through the long range model next Tuesday, right at our investor conference. So we can talk a little bit more about 2025 then. Right now we’re not guiding for 2025. I think the biggest point is that recurring revenue will continue to grow. You’re seeing subscriptions grow 30% right now. And so we have to – that’s the gift that keeps on giving over the next several years. We think this is an air pocket, as we mentioned earlier. And so we think that there will be demand coming back towards the end of this year into 2025. So that should normalize and we still have a good – like we talked about pipeline and we have a building pipeline. And so that gives us confidence as well that this is a macroeconomic issue for a period of time and hopefully will abate here within this year.

And then 2025 should be a normal, more spending – normalized spending year. At least that’s the visibility we have right now into 2025.

Ed Meyercord: And Christian, I point out, we – a lot of our confidence comes from funnel and we mentioned that we have double-digit funnel growth in terms of the year-over-year opportunities. And so, a lot of the opportunities that are getting pushed out, will come to fruition in addition to new demand. So there’s a combination of our core business where we’re taking share. If Cisco is a market proxy in terms of what they’re calling, it’s kind of low single digit when we take share the function is how much share a point of market share is over 20% growth for Extreme because of our relative size. And that’s in the core business. And I also mentioned, we have invested and we’ve just rolled out and we’re the early stage of ramping a managed services platform.

There’s a lot of interest in MSP. We’re seeing a lot more people turn to MSP. We’ve talked about some of our other strategic investments in terms of global security compliance certifications that apply in the U.S. market as well as targeted opportunities abroad. And we have some other interesting opportunities that are really white spaces for us where we haven’t played. So as we look at the components of core market taking share, and then we look at new white space investments where we haven’t played before, and they’re more commercial models, they don’t require heavy investment. But it’s more about relationship and go-to-market. And these are new for us and they’re just at the early stages of ramp. So those growth rates will be much higher than the market.

And to Kevin’s point, I would encourage participation next week at our investor conference because we’re going to get into it in a lot of detail.

Christian Schwab: Okay, great.

Ed Meyercord: And the last point I would make is that subscription line is growing at 30%.

Christian Schwab: Right. Right. No, I understood that math. I just wanted the market share gain math, which I think you directionally understand what you’re saying. Yes. Great. Thank you.

Ed Meyercord: Thanks, Christian.

Kevin Rhodes: Yes. Thanks, Christian.

Operator: One moment for our next question. [Operator Instructions] Our next question comes from Greg Mesniaeff with West Park Capital. Your line is open.

Greg Mesniaeff: Yes, thank you. Looking at your geographic distribution, can you hear me?

Ed Meyercord: Yes, we can.

Kevin Rhodes: Yes, we gotcha.

Greg Mesniaeff: Oh, good. Okay, gotcha. Okay, looking at your global geographic distribution, I think EMEA was about 40% last quarter. I didn’t see what it was this slide. I haven’t had a chance to see it yet. But going forward, given that EMEA has been a soft area for you for understandable reasons, do you foresee just shifting your sales and marketing focus more back home to the domestic market and maybe to Asia Pac markets, to kind of offset, to kind of channel your resources where the opportunities are still strong from a macro standpoint?

Kevin Rhodes: Yes. Greg, EMEA is still hovering around 40%. I think it was 41%-ish. We talked about realigning resources and the answer is yes. We’re actively managing. Fortunately, because of our size and because of the way we manage the business, we move very quickly. And yes, we’re realigning resources to drive our investment behind success where we see the growth markets. Within a very short time when we realized what was going on here with near-term demand, we made some quick decisions as we pointed out. And a lot of those decisions were around go-to-market. And we commented on investment in Asia Pacific. There’s a lot of year-over-year growth in Asia Pacific for us will be higher above the mean overall. And we’re looking at target investments, for example, in federal where we have significant opportunities and in other pockets.

But your point is spot on. Yes, we’re looking at realigning resources where we can drive growth in the business. And we also look at the productivity of our resources that are in the field. And if sales are off, then we have to realign those resources to make sure we’re driving productivity.

Greg Mesniaeff: Gotcha. And my follow on is, Ed, you very briefly mentioned what I thought was a very interesting opportunity that you are currently in, I guess, discussions with some carriers about offering a enterprise solution through wireless carriers. Can you give a little more color on that?

Ed Meyercord: Yes. I think we’ll talk more in detail next week at our Investor Conference. But the bottom line is that we have some strong relationships with some very large service providers who are just satisfied with current networking relationships. And there’s been a kind of, I’d say, mutual outreach. We see some creative ways to work with them, to help them drive the profitability of their business. There’s a lot of interest in this. It’s still early innings, but the volumes and potential size of the opportunities are quite large. And so, yes, there’s an opportunity for us to work with them in a way where they can enhance and drive profitability and kind of reinvigorate some of their enterprise sales by replacing, I’d say, some of maybe the older, larger networking vendors with Extreme. And we’ve got a customized solution that we’re working on and we’ll share more details in Investor Day.

Greg Mesniaeff: Thank you.

Ed Meyercord: Thanks, Greg.

Operator: [Operator Instructions] Our next question comes from Mike Genovese with Rosenblatt Securities. Your line is open.

Mike Genovese: Hi. Great, thanks. A lot of my questions have been asked already. Questions about your sort of new go-to-market initiatives and confidence that orders will come back. So I’ll just want to kind of summarize those comments for us again? And then my second question, which I’ll ask now is just if you could talk about margins. Despite the revenue cut, you’re still looking for pretty good EPS growth. So just sort of go through those dynamics of what we should expect from margins a little bit more, please? Thanks.

Kevin Rhodes: Sure. So there’s what we’re doing, Mike – there’s what we’re doing in the core business to take share, my comments. Yes, I made a point of commenting on what matters the most in the market overall right now, and networks are inherently complex. And in the enterprise space, people are trying to come to grips with how do we simplify – how do we simplify the environment and how do we make sure that we have flexibility going forward, and we don’t have a vendor lock situation where we get kind of stuck in a certain technology. And do we have modern networking tools? And today Extreme is by far the simplest in terms of our solutions, the most flexibility, and we have the most modern tools in terms of modern networking tools.

So we become a very attractive alternative. So our share gain profile, and when we’re winning the kind of accounts that we’re winning with the kind of names that we’re winning for references, that bodes very well for us. And our customer names support our brand and support us in building our brand in the marketplace. So that’s just core market, market share gains. You’ll hear more about that, but we have a ton of these larger opportunities behind us, and it’s kind of success begets success. In terms of the new market opportunities, a lot of enterprise customers don’t want to be in the networking business. And so they want service provider or managed service providers, which are a lot of people on our channel to provide a managed service. The problem with managed services is that the platforms are really complicated and difficult to manage.

And a managed service provider has to have so many interfaces into so many different clouds and into so many different portals, and the billing is complicated, et cetera. So we set out over a year ago to build a managed service platform – a modern managed service platform based on simplicity. And we’ve come up with what is a very exciting platform that greatly simplifies the ability to provide a managed service from a networking perspective and all the elements that we’re providing. And so there’s been a huge amount of excitement around it. It does take a while to stand up. We started off with a goal of five service providers. We mentioned now we’re at seven. We think that’s going to scale up quite a bit. And we’re going to make it much easier for a managed service provider to deliver a networking experience, far easier.

And then with the simplicity of licensing, et cetera, the whole package will make it easier. So we’re optimistic there. It doesn’t really affect fiscal 2024 much, but it’ll start to play a role in fiscal 2025. We talked about the private subscription offers to some very large service providers to support them in their enterprise business. Very early innings here, we have a couple of large players we’re talking to. One specifically, it has a massive backlog and a pipeline of opportunities. So we’re excited about that. We’re investing in FedSerts [ph]. It’s an area that we had under-invested in previously. We have new resources that we’ve hired that have uncovered some very targeted specific opportunities that we’re pursuing that open up much higher than normal industry growth opportunities there.

We also mentioned Asia Pacific where we have been rebuilding that team. We have very strong leadership there and we see big opportunities and verticals like hospitality. And we’ve had a massive – the largest deal ever that we’ve won in Asia Pacific, $10 million deal in Indonesia. We can build on that success. We’re having a lot of success right now in Japan. Korea, where we’ve been historically strong, we have some really large opportunities with some of the large players there. So those are the areas in terms of managed service with global security and certification, the private offer as well as Asia Pacific investments. The last thing that we’re doing is we’re about 66% of our networking gear is licensed and runs in cloud. And we have a plan to make that 100%.

So we see accelerated growth and subscription as we build out our Extreme cloud, not just a cloud management platform, or a management tool, but an Extreme cloud platform as a service orchestrator. And we’ll talk about that on Investor Day as well.

Mike Genovese: Okay, that was a lot of color. Thanks for that. And then just on the margins, talk more about how the bottom line here grows a lot faster than the top?

Kevin Rhodes: Ed, you want me to cover that one?

Ed Meyercord: Go for it.

Kevin Rhodes: Yes. I think Mike, so it’s kind of rooted in our planning process, right? When we develop our annual planning process, we look at discretionary spend and what that is, and then our fixed spend. And we understand that the levers we need to pull, if we need to pull back, we can pull back on hiring, we can pull back on discretionary spend and the like, if we see the business environment changing. We were able to act quickly, which was great for us in the quarter, to this kind of evolving market environment. So that’s still enabling us to have a good second quarter from an EPS perspective, and obviously helps us for the rest of the year as well. So I would say, we feel confident in our ability to achieve that 25% growth in EPS this year.

There’s not many companies out there where you can say, hey, even if your top line is single- to high-teens revenue growth, you’re still delivering 25% profitability. And we’ve been delivering high levels of growth and profitability for quite some time, for several years. And so we think that that is an important element for shareholders to look at and realize that this company is going to get through this air pocket, still deliver good, strong, profitable growth this year. And then next year, we’ll turn back into a more mid-teens growth company and deliver that margin as well. So that’s the goal.

Mike Genovese: Great. Can I just have one quick follow up there? Could you just talk a little bit of sort of gross margin versus operating margin? The comments seemed to me focused more on the operating expenses, but I think there’s a gross margin to come as well?

Kevin Rhodes: Yes. I mean, we’re going to continue to look at ways of how we can continue to expand our gross margin for sure, Mike. I think we originally said that we’re expecting it to be somewhere in the 62% range for the full year. We’re not backing off that. We think that we will continue to see improvement throughout the year. I don’t know if it’s going to be 90 basis points sequentially every single quarter, but we are expecting that we continue to improve our gross margins throughout the year. That’s going to help.

Ed Meyercord: Yes. And Mike, what’s implied in a 62% gross margin is obviously we end the year over that and more of a 63% range. So it relates to growth margins. We continue to see gross margin stepping here as we come out of supply chain and as we see some of the mixed dynamics as it relates to subscription, et cetera.

Kevin Rhodes: Good point, Ed. Yes.

Mike Genovese: Very well, thanks. Thanks for the answers.

Operator: Thank you. That concludes the question-and-answer session. At this time, I would like to turn it back to Ed Meyercord for closing remarks.

Ed Meyercord: Okay. Well, first of all, I thank everybody for participating in the call. We appreciate your interest in Extreme. I want to shout out. We get a lot of employees and customers and partners that join as well. So I want to thank our employees for all the hard work and customers and partners for the business relationship and the commitment to Extreme. As far as everyone is concerned here, we invite everyone to tune into Investor Day. We have a lot of opportunities and we’re going to go into a lot of detail around the core market, the growth opportunities, as well as kind of help what this looks like from a financial perspective. So we invite everyone to participate there and we hope to just see you there. I’ll reiterate, we see this as a short-term phenomenon and we remain committed long-term to delivering on double-digit growth in the top line. And obviously what that means with operating leverage to the bottom line. Thanks everybody and have a great day.

Operator: Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.