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Aruba Networks, Inc. (NASDAQ:ARUN)

F4Q09 Earnings Call

August 27, 2009 5:00 pm ET

Executives

Jill Isenstadt – Blueshirt Group

Dominic Orr, Ph.D. – President & Chief Executive Officer

Steffan Tomlinson – Chief Financial Officer

Keerti Melkote – Chief Technology Officer & Director

Hitesh Sheth – Chief Operating Officer

Analysts

Min Park – Goldman Sachs

Ryan Hutchinson - Lazard Capital Markets

John Marchetti - Cowen & Company

Mark Sue – RBC Capital Markets

Analyst for Greg Mesniaeff – Needham & Company

Erik Suppiger – Signal Hill Group

Jeffrey Kvaal - Barclays Capital

Rohit Chopra – Wedbush Morgan Securities, Inc.

Analyst for Bill Choi – Jefferies & Co.

Analyst for Sanjiv Wadhwani – Stifel Nicolaus & Company

Blaine Carroll – FTN Equity Capital Markets

Joanna Makris - Brigantine Advisors

Operator

Welcome to the Aruba Networks fiscal fourth quarter and year end 2009 conference call. (Operator Instructions) This conference call is being recorded today, Thursday, August 27, 2009. I would like to turn the call over to Jill Isenstadt of the Blueshirt Group.

Jill Isenstadt

Good afternoon and thank you for joining us on today’s conference call to discuss Aruba Networks fiscal fourth quarter and fiscal year 2009 results. This call is also being broadcast live over the Web and can be accessed in the Investor Relations section of the Aruba Networks Web site at www.ArubaNetworks.com. With me on today's call are: Dominic Orr, Aruba’s Chief Executive Officer; Steffan Tomlinson, Chief Financial Officer; Keerti Melkote, Aruba’s Co-founder and Chief Technology Officer; and Hitesh Sheth, Aruba's Chief Operating Officer.

After the market closed today, Aruba Networks issued a press release announcing the results for its fiscal fourth quarter and fiscal year ended July 31, 2009. If you’d like a copy of the release you can access it online at the company’s Web site or you can call the Blueshirt 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 will make forward-looking statements, including statements regarding expected revenue, gross margins, non-GAAP EPS, and tax rate for the fourth quarter of fiscal 2010, the company's belief that it will continue to gain market share and derive significant traction from both new and existing customers, expected customer demand for the company's 802.11n products and other software innovations, the company's belief that its pipeline for its network right sizing and VBN solutions is growing, which presents significant incremental growth potential 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 based on the company’s current expectations and beliefs. These statements involve a number of risks and uncertainties, some of which are beyond our control, that could cause actual results to differ materially from those anticipated by these forward-looking 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 this call.

Also, please note that Aruba's application of U.S. generally accepted principals, or U.S. GAAP requires disclosure that availability of new products, planned features, and upgrades discussed during this call are subject to change or cancellation.

For a more detailed description of these risks and uncertainties that may affect our results, please refer to the risks and uncertainties described under the captions Risk Factors and Managements’ Discussion And Analysis Of Financial Conditions And Results Of Operations in our quarterly report on Form 10-Q filed with the SEC on June 9, 2009, as well as our earnings release posted a few minutes ago on our Web site.

Copies of these documents may be obtained from the SEC or by visiting the investor relations section of our website.

Also please note that certain financial measures 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, amortization expense of acquired intangible assets, and restructuring expenses. We have provided reconciliations of these non-GAAP measures to GAAP financial measures in the Investor Relations section of our Web site 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, Ph.D.

Good afternoon and thank you for taking the time to attend our fiscal fourth quarter and fiscal year end 2009 conference call.

Overall we had a very strong quarter with over 10% year-over-year and 16% sequential revenue growth, to $53.3 million. Demand was especially strong in the U.S. where we experienced a 35% sequential revenue growth. As a company, we believe we are hitting on all cylinders and I am pleased with our execution throughout fiscal 2009 in what has been a challenging environment.

Customers are focused on value and on maximizing return on investments, two areas in which Aruba's solution excel and we believe it is because of this that we are taking market share from our biggest competitors and seeing smaller competitors less and less.

Our visibility has continued to improve over the last three months and looking forward, our pipeline is promising.

During the fourth quarter non-GAAP gross margins increased sequentially to above our target range and we were able to drive up rating leverage by continuing to position the company for future growth with targeted investments in key areas.

Overall, we reported non-GAAP operating margins of 6.5%, more than tripling fiscal Q3 operating margins and non-GAAP net income of $0.03 per share. While we have remain focused on controlling expenses, I am pleased that our strong bottom line results were primarily a consequence of meaningful revenue growth.

During the quarter we added over 600 new customers, among our highest ever quarterly new customer totals. And we now have nearly 8,000 total customers spread across a wide range of industries and geographies. New customers in the fourth quarter included hospitals in the United States and abroad, a leading software company based in the U.S., a tower complex in the Middle East, and New York State University with over 22,000 students, and one of the largest restaurant operators in the world.

While demand was broadly based, it is clear that our decision a year ago to commit resources to the government, health care, and education verticals, is paying off. This was an especially strong quarter in the education market, which is seasonally strongest in our first and fourth fiscal quarters.

Despite shrinking in [inaudible] and cuts in school spending, the majority of our education customers continue to view our products as necessary infrastructure and the most cost-effective solution to their networking needs.

One key driver has been that many universities and school systems are upgrading to 802.11n to support high-bandwidth, Ethernet replacement, electronic learning, VDO, and voice applications.

We believe that our 802.11n solutions offer better performance and significantly lower deployment and maintenance costs because of our adaptive radio management, or ARM, technology. Tests conducted at the University of Washington showed that ARM increased 802.11n throughput by more than 200% and enabled multi-media applications to be reliably delivered to more than 100 laptops from a single access point.

ARM is just one of our innovative technology differentiators with tangible costs and performance benefits. During the quarter we introduced software innovations which continue to raise the competitive bar. For example, our new AirWave Management suite included in the wave of new [inaudible] defection capability and our release of ArubaOS 3.4 software featured two significant enhancement RF performance, namely 802.11n Mesh, and Channel Reuse for improving capacity of wireless networks on a single channel.

Additional features like this enhance our competitive differentiation, which we believe has never been more pronounced and has helped us gain market share.

According to [inaudible] most recent quarterly report our continued position of the number two wireless LAN supplier worldwide is firmly established. We expect our market share to grow. Given both our strong fourth quarter performance and the double-digit, year-over-year revenue declines reported by many of our competitors.

In addition to our strong performance in our core wireless LAN market, we are demonstrating progress in our effort to incrementally add to our addressable market opportunity with initiatives in LAN rightsizing and virtual branch networks, or VBN. Both are these initiatives have significantly contributed to our pipeline and customer mindshare.

Network rightsizing lowers life-cycle costs by consolidating ports into fewer switches while enhancing mobility and productivity. For example, in a typical existing facility it is not unusual to find that a significant portion of wire Ethernet ports are either under-utilized or not used at all. We believe that network rightsizing resonates with companies and institutions in the current marketplace, helping to control costs today while laying the foundation for significant productivity growth as the economy rebounds.

There is no question that we have gained significant mind share over the last six months and executives who are now willing to look at non-traditional approaches, are increasingly and enthusiastically agreeing with our approach to rightsizing. Even post-recession, we believe that IT departments are going to continue to rationalize each and every dollar they spend and that the days of over-provisioning, wired networks might truly be in the past. We are seeing a similar focus on decreasing the costs of deploying and supporting remote networks to branch and home offices.

Our VBN solution delivers significant value to enterprises by lowering the equipment and wire area network costs and simplifying the task of connecting remove uses. We believe that our VBN solution can be one quarter to one eighth the cost of a competing systems while offering ease of use unmatched by any competitors.

Because strong Q4 performance and robust pipeline we are increasing confident in our ability to grow. To capitalize on the longer-term opportunities in front of us, I very pleased to welcome Hitesh Sheth to the organization as our new Chief Operating Officer. Hitesh brings with him over 20 years of enterprise and service provider experience, most recently as executive vice president and general manager of Juniper Networks Ethernet Platform Business Group. In this position, he has the overall responsibility for driving the Ethernet switching business. Hitesh is a great compliment to our team and will run on a day-to-day basis of operations, marketing, engineering, product management, and support organizations.

I very pleased, indeed, with our execution of recent quarters and believe that Hitesh's experience and skill will help us address even larger markets. He will also free me up to concentrate on my roles of CEO and overseeing the worldwide sales organization. I am very excited to have Hitesh on board and glad that we were able to attract him to Aruba.

To summarize, while it remains a tough and highly competitive market, we had one of the strongest quarters in company history with record revenues and EPS above our guidance. Looking back, Aruba has performed well over the last year and I am please with our execution in a challenging environment.

We are gaining market share in our core market by adding incremental growth opportunities that increase our total addressable market. Our visibility has improved and we fully expect to continue to grow in the future. While immediate focus is on generating short-term revenues and profits, we are not losing sight of the longer-term objectives to be the leader in providing secure mobile access for the largest enterprises and organizations in the world and will make prudent investments to support this goal.

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

Steffan Tomlinson

In Q4 total revenue of $53.3 million increased 10.5% year-over-year. Product revenue of $43.4 million increased 7.2% year-over-year and was up 21.1% from the prior quarter. Professional services and support revenue of $9.7 million increased 35.6% year-over-year and was flat from the prior quarter.

In Q4 approximately 92% of our revenue came from indirect channels while 8% was direct. As a reminder, our indirect channels represent sales through our bars and distributors as well as our strategic OEM partner, Alcatel-Lucent. Our goal has been to move deals into our channel and we expect a percentage of revenues from our indirect channel to be 85% to 90% in the upcoming quarters.

During the quarter Alcatel-Lucent and Avnet were 10% partners. Approximately 70% of our sales were generated in the U.S. and 30% of our sales came from international theaters as we had a soft quarter in Europe. Bookings overall were at record levels with strong contribution from various international markets.

Non-GAAP gross margins in Q4 were 68.5% compared to 67.6% in the prior quarter and above our target range for non-GAAP gross margins of 65% to 68%. Q4 non-GAAP product gross margin was 65.3% compared to 63.3% in the prior quarter. The number of 802.11 access points as a percentage of total access points shipped was up from the prior quarter to approximately 33% of shipments.

Q4 non-GAAP services gross margins were 83.2% compared to 83.6% in the prior quarter, which had been especially strong due to service renewals. Going forward, we expect total non-GAAP gross margin to be within our target range.

Moving on to operating expenses, we improved operating leverage this quarter. Non-GAAP research and development expense was down approximately $156,000 from the prior quarter and decreased as a percentage of revenue from 17.9% in Q3 2009 to 15.1% in Q4 2009.

Non-GAAP sales and marketing expenses increased by $3.1 million from the prior quarter and increased as a percentage of revenue from 38.1% in Q3 2009 to 38.6% in Q4 2009.

The increase was due primarily to higher revenues, year-end commissions and marketing-related activities. We expect sales and marketing to decline as a percentage of revenues in Q1 2010.

Non-GAAP G&A expense was basically flat with the prior quarter and decreased as a percentage of revenue from 9.8% in Q3 2009 to 8.3% in Q4 2009. Q4 legal expenses for the Motorola law suit continue to impact our G&A line and total approximately $931,000, or $0.01 per share. We expect legal expenses to continue to increase through our trial date of January 10, 2010.

Headcount at the end of Q4 was 545, an increase of 14 people from the prior quarter. Even with the ongoing legal costs, I am pleased that we are able to deliver lower operating expenses at 62% of sales on a non-GAAP basis.

Our non-GAAP tax rate was 8.2% in Q4 compared to 17.5% in Q3. We expect our tax rate in Q1 to be approximately 10%.

Non-GAAP net income for the quarter was approximately $3.2 million, or $0.03 per share. This compares to non-GAAP net income of $1.0 million, or $0.01 per share in Q3 2009 and non-GAAP net income of $177,000 in Q4 2008. GAAP and non-GAAP net income include approximately $0.01 a share worth of expenses related to the Motorola law suit.

Due to the appreciation of Aruba stock throughout the quarter, Q4 2009 weighted average shares outstanding were 98.4 million shares on a diluted basis. As we move into 2010, assuming no significant changes in our total shares outstanding, we expect that for each dollar increase in our share price, there will be a corresponding 2.0 million share increase in our weighted average shares outstanding.

The GAAP net loss for the quarter was $4.5 million, or $0.05 per share, compared to a GAAP net loss of $5.8 million, or $0.07 per share, in Q3 2009 and a GAAP net loss of $6.8 million, or $0.08 per share, in Q4 2008.

Our fourth quarter GAAP results included $6.4 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 July with cash and short-term investments of $1.25 per share, or $123.1 million. This represented an increase of $11.4 million from last quarter.

Cash flow from operations was a strong $11.5 million. Given our top line growth, we ended Q4 with $33.5 million of accounts receivable, up from the Q3 2009 balance of $30.7 million.

Moving down the balance sheet, short-term deferred revenue was at a record level of $34.7 million at quarter end, compared to $24.6 million at the end of Q3 2009 and $27.1 million at the end of Q4 2008.

Days sales outstanding were 56 days, down five days year-over-year and down four days from Q3.

Inventory totaled $8.4 million at the end of Q4, down by $3.9 million from the end of Q3. Inventory turns increased sequentially to 5.8x.

As we look towards fiscal Q1 2010, we are aware that global economic conditions continue to impact our business and the level of competition in our target markets remains high. At the same time, we had a record fourth quarter, bookings were very strong, and our deferred revenues are at record levels.

Balancing all of these factors, we expect revenues in our first fiscal quarter of 2010 to be in the range of $54.0 million to $56.0 million. We expect non-GAAP EPS of approximately $0.03 per share, using 98.4 million shares on a fully-diluted basis.

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

Dominic Orr, Ph.D.

Not Stephen, Keerti, Hitesh, and I would now be happy to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Min Park – Goldman Sachs.

Min Park – Goldman Sachs

With Hitesh coming on board, I was wondering if you could please update us on your views on the wireless/wire line integration just quickly, and then talk about whether you are looking to provide integration solution organically, or still focused on your partnerships going forward.

Dominic Orr, Ph.D.

I want to remind everyone that Aruba's core value proposition is a user-centric policy management engine sitting in the core of the network managing distributed mobile secure access and enterprise. We started our business through wi-fi connectivity and extending, even now, into Ethernet connectivity. In our view, over time, the media of access ranging from wired to wi-fi to 3G, 4G, is going to be all-comprehensive and Aruba's strategic direction is going to be encompassing all this mode of operation.

The appointment of Hitesh is really to help us to scale the operation of the company to take advantage of the impending explosive growth that we expect in the coming years and also to free myself up to spend more time with global alliances and doing my job as the V.P. of worldwide sales, running the theaters and so that really is—those are two independent factors.

Min Park – Goldman Sachs

And can you give us a little more color on the pipeline by customers that are vertical? And from areas are you expecting [inaudible] strength in the second half of the year?

Dominic Orr, Ph.D.

If you are looking to the strength of our last quarter, as mentioned that a lot of the momentum came from our targeted area of government, health care, and education. But we also make the observation within the quarter from the booking momentum, that it looks like the general enterprise market domestically has definitely hit bottom and seems to be coming back.

We are also seeing a stronger pipeline from selected international markets, notably in the Middle East, in part of North Asia Pacific and Australia and also in Canada, I would say.

Min Park – Goldman Sachs

Great. And just lastly, can you just tell us what your book to bill was in the quarter?

Dominic Orr, Ph.D.

I'm sorry, we do not disclose that.

Operator

Your next question comes from Ryan Hutchinson - Lazard Capital Markets.

Ryan Hutchinson - Lazard Capital Markets

Can you help us better understand the dynamics of the deferred revenue here in the quarter. Up about $10.0 million, down about $4.0 million last quarter. So I guess the real question is what it consists of, how much of that is recognized next quarter?

Steffan Tomlinson

It's both product and support that is in the short-term deferred line. Clearly the sequential increase from Q3 to Q4, there is more product in the short-term deferred revenue line than there has ever been in the company's history.

Regarding how that rolls off, we don't give commentary on what percentage of deferred revenue will be recognized in the following quarter.

Dominic Orr, Ph.D.

That's generally the result in the last couple of quarters. We have deals that are starting to build out in a multi-quarter fashion and part of that is reflected in the ramping for revenue.

Ryan Hutchinson - Lazard Capital Markets

And related to that, is it related to a specific system integrator. And if it is, maybe if you could disclose that.

Steffan Tomlinson

The ramp in deferred revenue was due to a number of different customers. We had broad growth from a number of different verticals and a number of different customers. So the composition of the deferred revenue was really due to a number of customers, not just one.

Dominic Orr, Ph.D.

One comment I also want to make is despite the strong quarter we had, we did not have any single 10% end user customers. We did have two 10% partners and so the spread of the business is quite pleasing.

Ryan Hutchinson - Lazard Capital Markets

And on the revenue line, the product is obviously well above consensus. Services line was flattish. Maybe you could help us understand why that was the case and the expectations for the services line item next quarter.

Steffan Tomlinson

If you recall, in the last quarterly conference call we held, there is a very big increase on a sequential basis from Q2 to Q3 in the services line and that was due in large part to service renewals that came in that were a little bit from some past periods so there was a little bit of a catch up that was included.

We were very pleased that services revenue grew 35% year-over-year. While we don't break out revenues for the forecast for the next quarter, I can tell you that we're looking at, I would say, another quarter of what I would say modest growth in the services revenue and we would look to more product growth in Q1.

Ryan Hutchinson - Lazard Capital Markets

On the relationship you have with IBM that's out there, can you walk us through that, how significant an opportunity you think that is and if so, when we should expect that to materialize and be a strong contributor to the top line.

Dominic Orr, Ph.D.

As I mentioned in the last earnings call that our relationship with IBM is more at the field level and at the geographic theater, so to speak. And we have started out in Asia Pacific and now we are developing a good relationship in Europe and the Middle East. And we expect that there will be continued activity to spread to the other theaters.

I cannot really forecast what percentage of activity forward revenue is going to go through this channel, but what I can tell you is we are getting increasing receptivity at the field level to collaborate.

Ryan Hutchinson - Lazard Capital Markets

And do you feel that you will see some business here in the U.S. over time, as well?

Dominic Orr, Ph.D.

That's certainly the intent. I can't comment on it now.

Operator

Your next question comes from John Marchetti - Cowen & Company.

John Marchetti - Cowen & Company

Can you comment about how the quarter progressed for you, was it more normal than what you've seen obviously as the economy has struggled through the first half of the year, and specifically in North America, was it strong or solid for you relatively throughout the quarter or did it really sort of come one at the end for you?

Steffan Tomlinson

Unlike typical quarters where approximately 50% of the business comes in the last couple of weeks, we did have better linearity throughout the quarter and we anticipate given what we know now, that same linearity pattern heading into fiscal Q1.

John Marchetti - Cowen & Company

Any signs of life whatsoever in the European market right now. You know, we have started to get a little bit of glimmers that maybe Germany and France are starting a little bit better. Just any sense that you're getting in dealing with the European theater that that is showing kind of any signs of life. I know you said it was a little bit soft, but any sense that that improved for you maybe at the end of the quarter at all?

Dominic Orr, Ph.D.

Our planning for the quarter assumes that continental Europe and the U.K. is still flattish. We are seeing signs of recovery, pretty clear signs, in the Middle East. And so if indeed we were at the recovery of France and Germany and so on to be true, that would be good upside.

John Marchetti - Cowen & Company

Hitesh, would you mind sharing with us what it was about Aruba that attracted you to this COO role?

Hitesh Sheth

There are a couple of things here. First and foremost, from a market standpoint I see a great opportunity for Aruba ahead, as the network edge in enterprise networks transitions from wire to wireless. And Aruba is uniquely positioned to go and drive that, very successfully with our customers. Number one.

Number two, it's a great privilege to be part of a very, very good team and help this team build a multi-billion dollar business. Those are the two reasons as to why I chose to come to Aruba.

Operator

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

Mark Sue – RBC Capital Markets

There seems to be some larger dynamics going on than just a handful of select verticals. Do you feel the market is growing a little faster or is it still mostly share gains, from your perspective? Is there a further divergence in cost between regular wired and wireless ports from a TC point of view that might be actually accelerating the market near term?

Dominic Orr, Ph.D.

I think if you look into the application of why the planned technology into the enterprises, we see two kind of segmentations of applications. First is the traditional, using wireless LAN to enable a mobile workforce. In that area I would not say that it's a big market expansion. I believe that our growth is primarily coming from market share gain.

But on the other hand, the second application is now with the evolution of 11n more and more customers are looking at using 11n wireless LAN as a complement or supplement and replacement of some new wire line projects. Now, granted that these projects have a more longer life preparation life cycle, so I keep cautioning that the rightsizing project is why we have a good pipeline. It's going to be probably making significant impact on top line in the second half of our fiscal year.

So I think the market expansion for wireless LAN enterprises really come primarily in the LAN rightsizing initiative at this moment.

Mark Sue – RBC Capital Markets

And the new found linearity that you have, is that more customer-centric do you feel, or is that because the rightsizing of the network and also the wireless component is no longer as discretionary as it used to be.

Steffan Tomlinson

At this point it's the former. And we have large customers in the U.S. and across the globe that have picked up their spending and we've categorized that as install base accounts. I think it's probably a couple of quarters away until we really see the impact of network as rightsizing, plus the VBN method that we're attacking the market with.

Mark Sue – RBC Capital Markets

And with the improving visibility, do you feel we're at a point where we should start thinking about annual guidance once again?

Steffan Tomlinson

I wish that were the case. We really take this on a quarter-by-quarter basis at this point and until things really firm up in the overall economy, I think that's going to be one of the determining factors around us moving from one quarter out to something longer in duration.

Operator

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

Analyst for Greg Mesniaeff – Needham & Company

Could you provide more color on the progress being made with your BBN solution and what sort of revenue expectations you might have set for the year and if you expect any meaningful revenue traction in Q1.

Hitesh Sheth

From a traction perspective right now, I am pleased to report that there are a large number of pilots that are in progress. And we have had some revenue this quarter but it's not meaningful. I think revenue will be more meaningful in the second half of this year rather than in the first half. And in terms of traction, we are seeing it in the traditional distributor enterprises that are looking at doing home office type applications or retail store type applications. That's where most of the early traction has been.

Analyst for Greg Mesniaeff – Needham & Company

In regards to the margin improvement during the quarter, I'm wondering how product mix trended and if you are selling more controller than access points and how mix has trended so far in Q1 and how you see mix going forward.

Steffan Tomlinson

In Q4 we actually had a little bit more access points shift than normal. However, the profile of the access points that were shifted were typically at the higher end of the spectrum of our gross margin range and when we look at the nearly 200 basis point improvement in product gross margins, part of that is due to a little bit of the mix but also we were able to get some of the benefits from pricing and in selling on value, as opposed to any other key benefits.

Operator

Your next question comes from Erik Suppiger – Signal Hill Group.

Erik Suppiger – Signal Hill Group

You had mentioned that there is no question that you are gaining mine share and I think there have been some comments also about goals that you have for gaining market share. Can you talk a bit about how you are so convinced that you are gaining share here and what some of your goals are?

Dominic Orr, Ph.D.

From the market share perspective, we know what we shipped the last quarter and we have also looked at the announcement of our competitors and so from that trajectory we feel good. Also there are industry data that suggests similar.

From the prospective of gaining mine share, I can tell you what the introduction of the rightsizing initiative and the VBN initiative. The level of managers, the executives, that we were able to call, I personally was able to talk to for example, is at least one or two levels higher because instead of talking about details, technological differentiation, now you are talking about meaningful savings of operations and capital budget at the corporate network level and an ongoing wire and network cost level. So suddenly we are getting very, very serious attention from executives who are examining the budget and every large corporation we deal with had some form of infrastructure optimization project at the height of CEO level and both of our programs feed quite well into that agenda.

Erik Suppiger – Signal Hill Group

Are there any goals that you have for market share further out, long-term goals?

Dominic Orr, Ph.D.

For the basic enterprise, wireless LAN, this is just a pure wireless LAN for campus, we have stated on several occasions that our objective is to get to above 20% and this is something that we believe we can do in the foreseeable future, and that is a vision that I put in front of the whole company and of our partners to do. And I think quarter by quarter we feel we are moving towards that target.

Erik Suppiger – Signal Hill Group

Foreseeable future is probably three to five years, something like that?

Dominic Orr, Ph.D.

I really would rather not specify the exact time frame, but I think if it takes that long.

Erik Suppiger – Signal Hill Group

What percentage of our access points were in for the quarter?

Steffan Tomlinson

A third.

Erik Suppiger – Signal Hill Group

Is that growing or is that leveling off at this point?

Steffan Tomlinson

That grew 5% quarter-over-quarter.

Erik Suppiger – Signal Hill Group

On the deferred revenue, just to be clear, is the deferred revenue the product piece? Is that product that's being held by your partners or is it typically installed to the customer but waiting for acceptance?

Steffan Tomlinson

There are a number of reasons for deferred revenue. You've hit on a couple. There's also a third category of orders that we received at the very end of the quarter that we just couldn't ship out, and that constitutes the products portion of the deferred revenue. There is also a maintenance portion of the deferred revenue as well. So a combination of both of those elements in the deferred revenue line.

Erik Suppiger – Signal Hill Group

Just to be clear, you say it could include some orders that you received but did not ship and that would be part of deferred revenue?

Steffan Tomlinson

No, I'm sorry. There are some orders that we received that we could ship and we did ship at the end of the quarter but could not be recognized.

Erik Suppiger – Signal Hill Group

Any one of those categories contribute to the increase this quarter in particular?

Steffan Tomlinson

There was really kind of broad-based, across the spectrum.

Operator

Your next question comes from Jeffrey Kvaal - Barclays Capital.

Jeffrey Kvaal - Barclays Capital

On the outlook, obviously business seems to be picking up with strong sequential growth this quarter, plus an uptick in deferred revenues. So that would, under many circumstances, lead me to think that you might be able to do more than the sequential growth you have guided to for the upcoming quarter. So I was wondering if you could step through some of the principles that you used in coming to that guidance and how we might think about that.

Steffan Tomlinson

When you look at some of the principles, first we look at both sequential and year-over-year. If you take a look at the year-over-year comparable, this is probably one of the toughest comparable quarters in the company's history. If you recall Q1 of 2009 was a record quarter for us where we did $52.4 million in revenue. And so the fact that we took a look at our historical performance, we take a look at pipeline coverage and we also look at some of the elements of the deferred revenue, plus some other factors, all that goes into the calculation in calculus in setting a revenue range for guidance.

Now, the other component is obviously looking at the overall macroeconomic and while things seem to have bottomed out and in some areas we're actually seeing an uptick, it's appropriate to be conservative with the guidance.

And one other thing about last fiscal year in Q1, if you remember when we did $52.4 million, approximately $5.0 million of that was due to Safeway, which was a 10% customers in that quarter. So if you were to strip Safeway out, the actual year-over-year growth is much better than the single digits that we're talking about right now.

Jeffrey Kvaal - Barclays Capital

So would it be fair to say that you've used similar principles in evaluating your pipeline, etc., that you used in the guidance for this quarter, this past one?

Steffan Tomlinson

Correct.

Jeffrey Kvaal - Barclays Capital

Could you help us a little with the opex trajectory that we should anticipate for you. Is there a margin level that you would like to be at? Say $65.0 million or $70.0 million in revenue, that type of thinking?

Steffan Tomlinson

The near-term outlook around EPS at approximately $0.03, part of that is driven by the fact that we have increasing legal costs related to Motorola. As we approach the trial date of January 10, 2010, the expenses related to the Motorola lawsuit start to peak, which is really kind of dampening some of the leverage that we would otherwise like to see. But as far as looking at a midterm operating target, we are not prepared to talk about that. Although I will reiterate our long-term operating margin target of 19% to 20% and that's something that we feel is achievable at approximately $90.0 million to $100.0 million for quarterly revenue.

Operator

Your next question comes from Rohit Chopra – Wedbush Morgan Securities, Inc.

Rohit Chopra – Wedbush Morgan Securities, Inc.

I wanted to get a sense of where you were in the Australia deal. Could you tell us if you're ahead of plan there or on plan?

Dominic Orr, Ph.D.

As we announced, when we won that deal, our partner was IBM. The manage the deployment and as part of the announcement it was stated the schedule for deployment is over a 12-month period. At this moment we are pleased to report that the deployment schedule is on track. We have recognized some of the revenue of the projects and expect similar recognition of revenue, what happened in upcoming quarters. I also want to point out, again, that we do not have any 10% end-user customers.

Rohit Chopra – Wedbush Morgan Securities, Inc.

And I was trying to get a sense of another thing. It looks like Cisco is becoming a little more aggressive. You've always said they're aggressive. But I wanted to get a sense of how many deals you're actually winning which are replacement deals, where you are actually going in and replacing somebody who may have had a competitive product, including Cisco.

Dominic Orr, Ph.D.

Actually the profile of replacement deal versus new green field deals haven't changed significantly during the last four quarters. You probably are aware that most of the accounting is going to have some form of wireless installed and historically it has been most likely Cisco or Motorola. So it's almost every audit in the greenfield deals in some form with replacement of competitive equipment. It's just an issue of how large the scale and how rapidly the time frame.

And as regarding what have seen as to more intense competition. Yes, I can confirm that the field is more competitive and we have definitely seen competitors being more aggressive in discount, but our big value proposition is multi-year, total cost [inaudible] advantage, architectural advantage resulting in lower capex, so as tested by our gross margin being held pretty nicely, in a lot of situations we do not need to go there.

Operator

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

Analyst for Bill Choi – Jefferies & Co.

On 11.n, it was good traction this quarter, it seems like there was a lot of strength there. How much of it is due to the education vertical being strong. And could you give us some color on what are you seeing in terms of adoption outside of education in broadbase enterprises.

Dominic Orr, Ph.D.

In general, the education market is early adopter for 11n. We have seen it for several quarters now. To the extent that last quarter was a seasonally strong quarter for education, 11n followed that pattern. But also, as we are progressing a few more months towards the ratification of 11n there are more enterprise class customers who are also starting to adopt 11n solution. As you may recall, that we actually have a lease with the KPMG headquarter deployment in the Netherlands with 11n and we are seeing a lot of the new corporate headquarters, either new headquarters or refurbished projects, also going 11n as well.

Analyst for Bill Choi – Jefferies & Co.

Could you comment on data close rates, if that has changed meaningfully, or what you have seen in the last three months with respect to that.

Dominic Orr, Ph.D.

If you recall, the trend for the U.S. domestic market, for the enterprise was that we had a very strong December month in last calendar year and then throughout the first three months it was really very quiet, and then starting at the end of March, beginning of April, we see things start moving again. And I would say that trend has continued. We haven't seen any major acceleration but what we have seen when things come back to life we continue to see until this month.

Operator

Your next question comes from Analyst for Sanjiv Wadhwani – Stifel Nicolaus & Company.

Analyst for Sanjiv Wadhwani – Stifel Nicolaus & Company

Can you characterize, was your 802.11n uptake faster or slower than you expected this quarter and how do you see it going forward?

Dominic Orr, Ph.D.

I think that it is about where we like it to be. I think as we go towards our next fiscal year, we expect that every quarter we will see some increment in the mix.

Analyst for Sanjiv Wadhwani – Stifel Nicolaus & Company

Generally speaking you think there is going to be increment throughout the second half of the year?

Dominic Orr, Ph.D.

My expectation is that every quarter from now on into the fiscal year, that we will see the 11n mix is going to be either stable or ratchet up. I think that's the expectation.

Analyst for Sanjiv Wadhwani – Stifel Nicolaus & Company

Can you comment on any recent progress you've made on your plans to broaden your portfolio products? You have mentioned in the past that you were looking to leverage the investment you've made with the sales organization to drive operating leverage going forward and I was curious if you had made any progress on that front and if we should expect anything in the second half of the year.

Steffan Tomlinson

We've articulated the network rightsizing and VBN as the major initiatives that we are looking to increase the overall productivity of our sales organization. Those are the two initiatives that the company working on. We're still in the very early stages. Call it the first inning of the game. So there is a lot of room left to not only attack our core market, which is the traditional enterprise class, you know, wireless LAN, but also looking at the network edge LAN rightsizing in virtual branch networking. Those are the things that we're really focused on.

Operator

Your next question comes from Blaine Carroll – FTN Equity Capital Markets.

Blaine Carroll – FTN Equity Capital Markets

One of the things that you were saying was that visibility improving and moving through the year and so forth, do you expect revenue to increase sequentially each quarter or do you still expect there to be seasonality between the different quarters?

Steffan Tomlinson

As we said in last quarter's call, our expectation is to be able to grow revenue sequential.

Blaine Carroll – FTN Equity Capital Markets

Tax rate for 2010 and 2011 is it going to remain at that 10%. What went on with the accounts payable that it was so low? And then you talked about the legal expenses, what number is that going to max out at? I think it was $900,000 this quarter.

Steffan Tomlinson

On the tax rate front, we're looking at approximately 10% tax rate for this year. I can't really comment on 2011 at this point.

Accounts payable came down to about $936, 000. There is just more of a timing of payments. If you also look at cash flow from operations, it was a record cash flow from operations at $11.5 million.

Legal expenses, we don't guide on specific estimated legal costs for future quarters. What we have given is directional commentary around them increasing. And typically as you get closer to trial, which is where we're headed, we will see increasing legal costs. Right now it's been approximately $0.01. As we go through the first half of this fiscal year, it could be at a range of $0.01 to $0.02.

Blaine Carroll – FTN Equity Capital Markets

So it could double from here?

Steffan Tomlinson

Potentially.

Operator

Your final question comes from Joanna Makris - Brigantine Advisors.

Joanna Makris - Brigantine Advisors

Can you talk about visibility into the federal business as you head into next quarter, is that sustainable and maybe the nature of some of those projects?

Dominic Orr, Ph.D.

In the federal business we are on to several programs, and as explained in the previous quarter, the program spending comes pretty lumpy but we have enough of those programs that we feel that every quarter we have enough business in the run rate and also on the project basis. So we expect that our fiscal Q1 federal business will come in like the normal quarter.

Joanna Makris - Brigantine Advisors

But you wouldn't expect any additional seasonal strength heading into the fiscal year end? Or how would you view that?

Dominic Orr, Ph.D.

I'm not forecasting any blowout federal quarter next quarter, but however we are pleased with the forecast we are putting in for Q1 for federal.

Joanna Makris - Brigantine Advisors

Can you talk about the nature of your network management platform being multi-vendor? What kind of activities are going on with respect to the competition about getting close to something multi-vendor in nature? And to what extent do you think that is a key factor in winning some deals as you start to move into the virtual branch and remote access points.

Dominic Orr, Ph.D.

If you recall, the reason that we make the AirWave requisition was that a lot of the customers, why they selected Aruba for forward-looking technology and architectural choice, they nevertheless have installed equipment from our competitors that they are not willing to immediately write down. The strength of the AirWave platform allows us to let a customer migrate at their own schedule, and maintain a unified view of management and monitoring and diagnostic of the LAN equipment, shooting them from the different idiosyncrasy of the different vendor.

And to the extent that we are aware of, we are very unique in this capability. As we deploy our architecture outside of the campus and get into the virtual branch where business is, the AirWave management platform will be a unique differentiator because we are, as far as we know, the only network management platform that will extend the management into the user end device level. And when you are creating the virtual branch office environment, you cannot rely on IT personnel being available in a lot of those small branches in the home tele-working office. So the ability of the multi-vendor network management platform becomes increasingly a differentiator for Aruba.

Joanna Makris - Brigantine Advisors

At least one of your competitors, some of their largest deployments are based on the AirWave network management platform. What has been the competitive response there? How are some of the other companies reacting?

Dominic Orr, Ph.D.

Obviously people don't feel very comfortable having their largest customer's network being managed by a competitor but on the other hand, some of the offerings we have is rather unique. We are also investing very strategically and significantly in this platform. It's not like we're sitting on our laurels. We have a significant percentage of R&D budget invested in this platform.

So on the one hand we will continue to compete on features against the larger vendor but at the same time I think because we have the very unique user-centric approach to doing the mobility network, our port-centric view of our competitors is preventing them from being very competitive in this area. If the customer truly believes in enabling mobility for workforce. We have some inherent architectural advantage then.

Dominic Orr, Ph.D.

Thank you again for being on the call today. And I would like to take a moment to thank our hard-working employees, our loyal customers, and our very enthusiastic partners for giving us their support throughout the fiscal year at a time that is very tough for everybody.

I am very pleased with our execution in Q4 and optimistic about our outlook for Q1. We are realistic about how hard it is to grow in the current market. We believe that our value proposition is resonating with prospects and customers alike and that we are gaining momentum in the marketplace and I believe that our competitive position has never been stronger. And the long-term value of our growing customer base is very encouraging indeed.

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

Operator

This concludes today’s conference call.

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Source: Aruba Networks, Inc. F4Q09 (Qtr End 07/31/09) Earnings Call Transcript

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