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Executives

Dominic Orr – President, CEO

Steffan Tomlinson, Chief Financial Officer

Keerti Melkote – Founder, Chief Technology Officer

Analysts

Jeffrey Kvall – Barclays Capital

Eric Suppiger – Signal Hill

Ryan Hutchinson – Lazard Capital

Greg Mesniaeff – Needham & Company

Bill Choi – Jefferies & Co.

Ehud Gelblum – J.P. Morgan

Sanjiv Wadhwani – Stifel Nicolaus

Mark Sue – RBC Capital Markets

Blain Carroll – Ftn Midwest Securities

Aruba Networks (ARUN) F1Q09 Earnings Call November 20, 2008 5:00 PM ET

Operator

Welcome to the Aruba Networks first quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Jill Eisenstat of Investor Relations.

Jill Eisenstat

Thank you for joining us on today's conference call to discuss Aruba Networks fiscal first quarter 2009 results. This call is being broadcast live over the web and can be accessed in the investor relations sections of the Aruba Networks website at www.arubanetworks.com. With me on today's call are Dominic Orr, Aruba's Chief Executive Officer, Steffan Tomlinson, Chief Financial Officer and Keerti Melkoke, Founder and Chief Technology Officer.

After the market closed today, Aruba Networks issued a press release announcing the results for its fiscal first quarter ended October 31, 2008. If you would like a copy of the release you can access it online at the company's website or you can call the Blue Shirt group at 415-217-7722 and we will fax or email you a copy.

We'd like to remind you that during the course of this conference call, Aruba Networks management may make forward-looking statements including statements regarding expected revenue and non-GAAP ESP for the second fiscal quarter of 2009, expected revenue growth resulting from among other things, follow on sales and upgrades from our customer base, our ability to generate faster growth than most of the networking market, growth in demand for enterprise from networking products, the amount of reduced expenses and other savings resulting from our cost reduction programs and our beliefs that such reductions will improve our operating leverage and will not impact our long term growth, and other statements as to the company's future economic performance, financial condition or results of operations.

These forward-looking statements are not historical facts but rather are based on the company's current expectations and beliefs. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those anticipated by these forward-looking statements. These risks and uncertainties include a variety of factors some of which are beyond our control. These forward-looking statements apply as of today and you should not rely on them as representing our views in the future.

We undertake no obligation to update these statements after this call. Please refer to the risks and uncertainties described under the captions risk factors and management discussion and analysis of financial conditions and results of operations in our quarterly report on Form 10K filed with the SEC on October 7, 2008 as well as our earnings release posted a few minutes ago on our website for more details on these risks and uncertainties that may affect our results. Copies of these documents may be obtained from the SEC or by visiting the investor relations section of our web site.

Also, please note that certain financial measures that we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges including non cash stock based expenses, the valuation of warrants to fair value and amortization expense of acquired intangible assets.

We have provided reconciliations of these non-GAAP measures to GAAP financial measures in the investor relations section of our website located at www.arubanetworks.com and in our earnings press release.

Now I'd like to introduce Dominic Orr, President and Chief Executive Officer of Aruba Networks.

Dominic Orr

Good afternoon and thank you for taking the time to attend our fiscal first quarter 2009 results conference call. We had a strong first quarter with record revenue, improved operating leverage and solid bottom line results. I'm especially pleased with this performance because unlike many companies whose quarter end was in September, we faced the worst of the economic slowdown for the majority of our quarter and were still able to deliver a solid performance all around.

We believe this performance reflects both our strong competitive position and our ability to succeed in an environment where customers are focused on reducing operating expenses, improving productivity and making the most of their IT infrastructure investments.

Revenues were $52.4 million with strong sales to education, health care; government and enterprise include retail customers. Sequential growth of 9% was drive by both existing customers and strong new customer growth as we added over 700 new customers.

Operating expenses decreased as a percentage of sales by 410 basis points from the immediately proceeding quarter as we closely managed expenses to provide more operating leverage to the model. Driving more operating leverage will be a focus for us and both Steffan and I will discuss this in more detail later on in the call.

Based on our strong sales and decreasing operating expenses as a percentage of sales, non-GAAP earnings per share ended up $0.01 higher than our guidance at $0.02 per share. Overall this was a solid performance in a very tough climate. We attribute our success to a number of key factors including; our competitive differentiation versus other companies in the space, the diversity of our customer base across both industries and geographies, and our ability to increase our customers' productivity while reducing their overall costs.

Over the last month we have seen a number of updated forecasts on 2009 IT spending with Gardner and IDC forecasting 2.3% and 2.6% growth respectively. Even with flat IT spending we believe that wireless land solutions are a priority for many companies and we will expand upon this later in the call.

Regarding our existing customers, many of them are in the midst of multi quarter or multi year roll outs and are already fully committed to wireless land as a key component of the networking infrastructure which we believe will lead to follow on sales and upgrades.

We are also encouraged by our first quarter sales to new customers which grew even faster than sales to existing customers. Overall, after softer results in August, we had healthy year over year sales growth in September and in October. Like everyone in our industry, our visibility is limited given the macro economic conditions. However, we believe that our sales momentum in September and October is an indication of the value that we bring to our customers, and as long as there is money to spend, we feel comfortable with our ability to generate faster growth than most of the networking market.

We believe our customers are looking to Aruba to help them increase productivity while reducing operating expenses. Let me give you a few examples of how we help companies achieve this goal and why we believe wireless land spending will remain a priority for many companies.

First, our customers increasingly view our 802.11N solution as a cost effective way to increase band width without undertaking a wholesale wide infrastructure upgrade. The cost savings resulting from this approach benefits customers concerned about cost control and holding the line on IT spending in a tight economic environment.

Second, our airwave wireless management platform is designed to extend the useful life of installed Legacy networks. This capability has been a significant factor in a number of wins in which our ability to easily integrate an Aruba solution together with Legacy equipment enables us to win the customer.

Third, our remote networking products reduce office build out and employee travel time by securely and reliably supporting the remote work force. We believe demand for this capability will grow as companies close satellite offices to productively retain key personnel. In some of our markets, wireless is becoming the defacto means of access.

For example, in education wireless is the only way to deliver internet connectivity and networking to the majority of users and Aruba's solutions are designed to help strained IT personnel accomplish more on a tight budget. This benefits a well recognized within the higher education community and we have not yet seen any slow down in the demand for wireless solutions in high education outside of normal seasonality.

We continue to develop and release innovative solutions. A new release of adaptive radio management or ARM2.0 software both demonstrated in text to increase 20811 through put by 200% without adding any new hardware or client software while improving both reliability and resiliency.

The uniqueness of our solutions has enabled us to maintain a robust win rate and record new customer acquisition. For the second quarter in a row, we acquired over 700 new customers which is well over 50% greater than the number of customers we winning a year ago. These customers included major health organizations in Korea and the United Kingdom, a major public utility in the United States, one of the world's largest financial service firms, a Fortune 500 health care distributor, a leading social networking site, a major North American airline, an office supplies retailer with over 2,000 stores, and a leading university in the United States and abroad.

We also had strong sales to Safeway, our only 10% customer in the quarter. We have successfully rolled out our technology in all 1,750 of their stores nationwide. Given the nature of our technology, multi quarter or multi year roll outs are standard for mid size to large customers and we believe that new customers want today will have a much greater impact over their full life span as a customer.

At the end of Q1 the repeat order value of our top 25 customers was 8.4 times the value of the original purchase order and most of our top 25 customers are still in the midst of rolling out our technology.

However, given the economic uncertainty we think it is prudent to be cautious in the current market. We believe we have the experience, the competitive advantage to navigate through this challenging environment and we have defined and begun implementing both a short term cost containment plant and a longer term resource allocation strategy.

By continuing to make calculated investments to sustain and increase our long term competitive advantage, in the short term we closely focused on a comprehensive cost reduction program. The plan is to reduce operating expenses by approximately 10% through a combination of reduction in work force and reducing expenses related to travel, marketing expenditures and other discretional spending.

We believe these cost reduction efforts will not impact our long term growth. It is important to note that as the result of our decisions in internal growth over the last couple of years, we have added a significant number of staff to the organization. We believe that a selective reduction is fiscally responsible strategy.

As part of our overall strategy we are selectively realigning responsibilities to focus on key growth areas and carefully managing our growth assets. The net result of this effort will decrease costs to position us to improve our operating leverage and increase our profitability.

A little later in the call I will be happy to answer any questions you may have. I will now turn it over to Steffan to go through the financials in more detail.

Steffan Tomlinson

In Q1 total revenue of $52.4 million increased 9% sequentially and 12% year over year. Product revenue of $43.9 million increased 8.5% sequentially and 14% year over year. Professional services and support revenue of $8.1 million increased 14% sequentially and 12% year over year.

As expected, [radible] product and related services revenue of $441,000 declined 37% sequentially and 56% year over year.

In Q1 the revenue breakout by channel was as follows: approximately 70% came from indirect channels while 22% were direct. As a reminder, our indirect channels represent sales through our VARS and distributors as well as our partner Alcatel Lucent. Additionally during the quarter, existing customers accounted for 62% of sales. Safeway was a 10% customer in the quarter and we had no 10% partners.

Approximately 68% of our sales were generated in the U.S. with the remaining 32% coming from international. We had solid bookings across all geographies. Non-GAAP gross margins came in at 66.5% compared to 68.7% in the prior quarter in at the mid target of our target range for gross margins of 65% to 68%.

Gross margins were impacted by both product mix and an expected higher percentage of retail business which typically carries lower gross margins as we've discussed in the past. Moving forward, we expect gross margins to remain in our target range.

Non-GAAP research and development expenses was flat with the prior quarter in actual dollars and decreased as a percentage of revenue from 17.1% in Q4 '08 to 15.9% in Q1 '09. Non-GAAP sales and marketing expenses were flat with the prior quarter.

Sales and marketing decreased as a percentage of revenue from 43.9% in Q4 '08 to 41% in Q1 '09. Non-GAAP G&A expenses increased by $300,000 and relative to Q4 '08 were approximately flat as a percentage of revenue at 7.5% in Q1 '09.

Legal expenses of approximately $450,000 related to our law suit with Motorola and counter-suit against them continue to impact our G&A line. Non-GAAP income for the quarter was approximately $1.4 million or $0.02 per share compared to a non-GAAP net income of $0.2 million or $0.00 per share in Q4 '08 and non-GAAP income of $4.1 million or $0.04 per share in Q1 '08.

GAAP and non-GAAP income included approximately $0.01 of expenses related to the Motorola lawsuit. Q1 '09 non-GAAP weighted shares outstanding were 89 million shares on a diluted basis.

The GAAP net loss for the quarter was $6.4 million or $0.08 per share compared to a GAAP net loss of $6.8 million or $0.08 per share in Q4 '08 and a GAAP net loss of $0.6 million or $0.01 per share in Q1 '08.

Our first quarter of 2009 GAAP results included $6.5 million of non cash stock based expenses and $1.2 million of amortization expenses of acquired intangible assets.

Turning to the balance sheet, we finished October with $108.2 million or $1.22 per share of cash and short term investments. This represented an increase of $6.5 million from last quarter. We generated $5.6 million of cash flow from operations. We ended Q1 with $32.3 million of accounts receivable, a modest decrease from the Q4 '08 balance of $32.7 million.

Moving down the balance sheet, short term deferred revenue was $28.9 million at quarter end compared to $27.1 million at the end of Q4 '08. Day sales outstanding were 55 days, a decrease of six days from Q4 and within our long term DSO target of between 50 and 55 days. Inventory totaled $14.1 million at the end of Q1, increasing from $11.6 million at the end of Q4 '08. Inventory turns increased from 4.5 to 4.9.

Looking forward let me first briefly touch on the cost reduction program that Dom mentioned. To streamline operations, the company is taking steps to reduce it's operating expenses in Q2 through a combination of a reduction in work force by approximately 9% and reducing travel, marketing and other discretionary expenditures.

Net expense associated with the reduction of work force which is primarily for severance and severance benefits is expected to total approximately $1.2 million primarily incurred in the company's fiscal second quarter. The work force reduction is expected to be completed by the end of this week.

Compared to our prior guidance in August, the total pre tax savings of all the cost reduction efforts will be approximately 10% or $2 million to $2.5 million in Q2 and $5 million to $6 million in the second half of fiscal 2009. We believe these cost reduction efforts are reasonable and appropriate in light of the economic environment and will improve our operating leverage.

We will continue to selectively invest and believe strongly that our market opportunity is large and growing. Our solid performance in Q1 and our current pipeline are encouraging factors as we look toward the future. However, we are entering a seasonally softer second quarter. While we haven't seen any material changes yet in our sales cycle from the first quarter, we believe it is prudent and cautious and conservative in light of the economic environment.

Given all these factors, we'll provide guidance for Q2 '09 only and will not be updating or reaffirming guidance for the full year. In our second fiscal quarter of 2009, we expect revenues in the range of $44 million to $48 million which represents a year over year growth rate of 8% to 18%. We expect non-GAAP EPS of -$0.01 to $0.02 per diluted share.

With that, let me turn the call back over to Dominic.

Dominic Orr

Steffan, Keerti and I would now be happy to answer any questions that you may have.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Jeffrey Kvall – Barclays Capital.

Jeffrey Kvall – Barclays Capital

I want to ask you a little bit about the pipeline of business. It sounds as though if things do continue to progress for you but at the same time guidance is coming down, so could you help us reconcile those two?

Dominic Orr

The pipeline continues to be very strong and also we are several weeks into November of Q2 now and there is actually nothing unusual about booking trends. However, having experienced what we have experienced in January and February earlier this calendar year, we seriously believe that the budget cycle for the mixed calendar year for a lot of enterprises would take a decline, so I believe that the CIO and therefore IT budgets probably will not get finalized until pretty late part of the first calendar quarter in the March/April time frame and therefore we are taking a very, very cautious view of the month of January.

Jeffrey Kvall – Barclays Capital

So essentially the point there is that things should be fine through the balance of the year but the '09 budget there's little visibility there.

Dominic Orr

We feel the pipeline is strong. Competitively we're gaining strength against particularly the smaller competitors. We're standing a win rate against our major competitor's remains very strong. So if they spend, we can capture it. The question is, in the month of January, will they spend and we don't really have the answer to that any better than the other companies.

Jeffrey Kvall – Barclays Capital

On the OpEx side of things, you're expecting the OpEx to get to the $30 million plus range by say the middle of next year?

Steffan Tomlinson

We don't give guidance specifically on OpEx, but what we have done is put in a cost reduction effort that spans both production and work force and discretionary items that we highlighted, travel, marketing and other programs. So we want to basically be right sizing the company to ensure that we can have operating leverage growth throughout the rest of the year.

Dominic Orr

The fact that our bookings in the month of September and the month of October were showing year over year growth shows that in this depressed economic environment our value proposition is showing through. So again, if our customers spend on IT budgets we actually have confidence that we can get our share. It is just that beyond December when we get into January we really do not know whether people do have money to spend.

Jeffrey Kvall – Barclays Capital

Let me just clarify then that 10% OpEx reduction, is that from where you are currently or from where you would have been had you not taken this action?

Steffan Tomlinson

As I'd mentioned, it's relative to the guidance that we have provided on our August call and what we did was on the call we had given a range for the fiscal year and basically the 10% is off of that guidance back in August.

Dominic Orr

And obviously when we were in the middle of Q1 seeing what it is, we're very prudent in trimming expenses and head counts as well so the reduction is off that constraint base.

Operator

Your next question comes from Eric Suppiger – Signal Hill.

Eric Suppiger – Signal Hill

I just want to get a little more clarity on what you mean by the 10%. Can you remind us what guidance you're referring to and where we can take the 10% off of?

Steffan Tomlinson

Back on our call when I outlined guidance for the full fiscal year, I had mentioned a revenue range of $220 million to $230 million and EPS range of $0.12 to $0.15, Effectively using from that guidance taking down the models 10% based off of that guidance. As I stated in the script, we're not reaffirming or updating our full fiscal year guidance but to give folks a parameter of the type of cost reduction that we're doing, we're taking about 9% of our work force out and we're curbing miscellaneous expenditures.

Eric Suppiger – Signal Hill

Should we assume that you'll be 10%; would it be your OpEx for the fourth quarter of this year that would be down 10% from where you would have been had you been on track to do the old guidance?

Steffan Tomlinson

That's a reasonable approach to take but it's not only in Q4. We've implemented the controls as of right now, so we will be seeing the benefits of that cost reduction program basically flow throughout Q2, a little bit into Q3 and Q4.

Eric Suppiger – Signal Hill

So Q3 should be close to 10% less than what you were originally targeting?

Steffan Tomlinson

Correct.

Eric Suppiger – Signal Hill

Alcatel fell below 10%. Is that correct?

Steffan Tomlinson

It did. They were very close to 10% but they did not surpass the threshold of 10%.

Eric Suppiger – Signal Hill

Any thoughts? Is this an anomaly or do you think it goes back? It's been about 10% for awhile, is it going to be rebounding? Any thoughts on how that relationship is going?

Dominic Orr

First of all the relationship is going very well. I think we are extending our cooperation in all geographies. As you may recall our relationship started primarily in Europe but now it is getting strength in North America as well as Asia Pacific.

Steffan Tomlinson

You may recall last quarter, I should say last year during this quarter, Alcatel did not rise to 10% customer either. They were close but the fact that they are not a 10% customer doesn't mean that they haven't done very well in terms of contributing to the business and they're close to being a 10% customer.

Eric Suppiger – Signal Hill

In terms of the linearity for the quarter, it sounds like both September and October were pretty strong. Did you do less than 50% in the last month of the quarter?

Steffan Tomlinson

We did just a shade under 50% in the last month of the quarter and when we talked about linearity in terms of September and October, August was a little soft but that was basically due to us kicking off our first fiscal quarter of the new year and coming off of Q4 that was very strong.

Eric Suppiger – Signal Hill

So when I think of linearity it seems like maybe there was maybe a little bit of shift from August to September then October was kind of a normal linearity for your typical quarters. Is that the way to think about it?

Steffan Tomlinson

Correct.

Operator

Your next question comes from Ryan Hutchinson – Lazard Capital.

Ryan Hutchinson – Lazard Capital

On the guidance where we stand, can you help us understand expectations by vertical? Obviously education, retail and government had good quarters. Just trying to get a better sense of what you view as sustainable in the current quarter and what's not.

Steffan Tomlinson

Some of core verticals that we've outlined in the past, it actually turns out that in Q2, they are seasonally weak relative to the other quarters in our fiscal year. Education, federal government and retail, typically this is a soft quarter for them for a myriad of reasons. Retail effectively shuts down between now and the end of the year for locking down their environment.

Federal, there's new budgets that are being approved and education, the lion's share of large deployments get rolled out during the summer months and at other points during the year. The great thing about the growth that we had this quarter was, and is very much similar to Q4; we have very balanced growth across a number of verticals.

So the traditional enterprise was strong for us. If you break down that into hospitality, financial, we saw some decent results in those verticals and so just given the broad nature of our solution, we are very please with the diversity we have today.

Ryan Hutchinson – Lazard Capital

Obviously a lot has happened since the last quarter just from a macro perspective, but just a general sense on what you think the underlying growth rate for this whole market is as we look over, not necessarily in the near term but sort of the next 12 to 24 months.

Dominic Orr

I think there is a general growth rate reduction of everything in the IT segment and infrastructure, however, we are expected an actuated growth rate of 11N. As the economic downturn happens, people with budgets get crunched are still talking about the wholesale wired network infrastructure upgrade. They talk about an optimized upgrade meaning that you can throw much more cost effective 11N solution at the edge to offload some of the excess bandwidth and so that you can save some money and apply to the other part of the infrastructure where you truly need the bandwidth upgrade at the core.

So we've actually seen more projects approaching along that line and also the remote networking solution that we offer, I think a lot of the companies are actually reducing their expenses having work force work from home and also down sizing some of the operations, costs of supporting a remote brand solutions so our new cost effective seamless extension of the wireless land into the remote branch of the home office is actually hitting a major cord there.

So I think because of those reasons plus the fact that the airwave platform is getting more and more tension because with that platform you can actually get a lot more life cycle of your in-store and on all those three fronts we expect that actually interest will actually ramp in this downturn environment.

Ryan Hutchinson – Lazard Capital

We all know where IT spending is headed but does that mean a 5% type growth environment or is it north of 10%?

Dominic Orr

I am personally expecting, if they spend, and this is an important factor, then we definitely looking at the higher range of what you said because we fully expect to gain market share. Some of the smaller players in our field are definitely getting less noisy in the market and it is more dramatic now that it is clear that it is a two horse race in most of the deal, obviously in some of the retail deals that move Aruba to a strong force to be reckoned with. Generally speaking, it's a two horse race.

Ryan Hutchinson – Lazard Capital

On consolidation of the market, obviously we've seen a lot of transactions in the space over the last several months. What's your expectations in terms of whether or not that continues and can you just remind us of what your last round was done at per share part of the IPO?

Steffan Tomlinson

The last round was done at $6.54 per share and as far as the market consolidation, we're very much interested in being a long term independently run company and we'd actually contemplate using our balance sheet to pick up stressed assets. Giving balancing everything, we'd have to make sure that it was the right thing to do by the business, but we would be looking to use our balance sheet as a weapon.

Dominic Orr

Increasingly I think some of the private venture firms are very interesting propositions. I'm getting a lot of inquiries in that area.

Operator

Your next question comes from Greg Mesniaeff – Needham & Company.

Greg Mesniaeff – Needham & Company

On the transition to N, you mentioned 62% of your existing customers. I'm wondering if you can give us some color as to whether most of these customers are deploying the N solution in new applications or actually going back and retrofitting some existing ones. And if so, has the current economic climate slowed down that retrofit activity.

Keerti Melkote

In terms of in demand as we indicated in the prior quarter calls, it's still coming from higher education where there's a huge uptick of technology and as well as large strategic projects wherever there's a requirement for deploying hundreds of access points. Those deployments are trending towards N.

Having said that, existing customers that have already begun a multi phase roll out have not yet migrated to N in the vast majority of the cases. We're beginning to see it but it's not happened a great deal because they're still completing the roll out of the prior generation of technology.

Greg Mesniaeff – Needham & Company

So most of the N deployments are new customers.

Keerti Melkote

I think that's fair to say. Yes.

Greg Mesniaeff – Needham & Company

You talked quite a bit about OpEx reductions and I'm wondering with you giving guidance on gross margins to be relatively stable going forward, I'm wondering if there's any product cost reduction cost initiatives that you are undertaking and perhaps there may be some opportunities in the areas of component pricing that are available to you that you can share with us.

Steffan Tomlinson

We are taking every opportunity to look at product cost reduction programs. We have a great manufacturing operations team that focuses on that. We have internal programs to decrease those costs and we've actually be very successful over the past few year. So it's a continuing program. We'll have a greater focus and emphasis on it especially in this environment and given our volume levels and our market share growth, we should be able to squeeze more money out of our existing product cost infrastructure.

Greg Mesniaeff – Needham & Company

In other words had the volume constraints given the economy what they are, we could have potentially seen gross margins expanding just based on these opportunities.

Steffan Tomlinson

In the quarter that we just reported probably not too much mainly because we had some product mix emphasis on AP's as well as retail being a 10% customer for us. For this quarter no, but going forward, absolutely.

Operator

Your next question comes from Bill Choi – Jefferies & Co.

Bill Choi – Jefferies & Co.

On the gross margins you just touched on a little bit, can you give any additional color on what the breakdown was, the sequential dip. How much of that was from product mix and how much of that was from the larger percentage of retail?

Steffan Tomlinson

We were very happy that our gross margins came within our targeted range, right at mid point, and when we look specifically at product gross margins, the majority of that was product mix and then a portion of that was retail mix. We had been very explicit in prior calls around retail carrying a lower gross margin profile, and so this was in line with our expectations and we were happy that the overall gross margin profile, the company came smack in the mid point of our range.

Bill Choi – Jefferies & Co.

Regarding the employee reductions, the 9% reduction in work force, is there any additional information you can provide specifically around that? Which regions that will be targeted in and which division, which departments rather?

Dominic Orr

Let me tell you where we are not reducing. We are not reducing our customer service, customer advocacy organization because we believe in tough times one needs to be much closer to the customer. We have not done any reduction in our manufacturing operation because we already primarily have an outsourced high leverage model. We are very streamlined there.

And for the rest of our organization we are taking selective cuts where the discretionary marketing initiatives, we're turning that, scaling that down. Obviously the coverage is very important to us. We are winning wherever we are going and we will not compromise on our field presence across the world and we obviously have been very careful in making sure that our R&D programs are sufficiently funded.

Bill Choi – Jefferies & Co.

On the new customer additions, under new customers in the quarter, any one vertical in particular that was really robust there? Was a lot of it from the education market?

Dominic Orr

Actually the last quarter, something that's happening is actually our new customer acquisition is coming from a lot more industry segment than our traditional education high tech and federal so I'm actually quite pleased that they are geographically and industry wide quite wide spread.

Bill Choi – Jefferies & Co.

And you characterize that as more competitive wins? Do they continue to show particularly in retail?

Dominic Orr

I think every deal we go into is competitive and the majority of them has one key competitor in each, and I would say 50% of the deals are more that we've had one or two other competitors. So yes, it is all very competitive but our win rate continues to stay up and our win rate against the small competitors has actually increased.

Operator

Your next question comes from Ehud Gelblum – J.P. Morgan.

Ehud Gelblum – J.P. Morgan

You pointed out that the higher percentage of retail was one of the factors in the gross margin. Can you give us a sense of roughly what percentage of your revenue is retail this quarter and what it was last quarter so we can see the magnitude of that move from quarter to quarter?

Steffan Tomlinson

Retail was a significant contributor this quarter. Safeway as it is alone was a 10% customer in the quarter. We had other traction in retail but Safeway was by far and away the largest customer. The traction in retail that we had in the prior quarter, it was in the low single digits in terms of percentage of revenues. We typically don't break that out but that gives you some color commentary to help you do the math.

Ehud Gelblum – J.P. Morgan

When you say Safeway was 10%, were they 10% of revenues or a 10% customer and it could have been as high as 15% or 20%?

Steffan Tomlinson

It was 10% of revenues.

Ehud Gelblum – J.P. Morgan

In your discussions with Safeway, and it's actually very positive about a company that future sales come much higher than the initial value of the initial sale. When Safeway went through this procedure, did they indicate they'd be back for more? It sounds like you did all 1750 stores and that's pretty much that's the Safeway account and Safeway won't come back for another year or two if five years. What's the future value of Safeway once you've done all their stores?

Steffan Tomlinson

In retail in general you have the stores and you have distribution centers and you have headquarter offices. In the case of Safeway it's a deployment that we just finished was for your stores. There are other opportunities at Safeway as well as other retail customers that we have and we feel like there is more opportunity there for us to harvest.

Ehud Gelblum – J.P. Morgan

Is that more stores or they will just put more access points?

Steffan Tomlinson

It's not more stores because we've blanketed, we're talking about distribution centers and other parts of the company.

Ehud Gelblum – J.P. Morgan

The revenue was recognized this quarter and I guess was deployed this quarter too. When did you win that Safeway deal? Was that six months ago, a year ago? When was it actually locked in that you won that deal?

Steffan Tomlinson

Within six months.

Ehud Gelblum – J.P. Morgan

So in six months you won the deal and then deployed. So you have roughly about a six month visibility on further retail deals?

Steffan Tomlinson

You can't really extrapolate.

Dominic Orr

All I can say is we definitely are working on similar sized activities in retail and outside of retail but because of the current economic climate, you really cannot forecast the closure and it is not prudent for us to deal with such kind of big lump projects.

Ehud Gelblum – J.P. Morgan

The reason the guidance is where it is in the mid forties it sounds is essentially the loss of Safeway. That takes you two thirds of the way there. When you want to pick a spot in the guidance, but it sounds like the plan with the retail environment is where is right now, you lose Safeway. You deployed already and you don't have one to take it's place and that would make sense why you stay in that guidance range. And would it therefore make sense that until retail comes back that that's sort of the range you'll be in or are you seeing growth in other areas?

Dominic Orr

First of all I want to reiterate my comment earlier on we have many opportunities not only in retail but in other industry segments that we're working on, point number one. Point number two is in general, when we set guidance we look at our business plan, we don't think it is prudent to include the big lump projects particularly to assume that they come in in one quarter.

You probably remember of our top 25 customers, 10 are deployed throughout many, many quarters. In this particular case we had a very concentrated period that they needed to roll out. so I would say for all the large projects that's probably one of the most immediate ones we have done. This is a singular event, or is it singular relative to industry, w do not know.

Ehud Gelblum – J.P. Morgan

As retail became a larger percentage of the revenue what were the pieces that became smaller. Obviously you're talking about your federal and education did and continues to do well and are both strong. Were there any parts that you could point to verticals or otherwise gotten smaller as retail got larger?

Dominic Orr

I would say in general as things grow I think the high tech and the price portion relative to an industry, we have very good market share so that portion relatively speaking might be not growing as fast, but that's still not, I can't make it a blanket statement.

Steffan Tomlinson

If you look at year end growth by the verticals that we track, nearly all of them were list year over year growth but in terms of share directly to your question education came down a little bit from historic highs in Q4. If you were to look at share, part of that went to retail.

Ehud Gelblum – J.P. Morgan

When you gave EPS guidance did you say the $1.2 million of cost for the severance packages, was that included in that? I'm assuming that comes out of the one timer.

Steffan Tomlinson

That comes out as a one timer.

Ehud Gelblum – J.P. Morgan

Last time you gave a great run down by geography. Is there anything notable when you go through the geographies in terms of either revenue this quarter aside from Safeway?

Dominic Orr

I would say from a booking point of view for the last quarter all theaters grew year over year.

Ehud Gelblum – J.P. Morgan

How about sequentially?

Dominic Orr

Sequentially, typically Q4 is our largest quarter because it's the end of the year. If you take the Q4 factor out, last quarter was record booking for all theaters.

Operator

Your next question comes from Sanjiv Wadhwani – Stifel Nicolaus.

Sanjiv Wadhwani – Stifel Nicolaus

You spoke about the pipeline being healthy and if you look at your backlog going into the January quarter, what percentage from multi quarter, multi year builds that you have ongoing versus new builds that you might have won in the October quarter? Any color around that?

Dominic Orr

I think that the color I'd like to give you is generally about 65% plus minus a few points of bookings every quarter tends to come from in store so you can assume the potential.

Sanjiv Wadhwani – Stifel Nicolaus

In the past couple of quarters you've given percentage of access point that are 11N. Any further updates on that for the October quarter?

Steffan Tomlinson

In October 11N access points were about 20% of the AP shipments.

Sanjiv Wadhwani – Stifel Nicolaus

Was that flat as a percentage of revenue or did that actually fall a little bit?

Steffan Tomlinson

It was modestly up.

Operator

Your next question comes from Mark Sue – RBC Capital Markets.

Mark Sue – RBC Capital Markets

If you look at everything that's going on as we approach the end of November and where we are with IT budgets is it possible that things can be worse than $44 million next quarter or is that factoring a worst case scenario and there's a good change that you might get another large 10% customers that's not factored in the $44 million?

Dominic Orr

Considering that there are several factors that come into our giving a range. First of all, we feel good about how September and October booking momentum year over year despite the market conditions showing that the value our solutions are adding in this environment. I'm not unpleased about our backlog situation coming into this quarter.

I also feel that for the three weeks into the quarter bookings trend reasonably normal, so those are all great. On the other hand, the thing that I really do not know is whether people have money to spend in January so if they have money to spend, I think we are competitively in a very, very good position to catch it.

I believe that there will be some money but I think the planning mindset is that January will be tight, so we're putting all that into the equation and coming up with the range that we feel is the right range.

Mark Sue – RBC Capital Markets

Are you assuming a stretched out closure rate for the coming January more so than we saw in last January?

Dominic Orr

You've probably seen more stuff than I do so I think your crystal ball is as good as mine.

Mark Sue – RBC Capital Markets

On Motorola, are we at the point where we can actually make a case for a settlement or do you feel things are so far apart from the zone of possible agreement that this is going to continue so we should factor it into our income statement?

Steffan Tomlinson

We recently discovered that Motorola was infringing on two of our own patents and asked the judge to prevent us to include our infringement claims in the pending suit. He agreed and now we have to sued Motorola and Cingular Wireless Valley for infringing on both of our patents and the law suits are apparently still in discovery phase. As we said before, we believe we will ultimately prevail and we do not believe we infringed on any of Motorola's patents.

Moreover, we believe that all the patents [inaudible] are invalid and that the PTL will ultimately conclude that these patents would never have been issued by the PTO had it know that we had submitted it as part of our examination request.

Mark Sue – RBC Capital Markets

So don't count on a settlement is what you're telling us?

Steffan Tomlinson

We can't really comment on that.

Mark Sue – RBC Capital Markets

Any thoughts on cash generation for calendar 2009?

Steffan Tomlinson

We don't provide cash flow projections. The intent around the cost controls that we put in place is to set us up to have positive cash flow generation.

Operator

Your next question comes from Blain Carroll – Ftn Midwest Securities.

Blain Carroll – Ftn Midwest Securities

You talk about how bookings seem to be relatively normal and Steffan went into seasonality around the educational and the federal government and the retail and what that looks like during the November and December time frame, so my question is what vertical is it that's making you nervous as we turn into the new year and we're looking at the month of January. If my memory is right, wasn't it the federal government that caused the hiccup that we experienced last year?

Dominic Orr

I think the hiccup last year was due to several programs were specific of spending irregularity which we have not seen this time. In fact our Q1 federal business was up quarter over quarter and year over year as well, so I feel that the federal business is on track. I think our health care business has very little seasonality and so the hospitality and transportation and energy sectors and industrial enterprise they seem to not have seasonality.

One factor that we see since last quarter is a lot of our leads are coming in cross industry sector rather than us a year before we really have three or four more specialized verticals to deal with.

Blain Carroll – Ftn Midwest Securities

So which vertical is making you nervous with the current guidance?

Dominic Orr

I'm not nervous about one particular vertical because I think everybody who has a manufacturing business, import export business and ultimately supplying the consumer, they are all subject to a real test through the holiday season and so on. I really think our nervousness is really not nervousness. It's just we're sitting here with no visibility of what January and February will be like, like everybody else. So it's more lack of visibility rather than nervousness.

I'm actually not nervous at all. In fact I'm very confident because every single engagement we go into we see that we continue to be winning against the incumbent at an 80% rate and we see an increased win ratio against small competitors. So I'm just waiting here, sitting here calmly waiting for deals to happen and when deals happen we win. I'm very confident about that.

Blain Carroll – Ftn Midwest Securities

Is there anything new in the pricing environment whether it's from competitive pressures or maybe anticipate some of the customers pushing back for further discounts for products if the market does soften or potentially you lowering the pricing on some of your products in order to get deals done.

Dominic Orr

I think there are two kinds of projects going on that deals get won at. One is if you can really create unique value from a CIO office to the line of business managers so the company as a whole, the customers company as a whole becomes more competitive, and the underlying spending is basically a given. I have a smaller budget, how can you optimize the small budget in my core spending both in CapEx and in OpEx in my infrastructure so that I can free up some money to fund the first project.

So what you see is that actually a lot of our projects that get do get funded are the second kind which is to say, you actually by deploying the Aruba solution, I actually can spend a fraction of the original CapEx and then I can save a lot of OpEx through a optimized network using 11N, through using the multi managing platform to extend the life if I install wider, and through the very cost effective networking solution to really extend my telecommuter and my branch productivity and all those are helping not only the CIO to do more with less, but then actually dramatically free up OpEx.

And when you're in a position like that you don't need to negotiate so much the price. On the other hand, for the projects that going for value creation and new mobility application and so on, yes, people will try to see whether they could do a phase out project and CapEx spending would be left for the project and in those situations there would be some price pressure.

Operator

At this time there are no further questions. I will turn it over to management for any closing remarks.

Dominic Orr

Thank you. And again we thank you for being on the call today and I appreciate your support. Clearly this is a rough market and a tough economy but at the same time, money is still being spent on IT projects that improve productivity, lower operating costs and improve competitive position as I said.

This of course is strength of Aruba solutions and we believe that they have and will continue to serve us well. I believe that our competitive position has never been stronger and the long term value of our growing customer base is highly encouraging for the future. While we believe that we are poised to gain market share in this tough environment, in our guidance we track a conservative stand given uncertain macro environment.

We look forward to updating you on our progress in the coming months and thank you. Have a good afternoon and evening.

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Source: Aruba Networks F1Q09 (Qtr End 10/31/08) Earnings Call Transcript
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