Extreme Networks, Inc. (EXTR) Earnings Call Transcript

Hello, everyone. Thank you for joining us, and welcome to Extreme Networks First Quarter 2027 Fiscal Year Financial Results Conference Call. [Operator Instructions] I will now hand the conference over to Stan Kovler, Senior Vice President, Finance and Corporate Development. Please go ahead.

Thank you, Jade. Good morning, and welcome to Extreme Networks first quarter fiscal year 2027 earnings conference call. I'm Stan Kovler, Vice President of Finance and Corporate Development. With me today are Extreme Networks' President and CEO, Ed Meyercord; and Executive Vice President and CFO, Kevin Rhodes. We just distributed a press release and filed an 8-K detailing Extreme Networks' financial results for the first quarter. A copy of the press release, which includes our GAAP to non-GAAP reconciliations and our earnings presentation is available in the IR section at extremenetworks.com. Today's call and Q&A may include certain forward-looking statements based on current expectations about Extreme's future financial and operational results, growth expectations, new product introductions, supply chain dynamics and management 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 our 10-K and 10-Q filings. Any forward-looking statements made on this call reflect our analysis as of today, and we have no plans to update them, except as required by law. 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. Revenue grew 10% year-over-year, marking Extreme's seventh consecutive quarter of double-digit revenue and product revenue growth. Non-GAAP EPS increased 50% year-over-year as we continue to translate strong top line performance into even faster earnings growth. SaaS ARR accelerated to 22% year-over-year growth and reached approximately $265 million. Based on the combination of our performance, visibility into customer demand, strong funnel growth, continued share gains and accelerating adoption of Extreme Platform ONE, we're raising our expectations to 10% growth for both the second quarter and full year fiscal 2027. We expect our SaaS ARR growth to exceed 20% for the rest of the year as well. We continue to outgrow the market, expand within larger enterprises, win competitive opportunities and strengthen our position as customers increasingly standardize on our AI-powered integrated networking platform. Customer demand remains strong. Our open funnel grew at double-digit rate with strength in all regions. Our regional POD strategy with a strong focus on specific verticals is helping us win more of the opportunities we pursue. Our disciplined execution and supply chain strategy give us ample product availability to convert that demand into revenue. There are 3 key pillars driving our growth. First, we're moving upmarket. We booked 44 customers at over $1 million this quarter, up from 36 a year ago, largely due to our technology differentiation. Our Campus Fabric takes complexity out of the network with zero-touch provisioning, sub-second recovery and built-in segmentation that helps prevent lateral attacks. Our Wi-Fi is built to perform in complex high-density environments, keeping users connected and applications running reliably. That differentiation, along with our simplicity and lower total cost of ownership is helping open new doors and win bigger deals. Second, Platform ONE adoption is accelerating as a result of continued innovation and now accounts for over half of our subscription bookings. Customers want a single AI-powered platform that integrates security and networking to help reduce complexity, simplify operations and manage their wired and wireless environments in one place. Third, market conditions are working in our favor. Competitor refresh cycles, Wi-Fi upgrades and the disruption from the HPE and Juniper integration are creating a multiyear opportunity. Supply is also a differentiator. Our components are secured through calendar '27, while our competitors are quoting extended lead times. These advantages matter most when customers are making large high-stakes decisions and our recent wins show it. One of the largest integrated healthcare networks in the United States chose Extreme for a campus transformation, spanning 21 hospitals and roughly 600 care locations. Where network availability directly affects patient care, Campus Fabric delivered the automation, resiliency and segmentation the customer needed. Within the first month, support tickets dropped over 90%. When customers evaluate Fabric through a proof of concept, the differences become clear and our win rate is excellent. Wi-Fi refreshes is another important driver of our success. Hard Rock Stadium in Miami selected Extreme to replace its aging Wi-Fi 5 environment with Wi-Fi 7, supported by a full switching upgrade. In addition to Dolphins Games, the network will support events like the Formula 1 Miami Grand Prix and the Miami Open, providing the capacity and lower latency required to support tens of thousands of fans simultaneously streaming, sharing content, making mobile transactions and using digital services. This deployment demonstrates how these Wi-Fi refresh wins create an opportunity to then sell our entire infrastructure portfolio. Platform ONE is a key growth engine that strengthens our recurring revenue. Customers value the simplicity of managing their wired and wireless on a single AI-powered platform. We have a number of Platform ONE customers across verticals, including Cambridgeshire & Peterborough NHS Trust Foundation in the U.K. where Platform ONE will manage the Extreme wired and wireless network, delivering enterprise security and operational resilience across the healthcare organization's clinical sites. regio iT, the largest municipal IT service provider in North Rhine-Westphalia, Germany, will leverage Platform ONE to manage its Extreme Wi-Fi 7 networks across hundreds of sites, helping municipalities, schools and utilities deliver digital services with less IT overhead. One of Austria's largest banks chose Extreme over a long-time competitor to refresh its wired and wireless networks across more than 70 branches, all managed through Platform ONE. With its cloud-first strategy, Platform ONE will give the bank's network team centralized cloud-based management at scale. Last week, we held our second Annual AI Summit in Amsterdam, bringing together senior IT leaders to discuss industry trends and share our longer-term vision. We showcased early Agent ONE momentum and previewed the industry's first on-prem enterprise AI infrastructure for networking. Extreme's AI understands each customer's network topology, history and operating context, turning that insight into practical recommendations and measurable productivity. Agent ONE Coworker, our next-generation AI agent, reached all Platform ONE customers in early September and drove a 10x adoption rate over the first generation. Its signature feature is Nudge. Unlike conversational AI, which waits for someone to ask the right question, the Nudge feature proactively surfaces timely contextual recommendations inside the workflow and 98% of critical nudges got a response. 58% of cases open through Agent ONE Coworker arrive with everything our engineers need to begin troubleshooting so work starts sooner. At Hill College in Texas, the CIO said his team solved a wireless outage in minutes with Agent ONE, a task that would have taken a full morning. It also helped the team respond to a device on the guest network running crypto mining software by tracing the device through the access points, narrowed its location and resolved the security issue that could easily have gone unnoticed, all within minutes. In calendar '27, we will make Agent ONE operator mode available to customers. It will execute tasks independently within defined governance boundaries, respond to events in real time and run scheduled workflows, learning from each outcome to become more effective over time, creating autonomous AI. We also previewed Extreme Exchange zones expected in the first half of calendar '27. Exchange zones bring enterprise AI on-premise, letting customers run the same applications locally or in the cloud with full control over data residency. This will allow customers to comply with data sovereignty requirements, which have become increasingly important in international markets. Exchange zones will also pool spare compute across their extreme access points and switches. None of our direct competitors offer this. Our MSP program is also gaining traction, closing the quarter with 85 active MSPs, up from 74 last quarter. Consumption billings grew 21% quarter-over-quarter and 131% year-over-year. Platform ONE is already contributing to that growth. Our funnel remains strong. We are expanding with larger customers. Industry disruption continues to create share gain opportunities. We have the supply availability to meet customer demand. And the differentiation of Platform ONE and Agent ONE are strengthening our recurring revenue growth and strategic relevance with customers. Now let me turn the call over to Kevin to discuss our financial results and guidance.

Thanks, Ed. I'm pleased to report strong first quarter financial results. Starting with revenue. Total revenue of $341 million exceeded consensus and the high end of our guidance range, representing 10% year-over-year growth. Product revenue of $218 million grew 12% year-over-year, indicating strength of customer demand above our typical seasonality. We are continuing to see growth in both wireless revenue, especially with Wi-Fi 7-based products and in wired switching as well. This marks our seventh consecutive quarter of double-digit year-over-year growth in product revenue, demonstrating strong demand and our continued strong go-to-market execution. The industry pricing environment continues to be fluid, and we expect this dynamic to continue based on a combination of product cycles, mix and demand as we pass through component cost increases. Recurring revenue of $119 million grew 7% year-over-year, aided by SaaS ARR growth of 22%. As we previously stated, fiscal year '27 is the transition year where legacy support contracts are subsumed into Platform ONE contracts, the fastest. We expect a sharp reacceleration in recurring revenue growth in fiscal '28 coming off our balance sheet as SaaS deferred revenue ramps this year. Through the transition, we expect continued improvement in free cash flow and margins. Turning to the first quarter margins. Gross margin of 62.6% was up 130 basis points year-over-year and above the midpoint of our guidance. We're pleased that we were able to preserve our price advantage over our competitors, while passing on component cost increases. We've also solved for memory needs by executing on our supply chain strategy, providing us with ample supply to meet demand and good visibility into gross margins. Earnings per share of $0.33 accelerated to 50% year-over-year growth and above the high end of our guidance range. Geographically, we had strong revenue growth in the Americas and EMEA. In Asia Pac, while revenue fell due to elevated prior year comparisons, we continue to win large deals in the region and our funnel remains strong there. We continue to expect growth across all regions in fiscal '27. Operating margin expanded to 17.4% in the quarter, up 410 basis points from the prior year quarter and 170 basis points sequentially and well above the high end of our guidance range. We also generated $66 million of adjusted EBITDA, up 47% year-over-year, and our adjusted EBITDA margin of 19.2% was up 480 basis points year-over-year as well. If you look back 2 years ago, we have nearly doubled our profitability as a company. We continue to achieve operating leverage through healthy growth as well as prudent cost management, thus outperforming in the first quarter. In the second quarter, while we plan for seasonally higher expenses due to sales and marketing expense, such as our annual sales kick-off, AI Summit and advisory council events, just to name a few. We continue to expect our profitability to maintain its current course. Over the long term, we continue to drive operating leverage as we scale. In terms of cash flow, we generated $39 million of free cash flow and ended the quarter with $245 million of cash, our highest cash balance since fiscal '21 and a healthy $45 million of net cash. This was during a quarter in which we repurchased $25 million worth of shares and made strategic memory purchases, of which we now have $36 million of memory on our balance sheet. We are effectively generating cash and using it strategically while returning cash to shareholders and maintaining a healthy balance sheet. On a vertical basis, we experienced broad-based strength with particular standout bookings growth in education, manufacturing, healthcare and sports and entertainment. We mentioned a few of these wins in these customers earlier. Looking at the second quarter and the rest of the year, we're increasingly confident in our ability to achieve double-digit revenue growth. In the second quarter of fiscal '27, we expect revenue to be in a range of $345.8 million to $350.8 million, gross margin to be in a range of 62.2% to 62.7%, operating margin to be in a range of 16.4% to 17.4% and earnings per share to be in a range of $0.32 to $0.34 per share. For the fiscal year '27, we are increasing our guidance as follows: we expect revenue to be in the range of $1.402 billion to $1.412 billion, up 10% year-over-year at the midpoint. Gross margin, we're expecting to be in a range of 62.3% to 62.8%, operating margin to be in a range of 17.2% to 17.6% and earnings per share to be in a range of $1.35 to $1.39 per share. We expect our fiscal '27 non-GAAP tax rate to be 21.8% for the year. And with that, let's now turn the call over to the operator to begin the question-and-answer session.

[Operator Instructions] Your first question comes from the line of Ryan Koontz from Needham & Co.

Nice results and guide. Nice to hear the business is humming here. With regards to gross margin and supply and memory specifically, any particular things you'd point out with regards to availability in terms of your strategy, how that's playing out and how we should expect gross margins to fare going forward? It's nice you guys have supply, but I think we've all been -- investors have been worried about cost here. So maybe you can shed some more light on that. Nice job, though.

Yes. Thanks, Ryan. And yes, our teams got on this early. And what we've tried to do is flip what is a negative in terms of constrained supply into a positive because we have plenty of memory. You will see the cost pressure in our gross margin number because you'll see the higher cost of memory embedded in what we just announced. But the bottom line is that we are -- we've got full supply out well into fiscal '28. And for us, what we see is an opportunity to provide shorter lead times than what's out there for the industry. So we continue to remain in a strong position on that and the higher cost of memory is built into the gross margin that we just reported and our guide.

Got it. And the pricing environment allows you to essentially raise price to offset that?

That's right. We've been a little more conservative than our larger competitors in raising price. We hear this from distributors, partners and customers that the bigger players have been raising price more aggressively. So I would say we still have room there, but we've been able to deliver the margins with what we've done so far.

Your next question comes from the line of Mike Genovese from Rosenblatt Securities.

So Platform ONE bookings are over 50% of subscriptions, up 5x from last year. Could you just -- what are you saying now? You might have said on the call, but if you could repeat it, about where you're going to be at the end of fiscal '27? And how much is new logos versus conversion of existing customers?

Yes. And let me cover the first part, and Kevin, I'll let you jump in on the new logo number if we're sharing that. But Mike, by the end of this year, we expect half of our customers to be on the platform, which it's the fastest move and migration that we've ever seen. But we've -- at the end of this past year, we had 10% of our customers on the platform, and we would expect that number to grow to over 50% of our customers on Platform ONE at the end of this fiscal year. And then that number growing to approximately 80% the following year. So the adoption has been very high. Our teams commercially have done a great job positioning and selling Platform ONE. I think you can see demand for the most modern industry tools and also the differentiation that we bring. It does, from a new logo perspective, the market is interested in how to leverage AI and how to leverage modern networking tools, the most modern networking tools as they consider investments into the future. So it's giving Extreme more at-bats and more opportunities. Kevin, I don't know if we're sharing exact percentages in terms of new logo, but I would expect new logo adoption to be closer to 100%.

I would agree, Ed. That's what I was going to say. It's like, when we're going to market right now, Mike, we are going to market with Platform ONE. And that is all new logo activity. That's where we're kind of center staging, focusing that technology for that new logo. And then, of course, you've got the movement of the migration of all the customers into Platform ONE as well. And that happens more episodically as they come up for renewal. But we are seeing tremendous success in existing customers moving over into Platform ONE. And it's not a big lift for them to move from XIQ into Platform ONE. We saw even one customer, a hospital system, do it in 40-some-odd minutes. So it is -- you get the benefit of the AI and you get the benefit of all the new technology that we're building there. And so people were eager to go and move. So we don't have percentages there that we're sharing, but I would say it's really strong across the board.

Great. Great. And then just for my follow-up, on the -- just the monetization of Agent ONE Coworker and then also Exchange zones. Is this monetized through the subscription, through utilization? Does it pull through hardware? Like how do we think about monetizing these things?

Sure. Yes, and they're different. So we came out with Coworker in September, which was our second-generation AI platform, if you will. And that's where we made the move from what we would call conversational-based AI, which is where the industry is, simply put, you have to prompt AI in order to get an answer. So it's sort of -- it's almost chatbot-ish where people are having to converse if they want to use AI. In this case, Coworker is conversational. It's included in the subscription. So all of our customers have it. And that's what we're excited about. And we mentioned 10x the usage because it's always on. It's context aware of your network. It's always on, it's ambient, it's proactive and it's watching what you're doing. And if it feels that it can support you or if it can highlight, let's say, a network issue or a solution or suggest a workflow, et cetera, it's going to do that. And so that's that nudge we're talking about. So now that's built into the platform. And what we're seeing is the customer adoption and engagement with our platform, which is our -- we're already on our second is far greater than what we have with what was our old AI expert. When we move into operator mode, which does contain the governance element of our agents, -- so that element of operator is already out there. But we're introducing new features and new capabilities like what we said in terms of localization of data as it relates to data sovereignty, some people wanting to keep workloads in the enterprise on campus without going out to the cloud, survivability from a security standpoint, if you don't want to get disconnected from the cloud and you want to hold the workloads local. That's what's coming out in operator mode. And the big change for Extreme from a revenue perspective will be in token economics for Extreme. We're calling tokens agent actions. And these agent actions will bring in a new stream of revenue for Extreme. And this is where we're talking about unlocking data in the network for other use cases outside of traditional network management. So the idea that we can work with stadium customers and enhancing the fan experience or the patient experience or supporting caregivers in a health care environment or retail outcomes from a supply chain standpoint or from a consumer standpoint. The list goes on and on, and there's a lot of different ways when you think about the network being literally in the middle of everything, the network being strategic and all the data in the network, this is where we're excited in the second half of calendar '27 -- I'm sorry, in the first half of calendar '27, the second half of our fiscal to bring operator mode to bear for customers. And we're already working with what we're calling our foundry customers on applications and ways to leverage data from the network in this new platform.

[Operator Instructions] Your next question comes from the line of Eric Martinuzzi from Lake Street Capital Markets.

Yes. Ed, you commented on your 3 key pillars of the growth story. I wanted to focus in on the upmarket move. I think when you exited FY '26, you guys were talking about the $1 million-plus opportunities in the funnel up by mid-teens kind of year-over-year. Where does that stand today? Obviously, you had good success in Q1, but where are we with the 9 months to go in the fiscal year?

Eric, it's actually up a bit. So I think you would see that, that number would be up over 20% depending on the period that you're looking at because our funnel, obviously, we slice and we're looking at it by quarter for the next -- for the rest of the fiscal year. So we see these opportunities continuing to grow and that percentage in the funnel growing beyond the mid-teens number that we discussed.