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Executives

Maria Riley - Director

Dominic P. Orr - Chairman, Chief Executive Officer and President

Michael M. Galvin - Chief Financial Officer and Principal Accounting Officer

Keerti Melkote - Co-Founder, Chief Technology Officer and Director

Analysts

Ehud A. Gelblum - Morgan Stanley, Research Division

Amit Daryanani - RBC Capital Markets, LLC, Research Division

Jason Ader - William Blair & Company L.L.C., Research Division

Kent Schofield - Goldman Sachs Group Inc., Research Division

Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

William H. Choi - Janney Montgomery Scott LLC, Research Division

Roderick B. Hall - JP Morgan Chase & Co, Research Division

Brian T. Modoff - Deutsche Bank AG, Research Division

Jess L. Lubert - Wells Fargo Securities, LLC, Research Division

Aruba Networks (ARUN) Q2 2013 Earnings Call February 21, 2013 4:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Aruba Networks Second Quarter 2013 Earnings Conference Call. [Operator Instructions] Today's conference is being recorded, February 21, 2013. I would now like to turn the conference over to Maria Riley with The BlueShirt Group. Please go ahead.

Maria Riley

Good afternoon, and thank you for joining us on today's conference call to discuss Aruba Networks' fiscal second quarter 2013 results. This call is also being broadcast live over the web and can be accessed in the Investor Relations section of Aruba Networks' website at www.arubanetworks.com. With me on today's call are Dominic Orr, Aruba's President and Chief Executive Officer; Mike Galvin, Aruba's Chief Financial Officer; and Keerti Melkote, Aruba's Co-founder and Chief Technology Officer.

After the market closed today, Aruba Networks issued a press release announcing the results for its fiscal second quarter ended January 31, 2013. If you would like a copy of the release, you can access it online at the company's website or you can call The BlueShirt Group at (415) 217-7722, and we will send you a copy.

We would like to remind you that during the course of this conference call, Aruba Networks' management will make forward-looking statements, including statements regarding the company's expectations regarding growth drivers, including the rapid proliferation of mobile devices, BYOD and IT spend; customer adoption and penetration of our MOVE architecture, Mobility Access Switches and software solutions; the company's ability to penetrate larger accounts; the company's future economic performance, pipeline, financial condition, tax rate, revenues, non-GAAP EPS, results of operations and expectations regarding continued R&D investment; the company's ability to expand its business and grow its market share in its core market segments as well as new segments such as managed services, service providers and mid-market customers; and the company's expectation that it will grow revenue faster than expenses as a general trend.

These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future, and we undertake no obligation to update these statements after the call. For a more detailed description of these risks and uncertainties, please refer to our most recent report on Form 10-K and 10-Q filed with the U.S. Securities and Exchange Commission or SEC on October 11, 2012, and December 7, 2012, respectively, as well as our earnings release posted a few minutes ago on our website. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of the website.

Also, please note that unless otherwise specifically noted, all financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the Investor Relations section of our website located at www.arubanetworks.com and in our earnings press release.

Before I turn the call over to Dominic, I would like to announce a few upcoming events in the investment community. On the conference front, on February 25, Aruba will attend Morgan Stanley TMT Conference in San Francisco. And on March 6, Aruba will attend the Wedbush TMT Management Access Conference and the UBS Trends in Wireless conference [ph] both in New York City.

Additionally, Aruba's hosting its annual Analyst Day in New York City on Wednesday, March 27, and in New York City. If you would like to attend, please contact either me or Hadley Rokicki at The BlueShirt Group or email ir@arubanetworks.com. We hope to see you there.

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

Dominic P. Orr

Thanks you, Maria. Good afternoon, and thank you for taking the time to attend our fiscal second quarter 2013 conference call. We delivered a strong second quarter and achieved our 15th consecutive quarter of record revenue. The second quarter, we grew revenue to a record $155.4 million, up 23% year-over-year and 8% sequentially. We also delivered 22% operating margin, EPS of $0.22, generated over $45 million in cash from operations, and purchased 1 million shares of our common stock. It was a strong quarter and demand was broadly spread across all verticals. We are pleased with our continued momentum into markets. While market analysts estimate that enterprise wireless LAN business is growing in the high teens, we are growing faster than that. Our competitive win rate remains high, and we believe our chronological differentiation and value proposition have never been stronger.

Our new product initiatives under our MOVE architecture are fueling our growth into new markets and in new customers and offering unique solutions that solve today's critical IT problems, including mainly in the proliferation of mobile devices and applications accessing the network in the BYOD environment. With MOVE, Aruba is the only provider today with a full range of product that are truly based on a Layer 4-7 application-aware software platform designed from this onset for the Mobile Edge.

The momentum continues for ClearPass. Our unique access management software solution allows companies and organizations to seamlessly onboard any device on any network. I'm pleased with the number and the quality of new accounts that ClearPass is allowing us to access. Its ease of use, scalability and value-added feature modules, such as guest access and BYOD management, differentiates ClearPass against Cisco's ISP platform.

Another key element of our MOVE architecture, Aruba Instant Enterprise, is the first controller-less, wireless LAN solution to deliver a comprehensive enterprise-based security, reliability and scale, and have been a success with distributor enterprise like restaurants and retail stores. In addition, Aruba Instant allows us ability to address the mid-market.

Let me give some examples of customer project involving elements of our MOVE architecture. A large web hosting company purchased core wireless LAN and ClearPass for guest access and device onboarding. A major international investment bank purchased ClearPass for rapid onboarding and BYOD provision. A large U.S. supermarket chain selected Aruba Instant for in-store connectivity. A Fortune 500 insurance provider selected Aruba Instant for remote access. A large health care provider purchased Aruba for wireless LAN and BYOD. A major financial institution, who started out as Aruba Virtual Branch Network customer, now has adopted Aruba Enterprise wireless LAN across the entire infrastructure. An education institute recently purchased over 1,000 unit of Mobility Access Switches for the deployment of its next-generation access network across their campuses.

Over the last couple of quarters, the number of customers in the education vertical who are adopting all elements of our MOVE architecture has been increasing. As a reminder, the education vertical historically has been an early adopter for next-generation access network technology. Overall, we added another record number of new customers in Q2. These new customers span across all of our verticals and geographies.

A couple of quarters ago, we announced that Aruba's MOVE architecture received qualification for Microsoft's Lync Server Wi-Fi compliance program. As of today, we are still the only provider to have received this qualification. We have seen an increase in customers who want to deploy Lync or other unified communications applications over wireless LAN. This type of applications have a heavy requirement for network availability and high quality of service. Our MOVE architecture has the intelligence to prioritize network resources in order to deliver a flawless user experience for this unified communication applications.

Further strengthening our MOVE platform, we introduced the new controller, Aruba 7200 Series. The controller has our new application RF technology, which uses Deep Packet Inspection for Layer 7 insight to identify application traffic and optimize application delivery over the air for each application type and user profile. This insight and the ability to take realtime action results in better performance and more granular controls. Customer adoption of the new controller has been strong.

Additionally, the 7200 is a key component of our new, highly scalable architecture for managed service providers, building a hybrid private and public access network. This new architecture addresses an acute area for pain for carriers where they need both to manage Wi-Fi services and large-scale cellular offload on the same infrastructure. This is our first targeted product solution for this market segment. We will discuss this new architecture in more detail in the Mobile World Congress in Barcelona next week. And I welcome you to come by our booth.

I would now like to turn the call over to Mike for more detailed financial review for the quarter.

Michael M. Galvin

Thank you, Dom. In Q2 2013, total revenue was $155.4 million, growing 8% sequentially and 23% year-over-year. Product revenue of $130.9 million grew 10% sequentially and 24% year-over-year. Professional services and support revenue of $24.5 million decreased 3% sequentially and increased 20% year-over-year. As we have said before, our services revenue is driven by the amount and timing of support contracts. This was evidenced last quarter, our Q1 '13 was an especially strong quarter for support revenue in the U.S.

U.S. revenue grew 23% year-over-year, representing 61% of total Q2 revenue. EMEA revenue grew 16% year-over-year, representing 18% of total revenue for Q2. And Asia Pacific/Japan revenue grew 32% year-over-year, representing 18% of total revenue. While our growth in EMEA was solid, we continue to be cautious given macro uncertainties are still impacting this region.

Total non-GAAP gross margin in Q2 was 73.4%, a decrease from 74.2% in Q2 '12 and an increase from 73% in Q1 '13. Q2 non-GAAP product gross margin was 73%, a slight decrease from 73.2% in Q2 '12 and an increase from 71.6% in Q1 '13. Our product gross margin continues to perform very well and is driven by product and geographic mix variables in each quarter.

Q2 non-GAAP services gross margin was 75.4% compared with 79.7% in the prior quarter and 79.6% in the same period a year ago. In Q2 '13, we continue to invest in the infrastructure of our services business, including both people and systems. Our guidance for total non-GAAP gross margin remains at the high end of our near-term range of 70% to 72%. Non-GAAP research and development expense was $24.5 million. As a percentage of revenue, R&D was 15.7% compared with 15.6% in Q1 '13. Our R&D spending levels are affected by the timing of headcount additions and programmatic spend related to our product roadmap. We will continue to invest in R&D for further product innovation and differentiation.

Non-GAAP sales and marketing expense was $46.8 million in Q2. As a percentage of revenue, Q2 sales and marketing was 30.1% compared to 30.9% in Q1 '13. Non-GAAP G&A expense increased to $8.2 million in Q2 from $7.9 million in Q1 '13. As a percentage of revenue, G&A expense in Q2 was 5.3% compared to 5.5% in Q1 '13.

Total headcount at the end of Q2 was 1,407, an increase of 114 from the prior quarter. In total, Q2 non-GAAP operating expenses were $79.4 million or 51.1% of revenue compared to $75.1 million or 52% of revenue in Q1 '13. While we will continue to make investments in the business, we expect to grow revenue faster than expenses as a general trend and as we did this quarter. Our non-GAAP operating profit in Q2 was $34.6 million or a record 22.3% of revenue compared to 21% in both Q2 '12 and Q1 '13. Our non-GAAP tax rate in Q2 was 21%. Our tax rate in Q2 was favorably impacted by the extension of the federal R&D tax credit at the beginning of calendar 2013. This rate retroactively applies to credit for both FY '12 and Q1 '13 and increased our Q2 reported non-GAAP and GAAP earnings per share by $0.02. The extension of the credit is now factored into our remaining non-GAAP tax rate forecast for the balance of FY '13. As we have previously discussed, our overall tax rate is subject to change including from the projected geographic mix of the company's revenue, as well as changes resulting from any new U.S. or international regulations or interpretations.

We expect our full fiscal year 2013 non-GAAP tax rate, incorporating the benefit of the R&D credit, to be in the range of 26% to 27%. Non-GAAP net income for the quarter was $27.3 million or $0.22 per diluted share. This compares to $22.1 million or $0.18 per diluted share in Q1 '13 and $19.4 million or $0.16 per diluted share in Q2 '12. The weighted average shares outstanding were 123.3 million shares on a diluted basis in Q2.

On a GAAP basis, net income was $5 million or $0.04 per diluted share compared with a Q1 '13 net loss of $0.8 million or $0.01 per diluted share and a Q2 '12 net loss of $11.4 million or $0.11 on a per diluted share basis. A full reconciliation of GAAP to non-GAAP information is contained in our financial results press release issued this afternoon.

Turning to the balance sheet, we finished Q2 with cash and short-term investments of $402.3 million, an increase of $24.8 million over the prior quarter. Cash flow from operations in Q2 was a record $45.7 million. Under our share repurchase program, in Q2, we have purchased approximately 1 million shares of common stock at an average price of $18.72 per share or an aggregate purchase price of approximately $19 million. The weighted average shares outstanding impact from the repurchase in the quarter were 754,000 shares. We ended Q2 with $70.1 million of accounts receivable, a decrease from the Q1 '13 balance of $73 million. Days sales outstanding improved to 41 days, a decrease from 46 days in Q1 '13 and 49 days in Q2 '12. Our target range remains 50 to 55 days.

Total deferred revenue of $118.1 million increased 30% year-over-year and $4.2 million or 4% from Q1 '13. Short-term deferred revenue of $89.9 million increased 24% year-over-year and 2%, sequentially. Aruba's inventory totaled $29.4 million at the end of Q2 and the increase of $1.3 million from the end of Q1.

Before reviewing guidance, let me remind you that the guidance consists of forward-looking statements, and please keep in mind our earlier comments regarding such statements.

While we are pleased with our strong Q2 performance, we remain cautious about the macro environment, particularly in Europe. Balancing these factors, we expect Q3 '13 revenue to be in the range of $159 million to $161 million, and the increase of 21% to 22% year-over-year and 2% to 4% sequentially. We expect non-GAAP EPS to be approximately $0.20 per share using 125 million shares on a diluted basis.

With that, let me turn the call over to the operator to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Ehud Gelblum with Morgan Stanley.

Ehud A. Gelblum - Morgan Stanley, Research Division

Can you give us a sense just for starters on the individual products? Dominic, can you talk about each quarter for ClearPass and ClearPass Instant and give us a sense as to how large they might be, and when we can actually start tracking them?

Dominic P. Orr

Ehud, we, in the history of the company, have not broken out revenue by product segment. It was quite a bit away from segment reporting, so all I can tell you is about -- we continue to have a very strong pipeline on ClearPass pilots and about 1/3 of this new and non-Aruba infrastructure account, so we take that as a very good lead-in to new accounts opportunity. The rest is balanced between upgrading Aruba in installed base to MOVE architecture with various component and ClearPass as umbrella policy management system. And then the remaining with ClearPass as a component of a complete access network offering. As regarding Aruba Instant, as we mentioned in the prepared text that we are very, very pleased with the traction that it is taking in the distributor enterprises, taking us to kind of retails and hospitality and that kind of environment, quick-service restaurant environment where the controller base architecture would be more limiting in terms of the cost point. So that is a very successful program, and we are actually seeing a strong pipeline being developed for service prior to managed services based on the Aruba Instant line. I think I would just comment to that.

Ehud A. Gelblum - Morgan Stanley, Research Division

Okay. Some follow-ups quickly. DSO is, obviously, very low. And could you comment on linearity on the quarter and how that flow through to the DSO to the quarter? And early, was there some structural reason why perhaps orders may have been -- not closing in the quarter, so DSO have been lower just -- how should we read into that? And can you just give us a context around the new 7200 controller, how that may be doing, and how should we should be modeling that going forward?

Michael M. Galvin

Ehud, the DSO, we're obviously pleased with the performance including the last few quarters. We're just -- the quality of the receivables and the efforts obviously by the internal team in terms of keeping that number good have been very good. We always talk about linearity in kind of 2-fold: one is shipping linearity, and one is booking linearity. I would say on the shipping side, which obviously affects the DSO number, it was, I would say, just good solid Q2 linearity. So we've had good performance on that number. We obviously hope to continue that, but overall it's good. And I'd say, the linearity on the shipping side was solidly consistent with our other Q2s.

Ehud A. Gelblum - Morgan Stanley, Research Division

And any comment on the 7200?

Dominic P. Orr

The 7200 has been shipping for a couple of months now, and we are very pleased on its traction both in new accounts and also a strong pipeline for installed base refresh. And as I mentioned in the text, also we come out with a new set of capabilities both hardware, firmware and software in giving even more Layer 4-7 functionality real life -- realtime detected inspection, tuning of application, delivery support for application such as unified communication like Lync. So a very, very strong reception in the marketplace for the 7200.

Operator

Our next question comes from the line of Mark Sue, RBC Capital Markets.

Amit Daryanani - RBC Capital Markets, LLC, Research Division

This is Amit on behalf of Mark Sue. My question is more on the overall macro environment that remains tepid and you're seeing some system challenges in Europe and with the U.S. federal. Have you seen any changes in the willingness of customers to adopt the wireless solutions? Have you seen any sort of deals pushed out or delays in sort of the decision-making process?

Michael M. Galvin

On the macro environment, I mean, it definitely flavors in, especially obviously as we look forward. Europe, we've been feeling that, I would say, for several quarters now. And overall, it's something we factor in. I don't know if you know specifically on deal flow or anything, Dom, with regards to the impact.

Dominic P. Orr

I don't see any deterioration in Q2 compared to what we have seen over the last year, people have silent in decisions cycle. [ph] And I think we also comment on the -- in Europe, in theater, the deal size. Actually, it's a little bit smaller because the purchases get segmented out. But that is not any different from what we saw particularly in last quarter compared to the previous quarter, so I would not comment on its trending down. But it's definitely it's ...

Michael M. Galvin

Definitely there.

Dominic P. Orr

It's there, yes, yes.

Operator

[Operator Instructions] And our next question comes from the line of Jason Ader with William Blair.

Jason Ader - William Blair & Company L.L.C., Research Division

Mike, can you remind us on how big Department of Defense is for Aruba, the percentage of sales? And then have you factored in the sequester to your Q3 guidance?

Michael M. Galvin

Yes, so we don't break out the DoD or really any of our verticals explicitly. But it's obviously been -- and the Fed has been and continues to be a very good business for us. We look -- we're looking at sequestration like everyone else as a risk factor. It flavors into the way we have to think about the next few quarters. We're not calling anything one way or another. It's just -- it maybe goes into the macro bucket of something that you just have to be a little more cautious about in the way you look at things.

Dominic P. Orr

And particularly, relationship with the Department of Defense, I want to kind of highlight that we continue to feel very differentiated, and the barrier to entry for that segment of the market is very high. And we are embedded in various multiyear program that at least for this current quarter, we don't feel it is a lot of sensitivity to the HLU measure. [ph]

Operator

Our next question comes from the line of Kent Schofield with Goldman Sachs.

Kent Schofield - Goldman Sachs Group Inc., Research Division

You mentioned getting into the cellular offload Wi-Fi market. It would be great to kind of get a little sense as to what you're thinking about in the go-to-market side, and then what you think Aruba's differentiation is in that market?

Dominic P. Orr

Good question, Kent. First of all I want to emphasize that we are not going back to the low-margin, low-differentiation Layer 2 carrier Wi-Fi market that some of our colleagues in the industry are targeting. We are focusing on still our main core competence of Layer 4-7 Wi-Fi high security and to the service provider deliver into many services environment in large to medium enterprises. It's just that over the course of last year or so, we find out that there is a overlap of the service provider market and the enterprise managed services market in we call public facing Wi-Fi. And that is at venues where a hybrid environment or a new use environment of both a secure managed service on top of a high-density cellular offload requirement would be ideally implemented on the same infrastructure such as stadiums, such as lodge, airports, train stations, shopping malls and so on. In those environment, we are introducing an architecture that will allow the service provider to solve both problem in a highly, highly scalable form with a single infrastructure. And that is what we are now introducing in Barcelona.

Kent Schofield - Goldman Sachs Group Inc., Research Division

But anything on the go-to-market side of things? Are there any investments you need to make there? Can you work with the existing relationships?

Dominic P. Orr

We actually have been developing very good relationship in this space, in a lot of service provider around the world through the managed service store[ph]. And so with this offering, obviously, we are extending our footprint inside in the service provider to a little bit broader market footprint.

Operator

Our next question comes from the line of Sanjiv Wadhwani with Stifel, Nicolaus.

Sanjiv R. Wadhwani - Stifel, Nicolaus & Co., Inc., Research Division

Dom, I wanted to ask about the product growth rate. We definitely saw an acceleration in the Jan quarter, up about 10% sequentially. Last 5 quarters, I think you posted between 2% to 6% sequential growth on the product side. I'm just curious, has anything changed incrementally on the positive side over the last 3 or 6 months in the wireless market, or is it a function of ClearPass, Instant, et cetera, driving that incremental growth? And then second question I had was I think you mentioned about 1/3 of your ClearPass deployments are with non-Aruba customers. I'm just curious if you had an update on the experience in hardware being pulled in by those customers?

Dominic P. Orr

Okay. So, Sanjiv, the first question, the product growth rate, as I mentioned in our prepared text that in the education segment, we are still trying to see increasing number of customers adopting the full MOVE architecture product suite in addition to just pure core wireless LAN, so that is some lift. Aruba Instant is taking us into a broader set of distributed enterprises that we can very cost effectively address. ClearPass, as a software product, is definitely making some impact. We're not breaking out specific contribution, but certainly we're generating revenue there. And from the -- so from the point of view of -- for the new accounts where we are getting into other vendor's network infrastructure using ClearPass as access management system, we are starting to see some examples that we have been invited in to bid for the infrastructure business and some early successes. I would not say that it would meaningfully contribute to our revenue at this moment, but certainly from our perspective that the strategy seems to be heading the right direction. It seems to be working.

Operator

Our next question comes from the line of Ryan Hutchinson with Lazard.

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

A couple of questions. First off, Dom, just on guidance. I want to better understand the guidance with respect to it incorporating ClearPass pilots converting to revenue. And also obviously, you touched on the managed services opportunity. Does that also take that into account there? And then on the gross margins, just thinking about over the next couple of quarters, if we get an increase in ClearPass but also an increase in managed services with respect to the opportunities in the service provider segment, how do we think about overall product gross margins?

Dominic P. Orr

Okay. So let me handle the guidance part of it. You -- and then I'll let Mike handle the gross margin. Obviously, as we mentioned that we are very encouraged to see in certain market segments the whole MOVE architecture being taken up. But also, we are also very cautious about global macro factors, and the guidance is really a blended view of our perspective. I would not say that there is any particular break out of upside.

As regarding managed services, we're already having a run rate managed service business that's quite robust. What we're announcing next week is going to take us into new opportunities as you know in the service provider world that it takes multiple quarters to ramp-up. And the new footprint really is we're still staying focused on managed services, it's just that now service providers doesn't need to go from multiple solutions to solve multiple problems. They can put 1 infrastructure in and solve 2 or 3 of the key headaches that they have on the same venue. And that really would translate to us a higher win rate and also a higher pipeline, a bigger pipeline, I think.

Dominic P. Orr

Yes, Ryan. And on the gross margin, so ClearPass, obviously, is a good component of that. And overall, software, even beyond ClearPass, had a good quarter. But what we've also seen in a few quarters ago, if you recall, we had a similar phenomenon where we did have a good software quarter. But it's not at a point yet where we trended on a perfect ramp every quarter yet, right? So we -- it's definitely factored in. From the SP side -- we factor in everything is, I guess, the simple answer. On the SP side, as Dom mentioned, there is a gross margin profile that we've achieved in one and will go after in that market. And that being said, it's not always at and better than our company gross margins, so we have to factor all those balances in when we look at the mix. And you can even see -- just looking at our last several quarters with regards to product gross margin, the movement that can go on between quarters and services gross margin is even sensitive to that. So we factor all that in. We obviously feel really good about it. We're going to try to keep executing on it.

Operator

Our next question comes from the line of Bill Choi with Janney Capital Markets.

William H. Choi - Janney Montgomery Scott LLC, Research Division

First, a clarification on that ClearPass comment. So you're expecting that to be sequentially down? And do you want to call out any large deals that you might have had in Q2? A year ago, you obviously talked about a multimillion deal that was more onetime in nature, just if you could clarify that? And then, Dominic, last quarter, you talk about ClearPass really having the gating factor of how quickly you could certify and train the resellers. Is there any update you can give on how well you're doing on that, any numbers of resellers that have signed on and have gotten certified? And then just lastly just in terms of 7200, is it -- is the right way to think about it, deployment with new use cases like unified communications and managed services? Or is there something more horizontal, more applicable to what you're doing on the ClearPass BYOD that would drive an upgrade from the installed base of your older systems?

Dominic P. Orr

That's very good point. So first of all, there's no lumpy one deal that contribute to our margins, so there's nothing to call for. I think what Mike earlier on meant to say was that this thing is still in early stage. We have not developed a full quantitative trend that we want to model yet, so we've been having this kind of a blend with the other product mixes. Regarding to ClearPass implementation capacity, I think for the last 90 days, we made very good progress. I'm very pleased with our domestic implementation capability both in-house and with partners. Now we're extending the similar programs to international, and would continue very, very strong support from the partners community. Regarding the 7200, there's really multiple applications. First of all, a lot of the campuses now in the new [indiscernible] deployment obviously you want future proof for 11ac. 7200 has lots of headroom for 11ac support. And then the strong application awareness capability and realtime deep packet inspection allowed you to have this platform to be ideally suited for applications such as unified communications as you pointed out.

William H. Choi - Janney Montgomery Scott LLC, Research Division

Any number on the number of resellers that have been certified on ClearPass?

Dominic P. Orr

No. We're at -- just let Cisco keep guessing.

Operator

Our next question comes from the line of Rod Hall with JPMorgan.

Roderick B. Hall - JP Morgan Chase & Co, Research Division

Just a couple of questions. One is on the gross margin guidance and I guess the services gross margin. The services gross margin dropped off quite a bit. I wonder if you could just -- with that additional hiring of services personnel, and is the that another drop-off in that embedded in your gross margin guidance for the Q3? So if you could just kind of comment on the trajectory that was driving, it would be helpful. And then just back to ClearPass. I wonder -- would you guys comment on who -- are people replacing other systems with ClearPass? And if they are, could you comment on what types of systems you're seeing replaced? Or are most people that are taking it up from you so far testing it looking to initiate it as a new system? They haven't had a BYOD sort of management system before. So could you just comment on the type of ClearPass deals you're seeing?

Michael M. Galvin

Rod, on the services GM, it's obviously affected by the revenue growth in any quarter and then the investment. And you can see on the COGS line, we are definitely investing in that business, people, systems, processes, et cetera for just the efficiency with our customer relationships, et cetera. We've also got ClearPass professional services emerging in that line. It's a relatively small number, but it still is emerging. So we are doing that. We're really just kind of outstanding customer interaction and interfacing.

And then with regards to how revenue affects it. I mean, the revenue can be a little lumpy if you look back to last quarter. If you kind of trend -- just go backwards 4 or 5 quarters, you can see the last quarter was a bit of an abnormal jump in services revenue. And part of that is -- a key part of our revenue stream is the renewal of support contracts. And the timing of those on some of the big ones can be lumpy at times. So we had a bit of a downtick in revenue this quarter, which we talked about a little bit last quarter just in terms of the big Q1 numbers. That downticks a little bit. We continue our investment and we get the gross margin that we do. But I think, go forward, I think you should expect to see the same kind of services revenue trending ramp. And the investments we're making will continue, but they will also begin to pay off obviously over time. And so we're in investment mode there, but the margin should definitely be in the historical ranges from what you've seen.

Roderick B. Hall - JP Morgan Chase & Co, Research Division

Mike, could you comment on the timing for that? I mean, when you say it should be back to the kind of historical ranges, by when? I mean should we see that by the end of this year or do you think that's on in the early part of next year?

Michael M. Galvin

Nothing specific on that. The investment, I'd say we started talking about that service investment probably a year ago, so it takes different forms with the ClearPass professional services piece, et cetera. But I think if you look at our GM range there over the last year, there's nothing that says that shouldn't perform that way in the coming year.

Dominic P. Orr

And on the second question about ClearPass, whether it's a new system or we'll be replacing an existing system. For the most part it's a new system. If you think about in a pre-BYOD era, the wireless LAN typically only had to authenticate employees on corporate devices. And for the most part, Microsoft Active Directory was the system that we interfaced with. But in the BYOD world, what we end up having to do is augments Active Directory with the ability to onboard guest users, as well as guest devices, and those systems have not existed in the past. So ClearPass is effectively a new platform that wraps around Microsoft Active Directory for BYOD.

Operator

[Operator Instructions] Our next question comes from the line of Brian Modoff with Deutsche Bank.

Brian T. Modoff - Deutsche Bank AG, Research Division

Just a question around the offering you're going to have next week in Barcelona. Are you going to be supporting HotSpot 2.0? And how are you planning to integrate the product with the carrier on the carrier side? Is this really more targeted where the carriers wanting to have a managed services offering into a vertical like, say, hospitality and you want to be that managed services offering? Or is this a situation where the carrier looking at this as part of an overall strategy like, say, AT&T and they're needing product for in-building application, as well as street-level application, where you're mainly dealing with existing mobile users moving in and out of the network?

Dominic P. Orr

Yes, so on the first question, Hotspot 2.0, we are absolutely going to support it. In fact, it is already supported in our operating system today. And we are participating in all the different industry activities in a surrounding Hotspot 2.0. In regards to the ability to integrate with the mobile core, I think they're 2 distinct opportunities. There's an outdoor opportunity like you mentioned, which is primarily an extension of the mobile core. There's really no requirement outdoors to integrate with a private wireless LAN. But the moment you've crossed the hurdle and get indoors, there's usually a hybrid requirement for a supporting enterprise wireless LAN with all the BYOD features and so on, where cellular offload is typically a feature rather than the main aspect. And for the cellular offload traffic, we'll have capabilities that will allow us to integrate back with the mobile core. But -- and we'll, in fact, next week, talk more about how we can scale that to a very, very high level, something that the industry hasn't seen so far. So we're very excited about this new offering, and stay tuned more for next week.

Operator

Our final question comes from the line of Jess Lubert with Wells Fargo Securities.

Jess L. Lubert - Wells Fargo Securities, LLC, Research Division

I was hoping you could talk about average deal sizes across geographies and to what degree some of the strengthening you saw last quarter in the U.S. and Asia had continued this quarter. And then secondly, I was hoping you could touch on the competitive environment. Cisco's introduced several new products in this space. The company reported very good growth metrics this past quarter, so I was curious if you've have seen any change in Cisco's competitiveness, your win rates versus them and what impact you believe the Meraki deal may have going forward?

Michael M. Galvin

On the average deal sizes, I would say they continue to perform in historical ranges. But remember about -- I'd say about a year ago, we did start to talk about our customers kind of in 2 different buckets. One is our traditional larger enterprise customers, and then emerging mid-tier element of our business. And if you recall that affected our customer counts for instance, et cetera. So really what we've seen is that those deal sizes in the 2 segments are performing right in their historical ranges.

Keerti Melkote

And regarding the Cisco competitiveness, I would say one distinct element happened in the last 90 days or more. It seems like they seemed to have lost the interest to compete with us head on, on a technological ground. We're seeing more and more when we get into engagement their wireless LAN sales force trying to hide behind the wired counterparts that bury themselves with some kind of a data center upgrade or router refresh or leasing program or anything other than head-to-head technical competition. So obviously, we had also adjusted our posture. And despite all these new approach, our competitive rate, win rate actually has not gone down or in fact I feel probably have increased modestly.

Jess L. Lubert - Wells Fargo Securities, LLC, Research Division

Dom, can you maybe talk about the win rate for ClearPass when going against the identity service engine?

Dominic P. Orr

Extremely, extremely, extremely high. But let me give you an example. They have now just recently announced a 6 months temporary price reduction for 25% from the key modules. And if it is relating to wireless, they have announced a 15% temporary 6 months reduction when -- I feel pretty good about that they have the resource to do that.

Jess L. Lubert - Wells Fargo Securities, LLC, Research Division

And any thoughts on Meraki going forward?

Dominic P. Orr

We have not seen Meraki before Cisco. They are in the lower end of the SMB. We continue not to see them in the post fiscal year.

Operator

Ladies and gentlemen, this concludes our question and answer session for today. Mr. Orr, I would like to turn the call back to you for any final remarks.

Dominic P. Orr

Thank you. Again, I thank you for being on the call today. I'd like to take a moment to thank our various employees and our loyal customers and partners for their dedication and commitment to our franchise. Once again, if you're in Barcelona next week, please drop by our booth. And additionally, I look forward to seeing most of you on our Analyst Day in New York City on March 27. Thank you again.

Operator

Ladies and gentlemen, this concludes our conference for today. Thank you for your participation. You may now disconnect.

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