Melanie Solomon - IR, The Blueshirt Group David Flynn - President & CEO John Ritchie - CFO.

John Lucia - JMP Securities Jason Ader - William Blair Rohit Chopra - Buckingham Research Catharine Trebnick - Dougherty Matt Robison - Wunderlich.

Welcome to Aerohive Networks Second Quarter 2016 Financial Results Conference Call. Today's conference is being recorded. At this time I would like to turn the conference over to Melanie Solomon. Please go ahead, ma'am..

Thank you. Welcome to Aerohive Networks second quarter 2016 financial results conference call. After 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 chief financial officer.

During the course of today's call management will make forward looking statements including statements regarding your projections, operating results, expectations for future revenue growth, operating profitability and operating margin, plan for future investments, product development, deployment, adoption and performance 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 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 discussion and analysis of financial conditions and results of operations in our recent annual report on Form 10K and quarterly on Form 10-Q.

Aerohive's SEC filings are available on the relations section of our website at ir.aerohive.com and on the SEC's website at sec.gov.

All forward-looking statements in this presentation and the referenced press release are based on information available to us as of the date hereof and we disclaim any obligation to update the forward-looking statements provided to reflect events that occur or circumstances that exist after the date on which they were 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 reconciliation of these non-GAAP financial measures to corresponding GAAP measures as a discussion of why we present non-GAAP financial measures please see the today's press release available on our website. And now I'll turn the call over to David Flynn, President and CEO OF Aerohive..

Thank you, Melanie and thank you all for joining us today. Q2 is a record quarter for Aerohive with industry's leading growth of 29% over last year. We had particular strength in enterprise K-12 education and retail representing a balance quarter driven by continued innovation on our product line and progress expanding our channels.

We also demonstrated leverage in our operating model allowing us to deliver our best operating performance to-date. We are pleased with our generally strong execution and particular strong results in APAC offset by an unsettled business environment outside the U.S. including Brexit and continuing administrative issues with the E-Rate program.

We had a very strong quarter in terms of new product delivery with seven new products introduced in the quarter. Our new wave two access point the AP250 significantly contributed to our Q2 results AP250 was announced in early April and quickly ramps to account for 19% of our AP business in the quarter.

In stark contrast major competitors reported their wave two business at 11% or less of the total even several quarters after introduction.

This rapid ramp demonstrates we made the right decision to take the time to deliver our highly differentiated Wave 2 product with innovative dual 5 GHz radio design and the ability to work with existing switches utilizing 802.3AF power demand.

And the additional functionality in differentiation is enabling us to beat the competition and is also prompting upgrade conversations with existing customers.

For example to secure a during the second quarter as our long-time customer the College of William and Mary upgraded much of its old into 802.11 infrastructure to handle increase client and traffic load. They valued the added the network capacity provided by both Wave2 and the dual 5 GHz radio functionality of AP250.

Following on the success of AP250 we released AP245x which delivers Wave2 functionality with external antennas and rugged design for challenging environments further the broadening our AP portfolio.

In addition our new access point we shipped four new switches during the quarter expanding our ability to deliver complete unified wired and wireless cloud network management from a single payment class. This unified solution provides improved visibility, centralized control and reduced cost and complexity.

These switches now available in the range of port densities from desktop to stacking capable rack mount are managed through HiveManager NG and allowed us to win major European shoe company that operates 3000 retail locations around the world.

The selected Aerohive based on the reduced operating expenses delivered by our unified wired and wireless management solution. Another example of our continued progress in the retail vertical was a significant win at [indiscernible] an 850 store French grocery chain.

They chose Aerohive over Cisco and Aruba to replace their aging Motorola infrastructure to improve store operations and provide customers with Wi-Fi access that can enable customer engagement and loyalty programs.

We also announced developments to further strengthen our channel and expand our go-to market strategies, first our partnership with Dell continues to progress Dell released a cobranded version of HiveManager NG that manages Dell switches allowing them to sell manage and support a unified wired and wireless solution.

This delivers enterprise class conversion wired and wireless management and is available in both the public and private cloud. A key win with Dell in the second quarter was a high six-figure deal for a large school district in Texas which will deploy Aerohive access points along with Dell switches to serve their 25,000 students.

And finally we announced our advantage MSP program and the MSP focused features on HiveManager NG.

We see an increasing trend towards deploying Wi-Fi the service and our distributed control architecture without controllers plus cloud management with APIs is ideally suited for MSPs to have ease of deployment, low operating cost and the ability to innovate on top of our platform.

We're very pleased that in Q2 T-Systems announced new management LAN service based upon Aerohive Wi-Fi and Juniper switching. We’re pleased to be partnered with one of the world's leading carriers and are excited about the potential for the business.

Overall we are pleased with our execution and performance of the second quarter and I look forward to continued momentum and progress towards profitability. I will now turn it over to John to go through financials in detail and provide our guidance for the this third quarter.

Thanks, Dave. Good afternoon everybody and thanks for joining us today. Before we go to the quarter in detail I'd like to highlight some financial and operational milestones Aerohive achieved in the second quarter of 2016.

Q2 was a record revenue quarter with revenue growing 29% year-over-year with both product and service revenues hitting all-time highs. Non-GAAP gross margins set a new company record coming into the 68.3% driven by record service margins and lastly we recorded our best ever non-GAAP operating margin.

Overall our results show we executed well in the face of an administratively trouble E-Rate program and unsettled business climate outside the U.S. Despite these headwinds we delivered strong results based on continued improve execution across the organization.

As we've said before we are pleased with how far we've come to but know we have a lot of work ahead of us. During the balance of my prepared remarks I will cover our GAAP, our non-GAAP P&L, our balance sheet Q2 and provide some related commentary on our business and lastly I will close by providing financial guidance for the third quarter.

Now moving onto the quarter, total revenue for the quarter was $47.6 million up 19% on a sequential basis, Q2 product revenue came in at $39.5 million or 83% of total revenues an increase of 29% compared with the same quarter a year ago at an increase of 22% on a sequential basis.

We continue to make progress increasing our recurring revenue streams as our software subscription and services deferred revenue balances continue to grow quarter after quarter. This recurring revenue brings visibility, predictability to our model.

Q2 was a record for software subscription revenues coming in at $8.1 million or 17% of revenue an increase of 33% compared with the same quarter a year ago and an increase of 6% sequentially. As we grow our stolen base we expect to see sequential quarterly increases in this revenue line.

We believe our recurring revenues will increasingly differentiate our business model. On a geographic basis revenue in the Americas were $28.7 million or 60% of total revenue. America's revenues increased 60% compared with the same period a year ago and 18% percent on a sequential basis.

On a year-over-year basis Americas benefited from strength in education and enterprise verticals. Moving on toe EMEA, we saw healthy results in that market with revenues up $12.1 million or 26% of total revenues, EMEA revenue increased 32% compared with the same quarter a year ago and was even on a sequential basis.

We are particularly pleased with these results given the turmoil in Europe related to the Brexit. Moving on to AsiaPac revenue in AsiaPac region was at an all-time record of $6.8 million or 14% of total revenues. AsiaPac revenues increased 139% compared with the same quarter a year ago and 81% on a sequential basis.

AsiaPac revenues benefited from the final shipments related to our previously disclosed 40,000 unit AP retail deal that we talked about in the prior quarters.

As a reminder and international businesses is a material portion of our revenues and it's important to remember that will bill all locations in USD so we may see pricing pressure during periods in which the US dollar is strong.

Now moving on to gross margins, on a non-GAAP basis our overall Q2 gross margin was 68.3% an all-time high compared with 67.7% in the same period a year ago and 67.5% in Q1. Non-GAAP product gross margins for the quarter came in at 68.8% compared with 68.8% in the same period a year ago and 68% even in Q1.

Non-GAAP software subscription and services gross margins were 66% in Q2 compared with 62.1% in the same quarter a year ago and 65.5% in the first quarter.

Moving on to operating expenses total non-GAAP operating expenses were 33.5 million in the quarter compared to $31 million in the same quarter a year ago and essentially flat with the prior quarter.

With regard to non-GAAP functional expenses R&D increased to $9.2 million or 19% of revenue compared to $7.9 million or 21% of revenue in the same period a year ago. This compares with $8.9 million or 22% of revenue in Q1. Looking to Q3 we expect to see an uptick in R&D spend levels.

The sequential increase will be driven by increased headcount and discretionary spend as we continue to invest in our market leading technology. Non-GAAP sales and marketing came in at $19.3 million or 40% of revenue in Q2 compared to $18.5 million or 50% of revenue in the same period a year ago.

This compares also with $19.3 million or 48% of revenue in Q1. We are pleased with the leverage we are seeing in our go to market model leading to steady decreases in sales and marketing expenses as a percentage of total revenues.

And lastly on the non-GAAP basis our G&A costs were $5.1 million or 11% of revenue in Q2 compared to $4.7 million or 13% of revenue at the same period a year ago. This compares to $5 million or 13% of revenue in the first quarter.

Our overall operating margin level was negative 2.1% in all-time low for the company which was improvement of 14.4 percentage points from the negative 16.5% we saw in Q2 an improvement and an 13.1 percentage points from the 15.2% we saw in Q1.

On a non-GAAP basis we reported a net loss of $963,000 in the second quarter compared to net loss $6.3 million in the same quarter a year ago and compared with a loss of $6.2 million in Q1. This is our lowest non-GAAP net loss for the quarter to-date.

On a GAAP basis in Q2 the net loss was $0.15 per share compared with a net loss of $0.23 per share in the year ago and a net loss of $0.25 per share in the prior quarter. Our GAAP net loss included stock-based compensation expenses of $5.5 million and had a quarter relocation related expense of about $900,000.

The non-GAAP basis net loss per share in Q2 was $0.02 this compares to a net loss of $0.14 in the same period a year ago and a net loss of $0.13 per share in the prior quarter. The net loss per share for Q2 is based on a weighted average common shares outstanding number of 49.8 million shares.

Our total headcount at the end of the quarter was 634 compared to 620 at the end of Q1 and up year-over-year from 589 employees at the end of Q2 2015.

Now turning to the balance sheet cash and short-term investments came in at the end of the quarter at $79 million, inventory levels increased to 14.7 at the end of the quarter compared to a $11.5 million at the end of Q1 as we built stock in anticipation of demand for multiple new product introductions.

Accounts receivable increased to $29.5 million as of the end of June compared to $20.9 million at the end of the first quarter. As we mentioned on the Q1 call we expected a very backend loaded quarter this resulted in an anticipated increase in DSOs 47 to 56 days on a sequential basis.

We expect Q3 shipments to also be backend loaded with similar DSO levels. Deferred revenues increased 5% sequentially to $63.4 million at the end of June, an increase of 24% from the $51 million at the end of June of last year.

Deferred revenue from software and subscription and services increased 5% to $61.5 million in Q2 increased 29% to 47.8% at the end of June 2015. Our repurchase program continues to say pace as we experienced in first quarter. To-date we have repurchased approximately 261,000 shares for total cost of about $1.5 million.

Now moving on to guidance for our fiscal Q3 of 2016, we’re currently anticipating revenues in the range of $46 million to $50 million this guidance reflects the impact of an administratively troubled E-Rate program and unsettled business environment outside of the US.

On a non-GAAP basis we expect gross margins to be the range of 67% to 68% and a non-GAAP basis we expect operating margins between negative 7% and negative 1%. We expect other income and expenses in Q3 to be in the expense of approximately $200,000 and we expect the tax expense of same levels $200,000.

Lastly we expect non-GAAP EPS in Q3 to be between a loss of $0.07 and $0.01 on a weighted average common shares outstanding number of $50.7 million. Since we are in a loss position certain stock-based awards are not included in our weighted average shares outstanding numbers as they would be anti-dilutive to the EPS calculation.

On a GAAP basis we expect Q3 EPS of between negative 20 and negative $0.14 per share on the same $50.7 million with a common shares outstanding number. Once again we like to take this opportunity to reiterate our commitment to achieving non-GAAP operating profitability with revenue levels in the range of $50 million to $51 million.

We expect meet this objective through a combination of the revenue growth and control operating expenses focus with a focus on investment in the areas that we feel will yield the highest returns and secure long-term success.

Now with that I'll turn the call back over to Dave to provide additional details and market factors affecting our business in Q3 as well as our concluding remarks..

Thanks John, as we discussed on our last conference call as has been discussed by the UA community the 2016 E-Rate program has experienced operational issues related to their filing, approval and funding processes that have made it difficult for schools to navigate the process and delay the late issuance of funding letters.

These issues have led some schools to abandon their applications to pursue other funding vehicles or to wait and reapply next year cycle. As a result industrywide category two funding request are down 17% versus last year.

In that context we executed very well in the program and actually increased our share of Wi-Fi awards from 10% to 11% which is led to the value of our awards being down only 12% versus 2015.

As we said in the past we view E-Rate as just another funding vehicle that have a modest effect on education TAM, the majority of schools still do not have wireless networks able to support one-to-one learning so while these administrative challenges will have a short-term impact as customers modify their funding plans we did not see the decrease funding request in the 2016 E-Rate program as an indicator of overall market demand for wireless network and education.

We also continue to diversify our verticals looking at the second half of the year were pleased with our competitive positioning. We continue to grow faster than the market gaining share through our highly differentiated Wi-Fi in cloud networking solutions and our strong partnerships. I will now take your questions.

Operator?.

[Operator Instructions]. We will take our first question from John Lucia with JMP Securities. .

So you mentioned issues with E-Rate cause you to guide a little bit lower than maybe you were expecting, looks like you are looking for flat revenue sequentially versus last year you had a 16% increase I think that was off of a 43% sequential increase in Q2 and this is off of a 19% increase.

I just want to understand it sounds like you were saying the total business to Aerohive should be down around 12%, is there also a significant delay and approvals and you just expect business to come later in Q4 and maybe into next year or are you expecting significantly less business in total from E-rate just want to get your kind of view on that?.

Yes, there's two factors at work one is there is less funding requested which did lead to a 12% year-over-year decline in total award request for Aerohive that was much better than the industry, the industry was actually down 17%.

We believe as we said this is due to these administrative challenges that have lead many customers to abandon their application in mid-process, so we're actually optimistic that in 2017 people come back and reapply or they will continue to pursue other funding vehicles but it's going to take a little time for them to work through those other funding vehicles.

So there is one factor that 12% less total award value and administrative delays have also been delaying the pace of issuance of funding letters, which is one of the factors leading to this being a more backend loaded Q3 than traditionally.

And some of those funding letters we anticipate will skew the linearity, skew some of the spend out through the calendar year a bit more than we saw in 2015..

Okay and did you guys have E-Rate spending from last year's funding cycle, come in the June quarter was that a meaningful contributor in the June quarter and will it continue to contribute in Q3?.

Yes, we are still collecting PEOs against the 2015 cycle we had there's a meaningful contribution in Q2, getting down to minimal contribution in Q3 the 2015 cycle is largely behind us and in fact we are actually starting the competition for the 2017 cycle kind of as we speak..

Okay, and then I wanted to get an update on the Dell partnership it's been over a year since you announced that partnership, how is that ramping you talked about a couple of deals but is it starting to generate meaningful revenues if not when do you expect it to start generating some significant revenues?.

Yes, it is making good progress, it's growing the business has grown sequentially, every quarter since the partnership has been announced. We talked about this quarter, a high six-figure win.

We have many hundreds of customers through the partnership with Dell, and see it progressing I think we indicated we expect the total Dell business to be material by the end of this year, and continue to drive towards achieving that goal.

We think that the delivery of the integrated HiveManager NG with integrated Dell switch management in it that happened in later part of Q2, is a significant milestone and we are excited about potential for that further accelerate the relationship..

So you continue to expect the Dell business to be material by the end of this year?.

Yes. It's John speaking, it's progressing well, I think there was a comment we have made for several quarters and we're still sticking to that. We think it's a great relationship it's working out well for everybody..

We will take our next question from Troy Jensen with Piper Jaffray..

This is actually Austin on for Troy, just my first one is it sounds like you had some macro headwinds in Europe, just wondering now with Brexit vote decided looking into the second half, how does demand trends look to fair going forward?.

You know that’s embedded in our guidance, we think Europe that was unsettled it was starting to look a little unsettled as we headed towards the end of Q2. And we think that is in fact continuing.

But we also that's one layer in a relatively there's trouble elsewhere in South America is not particularly good shape, Brazil, I'm talking from a macro standpoint, Brazil isn't in the healthiest of shape. So I think the Brexit issue kind of little unsettled elsewhere across the globe all those factors along with E-Rate were baked into our guidance.

Okay and then just one of the housekeeping issue, could you just give me the percentage of revenues in each geography again?.

So starting off with the Americans 60% of total revenues, EMA 26% and APAC 14%.

We will go next to Jason Ader with William Blair..

I guess first question for you guys, on the vertical breakout, enterprise education retail could you give us approximate percentage of the business from those three areas?.

Yes, the K-12 education was approximately 40%, which is fairly consistent with it was last year we had a strong enterprise quarter which led the retail and retail plus -- the verticals will be approximately 20% so solid education quarter strong enterprise the retail and health about 20%.

Okay so about 40% from the general enterprise?.

Yes..

Okay, and then on the APAC I know you don't guide by geography that do you expect to continue the strength in APAC over the next couple of quarters?.

Yes the short answer is APAC benefited from us wrapping up the previously announced deal to sell the 40,000 -- we had a retail deal to sell 40,000 APs so we will expect a little bit softness there, because it won't benefit from that but we expect that softness to be offset in other geos.

Okay. And then lastly just on the E-Rate side of things, what changed this year versus last year for these as you call them administrative issues and is it a staffing issue, I would've thought that they would kind of nailed this down at this point..

Yes, we would've thought that too but largely it's been attributed to some online systems, online portal and some backend systems that are making the filing and the processing of reward request challenge. So it's truly systems issue.

Yes is a technology, one of the comments that will make sure we got across on the call is we don't think it's at all indicative of end user demands in education market, we think it's indicative of an administrative troubled plan that's not reflective of the overall market..

Sounds like the same systems that were running healthcare.gov..

We will take our next question from Doug Clark with Goldman Sachs..

This is Balaji, on behalf of Doug, could you comment on Ruckus and their integration with Brocade.

So maybe in terms of what you're seeing there, are you able to pick up any shared as they go through their integration process or do you think they are already down with that?.

I think they're probably still in frankly the early days of integration those things take a long time to work through.

So I'm sure they are dealing with some disruption and discontinuities, at the same time, our expectation -- I think we have commented before the Aruba and HP merged that was much more disruptive to the Aruba channel and created more opportunities for us, but we don't expect the Ruckus Brocade merger to be as disruptive because they had a more consistent channel philosophy between the two organizations, so we're much more focused on continuing to pursue the Aruba channels and are making good progress with a number of those..

And do you have any assessment of the cloud offering that they recently introduced and I'm still talking about Ruckus there..

Yes, we've taken initial look at it, it looks to be a very basic offering and we’ve seen a number of competitors introduce cloud offerings with the idea of extreme simplicity for small SMB type customer, which is very different than our approach we have a cloud offering that our cloud and our on-premise offering, our equivalent functionality and our design to scale up to the largest enterprise organization.

So there's is a very thin slice of what sophisticated enterprise customer would want much more SMB oriented and very early in a life cycle..

And then just one last question on Wave2, so are you still seeing a similar price premium as previous quarters is it still the 20% to 25% range and if so when you do you think that pricing will drop and maybe if you could also comment on the margins you are seeing with Wave2 products right now, are they better or worse than your corporate average?.

So this is John here I'll speak to the gross margin, the gross margins come in kind of at our corporate average, but we've had a very, very strong gross margin quarter, across the board. I'll turn it over to Dave on the pricing question.

Yes, industrywide we are still seeing Wave2 products be priced at and command significant premium above with Wave1 products, ours are 25% premium on a list price basis and we're seeing in fact essentially the same kind of premium on the street price basis.

The Wave2 technology the CPU chipsets etcetera are more expensive and so at least for the foreseeable future we don't anticipate seeing people seen those prices collapsed down to Wave 1 the product out there are premium products and customers are paying for those premium products..

We will take our next question from Rohit Chopra with Buckingham Research..

Just a few questions here, so I just want to get a sense on the general competitive environment did you see any uptick testing sort of close towards the end of the quarter given the slowness is there anything like that.

Yes we had a very good Q2 so the slowness we’re talking about is projection the forward-looking got a little lower but Q2 great results and very healthy margins as you can see, indicate we had that's indicative of a healthy repetitive environment, so didn't see any extremely different discounting similar competitive environment that we have seen in the past..

Okay and can you talk also about the other partners? I know we talk a lot about Dell but how is Synnex doing on the [indiscernible] side and Apple you mentioned the Juniper deal but can you just go through some of those and where you are in that process?.

Yes. The Synnex relationship is continuing to develop, they are helping our operational efficiency and we put most of our U.S. VARs all the U.S.

VARs other than the largest one is still direct, but most of them are transaction Synnex and their providing what we want them they also are helping us to recruit and develop new VARs, so seeing continued good progress on that front, Juniper relationship continues at a think it's we've gotten higher levels of engagement following the Ruckus acquisition by Brocade, the project at T-Systems had been well before that that's been a project under development for quite some time, but we are seeing some good engagement with Juniper, remind you that it will continue to be meeting the channel partnership as is the Apple partnership, meet the channel partnership.

So I think no material change on the Apple and on Juniper strengthening over time with Brocade being out of the mix with Ruckus being out of the mix rather.

Last question just on the R&D uptick I know is also mentioned last quarter that R&D would see an uptick and you are saying it again I just want to know maybe just give us a sense of what types of projects you're working on the actual ones obviously but what are you directing R&D towards?.

Yes, the biggest single investment is continuing to expand and refine our next-gen cloud platform HiveManager NG, it's out winning many customers with it but there's a lot of work to be done to fully realize its potential in terms of building out the features, building out the big data back-end, exposing the APIs, allowing innovation on top of it.

So I think the ongoing investment in that area continuing with additional APs in the roadmap, continuing to expand our switching functionality those are the key things in the roadmap..

We will take our next question from Catharine Trebnick with Dougherty..

I missed your revenue guidance, the most important piece, can you say that again?.

Sure, the revenue guidance was 46 million to 50 million..

Okay and then my other question is really around again the E-Rate I know you beat it to death, outside just the ministration issues, you had said that you're still seeing purchase orders come in 2015, are you seeing any coming in the tranche and then how much you think they are releasing this year for 2017?.

Well I think we're seeing the tailends, I mean 2015 is definitely getting to the tail end of 2015, don’t expect a ton of that activity in the third quarter, but we did see some in the second quarter, in the second quarter we did see some 16 activity but again that is been we expect that activity to continue into Q3 but expect it to suffer from some of these administrative issues that we alluded to..

Just the timing of it, in the Q2, people on 2016 cycle are able to buy ahead of the July 1 funding release dates but based on the repurchase method where they call the Bayer process, so we did book some orders under Bayer and we can continue to book orders under Bayer if funding letters aren't issued but some customers, many customers will wait for their funding letter so that will affect the timing of release of funds over the next couple of quarters..

All right.

So then typically Q4 and Q1 are seasonally low on education vertical, could it possibly be with this troublesome backend systems that end portal that again you might have a better than a low seasonally quarter due to that that people continue to buy?.

Yes, we give 90 days' worth of guidance and that’s why I avoid your question, there is some validity to your point if the processing payments slowly eventually they have to catch up, but we don't want to take a guess at this point of when that will occur..

Okay and then one final question you know you talked about replacing some 11 N out there how much 11N do you think there's still available to replace with both Wave 1 and Wave2 and congratulations on the Wave2 that was a nice ramp..

Yes, if you look at some of the market research houses the overwhelming majority of installed base is 11N I think AC -- have to confirm the number but it's roughly like 20% of installed base is AC so 80% of the install base is all radio technology that is potentially available for upgrade..

We will take our next question from Matt Robison with Wunderlich..

I was wondering if you could comment on a little bit on growth of enterprise relative to education, and if John with your profit guidance for the quarter a pretty similar revenue looks like mid ranges a little bit down sequentially, is that the R&D comment you made before and that’s the kind of thing that was on a trajectory before you saw things soften up a bit..

No it's a combination of the modest uptick in R&D spend and be the inside the guidance range we gave for gross margins, that's why you see the modest the midpoint of the EPS number is modestly lower than what we just experienced.

So the gross margin is really driven by we think continue to improve on the service gross margins by the product side reason we stuck with the 67% to 60% as we expect switch from a product mix standpoint we expect to see an uptick in our switches which have modestly lower margins than our APs so that's what's driving that..

Okay.

That's interesting because I was going to ask you what the tax rate you have is switches is at this point I would assume it's pretty small since you just started but how is that going?.

Yes, to be clear we have had switches for a while although the switches were the first-generation switches were not as complete of a software stack or is actually cost-effective as to the new switches that we've created.

So I think we expect to drive the new switches harder than we did the old ones, I think we realized that the switching businesses is well under 10% of the business we haven't broken out specifics..

Okay enterprise versus education?.

Just so we had the enterprise quarter was a very strong quarter, the education year-over-year was pretty similar about 40% of the total mix, but our enterprise business in this quarter was pretty much it was tied for the second biggest that it ever been in our history. So we felt good about the strength of enterprise business..

We will go next to Meta Marshall with Morgan Stanley..

It's is Eugene Henderson on for Meta.

I just what's on the outlook here, maybe if you look at it from sort of a refresh cycle point of view are these headwinds E-Rate or otherwise are they effecting more greenfield or refresh activities or just kind of evenly, I mean I guess for the verticals outside of E-Rate what stage do you think we are right now in terms of refreshing your install base? Thanks.

I think we're if you were to take some of the macro numbers we are looking at we’re 20% into -- if 20% of the installed base is AC and 80% is prior generations, that kind of gives you an indication of where we are at in the transition.

In terms of the different headwinds and how they are affecting us I think it's affecting us relatively evenly, one of the messages we'd like to get across is the last time there was issues and troubles around the E-Rate business it impacted the company very, very dramatically.

Now no one is pleased and we like to have given better guidance but we are really, we're somewhat pleased with the strength and the model that we're seeing in spite of all these headwinds.

We’ve talked about the service business providing a modest level of stability and helping with profitability and we're seeing good execution there so I'm not sure I'm answering your question directly but those were points that you would be interested to get across..

I guess just kind of a follow-up you mentioned just with your new product cycle ramp it's getting some interest in terms of accelerating refresh activity is that primarily the older generation, is that also Wave 1 perhaps, just anecdotally trying to get more color on what that acceleration looks like..

We've seen the refresh cycles start probably over the last year or so we started to see some of the customers refresh the older install base customer refresh and go to AC Wave 1, I think that the launch of the 250 and in particular the dual 5 Ghz capability that really helps in high density environment is an even bigger catalyst to create more refresh opportunity.

So yes most of them -- the experience we had with customers were not necessarily waiting for Wave 2 they're still like of Wave 2 clients out there is making the strong pull for Wave 2 is making the pull not particularly strong for Wave2 but we have found that that dual 5 GHz capability plus the ability to work with their existing switches is making this kind of a no-brainer for them to refresh to that platform..

We will now take a follow-up question from John Lucia with JMP Securities..

I just wanted to ask a question on Wave2 it's definitely ramping faster than I had expected, I thought the Wave1 speeds were pretty sufficient for most customers at this point, especially except for high density environments and also like you said you don't have the Wave2 clients yet what are the use cases for Wave2 speeds or performance versus a Wave1 what are the use cases there in those customers?.

Yes, the most generally interesting use case is the ability to run what they call multi-user [indiscernible] multiple parallel conversations at the same time, which will reduce contention and increase network capacity.

The problem is that it doesn’t work until you have Wave2 clients which one of the reasons why it's been little bit slower the uptick and why some of our competitors one of our largest competitor is actually in their in the [indiscernible] report in support Q1 had only 3% of their business on Wave2, and so that's the long-term potential, of Wave2.

As I said in our case we took advantage of the fact that we are building a new Wave2 platform and said let's not make it just Wave2 but let's make it a dual 5 GHz which allows us to essentially double the spectral capacity in a high density deployment because in many very high density deployments take a school for example you put one AP per classroom, you’ve too many 2.4 GHz radios in those environments and many customers shut off the half of the 2.4 GHz radios they are now able to turn those radios into a 5 GHz radio and 5 GHz has more capacity than 2.4 so the net math is they can actually have twice the capacity of the network.

So that’s the use case driving the success of our Wave2 product, and is frankly not really a Wave 2 use case's it's an innovative and largely running, what all can be done in a Wave 1 environment, we just did it on a Wave 2 product. Those customers were also future proof for the day the Wave2 quite show up so they can handle more things..

When are the Wave2 clients supposed to show up?.

The expectation -- there's a tiny number of them available, expectation is towards the later part of this year that you'll start to see broad-based adoption of the many speculate the new Apple phones coming will have Wave2 the first Samsung product has Wave2 now so it's just starting but should be picking up towards the end of the year.

We will also take a follow-up from Doug Clark with Goldman Sachs..

Just a housekeeping question, could you repeat your gross margin and GAAP EPS guidance?.

Non-GAAP guidance 67% to 60%, and what was your other question?.

GAAP EPS.

GAAP EPS was -- there is a $0.13 difference between the two.

So it's $0.20 and $0.14?.

That concludes today's question and answer session. At this time I would like to turn the conference back to Mr. David Flynn for any additional remarks..

Thank you all for joining us today. We will be at Oppenheimer Conference next week in Boston. And hope to see many of you there. Good night.

This does conclude today's conference. Thank you for your participation. You may now disconnect..