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Aruba Networks, Inc. (NASDAQ:ARUN)

February 26, 2013 4:20 pm ET

Executives

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

Dave Logan

Analysts

Jeremy David - Morgan Stanley, Research Division

Jeremy David - Morgan Stanley, Research Division

All right. Let's get started, everybody. Good afternoon. My name is Jeremy David. I work on the communications equipment team here at Morgan Stanley with Ehud Gelblum, who, unfortunately, could not be here today with us. So welcome to the Aruba session. It's my pleasure to introduce Michael Galvin, CFO; as well as, Dave Logan, VP of Product Development. Mike, Dave, welcome.

Michael M. Galvin

Thank you.

Dave Logan

Thank you. Good afternoon.

Question-and-Answer Session

Jeremy David - Morgan Stanley, Research Division

So I'd like to get off to a few questions. First thing, the earnings call last week, great results. We saw a reacceleration in your revenue growth, which was really nice to see. Do you think that reacceleration is sustainable as we look forward over the next couple of quarters? And what is your -- has your view changed on the long-term growth of the wireless LAN market over the past couple of months?

Michael M. Galvin

Yes. So the last -- our Q2 results. I think maybe, maybe the theme of that quarter for us was that we felt very good about the breadth of the platform that we've rolled out and kind of the performance of the products, our traditional WLAN products along with our instant platform, our ClearPass platform, and we talked a little bit about the switches and the success we had there. So I think from kind of a geographic and a product perspective, just the breadth and kind of consistency of the performance, we are really encouraged by. We -- in terms of go-forward, we obviously only guide out 1 quarter. But really, what we're trying to do is the disruption, if you will, that's going on in the market that we're playing in and the evolution of mobility, BYOD, these things that you're hearing so much about, as those TAMs and those growth rates and those market sizes get disrupted, is really trying to position ourselves, platform-wise to capture the growth of those markets. We feel good about the size of the markets we're playing in. And we're trying to execute to -- we felt good about the growth last quarter, obviously, we put a guidance out for the next quarter that we used the same process every quarter in terms of trying to put a -- the analytics, et cetera, around the pipeline and what our sales force is telling us and factoring in things that exist out there. Europe is still a tough environment, overall. We've got this new phenomenon of sequestration that's lingering out there. So we try to factor in some macro elements to that, on top of the detailed analytics and pipeline that our field organization is telling us. So we put a guidance out there for the next quarter. But felt good about the growth that happened in Q2.

Jeremy David - Morgan Stanley, Research Division

So you seem to be still worried a little bit about EMEA, but it was up about 32% last quarter, sequentially. And other companies, Infoblox, which reported last week as well, also some nice growth in Europe. So, are those growing shoots, or do you think that we're not quite there yet in terms of the recovery in Europe?

Michael M. Galvin

Yes. One way I described it was, for several quarters now Europe has been a concern. And maybe the difference this quarter was it's been a concern for a while now. And maybe you could even say it was a worsening concern, each quarter, maybe this quarter, it didn't turn around, but maybe it was no worse of a concern is kind of the way I have thought about it. So maybe a little bit of stabilization there and -- but we're still pretty cautious. There's a -- there's a bigger portion of our Europe business that is based on -- that derives from public sector funding, just because of the nature of Europe versus the U.S. And so, with that tied to the public service, public sector funding, it is still a cautious environment.

Jeremy David - Morgan Stanley, Research Division

What led the recovery there in Europe? Was that the public sector piece or that was just broad based overall?

Michael M. Galvin

And I'm sorry, the recovery...

Jeremy David - Morgan Stanley, Research Division

Last quarter that you saw in Europe? Was it broad based? You mentioned in the quarter...

Michael M. Galvin

Yes, maybe to use my -- I don't put it in the category of recovery yet. I guess I'd put it in just not quite as descending as much as the prior quarters. Still, in terms of what the makeup was, I'd say the mix was pretty consistent with the past year. It was just still a tough environment, but not quite descending as much as it had been over the past year. I wouldn't call it a recovery.

Jeremy David - Morgan Stanley, Research Division

Okay. Second rate of -- secondary activity is always important, the investing standard [ph]. That's always a positive. As you look forward over the next several quarters, which verticals are you most excited about in terms of amounts of greenfield you can go after? Or in terms of penetration you can get to from your current base?

Michael M. Galvin

Yes. For everyone's perspective, we've kind of are -- we've kind of had a big 5 in terms of verticals that have been solid business for us for a couple of years now. Those are higher education, retail, health care, the U.S. federal piece and then what we call the general enterprise. General enterprise is a little bit of a catch-all bucket for everything not in specific buckets and those have, those have been strong verticals for us for a while. I've seen in the last 12 to 24 months, the up and comers have been K-12, which we distinguish from higher ed, and financial services. Financial services is kind of a late-adopting IT industry by nature. And that has really shown strong growth. And so in terms of looking forward, I'd definitely put, I think continued strength in financial services is -- we feel pretty good about. The other piece in the last 12 months, and something we did some big announcements on this week in Barcelona, is the managed service offerings with the service providers, where they are offering our platform out to enterprises. And so it's almost a little more of a vertical, if you will -- or, I'm sorry, a channel, if you will, than a pure vertical. But the managed service business and what we've been leveraging, we've been talking for several quarters about very good growth there and kind of how that's evolving. So I think that's one we feel good about.

Jeremy David - Morgan Stanley, Research Division

Great. And we'll definitely come back to that last point that you made later on. On the conference call last week, Dominic said that your win rates against Cisco seem to have improved modestly, I think that's the word he used, in the past 90 days. Which competitors do you see less often or more often now besides Cisco, which is your primary competitor? And what is your overall win rates outside of you competing with Cisco, outside of the comps?

Michael M. Galvin

Yes. So without question, Cisco is the predominant competitor that we see pervasively and really have through our whole history. We see some other of the larger companies, but I would really put it into more of a sporadic category in terms of if you -- I think HP plays a lot in the mid-market. We really see them in frequently in the enterprise. Motorola plays, but again, I think we mostly see them in maybe some of the retail focus deals with the symbol handheld division. But really, sparsely anywhere else. I think that's predominant. I think if you, especially in the enterprise, if you go down into the mid-market area, I think you see a wider spectrum of players there. And I think that's because it's a, it's an easier -- the configurations, et cetera in the mid-market, and I'm even distinguishing mid-market a little bit from -- if you take the SMB or SME business, there's small and then there's mid-tier, we don't play in the small, we don't play in the S. But in the mid-tier, you do see a wider range of players. And I think part of the reason for that, it is an easier to configure kind of a little bit easier to tackle environment. So there are -- there's a wider variety of platforms and probably players who can take a few percentage points' market share and play there, and do okay. So I think you see a wider spectrum in there. But once you get up into the upper part of the mid-market and then into the enterprise, it really, Dave, it's really us and Cisco, is the prevailing sentiment.

Jeremy David - Morgan Stanley, Research Division

Okay. And so overall, so your win rate is a little -- seems to be improving.

Michael M. Galvin

Yes. I think part of Dominic's comment was the -- we feel really good about the breadth of the platform. We feel very good about our ClearPass platform and our ability to compete on differentiation. And so I think Cisco's always been formidable. They're formidable on a -- from a pricing perspective, they're very aggressive there. And they obviously have a lot of other pieces that they bring in to a customer to go at. But we feel, I think, Dom was commenting that more and more they've had to do more of that because we feel good about our win rate on a technological differentiation basis.

Jeremy David - Morgan Stanley, Research Division

So let's talk a little bit more about your differentiation, and there are 3 new products that you've really been introducing over the past, call it, 2 years. ClearPass, Aruba Instant and then there's the 7200 mobility controller, and at the forefront will be the Switch. We will spend some time on that as well, if we can, if we have time. But on ClearPass, there's a lot of industry interest on that product. But also, I think, a fair amount of misconception what ClearPass actually does. Can you tell us what this product is about? And for a customer who is not going to buy ClearPass, what do they do?

Michael M. Galvin

What are the alternatives?

Jeremy David - Morgan Stanley, Research Division

What are the alternatives, yes.

Dave Logan

So ClearPass is fundamentally a platform to enable an organization to embrace BYOD. Enterprises, in general, had been trying to deal with BYOD for quite a long time. RIM, a good example company of providing mobile services to their enterprise employees, connecting back to exchange. So how do you -- how do you recreate that, except, how do you recreate that experience with a little bit of enterprise control and yet allow end-users to bring in their own devices, make their own choices? The first fundamental problem that needed to be addressed was one of partial trust. You trust the employee, but you don't necessarily trust the device. And so the first fundamental capability that ClearPass provided is the ability for an employee through an enterprise enabled with ClearPass to enroll their device and register it into the enterprise information system and say, "I am trusted employee here. My credentials, I'm going to register my device. Now at least you know I'm in your organization using my own device rather than the one you provided me." But then, that is adjacent to other capabilities like guest access. That's adjacent to other capabilities like differentiating a user using a trusted device versus a user using an untrusted device. Perhaps, an enterprise needs 2 different sets of policies. So ClearPass is really a policy management platform and a policy enforcement platform that is designed to integrate into any enterprise network infrastructure to provide this policy layer that enables BYOD and enables guest access, guest services, and forms a wrapper around existing directory systems such as Active Directory or other legacy systems. So from our perspective, it's a -- there are both point product sale opportunities going into replace existing authentication and directory systems to augment the existing enterprise of BYOD, as well as serve as a strategic platform as more and more use cases for a personal device emerge in the enterprise.

Jeremy David - Morgan Stanley, Research Division

So when an enterprise is moving towards BYOD and really embracing BYOD, do they need a ClearPass-like solution and a mobile device management-like solution as well? Is there some overlap between the 2? Are you competing with like MobileIron or good technologies, for example?

Dave Logan

Generally speaking, we don't compete. Because we're all swirling around the same space, which is dealing with the intersection of the personal into the enterprise, the personal device into the enterprise infrastructure and enterprise policy. We're all going to implement a few of the same features. But by and large, when we go and enable a full, robust BYOD solution inside a given enterprise, we're going to be partnered up with a MobileIron, or Zenprise, or AirWatch. To a great extent, it's driven by enterprise policy. What is their current policy for BYOD systems and what is their future policy, say, 1 to 2 years out. If the policy is very simple, if it is you're allowed to bring in your device, but the only thing your device is allowed to do is connect up to the Internet and whatever you do from there is up to you, then it's not -- it may not be necessary for a full MDM solution to be put into place. If the enterprise doesn't need to put a footprint on this and control an employee's mobile device in any way like remote wipe or remote deactivation, then MDM may not be necessary. By and large, we find most of our customers do have a robust, at least, target policy in mind and we frequently find ourselves meeting in the channel or meeting in their integrators with these other vendors.

Jeremy David - Morgan Stanley, Research Division

Okay. That's very helpful color. So on ClearPass pricing, how is it priced? And are earlier wins, the adoption of ClearPass in terms of building the channel awareness, building customer relationship and signing these new deals?

Dave Logan

Talk about the basics of the pricing...

Michael M. Galvin

It's an enterprise software sale and I think one key thing that we find in these early days with ClearPass is that it's really not about pricing competition on ClearPass, it's really about can it do the buyers -- the customers are saying, can you solve this problem? And that is the question. And if the answer is yes, pricing and pricing competitiveness is not really in the equation at all. We just don't hear it, it's about solving the customer's problems and getting it done. And really, in terms of tackling that particular piece of what ClearPass does, it's really -- it is really us and to Cisco, in terms of the only 2 companies that are trying to comprehensively tackle that issue. And what we feel, in the first few years, that ClearPass has really shown differentiation by the win rate and just the customer build that we've done. I think it's tremendous. In terms of -- I don't know any more flavor on how it prices. But it's basically license, enterprise license.

Dave Logan

Yes, perpetual license, classic revenue or PO size scales with the size of implementation, it's really not any more complex than that. There's optional software modules that some enterprises may choose to implement as well. And so based upon capability and capacity, it's licensed appropriately.

Jeremy David - Morgan Stanley, Research Division

So you said Cisco and yourself are competing primarily for ClearPass-like projects. If you go towards the small-medium businesses and let's talk about the mid-market, do you expect the other competitors that you're seeing there to also develop such capabilities? We had Ruckus yesterday and Ruckus agreed that this is table stake. Everybody will have similar product and then you will start to see competition. Is that a product that matters in the mid-market and who else is going to be playing there?

Michael M. Galvin

So to a certain extent, it certainly depends upon the business model of that organization. If you had a midsized, say, 100-bed health care organization for a home health care agency. Anybody that's got touching regulatory or deeply engrained in a regulated environment, clearly the ability for this device to expose that enterprise's information assets and be exposed to what the industry calls data leakage prevention is a serious issue. It would be -- given the development that went into the ClearPass product overall, long period of time, while it might be table stakes, and it's going to be difficult for mid-range competitors to enter the product category. There's simply too much work to do to catch up. Now with that said, Apple, Google, the other purveyors of endpoint software systems, operating systems, are trying to enable at least a baseline of capability, so that any end organization may be able to participate in a MDM or BYOD kind of an environment. It's our strategy to really differentiate based upon needing to know complex policy, user device application location, but then allow an enterprise to translate that into a very simple implementation. And for us, it doesn't matter whether it's large enterprise or mid-market. Small to medium business is not a market segment we cater to.

Jeremy David - Morgan Stanley, Research Division

Okay. So I should gear to Aruba Instant, which is another big product line, emerging product line of yours. How big is your opportunity for Aruba Instant, like deployments into the distributed enterprise? And to what extent is that incremental to your current -- to the TAM you addressed by selling controllers and access points, or if there is actually a fairly selling overlap? If you could elaborate on that.

Dave Logan

So Aruba Instant is enabling to Aruba on several different fronts. First of all, it is simply a different product manifestation of the technology we've been developing for 10 years. Years ago, we released our controller plus access point architecture for allowing a general organization to scale-up mobility services and provide securely and provide a managed mobility environment. We've simply taken those capabilities, which are largely software-based and made them available in our access points in a product packaging called Instant. This caters to the mid-market very well. But Instant also forms the basis of our architecture for managed service providers. It forms the basis of our architecture for the distributed enterprise, such as an organization that has thousands or tens of thousands of small branch office locations. We've created a hybrid architecture, which we announced this week, called Hybrid control, that puts the right elements of control and data processing capabilities in the Instant Access point out in the hotspot or remote site, and the right amount in the controller architecture, which would be at the -- in the core of the network. Allowing an MSP to deliver very scalable services that are blended between data offload, Wi-Fi access, differentiated services with packet core integration back in the head end so to speak. So we've really blended these architectures together. It's incremental, predominantly. We are winning insurance companies that have thousands, tens of thousands of employees working from their homes doing claims processing. And we were able help them transform what would have been a complex kind of classic WAN architecture, heavy-router-based architecture, into a very seamless, simple, user installed, no IT touch architecture. So it's got that both better CapEx and a better OpEx value proposition, while actually being more secure and extending mobility into these end-user environments. And so it's transformative and incremental for us.

Michael M. Galvin

We've also considered the incremental into that mid-market business. It's -- Dave described the distributed enterprise, et cetera. But it also has been the main avenue for us. I talked earlier about us earlier about going to mid-market. It's been the main avenue for that, to go down in a place very well, not even what you call a distributed enterprise, but just a mid-market sized company and the functionality that it brings and the cost, the price level and cost structure that it brings, works very well in that level.

Jeremy David - Morgan Stanley, Research Division

Okay. So, let's talk about your other big product introduction as of late, which is 7200, which is the controller product. I think based on that, you actually had some announcements -- you made some announcements earlier this week at Mobile World Congress. What does that new product do for you in terms of getting -- I don't want to say getting back into the service provider business, because I don't think that's what it is. It's more about managed services. But to what extent does it help you in that goal of targeting the service provider space financially speaking?

Dave Logan

So Aruba -- whether I would call us lucky or fortunate, a little bit of both, we -- when we first designed our product architecture 10 years ago, we designed it with a certain amount of software processing horsepower in mind in the products that we physically were delivering into the market. We knew that we wanted software innovation and software controls to be layered into our customers' architecture so that they could then fulfill their particular application requirements -- their particular technology requirements. The 7200 represents our third generation of controller product for this architecture. Our second generation product architecture still actually continues to be developed against. But we needed a third generation. We needed a third generation for scale. We needed a third-generation for additional software horsepower capability, so we can continue to innovate along our MOVE architecture roadmap that we announced almost 2 years ago. The 7200 -- a single 7200 controller, which is relatively small, it's what technologists call it 1 rack unit in height, can serve up to 32,000 remote hotspots. Every hotspot could have 1 AP, you could have 10 APs, you could have 100 APs out there and -- with this hybrid control architecture that I mentioned earlier. So it allows our service providers to apply a level of intelligence and provide interesting integrated network services at very massive scale, which means they're going to be able to meet their own requirements at a low cost of ownership.

Jeremy David - Morgan Stanley, Research Division

Great. I do want to open the floor for questions in the audience, but I -- just one more before I turn to the audience. dot11 AC, you said it's not really a big impact. But to what extent, when we see dot11 AC iPads and iPhones, to what extent does that mean the enterprise needs to think about purchasing more wireless non-equipment? Is there a direct correlation here?

Dave Logan

So the way we're going to see 11 AC take off, it is an incremental technology advantage over 11n, which has been mainstream now for 5, 6 years. There are environments which are demanding it today just because of the sheer capacity that they need of connectivity and they need to deliver into a given environment. We talk a lot about educational institutions and auditorium-size classrooms where all of the students have -- they've got a laptop in front of them, potentially an iPad, they may have a phone. They may actually be doing multiple things simultaneously. They may be taking notes on their iPad while watching a video on their laptop simultaneously. It's a connected audience in the most extreme case. Those kinds of organizations are going to demand that kind of capacity early on. The general enterprise, 11n is going to be mainstream for a number of years, and we're going to see a -- we'll see a growth and a decline over a long period of time as opposed to a short period of time, between 11 AC and 11n.

Jeremy David - Morgan Stanley, Research Division

Are there any questions in the audience?

Unknown Analyst

So the 7200 is a continuation of an existing product that's going to target or retarget the service provider market. Can you talk about a use case? And secondly, can you -- I'm a little confused now between the 7200 product and the hybrid control you talked about. Is that the same, or is that...

Dave Logan

Yes. So the 7200 controller product is applicable across our entire -- all of our market segments. It is an evolutionary step in our controller product line overall. It runs the same ArubaOS software that our existing 2nd generation product line operates. So, for example, ArubaOS 6.2 runs on our second gen products, as well as the 7200. It has simply been designed to scale-up massively. So 10x the number of access points at 1/3 of the installed base price is really the top level metric to think about. So it's going to be applicable in the general enterprise, in EDU, in health care, in government, where they will take -- as a simple example, perhaps they've capitalize their current controller base and installed base products and they want to collapse 8 rack units worth of controllers into a single rack unit worth of controllers, or 2 racks into a half rack. So there's a performance, price, capacity, cost, energy space trade-off that they're able to optimize against. Hybrid control is a brand name to our overall service provider architecture, which includes the 7200, Aruba Instant, ClearPass, Aruba Activate service and the AirWave, the AirWave management product, all as 1 product family, if you will, for managed service provider.

Michael M. Galvin

And I think part of the reason the 7200 comes into the managed service conversation is because of the scale Dave talked about. Obviously, in that environment, you can get whole different levels of scale. And so the 7200 just fits very well into that platform.

Jeremy David - Morgan Stanley, Research Division

Any other questions? Can we get the mic over there?

Unknown Analyst

Obviously, it varies by market, but could you talk a little bit about where do you think you are in terms of market penetration and sort of how much runway is left in the business?

Michael M. Galvin

Yes. I think, the -- maybe put it in terms of innings of a baseball game or whatever. I mean, we still absolutely feel, not only is it kind of early to mid-innings, it's early to mid-innings because of the disruption going on in the market. And if you kind of look at the first part of our life as a company, it was WLAN. It was secure, efficient transmitting of enterprise data through the air. And really what's happening now is we're evolving into this complete mobility, bring your own device environment, which is creating a whole separate set of issues and challenges that ClearPass, for instance, is tackling. And with 11 AC coming down the road, it is still a rapidly evolving and kind of early to mid-innings element of the market, where a few years from now, people, everybody in this room in general, our mobility is just going to be pervasive, it's going to -- it's at the inflection point now where it is going to the primary strategic architecture. And so, there's a lot of legs left.

Jeremy David - Morgan Stanley, Research Division

So we're still in the early innings of the Wi-Fi market, but its penetration is not over. Thanks, Mike. Thanks, Dave.

Michael M. Galvin

Thanks.

Dave Logan

Thanks, everybody. Have a good day.

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