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HIVE Digital Technologies Ltd. (HIVE)

Q2 2015 Earnings Call· Wed, Aug 5, 2015

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Transcript

Operator

Operator

Good day and welcome to the Aerohive Networks’ Second Quarter 2015 Financial Results Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ms. Melanie Solomon. Please go ahead.

Melanie Solomon

Management

Thank you, Jessica. Welcome to Aerohive Networks’ second quarter 2015 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 Gordon Brooks, Chief Financial Officer. We will also hear from Tom Wilburn, Senior Vice President of Worldwide Sales. During this conference call, we will make forward-looking statements regarding future events or results of the company and its operations. These forward-looking statements include statements regarding our projected financial results, general demand for mobile and wireless networking in the industry verticals we target, demand for our products and solutions in particular and our ability to take advantage of opportunities in the industry verticals we target, potential drivers of growth in our business, new customer acquisition and continued adoption of our products and solutions by existing customers, future product and service offerings, continued 802.11ac transition and adoption of Aerohive cloud management applications and product offerings, fluctuations in our gross margins, seasonality of our business, changing market conditions, the timing and potential level of our participation in the E-Rate program and our expected benefits and investments related thereto, our plans of future investments, our expectations regarding our level of operating expenses, progress in our sales execution strategy particularly in our underdeveloped territories. Risks associated with the deployment and adoption of new products and services. Risks associated with our continued growth and competitive pressures from existing and new companies. The actual outcomes and results may differ materially from these contemplated by these forward-looking statements as a result of these uncertainties, risks and…

David Flynn

Management

Thank you, Melanie. Thank you all for joining us today. With second quarter 2015 revenue of $36.8 million, we are pleased to report a strong sequential improvement of 43% growth over our challenging Q1. These results reflect continued growth in our business outside of education, plus a significant recovery in U.S. K-12 spending. We added over 1,450 new end customers in the second quarter bringing the total number of end customers to over 22,000. We also saw a continued expansion from our existing base with repeat customers contributing 72% of our business over the last four quarters. Let me now review some of the key results from our second quarter including the important customer wins. Education was a key driver of our business in the second quarter. We saw a solid recovery in education spending relative to Q1 and did more business than we expected. However, relative to our overall business, U.S. K-12 spending was less robust than prior year’s representing 40% of our business in Q2, 10 points less than in Q2 2014. While we closed the significant amount of K-12 business in Q2 that was unrelated to E-Rate, we continue to see the E-Rate program timing having a direct impact on our seasonality. In Q2, we saw some U.S. K-12 spending on E-Rate projects from schools that were compared to purchase ahead of their funding letters with the expectation of being reimburse after July 01. Horry County in South Carolina purchased over 2,000 APs using this approach to upgrade much of their infrastructure from 802.11n to 802.11ac during the summer break. In addition, we did see some schools we expected to purchase in Q3 received funding letters and placed the orders in the latter part of Q2. Tuscaloosa County in Alabama got their funding letter in June which…

Tom Wilburn

Management

Thanks Dave. I am pleased to be on the call and wanted to make just the few comments regarding the potential IC for Aerohive. While I was with Cisco we acquired Meraki, and I witnessed firsthand the simplicity and speed of innovation brought by cloud managed networking. I am convinced that cloud managed networks are the future of our industry. While cloud got its initial traction in the mid-market, at Cisco and here at Aerohive I have increasingly seen large enterprises chose cloud managed solutions over a legacy controller base technology because of the speed of deployment and lower cost of ownership. I joined Aerohive because we have platform that closed the gaps I saw at Cisco between cloud managed and enterprise class solutions and because I believe the market wants an alternative. This competitive dynamic positions Aerohive as a market leader and I look forward to growing the capacity and productivity of Aerohive sales force while expanding our reach and footprint worldwide. Since I joined the company in April I have been focusing on strengthening several areas of the sales organization. Noting that the weakness here are not unique and do not require a major overhaul. First, with the focus on the less developed territories, I made targeted changes in leadership and staffing to make sure we had a proven team in place with the industry expertise and with an improved span of control. Second, I am reinforcing Aerohive’s discrete inside and outside selling model, which I also saw work well at Meraki. Both of these steps will drive greater accountability and help to improve our execution as we grow. Third, I am working a team to build on our Dell partnership, which as Dave mentioned is off to a promising start with very positive feedback from Dell. It is a great example of our channel partnering strategy at work. I am pleased with the team I have and the talent we are able to attract in sales and I am working to reinforce our partnership focus as we leverage our new and important relationships. I love the tailwind that the education business is providing and I am excited about our opportunity. This is a great marketplace to be in as we transform mobility across verticals and market segments. I will now turn it back to Dave.

David Flynn

Management

Thanks again Tom. I just wanted to say how excited we are to have you as part of the team. I will turn it over to Gordon to go through the financials in detail and provide our guidance for the third quarter.

Gordon Brooks

Management

Thank you, Dave and good afternoon. We are very pleased with our revenue performance in Q2. We experienced our historical pattern of a significant sequential increase in revenue from Q1 to Q2, primarily driven by US K-12 spending. Though education spending driven by the E-Rate program began to flow in the quarter, the funding letter you processed and related reimbursements had not hit full stride by the end of the quarter. Therefore we were also pleased with contribution from our other key verticals. We had very good performance against our other key financial metrics and the over performance in revenue positively impacted our bottom line. I will review our GAAP and non-GAAP P&L, balance sheet and cash flow metrics for Q2 and provide some related commentary on the business. Lastly, I will close by providing financial guidance for Q3 of fiscal year 2015. Net revenue for Q2 was $36.8 million, a decrease of 2% compared with same quarter a year ago, but an increase of 43% sequentially. This revenue achievement was above our guidance range of $34 million to $36 million, primarily due to slightly more E-Rate based education spending occurring than we anticipated. Product revenue for Q2 is $30.8 million, a decrease of 9% compared with same quarter a year ago, but an increase of 50% sequentially. The vast majority of our product revenue continues to be driven by our access points and related management software licenses. Software subscription and services revenue was $6.1 million for Q2 or 17% of revenue, an increase of 59% compared with the same quarter a year ago and 14% increase sequentially. As measured by customer count approximately 75% of our end customers were on our public cloud platform at the end of Q2, while the four quarter rolling average units managed by our…

David Flynn

Management

Thanks, Gordy. We believe we are headed in the right direction with the more focused sales effort growing partnership base and continued channel execution, all of which will help to drive future growth of our organization. In addition, we look forward to the return to more normalized spending environment in U.S. K-12 education and the positive impact we believe it will have on our business. We will now take your questions. Operator?

Operator

Operator

Thank you. [Operator Instructions] We’ll go first to Erik Suppiger with JMP.

Erik Suppiger

Analyst

Yes. Congratulations on a real solid quarter.

David Flynn

Management

Thanks, Erik.

Erik Suppiger

Analyst

First off, I just wanted to get a sense on the cash flow, negative $9 million, can you give us a little sense for how you think cash flow might progress next quarter and what we might think going forward?

Gordon Brooks

Management

Certainly, Erik. This is Gordy. The cash flow this quarter is we are no longer capitalizing R&D. Those quarterly expenses have now moved into operating cash flow and our seasonal Q3 pattern has been over the last several years have positive cash flow in Q3 and we expect that seasonal pattern to continue here in Q3 due to the ramp up of the revenue and the accounts receivable.

Erik Suppiger

Analyst

Okay. What is driving the growth outside of the education? Is there particular market dynamics that are getting the controller-less architecture in a stronger competitive position?

David Flynn

Management

I think we are seeing customers increasingly desire and embrace both cloud and controller-less and I think we are seeing that consistently as customers are accepting and asking for it which will play to our strength. In addition, I think we are seeing improvements in execution and some of our channel program and other elements that are contributing to the growth in those markets. And we’ve always seen those core markets of health and retail and the distributor enterprise having significant strong demand drivers and it’s just a continuation of that.

Erik Suppiger

Analyst

In the past, you had retail in excess of [indiscernible] was that the case this quarter and was healthcare greater than 10%?

Gordon Brooks

Management

Yeah. Retail and healthcare combined, we don’t break them out separately each quarter but they compose between little under 25% overall for the quarter. So they have grown slightly in combination over the last several quarters.

Erik Suppiger

Analyst

And then last question, do you see other strategic partners outside of Dell in light of the Aruba acquisition. Do you see other partners showing interest in partnering with yourself in light of the Aruba acquisition at this point?

David Flynn

Management

Yes. We have – there is two types of partners, one is channel partners that we have seen some engagement with some of those Aruba channel partners that maybe don’t want to be part of the HP program and then also is the go-to-market partners particularly the switching vendors. And we do have engagement going on with a number of those people. I think normal formal to announce today, but a lot of active dialogue engagement and co-selling with a number of those people.

Erik Suppiger

Analyst

Very good. Thank you very much.

Gordon Brooks

Management

Thanks, Erik.

Operator

Operator

We’ll go next to Rohit Chopra with Buckingham Research.

Rohit Chopra

Analyst

Thank you very much. Couple of questions from me. I just want to get your updated thoughts Gordy on targets and targets breakeven if you don’t mind. And then the second question, just want to get a sense on the competitive environment anything changing? And then maybe you could sort of direct that towards APAC as well, is there anything different than we know over there for it to be down?

Gordon Brooks

Management

Yeah. In terms of any targets, no changes at this point in time. To remind everybody on the call that we’ve talked about a, you know, high 40s to $50 million of revenue per quarter to get to non-GAAP breakeven and we continue to believe that that is a model that we have in place and that we are pointed to.

David Flynn

Management

Yeah, on the competitive environment, we have not seen a significant change in the competitive dynamic, obviously Aruba is rolling into HP, it has had some impact of making some channel partners available. We’ve seen some probably some turnover in some of the sales force in that organization, but I’ve not yet seen a combined entity I think they’re still operating more independently as Aruba and not yet kind of combined the sales force there and so haven’t seen a material difference in their behavior or in the behavior out of Cisco, who are the two primary competitors we engage with.

Rohit Chopra

Analyst

[indiscernible]

David Flynn

Management

[indiscernible] you know come off the market, but that was not a material impact in the normal business.

Rohit Chopra

Analyst

Dave, can I ask you a quick follow-up?

David Flynn

Management

Sure.

Rohit Chopra

Analyst

You didn’t mention anything about Apple. Just, any thoughts around that, and then you talked a little bit about Dell, but is there anything happening with Apple or is it too early?

David Flynn

Management

Yeah, I think Apple continues to be a kind of a strong referral source and we do a lot of joint work with Apple, particularly in the education marketplace and so I think that you know we expect that, we see that continuing and that is progressing well. I think we’ve, we already indicated from beginning the Apple reseller relationship, I don’t expect to contribute nearly as much direct revenue as we expect the Dell relationship to be that Apple relationship we think will be a way to transact into certain projects to want to wrap Aerohive product into an Apple lease or do a solution sale or you know expand upon one of the connected projects that we jointly deployed with Apple, but I wouldn’t expect Apple to be driving hard and, you know, pushing their people to sell Aerohive. It’s more of a transaction efficiency. Dell on the other hand is highly motivated to push and sell a lot of Aerohive product along with their switches.

Rohit Chopra

Analyst

Thanks guys.

Gordon Brooks

Management

Great. Thank you.

Operator

Operator

We’ll now take a question from Catherine Trebnick with Dougherty.

Catherine Trebnick

Analyst

Thank you for taking my question. Solid quarter, congratulations. Could you give us some more on the Dell relationship? Do you - have you split out the revenue - you did say in the call that there were some EMEA contribution, was that also from Dell, clarify that and then also Tom a question for you is, how have you divvied up the internal inside sales versus outside sales and what’s different than it was maybe before you started, thanks.

David Flynn

Management

Hey Catherine, I’ll take the Dell question. So, indicated that the relationship is progressing well, and we’ve got the channel in place and the support infrastructure in place to be able to transact in U.S. and EMEA, APAC is not yet online. We have to align on the distribution channel and the support vehicle, but we expect to have that done inside this quarter. And I also indicated that we did close our first orders with Dell in the later part of Q2, but we aren’t providing specific break-out of the Dell revenue and a reminder our previous commentary was we said you know, the relatively expected to close first orders in Q3, we expect them to be small as it’s typical in a land and expand world, start to expand in Q4 and become material in 2016 that’s the expectation. We closed the first orders a little bit quicker than we expected. We are pleased with that, but I think the general profile of the business ramp is consistent with what we said before.

Catherine Trebnick

Analyst

Okay. Thanks. And then on just on the inside versus outside sales that’s interesting I know a lot of different companies are doing the same thing I really like to hear how the strategy is working.

Tom Wilburn

Management

I’ll take that Dave. Catherine. Aerohive had already established a bright line between inside and outside sales based upon customer size and what I did was to reinforce the focus within each selling team. They were elements of a team quota that was a small part of compensation and I drove that to two separate teams with different quotas collaborating through a common channel organization and SC community, so really just re-enforcing the bright lines that already existed.

Catherine Trebnick

Analyst

Alright, thank you, I will move out of the queue.

Operator

Operator

Thank you. We will take our next question from James Faucette with Morgan Stanley.

James Faucette

Analyst · Morgan Stanley.

Thank you very much for taking my question, just a couple on operations and how to think about those going forward. In the quarter as you mentioned you grew OpEx a little more slowly than you had anticipated originally, is that because you were unable to hire as many people as you would like and we should expect a bounce back over some of your organizational changes you think you can have better efficiency going forward and you don’t need those people first and I guess I also wanted to follow-up on that, services margin on the other hand was a little bit below at least for we had anticipated, can you talk about anything that maybe adversely impacting services.

Gordon Brooks

Management

Yes, I think from a operating expense standpoint, this is Gordy, two things you can see by the quarter headcount we added a net number of significant number of heads, really probably more back end loaded in the quarter, so not a full extent overall in the quarter as much as we expected. So, I think just the timing of hiring help with providing a little bit more favorability in the quarter. At this point in time, I don’t see that as a go forward efficiency gain as of yet, but really more the timing of our expenses in the quarter. We also do our programmatic expenses that can be discretionary in and out of each quarter which had some impact as well. So, the key is probably unique favorability to the quarter but not a trend as of yet. In regards to the services gross margin, the main driver there is our amortization of our cloud platform development. I think if you take that out this quarter and do an apples-to-apples our services margin was probably equal to if not a little bit more favorable than Q1, but the burden they are bringing in that – that amortization of internal used software as we consider our cloud platform development was the impact that we had tried to go ahead and pattern and call out to everybody at the end of Q1 that this would be coming.

James Faucette

Analyst · Morgan Stanley.

Thanks. And then just from a product stand point, we have seen way of two products start to hit the market. I am just wondering how that maybe impacting you competitively and what the outlook and – or customer behavior around the availability of Wave 2 and how do you think that will play our for Aerohive over the next few quarters? Thanks a lot.

David Flynn

Management

At this point we are seeing customer curiosity about Wave 2, but we aren’t seeing an aggressive move towards the Wave 2, most of the Wave 2 products that have been announced are significant price premium over Wave 1 has some limitation around functionality on standard and power over Ethernet and there are Wave 2 clients aren’t available yet. So, we see kind of a minimal impact now. We do anticipate that will increase over time, as we saw with Wave 1, it was a similar a few quarters of fairly slow adoption rate and then acceleration as mover Wave 2 products came to market, cost came down, power budgets came down and we would expect to see a similar impact with the rollout of Wave 2. So, it is been there, but not a material impact at this point.

James Faucette

Analyst · Morgan Stanley.

Okay, thanks.

David Flynn

Management

Okay.

Operator

Operator

And we will now take a question from John Lucia with JMP Securities.

John Lucia

Analyst

Hi guys thanks for taking my questions. First question is on E-Rate, despite the pushed out deadline, if sounds like you are expecting some E-Rate business in Q3. I just wanted to get a sense for how much E-Rate spending you have backed into the 3Q guide and kind of what’s the opportunity for upside there?

David Flynn

Management

So, we have, we are not breaking out specifics on the – to what percentage of the mix is E-Rate, but we have looked at the E-Rate guide and have some assumptions about how many people will get funding letters and customers that have told us that they intend to spend immediately upon receiving their funding letter. Most of those are factored into our guidance. We have a number of – number of customers have already indicated they are going to face those and rollout their projects in Q4 and into 2016 and so as we indicated the majority of the remaining pipeline, you know we closed some in Q2, but the majority of the remaining pipeline is actually reflected beyond Q3. So, significant impact but this is, we don’t expect a huge wave of upfront spending, it will be more measured through the period of the E-Rate year.

Gordon Brooks

Management

Yeah John this is Gordy. I think our key is to be cautious so that we track this, you know we are cautious of how we build it into our pipeline and we want to see those deals and get evidence of those deals. So, we did similar to what we did in Q2, which we scrubbed our pipeline, you know that we had a high probability of closure on anything tide to E-Rate. I think one of the comments we made here is that we expect again the majority to be outside of Q3 and traditionally or historically we talked about Q3 would be more than 25% of the remainder, you know for the rest of the year, but it wouldn’t be as high as a 50% that’s why we think the majority is pushing out into Q4 and early 2016. So, we just continue to monitor at and try to cautious until we have as much visibility as possible.

John Lucia

Analyst

Okay thank you. And then my second question is on Dell. I just wanted to see if you guys have any Dell in the guide for Q3, are you forecasting any business at all from Dell in Q3 and I believe Dell is still a partner of Aruba HP on paper, I just wanted to understand kind of how that shift is going and how Dell is positioning Aerohive in lieu of Aruba?

David Flynn

Management

Yeah. So, I would say they indicated we thought that the Dell business in this quarter would be fairly immaterial, so it is, it is probably in the guide, but I don’t think it is a significant contributor to the guidance. We think we are still in the process of, we will go out and close some initial orders and get some footprint that we will hopefully turn into much more significant business in the quarters that follow. In terms of the Dell relationship with us versus this Aruba, I think Dell continues to have a contractual relationship with Aruba and they are definitely continuing to sell the Dell W series product into installed base environment and so I think there will continue to be some of that business going on. I think the corporate level I they would like to be on the – have that business continue and be healthy while Aerohive grows and really enables the cloud portion of the business, but often what we are seeing is that the sale level where the rubber meets the road of a deal. The Dell and HP/Aruba reps are pretty rapidly parting ways and we are seeing the Dell reps definitely have our strong preference to bring Aerohive into a project rather than have a HP rep in their project.

John Lucia

Analyst

Okay, got it. Thank you.

Operator

Operator

And it appears there are not further questions at this time. I would like to turn it back to you Mr. Flynn for any additional or closing remarks.

David Flynn

Management

Yes. Thank you all for joining us today. We will be at the Oppenheimer conference next week and look forward to seeing some of you there.

Operator

Operator

This does conclude today’s conference. Thank you for your participation, you may now disconnect.