David Flynn - President, CEO John Ritchie - SVP and CFO John Lucia - JMP Securities Melanie Solomon - IR.

Balaji Krishnamurthy - Goldman Sachs Mark Kelleher - D.A. Davidson Matt Robison - Wunderlich John Lucia - JMP Securities Meta Marshall - Morgan Stanley Eugene Anderson - Morgan Stanley Welcome to the Aerohive Networks' Fourth Quarter and Full-Year 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. .

Thank you and welcome to Aerohive Networks' fourth quarter and full FY '16 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 margins, plans for future investments, product development, deployment, adoption of 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 10K and quarterly report on form 10-Q.

Aerohive's SEC filings are available on the investor relation 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 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 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. I'll now turn the call over to David Flynn, President and CEO of Aerohive. .

Thank you, Melanie and thank you all for joining us today. Today, I'll will start with a review of our Q4 and FY '16 results.

I'll then turn it over to John to provide more detail in the financials in our guidance for Q1 and I'll then continue with the discussion of our growth opportunities for 2017, including our new product line announced last month. In Q4, we exceeded our guidance range on both GAAP, gross margin-- non-GAAP gross margin and EPS.

While revenue came in at $41.7 million, a 3% sequential increase, but slightly below our guidance range. We're pleased with the beat on gross margins and EPS, driven by our focus on improving operational efficiency. We'll share more detail on those efforts later in the call.

As expected, E-Rate continues to be a headwind in Q4 and almost 70% of our business for the quarter was outside of K-12. Our Q4 results were more negatively impacted by the challenges associate with our ongoing transition to HiveManager NG, the newest version of our network management platform.

Recent quarters have seen growth of our HiveManager NG business among mid-sized customers as we build out our platform and feature set. As we introduced it into a larger sales opportunities, we're seeing elongated sales cycles and product enhancement request as customers evaluate NG in far more complex and demanding environments.

Longer sales cycles have a compound impact by requiring more time and attention from our sales teams to close current deals as well as development new sales opportunities. We're seeing continual improvement and we expect these challenges to gradually diminish over the next two quarters.

We remain confident that the HiveManager NG is our strategic management platform for the future and we're working hard to ensure it is ready for our largest and most demanding customers.

Despite transition challenges, the court differentiators of our solution remain and we continue to win business with both HiveManager Classic and the newer HiveManager NG.

There were some incurring developments in Q4, particularly growth of our innovative Dual 5GHz Wave 2 products which accounted for 33% of our access points sales in Q4 and growth in markets outside of the U.S.

We had a record quarter in our MIA business which was up 23% year-over-year and up 42% quarter-over quarter driven by key retail and enterprise wins. Our partnership with Dell continues to grow throughout the year. Q4 was a record quarter for Dell and for Dell wins and that business was a material contributor to our results.

With Dell, we transacted with almost 300 customers, including two large international education projects, each of which were worth approximately $1 million. I'll highlight a few other notable Q4 wins.

Working closely with one of our MSP partners, we were selected by rapidly growing 400 store, multinational, fresh food and coffee shop chain, to provide managed Wi-Fi solution and retail analytics using the public cloud version of HiveManager NG.

We continue to have success with European shoe retailers, this time winning a project to provide connectivity and an engage shopping experience for a 350 store chain which is deploying 1,200 of our new AP 122 Access Points.

At a 30,000 students state college in the southeast, we replaced an existing Aruba deployment with our Dual 5GHz AP250 our outdoor AP1130. We competed against Cisco Meraki and others and won because of the strength of our solution and ease-of-use.

One of our recurring themes has been intensifying our vertical diversification efforts to reduce dependence on K-12 education. Analysis of our net new accounts in the fourth quarter, shows progress in this regard.

Of the 10 largest net new customers in Q4, three were retail, three were universities, two were enterprise, one was health and only one was K-12. All these deals were above six figures and eight of these were on the new HiveManager NG platform, proving the value of this platform to new customers. Q4 was a challenging end to 2016.

For the year, our revenue of $169.8 million, grew 12% over 2015. While we're always looking for faster growth, even with the challenges in the second half of the year, we still significantly exceeded the enterprise Wi-Fi market growth rate estimated at 7% by DeLauro [ph].

Our software subscription services revenue was a record $33.3 million or 20% of total revenue for the year, 31% growth over last year.

With this foundation, in 2017 we remain committed to diversification and expanding our product offering to reduce our exposure to the volatility of E-Rate and broaden our opportunities with enterprise customers and other market segments. I'll now turn it over to John to discuss our financials in more detail and provide our Q1 guidance.

Then, I will come back and give some additional comments on 2017. .

Thanks, Dave. Good afternoon, everybody and thank you for joining us today. Before we go through the quarter in detail, I would like to highlight some financial and operational milestones Aerohive achieved in the fourth quarter, despite a continued challenging revenue environment for us.

Q4 was a record revenue quarter for our software subscription business growing 21% on the year-over-year basis and achieving record non-GAAP gross margins optimizing this business will be of focus for us as we head into 2017.

Our overall non-GAAP gross margins also set a new company record coming in at 68.8% driven by records -- by record contributions from the software subscription business. Looking back at 2016 on the full year basis, revenues came in at 169.8 million, up 12%.

Our software subscription business strongly contribute to our growth for the full year increasing 31%. Although we grew year-over-year, faster than the industry, our results continue to highlight our over dependence on the troubled E-Rate program. As mentioned last quarter, we have accelerated our plans to lessen this dependency.

As a key component of this strategy, we recently introduced the Aerohive Connect Product line which Dave will talk more about later on in the call. During the balance of my prepared remarks, I will cover our GAAP and non-GAAP P&L and our balance sheet for Q4 and provide some related commentary on our business.

And lastly, I will close by reviewing our financial guidance for Q1, 2017. Now, moving onto the quarter, total revenues for Q4 were $41.7 million down 10% on the year-over-year basis and up 3% sequentially. Our product revenues came in at $32.9 million.

Despite the difficulties with our overall revenue, we continue to make progress increasing our recurring revenue streams, this recurring revenue increases visibility and predictability of our model.

Q4 was a record for software subscription services revenues, coming in at $8.8 million or 21% an increase of 21% compared with the same quarter a year ago. We believe our recurring revenues will increasingly differentiate our business model and is a critical component of our strategy as we move forward.

On the geographical basis, revenues in the Americas were $23.7 million or 57% of total revenue. America's revenues decreased 19% compared with the same period a year ago and decreased 8% on the sequential basis.

On a year-over-year basis, the Americas were negatively impacted by the ongoing problems with the E-Rate program and the product transition Dave talked about earlier in his prepared remarks.

Moving on to EMEA, our second largest market which had a record revenue quarter coming in at $15 million or 36% of total revenues, EMEA revenue increased 23% compared to the same quarter a year ago and was up 42% on a sequential basis.

The region did benefit from the closing of deals that have been delayed from Q3 into Q4 as we discussed on the Q3 earnings call. Moving on to APAC, revenue in the Asia PAC region was $3 million or 7% of total revenues. Asia PAC revenue decreased 35% compared with the same quarter a year ago and was down 26% sequentially.

We expect results from this region to continue to evolve while driven by lumpy heels of a relatively small revenue base. As a reminder, that we've given you in past quarters, our international business is a material portion of our revenue and is important to remember we built all locations in U.S.

dollars, so we may see pricing pressures during extended periods in which the U.S. dollar is strong. Moving on to our overall gross margin. On a non-GAAP basis, overall gross margins came in at 68.8% pointed percent, an all-time high compared with 67.7% in the same period a year ago and 68.5% in Q3.

Non-GAAP product gross margins for the quarters came in at 68.8 % up when compared with the 68.4% in the same period a year ago and up from 68.6% in Q3. Non-GAAP software subscription and services' gross margins were 68.7% in Q4 compared with 64.3% in the same quarter a year ago and 68.2% in Q3.

Non-GAAP operating expenses for the quarter, came in at $31.1 million compared to $33 million in the same quarter a year ago and slightly up from the $30.9 million recorded in the third quarter.

The year-over-year reduction in operating expenses was related to a significant decline in our variable expenses, specifically compensation related expenses which are tied to financial performance.

We believe that it is important to have variability in the operating expense model that tie our expenses to the variability in our top line in other financial metrics. We took actions in Q1 that will increase our efficiency, lower cost and help us in our drive toward profitability. I will provide more details on this in the guidance discussion.

With regard to non-GAAP functional expenses, R&D spend came in at a $8.9 million up-- or 21% of revenue compared with $9.1 million or 20% of revenue in the same period a year ago. This compares with $9.1 million or 23% of revenue in the third quarter.

Non-GAAP sales and marketing expenses came in at $17 million or 41% of revenue in Q4, relatively flat when compared with the third quarter. On the year-over-year basis, sales and marketing spend was down from $19.1 million or 41% of revenue in the same period a year ago.

The decline in sales and marketing expenses was primarily related to lower variable sales compensation costs. Lastly, moving on to G&A, G&A expenses came in at $5.1 million or 12% of revenue in Q4 compared to $4.8 million or 10% of revenue in the same period a year ago. This compares with $4.6 million or 11% of revenue in Q3.

The increase in G&A was primarily attributable to IP litigation costs related to a matter that we chose to take to trial and not to settle. We feel vindicated in our decision to litigate this matter as a jury recently found in our favor.

A key takeaway regarding our functional operating expenses, is that we have built a variability into the cost structure. Operating expenses now scale more appropriately with the overall performance of the business. Overall, our non-GAAP operating margin was negative 5.7%, compared to negative 3.7% in the same period a year ago and negative 7.9% in Q3.

On a non-GAAP basis, we reported a net loss of $2.3 million in the fourth quarter compared with a net loss of $1.7 million in the same quarter a year ago and compared with a loss of $3.3 million in the third quarter of last year.

On a non-GAAP basis, net loss per share was $0.04 compared to a net loss per share of $0.03 in the same period a year ago and a net loss of $0.06 in the third quarter of 2016. The net loss per share for Q4 is based on a weighted average common shares outstanding number of 51.6 million shares.

On a GAAP basis in Q4, the net loss was $0.14 per share compared with the net loss of $0.15 in the year ago period and a loss of $0.19 in the prior quarter. Our Q4 GAAP net loss included stock-based compensation expenses of approximately $4.9 million. Now moving on to the balance sheet.

Cash and short term investments at the end of the quarter totaled $76.8 million. Inventory levels decreased $3.1 million to $12.6 million at the end of the quarter compared to $15.7 million at the end of Q3. The decrease in inventory was related to a continued focus on improved inventory management.

Accounts Receivable increase to $26.2 million as of December 31 compared to $22.5 million at the end of the third quarter. DSOs increased from 51 to 58 days. Our business has become more backend loaded we expect this to continue in 2017. Now moving on to guidance for the first quarter of 2017.

We currently anticipate revenue in the range of $35 million to $36.5 million, our revenue guidance anticipates our typical seasonality compounded by the impact of the elongated sales cycles that Dave discussed in his prepared remarks.

On a non-GAAP basis, we expect gross margins to be in the range of 66.5% to 67.5% driven by fixed operating costs over a lower revenue base and modestly impacted by our new connect product offerings.

On a non-GAAP basis, we expect our operating margins to be between negative 16% to negative 13% and we expect other income and expenses, including tax expense, of approximately $200,000 in the quarter.

Lastly, we expect non-GAAP EPS in Q1 to be between a loss of $0.09 and $0.11, on a weighted average common shares outstanding number of 52.5 million shares. Since we're in a loss position, certain stock-based compensation awards are not included in our weighted average shares outstanding number as they would be anti-dilutive to the EPS calculation.

On the GAAP basis we expect Q1 EPS of between negative $0.19 and negative $0.21 per share on the same share count of 52.8 million weighted common shares outstanding. Our Q1 GAAP results will include approximately $1.5 million worth of restructuring charges for actions we took in the first quarter.

As a result of these actions, we're expecting a year-over-year decline in our 2017 operating expenses and are updating our guidance regarding non-GAAP operating profitability achievements. Our previous goal was to achieve profitability with approximately $50 million in revenue.

We now feel very comfortable that this goal can be reached with revenue levels of approximately $45 million. We expect to meet this objective through a combination of revenue growth, controlled operating expenses with focused investment in areas that we fill will yield the highest returns and secure our long term success.

Now with that, I'll turn the call back over to date for some further remarks. .

Thanks, John. The recent challenges we have faced have helped us to sharpen our focus on diversifying our business, streamlining our operations and generally enabling more opportunity outside of K-12 education. We said last quarter that in 2017 we would be taking tangible actions to improve our growth trajectory.

I would like to share with you some of the steps we're already taken, that we think left a positive impact on our business over the coming quarters. Growing our business means winning more deals, we're extremely pleased to announce we have hired Ron Gill as our Vice President of America sales reporting to Tom Wilborn.

Ron was formally Ruckus' head of sales for North America -- America where his team had great success. Ron brings a deep understanding of the Wi-Fi market channels and customers.

We're pleased with such a respected industry veteran is joining Aerohive and see this as another validation of our ability to attract top talent based on our compelling strategy and market opportunity. Enabling growth demands and organization that can be faster and more nimble.

In December, we implemented changes in our product determined organizations under the leadership of Allen Amrod, a respected network and Wi-Fi industry veteran. These changes are specifically intended to help us more quickly advance the maturation of HiveManager NG. We're already seeing a positive impact from this new unified organization.

I'm also please report that John Ritchie has accepted the expanded role of Chief Operating Officer, in addition to his duties as Chief Financial Officer. This is a new position for us at Aerohive. Since John joined Aerohive in August 2015, he has taken on an increasing operational focus as he has worked to improve our financial efficiency.

I have no doubt that his now more formal focus on operational execution will benefit the company as we invest to grow. Under our new structure, I will continue to directly manage sales, marketing and products.

Finally, the most significant change of last month's announcement of Aerohive Connect, a disruptive new product line that we believe will open doors for new sales opportunities as we often say get us more at-bats.

When we had the opportunity to get in front of prospects, in an appropriate point in the sales process, we generally do very well at winning the deal. The challenge is giving prospects or resellers, who are you working was competitor solutions, a reason to meet with us and consider us. The connect offering addresses this challenge.

If the bundled Enterprise Class Offering and disruptive price point that includes our entry-level two by two AP's, a streamlined version of our HiveManager application and community and e-mail based customer support.

In our observation of the marketplace prospects, including large organizations, frequently use the AP hardware price as point of comparison when evaluating solutions. We believe that our aggressive must-consider pricing will be a catalyst to introduce Aerohive to new prospects.

Aerohive connect will be sold in the market alongside Aerohive's previously available product line now refer to as Aerohive Select. Aerohive Connect customers can purchase a select subscription at any time to upgrade their Connect AP to our full select functionality and customer support.

We have shipped in solution value from hardware to software and subscription, so we expect the select upgrade will generate more subscription revenue per AP than our prior model and lead to only modest reductions in ASP for the select customers.

The true product lines have different price points that reflect the significant differences in the features that each offers.

For example, Aerohive Connect is only available as a public cloud solution, while Aerohive Selects is a full range of public, private and on-premise deployment and Select deliver substantially more breadth and depth of enterprise functionality.

Our primary objective with Aerohive Connect is to earn new meetings and then introduce the prospect to our full portfolio capabilities. As the deal moves forward through the sales process, this could result in one of three outcomes-- Many prospects will see the value of and purchase our full select solution.

Some prospects may choose the more limited connect feature set, particularly for hotspot, hospitality and film retail management services project. These deals would be incremental opportunities for us.

Finally, prospects may choose Connect today, become qualified new leads for up selling our full Cloud Solution and then upgrade to Select at a later date. All three outcomes yield a positive contribution to our business.

We expect increased at-bats and new Connect business to drive enough incremental growth to more than offset the modest impact in some current Select customers opt to move to the lower function Connect offering.

Remember that approximately 70% -- 75% of our business in the quarter, is expansion orders from existing customers who are already running our Select offering and who the generally need our enterprise features and support. The majority of our IP's are deployed with on-premise private cloud management, a capability only available with Aerohive Select.

This minimizes exposure to our current business will providing upside potential for new opportunities. The initial response to Connect in it's first two weeks of launch has been quite positive. We received our first order for Connect on our first day in the market from a customer who had previously told us we had lost their business.

Our first new connect channel partner is a managed service provider we've been trying to recruit for over a year. Over 800 new HiveManager demo accounts have been created since the launch of Connect. Almost a three ex-increase over normal.

Often, this is the first step in the customer evaluating our full set of capabilities and starting the sales process. We will take some time for us to see how this translate into our ultimate goal of revenue growth but we're encouraged by these leading indicators.

In summary, as we enter 2017, we've strengthened our organization to drive improved execution and we've built a model with a propelling solution set, higher recurring revenue, strong gross margins and a focus on expense control. As we intensify our focus on growth, we believe this foundation will serve us well. I will now take your questions.

Operator?.

[Operator Instructions]. Our first question is from Doug Clark with Goldman Sachs. .

This is Balaji Krishnamurthy on his behalf. A couple questions on pricing, maybe just a segway from that discussion. On your recent announcement for AP 121 to 8130 that is obviously well below your existing portfolio pricing. Are you targeting a new customer set or channel or is this just obscured to lower end of your portfolio.

Then, around the same time you [indiscernible] also introduced BF 2 axis point which is $350, so what are your thoughts on potential for price declines from a competitive standpoint?.

As you said, the connect offering is a much more aggressive price point and it is designed to target a different customer segment which is a connectivity oriented customer that generally doesn't need the more advanced complete enterprise feature set that we have, the more sophisticated Policy Management, lower security advanced capabilities and there is a rich set of features that are available in Select that are not in Connect and we have that documented on our website, you can take a look at that.

The Connect segment is a segment that we have not been attacking very aggressively. We see a good opportunity down in that segment. We built the 122 to be a very low-cost product, we invest a lot in cogs to make it a very compelling product, optimized for that connectivity oriented segment.

At the same time, were able to bring it up into the larger enterprise with a selects software upgrade on the subscription side. We're encouraged by it.

Very important to remember that, we have moved value from hardware to software so when someone runs with the Select subscription, the average selling price of an AP 130 is still very similar to what it was before we did this transaction.

We're welding the staff subscription recurring revenue business and using our aggressive hardware price to get into accounts. Now turning to ubiquity offering, ubiquity has been in the market for a long time. We still very rarely see them, they're very much in a lower end to environment.

They have made an announcement that they are going to try to move up to redetermine how well they do that and there's a lot of depth of enterprise functionality that is required to truly compete in the select category.

They have not yet built a support organization, it takes a long time to build a world-class organization like ours that delivers-- consistently delivers high network motor score and to have an organization that response with urgency to customers and issues which is what we have always built serving enterprise customers. .

Okay, that makes sense and if I could follow up with one more for John. On the R&D line, the R&D intensity for the last couple of years has been around 21% of sales. How should we think about that in the next year? Is that going up or down or-- if there is any changes to the long term target that would be very helpful. .

The only granularity I can give you on that is, overall expenses will be down nominally, 16 when you compare 17 to 16 and in terms of where we cut, the majority of our cuts were not in engineering so when you model it out I would have that with probably the most modest of the decline, to add decline the three line items. .

Our next question is from Mark Kelleher with D.A. Davidson. .

Just a clarification, did you say 30% of business came from K-12 in the quarter?.

Yes. We said the inverse, almost 70% came from non-K-12 so yes K-12 is in the low 30s. .

Last quarter, you indicated about half of that came from E-Rate, is that about the same percentage?.

Yes. It was a little bit less actually we had some of our come I mentioned those two largest Dell education wins that were outside of the U.S. They were a couple of large international education wins that were in that so E-Rate would have been a bit less than that. The pace of E-Rate continued largely unchanged from Q3 to Q4, continue to be a headwind.

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But that takes me to my real question, is it possible to go round E-Rate and ramp up K-12 spending in the U.S.

without E-Rate? Is that possible or do you have to get E-Rate working to ramp up in the U.S.?.

I think E-Rate has to start working for us to have any level of confidence and baked that in. We're not baking into our model as we look out to 2017, we're not baking in any sort of real improvement in the E-Rate administration or the administration of the E-Rate programs. .

There is a point, there are many of the projects funded outside of E-Rate and as indicated and often call it sometimes have, if E-Rate, with E-Rate depressed it is half. If E-Rate is robust, we've seen overall demand in the percentage of it being E-Rate being better.

There are schools that are looking at funding from other things like bond initiatives. While E-Rate is there, there's going to be another huge pool of money available in this coming year, people are likely going to look to it and we need the government to get more efficient with dispersing the funds. .

All right and if I can squeeze one last question in, just a numbers question.

Are you going to or could you breakout Dell as a percent of sales?.

We would likely not break it out. We've given directional indicators in terms of what percentage of the business it makes in any given quarter and our goal was for it to get to 10% in Q4 and-- actually, our goal was for it to be material, using 10% as the definition and we exceeded that.

Because we sell the product to Dell through Dell selected distributor, it doesn't actually show up from our standpoint, doesn't show up directly as a Dell sale, even though it ultimately is. We wouldn't clip any threshold where we would have a reporting requirement. .

Our next question is from Matt Robison with Wunderlich. .

Can you guys talk about the market breath in sales cycle implications of the new approach, starting lower and then achieving upsell down the road?.

There is two things as we said, there are some segments we have not been addressing, some of these connectivity oriented segments and some things that just are -- some of it could be midmarket are some of it could be MSP providing connectivity oriented services to a large number of mid-market customers.

I think there is an incremental growth opportunity just with the Connect offering on its own but one of the other big opportunities-- actually, sorry a key thing of that is getting into those deals and then that becomes a large installed base that we can now effectively market to.

We now know who they are, we can now start the upsell process to sell the Selects software subscription on top of it.

Our marketing team will be continually reminding them of the cool advanced features they do not have an actually the product has been redesigned to highlight those features and to remind them of the things they could use to troubleshoot an issue or to do more advanced configurations.

So we would be up selling those people continuously, to help drive recurring fast revenue of the larger footprint.

And then, in our more traditional market segment, we actually think it will be an opportunity to get into new accounts more efficiently, because I think it would be negligent of many enterprise customers to not at least look at connect and bring us in and assess what we have to offer.

More than likely they will end up probably requiring the Select functionality but in some of their scenarios they may be able to deploy Connect.

We think it will be a door opener and a sales accelerator and by the way, they can always -- even as large enterprises can start with connect and then just purchase a Select subscription, loaded into the HiveManager and they're upgraded to Select.

So there is no need to wait to get started until they complete the evaluation, they can start on connect and easily upgrade. .

Do you have any customers that have been using your Select and then in certain sites, where requirements are less stringent, the purchasing from brand ex in those scenarios do you expect to get some share?.

We absolutely have seen that where we have seen some examples of a long term care provider that, in their higher care environments, they would use our Select offering but in their assisted living and skilled nursing environments they would use the high-end but in the independent living facility, they might have just used a low-end commodity vendor ex offering and now they're looking at the connect offering as an example to put us into that broader set of the deployment.

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How do you comp your staff so they do not just go out and sell in price?.

Ultimately their incentive, they are motivated to maximize revenue. They are paid on revenue and we do have some consequences if they end up doing low gross margin deals. There's some [indiscernible] that we enjoyed together to make sure people focus on delivering both revenue and maintaining margins. .

There is a meaningful disincentive to bring a low-margin deal to the table. We do promote behavior with compensation. .

Our next question is from John Lucia with JMP Securities. .

A couple here, you said Connect will give resellers a reason to consider Aerohive.

Would that incremental reason simply be the lower price or is there another software feature or anything that would push them over the edge in terms of the Connect? And as a follow-on to that, wouldn't customers have sticker shock if you coming at $300 for Connect and then you suggest the $800 price or whatever it is for Select? Just walk me to that.

.

Sorry, can you ask the reseller question again?.

You said the connect would give resellers a reason to consider Aerohive.

The question is, is the reason just price or is there anything else that would give them another reason to consider you guys?.

I think the issue with Connect is that now we can address the whole range of offerings that they might need to go deliver.

We have already seen some of our resellers who-- we have been selling to successfully into the enterprise environment and then you find out oh, some of them are actually selling something like [indiscernible] into the low-end environment and now resellers say this is great I can use you for my entire offering.

Other resellers are interested in delivering more-- a lot of resellers delivering lightweight managed services to connectivity oriented customers and this is a really compelling offering to those customers. There's a lot of things we've done to the product to make it operational easier for them to purchase and deploy.

They can buy them ahead of time and deploy them as they need, that makes it easier to transact with this product. I think it will be easier for the resellers and create some new opportunities for them. Then, in terms of the upgrade price, I think that subscription price you talked about is over a three-year term.

If you look at it on -- over a three-year term that will have about the same subscription price, but if you think about it on a per-year basis, the upgrade for them-- the actual out-of-pocket cost for them to move to a full Select offering with full support and the more advanced features is sub $100 at the street level in terms to what they would likely be paying.

$100 a year?.

Yes, in that range. That is more at the street-price level but in terms, it ends up come you to the list price comparison to a big number but when you actually talk about how much they are spending out-of-pocket it is much less of an upgrade. .

Okay, that's helpful. If I understand correctly, in the Select offering the hardware cost of the AP 130 which I think is one of your better selling of your access points, was cut in half and then you increased the software cost and the maintenance cost to make up for the difference.

I just want to understand the dynamics around product gross margin versus service gross margin and how this all works into your guidance for total gross margins. .

This is John speaking here, John. In general will have a nominal impact. It will have an impact but it will not be particularly meaningful so in our gross margin guidance we gave 66.5 to 67.5 points which is about 50 basis points lower than the guidance we have given all year.

Two components of that are -- two components of that guidance or the reasons for that 50 basis point decline, were the lower revenue base over the fixed cost and the rest of it would be Connect related. I think for argument sake, you could say split roughly 50/50.

Connect -- so speaking on the service now and the product, the connect margins that are sold without the upgrade will be less than our standard gross margins but the incremental, the margin pickup when we upgrade that customer to Select, is we have very little incremental service costs for that service or subscription cost for that incremental revenue.

Once this program kicks in, over the long haul it should be, our service margins, the buy should be up and to the right, off of fairly strong margins as we speak. We just set a record on our service gross margins this quarter.

That business which is a focus for us in 2017 and beyond were actually starting to see the benefits of the programs we put in place prior to Connect and Connect Select will compound those. .

Is this your standard selling motion now? Are you going to do this for the rest of your access points going forward? It's just that the AP 130 is the one that I know of and the AP 122.

But what about the higher-end access points, would be doing the same kind of pricing structure where you lower the price of the access point and increase the price up the software and support or is this only just for certain access points?.

We launched this on the new AP 122 which is a brand-new product and the AP 130, those are our 2 by 2 wave one access points.

It is only on those products at this point and not on any others, so all of our customers, we mentioned 33% of our business was on the high end Wave 2 products, none of those are affected by this as is the 3 by 3 wave one products and our switches are not affected by it.

We're launching out with this to pursue the strategy of opening doors and recruiting channels and getting more at-bats. We will, of course, assess the results of this and as with any pricing action and decide if this applies-- be useful to apply to other places but at this point it is just on the low-end products. .

Last question which you expect to reach profitability this year or are you willing to talk about profitability in the year?.

We would like it this year. Where little hesitant to commit because we committed last year to getting it to 50, but we think we have created a cost structure that will get us there at $45 million and it does not seem like an unreasonable goal to get there this year. .

Our next question comes from Meta Marshall with Morgan Stanley..

Hi, It's Eugene Anderson on for Meta. Thanks for taking my question.

First, on E-Rate, I believe on the guidance you provided in the last call you mentioned that you weren't expecting an improvement in E-Rate, so for Q4 did you see E-Rate still fall below expectations or was it more, the surprise, more related to the longer sales cycle?.

The surprise at this revenue miss was primarily driven by the elongated sales cycles as we took the NG product into larger enterprises and we let that effort in North America which is where we spearheaded the push to move it up market.

E-Rate had a nominal impact, we have factored in almost all of the E-Rate softness into the guidance we have provided on the Q3 call. .

A question on OpEx, in just considering the longer sales cycle here, is there a chance that you will have to step back, step up hiring again perhaps in response to that or is your plan to reduce OpEx year-over-year, coming more out of a different area?.

We're committed to the profitability at the $45 million and we will hold spending at or below the level required to get to profitability. So we don't anticipate any step up in any of the line items of OpEx throughout the year. .

You think your specifically saying we need to hire more salespeople to deal with the elongated sales cycle and the answer is no.

We're focused on continuing the maturation of the product and I mentioned changes for the products organization that are really delivering very nice results and improving the philosophy of our ability to finish the enhancements we need to get past that.

We think will take about two quarters to work through that and it will be counterproductive to hire more salespeople instead of [indiscernible] to the product. .

One last question, if you look at the other verticals you are targeting outside of education, any updates on demand like where are you seeing the activity going into 2017 and perhaps with your new programs, does that help your opportunities in a given vertical or is it just more widespread?.

I think it primarily it's going to help us with getting more at-bats into the whole range of enterprise and health and retail opportunities, those core verticals. We do think it will help us to add some of these additional more connectivity oriented verticals to the mix to help with the growth.

We would anticipate seeing a bit more hospitality and a bit more hotspot business as we go forward driving the managed service provider segment. So we think it can help across multiple vertical segments. .

That does conclude our question-and-answer session. At this time I would like to turn the call back over to David Flynn for closing remarks. .

Thank you all for joining us today. We will be at the Goldman Sachs Conference tomorrow in San Francisco and later this month at the JMP and Morgan Stanley conferences and we hope to see many of you there. Good night. .

Once again that does conclude today's call. We appreciate your participation..