Aerohive Networks, Inc. (HIVE) CEO David Flynn on Q2 2018 Results - Earnings Call Transcript

Aerohive Networks, Inc. (NASDAQ:HIVE) Q2 2018 Results Earnings Conference Call August 1, 2018 5:00 PM ET

Executives

Jessica Stancil - IR, The Blueshirt Group

David Flynn - President and CEO

John Ritchie - CFO and COO

Analysts

Mark Kelleher - D.A. Davidson

Christian Schwab - Craig Hallum

Operator

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

Jessica Stancil

Thank you, operator. Welcome to Aerohive Networks second quarter 2018 financial results conference call.

After the market closed today, Aerohive issued a press release through Business Wire. The release is also available on our website at aerohive.com. This call is being webcast live on the Investor Relations section of the Aerohive website and will be available for 30 days. Today’s call is being hosted by David Flynn, President and Chief Executive Officer; and John Ritchie, Chief Financial Officer and Chief Operating Officer.

During the course of today’s call, management will make forward-looking statements including statements regarding our projections, operating results, expectations for future revenue growth, operating profitability and operating margin, plans for future investments, product development, deployment, adoption and performance and expectations of customer buying patterns and the growth of the market for our products and business generally.

These forward-looking statements involve a number of risks and uncertainties some of which are beyond our control, and the actual outcomes and results may differ materially from those contemplated by these forward-looking statements, as a result of these uncertainties, risks and changes in circumstances that could affect our financial and operating results, including risks and uncertainties included under the caption Risk Factors and Management’s Discussion and Analysis of financial condition and results of operations in our recent annual report on Form 10-K and quarterly report on Form 10-Q. Aerohive’s SEC filings are available on the Investor Relations section of our website at ir.aerohive.com and on the SEC’s website at www.sec.gov.

All forward-looking statements in this presentation and the reference 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 on which they are made, except as required by law.

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

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

David Flynn

Thank you, Jessica, and thank you all for joining us today.

We have been very hard at work for the last several quarters to transform the Company by improving our execution and reducing our dependence on the U.S. K-12 market. We believe our second quarter results show important progress of this plan with strong financials, improving profitability and double-digit growth outside of the U.S. K-12 market. We strengthened our product line, including being the first enterprise vendor to ship 802.11ax and we’ve optimized our cost structure and are operating with discipline. We are looking forward to returning to growth in the second half of this year as you will see in the third quarter guidance that John will provide later on the call.

Now, for the highlights of the quarter.

We are pleased to report second quarter results at the high end of our guidance range for revenue, with the record subscription and support revenue, and strong growth in deferred revenue, demonstrating our progress moving towards a SaaS-like business model. We also had exceptionally strong cash generation of approximately $10 million in the quarter, and an EPS beat resulting in non-GAAP profitability of $0.02.

Our second quarter results are continued evidence of progress in our vertical diversification strategy as we’ve delivered strong double-digit year-over-year growth rates in our enterprise business, which led K-12 to be only 33% of our business in the second quarter compared to 46% a year ago. In the Americas, our non-K-12 business grew approximately 20% year-over-year. In the rest of the world, we delivered revenue growth of 18% in EMEA and 107% in APAC.

Now, I’ll discuss a few key wins for the second quarter. Q2 was a particularly strong quarter in retail for us. One key win was a mid-six-figure project at Pier 1 Imports to bring wireless to over 500 North American stores to enable customers to use tablets as part of their omnichannel strategy.

We continue to see great success in the quick serve restaurant space, including a win at chicken specialist, Zack [ph], which is deploying Wi-Fi into their restaurants to reduce wait time through tablet-based order taking and credit card processing. The initial project is for 200 restaurants and is expected to expand to most of their 800 restaurants. We were selective over Meraki, based on the strength of references we have in similar line busting deployments including Chick-fil-A.

A mid-six-figure wired plus wireless project at international chicken specialist Nando’s, led to a record quarter in our switching business while accelerating our march towards world domination of the quick serve chicken market.

Finally, the innovative new products and features that we have developed for the hospitality in MDU markets, led to a mid-six-figure win at one of the largest long-term care providers in the Netherlands. They’re using our wallplate AP and our unique private client group functionality to give each residence a secure, private wireless network that spans the entire facility. We are seeing higher levels of interest in this unique solution across the MDU, hospitality and higher ed markets.

Our Q2 results also highlight our progress in improving sales execution and strengthening our channel as evidenced by non-GAAP sales and marketing spend coming in at only 36% of revenue, a record low. Our strong European growth demonstrates our ability to get leverage from our more developed EMEA channel as we feed new and improved products into it. And the channel development efforts are also paying-off in the U.S. where the fastest growth came from our commercial sales team, an inside sales that supports our channel-led sales into smaller enterprises.

Moving to product. We’re seeing a lot of interest in the new products we’ve launched this year. We continue to make great progress delivering these innovative products to customers and enchaining their features. Atom which is our enterprise class pluggable AP, the first of its kind, began shipping in the Americas in late Q1, and we will be expanding the availability to EMEA and APAC this quarter.

Over the last week, we announced that we shipped our 802.11ax APs in the U.S. and Europe. We’re very excited to be the first vendor to deliver enterprise class AX products to the market and be at the forefront of this new technology. AX continues to garner a lot of interest in the industry, and we’ve already built a significant backlog. Being first to market with AX and a pluggable AP is having a halo effect across the broader business. Our sales people are starting to see the benefits in the form of increasing awareness, new doors being opened and increasing channel partner engagement.

We are also seeing the high degree of interest in our SD-WAN offering. And during the quarter, we expect to deliver new SD-WAN hardware, coupled with further expansion of SD-WAN software capability. And we also plan to bring more security functionality into our SD-WAN solution for the cloud based DNS protection offering, later this year.

And speaking of security, with the delivery of A3, our first standalone security product, we are now fully participating in the secure access management market which is estimated to be over $1 billion today and projected to grow at a CAGR of 20% to 30% over the next two to three years. We shipped the initial release of this vendor agnostic, secure access management and network access control product. We’re seeing extremely strong interest in the product and in many cases it’s expanding our customer engagement from the networking team to the security team. This is opening up dialogue with more security centric channel partners and laying the foundation we need to sell additional security oriented offerings that are on our roadmap such as IoT, device detection, profiling and anomaly reporting.

Another highlight in the quarter was the further validation of our competitive positioning with the signing of a strategic relationship of Juniper, allowing them to sell Aerohive as their wireless solution. The Juniper sales team is rapidly bringing Aerohive into their deals. And already in Q3, we have begun shipping to fill a six-figure deal for one of the largest cities in the U.S.

In summary, it was a great quarter for us, and we’re very pleased with how the team has performed. Being first to market with products like AX and Atom as well as expanding into security with A3, our standalone security product, has reestablished us as the innovation leader in the market. This further bolsters our confidence in returning to year-over-year growth in the second half of 2018.

I’ll now turn it over to John to talk in more details about our financials.

John Ritchie

Thanks, Dave. Good afternoon, everybody, and thank you for joining here this afternoon.

Before I begin, I’d like to remind everybody that all numbers discussed today have been adjusted for ASC 606, which took effect January 1 of 2018.

Now, moving on to the quarter, I’d like to highlight some financial and operational milestones achieved by Aerohive in the second quarter. We exceeded our guidance metrics for non-GAAP EPS and non-GAAP operating margin. We came in at the high end of our guidance range for revenues and non-GAAP gross margin. Our cash and investment balances are at the highest levels since late 2015 and our subscription support business set all-time records for revenues and gross margin. And lastly, as Dave mentioned, we signed an important distribution agreement with Juniper.

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

Now, moving on to the second quarter results. Revenue came in at $40.5 million, up 13% sequentially and down 4% on a year-over-year basis. The primary driver in the modest year-over-year decline was related to our planned decreased dependence at the U.S. K-12 vertical, offset by significant improvement in our enterprise business.

Product revenue in the second quarter was $29.3 million, up 17% sequentially and down 9% on a year-over-year basis. Subscription support contributed a record $11.2 million in the quarter for 28% of total revenues, up 5% on a sequential basis and up 11% compared with the same period a year ago.

Moving on to geography. Revenues in the Americas came in at $23.4 million or 58% of total revenue. Americas revenue was up $2.6 million or 12% on a sequential basis and down $6 million or 20% on a year-over-year basis. The sequential decline was related to the aforementioned U.S. K-12 vertical. Moving onto EMEA. Revenues for EMEA came in at $12.7 million in the second quarter or 31% of total revenues. EMEA revenue increased $800,000 or 6% on a sequential basis and were up $2 million or 18% on a year-over-year basis.

The improving efficiency of the European channel model combined with our new product offerings are contributing to our continued success in Europe and helping us deliver our second consecutive quarter of year-over-year growth.

In the second quarter, for Asia PAC revenues came in at $4.4 million or 11% of total revenue, up $1.4 million or 45% on a sequential basis and up $2.3 million or a 107% on a year-over-year basis. We expect results from this region to continue to be lumpy, given the relatively small revenue base. Overall, however, we view this region as offering tremendous growth potentials and opportunities for us.

I’ll turn the discussion now to our non-GAAP gross margins and expenses.

For the second quarter of ‘18, non-GAAP gross margin came in at the upper end of our guidance range at 66.7%, down modestly when compared with the 67% in the first quarter of 2018 and down from 68.5% recorded in the year-ago period. The expected year-over-year decline is related to the implementation of our connect to select strategy.

Non-GAAP product gross margins for the quarter came in at 64.6% compared with 65.5% in the first quarter of ‘18. The sequential decline was related to a modest product mix shift. We had a record quarter for our lower margin switching business. On a year-over-year basis, non-GAAP product gross margins declined from 67.6%. This is attributable to the aforementioned connect to select strategy and the mix shift.

Non-GAAP subscription and support gross margins were 72.1% in the second quarter, up a 160 basis points when compared to 70.5% in the first quarter and up 80 basis points when compared with the 71.3% from a year ago period. This marks a Company record and our fifth consecutive quarter of greater than 70% gross margins for the subscription support business.

Now, moving onto non-GAAP expenses. Non-GAAP operating expenses were $26.2 million in the quarter, down $1.2 million or almost 5% when compared with the $27.4 million in the first quarter of ‘18 and down $1.8 million or over 6% from the $28 million in the same period a year ago.

Non-GAAP research and development came in at $7.6 million or 19% of revenue, compared with the $8.2 million or 23% of revenue in the first quarter. This compares with $8.2 million or 19% of revenue in the same period a year ago.

We continue to be very pleased with the unprecedented level of productivity we’re seeing out of our R&D organization. Taking a highly disciplined approach to spending, we believe we continue to punch above our weight class in regard to innovation. Already in 2018 amongst other achievements, we have introduced A3, our first standalone security product, we are first to market with the family of 802.11ax. We introduced the industry’s first enterprise class pluggable access point. And we did all of this while reducing our costs, both on the year-over-year basis and on a sequential basis.

Moving on to sales and marketing. Expenses there came in at $14.6 million or 36% of revenue compared to $14.7 million or 41% of revenue in the first quarter. These results point to some of the success we’re having with our ongoing effort to improve our sales efficiency with sales cost as a percentage of revenue hitting an all-time low. As we have mentioned, improvement in this area is key to our goal of stable and consistent profitability. On a year-over-year basis, non-GAAP sales and marketing expenses were down $1.3 million or 8%.

And lastly, G&A. G&A expenses came in at $4 million or 10% of revenue in the second quarter, compared with $4.5 million or 13% of revenue in the first quarter, and approximately even with the year-ago period. Our overall non-GAAP operating margin was 2% compared with a negative 9.5% in the first quarter of ‘18, and approximately even with the year ago period. Our non-GAAP operating income was $800,000 compared to an operating loss of $3.4 million in the first quarter and again approximately even with year ago period.

We reported non-GAAP net income of almost $1 million in the second quarter, an improvement compared with a non-GAAP net loss of $3.5 million in the first quarter, and non-GAAP net income of $700,000 in the same period a year ago. All of this translates to a non-GAAP net income per share in the second quarter of $0.02, a significant improvement when compared to the non-GAAP net loss of $0.06 cents in the first quarter and non-GAAP net income of a $0.01 for the same period a year ago. The non-GAAP net income per share for Q2 is based on approximately 56 million weighted average common shares outstanding.

Moving on to the GAAP results. On a GAAP basis, in the second quarter, the net loss was $0.05 per share compared with a net loss of $0.13 per share in the first quarter and a net loss of $0.07 per share in the year ago period. Our Q2 GAAP net loss included stock-based compensation expense of approximately $3.6 million.

Now, turning to the balance sheet. We had an exceptionally strong cash quarter with cash, cash equivalents and short-term investments as of the end of June, totaling $87.6 million. This is an increase of approximately $10 million from the prior quarter. These amounts include the impact of approximately $1 million used in conjunction with our share repurchase program. As mentioned earlier, this is our highest cash level since late 2015.

Accounts receivable decreased to $17.2 million as of the end of June compared with $19.5 million at the end of Q1 2018. DSOs decreased by 10 days to 39 days from 49 in the prior quarter. We’re pleased that these metrics remain in a very, very comfortable range.

Inventory declined $2.3 million coming in at $11.2 million at the end of the quarter compared with $13.6 million at the end of the previous quarter. Our deferred revenue balance now stands at an all-time high of $71.3 million, up $3.4 million from the $67.9 million in the previous quarter.

Now, moving onto the third quarter, I’ll provide guidance for the Q3 of 2018. We currently anticipate Q3 revenue in the range of $40 million to $42 million. On a non-GAAP basis, we expect gross margins to be in the range of 65.5% to 66.5%. The sequential modest decline is largely attributable to the well-publicized price increases we are seeing in MLCC component.

On a Non-GAAP basis, we expect our operating margins to be between breakeven and 2%. We expect other expenses including tax expense to be negligible in the quarter. And lastly, we expect Q3 non-GAAP EPS to be between breakeven and $0.02, and based on an estimated average share count of approximately 57 million shares outstanding.

On a GAAP basis, we expect Q3 net loss per share to be between $0.08 and $0.06 based on 55 million weighted average common shares outstanding. As a reminder, we exclude stock-based compensation and shareholder class action litigation costs from our non-GAAP results.

And lastly, I’d like to provide an update on our $20 million share repurchase program. The Board has authorized the extension of this program for an additional two years.

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

David Flynn

Thanks, John. In closing, we are pleased with the progress we are making. We are executing our plans are poised for growth in the second half of the year. I’d like to thank our partners, customers, and employees for their support and loyalty as we continue to improve our execution.

And we’ll now take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And we will take our first question from Mark Kelleher with D.A. Davidson. Go ahead sir.

Mark Kelleher

Great. Thanks for taking the questions. Congratulations on a pretty solid quarter there. Can you give us an update -- I know you talked about Juniper, and that’s just getting up and running, maybe given -- did that contribute in the quarter? And maybe talk about Dell and how that’s doing.

David Flynn

Yes. So, with regard to Juniper, we’ve been working to put in place -- for much of Q2 working and put in place the partnership and the transactional models, which we just announced the last days of the quarter. So, it did not contribute to Q2 results. I did comment in my script that we have booked some significant deals already in this quarter and are fulfilling them including a big project, one of the largest cities in the U.S. So, we are excited about the early progress, but it did not have any impact on the Q2 results.

And with regard to Dell, obviously, we continue to have the Dell partnership; we now added the Juniper partnership. Our plan, now we have two partnerships of strong switching vendors that are selling here Wi-Fi. Going forward, we don’t plan to comment on specifics between the two of them for a competitive reasons in the companies.

Mark Kelleher

Would you say Dell is -- you just sold more through Dell than you did last quarter, just some general metrics around that?

John Ritchie

Well, just to be clear, we didn’t have any transactions in Q2 with Juniper. So, the short answer is yes, we sold more through Dell. But as Dave mentioned…

Mark Kelleher

Not between the two, not between Dell and Juniper; between Dell this quarter and Dell last quarter? Did you sell more Dell this quarter than last quarter?

John Ritchie

Did we sell more Dell Q2 than we did Q1? The short answer to that is no. We did not sell more in Q2 than we did in Q1. And we don’t want to get in too much more specificity on that because of the competitive nature of our relationships.

Mark Kelleher

Does the partnership with Juniper impact the partnership with Dell?

John Ritchie

No.

David Flynn

No. We see them as a -- I’m sorry. You broke up there. What was that?

Mark Kelleher

No. I was just wondering if Dell might be less inclined to work with you if Juniper is working more with you.

David Flynn

No, we’ve seen no indication of that. I think that they tend to sell to slightly different kinds of customers. We have engaged -- we’re engaging effectively with both. So, we don’t see that as an issue. The Juniper partnership shouldn’t impact our Dell partnership.

Mark Kelleher

Okay. And if I could flip to another question and the 802.11ax, what’s your perception on the adoption of that? Is it still in the very-early stages, are we in the third inning? Where are we in terms of rolling that out, and what kind of visibility do you have on that?

David Flynn

Yes. So, in terms of rollout, it’s absolutely the first inning. We’re the first vendor in the industry to ship it. So, we’re way ahead of the competition. And so, -- and at this point, the interest is high because a lot of customers are starting to understand, it’s the next generation of Wi-Fi. We’re thrilled to be at the forefront and are getting a lot of visibility because of it. In the short-term, the sale is going to be largely a future proofing sale on the part of the customer where they’re putting in Wi-Fi infrastructure they want to last for 5 or 7 years and they want to put in the latest and greatest. A lot of them are looking to put in AX, because they know it’s the future. But, the reality is, AX clients aren’t available yet. So, there is not a measurable benefit of it today. But, if you are going to put in something today, next year, you are going to have AX clients showing up and a lot of forward thinking customers are interested in putting it in. So, they are ready for the next 5 to 7 years of wireless.

We’ve already built -- I mentioned we’ve built a significant backlog kind of well into the 7 figures. So, significant backlog of AX products when we started shipping to our first customers.

John Ritchie

And just emphasizing what said on the call, we really are seeing the halo effect of being viewed as much more of the innovative leader in the space between 802.11ax, for standalone security product, the pluggable APs. If you want to talk to the innovative leader in the space, you are going to pick up the phone and talk to us.

Operator

And our next question comes from Chase Bunnell [ph] with Dougherty and Company.

Unidentified Analyst

Hi. This is Chase. Thanks for taking the question. I’m on for Catharine Trebnick. And we had a question about your recent product releases. With so many of them coming out recently, what improvements have you seen in your launch process and how do you expect that to kind of impact your position going forward.

David Flynn

You’re right. We have introduced a lot of products recently. We introduced SD-WAN in January and then Atom, the pluggable AP, A3 the secure access security product now AX. So, we’ve been very busy working to launch these things to our sales force and through our sales force to our channel partners. I think, we’ve -- there’s a lot of ongoing effort to create awareness and largely to train the channels and our sales people to understand the products. We feel we’re making good progress on that. Although there’s a lot to do, there’s so many new products that have been introduced that they’ve not materially impacted the revenue, largely the revenue growth we’ve had over the -- in Q2. The success we had in Q2 was strength in the core wireless business and the switching business. But augmented by the halo effect of all these new products, it’s increasing the buzz and awareness. I think we’ll be continuing to work for the next few quarters to continue to train the channels and to fully capitalize on all the products we’ve delivered into the market.

Unidentified Analyst

Awesome. And then, the last one was just on the education market. What’s your kind of -- or what’s kind of like an update on that and where do you guys kind of stand on that going forward into the rest of the year?

David Flynn

So, as we talked about previously, we’ve been actively working to diversify our business mix and reduce our dependency on the K-12 market and in particular the U.S. K-12 market which has been very volatile. And we’ve made great progress on that. As we highlighted, the dependence on education this quarter was down from 46% a year ago to 33% this year, which is a great move to diversify the business. The U.S. education business was down year-over-year, as expected. That was factored into our annual operating plan and our guidance for the quarter. And it’s been down, especially the E-rate program, each of the last three years has been sequentially down at a market level. Our share has been largely unchanged in that market. So, we feel we’re holding our own and doing well, but it’s a declining market, which is why we’re focusing on growing the other markets. Overseas education did grow year-over-year but it’s a much smaller percentage of the total.

Operator

And next, we’ll hear from Christian Schwab with Craig Hallum.

Christian Schwab

Hey, great. Thanks for taking my question. So, congratulations on returning to year-over-year revenue growth in the back half of this fiscal year. Given your product leadership that we’ve been highlighting as well as expansion of potential growth opportunities with relationships with Juniper and Dell, what do you think on a multiyear basis we should expect the top line for you guys to grow exiting this year? Not exactly specific guidance for ‘19 but kind of over a three-year timeframe, what is the range of outcomes that we should consider to be logical?

John Ritchie

It sounds awfully much like multiyear guidance. I would tell you that we -- and Dave chime in, but we think with the product portfolio, where we’re positioned in the market regaining what we really believe is the kind of -- at least amongst the innovative leaders if not the most innovative company in the space. Mid to high teens I don’t think is unrealistic. But again, lots of -- economic cycles, all kinds of things could happen to that. But, I think with the improved execution you see now that was lately, heading back to growth for the back half of the year, I think, a long-term model of mid to high teens with approaching the same level of operating margin and I could tell you the time frame it would take us to get there, but we still think that that’s an achievable goal.

David Flynn

If you look at a lot of our metrics this quarter, you saw those strong double-digit growth rates and many of them 20% growth outside of it -- the decline in U.S. education market. So, I think we’ve demonstrated in the number of the markets that we can do that already. And as education becomes a smaller percentage of our mix, we’ll have a less of a headwind from it.

John Ritchie

So, just one other comment on that. I think we’ve been very clear in terms of our view, our road to profitability is driving efficiency out of that sales and marketing line. We had a multiyear low in that in the fourth quarter. And the profitability that comes out of our recurring revenue business, our SaaS-like model, hit record revenue levels, hit record gross margin levels, you pour a little bit of revenue growth on there, and we’re bullish about the future.

Operator

And there are no further questions in the queue. I’ll turn it back over to our speakers for closing comments.

David Flynn

All right. Thank you. Thank you all for joining us today. We look forward to seeing many of you soon at conferences and on the road. Good night.

Operator

And that concludes today’s conference call. We thank you for joining.