Meru Networks' CEO Discusses Q1 2014 Results - Earnings Call Transcript

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 |  About: Meru Networks, Inc. (MERU)
by: SA Transcripts

Meru Networks, Inc. (NASDAQ:MERU)

Q1 2014 Results Earnings Conference Call

April 28, 2014 05:00 PM ET

Executives

Ed Keaney - Investor Relations

Dr. Bami Bastani - President and CEO

Brian McDonald - CFO and CAO

Analysts

Matthew Hoffman - Mizuho Securities

Jason Ader - William Blair

Paul Silverstein - Cowen

Operator

Good day, ladies and gentlemen. And welcome to the Meru Networks First Quarter 2014 Earnings 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.

I will now turn the call over to your host, Ed Keaney. Please go ahead.

Ed Keaney

Thanks, Patrick and thank you all for standing by. Welcome to Meru Networks’ first quarter 2014 conference call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, this conference will be opened for questions. On the call today are Dr. Bami Bastani, President and CEO; and Brian McDonald, CFO and CAO.

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 risks and uncertainties that could cause the 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 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 annual report on Form 10-K 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 intended to be -- are not intended to be considered in isolation from, or a substitute for or a as superior to our GAAP results. We encourage you to consider all the measures when analyzing Meru’s performance.

Information relating to the corresponding GAAP measures, as well as a reconciliation of the non-GAAP measures and GAAP measures can be found in our press release, on our Investor Relations website at www.merunetworks.com. Press release has 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 results.

Now, I’d like to turn the call over to Dr. Bami Bastani, the President and CEO of Meru Networks.

Dr. Bami Bastani

Thank you, Ed. Good afternoon everyone and thank you for attending our first quarter 2014 conference call. In the previous quarter, we told you that 802.11ac had significant traction in the marketplace. I am pleased to announce that market momentum towards adoption of 802.11ac continues to be strong.

In Q1, Meru’s 11ac unit shipments were up 12% sequentially. This represented approximately 50% of Meru’s total [AP] unit shipments.

This afternoon, my comments are going to be focused on three key topics. First, I’ll briefly discuss our results for Q1, 2014. Second, I want to talk about 802.11ac, our portfolio and serve market expansion. And third, I want to highlight our strategic plan for sustaining a competitive advantage by combining early leadership in 802.11ac, with our truly open approach to software defined networking or SDN. Later, Brian will provide more details on our financial results and guide for the June quarter.

Meru revenues for the first quarter totaled $20.6 million, within the $20 million to $24 million guidance. We also reported a non-GAAP net loss of $0.23 per share within the guidance range. Our cost reduction efforts that we outlined in the last earnings call are being implemented and we have achieved meaningful headcount reductions by streamlining our organizational structure. We remain on track to reduce our operating breakeven sales to $27 million per quarter by the end of the second quarter this year.

Our customer installation count rose to more than 12,900 in Q1. I am pleased to announce that 802.11ac products represented approximately half of our shipments in Q1, up from 30% of shipments last quarter.

We have the strong architectural and product level differentiation with 11ac that is resonating well with both new and existing customers. The University of Huddersfield, a 20,000 student school in UK is replacing Cisco with a campus wide Meru Education Grade or MEG 11ac solution. The new network supports high densities of students accessing voice and video applications over their mobile devices.

As the manager of the data center for infrastructure and network services at the University of Huddersfield said, and I quote, we were experiencing poor patchy performance with our previous network and had particular challenges with roaming. We’re finding that devices would connect to a wireless access point, but then stick to it as people moved from place-to-place. This affects performance by reducing the bandwidth available to each client; Meru makes life a lot easier by putting the network in control.

The Goffstown school district in New Hampshire also selected in Meru Education-Grade 11ac solution to enable uninterrupted learning. The district replaced existing access points with the MEG solution to eliminate daily connectivity issues, support academic excellence and increase teacher effectiveness. Previously, they spent a lot of time placing access points, making sure the channels didn’t been overlap, worrying about RF interference and troubleshooting connectivity issues. Meru’s MobileFLEX architecture has eliminated that according to the Director of Technology.

Cornwall Community Hospital in Canada has deployed Meru’s 11ac based uninterrupted care network as part of $120 million redevelopment plan. They selected Meru because of the MobileFLEX architecture’s unique ability to physically separate life critical, mission critical and patient applications on a single wireless network. Meru 11ac is allowing them to implement a fully integrated clinical system, making patient’s electronic health records accessible from any mobile device, anywhere anytime. The Meru solution is also supporting the hospital’s wireless VoIP phones, housekeeping, dietary and maintenance departments as well as patient and visitor internet access.

Additional 11ac competitive wins in the quarter included large school districts in the UK and the U.S., colleges in Spain, the UK and the U.S., and municipalities in Denmark and Australia. We also won a 50,000 seat stadium in Germany, the world class resort in Quebec and began a large 802.11ac transition at a major league baseball stadium.

Now on to our portfolio expansion. Our increased investment in product development is bearing fruit. At the end of Q1, we announced the expansion of our 802.11ac product portfolio with two new access points, the general purpose AP822 and the wall plate AP122. Both of these two radio, two stream APs are priced significantly lower than existing three-by-three 11ac at this points. These new products position Meru to take advantage of the 11ac in a much broader mid-market opportunity. The AP822 runs on a standard PoE wiring with a much higher performance than 11n, but at similar prices. The total cost of ownership for the AP822, which started shipping in Q1 is a compelling proposition in the education and healthcare markets.

The AP122 ability to be mounted discretely a top existing internet, wall plate in hotels and university resin halls will drive further traction in our already fast growing hospitality vertical and will help ensure Meru’s continued leadership in higher education. AP122 general availability is anticipated in the second half of 2014.

The market response in Meru’s portfolio expansion has been significant and the reasons for switching to Meru 11ac are clear as Craig Mathias, principal of leading industry analyst firm the Farpoint Group said, the Meru AP122’s broad range of applications and the AP822’s performance and price at the clear and compelling case for moving to 11ac instead of expanding legacy 802.11n networks. Our channel partners are also looking forward to the new opportunities our expanded portfolio gives them. As a Meru platinum partner said, they improved performance and lower price points of the AP822; make 802.11ac attractive to a wide much wider range of customers.

This will help accelerate the adoption of gigabit Wi-Fi in markets like education, healthcare and hospitality that have been both at high density and high performance requirements. We are enthusiastic about the opportunities the new platform presents.

Our R&D efforts don’t end with 11ac. We are continuing to evolve and expand our family of wireless LAN offerings; our network management and system direct to releases this quarter have greatly improved manageability and usability of our products. We expect to continue this pace of innovation to broaden our portfolio allowing us to improve our adjustable market and meet the needs identified by our customers.

The significant amount of R&D investment is now focused on cloud enablement. This will position us for participation in the fast growing SMB market. As the first step, we have started enabling selected managed service providers to deliver Meru’s Wi-Fi at the cloud-based offering to their customers. This has been well received by our channel partners. We will hear more about these developments in the upcoming quarters.

In addition to the new APs Meru in Q1 announced plans for truly open software defined network-enabled Wi-Fi solution that simplifies multi-vendor management and policy enforcement. Meru’s approach to SDN goes further than strategies from other Wi-Fi vendors, by providing both Northbound and Southbound APIs in our mobility controllers.

This enables full third-party unified access management and control from the wired network to the mobile access point. We demonstrated this recently at the Open Networking Summit. Meru’s uniquely open approach to SDN has been recognized by the market. Network’s Computing Lee Bradman specifically noted that Meru Networks approach with SDN and Wi-Fi gives hope. That maybe SDN can provide far ranging benefit to wireless customers beyond simply being a replacement for proprietary magic in the middle.

SDN marks the first time since the internet boom up in late 1990s that there has been a significant inflection point in the networking technology. SDN markets or enterprise access alone is expected to approach $4 billion by 2018 according to market sizing report by SDN Central.

This unique innovation is generating a wide range of new discussions focused on new market opportunities. SDN has the potential to significantly expand our market 2015 onwards.

In closing, I would like to discuss the reasons that I believe Meru’s traction in the market will grow and how Meru expects to build on our technology leadership. One, 802.11ac represents a tectonic shift in the marketplace faster than what industry analysts and our competitors expected. We made an early commitment to and have been prepared for this shift to 11ac.

Number two; our 11ac offerings are seeing strong support and adoption with both new and existing customers. This demonstrated by 12% sequential growth in 11ac AP shipments and 11ac making up 50% of our AP unit shipments in Q1.

Three, Meru is a market innovator reflected by a recently announced SDN demonstration at the Open Networking Summit our commitment to the open flow standard, ease of management and enhanced application performance sets us apart from others in the marketplace.

Looking ahead we are confident that we’ll return to operating profitability in the second half of the year. We also firmly believe that the expansion of our 802.11ac portfolio and delivery on innovations including our SDN strategy will drive us to sustained growth in the same period.

I would now like to turn over the call to Brian McDonald, our Chief Financial Officer for some additional color on the first quarter and to provide our guidance for the second quarter. Brian?

Brian McDonald

Thanks Bami. Please note that the following discussions of our operating results will be on a non-GAAP basis, which excludes stock-based compensation expense and amortization of various intangibles. 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 website.

Total revenues for the first quarter were $20.6 million, down 16.6% year-over-year and within our guidance. Product revenues in the first quarter were $15.8 million, down 23.1% from last year. Support and service revenues were $4.8 million, up 16.2% from Q1 of last year.

Approximately 53% of Q1 revenues were from the Americas, 36% were from EMEA and 11% were from Asia Pacific. Year-over-year America revenues declined 29%, primarily due to a tough comp from Q1 last year, which included a large school district order. Year-over-year, Asia Pacific revenue declined 16%.

EMEA revenue grew 11% year-over-year in part due to the strong channel partner network we have developed there. Total non-GAAP gross margins in Q1 were 63%, down slightly from 63.5% for Q1 last year.

The short-term pressure on margins is primarily attributable to our 11ac trade up program and [incentive] pricing on the 11 end products. We continue to target our long-term gross margin range at 65% to 68%. Total non-GAAP operating expenses in Q1 were $17.9 million, up slightly from Q1 last year and equal to 87% of Q1 2014 revenues.

We continue to invest in our technology and increased our R&D spend by 44% from Q1 last year. Non-R&D operating expenses were down 4% from Q1 2013. The total non-GAAP operating loss for Q1 was $4.9 million versus a loss of $1.2 million for Q1 of last year.

Our Q1 non-GAAP net loss was $5.4 million or $0.20 per basic and diluted share, share count use for Q1 non-GAAP EPS was $23.1 million shares.

We finished the quarter with $25.7 million in cash and equivalents and with $5.6 million of debt on the balance sheet. During the first quarter, we recorded a negative cash flow from operations of $4.1 million. DSO at the end of the first quarter was 45 days, we ended the quarter with full time equivalent headcount of 403, a net decrease of 16 from Q4 of 2013. This is consistent with our overall plan to reduce our operating breakeven point.

Now looking ahead to Q2, we currently forecast Q2 2014 revenues of $22 million to $26 million. We expect non-GAAP gross margins to be in the 63% to 65% range. Based on these estimates, we expect Q2 non-GAAP net loss of $1.3 million to $3.9 million or $0.05 to $0.17 per share, based on assumed share count of approximately 23.4 million.

Operator, we are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Matthew Hoffman with Mizuho Securities. Your line is open.

Matthew Hoffman - Mizuho Securities

Hi, good afternoon, I’m still going through the guide there. But first question is on the R&D side, it looks like it tops up a little bit here in the first quarter of 2014 versus last quarter year-over-year. So you talk about the cost equation where you are targeting that R&D side, choose to report in our other couple of elements? Thanks.

Brian McDonald

Let me take a crack at that. What we have indicated over the last couple of calls is that we were going to continue to increase our R&D spending over the next few quarters to get the critical programs squared away and then at that point we would start to let the number glide into the model number, which is in the 14%, actually 14% and 16% range.

So we are currently on track to do that, what we have been doing is offsetting the G&A and the other sales areas that are coming down with the R&D increase.

Matthew Hoffman - Mizuho Securities

All right. So more positively it looks like the $24 million mid-point for next quarter is up 15% to 20% sequentially here.

Brian McDonald

That is correct.

Matthew Hoffman - Mizuho Securities

From where you are at right now. So what gives you confident that quarter-on-quarter is it the order book is it the deal flow, what are you seeing that will make you guys feel confident about that number?

Brian McDonald

One we look at our pipeline on a regular basis and we look at the ratios going into the quarter of the existing pipeline and we felt very comfortable that with existing revenue achievements and beginning pipeline numbers, that number was attainable.

Matthew Hoffman - Mizuho Securities

Alright last one, what’s the fully diluted share count at the end of the 1Q ‘14?

Brian McDonald

Total 23.1 million shares.

Matthew Hoffman - Mizuho Securities

Okay, thanks.

Operator

Our next question comes from Jason Ader with William Blair. Your line is open.

Jason Ader - William Blair

Yes, just on the last one Brian, so 23 that’s the basic count, I mean for the purposes of EPS calculation, I think the question is what’s the fully diluted if you would include options in that number?

Brian McDonald

That’s right.

Jason Ader - William Blair

Right, it has to be a larger number.

Brian McDonald

It is larger, the 23 -- except basic and fully diluted are the same when you have a loss.

Jason Ader - William Blair

Right, but I think the question is what is it, if you had a profit, what would be the fully diluted share, kind of if you had a profit?

Brian McDonald

I’ll get back to you with that, it’s a few million higher, but I’ll get back to you on that, if it’s different.

Jason Ader - William Blair

Okay, great. And then Bami, what gives you the confidence in the second half of the year, I know that in the first half you are going to be, if you hit the midpoint of your guidance, you’re going to be at a negative growth rate for the full first half. And it sounds like you are assuming a return to growth in the second half. But why, what gives you so much confidence that you’re going to get there?

Dr. Bami Bastani

The whole industry is driven now by 11ac transition and what kind of a portfolio and what kind of a network management tool and software are you fitting into the opportunities. So we were an early starter on 11ac from market acceptance. We have demonstrated in various POC about the power of our technology, as validated by industry analysts.

And so, differentiation explained well. The other thing is that, we are changing the conversation, it’s just not about your hardware, it is about what’s your vision for the next three to five years, let’s when you talk to CIOs, our approach towards software defined network or a opening demonstrations at the Open Networking Summit. All of these have created the right buzz kind of traction towards Meru.

Jason Ader - William Blair

Okay. But you are seeing some of your competitors doing pretty well in the first half of the year with ac or talk about doing well in the first half of the year with your ac portfolio. So why are you not experiencing the same success as they are?

Dr. Bami Bastani

If you, kind of a forward looking of one of the elements that brought us to be more conservative in Q2, I am talking because Q1 we had talked in the past when the guidance we gave is there is pressure on the E-Rate business in education and we’re making that with our newly launched programs, with the community college universities and in private schools. As you know, E-Rate participation is primarily with mid to large schools and that’s something that are -- just looking forward, we have been conservative about and have dialed it in.

Jason Ader - William Blair

Okay. Could you expand on that what’s happening with E-Rate that’s changed?

Dr. Bami Bastani

E-Rate for 2014, their priority two funding has been put on hold, priority two basically covers the Wi-Fi world. However, at the same time SEC is discussing expanding 2015 funding to tune of sort of $2 billion and moving Wi-Fi to priority one. So the transitional discussions are going that affects the I call it the short-term, the education specific North America market.

Jason Ader - William Blair

Okay. So you’re saying you’re haircutting your guidance to some extent because of E-Rate, won’t that also affect your September quarter results?

Dr. Bami Bastani

We’re having like I said, tremendous amount of focus on other aspects; E-Rate is not end all-to-all, so there is a lot of private schools, there is a lot of non-E-Rate funded schools to be a E-Rate school like 90% of your lunch money needs to come from federal government, so generally it makes it larger school district in different category.

So community college, universities and those kind of things are you backfill it.

Jason Ader - William Blair

Okay. Thank you.

Dr. Bami Bastani

All right.

Brian McDonald

Hey, Jason?

Jason Ader - William Blair

Yes.

Brian McDonald

This is Brian. On that share count, the 23 one that we talked about is not the fully diluted number although they are the same for SEC reporting purposes, but the fully diluted count on top of that for all other options is about 28 million.

Jason Ader - William Blair

Excellent, thanks Brian. I appreciate it.

Brian McDonald

Okay.

Operator

(Operator Instructions). Our next question comes from Paul Silverstein with Cowen. Your line is open.

Paul Silverstein - Cowen

Thanks for taking the questions. Couple of questions if I may, first off, just going back to Jason’s question, I want to make sure I understand this. The reason you are not seeing growth despite of being in this 802.11ac upgrade cycle, is it a purely a function of the E-Rate issue identified or something more going on in connection with response to the E-Rate? I know the education vertical is a big piece of revenue but given the issue you’ve identified, can you be a little bit more precise in terms of how big an issue E-Rate is in terms of revenue growth?

That’s the first question and I’ve got a follow-up.

Dr. Bami Bastani

Yes. From 802.11ac transition, let me address that, note that Q1, we had a sequential unit growth from Q4 in our ac shipments and about 12% and 50% of the units shipped were ac. So within that ecosystem, the momentum is there to carry us forward as evidenced by Q1. From what’s the total E-Rate on Meru education part, about half of our revenue is education. And I would say from a total perspective some in the 5% to 10% of our revenue is E-Rate related.

Paul Silverstein - Cowen

And so Bami, is E-Rate and would you able to give the entirety revenue, what you expect given the growth, given the strong growth in ac see both for you and the market in general, won’t we expect to see revenues increasing? Is the fact that revenues are not increasing in total is a purely function or E-Rate or there are more and more other issues that have also depressed revenue?

Dr. Bami Bastani

From a ac transition, I think we have very good momentum. The wall plate is a important catalyst for example in our hospitality. We’re one of the first to market to announced that with 11ac. The 822 fills in the mid-range. So our play is [terrific] charge, all the other aspects of the business, and an overcome to 11ac, the E-Rate part of it. So it’s primarily E-Rate to answer your question.

Paul Silverstein - Cowen

All right. So primarily one of the secondary issues?

Dr. Bami Bastani

The secondary issues are going to be just market transitions and customer timing and those kind of things.

Paul Silverstein - Cowen

All right. Let me move on. On 802.11ac, how much of the AC revenue is from new customers as opposed to existing customers?

Dr. Bami Bastani

It was 30% new customers, 70% existing customers.

Paul Silverstein - Cowen

I appreciate that, 30% new. And finally on the -- I think you already (inaudible) but just looking for with respect to the decline in product gross margin say over the last few quarters, is that truly a function of the (inaudible) but truly a function of the AC incentives, as well as the discount on the 11 and that you identified and when did those, when do you those trailing off?

Brian McDonald

Those will trail off in the next couple of quarters. So, by the end of Q3, I would expect that to happen.

Paul Silverstein - Cowen

Okay.

Dr. Bami Bastani

And the answer is yes, it was primarily that, there was a slight product mix issue in Q1 with the service revenue being lower than expected and that accounted for about a percent of the drop and then the balance of it was for those items.

Paul Silverstein - Cowen

All right. So what’s -- I apologize, you said, you’re thinking to grow the trade up volumes into the third quarter once you get the earn-out and you expect product gross margins to return, as well as total gross margins to return in the same range?

Dr. Bami Bastani

That is correct.

Paul Silverstein - Cowen

Okay, that’s all. Thank you.

Operator

Thank you. This ends our Q&A session today. I will turn it back to Dr. Bastani for closing remarks.

Dr. Bami Bastani

Thank you, operator and thanks everyone. To close I would like to say that we remain enthusiastic about our attraction with 802.11ac and our confident that our differentiators will drive growth in the second half. Our ongoing financial discipline and technological innovation gives us a strong foundation. I remain confident that we are taking the right measures to achieve the goals and objectives that we have set. And on behalf of everyone at Meru, I thank you for your participation in this call and your comments and your continued support. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today’s program. This concludes the program. You may all disconnect.

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