Meru Networks' (MERU) CEO Bami Bastani on Q2 2014 Results - Earnings Call Transcript

Jul.28.14 | About: Meru Networks, (MERU)

Meru Networks, Inc. (NASDAQ:MERU)

Q2 2014 Results Earnings Conference Call

July 28, 2014 05:00 PM ET

Executives

Ed Keaney - IR, Market Street Partners

Bami Bastani - President and CEO

Brian McDonald - CFO and Chief Administrative Officer

Analysts

Matthew Hoffman - Mizuho

John Lucia - JMP Securities

Operator

Good day, ladies and gentlemen. And welcome to the Meru Networks Q2 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. (Operator Instructions). As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, Mr. Ed Keaney. Sir you may, begin.

Ed Keaney

Thank you, Benton and thank you all for standing by. Welcome to the Meru Networks’ second quarter 2014 conference call. During the presentation today all the parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. On the call today are Dr. Bami Bastani, President and CEO; and Brian McDonald, CFO and Chief Administrative Officer.

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 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, or a substitute for or superior in any way to our GAAP results. And 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. The 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 events.

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

Bami Bastani

Thank you, Ed. Good afternoon everyone and thank you for attending our second quarter conference call.

I'm pleased to report that Meru's core business of 802.11ac continued to show strong momentum. Our 11ac business demonstrated sequential sales growth of 63% in Q2. 11ac represented 70% of total unit shipments in the quarter well ahead of technology, industry analyst estimates for overall 11ac market penetration. This is a testament to our technology leadership and our focus on the new standard. Overall, total Q2 revenues grew 14% sequentially.

This afternoon my comments are going to be focused on three key topics. First, I will briefly discuss our results for the second quarter. Next, I will describe in some detail our three step strategy for accelerating revenue growth. And finally, I will share some perspective on our 11ac sales momentum. Brian will provide more details on our financial results and guidance for the third quarter later in the call.

First, Q2 highlights. Meru revenues for the second quarter totaled $23.6 million, near the midpoint of our guidance with non-GAAP net losses of $0.13 per share, both within our stated range in Q4 [2013] [ph].

In Q4 2013, we told you that we’re bringing the revenue breakeven sales to approximately $27 million by end of Q2, down from $30 million then. I am pleased to say, we have accomplished that goal.

As we have mentioned previously, sales in Q2 did not have the benefit of E-Rate funding for Q2 schools. The FCC recently approved an additional $1 billion in each of the next two government fiscal years for the purchase of wireless LAN equipment in K through 12. This gives us confidence and we applaud the commission for its commitment to providing wireless connectivity in U.S. schools.

I am cautiously optimistic that E-Rate funding will be available by Q4 2014. Recent notable achievements include the ramp up of our mid-range 11ac access points, the AP822 which provides the optimal balance of high performance and low cost. The release of our highest quality mission critical System Director software was the second highlight as wireless is becoming the primary connection, we expect robustness of solution to become a differentiator.

And third, Meru becoming the first Wi-Fi vendor to receive OpenFlow certification from the Open Networking Foundation, ONF; reflecting our industry and technology leadership. Adoption of software defined networking or SDN at the enterprise edge which is primarily wireless will drive increased IT agility, lower TCO and unify wired and wireless management. Meru has taken a leadership role in this space, more on SDN in a moment.

Now, our three step growth strategy. To return Meru to above market growth rates, we have identified three key areas of strategic focus moving forward. First, we expect to maintain and grow our technology leadership in 802.11ac, meaning that we plan to be best of breed in performance and quality. Second, we expect to maintain leadership in open standard based SDN solution. Third and very timely, we expect to launch our cloud managed product line tailored to the SME market segment.

I'll now explain each step in some detail and invite you to monitor and measure our progress in the coming quarters.

Step one, Meru's 802.11ac technology leadership, Meru's early market participation in the production ramp of 802.11ac standard is paying off. In the three quarters since we announced general availability of AP832, 11ac equipment has represented 30%, 50% and now 70% of total Meru access point shipments, respectively.

We currently hold the number three position in global 11ac market share according to Dell'Oro. Last month we announced the results of a competitive benchmarking test comparing Meru's AP832 against top of the line access points from Cisco, the Aironet 3702i and the Aruba Networks AP-225, conducted by Tolly Group a premier independent testing lab. This test carefully evaluated and emulated a real world enterprise network environment with multiple access points and client devices including video and VoIP. The Tolly Group used publically available vendor recommended settings with the Aruba and Cisco configurations the same as those used in comparison test published recently by Aruba.

The bottom-line was that Meru Systems provided 40% higher throughput than Cisco’s and 100% higher than Aruba’s. Let me say that again, a higher 100% higher than Aruba’s. The results validate our claim that the AP832 is the fastest enterprise grade AP in the market, and demonstrates that our system architecture which puts the network in control better handles high bandwidth demands, traffic diversity and VoIP and video streaming with low latency.

We also announced industry’s first dual 11ac Wall Plate. This further expands our solutions portfolio 11ac Wall Plate enhances our position in hospitality market and is expected to be a growth driver for Meru. We plan on shipping Wall Plate in volume in Q4 this year.

Step two, Meru’s early commitment to SDN. In Q2 we announced that Meru was the first wireless LAN vendor to receive a Certificate of Compliance from ONF. This established our 11ac solution as compliance with the OPENFLOW certification. OPENFLOW is the first published open-SDN standard. Let me tell you why this certification is important.

The certification makes us first in wireless networking to offer an SDN enabled unified wired and wireless solution for enterprise. It increases addressable market which should drive future growth, it makes us an attractive partner to SDN switch vendors and SDN app developers.

Last week we announced that Meru and NEC are partnering on SDN enabled unified wired wireless solutions. We expect this to be the first of many partnerships to help us open door to new accounts and make Meru an attractive option for early adopters of SDN.

As the University of Houston, Meru's SDN is being tested from emergency management portal as well as data collection app. This approach would replace the need for IT staff to [turn on] laptops and plug them into ports in the various buildings to do packet captures.

Early adopters such as Amazon, Google and Facebook have utilized SDN in their data centers enabling them to forsake expensive proprietary switching equipment in several standard base solutions. We believe this revolution in networking, little migrate from the data center to enterprise environment driven by three key trends; the rise of cloud services or SaaS applications, the bandwidth demands of big data apps and the BYOD and mobility phenomena with wireless quickly becoming the primary connection.

Meru intends to remain at the forefront of the open standard movement driving growth for the company and enabling increased flexibility, efficiency and productivity for its customers.

Step three, Meru's cloud managed solution. Meru had historically gained traction with mid to large organizations within its target verticals of education, hospitality and healthcare. These types of customers typically deploy between 200 and 2,000 access points. In recent quarters wireless LAN spending in the cloud managed, small to medium enterprise or SME segments have been growing three to four times the rate of large enterprises. This SME market is highly fragmented and is expected to grow at an attractive rate of 44% CAGR from 650 million in 2014 to 2.5 billion in 2018 per IDC.

As these are migrating to enterprise grade due to the proliferation of BYOD devices. This segment values high performance but also requires ease of deployment, simplified management of the network and low cost equipment. To participate in this market we intend to offer cloud managed subscription based solutions enabling Wi-Fi to be delivered as a service.

Many of our current partners and managed service providers to MSPs have expressed the strong interest in deploying our cloud based solutions. We'll provide more detail on this initiative next quarter.

Now let me talk about our 802.11ac market momentum. Our technical leadership enabled in 802.11ac has driven strong customer attraction. We are upgrading our customers, acquiring new customers and replacing competitors.

One of our largest existing customers listed among the top five school districts in the U.S. started migrating to Meru 11ac network. They are deploying more than 4,000 Meru AP832 access points to support rapid growth of mobile devices in the school. Notable events that we announced during the quarter included Cedarville University, the University deployed an 11ac education grade Wi-Fi solution to support thousands of simultaneous connections in residence hall and the school chapel for more than 2,500 students all with multiple mobile devices gathered together daily. They picked Meru due to our superior ability to support high-density. Meru 11ac also replaced Cisco in a large college in Southeast, the college in Canada, a large convention center in Ireland and both in university and a large public exhibition center in Italy. We replaced Aerohive in a 13 campus school district in Southeast and replaced Aruba in a 35 campus school district in the UK. In addition, we want 11ac installed against this competition at higher education institutions in the U.S., Spain and UK along with several K through 12 school districts in the United States.

The Georgia World Congress Center in Atlanta also has begun an extensive migration to Meru 802.11ac. It recently hosted the ISTE 2014 the largest annual K through 12 education tradeshow. During ISTE, Meru Wireless LAN flawlessly supported as many as 13,650 concurrent sessions, 13,650 concurrent sessions, may I repeat. Conference organizers presenters and attendees were unanimous in the praise of the network and its support for thousands of attendees in hundreds of interactive sessions. This is a real life example for our competitors had failed and Meru successfully delivered the higher density with our differentiated technology.

Meru successes are attracting strong channel partners. Recently we added Stratix one of Motorola Solution’s largest partners and one of the largest outsourcing managed mobile service providers. With Stratix, our customers can now access a wide range of essential and fully integrated support services, superior logistics and flawless execution. Stay tuned for more strong addition to our channel partner base.

We are very pleased with our customer partner traction with the feedback that we received about the high performance and high quality of the Meru 802.11ac solution. The technology industry vendor landscape changes significantly when standards emerge; rewarding companies to move quickly to lead the advent of 11ac and SDN offered just such an opportunity and Meru has been quick to respond.

The 802.11ac standard with its 1.3 gigabit capacity is the most comprehensive upgrade to wireless connectivity since the establishment of the 802.11 protocol by the IEEE in 1997. Add to this, the ground breaking implications of SDN as a new paradigm in networking architecture and we see Meru is ideally positioned to capitalize on both trends. Consequently with this, we will grow our revenues faster than the market in 2015.

With that, I would now like to turn the call over to our CFO, Brian McDonald. Brian?

Brian McDonald

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

Total revenues for the second quarter were $23.6 million, down 10.9% year-over-year but within our guidance range. On a sequential basis, revenues were up 14.4%. Product revenues in the second quarter were $18.8 million, down 13.3% from Q2 last year. On a sequential basis, product revenues were up $3 million. Support and service revenues were $4.8 million, up 0.7% from Q2 of last year.

Approximately 61% of Q2 revenues were from the Americas; 30% were from EMEA and 9% from Asia Pacific. Year-over-year Americas revenue declined 15%; EMEA revenue declined 1%; and Asia Pacific revenue declined 15%. Total non-GAAP gross margin in Q2 was 63.2%, down from 65.3% for Q2 last year.

The short-term pressure on margins is primarily attributable to our 11ac trade up program and center pricing on the 11n products. We continue to target our long-term gross margin range at 65% to 68%.

Total non-GAAP operating expenses in Q2 were $17.4 million, down slightly from Q2 last year and equal to 74% of Q2 2014 revenues. We continued to invest in new product development and increased our R&D spend by 26% from Q2 last year. Non-R&D operating expenses were down 10% from Q2 2013.

Total non-GAAP operating loss for Q2 was $2.5 million versus a loss of $0.6 million from Q2 of last year. Our Q2 non-GAAP net loss was $3 million or $0.13 per basic and diluted share. Share count used for Q2 non-GAAP EPS was 23.4 million shares.

We finished the quarter with $19.4 million in cash and equivalents and with $4.7 million of debt on the balance sheet. During the second quarter, we recorded a negative cash flow from operations of $5.7 million. The cash flow was unfavorably affected by an expanded payment term issued to a large customer during the quarter.

DSO at the end of the quarter was 49 days. We ended the quarter with a full time equivalent headcount of 381, a net decrease of 22 from Q1 of 2014 and down by more than 9% from year end levels. This is consistent with our overall plan to reduce our operating breakeven point to approximately $27 million in quarterly revenues. Note that roughly one-third of our total employees work at our R&D facility in Bangalore, India.

Now looking ahead to Q3, we currently forecast Q3 2014 revenues of $23.5 million to $27.5 million. We expect non-GAAP gross margins to be in the 62.5% to 64.5% range. Based on these estimates, we expect Q3 non-GAAP net loss of $2.5 million to a profit of $0.2 million or a loss of $0.10 per share to a profit of a penny per share, based on assumed share count of approximately 23.7 million.

Operator, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). First question comes from Matthew Hoffman of Mizuho. Your line is open.

Matthew Hoffman - Mizuho

All right, thanks. First, I am not sure I heard the guidance for the topline you went through it quickly, let me just make sure I heard the numbers.

Brian McDonald

We said 23.5 million to 27.5 million.

Matthew Hoffman - Mizuho

Okay, so 25.5 mid-point, so it looks like around consensus at 25.4 for next quarter that I have?

Brian McDonald

Sounds right.

Matthew Hoffman - Mizuho

Okay. So let's go to the ac numbers, it sounds like 30%, 50% and 70% were the percentages the last three quarters, that was out of total sales or just the product sales side?

Brian McDonald

Those are the access point sales.

Matthew Hoffman - Mizuho

Okay, access points. Okay. So as you look forward what does the -- how does the ac business from the access point side -- how does that look? Do you think you will be up to -- is there a point at which you will cross over into the 100% range over the next couple of quarters, you will be moving away entirely from the old product lines and if so do you see some sort of cost synergies as you do that?

Bami Bastani

Yes, this is Bami. I would say you defined a limit appropriately today. We are very strongly encouraging 11ac, 300% better performance [inaudible] price points relatively saying, I mean there is a small premium, 5% to 10% or so.

And also the solution being a brand new solution by definition is a lot more robust and less customer care versus legacy products that are several years old. So our intent is to push 11ac extremely hard. There are always going to be some legacy business because of the consistency or compatibility. We’re building extra rooms those kinds of things, so it’s not going to be 100% but we will approach that number.

Matthew Hoffman - Mizuho

Okay. Let’s move on to the - you mentioned that E-Rate in the $1 billion of extra spending and the fact that it could hit fourth quarter - I know you’re just guiding to the third. If you think about how E-Rate affected your numbers over the past year, the past government year if you will, it led to a spike in the fourth quarter 2013 that kind of wane as the year goes on, will that additional $1 billion of spending that the government is going to do on 802.11 this year or in that bucket, will that lead to a less lumpy year where the fourth quarter it doesn’t -- the spending is still there for calendar 4Q this year and then it holds during the course of the year or will we see an even bigger spike in the fourth quarter that drops off into 2015 goes on?

Bami Bastani

Yes, it’s mostly back-end loaded. Generally it is the applications that go in about this timeframe and the money gets released primarily like around July of next year. And so you see the big impact of it in the second half of next year, but it is not unusual also to see a trickling effect.

Matthew Hoffman - Mizuho

So, the fact is that funds will become available beginning in the calendar fourth quarter of this year, will help out the fourth quarter of this year but you will likely see less drop-off next year because of that extra $1 billion, is that the way to think about it?

Brian McDonald

Yes.

Bami Bastani

Yes.

Brian McDonald

I think that’s good. And one other point there, just to give you an idea of the E-Rate business, its effect on our business, E-Rate supported about $7 million in sales in the first half of our 2013, so we generated about $7 million in E-Rate funded sales in the first half of '13.

In the second half of 2013, we generated about $4.1 million of E-Rate funded business. In the first six months of the current year, E-Rate fund generate revenues were less than $600,000 in sales. So you can see there has been a very significant effect on the drop off on the E-Rate business.

Matthew Hoffman - Mizuho

And so I guess, you think that those, the numbers to the first half of '13 is the potential market, that's the type of potential market…?

Brian McDonald

Yes, if you were to draw a line, you can start to look at that in the 2015 timeframe.

Matthew Hoffman - Mizuho

Great. I'll just ask one more question, that’s not the people ask a few year. But you mentioned the Motorola Solutions dealer Stratix and the win you had there. Can you go through that, I don't how specific you want to be on that win, but the reality is that the competitor where there is a ongoing merger distraction, but of course the unit is being spun out to Zebra or part of it is. Is that really what's behind this dealer bringing on additional product lines like Meru or is there some other product oriented weakness there or a strength in the Meru portfolio relative to those products that bring you the wins like the with Stratix?

Bami Bastani

Yes. The win like Stratix really is a strength of 802.11ac technology. And they see the Tolly report which is an independent, we have now literally a plethora of customers that are referenced customers whether it’s in K through 12 or higher Ed or healthcare, hospitality. And so that's what encourages them to come forth. We are in a inflection point to the positive, we believe, and as people see the action of 802.11ac we see more of them come forth, yes.

Matthew Hoffman - Mizuho

Okay. Thank you gentlemen.

Operator

Thank you. And our next question comes from John Lucia of JMP Securities. Your line is open.

John Lucia - JMP Securities

Hey guys, thanks for taking the question. First question on the E-Rate revenue that you guys got in ‘13 and this year, just want to confirm it was 7 million in the first half of ‘13 and then 600k for this year?

Brian McDonald

It was 7 million in the first half of ‘13, 600,000 in the first half of 2014.

John Lucia - JMP Securities

Okay, cool. My questions are related to the 2 billion in E-Rate funding approved by the FCC a few weeks ago. First, as you guys said you are cautiously optimistic on the call that the funding will be available what would stop the funding from coming through?

Bami Bastani

It’s just the timing of it. And generally the timing of these funds that were released are back end loaded, the applications are done now let’s say, rest of this year, applications go for review, selections are made by the time you are in the second quarter of next year, certain schools are informed that their applications were approved and the vendors are selected.

So the fly wheel gets going in the Q2 in terms of people knowing what’s coming in and in Q3 in terms of shipments and of course, these funds the spending just doesn’t, people don’t spend the whole billion in one year; that funding that is for next year as the applications get approved funds the next couple of years and then the extra billion, the following year is a cumulative on top of that. So now you have got a very good momentum building in funding that.

The other point John is also when people know that there is such funds coming, then they also supplement that with bond money and we had significant amount of bond money, because people [anticipate] [ph] or received E-Rate money in the past as well. So, the whole thing is a strong catalyst. And that's why we are what I call cautiously optimistic that the flywheel could start turning as early as Q4, even though the lion’s share of things is going to happen back end loaded for next year.

John Lucia - JMP Securities

Okay. My understanding is that funding will come on July 1st of next year, but you are saying they get the bond money and they'll start buying earlier than that…

Bami Bastani

Exactly.

John Lucia - JMP Securities

That’s when it will start. Okay. And then the $2 billion that was approved, will that all go to Wi-Fi component players like you guys and Aerohive and Aruba, Cisco or is there professional services component to that? How much of that is allocated to the actual Wi-Fi component players?

Bami Bastani

We all also offer professional services and network management tools and things like that. We believe that fund allows schools to include more of that. If you are asking is all $1 billion is for access points? The answer is no because there is a good part of it is for that but it also is a wider acceptance of other things that we do that in the past would have not been a part of E-Rate but now potentially could be, on-boarding, we're already on-boarding et cetera.

John Lucia - JMP Securities

Okay. And access point sales as a percentage of the $2 billion, do you have any kind of ballpark estimate of what you think that maybe?

Bami Bastani

No.

John Lucia - JMP Securities

Okay. That's it from me. Thank you.

Bami Bastani

Thanks John.

Operator

Thank you. Our next question comes from Paul Silverstein of Cowen and Company.

Unidentified Analyst

Hi. This is Michael on for Paul. First, just a quick question, can you tell us what percentage of your 802.11ac customers were new customers or just old customers or the percentage of shipments that went to newer or older some way of kind of that?

Brian McDonald

Yes. Of the 802.11ac shipments, 75% went to existing and 25% went to new customers.

Unidentified Analyst

Okay, awesome, thank you. And a more in-depth question on the SMB market, can you talk about what’s you are seeing there?0 And you had talked last time about how you are kind of making efforts to grow your position in that market, can you talk about any progress you've made over the last many days in that market?

Brian McDonald

Yes. And there is -- you see it from market dynamics at the lowest level, your [SOHO] people are now moving into enterprise grade. So these guys that in the past who just go and get something out of price electronic or whatever, now because of the complexity of their environment are moving to enterprise grade. So companies like Meru which have got the enterprise grade portfolio and a knowledge base engrained are very easily moved out.

The second characteristic is that most of these guys rather do OpEx versus CapEx in terms of their spending. So that's why cloud model has become very prevalent and favorable where you put people on a subscription basis. And the solutions are controller less. They’re cloud based they’re subscription model and in terms of -- we have made significant progress and we'll be announcing in terms of the product timings and things like that next quarter.

Unidentified Analyst

Okay, thank you. And last hopefully quick question. In terms of the headcount, the decrease in headcount, are those primarily sales and marketing employees or research employees or where is the headcount coming from, is this fixed in your mind?

Brian McDonald

It’s been coming really spread out across the board. We’ve seen it everywhere since things are very competitive. It’s been -- and we’ve seen it both in North America and Bangalore, but I think our rates are competitive with the benchmark companies that are out there.

Bami Bastani

Yes. We said in Q4 of last year, our breakeven sales were that $30 million revenue, our operating breakeven sales was around $30 million. We’ve charted a strategy and we’ve told everybody at that time that we’re going to go to 27.

So, if you go from a reference point to that point, we’ve been streamlined our product management/marketing activities in that area and in SG&A we have gone down. So from managing to headcount to a $27 million as well, just to complement I’ll add to Brian’s answer we’ve had very active in those areas.

Unidentified Analyst

Okay.

Bami Bastani

Actually in R&D we have increased our investments.

Unidentified Analyst

Okay. Thank you, guys.

Bami Bastani

Thank you.

Operator

Thank you. And at this time I see no further questions. I’d like to turn it back over to you Mr. Bastani.

Bami Bastani

Thank you, thank you operator. Since its founding Meru, has been focused on creation of intelligent Wi-Fi solutions, powering the all wireless enterprise. 11ac brings our realization of this vision closer than ever, enabling enterprises to embrace true mobility with a completely wireless office.

In this environment, Meru has compelling competitive advantages including the world’s fastest access point, seamless roaming, load balancing via our networking control technology, traffic prioritization and channel layering and that’s what customer see and that’s why they come to us. We are pleased with the continued momentum of our core 11ac business as demonstrated by the 63% sequential growth 11ac sales.

By focusing our company in 11ac, SDN and cloud managed services, we believe we'll get the company to above market growth rates in 2015. Thank you for participating.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes your program. You may all disconnect. Everyone have a great day.

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