Extreme Networks - Earnings Call - Q2 2025

Executive Summary

• Q2 FY25 delivered sequential recovery: revenue $279.4M (+3.8% q/q) and non-GAAP EPS $0.21 (+24% q/q), with gross margin 63.4% and operating margin 14.7%.
• EPS exceeded management’s guidance high-end ($0.20) and revenue came in above the midpoint of prior outlook; management raised full-year revenue guidance to $1.120B–$1.138B (from $1.117B–$1.137B) and guided Q3 to “better than seasonal” at the midpoint.
• Product bookings were the best in five quarters; large deal momentum strengthened (36 customers >$1M vs 27 in Q1) and EMEA grew both q/q and y/y, offsetting K‑12 seasonality in the US.
• Strategic catalysts: Platform ONE AI-driven networking platform previewed, airports and pro sports deployments highlight fabric/Cloud IQ differentiation, and subscription/private offer/MSP motions building recurring revenue visibility.

What Went Well and What Went Wrong

What Went Well

• Large enterprise traction: “36 customers spent over $1 million…up from 27 last quarter” and best bookings quarter in five quarters, driven by data center strength and double-digit wireless growth.
• Margin and cash generation: Non-GAAP gross margin 63.4% (up 90 bps y/y) and operating margin 14.7% (+230 bps q/q); free cash flow $16.1M and operating cash flow $21.5M.
• Platform ONE progress and AI narrative: “We are introducing new AI models…reducing complex tasks from hours to minutes,” with strong customer/partner feedback and CRN recognition as a “Ten Hottest Networking Product of 2024”.

What Went Wrong

• Year-over-year revenue decline: $279.4M (-5.7% y/y), with product -$14.3M and subscription/support -$2.7M y/y; non-GAAP EPS down to $0.21 from $0.24 y/y.
• Americas sequential decline from tough Q1 comps and US K‑12 seasonality; Germany’s budget uncertainty continues to delay public-sector projects.
• Gross margin modestly lower q/q on product mix and tax resets impacting COGS; management guides 62–63% in H2 vs long-term 64–66% target range.

Transcript

Operator (participant)

Good day, thank you for standing by, and welcome to Extreme Networks' Q2 Fiscal Year 2025 Financial Results Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automatic message advising your hand is raised. Please note that today's conference is being recorded. I will now hand the conference over to your speaker host, Stan Kovler. Please go ahead.

Stan Kovler (SVP of Corporate Development and Investor Relations)

Thank you, Livia. Good morning and welcome to Extreme Networks' Q2 Fiscal Year 2025 Earnings Conference Call. I'm Stan Kovler, Senior Vice President of Corporate Development and Investor Relations. With me today are Extreme Networks' President and CEO, Ed Meyercord, and EVP and CFO, Kevin Rhodes. We just distributed a press release and filed an 8-K detailing Extreme Networks' financial results for the quarter. For your convenience, a copy of the press release, which includes our GAAP and non-GAAP reconciliations, is available in the investor relations section of our website at extremenetworks.com, along with our earnings presentation. Today's call and our discussion may include certain forward-looking statements based on our current expectations about Extreme's future business, financial, and operational results, growth expectations, and strategies. All financial disclosures made on this call will be on a non-GAAP basis unless stated otherwise.

We caution you not to put undue reliance on these forward-looking statements as they involve risks and uncertainties that can cause actual results to differ materially from those anticipated by these statements. These risks are described in our risk factors in the 10-K report for the period ended June 30, 2024, and the 10-Q report for the period ended 30 September 2024, filed with the SEC. Any forward-looking statements made on this call reflect our analysis as of today, and we have no plans or duty to update them except as required by law. A reconciliation of our non-GAAP results can be found in the press release and financial presentation. Following our prepared remarks, we will take questions. And now I will turn the call over to Extreme's President and CEO, Ed Meyercord.

Ed Meyercord (President and CEO)

Thank you, Stan, and thank you all for joining us this morning. Our results in the Q2 were highlighted by a continued and broad-based recovery in the networking market. We grew revenues sequentially for the Q3 in a row, led by product revenues, and achieved our best quarter of product bookings in five quarters. Our competitive win rates continue to improve, especially with larger enterprise customers. In the quarter, 36 customers spent over $1 million with Extreme, up from 27 last quarter. We're seeing a promising recovery with larger customers, which is creating meaningful share gains across a variety of verticals, including healthcare, manufacturing, and IRS. Our EMEA business grew significantly both sequentially and year-over-year. In the Americas, we continued our strong execution in the enterprise vertical. Americas sequential growth was impacted by seasonality in the K through 12 vertical.

From what we see, we believe our customers love the simplicity and feature differentiation of our cloud networking platform. We're the only enterprise player that can deliver end-to-end networking solutions from the campus data center to the edge and across the wide area network from one cloud. In addition, our industry-leading enterprise campus fabric continues to be a significant factor in winning new deals because it offers zero-touch provisioning, provides the most resilience with subsecond convergence, significantly minimizing or eliminating downtime, and minimizes the potential blast radius of lateral cyber attacks on the network. Our competitors simply cannot match these features with their IP fabrics designed for data centers.

This quarter, customers such as München Klinik, the largest hospital network in Munich, Philadelphia International Airport, and the City of Temple, Texas, invested in Extreme Fabric for its ability to deliver seamless connectivity, reliability, and rapid recovery, ensuring uninterrupted operations across their high-demand environments. Our competitive displacements span a variety of verticals. We recently secured a multi-million dollar new logo win with the Pittsburgh Steelers to enhance their fan experience and optimize retail point-of-sale systems for greater stadium-wide efficiency. Taylor Wessing, a large law firm in EMEA with 28 offices, 1,200 employees, wanted to untangle themselves from the complex licensing structure of our largest competitor to simplify their operations. They chose Extreme for the ease of use and scalability of Extreme Cloud IQ and our industry-leading Premier services. We're encouraged by the early traction of our newer commercial models.

Bookings for our MSP pilot program have doubled quarter over quarter, and we currently have 37 MSP partners. These MSPs love the flexibility of the consumption-based billing program because it lowers their operational overhead and allows their own customers to scale at their own pace. This makes our offer sticky with upsell opportunities. We're also expanding our funnel with major customers with our private subscription targeted at large service providers. Last quarter, we secured several large global wins with long-term agreements that will drive high-margin recurring revenue for Extreme in the coming quarters. ExtremeCloud Universal Zero Trust Network Access, UZTNA, is also gaining momentum. This SaaS solution integrates our mature network access control with Zero Trust Remote Application Access. This quarter, a new aerospace customer upgraded their wired and wireless infrastructure with Extreme and adopted UZTNA for enhanced security.

They value the single policy engine and unified management of application and network access for both on-site and remote workers. Four years ago, we were the first in the industry to announce a universal platform for our unified wired and wireless portfolio. We combine the power of cloud management with next-generation switches and access points that simplifies the deployment experience for customers, increases flexibility, and allows customers to gradually adopt new technologies or change their desired use case by changing their OS or management system without a hardware upgrade. In December, we announced our vision for Extreme Platform One, an innovative technology platform that integrates Extreme's networking and security solutions by unifying all our applications into a single interface. The core of the platform includes AI models that will drive impactful advances in automation to the networking experience.

We previewed the platform with several of our partners and customers, and the response was overwhelmingly positive. They all highlighted the significant time savings their teams would experience by having everything integrated into a single platform powered by AI and with the support of our AI expert. Platform One will drive significant productivity gains for IT teams and network design, deployment, management, and commercial operations by reducing complex tasks from days to hours and hours to minutes. Shortly after our launch in December, CRN Magazine named Platform One one of the 10 hottest networking products of 2024. We have a lot of exciting plans to expand upon our Platform One story and capabilities, which we'll demonstrate at Connect, our annual user conference taking place in May in Paris before it goes GA in our fiscal Q1.

We anticipate further market share gains and revenue growth for the full year and a better-than-seasonal Q3. We expect this growth to be accompanied by increased margins and cash flow for the full year, and with that, I'd like to turn the call over to our CFO, Kevin Rhodes, to walk us through the results and guidance.

Kevin Rhodes (EVP and CFO)

Thank you, Ed. Our Q2 marked the Q3 in a row of sequential growth, and our strong gross margin performance and operating expense control demonstrated the strong operating leverage in our model. We achieved earnings per share of $0.21, up 24% from the previous quarter and just above the high end of our guidance range. Customer demand trends continue to improve gradually, particularly with large customers. Q2 revenue of $279.4 million grew 4% sequentially, based on 6% growth in product sales and attached subscription and support contracts. Professional services was down slightly year-over-year. On a geographic basis, our EMEA business grew quarter over quarter and year-over-year based on share gains and diversifying our business to enterprise verticals. Americas revenue declined sequentially, owing to difficult comparisons of significant deals that we closed earlier than expected in the Q1.

We do expect Americas to grow sequentially in the Q3, and our APAC region grew 5% sequentially. Overall, this was the best bookings quarter in the last five quarters. Trends were in line with our revenue during the quarter, and the product backlog was once again within our expected range. Channel inventory continued to improve to pre-pandemic levels, and sell-out was higher than sell-in. On a product basis, bookings were ahead of the prior four quarters, with sequential strength in data center and double-digit growth in wireless. Total subscription and support revenue was $107.1 million, consistent with the Q1. Our recurring revenue growth has been driven by the strength of our cloud subscription revenue. Total recurring revenue was 37% on higher product revenue and a predictable revenue stream for our business.

Our subscription deferred revenue was up 18% year-over-year to $290 million, and our total deferred revenue was $589 million, up 7.5% year-over-year. We expect subscription and support revenue to grow sequentially in the second half of the year. This reflects the difficult comparisons to the low product growth we experienced in the second half of fiscal 2024. Gross margin of 63.4% was relatively stable, down 30 basis points sequentially, largely due to product and subscription mix, but it was up 90 basis points year-over-year on improvement in standard costs. The combination of higher product revenue versus subscription and support drove the sequential results. We expect our gross margin to be in the range of 62% to 63% in the second half of fiscal 2025, also owing to mix. Q2 operating expenses were $136 million, down $2 million sequentially and down $5 million from the year-ago quarter.

We continue to focus on driving improvement in operating margin and higher profitability for the year. We expect our operating expenses to increase to a range of $140 million-$146 million in the second half of the year, slightly better than our previous expectations despite a consistently positive revenue outlook. Sales productivity and better efficiency from our new commercial models is driving this updated outlook. Operating profit for the Q2 was $41.2 million for 14.7% margin, up from $33.5 million or 12.4% of revenue in the prior quarter. Q2 earnings per share was $0.21 and grew from $0.17 last quarter, all above our guidance range. We ended the quarter with $170.3 million in cash and net debt of $15 million. Our inventory position also improved by $11 million sequentially, and we continue to target an inventory balance closer to $100 million on hand by year-end.

$16 million in free cash flow in the quarter reflects higher revenue and solid profitability. We expect a continued recovery in cash flow in the second half of fiscal 2025 as we grow revenue and improve profitability. Now turning to guidance, we are encouraged by the level of customer engagement and growth in the funnel we are seeing, which should bode well for us heading into the second half of the year. As a result of our improved visibility, we are increasing our full-year guidance and providing a slightly narrower revenue range for the next quarter.

For the Q3, we expect guidance as follows: revenue to be in a range of $276 to 284 million, gross margin to be in a range of 62% to 63%, operating margin to be in a range of 12% to 13.7%, and earnings per share to be in a range of $0.16 to 0.20. Our fully diluted share count is expected to be around 134.7 million shares. The improving cash generation and profitability we are achieving this year will allow us to restart our practice of offsetting dilution from stock-based compensation. For the full fiscal year 2025, we expect revenue to be in a range of $1,120 to 1,138 million, and with that, I'll now turn the call back to the operator to begin the question-and-answer session.

Operator (participant)

Thank you. Ladies and gentlemen, to ask a question at this time, you will need to press star one one on your telephone and wait for a note to be announced. To withdraw your question, simply press star one again. Please stand by while we compile the Q&A roster. Now, first question coming from Ryan Koontz with Needham & Company. The line is open.

Ryan Koontz (Equity Research Analyst)

Hi, great. Thanks for the questions. Really nice quarter, guys. With the US being down, you attributed that to K through 12 and then EMEA being up. Any particular verticals you'd point to there? Can you expand maybe on those trends and the geographies? Thanks.

Ed Meyercord (President and CEO)

Yeah, Kevin, I'll jump in, and then you can come behind. K through 12 revenue, Ryan, is usually impacted by E-rate and then just the general building cycle where K through 12 schools, yeah, and they don't want to build while kids and classes in session. And so I think it's a normal seasonality as it relates to K through 12 and E-rate, and that's where we felt it. We did see a recovery, and I would say in broader Europe. I will highlight, however, that we are still being negatively impacted by a lack of government in Germany. As many people may be aware, we have a lot of business there.

A large percentage of our EMEA business is concentrated in the German market, and a lot of those government customers and a lot of those frame contracts are on hold while the government sorts itself out. So when that happens, we expect pent-up demand to release from that market. So yes, it's an encouraging step in the right direction overall in EMEA, but there's more to come there. And then as it relates to K-12 back in the US, I think you'll see that recovers well.

Ryan Koontz (Equity Research Analyst)

Got it. And sorry, read into that the UK maybe is getting a little better?

Ed Meyercord (President and CEO)

Yes, that's right.

Ryan Koontz (Equity Research Analyst)

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

Kevin Rhodes (EVP and CFO)

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

Ryan Koontz (Equity Research Analyst)

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

Ed Meyercord (President and CEO)

I mean, look, I think our view, Ryan, is that that combination is that we would be a net beneficiary of those two companies coming together. And our expectation would be long-term that it would happen. Delays just create more risk around the transaction. And quite frankly, if you're a partner or you're a customer out there making a buying decision in the enterprise space, you've got to be cautious about the potential risk. And so we think delays probably help us somewhat. We had heard that the deal was going to close in March. Previously, we had heard the deal was going to close in December, and now it looks like there's a fresh round of news throwing doubt on the deal. We think both HPE and Juniper want to proceed. There's a pretty hefty breakup fee that we know HPE doesn't want to pay. And we'll see.

We're also not exactly sure how change in administration could affect this.

Ryan Koontz (Equity Research Analyst)

Right. Okay. Super helpful. Congrats again. I'll pass it.

Kevin Rhodes (EVP and CFO)

Thanks, Kevin.

Ed Meyercord (President and CEO)

Thanks, Ryan.

Ryan Koontz (Equity Research Analyst)

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

Christian Schwab (Equity Research Analyst)

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

Ed Meyercord (President and CEO)

Let me jump in,Christian, and thanks for the question, and then I'll let Kevin, I'll let you chime in. We're talking about more specifics than what we're saying. Wi-Fi 7 for us is starting to ramp. I think,Chris, you're well aware that Wi-Fi 7 brings a lot of benefits in terms of it's faster, it's more bandwidth, and in particular, it's about enhanced reliability and the fact that a lot of enterprise customers today who may not have thought about Wi-Fi for certain applications, mission-critical applications, now are feeling more comfortable given the performance of Wi-Fi 7, so we're expecting strong adoption of Wi-Fi 7. Extreme was one of the first to market with Wi-Fi 7, and we would expect continued ramp also as we build out our portfolio of Wi-Fi 7 products.

Kevin, do you want to add any more specifics or is there anything else to say?

Kevin Rhodes (EVP and CFO)

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

Christian Schwab (Equity Research Analyst)

Great. No other questions. Thanks, guys.

Ed Meyercord (President and CEO)

Thanks, Kris.

Operator (participant)

Thank you, and as a reminder, if you'd like to ask a question, please press star one one on your touch-tone phone and wait for your name to be announced. Our next question coming from the line of Timothy Horan with Oppenheimer.

Timothy Horan (Managing Director and Equity Research Analyst)

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

Ed Meyercord (President and CEO)

It's okay, Kevin. It's top of mind for a lot of people. We came out in December really with our vision for Platform One, and there's a huge amount of work going on inside of Extreme right now in developing Platform One. But if you think about the applications that we run supporting our business, everything from wireless and wired, we have something called Site Engine, which gives us the multi-domain capability to manage our competitor gears. We have SD-WAN. We have UZTNA. So if you package all of Extreme's solutions, you can access them through XiQ, through the cloud, but effectively, you're going into a different application. And so the big task that's being undertaken here is that we're unifying and consolidating all the applications into a single user interface that we call workspace.

And so I think for the field and for our partners, the big game changer there is going to be the fact that our fabric, which is our hottest technology because it's so differentiated and none of our competitors have it for the campus, you're going to be able to observe, from a visibility standpoint, manage and orchestrate fabric from the platform in the cloud. And that's been a huge ask from our field and for our partners. So there'll be this unified solution with common user interfaces, common services, ultimately common data. And in addition, we're also building in the capability for commercial. So you'll be able, from the same platform, to manage licensing and service, etc. And so it's a comprehensive platform that is truly unique in networking, and it's broader than just network management.

The other important thing to mention is that we built AI into the core of the platform so that you're going to be able to query, you're going to be able to interface with Platform One in a way that really hasn't been done before, and it's everything from starting off with querying if you're looking for configuration information both inside the network and you're looking for client performance or are we meeting all of our SLAs. You're going to be able to interface with the platform for some of these basic functions, and it's going to make it a lot easier to do that. As we move along, the idea is to add automation and build automation into this, so as we find certain network issues that happen all the time, we can recommend a mitigation, and over time, you can just automate that function.

And so these are some of the things that we're building into the platform that we feel are fundamentally going to change how people are interfacing with the network. So we talked about limited availability this quarter and then GA happening in our fiscal Q1. We would expect over the next three years that we will migrate all of our base onto this Extreme Platform One and that all new customers would be signing up and joining the platform. If you take our cloud management platform, which is very popular, if you take that and then you look at what you get from Extreme Platform One, everyone who's in our cloud is going to want to make that move.

And ultimately, what we will see is that there's greater value, and with greater value, we would expect to have the combination of our service and subscription revenue grow at a higher rate than where we are today, both in terms of new as well as renewal rates for subscription license. At the end of the day, we want to make it incredibly simple for people to go on this journey and to fundamentally change your networking experience. Kevin, do you want to add anything?

Kevin Rhodes (EVP and CFO)

No, Ed, I think you covered it all very well. I mean, to us, right, this is a platform that kind of leapfrogs what we're seeing in the marketplace today. And like you said, a lot of customers are very eager to jump on it. And then the AI is going to bring us to another level that we haven't seen. It's not just AIops, but it's also it really enables them to see better into their network and all the activity that's happening within their network. And it combines the security as well. So I think all the above is what you said.

Timothy Horan (Managing Director and Equity Research Analyst)

Will this cost them more initially, or is it more the increase in revenue kind of comes from them adding more and more products and services that's already on the platform?

Ed Meyercord (President and CEO)

Yeah, I think the value is going to come from the new capabilities of the platform and people wanting to get more value and wanting to trade up for the value. So it's not a big step, but we would expect incremental revenue from the combined offering of Platform One, which would include service compared to the standard XiQ license and service today.

Timothy Horan (Managing Director and Equity Research Analyst)

Thank you.

Ryan Koontz (Equity Research Analyst)

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

Dave Kang (Equity Research Analyst)

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

Ed Meyercord (President and CEO)

Yeah. Dave, as you know, we have very targeted opportunities with Verizon, Ericsson. These are our largest service provider customers. What we've talked about with new commercial models is a private subscription offer and the opportunity to work with them more like an MSP or in that capacity to leverage the MSP platform that we're building. The MSP platform that we're building was designed in something we call workspace, which is ultimately the platform that Extreme Platform will be built on and is being built on. And so we see an opportunity to expand our relationships with these larger service providers that are in, they have relationships with networking providers that the businesses are not very profitable. We think we can unlock profitability with our new platform and the new commercial model with a private subscription offer.

And we believe the economics are meaningful enough to want to pick off and get some of them to move. So it's a much longer-term sales process. We are in the middle of that, having productive conversations, but I would say that's the latest. We've had some large wins that we mentioned that will come into, and you'll start to see them feather into our results as we close out our fiscal 2025 and turn into fiscal 2026. Anything else, Kevin?

Kevin Rhodes (EVP and CFO)

Yeah. No, I think you hit it, Ed. That's the update.

Dave Kang (Equity Research Analyst)

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

Kevin Rhodes (EVP and CFO)

Yeah, Dave, I wouldn't want to get into a projection at this point for 2026 or beyond around what that looks like. It's obviously in our pipeline, and as we look at opportunities coming through, we can give updated guidance on what we think revenue mixes will look like in 2026 and beyond once we get a little bit closer to year-end.

Dave Kang (Equity Research Analyst)

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

Ed Meyercord (President and CEO)

Dave, we have very specific use cases for Ericsson and their platform that supports wireless players. Think about that as almost like an OEM relationship. In the case of Verizon, we're supporting their services platform and their back office as well as a direct customer. Those are very specific use cases, and that's where we're focused. As you know, we have not been active in investing in these hyperscale data center solutions. The margins in that segment have been getting squeezed, and there's a lot of larger players that are aggressively going after that, as well as white-box players that are going after that market.

We do think with some of the announcements that have recently been made, for us, we view them favorably because it's encouraging with the idea that some of these AI workspace workloads and use cases can be built and be applied to smaller enterprise customers in a way that's affordable. And this is something, obviously, it's early innings here, but we had already begun looking at how do we support our customers to the extent that some of these AI workloads come back on-prem that are more suitable to our solution. So it's early innings on that. You'll hear more about that later, but it's a response to the broader question.

Dave Kang (Equity Research Analyst)

Got it. Thank you.

Operator (participant)

Thank you. Our next question coming from the line of David Vogt with UBS. Your line is open.

David Vogt (Director & Equity Research Analyst)

Great. Thanks, guys, for taking my questions. Maybe the first one for you, can you maybe speak to kind of the type of exposure or how you're thinking about sort of the way the US is going about, at least on the federal government side, funding the federal government and what it might mean for states and local municipalities and how that might be sort of filtering into your business over the next couple of quarters just to kind of get a sense for how we should think about it? And then maybe one for Kevin, I'll give you both upfront. Kevin, when I think about your services and subscription business, particularly on the recurring side, if we adjust for the product, if we subtract out the professional services, that business has been around a little under a million business.

How do we think about that from an attach rate going forward as product revenue growth should continue to grow going forward? Is there kind of a good algorithm that we should think about going forward, or it's a little bit more complicated than that?

Kevin Rhodes (EVP and CFO)

Okay. Yeah. I'll answer the first question.

Ed Meyercord (President and CEO)

Yes. So most of it, Dave, most of our spend on the government side is in the state and local domain as well as in the education domain. And at this stage of the game, it is early innings, but we're not aware of any impact to the budgets that we're supporting in terms of the networking building for schools, K-12 and higher ed schools, and also our state and local government customers. Our federal spend customers are very well-established government entities. And here again, we don't expect at this stage; we're not anticipating any impact on the projects that we have underway or that are in our funnel.

David Vogt (Director & Equity Research Analyst)

Great. Thanks.

Kevin Rhodes (EVP and CFO)

And just to answer the second part of your question with regard to subscription and support and the outlook for that, right? There's really, I'd call it, four factors that are really going to help that. One, just increase in product sales as we've recovered, right, from Q3 and Q4 of last year where we had lower product revenue coming into this year. Remember, subscription and support is kind of a lagging indicator against those product sales. You sell the product, you get the attach, and then you've got the growth rate coming behind that. So there's a little bit of lag right now, and we're kind of feeling a little bit of the pain from Q3 and Q4 last year in the growth rate here. It's still 14%.

It's still where we're expecting to be in the kind of mid-teens growth on the subscription side, but nevertheless, still a little bit lower than what we experienced. But Platform One, so higher growth in product is going to help us, which we're calling in the second half of the year. The second part of that would be Platform One and Platform One attach. It's a little bit higher ASP, but also we're going to get more and more of the customers to renew in Platform One, and we'll get not only XiQ, but also we'll add other features to that, including the support to it, and we'll get all of that to renew at the same time with enterprise agreements with these customers. So that's going to be new as well. Three, we've got the Extreme Subscription Private Offer, which we just talked about earlier with the service providers.

The service providers are really Fortune 100 companies. That continues to do well, and we believe that we will get more and more subscription revenue associated with that. And then the last one is MSP and driving these MSPs, which again, 100% attach for every deal that closes within an MSP. And so it's a combination of a better attach rate, but it's more product sales, and it's these new go-to-market motions that we have that both have 100% attach rate as well on the MSP side and the EXPO side.

David Vogt (Director & Equity Research Analyst)

Helpful. And can I slip one more in? And I think I heard you say Q3 would be better seasonality this year. Can you maybe talk about kind of what's driving that? Is it what markets, what products, just general improvement in the networking backdrop, just kind of get a sense of what's going on there?

Ed Meyercord (President and CEO)

Yeah, that's right. So what we have is normally what you would see in our seasonality patterns and trends is a dip in March and then a nice step in the June quarter. And what we're calling here is a flat March quarter and then a nice step in June. So normally, instead of seeing you would see a downtick, and the strength in the market and our outlook and the opportunities that we have in our funnel and what we're seeing is that we're confident in calling a flat quarter. So that's why it's a seasonally stronger quarter because we're not expecting the dip in March that we would normally get. And yes, it's the broader market recovery. It's our commercial models that are adding and gaining momentum. We think that our competitive positioning continues to favor us and will continue to create opportunities for Extreme.

And as I mentioned, some of our markets in specific, like in Germany and Europe, we continue to be negatively impacted by a lack of spend in that particular market. And we're expecting to have a new government, and we're expecting to have budgets. And when that happens, we think spending will be unlocked, and that would be the tailwind for us.

David Vogt (Director & Equity Research Analyst)

Great. Thank you.

Operator (participant)

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

Eric Martinuzzi (Managing Director and Equity Research Analyst)

Yeah. I'm trying to get a feel for industry growth rates. Given your own action over the last, call it, 12 months or so, it's been hard to get a feel for just the overall industry growth rate. But is this an industry that you see kind of a high single-digits growth rate, mid-single digits? Because you've got the puts and takes with the competitive landscape, your own product launches, and then the channel issues from a year ago.

Ed Meyercord (President and CEO)

Yeah. Eric, I think our view of the industry is that it's a mid-single-digit grower and that we're in a share gain position. And when you think about Extreme long-term, you think about Extreme in the high single digits trending to double-digit territory.

Eric Martinuzzi (Managing Director and Equity Research Analyst)

Okay.

Ed Meyercord (President and CEO)

Kevin, you want to add? Kevin, I'll open the door for you here.

Kevin Rhodes (EVP and CFO)

Yeah. No, I think you're right, Ed. I mean, that's exactly what we would say. And actually, the larger companies like a Cisco might even, in their networking business, have low digits, single digits. But I think that that's what we're positioning ourselves for from a long-range expectation.

Eric Martinuzzi (Managing Director and Equity Research Analyst)

Okay. And then I just wanted to go a layer deeper on the slight step down in the gross margin outlook to Q3 versus Q4. You finished out at 63.4% on the non-GAAP gross margin for Q2, and the midpoint for Q3, actually for the back half, is 62.5%. So I understand that it's based on mix, but in particular, what product is pulling that mix down or pulling that margin down?

Kevin Rhodes (EVP and CFO)

Yeah. It's just a function of the actual product gross margin is lower than subscription and support gross margin, right?

And so the growth that we see coming back here in the second half of the year is primarily going to be on the product side. And so that's the mix shift that we're owing to the slightly lower margin at the end of the day. There's a little bit of we also have taxes being reset here in January. And so we've got some COGS expenses as well as operating expenses that will be affected by the FICA limits being reset. And so that's a little bit of a drag on gross margins as well. We still feel comfortable, I would say, Eric, in terms of the 64% to 66% kind of long-term range for gross margin. And obviously, we'll try and overachieve that as we continue to drive here for the second half of the year with the 62% to 63% range.

But I would say it's certainly that's what it is. It's primarily just product in general being a higher mix of revenue in the third and Q4.

Eric Martinuzzi (Managing Director and Equity Research Analyst)

Got it. Thanks for the clarification.

Ryan Koontz (Equity Research Analyst)

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

Ed Meyercord (President and CEO)

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

Kevin Rhodes (EVP and CFO)

Thank you.

Ryan Koontz (Equity Research Analyst)

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