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Edited Transcript of HIVE earnings conference call or presentation 31-Oct-18 9:00pm GMT

Q3 2018 Aerohive Networks Inc Earnings Call

Sunnyvale Jan 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Aerohive Networks Inc earnings conference call or presentation Wednesday, October 31, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David K. Flynn

Aerohive Networks, Inc. - Chairman, President & CEO

* John Ritchie

Aerohive Networks, Inc. - Senior VP, CFO & COO

* Jessica Stancil

Aerohive Networks, Inc. - Investor Relations

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Conference Call Participants

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* Erik Suppiger

JMP Securities LLC, Research Division - MD & Senior Research Analyst

* Mark Kelleher

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Zack Turcotte

Dougherty & Company LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Aerohive Third Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jessica Stancil. Please go ahead, ma'am.

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Jessica Stancil, Aerohive Networks, Inc. - Investor Relations [2]

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Thank you, operator. Welcome to Aerohive Networks' third quarter 2018 financial results conference call. After the market closed today, Aerohive issued a press release through Business Wire. The release is also available on our website at aerohive.com. This call is being webcast live on the Investor Relations section of the Aerohive website and will be available for 30 days. Today's call is being hosted by David Flynn, President and Chief Executive Officer; and John Ritchie, Chief Financial Officer and Chief Operating Officer.

During the course of today's call, management will make forward-looking statements, including statements regarding our projections, operating results, expectations for future revenue growth, operating profitability and operating margin, plans for future investments, product development, deployment, adoption and performance and expectations of customer-buying patterns and the growth of the market for our products and business generally. These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, and actual outcomes may -- and results may differ materially from those contemplated by these forward-looking statements as a result of these uncertainties, risks and changes in circumstances that could affect our financial and operating results, including risks and uncertainties included under the captions Risk Factors and Management's discussion and analysis of financial condition and results of operations in our recent annual report on Form 10-K and quarterly report on Form 10-Q.

Aerohive's SEC filings are available on the Investor Relations section of our website at ir.aerohive.com and on the SEC's website at www.sec.gov. All forward-looking statements in this presentation and the referenced press release are based on information available to us as of the date of hereof, we disclaim any obligation to update the forward-looking statements provided to reflect events that occur or circumstances that exist after the date on which they are made except as required by law.

Today, we will be discussing both GAAP and non-GAAP financial measures. The non-GAAP financial measures have been adjusted to exclude certain charges and are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. For a reconciliation of these non-GAAP financial measures to the corresponding GAAP measures and a discussion of why we present non-GAAP financial measures, please see today's press release available on our website.

And now, I'll turn the call over to David Flynn, President and CEO of Aerohive.

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [3]

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Thank you, Jessica, and thank you, all for joining us today. We delivered third quarter revenue within our guidance range and gross margin at the top end of our range. We made excellent progress on our operational efficiency as demonstrated by EPS above the top end of our guidance range and $7 million of cash generation, which has driven our cash balances to a multiyear high of approximately $95 million.

We're very pleased with the continued progress in moving our business to a SaaS-like business model. We delivered record high subscription and support revenue and gross margins, leading this business to account for approximately a third of our total gross margin dollars in the quarter. Strong subscription and renewal orders also led to a record high increase in deferred revenue, bringing our total deferred revenue balances to an all-time high of approximately $76 million.

Strong growth in deferred revenue was a result of cloud subscriptions hitting record high contribution levels, as new customers increasingly embrace our cloud platform, and as existing customers show their confidence in us by renewing and extending their commitment to Aerohive.

While we are pleased to have returned to year-over-year revenue growth in Q3, the growth was dampened by softness in EMEA late in the quarter as well as our focus in Q3, and continuing Q4, on driving our subscription and renewal business. After it became clear that we would be constrained on AX shipments in the quarter, we made this a priority to ensure we cement our customer relationships, enabling us to offer these customers a seamless path to upgrade to our new and 802.11ax products over the coming quarters. The beauty of our architecture is that they can maintain their enterprise-wide cloud management subscription and simply swap out individual access points in a phased transition to 802.11ax, as they are ready.

This quarter, we won a number of new customers as a result of our innovative new products that we've recently delivered to the market.

And now a few of those notable wins ...

Atom, the industry's first enterprise pluggable access point, was deployed to bring WiFi to the dorms at Columbia International University due to its unique plug-and-play deployment model. Atom's plug-and-play deployment model was also instrumental in getting us into a significant trial to provide in-room WiFi for one of the world's largest cruise lines. The trial and our solution are opening up opportunities with several other leading cruising lines, which appears to be a new segment opening up to us.

We are pleased to have delivered on our plan to be the first-to-market with 802.11ax. We made our initial shipments in late July and moved into full volume production in September, leading AX to be 8% of our Q3 WiFi bookings. Our AX leadership was instrumental in landing a number of customers this quarter, including our first win at the Daimler Group in Germany. We believe being first-to-market with AX has given us a material advantage over the competition. And together, these wins contributed to a very strong quarter for our AX products.

We've also seen meaningful traction this quarter with our newly introduced stand-alone secure access offering, A3. The U.K. Cabinet office has deployed A3 to enable the Secure Access Management of their critical infrastructure, and a number of customers that are frustrated with the cost and complexity of Aruba ClearPass and Cisco ISE are in active pilots.

Now moving on to some exciting product updates...

Last month, we made significant enhancements to our A3 stand-alone security offering by delivering another industry-first with the release of cloud-managed secure access management and network access control. Cloud management of our A3 security offering accelerates our mission to radically simplify acccess networking and security through cloud innovation, while reducing cost and complexity. We're pleased by the initial reaction to this product and are encouraged as to the potential to leverage A3 to build a standalone security business.

We continue with rapid innovation of our cloud management platform, including significant addition, such as our machine learning-based, Client 360 and Network 360 dashboards that give IT admins unprecedented visibility into the health of their network.

And we further strengthened our SD-WAN offering with the release of the XR-600 branch router.

And today, we announced a disruptive new solution that can revolutionize network management with native Alexa voice integration into our HiveManager cloud platform. The new Alexa Shortcut Skill empowers busy IT personnel, who are on the go or away from their workstations to onboard devices, monitor network status and troubleshoot issues from their phones. This is further validation where we're retaking our position as an innovation leader in the space.

During the quarter, we benefited from our strategic partnerships with Dell and Juniper. Dell grew sequentially and Juniper has provided excellent engagements in the field, creating a multimillion dollar pipeline for us in the Americas alone. And we're now very excited to be expanding our Juniper partnership to international markets in Q4.

Looking ahead to Q4, while we are on track to continue to deliver year-over-year revenue growth, we are not yet projecting the growth levels we aspire to, because our enterprise business is not fully offsetting a seasonally weak education quarter. However, we are encouraged by positive leading indicators as we reassert our position as an innovator. Our improved product offerings are bringing us into more large opportunities with new customers and in new verticals. While this is encouraging, these new opportunity profiles and the binary nature of these transactions, compels us to view them through a cautionary lens in the short-term.

The need to accelerate growth in our enterprise business, and to capitalize on our increased number of large opportunities, has led me to put in place a sales leader to take our sales team to the next level. I have asked Alan Amrod to return to his roots as a sales leader to run our sales organization, following his successful transformation of our products organization over the last 2 years. Alan and has a rich history in leading successful sales teams at companies including Cisco, Xylan, Alcatel and Xirrus, so I look forward to seeing where he can lead our sales team.

In summary, we continue to work hard and transition the company and are pleased with our team's execution, and we believe we are well positioned for the future.

I'll now turn it over to John to talk in more detail about our financials.

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John Ritchie, Aerohive Networks, Inc. - Senior VP, CFO & COO [4]

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Thanks, Dave. Good afternoon, everybody, and thanks for joining us here today. Before I begin, I would like to remind everybody that all numbers discussed today have been adjusted for ASC 606.

Now moving on to the quarter. I'd like to highlight some financial and operational milestones Aerohive achieved in our third quarter. We exceeded our estimates for non-GAAP operating margin and non-GAAP EPS. We came in at the high end of our guidance for non-GAAP gross margin. Our subscription support business set all-time records for revenues and gross margin. And we had a very strong cash quarter in the third quarter of '18.

During the balance of my prepared remarks, I will cover our GAAP, non-GAAP P&L, our balance sheet for the third quarter and provide some related commentary on our business. I will close by reviewing our financial guidance for the fourth quarter of 2018.

Now moving on to the third quarter, revenue came in at $40.6 million, essentially even with the prior quarter and up $1.3 million or 3% on a year-over-year basis, marking our return to year-over-year growth.

Product revenue in Q3 was $28.8 million, relatively even both on a sequential and a year-over-year basis. Subscription and support contributed over $11.7 million in the quarter and 29% of total revenue, up 5% on a sequential basis and up 16% compared with the same quarter a year ago.

Robust demand for our AX product left us with limited inventory. As such, we refocused our sales teams to concentrate on driving our subscription and renewals business. This was a concerted effort to cement customer relationships and establish a seamless path to upgrade them to our new 802.11ax product families over the coming quarters. We view the growth in our subscription support business as a vote of confidence by our customers. This shift in our sales focus was successful as proven by the significant increase in our deferred revenue, which reached an all-time high this quarter. Our sales team will continue to focus on subscription sales in the fourth quarter, and we have factored this into our guidance for the fourth quarter.

On a geographic basis, revenue in the Americas was $26.6 million, or 66% of total revenue. Americas revenue was up $3.2 million, or 14% on a sequential basis, and up $2.5 million or 10% on a year-over-year basis.

Revenue in EMEA -- in the EMEA region was $11 million, or 27% of total, a decrease of $1.7 million or 13% sequentially, and down $400,000 or 4% on a year-over-year basis. Despite the softness late in the quarter that Dave mentioned in his remarks, we do expect revenue in EMEA to strengthen in the fourth quarter.

Q3 revenue in the Asia-PAC region was $3 million, or 7% of total revenue, down $1.4 million or 32% on a sequential basis and down $800,000 or 21% on a year-over-year basis.

While we view the Asia-PAC region as having tremendous growth potential, we continue to expect that results from this region will fluctuate given the relatively small revenue base.

Looking ahead to the fourth quarter, we are pleased that our innovative product portfolio has brought us into large deals with new logos and in new verticals. Due to the binary nature of these projects, we are being cautious regarding these opportunities.

I'll now turn the discussion to our non-GAAP margins and expenses. For the third quarter, our non-GAAP gross margin came in at the upper end of our guidance range at 66.1%, down modestly as anticipated when compared with the 66.7% in the second quarter and down from 67.5% recorded in the year-ago period. Per previous discussions on this topic, we are seeing modest declines in product gross margins, significantly offset by strong subscription support gross margins. This is reflective of the success we are experiencing in transitioning customer value from our hardware platforms to our feature-rich software subscriptions.

Non-GAAP product gross margin for the quarter came in at 63.3%, compared with 64.6% in the second quarter. On a year-over-year basis, non-GAAP product gross margins declined from 66.3%. This expected decline in product gross margins was partially related to the global MLCC shortage, compounded by higher than usual airfreight costs related to expediting inventory receipts prior to the implementation of trade tariffs.

Non-GAAP subscription and support gross margins were 73% in Q3, up 90 basis points compared to the 72.1% in the second quarter and up 220 basis points when compared with the 70.8% from the year-ago period. This marks a company record and our sixth consecutive quarter of greater than 70% subscription and support margins.

Moving on to non-GAAP expenses...

Non-GAAP operating expenses were $25.5 million in the quarter, down $700,000 or 3% when compared to the $26.2 million in the second quarter and down almost $1 million or 4% from the $26.5 million in the same period a year ago.

Non-GAAP R&D was $7.4 million or 18% of revenue compared to $7.6 million or 19% of revenue in the second quarter. This compares with $7.9 million or 20% of revenue in the same period a year ago. We are pleased with the level of productivity coming out of our R&D organization. By adopting a measured approach to spending and strategically focus our engineering efforts, we have enjoyed our strongest year of product deliveries, and are starting to realize the economic benefits and efficiencies of the cloud.

Non-GAAP sales and marketing came in at $14.3 million or 35% of revenue in the third quarter compared to $14.6 million or 36% of revenue in Q2 and compares with $14.6 million or 37% of revenue in the year-ago period.

Lastly, non-GAAP G&A expenses came in at $3.8 million or 9% of revenue in Q3 compared to $4 million or 10% in the second quarter. This compares with $3.9 million or 10% of revenues in the same period a year ago. This spend level marks a multiyear low in our G&A expenses.

Overall, our non-GAAP operating margin was 3.2%, an increase of 120 basis points compared to 2% in the second quarter of '18, and up 300 basis points compared to 0.2% in the year-ago period.

Our non-GAAP operating income was $1.3 million, an increase of 60% compared to the $800,000 in Q2 and an even greater improvement compared to breakeven in the year-ago period.

We reported non-GAAP net income of $1.5 million in the third quarter, a 74% improvement compared to the non-GAAP net income of $900,000 in Q2, and also a notable improvement from non-GAAP breakeven results in the same period a year ago.

All of this translates to a record non-GAAP net income per share in the third quarter of $0.03, a 50% improvement compared to the non-GAAP net income per share of $0.02 in the second quarter and non-GAAP breakeven EPS in the same period a year ago.

The non-GAAP net income per share for Q3 is based on 56.8 million weighted average common shares outstanding.

On a GAAP basis, in Q3, the net loss was $0.04 per share compared with a net loss of $0.05 per share in the second quarter and $0.09 per share in the year-ago period. Our Q3 GAAP net loss includes stock-based compensation expenses of $3.8 million.

Now moving on to the balance sheet...

We had another exceptionally strong cash quarter with cash, cash equivalents and short-term investments as of the end of September totaling approximately $95 million. Using our Q1 '18 ending balance at the low point, this is an increase of approximately $17 million. This is net of approximately $2.4 million used in conjunction with our share repurchase program over the last 2 quarters. This is our highest cash level since late 2015.

Accounts receivable decreased to $14.8 million as of September 30, compared to $17.2 million at the end of the second quarter. DSOs decreased by 5 days to 34 days from 39 in the prior quarter. We are pleased that these metrics remain in a very comfortable range.

Moving on to inventory. Inventory levels increased $2.5 million coming in at $13.7 million at the end of the quarter, compared to $11.2 million at the end of the previous quarter. The increase in inventory was primarily related to pulling inventory forward to minimize the impact of tariffs.

Our deferred revenue balances now stand at an all-time high of $75.8 million, up $4.5 million from $71.3 million in the previous quarter.

Now moving on to our guidance for the fourth quarter of 2018...

We currently anticipate Q4 revenue in the range of $38 million to $40 million. On a non-GAAP basis, we expect gross margins to be between 64.5% and 65.5%. Though, we, like many companies, are still trying to understand the full impact of the ongoing trade tensions, we want to remind you that only a minority of our product portfolio is currently subject to tariffs. And of that small subset of our product portfolio, which is subject to tariffs, we only pay tariffs on the products sold in the United States. The impact of tariffs across our portfolio is included in our guidance.

On a non-GAAP basis, we expect operating margins to be between negative 2% and 1%. We expect other expenses, including tax expense, to be negligible in the quarter.

And lastly, we expect non-GAAP EPS to be between a net loss of $0.01 per share and net income of $0.01 per share, based on estimated share count of approximately 55.7 million shares outstanding for the last estimate and 57.1 million for the income estimate. On a GAAP basis, we expect Q4 net loss to be between $0.09 and $0.07 per share based on 55.7 million weighted average common shares outstanding. As a reminder, we exclude stock-based compensation and shareholder class action litigation costs from our non-GAAP results.

Now with that, I'll turn the call back over to Dave for some additional remarks.

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [5]

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Thanks, John. In closing, in Q3, we strengthened our product line and delivered profitability, year-over-year growth and strong cash generation. We are making progress on our growth plan as demonstrated by the sustained growth in our subscription and support revenue. And while we are not yet seeing the level of top line growth we aspire to, we still do expect to deliver year-over-year growth, both in Q4 and for the second half. And we are encouraged that our improved product offerings are bringing us into more large opportunities, which suggests definite progress towards our long-term goals. I'd like to thank our partners, customers and employees for their support and loyalty as we continue to improve our execution and our return to growth.

We'll now take your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll go first to Mark Kelleher with D.A. Davidson.

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Mark Kelleher, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [2]

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Just wanted to ask about -- particularly, about the ramping at Juniper. You said that the pipeline was strong, not really seeing that in the Q4 guidance. Is there some start-up time that has to go before we can see some meaningful contribution from Juniper?

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [3]

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Yes, I would say, Juniper contributed some meaningful projects in Q3 and there are some in Q4. But we kind of referenced a few times that we're seeing more large projects in new verticals, with new customers. And Juniper has certainly been a contributor to that. I think what we've found is, sometimes new channel, new customer, new vertical, you have to be a little bit more cautious about your forecast of close on those. There's a risk of getting overenthusiastic about how quickly things have moved. And that's what we are suggesting that there -- we're looking at some of those opportunities with caution in our -- as we lay out our guidance. But we are encouraged that we are seeing more of those opportunities coming from Juniper.

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Mark Kelleher, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [4]

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Okay. And you mentioned some inventory issue with AX. Could you just talk about that a little bit?

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [5]

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So we have -- as we're launching a new product inventory comes in, fits and starts. The good news is, we just about sold out of everything we had in AX. That's -- we've got plenty of AX for the fourth quarter. But we wanted to take advantage of the fact that we could focus the sales folks on the subscription and support business, kind of cementing in that relationship. So when AX became more fully available in future quarters, those customers would already be locked in by extending their subscriptions. And importantly we -- yes, I would just say it was tight during the quarter, and John had commented about fits and starts. But we are beyond that now, and we actually have -- we have good flow of product and are positioned to capitalize on it.

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Mark Kelleher, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [6]

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All right. Last question. The headwind from K-12, could you size that what's that as a percent of revenue, now?

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John Ritchie, Aerohive Networks, Inc. - Senior VP, CFO & COO [7]

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What is K-12 overall?

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Mark Kelleher, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [8]

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Yes. As a percent of revenue? Yes, what's that headwind? I know that's still struggling.

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [9]

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Yes, so year-to-date, K-12 is about 1/3 of the business. It was about 40% year -- in 2017 over the same period. So we've kind of brought down the dependence on K-12. Q3 is usually normally a seasonally strong K-12 quarter, Q4 normally light. This one probably is lighter than usual because some of the E-Rate stuff funded relatively early this year in contrast with last year. So there's a bit more of -- K-12 is softer this Q4 than usual, which is why we needed to grow the enterprise business a little bit more to put up the kind of guide we would have like to put up.

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Operator [10]

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We'll now take our next question from Zack Turcotte with Dougherty.

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Zack Turcotte, Dougherty & Company LLC, Research Division - Analyst [11]

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Zack on for Catharine. If we kind of go back into the vertical a little bit, if you could quantify at all other verticals that you felt were strong in the period or weaker than normal in the period? And where you feel you have the biggest opportunity going forward for growth outside of education?

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [12]

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Yes. So inside the quarter, as we mentioned, the EMEA had -- was soft late in the quarter. It was -- had been a grower, it has been growing strong double-digit growth rates in the first half and it actually dipped. So that -- and that's our strongest enterprise territory. So that actually dampened some of the enterprise results inside the quarter. Actually, educational was strong because of the -- as we said, some of the early funding in some of the E-Rate letter. So, that was a bit of an anomaly from where we were in the prior quarters but year-to-date, as I said, we have substantially reduced the dependence on education with year-to-date taking it down from 40% to 1/3 of the business. As we look forward, absolutely, we see enterprise as a great market. We are seeing -- I mentioned the cruise line and some other hospitality segments that we are very encouraged with. Universities is growing as well as we have some very interesting kind of retail in health projects, kind of the other -- some of the other core markets we've been talking about. And so we expect to continue to reduce our dependence on education over the coming quarters.

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Zack Turcotte, Dougherty & Company LLC, Research Division - Analyst [13]

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Got it. And you said the softness in EMEA is expected rebound in Q4, correct?

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John Ritchie, Aerohive Networks, Inc. - Senior VP, CFO & COO [14]

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That's correct.

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Zack Turcotte, Dougherty & Company LLC, Research Division - Analyst [15]

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Okay. Got it. The only other thing I think, beyond the Juniper partnership in Q3, is how the Dell partnership is progressing? If you expect any sort of ramp-up from that in, say, the next 12 months?

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [16]

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I did indicate, we did see Dell grow sequentially from Q2 to Q3. I think on the last quarter's call, we did indicate the Dell had actually been surprisingly down sequentially. So pleased that we saw it turn more positive. We can continue to work to grow that relationship, and hopefully, we can continue to grow it going forward. And also very excited about the Juniper partnership and its potential to get us into new types of accounts going forward.

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Operator [17]

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We'll take our next question Erik Suppiger with JMP Securities.

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Erik Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [18]

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First off on the tariffs, do you do -- you said that only a small portion of your portfolio is going to be subject to tariffs. Do you do most of your manufacturing outside of China? Or can you talk a little bit about where -- what portion is in China?

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [19]

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We do 100% of our manufacturing in China. It's just the categorization of our products fall outside of those products that are categorized as being subject to the tariffs.

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Erik Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [20]

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Okay. Would you consider moving the manufacturing to another country? Or is it small enough that, that's not worth it?

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [21]

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No. We're reviewing all options at this point. Even that subset, we prefer not to pay tariffs on the subset of products that are subject to the tariffs. But yes. We clearly are looking at moving elsewhere. Obviously, that is a moving target about what future expeditions are on tariffs, and clearly -- and we know now where we stand. There's talk about higher tariffs and maybe change in categories in the future that could change things and change the dynamic. But for now, we feel we're in pretty good shape.

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Erik Suppiger, JMP Securities LLC, Research Division - MD & Senior Research Analyst [22]

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Okay. And then anything new on the competitive front, either with Cisco/HP or with some of the low-cost vendors like Cambium or Ubiquiti?

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [23]

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No, I don't think we've seen -- frankly, there hasn't been a material change in the core competitors in terms of what we see with Cisco. Obviously, more and more Meraki, generally as we go forward with Cisco. HP, unchanged. We don't see Cambium that -- that's a name that never comes up in a conversation here.

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John Ritchie, Aerohive Networks, Inc. - Senior VP, CFO & COO [24]

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Literally never comes up. We do see Ubiquiti on the rare occasion, not -- our paths don't cross very often, but our paths never cross with Cambium.

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Operator [25]

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And it appears there are no further questions at this time. I'd like to turn the conference back to David Flynn for any additional or closing remarks.

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [26]

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Thank you. Thank you all for joining us today. We will be presenting at the Needham Conference in New York on November 13. So we look forward to seeing you there or at upcoming conferences on the road. Thank you.

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Operator [27]

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And this concludes today's call. Thank you for your participation. You may now disconnect.