All right, perfect, everybody. Welcome. While everybody gets settled, I'll read the exciting disclosures. For important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. I'm Meta Marshall. For those of you who don't know me, I cover the networking space here at Morgan Stanley. We're delighted to have Extreme Networks here with us today, Kevin Rhodes, CFO, with us. So, Kevin, thanks so much for being here today.
Thanks for having me.
All right. So, networking has undergone a little bit of a challenging couple of years just between supply chain and inventory digestion and just kind of ongoing M&A within the space. Just how would you level set kind of the Extreme Networks value proposition today and maybe how that's evolved over the last couple of years?
Sure, and it's true. We have gone through a bit of a boom-bust cycle, if you will, from inventory not being available to there's too much inventory, to inventory digestion, and now we sit here today. I think we're at an opportunity now where it's like now there's a longer runway of network refresh that's coming at all of us in the industry. I think we're well positioned as a company, and there's a couple of reasons why. One, we've actually thought about our platform strategy and that we are introducing a new platform for the company called Platform One. And effectively, we see a convergence of networking, security, and AI all coming together. We thought very purposefully around what do we want our customers to experience with Extreme. Our thought really was, well, it's not just networking. It's networking with security embedded within that network.
And then why don't we just leverage AI also to enable all those people who are watching the network every single day to do their jobs better? And so that's what we've endeavored to do here recently is really to drive not only it helps us with adoption of subscription and revenue on our end, but it unifies a lot of our products that we sell on a bespoke basis today. And when we actually unify it under our platform strategy, the customers experience a lot more benefit from that unification. It's one pane of glass. It's being able to access all these different applications in one location. And so it just makes it a lot easier for them to interact and manage the network with us. That's one area.
I'd say the other thing that we've done is we've really kind of solidified and gotten two new go-to-markets going for us. So our traditional kind of market has been businesses with 50 million in revenue to maybe 5 billion in revenue. And our thought was really, hey, there's a widening of the aperture here in terms of the market we can go after. We can go after the larger companies. Now, those are the Fortune 100. We can actually start to service the service providers, and we think there's a market opportunity there. And so we've got a good specific go-to-market after those two.
Then at the low end of the market, where people outsource their IT, we've really done a really creative idea of doing consumption billing for those MSPs out there that they have hundreds of customers, and they manage the network for them, and that we have consumptive-type billing for them where our business model matches their business model, where they're charging their customer on a monthly basis. We're not going to lock them into a three-year or a five-year term license that we can, in fact, ebb and flow with their business as their business does. That's another area where we're excited about the market opportunity.
How much of that? Because you guys have had a fairly focused vertical specific, as you talked about, kind of within certain bounds of financial metrics, but you've been very focused on certain verticals. How much of that kind of expansion of the aperture of what you're going after is competitive disruption or just kind of how you see the market needs evolving?
I think it is competitively disruptive because at the low end and the high end, we really didn't have a lot of business there. We've created new business models there that we think that where our competitive set has business there, it would be really hard for them to repeat what we're doing. It's a little bit like the Blockbuster model. Remember back in the day, a third of their revenue was off late fees. They could never chase after the Netflix revenue on a subscription basis. It would be too harmful for their business. We think about Cisco, HP, Juniper, similarly, in as much that they have too much in these high-end markets or the low-end markets that in order to do what we're doing would be very disruptive to their markets. We think that it's not really a vertical market focus.
It's really at the high end and the low end of the market. We think there's more share to be gained there.
For those on the webcast, Blockbuster rented VHS tapes that went into machines. So just for all the people who don't know what that is at this point. So how is disruption to the competitive landscape informing your kind of go-to-market investment? And are there areas where you think you can be more opportunistic in terms of either sales and marketing or R&D to kind of go after that?
Yeah. I mean, we are investing in both sales and marketing and R&D. On the R&D side, it's this Platform One, but I think it's also on the AI side. And we're really leaning in on that side. Again, it's a convergence of all these different bespoke applications that we have, unifying them all and giving one kind of elegant experience for the customer to manage their networking experience. We think that that is something that we should lean into. We're the first networking company to have a platform strategy here, unifying all those together. That was the first part of your question. Sorry, what was the second part of your question?
I mean, just kind of what it leads to in terms of either go-to-market or R&D investment.
Yeah, so that's the R&D investment. On the go-to-market side, we continue to lean in on the vertical markets. We think that that's an area. We are very enterprise-centric. And so we haven't done as much on that data center side. I'd say from a data center perspective, we are thinking about that more from the enterprise data center, where it's not hyperscalers, but more like enabling our enterprise data centers and those customers. And so we are introducing, for instance, a 400 gigabit switch here in the June quarter that will help us capture that market on the enterprise side, on the enterprise data center side.
Can you give a sense of kind of what Platform One is or kind of this Extreme Platform One is, and then kind of what its differentiation is in the market?
Yeah, sure. So Platform One, I mean, we have cloud management software today that we sell. And then we also have support contracts on the hardware that we sell as well. We also have other extensions of SD-WAN or Universal ZTNA or Cloud NAC. Those are all things that we sell on a bespoke basis. What we're doing is we're unifying all of that into one screen that you can see all of your applications, manage all of your applications in one what we call workspace. And that is the ability for anybody who is managing the network to be able to see all of that. In addition to that, we're adding AI technology that's conversational, that enables you to schedule, for instance, reports coming to you, and it's conversational from that perspective.
But then we also have these autonomous AI agents that can also kind of give you insight into your network and the traffic that's happening there. And we think that that's going to be kind of industry-leading and leapfrog some of the AI that we see in the market today that's more AIOps-oriented, that this ends up being a leapfrog above and beyond some of our competitors on the AI front.
Just how do you see that being clearly kind of a competitive advantage, but kind of what is the path to getting that into your install base?
The path for us, so we're launching this in our Q1, which is fiscal year Q1, is the July time frame. And so we're starting to quote on that in the April, May, and June time frame. And so we're going GA, for instance, on the MSP side here in March. Then we're starting to quote for all equipment purchases starting in April. And then we'll launch the actual technology in the July time frame. We do believe that we'll get strong adoption of this. We've had focus groups with customers, and they're really happy to see what the AI looks like, but also the unification of all these technologies together. We think we'll get good adoption of this, and we believe that it will be an improvement of our recurring revenue over time. So we're excited about that.
Okay. Is there kind of any targets you've set just in terms of how services and subscription revenue growth rates are different kind of as a result of Platform One?
Yeah. Yeah, yes, we have. I mean, we do believe subscription and support revenue, again, the unification of this. Let me just back up. The challenge that we have in some of our recurring revenue growth is at year five, after you've bought a support contract on a piece of equipment, you may or may not renew that at year five. You might decide, "I'm not going to renew the support contract on that piece of equipment because if it dies, I'm just going to replace it." And so that's a savings. When you unify it all together in one, it's almost like what I think of as a Microsoft E5 subscription. Well, I don't want to use Microsoft Defender. Sorry, it's part of the subscription.
From our perspective, we should get a better renewal rate on support revenue in the future, where today we tend to see a little bit of more attrition than we would like to see there when we unify it all together. The customer is going to get support on everything they have no matter what. It's all part of the entire Platform One strategy, which, by the way, is like a SaaS company, like any SaaS company that has support that's embedded within the software price that they pay. It's really SaaSifying the business a bit there.
Got it. Okay. That's helpful. You have a stated goal of achieving double-digit growth longer term. Just how do you think about the different drivers and initiatives that will help you kind of transition from the mid-single-digit industry growth rate to kind of that higher trajectory?
And one thing I wanted to point out here is that we do think that subscription and support revenue over time will grow in the mid-digits, in the double digits, mid-double-digit growth on subscription and support. And that Platform One strategy is going to help us get there because not only do we have a higher ASP for that, but we also think we'll have a higher attach rate for that. And naturally, we've got better renewal rates on that as well. And they're getting the benefit of AI that they don't have today and much better AI that's going to keep them sticky over time. So we think about subscription and support growth rates kind of being in the mid-teens.
We think that the product sales would tend to be likely maybe double the growth rate of what we see in the marketplace, which the equipment sales tend to be in the 3% to 4% to maybe even 5% growth rate, and we could see ourselves being in the high single-digit growth rate on the product sales side.
Given the gradual recovery seen in fiscal Q1 and fiscal Q2, what are your expectations for kind of the pace of the market recovery across the different regions, particularly given maybe that North America has kind of recovered ahead of EMEA?
We had good recovery in EMEA in our Q2 . We were happy and highlighted that. We also identified in Q2 that that was the best bookings quarter we had in the last five quarters. So that was another kind of harbinger of what we're seeing as recovery in the markets. One of the big challenges we've had in EMEA is that in Germany or UK, they didn't really have the leadership in place, and they hadn't formed their governments. And so a lot of the governmental spending that we normally see in those regions were just not there. We had kind of refocused our sales organization to focus more on the traditional enterprise verticals while that government spending wasn't there. That actually paid dividends for us in our Q2 .
But now that we start to see these governments being formed, we think that there's an opportunity for us to get better tailwinds from governmental spending because they haven't really spent in the last couple of years. And we see some of that opportunity coming to us in EMEA. In Americas, I think that's been fairly steady from our perspective. And we continue to kind of win some market share in certain areas. Education is a good market share opportunity for us. I think some of the challenges that we've seen with the HP, Juniper deal is that it's kind of frozen a lot of customers from a, "What do I do? And what technology do I buy? And whose technology do I buy?
And what roadmaps will be there in the future?" Some of that's inures to our benefit in as much as some of those customers who may have already been our customers from a switching perspective have come to us and said, "You know what? I'm just going to buy my access points from you as well." So we've seen some benefit on the wireless side coming from HP Aruba and even some on the Juniper side due to the uncertainty of what's happening there in the marketplace.
Got it. Okay. You typically see a step down in the March quarter. Just how are you guided to kind of a flat March quarter? So what are kind of the drivers behind that?
Yeah, flat at the midpoint, but slightly up at the high end of our guidance range. And I think that's a tell in terms of what our view is around we tend to see in that March quarter it be down $10 million to 15 million. But in fact, if we're guiding flat to slightly up, that's a positive. It's a positive of what we're seeing, what we saw linearity-wise in the January as we were approaching guidance and as we were seeing in terms of our pipeline and the pipeline of opportunities that exist there, both from existing customers as well as new logo opportunities. We felt good and confident about what we were guiding there.
Okay. Just what are you seeing in terms of kind of adoption rate on Wi-Fi 7 products? And how is that expected to kind of contribute given kind of only currently 12% of your access points being sold are kind of Wi-Fi 7?
That's right. That's right. So I think there's a long tail there. So just a difference between Wi-Fi 6 and Wi-Fi 6E and 7. Wi-Fi 6 is a 2.4 and 5 gigahertz spectrum, and Wi-Fi 6E and 7 has got the 6 gigahertz spectrum, which is just a different spectrum. It's a cleaner spectrum, and you can put more traffic. There's also a 4 to 5x multiple of just throughput on 6E and 7. Where 7 really comes into play is where there's three radios there, and it really enables customers who have manufacturing operations or, in particular, hotel hospital systems. I think about really wanting to be on Wi-Fi 7 because of the reliability of the technology. And also, it enables a lot of IoT usage as well there. So we saw this 12% between 6E and 7.
As we think through fiscal year 2027, we think it could climb up to 50% at that point. We think Wi-Fi 6 is kind of older technology now, and that really people will start to adopt 6E and 7 as the staple.
Okay. Perfect. Another topical point this week is just government exposure. Most of your government exposure is with kind of state and local versus U.S. federal. But just kind of given it being so topical, just how are you thinking about kind of currently what's happening with federal spending and just how that impacts your business going forward?
Yeah. Good news is we don't see there's any impact on our business right now. We have about 5% of our revenue comes from what we call the E-rate program. The E-rate program is part of the Universal Service Fund, the USF Fund, which is basically a tax on all mobile phone bills and whatnot. And that tax goes into a fund that enables grant money for schools to apply for grants and get technology refreshes for their business. There are other uses of the USF Fund, but that's effectively the largest part of it. And we are still seeing grants being requested in our pipeline. And we don't see those, for instance, going after that because it's funded by this telco tax. It's fully funded by that. And so therefore, all of these school systems should continue to participate in that program.
Above and beyond that, we do have what I'd say state and local or municipalities that are great customers of ours. They tend to finance their IT purchases. And so it's embedded within their operating budgets. And so as they think about the property taxes that pays for IT or pays for school systems or even pays for the fire department or police department, that's part of their operating budget. And so we think that that will continue to be a part of their operating budget and not really impacted by any federal government grants that may be reduced at the state level, that we should still be okay and insulated from that.
Okay. So you kind of contextualize 5% being kind of E-rate exposed. Is there a way to, or have you disclosed kind of what public sector is in general of the business?
Yeah. So, public sector for us in general, we call it State, Local, and Education. So, we actually call that out. But the education part is really about 20%, and the other part is about another 20%.
Okay. Okay. Got it. Can you provide just a little bit more detail on the service provider strategy and particularly the progress with Verizon and Ericsson and just how MSPs, kind of the platform fits into this strategy?
Yeah, so great customers, Ericsson and Verizon, we tend to do work with them for their data centers. This is direct outside of our reseller network that we actually work with them. That's gone well, and we partner with them. And in some cases, we actually do some bespoke engineering for them. And as part of that, we get better commitments from them on what we're doing there. I would say the opportunity for us above and beyond just Ericsson and Verizon is the enterprise data center in general, which is that 400 gigabit switch that we're coming out with in June. And that's where we feel like between our traditional wired and wireless technologies, but now enterprise-level data center strategy, we can really manage and maintain a good hold on the enterprise in general.
Are there other kind of relationships that you would look to be adding kind of in this similar vein, or is there enough room to kind of grow with Verizon and Ericsson?
We would love to get more and more service providers to come to us. We did create an interesting, unique opportunity to engage with service providers that kind of disaggregates our hardware and software where they can purchase our equipment through our ODMs, through our distributors at a near cost level, and so they can get the equipment that kind of flows outside of my P&L at a low-cost level, but then the remainder, if you will, that value comes into the form of the operating system that manages that, if you will, that white labeled or that white box, and so it's my operating system as well as the support as well as the cloud management and all the other features that I have that we put into a subscription program.
And so we think that there's a unique disruptive market opportunity where a Comcast, a Verizon, others who buy a lot from either a Cisco or HP or others that they can actually get the equipment for a lot cheaper price. And then we get the benefit of the subscription on our end, which is a higher margin opportunity.
All right. Perfect. Kind of on that margin point, growth margins have fluctuated between around 45% to 63% kind of during 2024 and 2025 with Q1 reaching kind of these 64% level. But fiscal Q2 was showing a sequential decline. Just what factors are at play of kind of your long-term target range of 64% to 66% and kind of what is the plan to get there?
The real plan to get there is Platform One. So as we drive more and more people to the adoption of Platform One, that's got a higher margin profile for us as a business. And we will continue to have customers adopt Platform One. And that's got kind of a 75% to 80% gross margin profile for us. And as we see better adoption rates and better attach rates there, we'll continue to drive that. These other businesses, this MSP business and this Extreme Subscription Private Offer for the SPs and Fortune 100, all of that is subscription revenue as well. And so we'll continue to drive more subscription revenue in that regard as well. And that's going to continue to drive our overall gross margins.
I do think there's opportunities as well to improve the product gross margin as we continue to take a little bit more costs out of that or move more air freight to sea freight. And there's optimizations that we can do there to get product margin improvement. But I think the real benefit is recurring revenue today is about 38% of our revenue. And we will continue to grow that as a percentage of revenue into the 40s and maybe up to 50% at some point in the future.
Okay. Got it. We made it almost 25 minutes in before mentioning tariffs, so just kind of any impacts from tariffs or just how is it impacting kind of your supply chain planning?
Sure. So far, Canada, Mexico, China, really no impact for us, so that's the good news. We moved out four years ago out of China and into other markets for our ODMs, and so that's the good news for us. At the end of the day, and the other thing that we did is having moved outside of China, we also figured that even though the ODMs today ship into our El Paso, Texas distribution center, and then we distribute outside of that, we can go directly from ODM to different regions of the world like EMEA or like Asia and not go into the United States, and so really 50% of my revenue could be insulated from any tariffs should they go after those particular regions as well, and so I think we benefit from that. We have no exposure today.
But even if we had exposure, I could limit it to 50% of my revenue that happens in the United States. And even if that happens, obviously, we raise prices accordingly and manage through that process that way.
Okay. I mean, just in terms of is there concentration by country, or do you feel like you have enough options where, yes, you may have to raise price or there's going to be minimal impact, but just do you have the flexibility to kind of move around countries at this point?
I would say no, we don't really have a lot of flexibility from a manufacturing perspective to move very quickly from one country to another. That would be a challenge for us. But that being said, we do believe that we are ready. We are prepared. Where four years ago, I wasn't really as prepared. It was new to us. We had to create all that muscle, that new muscle to manage through the tariffs the first time. Now that's already created for us, and we know exactly what the playbook would be if we actually had to raise prices and manage through that in that scenario.
Perfect. You guys have been quite acquisitive in the past. Can you just lay out kind of how you view M&A as kind of a part of the strategy, and you've done a lot of consolidation, but just how you can look at acquiring into adjacent areas?
It's interesting. You have to evaluate when you evaluate M&A, you have to evaluate the distraction factor because we believe that we are on a really good course. Over the last five years, we acquired a bunch of companies, and now we've really taken all of that hardware and we've unified it. And now we've got this universal hardware platform that all that hardware works with each other. And it's very symbiotic. And now we've actually also with some of those acquisitions, we purchased software. And now we've unified all of that with this Platform One strategy. So that took us a lot of effort. And we know, by the way, with HP and Juniper, if they do combine together, how much challenge there would be behind all of that. And so from our perspective, we're clean and things go well.
What we could do now is I would think more software-centric in terms of if we were to look at something from a Corp dev perspective, it would probably be more on the security side of things. And it would really enhance our overall Platform One strategy with more security features. And as we think about networking, it's this convergence of the networking with the security features and AI all coming together. And so if we could benefit our platform by adding more security, we would.
Okay. Maybe a last question, and just in terms of we've been asking everybody this week. You've clearly talked about ways in which you're looking to kind of productize AI within your portfolio, but how are you using AI internally kind of within the organization?
So it's funny because I was at the MIT CFO Conference, and I talked on this very topic. We've got internally right now, and we've got other use cases that we'll go after. But for right now, we've really focused our IT resources on enabling our sales organization. And it's really two constituents. We created a RAG model where we've taken a container and we put all of our information in that model. And now we put an LLM on top of it. And we exposed it both to our sellers as well as our resellers. So our sellers can ask and query, "I'm going to visit a healthcare customer tomorrow. Can you please highlight for me the benefits and give me some reference customers that I can highlight during my meeting tomorrow?
Can you write me an email to that healthcare customer and identify all of the areas where our technology is better than anybody else?" Those are the use cases that we're perfecting right now, what we call a sales AI agent. On the opposite end, we're also doing the same thing with our resellers. Similar, but slightly different because the resellers really want to understand how are they competing against the competition. And so we're enabling those resellers to help them position themselves better to sell Extreme into a client. And what are the differentiations that we have from a technology perspective or otherwise? Our fabric technology versus IP fabrics is a good example of that. And so those are the use cases that we have today. We'll continue to drive more and more use cases as we think about that in the future.
So we've got it both externally built into our product and then internally for sales and resellers.
Got it. All right. Well, Kevin, thanks so much for being here today and let us hear more about Extreme.
Thank you so much. Thanks for your time.