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Edited Transcript of HIVE earnings conference call or presentation 8-May-19 9:00pm GMT

Q1 2019 Aerohive Networks Inc Earnings Call

Sunnyvale May 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Aerohive Networks Inc earnings conference call or presentation Wednesday, May 8, 2019 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

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Conference Call Participants

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* Mark Daniel Kelleher

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

* Tyler Leroy Burmeister

Craig-Hallum Capital Group LLC, Research Division - Associate Analyst

* Melanie Solomon

The Blueshirt Group, LLC - MD

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Presentation

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Operator [1]

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Good day, and welcome to the Aerohive First Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Melanie Solomon. Please go ahead.

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Melanie Solomon, The Blueshirt Group, LLC - MD [2]

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Thanks, Todd. Welcome to Aerohive Networks' First Quarter 2019 Financial Results Conference Call. Today's call is being hosted by David Flynn, and Chief Executive Officer; and John Ritchie, Chief Financial Officer and Chief Operating Officer.

We just distributed a press release and filed an 8-K detailing Aerohive Networks' first quarter 2019 financial results. Copies of these documents which include our GAAP to non-GAAP reconciliations are available on the Investor Relations section of our website at ir.aerohive.com. This call is also being webcast live on our website and will be available for 30 days.

I'd like to remind you that during today's call, our discussion may include forward-looking statements about Aerohive Networks and its future business and financial and operating results, products, customers and markets. These statements involves risks and uncertainties that may cause actual results to differ materially from those anticipated by these statements. The risks and uncertainties include those described in the risk factors outline under the captions risk factors and management's discussion and analysis of financial condition and results of operations in our reports filed with the SEC including our most recent Form 10-Q and Form 10-K, both available on the Investor Relations page of our website 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 hereof, and we disclaim any obligation to update the forward-looking statements provided to reflect events that occur or circumstances that exist after the date in which they were made except as required by law.

Today, we'll be discussing both GAAP and non-GAAP financial measures. The non-GAAP financial measures have been adjusted to exclude certain charges. 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, Melanie, and thank you all for joining us today. While we delivered first quarter results in line with our pre-announcement last month, I want to spend some time discussing the revenue shortfall before getting into some of the highlights from the quarter and our go-forward view on the business.

Revenue came in below our original forecast primarily because of 2 factors. One was a sales execution issue in the United States and the second factor was a two-pronged mix shift.

First, on sales execution. The sales team delivered results at or above forecast in EMEA, in APAC and in much of the Americas but this was not enough to compensate for very disappointing results in a few territories in the U.S. To be frank, a much more active 2019 E-Rate cycle with an end of March deadline for customers to make their vendor selection and file their funding requests likely caused some salespeople to take their eyes off the ball and overly focus on E-Rate at the expense of Q1 business.

On the positive side, our 2019 E-Rate campaign yielded very strong results. Reporting by ErateProfitWorks on customer funding requests shows industry-wide demand increased by 24% over 2018 and demand for Aerohive solutions specifically increased 55% year-over-year, then certainly a significant increase in market share for Aerohive. We expect these funding requests to start to turn into orders beginning this quarter but primarily to contribute to revenue over the second half of the year.

This lack of focus on closing imminent deals hurt our top line in Q1. And while we are optimistic about our position in the 2019 E-Rate cycle, I'm disappointed in the team's execution. We've made changes in regional leadership and organizational design to improve the focus, execution and productivity of the U.S. sales team. We plan for these actions to return sales efficiency in Q2 to levels at or better than levels seen in the second half of 2018 and to drive growth in the second half of the year.

Turning to the mix shifts. Now first, we experienced an unexpected mix shift in unit product mix from mid- to lower-priced access points. Because deal value on lower-priced access point business is more heavily weighted toward deferred subscription revenue, this mix shift reduced upfront revenue in the quarter. We believe this buying pattern was an anomaly in the quarter and not an indication of a future trend. And that belief is supported by our April order pattern and our Q2 deal pipeline, which both have returned to a more typical mix.

The second part of the mix shift was a faster-than-expected transition from licenses to multiyear subscriptions. This demonstrated increasing acceptance of our subscription-based cloud offering. However, it also resulted in a greater portion of revenue being deferred in the quarter.

We're pleased with the record amount of deferred revenue generated in the first quarter, but the downside was reduced in-product -- in-quarter product revenue. Despite the lower-than-expected revenue in the first quarter, we are encouraged that the sales execution issues were regionally isolated and appear fixable and that the mix shift was an anomaly. We're also encouraged by execution and results in many other aspects of the business that demonstrate we are making progress in executing to our plan. In Q1, we delivered record levels of subscription and support revenue and deferred revenue, demonstrating the continued progress in transforming towards a SaaS-like business model.

The EMEA region had another strong quarter showing continued year-over-year growth and a record Q1. This is based on strong sales execution and the strength of our channel in EMEA. We're very pleased with the results of our EMEA business over the last 5 quarters, and we're actively working to emulate that success across other regions.

Our Wi-Fi 6, or 802.11ax, access points are rapidly being embraced by customers, increasing sequentially from 15% to 20% of our total Wi-Fi business in Q1. In contrast, most of our competitors have only recently released their first Wi-Fi 6 access points and are still validating them in production networks. We believe that our early Wi-Fi 6 leadership and the increased ASPs of these products significantly contributed to the strong increase in our E-Rate market share.

We saw double-digit year-over-year growth in our health care business in the quarter which is anchored by our industry-leading position in the long-term care market, a market in which Aerohive is used by the top 4 providers and 6 of the top 10 in the U.S. The highlight in Q1 was a high-6-figure win to provide Wi-Fi 6 wireless and switching across 90 health care facilities in the southeast. The capacity of Wi-Fi 6 and the reduced operating expense of our single pane of glass, wired plus wireless solution were key to the win.

We had a good quarter with Dell including a number of 6-figure wins with many in the higher education space. One of those was a new customer win at a major university in Ireland, a country where we have no direct Aerohive presence. And this win demonstrates the potential for Dell to extend our reach.

We are seeing clear signs the U.S. education market is returning to growth, positioning this market to turn from a headwind to a tailwind. We're seeing high levels of interest in upgrading to 802.11ax for increased Wi-Fi efficiency and in embracing our cloud-managed AI and machine-learning-driven network architecture to simplify network deployment, operation and troubleshooting. We believe our increased share in E-Rate funding requests demonstrates the market appeal of our solution and our opportunity to benefit from the 2019 E-Rate cycle and beyond.

While we made significant progress in these areas, that progress was undermined by the lack of predictability we saw in the business in Q1. We know we need to improve in this area and we're working hard to improve both our sales execution and predictability of our results. As I mentioned earlier, we've already taken action to approve sales execution in the Americas. We are also driving to increase predictability by growing our recurring revenue business and by working diligently to close deals earlier in the quarter to reduce risk and back-end loaded -- loading. So far in Q2, we're seeing very strong order linearity which, combined with our highly predictable and growing subscription and support business, gives us a high degree of confidence in our outlook, which John will detail in a few minutes.

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, and good afternoon, everybody, and thanks for joining us here today. I'd like to start by providing some additional granularity as to what drove the lower-than-expected revenue performance in the first quarter. As Dave mentioned, the shortfall was attributable to 2 mix shift issues and a regionalized sales execution issue.

Regarding the mix shift issue, we saw an unprecedented mix shift towards our lower-priced products at the expense of our midrange products. Interestingly on a SKU-by-SKU basis, we saw minimal pricing erosion across the low-end and midrange product lines, with the resulting mix shift contributing to the revenue shortfall. On a unit basis, we shipped approximately the number of units we expected but the mix was materially different than anticipated, resulting in the lower revenue levels.

In addition, the mix also -- the mix shift also resulted in a higher percentage than usual of revenue being deferred. Because whether you purchase our higher- or lower-range products, the support and subscription prices are generally the same. As such, more of the dual value was deferred with lower-priced products. Lastly on the mix topic, we saw more customers than anticipated move from our perpetual license to our multiyear subscription product offerings.

Moving on to the sales execution issues. Our Americas sales team, specifically the U.S., fell well short of their bookings goals. We have already begun several corrective actions towards remedying this situation.

Next, I'd like to highlight some milestones Aerohive achieved during our first quarter. Our subscription and support business continues to perform very well. In Q1, we set a new record for subscription and support revenues. Our subscription and support businesses averaged growth in the mid-teens on the year-over-year basis for the trailing 5 quarters, and we expect this streak to continue in the second quarter. Q1 of '19 also marked the eighth consecutive quarter of greater-than-70% non-GAAP gross margins for our subscription and support business, another trend that we expect to continue in the second quarter.

Now during the balance of my prepared remarks, I will cover our GAAP, our non-GAAP P&L, our balance sheet for the first quarter and provide some related commentary on our business. I will close by reviewing our financial guidance for the second quarter of 2019.

Now moving on to our first quarter results. Revenue of $33 million was down $5.1 million or 13% sequentially and down $2.8 million or 8% on a year-over-year basis. Product revenue in the first quarter was $20.5 million, down $5.1 million sequentially and down $4.6 million on the year-over-year basis. Subscription support contributed over $12.5 million in the quarter for a total of 38% of revenue, nominally up on a sequential basis and up over 17% on a year-over-year basis.

Geographically, revenue in the Americas was $17.2 million or 52% of total revenue. Americas revenue was down approximately $3.5 million or 17% both sequentially and on a year-over-year basis. Americas revenue was impacted by the previously mentioned mix shift and sales and execution issues in the U.S.

Revenue in the EMEA region was $12.8 million or 39% of total revenue, a decrease of $1.7 million or 12% sequentially as expected in the seasonally down first quarter. Revenue was up $900,000 or approximately 7% on a year-over-year basis. The continued year-over-year European growth highlights the success we are seeing in the enterprise sector with our channel-centric approach. We are seeing record high levels of productivity with our EMEA sales teams and we're actively working towards emulating this in the U.S.

Moving on to Asia-Pac for the first quarter. Revenue was $3 million or 9% of total, an increase of 4% sequentially and essentially even on a year-over-year basis.

I'll turn the discussion to our margins and expenses. In the first quarter, non-GAAP gross margin came in at 62.5% compared with 66.3% in the fourth quarter and 67% in the year-ago period. Non-GAAP product gross margins for the quarter came in at 56.2% compared with 62.4% in the fourth quarter and 65.5% in the year-ago period. The decline in gross margins is related to the previously mentioned mix shift to lower-priced products which carry lower margins combined with fixed costs over lower-than-anticipated revenue levels.

Non-GAAP subscription and support gross margins came in at 72.8% in the first quarter compared with 74.2% in the fourth quarter of last year and 70.5% in the year-ago period. This marks our eighth consecutive quarter of greater-than-70% gross margins and is reflective of the success we are seeing in transitioning customer value from our hardware platforms to our feature-rich subscriptions.

Now moving on to our non-GAAP expenses. Non-GAAP operating expenses came in at $25.7 million in the quarter, up $700,000 or 3% on a sequential basis and down $1.7 million or 6% on a year-over-year basis. The resetting of the FICA payroll tax clock contributed almost all of the sequential increases in our operating expenses in the first quarter.

Non-GAAP R&D was $7.7 million or 23% of revenue compared to $7.6 million or 20% of revenue in the fourth quarter, and this compares with $8.2 million or 23% of revenue in the year-ago period.

Non-GAAP sales and marketing came in at $13.6 million or 41% of revenue in Q1 compared to $13.4 million or 35% of revenue in Q4 of '18 and compares with $14.7 million or 41% of revenue in the year-ago period. We expect sales and marketing expenses to return to the mid-30% levels of revenue that we saw throughout most of 2018.

Lastly, non-GAAP G&A expenses came in at $4.5 million or 14% of revenue in Q1 compared with $4.1 million or 11% in the fourth quarter of '18. This compares with $4.5 million or 13% of revenue in the year-ago period.

Overall, our non-GAAP operating margin was negative 15% compared to approximately 1% for Q4 of '18 and compared to negative 10% in the year-ago period. As a reminder, Q1 is typically our low point in operating margins for the year due to the revenue seasonality.

Our non-GAAP operating loss was $5.1 million compared to a non-GAAP income of $200,000 in the fourth quarter and an operating loss of $3.4 million in the year-ago period. We reported a non-GAAP net loss of $4.8 million in the first quarter compared with a non-GAAP net income of $400,000 in the fourth quarter of '18 and a non-GAAP loss of $3.5 million in the year-ago period. All of this translates to non-GAAP net loss per share in Q1 of $0.09 compared to non-GAAP net income per share of $0.01 in the fourth quarter and a non-GAAP loss of $0.06 per share in the year-ago period. The non-GAAP net income for the first quarter is based on 56 million weighted average common shares outstanding.

On a GAAP basis, for the first quarter, the net loss was $0.15 per share compared with a net loss of $0.10 per share in the fourth quarter and $0.13 in the year-ago period. As a reminder, our Q1 GAAP net loss includes stock-based compensation expenses of approximately $3.6 million.

Now moving on to our balance sheet. Cash, cash equivalents and short-term investments as of the end of March totaled approximately $82 million, an increase of $4 million when compared to March of last year. The sequential decline from our year-end balances is reflective of our normal operating seasonality combined with soft Q1 results. We expect cash, cash equivalents and short-term investments to increase in the second quarter.

Accounts receivable increased to $18.8 million as of March 31 compared to $16.2 million at the end of the fourth quarter of '18. DSOs increased to 51 days from 39 in the prior quarter. Despite the increase, we're comfortable with DSOs in this range. Inventory levels decreased $800,000, coming in at $15.3 million at the end of the quarter compared to $16.1 million at the end of the prior quarter.

Moving on to our deferred revenue balances which now stands at an all-time high of $79 million, up $1.7 million from the $77.3 million in the prior quarter. On a year-over-year basis, our deferred revenue balances increased $11.1 million or over 16%. It is important to note that deferred revenue growth comes at the expense of recognizing in-period revenue. We view the growth in our subscription and support business as a vote of confidence by our customers, that they are increasingly relying on us to run their cloud managed networks well into the future.

I'll now move on to our guidance for the second quarter of 2019. We are currently anticipating revenues in the second quarter in the range of $37.5 million to $39 million. Given the sizable short call in last quarter's revenue, we have taken extra steps to increase confidence in the guide. We have substantially more pipeline coverage support -- to support the guidance that we're giving. And this level of pipeline coverage is as great as it's ever been at this point in a quarter. The first month of the quarter is trending very favorably, as Dave previously mentioned. We have begun the execution of realigning our resource in the Americas to emulate the significant success we're seeing in the EMEA region. And lastly, we have an extremely high level of confidence that our subscription and support revenue will grow on a year-over-year basis in the mid-teens, which we expect will translate to approximately 1/3 of our revenue for the second quarter. On a non-GAAP basis, we expect a rebound in gross margins and to return to 64% to 65%.

I want to touch on the tariff topic. As a reminder, only a minority of our products are currently subject to tariffs and we only pay tariffs on the products sold into the U.S. Hence, the impact of the current tariffs across our product portfolio is included in our guidance. However, it is not yet clear how the most recent comments on potential new tariffs may affect us.

Moving on to our operating margins, we expect them to be between negative 2% and 1% in the second quarter. We expect other expenses, including tax expenses, to be negligible in the quarter.

And lastly, from an EPS perspective, we expect to be between a loss of $0.01 and profit of $0.01 based on approximately 56.7 million and 58 million shares outstanding respectively. On a non -- on a GAAP basis, we expect Q2 net loss per share to between $0.07 and $0.05 based on approximately 56.7 million weighted average shares outstanding. As a reminder, we typically exclude stock-based compensation, shareholder class action litigation costs as well as restructuring costs amongst other items from our non-GAAP results.

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. Despite the revenue challenges in the first quarter of 2019, we are encouraged by the strong performance in key aspects of our business, such as EMEA, our subscription and support business and our strong E-Rate results, all of which demonstrate the customer acceptance of our cloud networking platform.

Our priority now is to improve sales execution and results in the Americas so that it's no longer a growth inhibitor, which should enable us to more fully deliver on the business opportunity that the strength of our product offering enables. We've taken action here and we're encouraged by the strong start to Q2.

I'd like to thank our employees, partners and customers for their ongoing support and commitment.

I will 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 take our first question from Mark Kelleher of D.A. Davidson.

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

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The E-Rate pickup seems pretty encouraging. What do you think the ramp of that looks like? You said it's going to be a little bit in this quarter, but does that -- is it a little bit more in September and then a lot more in December? How does the seasonality play out there? And kind of connected to that, I know you said that the 802.11ax, WiFi 6, was helping that. Is there a situation where that may have been delaying sales in the March quarter?

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

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Yes, so with regard to E-Rate. You're right that it was very encouraging both that the industry returned to growth, 24% year-over-year growth, and that we grew much faster. Our -- the funding requests for Aerohive was up about 55%, so a nice increase in market share. So very encouraged by that.

The timing of when E-Rate is actually booked is -- it has wiggled around a lot over the years because some depends on the pace at which the FCC -- the USAC part of the FCC actually issues funding letters. But broadly speaking, we've seen a portion of that, 10%, maybe 20% on the high end or so. 10-ish-percent kind of showing up early and people buying ahead of the official release of funds, which is July 1 and later. And the bulk of it tending to be kind of Q3 and Q4 if they get the funding letters out on a normal basis. So would expect the vast majority to be Q3, Q4. Some can trickle on into the next year, but that's the typical seasonality with the concentration in Q3 if they are executing smoothly and getting funding letters out.

The ax issue. So we don't see -- the ax, we're shipping in volume. And until we have no -- there's no issue with people waiting for ax or for that impeding funding. The education spending in Q1 is always a light quarter because if they want to do fund E-Rate process, they have to purchase after April 1. So Q1 was a particularly low education quarter, in the very low 20% of the business. That's a little bit lower than usual but kind of as expected. But we see ax as mostly an ASP upgrade and we think it helps us with our share grade -- share gain because we were out ahead of the competition.

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

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Okay. And last question. You said the shift to the low-end access points was an anomaly. Is there anything, really nothing, that drove that? Are you sure that, that was an anomaly?

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

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Well, actually, great question. So we've looked at our pipeline for the current quarter, we looked at the mix shift and products that we shipped so far in April and it's looking like a snapback. And you can see that in our guidance, right? We're back to the guidance we gave you in gross margins. So all indicators were it was an anomaly, it was also somewhat regionally focused as well, and we're seeing the snapback. Again, that's what gives us confidence that we'll see margins take such a big step up in the second quarter.

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Operator [6]

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(Operator Instructions) We will take our next question from Christian Schwab of Craig-Hallum.

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Tyler Leroy Burmeister, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [7]

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This is Tyler on for Christian. So first, I was wondering if you could just help draw some parameters on the E-Rate funding. I believe you said education as a whole was about 30% of revenue last year. What percent of that education -- I assume it's a large part, but what percent of that is directly E-Rate?

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [8]

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Yes, E-Rate is typically less than half of that. There's a bunch -- all of the international education business doesn't -- is unrelated to E-Rate. And even in the U.S., it's somewhere -- or roughly half. So you could expect modestly below 50% of that business will be E-Rate.

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Tyler Leroy Burmeister, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [9]

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Awesome. And then I was hoping for maybe a little bit of an update on your expectations with the Dell and Juniper agreements. I guess maybe first, if you could somehow -- what are they contributing to results now? And what's a maybe full run rate at year 2, kind of all of their contribution?

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [10]

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Yes, so the durable relationship is kind of in a wind-down following the purchase of Mist. It had never become a very material portion of the business. I think orders of magnitude of just modestly above 1%, I think, in Q4. So did not have a material impact in the business. We'd originally hoped it would be a growth catalyst, but it hadn't developed into that prior to the acquisition. So that's not going to contribute.

And with the growth of Dell, Dell is generally a material customer in that -- around the 10%-ish range. We saw a good quarter with Dell, optimistic that it will continue at that level and hopefully increase modestly.

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Tyler Leroy Burmeister, Craig-Hallum Capital Group LLC, Research Division - Associate Analyst [11]

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All right, great. And then I understand it's Q1, but looking out for the rest of the year, confident it will bounce back here in Q2. Do you guys believe you can grow full year revenue for the full year 2019?

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John Ritchie, Aerohive Networks, Inc. - Senior VP, CFO & COO [12]

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Well, given that we should be begrudgingly give one -- a quarter's worth of guidance, that's hard to respond to because we're going to stick to that given quarter's worth of guidance. We -- different way of answering that, we think that E-Rate, given that E-Rate's going to be a back-half event for us, puts us in a position to have some growth in the back-half. But again, we're working at building credibility back 1 quarter at a time at this point given the size of the Q1 miss. So a little bit reticent to jump to telling a great back-half story, although we think we have all the components for a great back-half story. We'll give you more updates on that when we get into our second quarter conference call.

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Operator [13]

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Thank you. This concludes our question for today. I'll turn it back to management for closing remarks.

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David K. Flynn, Aerohive Networks, Inc. - Chairman, President & CEO [14]

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All right, thank you. And I thank you all for joining us today. Later this quarter, we will be at the Craig-Hallum and Bank of America Merrill Lynch conferences. We look forward to seeing many of you there. Thank you.

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John Ritchie, Aerohive Networks, Inc. - Senior VP, CFO & COO [15]

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Thank you. Have a good night.

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Operator [16]

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Thank you. Ladies and gentlemen, you may now disconnect and have a great evening.