Melanie Solomon - Investor Relations, Managing Director at The Blueshirt Group David Flynn - Chairman of the Board, President, Chief Executive Officer John Ritchie - Chief Financial Officer, Chief Operating Officer, Senior Vice President.

Christian Schwab - Craig-Hallum Erik Suppiger - JMP Securities Luke Morison - D.A. Davidson.

Good day and welcome to the Aerohive Networks' third quarter 2017 financial results conference call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Melanie Solomon, Investor Relations. Please go ahead..

Thank you Matt. Welcome to Aerohive Networks' third quarter 2017 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 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 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 will now turn the call over to David Flynn, President and CEO of Aerohive..

Thank you Melanie and thank you all for joining us today. We delivered third quarter results highlighted by non-GAAP gross margin performance and EPS at the high-end of our guidance ranges and a strengthening balance sheet with good growth in deferred revenue and $5 million of cash generation excluding buybacks.

We are pleased with the strength of these metrics as well as our continued progress on product delivery and channel development.

While our revenue came in slightly below our guidance, this was primarily due to challenges with forecasting the mix of current and deferred revenue as a result of better than expected progress in driving our business towards cloud-based subscriptions as well as the transition to our new Connect to Select model. John will discuss this in more detail.

Before I detail our Q3 highlights, I wanted to touch on of the significant announcements we made today. We have expanded into a full OEM relationship with Dell EMC where they will sell both our hardware and cloud solution as Dell EMC branded products.

Previously, they sold our APs as a reseller which created transactional complexity and limited us from fully benefiting from Dell EMC's global channels. With the whole solution now sold as a Dell EMC branded product, we will be able to leverage all of their global direct sales and indirect channels.

While we do not expect immediate benefit in Q4, we expect the growth of our business with Dell EMC to accelerate in 2018. Now turning to Q3. We continue to make excellent progress on delivering new products and strengthening our overall offering. We also have a number of significant improvements and innovations coming in our near-term roadmap.

I will highlight a few key areas. We have launched the AP150W wallplate AP to allow us to attack the hospitality and multi-dwelling unit markets. Leveraging this new product, we were able to win an MDU centric deal out of 12,000 student University of Missouri, a mid-six figure initial order that's expected to expand to close to a seven figure project.

The plan to further augment our MDU offering with a Q4 delivery of our private client group solution, which will enable MDU operators to easily give each tenant a private network over a shared infrastructure, which is a compelling differentiator in this market.

We also significantly enhanced our Connect offering with features for hotspot operators and larger still deployments. We used Connect to win a project in an Italian department store chain to deploy 800 of our cost-effective AP122s across 150 stores.

We competed against Meraki and won because the subscription-free Connect offering addressed their current need for cloud managed connectivity while giving them a seamless upgrade path to our Select solution and retail analytics.

We continue to enhance our hardware portfolio with the announcement of a new AP122X, the cost-effective external antenna AP for challenging low to medium density RF environments such as warehouses and high ceiling retail sites.

The 122X will complement our current AP1130 and AP245X external antenna products which were instrumental in a Q3 win to deploy WiFi at the new terminal at Incheon Airport in Korea, one of the world's busiest airports.

In Q3, we continued to enhance our HiveManager NG platform with three significant feature-rich releases as well as a new deployment model that allows us to deploy NG in a customer or service provider data center in minutes with the elasticity to scale over one million managed devices.

Leveraging this platform, we expanded our global presence with the regional data centers in Australia and Germany and we have added local language support for French, Japanese, Korean and German with more languages to come this quarter.

These investments position us to grow our international business as we see increasing acceptance around the world of the cloud managed approach.

In Q4, we plan to continue are replicating delivery on the NG platform, including innovations like the big database comparative analytics solution that allow customers to benchmark their networking into their peers as well as the initial release of our SD-WAN solution with application-based routing, VPN and path optimization.

SD-WAN combined with our WiFi and switching products will enable us to deploy a complete cloud managed branch office infrastructure with unified NG management.

Overall, we are very pleased with the progress we are making on strengthening our product offering as we mature our NG platform, enabling us to increasingly shift our development resources to new innovations.

In parallel, we continued strengthen our go-to-market, both through our full OEM relationship with Dell EMC and through the initiative we launched at the start of this year to pivot to a more channel centric go-to-market model to improve our sales efficiency and better address the mid-market.

The foundation of this plan was the launch of our Connect to Select offering and the launch of a number of channel recruitment and development initiatives.

Our sales leader, Tom Wilburn's strength and passion is around larger enterprise direct touch business So when we launched this initiative in Q1, he augmented his team with channel centric sales leaders who built much of Ruckus' channel as well as new leadership in APAC.

With this new program and team, we recruited 600 new resellers in the first half of the year and added 300 more in Q3. In Q3, we moved fully to a two-tier model by transitioning our direct VAR business through SYNNEX and we signed Wave as a distributor to help us develop the MSP and HSP channels.

Now with this team in place and the program on the right trajectory, Tom has decided to move on to pursue opportunities that better align with his prefer to go-to-market model.

Having successfully restructured my leadership team under a COO organization paired with a unified products and marketing organization, I now have the capacity to take on global sales leadership to drive this critical initiative working directly with our three fleet of sales leaders.

I would like to wish Tom well and thank him for his many contributions to Aerohive over last two-and-half years, which has positioned us very well for the future. While 2017 has been a challenging year in terms of our ability to drive topline revenue growth due to the disruption in the U.S.

education market, the impact of the NG transition and or shift to a more SaaS-like model, we have executed on many initiatives to improve profitability and position us to drive growth in the future. We have improved the execution of our product organization and strengthen our current product line and near-term roadmap.

We have moved to a full OEM with Dell EMC and are pivoting to a channel centric go-to-market model. We restructured marketing and stepped up the pace and aggressiveness of our marketing efforts. At the same time, we have brought down our operating cost and strengthened our balance sheet with increases in cash and growing deferred revenue.

We believe these actions position us to return to growth, but even if that growth takes longer to deliver than expected, we are committed to delivering full-year 2018 non-GAAP operating profitability and continued year-over-year cash generation as we operate as a more efficient organization.

I will now turn it over to John to talk in more detail about our financials..

Thanks Dave. Good afternoon everybody and thanks for joining us today. Before I go through the quarter in detail, I would like to highlight some financial and operational milestones Aerohive achieved this quarter.

We realized significant sales efficiency with our non-GAAP sales and marketing costs coming in at 39% of revenue driving this important metric to under 40% on a year-to-date basis.

We delivered gross margins and EPS at the high-end of our guidance range and we were meaningfully cash generator, including cash and equivalents and short-term investments in the third quarter and on a full year-to-date basis.

During the balance of my prepared remarks, I will cover our GAAP and non-GAAP P&L, our balance sheet for Q3 and provide some related commentary on our business. I will close by reviewing our financial guidance for the fourth quarter of 2017. But before we begin the revenue discussion, I wanted to provide some context.

For the last two quarters, we have delivered revenue which has been at the low-end or nominally below our revenue guidance. Offsetting this has been a better-than-expected build of our deferred revenue balances. Two factors have been driving this variance.

The first was the variability introduced by the transition to our Connect to Select business model. The second factor was the better-than-expected percentage of our customers who chose our cloud-based offerings over on-premise solutions.

With our subscription base public cloud products, we forgo immediate license revenue and instead book more deferred revenue. We view this change in customer behavior as a meaningful positive and proof that we have overcome the majority of our NG challenges that we talked about earlier in the year.

Now with a couple of quarters of Connect to Select transition behind us and more insight into our customer's preference for our cloud offerings, we are in a much better position to more accurately forecast our revenue. Now with that context, I will turn to our Q3 results. Q3 revenues came in at $37.1 million.

This was down 12% and down 8% on the year-over-year basis. Product revenue was $26.8 million, down 17% sequentially and 60% on a year-over-year basis. Subscription and support contributed a healthy $10.3 million the quarter.

Q3 was a record for subscription and support revenue coming in at 28% of total revenue, growing 19% compared with the year ago period. On a geographic basis, revenue in the Americas was $22.6 million or 61% of total revenue. Americas revenue was down $6.5 million or 22% on a sequential basis and down $3.1 million or 12% on a year-over-year basis.

As expected, the Americas region continues to be impacted by the volatile education market. Moving on to EMEA. Revenue for Q3 came in at $11.1 million or 30% of total revenue. EMEA revenue increased $700,000 or 7% sequentially and was up $600,000 or 6% on a year-over-year basis.

We are pleased that we have seen continued expansion all year in the EMEA region. Q3 revenue for the Asia-Pac region was $3.3 million or 9% of total revenues or up $600,000 or 20% on a sequential basis. As we have mentioned previously, we expect results from this region to continue to be lumpy given this relatively small revenue base.

I will now turn to a discussion on our non-GAAP margins and expenses. We are pleased with our non-GAAP margin performance given that our Q3 results reflect our first full quarter of our Connect to Select strategy.

Non-GAAP gross margins came in at the high-end of our expectations with strong non-GAAP subscription and support margins offsetting the planned decline in non-GAAP product margins.

As we discussed in the last quarter's call, the expected decline in non-GAAP product gross margin was related to our new Connect to Select product offerings while the strong non-GAAP subscription and support margins are driven by higher revenue levels over a relatively fixed cost base. Let me give you the comparisons.

For Q3, non-GAAP gross margins of 66.8% compared with 68.5% in the same period a year ago and 68.2% in Q2. Non-GAAP product gross margin for the quarter came in at 65.1% compared with 68.6% in the same period a year ago and 67% in the second quarter.

Non-GAAP subscription and support gross margin was 71.3% in Q3, up 310 basis points compared with 68.2% in the same quarter a year ago and down 50 basis points when compared to 71.8% in the second quarter. The modest sequential decline reflects a small increase in infrastructure investments for this business.

Now moving on to non-GAAP operating expenses. Non-GAAP operating expenses came in at $26.3 million for the quarter, down $4.6 million when compared to $30.9 million in the same quarter a year ago and down $1.7 million from $28 million in the second quarter.

The significant year-over-year reduction in non-GAAP operating expenses was related to previously discussed cost reduction actions taken earlier in this year. Non-GAAP R&D was $7.9 million or 21% of revenue compared with $9.1 million or 23% of revenue in the same period a year ago. This compares with $8.2 million or 19% of revenue in Q2.

We are pleased with the significant improvements we are seeing on the product side. Engineering productivity is up dramatically on more efficient spending levels.

During the quarter, we saw significant improvements in our sales efficiency as non-GAAP sales and marketing costs came in at $14.4 million or 39% of revenue in Q3, down $1.5 million from $15.9 million recognized in the second quarter. We are encouraged by several metrics that point to improved sales productivity.

For the third quarter in a row, we have reported year-over-year decline in sales and marketing expenses. In addition, for the last two quarters and also on a year-to-date basis, our sales and marketing costs as a percentage of revenue were sub-40%. This compares to the full-year results of 43% for 2016.

Lastly, non-GAAP G&A expenses came in at $3.9 million or 11% of revenue in the third quarter compared to $4.6 million or 11% of revenue in the same period a year ago and flat compared to $3.9 million or 9% of revenue in the second quarter.

Overall, our non-GAAP operating margin was negative 4%, a 390 basis point improvement when compared to the negative 7.9% in the same period a year ago and down from 2.1% in the second quarter.

Our non-GAAP operating loss was $1.5 million, a $1.7 million improvement when compared to the non-GAAP operating loss of $3.2 million in the same period a year ago and down from non-GAAP operating profit of $900,000 in the second quarter.

We reported a non-GAAP net loss of $1.6 million in the third quarter compared with a non-GAAP net loss of $3.3 million in the same quarter a year ago and non-GAAP net income of $600,000 in the second quarter.

All of this translates to a non-GAAP net loss per share of $0.03 compared to a non-GAAP net loss per share of $0.06 in the same period a year ago and non-GAAP net income of $0.01 per share in the prior quarter. The non-GAAP net loss for Q3 is based on 53.7 million weighted average common shares outstanding.

On a GAAP basis, in the third quarter the loss was $0.12 per share compared with a loss of $0.19 per share in the year ago period and a net loss of $0.07 per share in the prior quarter. Our Q3 GAAP net income loss included stock-based compensation expenses of approximately $5 million. Now turning to the balance sheet.

Cash, cash equivalents and short-term investments as of the end of September, totaled $83 million, a sequential increase of $2.8 million making us cash and short-term investments positive for Q3 as well as on a year-to-date basis.

During the quarter, we repurchased approximately 600,000 shares for an aggregate value of $2 million as part of our existing share repurchase program. Excluding the cost of our share repurchase program, we generated increases in our cash and short-term investments by approximately $9.3 million so far in 2017. Moving on to inventory.

Inventory levels decreased $1.8 million to $13.2 million at the end of the quarter compared to $15 million at the end of Q2. Accounts receivable decreased to $17.2 million as of the end of September compared to $22 million at the end of the second quarter. DSOs also decreased from 49 to 43 days.

Our deferred revenue balances now stand at $72.5 million, an all-time high compared to the $67.9 million in the prior quarter. So now moving on to our guidance for the fourth quarter of 2017.

As we explained earlier, the transition to our Connect to Select strategy results in the business taking on more SaaS-like characteristics with a shift to more deferred revenue, which impacts our topline. We are currently expecting Q4 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 66% to 67%, driven by the impact of our Connect to Select product offerings, partially offset by continued strong margins from our subscription and support business. On a GAAP basis, we believe our operating margins to be between negative 1% and positive 2%.

We expect other expenses, including tax expense, to be approximately $200,000 for the quarter.

Lastly, we expect Q3 non-GAAP EPS results of between a loss of $0.01 and income of $0.01 per share based on the estimated share count outstanding of 54 million shares for the EPS loss calculation and approximately 55 million shares for the EPS income calculation.

On a GAAP basis, we expect Q4 net loss per share to be between $0.08 and $0.10 based on 54 million weighted average common shares outstanding. Lastly, as reminder, you all have probably already seen this, we just issued a press release increasing our share repurchase authorization to $20 million, adding $10 million to our existing authorization.

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

Thanks John. I am encouraged by the significant progress of our product delivery and this has given Dell EMC the confidence in us to expand into a full OEM relationship. Our results demonstrate that we are steadily improving our operating efficiency while positioning ourselves to resume growth.

I want to thank our customers and employees for their continued loyalty and dedication as we work towards this common goal. I will now take your questions.

Operator?.

[Operator Instructions]. And at this time, we will go to Christian Schwab with Craig-Hallum. Please go ahead..

Yes. Congratulations on a good quarter, guys.

As we kind of think to 2018, is there any way that you can kind of bracket the revenue opportunity, the expanded revenue opportunity with Dell EMC?.

So I will take a shot at it first, Craig and I will let Dave chime in with additional color. So we reluctantly give 90-days worth the guidance. So we are a little reluctant to talk about 2018. I guess what we can do is, kind of scale were we were in 2017 with Dell. Our goal was that they would be about 10% of the business on a full-year basis.

So we were nominally above that if we come where we think we would be in the fourth quarter. And we do expect off of that base to have some amount of growth. But at this point, we don't think we are not really modeling anything in for the fourth quarter. These things take a while, even though we have all the infrastructure in place to crank up.

But we expect growth. We are just, at this point, not really prepared to scale that growth..

Is it fair to assume though that with an expanded channel and an expanded product and something labeled by themselves, over a multi-year timeframe, is it too unrealistic to assume that that would double at least?.

On a multi-year timeframe?.

Yes..

Yes. I mean certainly we believe that they have the potential to be that kind of a partner.

I think also in the past, we have given indications around, before we got into the Dell relationship they were OEM in the Aruba product and that product, I think it got about $40 million annualized run rate and they were expecting to grow it to $100 million over time until HP blew up that deal.

So it demonstrated it's ability to produce $40 million of revenue off of an OEM product. So if you kind of assume that we can get back that level of success over time, that would be consistent with your doubling the business..

Great. Yes. Thank you for mentioning that math so I didn't have to bring it up. I don't have any other questions. Thanks guys..

Thank you..

All right. Thank you..

We will now move to Erik Suppiger with JMP Securities..

Yes. Good quarter.

On the Dell EMC OEM, how will the margins on that compare with your traditional reseller relationship?.

So the margins on that deal will be lower. We haven't scaled how much they will be lower. But I think if you look at how we have managed through the Connect to Select business, I think that would give you kind of an indication or a broad outline of where it cold go..

Okay.

The E-Rate business in the quarter, was that about what you were planning? And can you give us a sense for what contribution education was?.

Yes. As I recall, overall E-Rate demand for the quarter, education was down because it was another bad E-Rate year. That all happened back in the spring. We discussed that last call. But the overall results came in generally in line with expectations. The worldwide K-12 was about 35% of the business which is lower, frequently it's 40% to low to mid-40s.

So for this quarter being down at 35% was consistent with those expectations..

Okay.

And then lastly, the SD-WAN features that you are developing, are you developing that organically? Or will you be partnering with anybody on that?.

No. That is developed organically. We are actually utilizing the same kind of embedded HiveOS operating system on the WiFi and we have had routing and VPN capabilities in that product for a while. It's been enhanced to do the SD-WAN multipath optimization and application-based routing.

And the biggest thing is, we are bringing that routing product line forward into our NG platform, which is kind of the last missing major piece of completing the NG transition. And that's on track to be launched by the end of December..

Very good. Thank you very much..

Thank you..

We will now take a question from Mark Kelleher with D.A. Davidson..

Hi guys. This is Luke, on for Mark..

Hi.

How are you?.

Good. So a quick question just touching back on E-Rate.

I was wondering if you guys had any update on the upcoming cycle? If you guys have any visibility there or anything at all?.

Yes. Unfortunately it's too early in that cycle to be really giving you commentary. We are just starting to see the first, they call it the 470 request for funding and very, very early stages. And you generally don't get a clear picture of that until late Q1 into early Q2 of next year in terms of how it's going to play out..

Okay. That's it..

All right..

And that will conclude the Q&A session. I will turn it back over to David for any closing remarks..

All right. Thank you all for joining us today. We will be at the upcoming Needham and Craig-Hallum conferences in New York later this month. I hope to see many of you there. Good night..

All right. Thank you..

Again, that does conclude today's call. Thank you all for your participation..