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Executives

Steve Pasko – Market Street Partners, Investor Relations

Dr. Bami Bastani – President and Chief Executive Officer

Larry Vaughan – Senior Vice President, Worldwide Sales, Services and Support

Brian McDonald – Chief Financial Officer

Analysts

Jason Ader – William Blair & Company, L.L.C

Rajesh Ghai – Craig-Hallum Capital

Meru Networks, Inc. (MERU) Q2 2013 Earnings Conference Call July 30, 2013 5:00 PM ET

Operator

Good day ladies and gentlemen and welcome to the Meru Networks’ Q2 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. (Operator instructions) As a reminder, this conference is being recorded.

I would like to introduce your host for today’s conference Mr. Steve Pasko. Mr. Pasko, please began.

Steve Pasko

Thank you. Thank you for standing by, and welcome to the Meru Networks’ second quarter 2013 conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, this conference will be open for questions. On the call today are Dr. Bami Bastani, President and CEO; Larry Vaughan, Senior Vice President of Worldwide Sales, Services and Support; and Brian McDonald, CFO.

During the course of this call Meru Networks’ management will make forward-looking statements regarding future events and the future financial performance of the Company. Generally these statements are identified by the use of words such as expect, believe, anticipate, intent and other words that denote future events. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important risk factors that could cause actual results to differ materially from those in the forward-looking statements. These risk factors are described in our press release and are more fully detailed under the caption Risk Factors in Meru’s most recent Quarterly Report on Form 10-Q as filed with the SEC and the Company’s other filings with the SEC.

In addition several non-GAAP financial measures will be mentioned on this call. These non-GAAP measures are not intended to be considered in isolation from, a substitute for or superior to our GAAP results and we encourage you to consider all measures when analyzing Meru’s performance.

Information relating to the corresponding GAAP measures as well as reconciliation of a non-GAAP measures and GAAP measures can be found in our press release on our investor relations website at www.merunetworks.com. The press release have also been furnished to the SEC as part of a Form 8-K. Please note that any forward-looking statements that we make today are based on assumptions we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events.

Now, I’ll turn the call over to Dr. Bami Bastani, President and CEO

Dr. Bami Bastani

Thank you, Steve. Good afternoon everyone and thank you for attending our second quarter 2013 conference call. I’m very pleased to report that we ended Q2 solidly within our guidance, despite a challenging macro economic climate. We delivered record revenue from a Q2 with $26.5 million and delivered earnings per share at the high end of our guidance.

We also increased gross margins from 63.5% in Q1 to 65.4%, a record for the Company. In Q4, last year, I projected that we will use less than $6 million in cash for the first half of 2013 and I’m pleased to report that the actual figure was $3.5 million, which included debt services of $2.2 million. We ended the quarter with $32 million in cash which was higher than expected. Brian will provide more financial details in his section.

I would now like to discuss some of the specific factors that are driving our business performance, these include execution against the turnaround of strategy that we outlined in April 2012, our vertical market focused primarily on education, healthcare, and hospitality, technology innovation and new product releases as evidenced by our launch of the AP832, the industries fastest 802.11ac access points and strengthening the global management team.

Our Q2 results including revenue growth and gross margin expansion and operating expense reductions demonstrate that the turnaround is progressing well, we continue to primarily focus on three key verticals education, healthcare and hospitality which IDC projects will total $1.8 billion in global revenues this year, growing to $2.5 billion in 2016.

This is almost half of our $4 billion total addressable wireless LAN market in 2013. Meru’s solutions are proven very attractive in these verticals in which we believe we have a clear advantage over the competition. Awareness of Meru’s value propositions and unique competitive differentiators are higher than ever before driven by targeting, target marketing campaign and continued product innovation.

We have just completed the lunch of our 802.11ac or gigabit WiFi offering the AP832. The combination of enhanced performance and cost avoidance that Meru 802.11ac offers is proving extremely resonant with customers and partners and we believe we will see increased traction going forward. As we have discussed for a number of quarters now 802.11ac gives Meru a unique opportunity to clearly demonstrate the customer benefits of the Meru single channel architecture.

The AP832 is the market's fastest access point and the only solution with two 802.11ac radio broadcasting on 80 MHz channels in the 5 GHz band. This gives customers the full 1.3 gigabits per second data rate per radio specified by the standard. Furthermore, and perhaps of equal importance, the Meru 802.11ac solution stands alone in its ability to enable the use of three spatial streams over two 802.11ac radios on a standard power over Ethernet.

This eliminates the need for customers to upgrade their entire Ethernet switch infrastructure as almost all of our competitors currently require they do. Even in those cases, where our competition enables us, enables use of 802.11ac access points with a standard power, data rates are effectively slashed by as much as 40%.

We’re very pleased with the response we received from press and industry analyst with whom we met with during the launch and want to express special thanks to both University of Houston and Bellarmine College Preparatory who participated in our launch webinar. We are truly grateful for their partnership.

Some of our other recently announced products or also gaining market traction with the AP332 our three-stream near-gigabit 802.11n access point now it is in second full quarter of shipments having outpaced sales of previous flagship products, such as AP320.

Our Identity Manager Guest Access and Management Solution also continues to gain traction in the market. Our customers note its ease of installation and management specially when compared to similar solutions from our competition. Many of these require deployments of multiple products developed by various companies to achieve the same results.

Turning now to our leadership team, Meru was fortunate to have added a number of new executives in Q2, aligning technology market expertise with core strategic needs, both at our headquarters in Sunnyvale and in key geographies worldwide.

Brian McDonald, who you will hear from later in the call, joined the company in June as Chief Financial Officer. Brain had served as CFO in a number of rapidly growing Silicon Valley Technology companies. We also added Mark Liu as General Counsel, Mark comes to us from NETGEAR.

In addition we’ve strengthened our leadership team in Asia-Pacific adding Kishore Reddy, as Vice President and Managing Director for India and Jeff Sage as Vice President of Sales for Asia-Pacific region. We also consolidated the education and healthcare BUs under Sarosh Vesuna and hospitality and cloud services under Srinath Sarang. I am very pleased with the leadership team we have established and the structure we have now in place to support our continued growth.

To close that and review the forces and conditions that I believe it will continue to drive our growth and guide us toward profitability. We continue to execute strongly against a turnaround of strategy that we outlined in April 2012 our primary focus on three key vertical markets, education, healthcare and hospitality is serving us well. Our technology innovation as evidence by our 802.11ac launch and a strong sales ramp of our AP332 continues and is gaining the strength and our global management team is at the strong as at any times in the Company’s history.

I will now turn the call over to our Senior Vice President of Worldwide Sales & Field Operations, Larry Vaughan for more on our sales vertical market and channel strategies, Larry.

Larry Vaughan

Thank you, Bami. Marketing sales and channel support continue to gain strength in Q2 with notable new activity in education, healthcare and the hospitality industries. Enhanced channel programs, new technological announcements and our new Asia-Pacific executive leadership.

We continue to build on our commitment of being a channel centric and channel led organization this quarter. In Q2 we launched new programs designed to streamline the purchasing process for Meru U.S. distributors and resellers. This greatly increases the ease of doing business with Meru clarifies differentiation among Meru partnered destinations and recognize an incensed partners who lead with Meru and drive deals to closure. These changes have been very well received by U.S. partners and we are in the process of rolling them out to the other geographies now.

In addition we partnered with leading technology distributor Westcon in Spain, Mexico and Brazil increasing our reach and making it easier for resellers in those countries to engage customers with Meru solutions. Focusing on our vertical markets the Meru Education Grade or MEG initiative continued to attract new customers and new partners in Q2.

Education program enhancements in Q2 included engaging a new education focused distributor and further in deployments with some of our largest customers. These included three of the top 10 K3-12 school districts in a country, one of whom opted to go with our new 802.11ac solutions over a previously planned 802.11n upgrade. Our 802.11ac launch was heavily education supported with a K3-12 institution, Bellarmine College Preparatory in San Jose as well as the University of Houston acting as references for the launch.

Notable customer wins in the education industry in Q2, included a large school district in Georgia and academy in UK and several municipalities in school districts in the Nordics and Germany. In healthcare Q2 customer wins included an expansion at healthcare center in the UK and renewal at a major healthcare center in the Midwest. Others wins included a private healthcare center in the UK, a hospital within a major healthcare group in Western Japan and a leading hospital in Spain.

In hospitality Meru, exhibited in Q2 at HITEC, the world’s largest hospitality trade show. We also added a number of new customers including a major luxury cruises line, a prominent hotel in the United Arab Emirates and a prominent five star hotel in the part of Bangkok’s shopping district.

Meru’s solutions were also selected by a major Western U.S. International Airport to provide high density WiFi in the airport terminals. This is an addition to a major global airline, which selected Meru for in flight WiFi.

The 802.11ac solutions from Meru with our clearly differentiated value proposition focused on performance gains and total cost of ownership reduction is resonating strongly in the market. Large customers and new prospects from each of our target verticals have expressed interest in our solutions since the launch.

802.11n products will continue to represent the majority of our sales in the near-term, especially in this period where N devices continue to dominate the consumer electronics market. The increased availability of ac devices after the 2013 holiday season will fuel growth for these new networks in 2014. We believe that the very low difference in price between our n and ac solutions coupled with the improved performance of N devices on ac networks will result in a quick ramp for solutions based on the new standards.

As Bami previously noted we greatly strengthened our leadership team this quarter with the addition of Kishore Reddy as VP and Managing Director for India and Jeff Sage as VP of Sale for Asia pacific. We are very excited about their joining Meru and I look forward to working with Kishore and Jeff as we continue to peruse the many opportunities that lie ahead for us in Asia.

To summarize, Q2 was a very positive quarter for Meru with a lot of growth in important growth areas and any number of programmatic improvements and enhancements that will build on in the second half of the year. Many of the processes we have implemented improved sales efficiencies and enabled us to better serve our customers and partners. As always I would like to thank our customers, partners and sales teams around the world for other great quarter.

And with that, I will turn the call over to Brian.

Brian McDonald

Thanks Larry. Please note that the following discussions of our operation results will be on a non-GAAP basis, which excludes stock-based compensation expense, amortization of acquisition-related intangibles and amortization of an outstanding common stock warrant.

For a reconciliation of GAAP to non-GAAP results, please refer to the press release issued today, and the supplemental financial information, which is posted on our Investor Relations website.

As Bami mentioned, we are very pleased with our Q2 financial performance which exceeded our expectations for gross margin and cash balance, and achieved a high-end of our EPS range. Total revenue for the second quarter were $26.5 million, up 8% year-over-year and within our guided range. Product revenues were $21.7 million, up 7% from Q2 last year. Support and services revenue were $4.7 million up 14% from Q2 of last year.

Approximately 64% of Q2 revenues were from the Americas, 27% were from EMEA and 9% were from Asia-Pacific. Americas grew 25%, and Asia-Pacific grew 22% year-over-year. EMEA declined 21% impacted by a large deal in Q2 of 2012. Normalizing for this, EMEA revenue grew by 10% and total revenues grew by over 20% year-over-year. Total non-GAAP gross margin in Q2 was a record 65.4% and above the high-end of our guidance.

As we have previously mentioned, we expect our gross margins to improve going forward and continue to target our long-term gross margin range at 65% to 68%. Total non-GAAP operating expenses were $17.9 million down 11% from Q2 last year and up 5% form last quarter, and inline with our expectations.

The year-over-year decrease relates primarily to an 18% decrease in sales and marketing expenses offset by an increase in our R&D expenses of 10%. Our Q2 non-GAAP net loss was $1.2 million or $0.05 per basic and diluted share at the high end of our expectations, and 74% reduction from the Q2 loss last year.

Share count used for Q2 non-GAAP EPS was approximately 22.3 million shares. We finished the quarter with $32 million in cash and cash equivalents and with $8.2 million of debt on the balance sheet. In our last two earnings calls, we said that we would use $6 million or less in cash the first half of 2013 and we are pleased to report that we beat this estimate by almost $2.5 million. The better than estimated cash usage included $2.2 million in debt service.

DSO was 49 days and within our expectations. We believe our DSOs continue to be best-in-class and the quality of our receivables are excellent. We ended the quarter with full-time equivalent head count of 397, a net increase of 19 from the last quarter. Deferred revenue continues to build finishing the quarter at $17.5 million, up 2% or $0.4 million sequentially. Our customers count rose to over 7,900.

Turning now to the guidance, typically we would expect our Q3 revenue to be flat with the second quarter. We are currently estimating that total Q3 2013 revenues will be in the range of $24.5 million to $27.5 million. We expect non-GAAP gross margins to be in the 64.5% to 65.5% range. Based on these estimates we expect Q3 non-GAAP net loss of $3.2 million to $1.3 million or $0.14 to $0.06 per share based on a share count of approximately 22.5 million.

This concludes our prepared remarks. Operator, can you please open the call for questions?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Jason Ader with William Blair. Your line is open.

Jason Ader – William Blair & Company, L.L.C

Yeah thank you, really good operating performance guys, but the revenue guidance is a bit below I think where expectation were from the street, wanted to ask you about that and whether you are going to update the annual $110 million to $120 million, it looks like its going to be pretty difficult for you guys to get even the mid point of that range given where you are through the first three quarters.

Brian McDonald

Yeah, Jason let me make a comment on the annual guidance. We currently believe in the current macro environment going forward is just prudent to give only quarter of guidance and that’s what we’ve done in the script. However, the pipeline is strong and growing; and I will let Bami, do you want to talk about Q3 guidance.

Dr. Bami Bastani

Yeah, clearly we are going to be more conservative towards second half and it reflects in our Q3, it’s too early to give any guidance on Q4 and we generally give one quarter guidance, but we are seeing some side wins as we talked about in Q2 as well.

Jason Ader – William Blair & Company, L.L.C

Can you elaborate on that what do you mean by side wins?

Dr. Bami Bastani

A strong pipeline, but some of the deals instead of closing this quarter kind of moved to the next quarter, so momentum in closing a little bit slower than we were anticipating in spite of very strong pipeline, and so that’s very typical when the macro is going a little bit side ways.

Jason Ader – William Blair & Company, L.L.C

Do you think it’s pretty much purely macro?

Dr. Bami Bastani

At this point, yes.

Jason Ader – William Blair & Company, L.L.C

Okay. And then just on 802.11ac do you feel like we're going to see any pause ahead of the when the kind of the upgrade cycle really kicks in, which sounds like it's going to be some time in 2014, do you think some customers could wait and that could affect results let's say over the next two or three quarters.

Larry Vaughan

This is Larry Vaughan, that’s something that I'm watching and we are watching very closely and I can tell you as of right now we really haven't seen any customers pause based on that, we’ll continue to watch it very closely, but like a lot of the analysts have written we really believe that this is a 2014 and 2015 initiative, but we will continue to keep an eye on it.

Jason Ader – William Blair & Company, L.L.C

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Rajesh Ghai with Craig-Hallum. Your line is open. Please go ahead.

Rajesh Ghai – Craig-Hallum Capital

Yes, thanks. I think you guys announced three reference customers for 11ac and the sense that I got from reading what those customers had to say while they were looking at deployments in the next couple of quarters, is that included in the guidance or that’s kind of – so what's giving if you have 11ac customers coming on board, I am just kind of confused on how the guidance is weak compared to the street?

Brian McDonald

The 802.11ac is part and partial for 802.11n so if somebody was going to go with N they see a ability to do a early deployment and then we have been very guarded against that, in terms of the formal introduction and ramp. So we have some early engagements and we have got very good call on those, so but it’s zero-sum game if you buy N you don't buy AC, if you buy AC you don’t buy N that’s why we have very good programs of upgrades from one to the other from N to the AC. But from a timing and general market call, I just want to reiterate what Larry said that, A, we’re seeing lot of interest, B, in terms of wide spread deployment we see it more of a 2014 timeframe.

Rajesh Ghai – Craig-Hallum Capital

And in terms of, how you look at reaching break-even given what you guided for Q3 and given what you said was tough macro going forward. Do you believe a break-even is possible in 2013 at this point in time?

Brian McDonald

I want to answer it with two ways. Number one, we still hold that at $30 million topline we will be reaching operating break-even at 65% gross margin and we feel confident about those two parameters. We’re a little bit not ready, it’s not time to do Q4 guidance, so from a timing, we’ll not make any commitment today whether it’s Q4 or Q1 what timeframe, but we know it’s a matter of time. Those two parameters of $30 million topline or 65% gross margin holds.

Rajesh Ghai – Craig-Hallum Capital

Your gross margin was pretty strong as last quarter end. If I assume that gross margin and your OpEx run rate, we could get to break-even a little below to $30 million. Do you think is that something that is feasible, actually I am trying to ask is, is your gross margin strength that you saw in Q2 sustainable going forward or you've guided it down a little bit for Q3?

Brian McDonald

In Q2, we’re actually affected, because we had a, didn’t have as many big deals in the number which gave us a higher margin. And then going forward, at that 65% rate like Bami said we will achieve break-even at the $30 million number on [18-ish] type OpEx number. Now we do watch the OpEx very closely and if we see – the revenue softening a little bit or strengthening we will react to that with the spending.

Rajesh Ghai – Craig-Hallum Capital

And on the education vertical I’ve seen a number of your competitors, come out and announce some several wins or deals over the past month to two. Has the competition – has the competitive landscape kind of changed for the worse over the last quarter, how do you see that evolving going forward? Thanks.

Larry Vaughan

Yeah it’s Larry again. I don’t really see any change to the competitive landscape whatsoever, education continues to be our strongest vertical by far, we had a number of customer wins last quarter, we choose obviously to announce a few on this call. But it’s a very strong vertical for us and we think it will continue to be so and haven’t really see any change to the competitive landscapes, the same folks we’ve competed with for many quarters now, continue to be the same, no better, no worse.

Rajesh Ghai – Craig-Hallum Capital

Okay great, thank you.

Operator

Thank you. I’m showing no further questions and would like to turn the call back to the management for any closing remarks.

Bami Bastani

As you notice from an operating perspective it was a very strong quarter for us. And we look forward to participating with you as we go forward and then thank you for being part of the call today.

Brian McDonald

Thank you.

Operator

Thank you. Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.

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