Aruba Networks Management Discusses Q4 2013 Results - Earnings Call Transcript

Aug.22.13 | About: Aruba Networks, (ARUN)

Aruba Networks (NASDAQ:ARUN)

Q4 2013 Earnings Call

August 22, 2013 4:30 pm ET

Executives

Tonya Chin

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

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

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

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

George C. Notter - Jefferies LLC, Research Division

Brent A. Bracelin - Pacific Crest Securities, Inc., Research Division

Erik Suppiger - JMP Securities LLC, Research Division

Kent Schofield - Goldman Sachs Group Inc., Research Division

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

Ameet Prabhu - RBC Capital Markets, LLC, Research Division

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Amitabh Passi - UBS Investment Bank, Research Division

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Aruba Networks Fourth Quarter and Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, August 22, 2013.

I would now like to turn the conference over to Tonya Chin, with Investor Relations. Please go ahead.

Tonya Chin

Good afternoon, and thank you for joining us today to discuss Aruba Networks fourth quarter and fiscal 2013 results. This call is also being broadcast live over the web and can be accessed in the Investor Relations section of the Aruba Networks' website at www.arubanetworks.com.

With me on today's call are Dominic Orr, Aruba's President and Chief Executive Officer; Keerti Melkote, Aruba's Co-Founder and Chief Technology Officer; and Mike Galvin, Aruba's Chief Financial Officer.

After the market closed today, Aruba Networks issued a press release announcing the financial results of its fourth quarter and fiscal year ended July 31, 2013. If you'd like a copy of the release, you can access it in the News Releases section of the company's website.

We would like to remind you that during today's call management will make forward-looking statements within the meaning of the Safe Harbor provision of Federal Securities laws regarding the company's anticipated future revenue, gross margin operating expenses, and other financial and business-related information. 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 this call.

For a 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 June 6, 2013, 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 our website.

Also, please note that unless otherwise 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 Don, I'd like to add that both Keerti and Mike will be attending the Deutsche Bank tech conference in Las Vegas on September 11. We hope to see you there.

Now I'd like to introduce Dominic Orr, President and CEO of Aruba. Dominic?

Dominic P. Orr

Thank you, Tonya. Good afternoon, and thank you for joining us to review our fiscal fourth quarter and year-end results.

I'm pleased to report we delivered a solid Q4. Total Q4 revenue grew to $153.1 million, up 4% sequentially, driven by a strong performance in the North America theater, which grew 12% sequentially.

We added a record number of new customers in the quarter, bringing our total customer count to over 32,000, exiting the fiscal year. Driving this improvement was a modest recovery in the enterprise, as well as strong demand within our core verticals which tend to be early adopters for mobility solutions. Overall, we are pleased with our Q4 bookings momentum, particularly with ClearPass and Aruba Instant, which more than doubled year-over-year.

Our competitive win rate remains strong as customers continue to recognize the significantly differentiated value of our Layer 4-7 capabilities. These capabilities enable customers to identify mission-critical enterprise applications such as Microsoft Lync and other multimedia applications, and improves the user experience by optimizing the air. Layer 4-7 intelligence also enables better security for BYOD deployments by controlling network access to enterprise applications, as well as enabling location-based services.

In the fourth quarter, adoption across of our MOVE architecture continued to grow, and momentum for our ClearPass and mobility access, which is increased.

Let me review some of our recent competitive wins, nearly all of which we won against our largest competitor. A Fortune 500 manufacturer of personal care products and a Fortune 500 avionics provider selecting Aruba for their wireless LAN, a university in the south with over 30,000 students deploying Aruba wireless LAN and ClearPass, a Fortune 500 retail chain and existing Aruba wireless customer replacing its legacy switches with Aruba's Mobility Access Switches, and a major Fortune 500 biopharmaceutical company, a leading West Coast health care facility and a large university in the East Coast with over 20,000 students selecting Aruba for large 11ac deployment.

Additionally, we're seeing strong traction for our public-facing enterprise solution, which we enhanced with the acquisition of Meridian, a mobile software company that helps enterprise deliver indoor GPS on location-aware Wi-Fi networks. The integration of the Meridian is going well and we believe that it will be an area of differentiation for Aruba moving forward.

We are pleased to have recently won a state-of-the-art U.S. sports facility deployment, leveraging our Meridian technology.

Let me discuss a few additional public-facing enterprise customer wins. A global retail chain has selected Aruba, and our service provider partner, for its large-scale rollout in the U.S. for high-bandwidth Wi-Fi network; two major international airports in the western United States have selected ClearPass for guest access; and a major European department store with over 130 locations is deploying Aruba wireless LAN and ClearPass.

On our Q3 call, we noted an increase in competitive tactics by our largest competitor, which caused deals to slip beyond the quarter end. I'm happy to report that in Q4 we closed many of those deals and our win rate continues to be in our historical performance range.

Looking ahead, we remain confident in Aruba's long-term strategy, our position in the marketplace and the power of our platform. Based on this foundation, we expect our growth to come from the 4 key drivers that follow: First, the adoption of 11ac technology; second, the growing public-facing enterprise market, where our new Meridian technology provides an added differentiation; third, the BYOD trend that has created a clear need for our ClearPass solution; and fourth, the growing demand for Aruba Instant products.

Aruba's solid Q4 performance, our growing pipeline of business and the strength of our product portfolio, make us confident that our investments in our sales capacity and product differentiation will enable us to return to 20% or better revenue growth in the second half of fiscal 2014.

With that, I will turn the call over to Mike for a detailed discussion of our financial results.

Michael M. Galvin

Thank you, Dom. In Q4 of 2013, total revenue was $153.1 million, representing a 4% sequential increase and 10% year-over-year growth. Product revenue of $125 million, increased 3% sequentially and 7% year-over-year.

Professional services and support revenue of $28 million grew 8% sequentially and 27% year-over-year.

U.S. revenue grew 12% sequentially and 15% year-over-year, representing 66% of total Q4 revenue. EMEA revenue grew 25% year-over-year, representing 18% of total revenue for Q4. And Asia Pacific, Japan revenue declined 16% sequentially and 25% year-over-year, representing 12% of total revenue. The Asia Pacific Japan region showed strong enterprise growth but was significantly impacted by a decrease in service provider sales.

Total non-GAAP gross margin in Q4 was within our target range at 72.5%. This compares with gross margin of 73.6% in Q4 '12 and 72.3% in Q3 '13.

Q4 non-GAAP product gross margin was 71.3%, a decrease from 72.9% in Q4 '12 and 71.5% in Q3 '13. Our product gross margin had normal fluctuations in product mix and geography mix for the quarter.

Q4 non-GAAP services gross margin was 77.6%, up from 76% in the prior quarter and 77.4% in the same period a year ago, driven by strong demand for Aruba's services offerings.

Looking forward, we expect total gross margin to continue to be within our near-term target range of 71% to 73%.

Non-GAAP research and development expense was $27.2 million, including the impact of our Meridian acquisition. As a percentage of revenue, R&D was 17.8% compared with 17% in Q3 '13. As we have discussed in past quarters, we will continue to invest in R&D for further product innovation and differentiation.

Non-GAAP sales and marketing expense was $52.1 million in Q4. As a percentage of revenue, Q4 sales and marketing expense was 34.1% compared to 32.1% in Q3 '13. As Don mentioned, we are investing in our go-to-market engine, in the areas of demand generation and sales coverage, to return our top line growth to 20% or better in the second half of fiscal 2014.

Non-GAAP G&A expense decreased to $9.1 million in Q4 from $9.9 million in Q3 '13. As a percentage of revenue, G&A expense in Q4 was 6% compared to 6.7% in Q3 '13.

Total headcount at the end of Q4 was 1,473 compared to 1,460 at the end of Q3.

In total, Q4 non-GAAP operating expenses were $88.5 million or 57.8% of revenue compared to $82.1 million or 55.8% of revenue in Q3 '13.

Our non-GAAP operating profit in Q4 '13 was $22.5 million or 14.7% of revenue compared with 16.5% in Q3 '13 and 21.7% in Q4 '12. For fiscal 2014, we expect operating margins to gradually improve from current levels throughout the year. While planned investments are expected to be heavier in the first half of fiscal 2014, we expect to exit fiscal 2014 at 20% operating margins and return to our 21% to 22% targeted range in early fiscal 2015.

In Q4, we had positive and negative impacts on our year-ending non-GAAP tax rate, including a previously unrecognized benefit of our corporate organization structure put in place at the beginning of fiscal year 2012. Netting the positives and negatives, our non-GAAP tax rate for the quarter was 32%, below our guide -- our Q4 guide of 37% to 39%. This lower rate resulted in a $0.01 benefit to the company in Q4 '13. We finished fiscal year 2013 with a full year non-GAAP tax rate of 30%. We expect our full year 2014 non-GAAP tax rate to be 30% to 32%.

As a reminder, our overall tax rate is subject to change, including from the projected geographic mix of company's revenue, as well as changes resulting from any new U.S. or international regulations or interpretations.

Non-GAAP net income for the quarter was $15.1 million or $0.12 per diluted share. This compares to $14 million or $0.11 per diluted share in Q3 '13 and $22.1 million or $0.18 per share in Q4 '12.

On a GAAP basis, our net loss was $16.3 million or $0.14 per share compared with a Q3 '13 net loss of $20.2 million or $0.18 per share and a Q4 '12 net loss of $3 million or $0.03 a share. Included in Q4's GAAP loss was a nonrecurring charge of $14 million to settle a patent lawsuit with a licensing entity. This settlement releases us from liability from claims of infringement in these patents.

A full reconciliation of both GAAP and non-GAAP information is contained in our financial results press release issued this afternoon.

For fiscal year 2013, we achieved revenue of $600 million, growing 16% from $516.8 million in 2012.

Non-GAAP full year gross margin was 72.8% compared with 73% reported in 2012. Our non-GAAP operating margin was 18.6% for fiscal 2013 compared with 20.8% in 2012, and non-GAAP net income was $78.5 million compared with $77.5 million in 2012.

Now let me turn to the balance sheet. Driven by our solid results and working capital management in fiscal 2013, Aruba generated $152.8 million in cash flow from operations and we added $68.6 million to cash and short-term investments, net of investing 80.6 -- $86.2 million in our stock repurchase plan, and $16.8 million for our Meridian acquisition.

In Q4, we generated $44.9 million in cash flow from operations. Cash and short-term investments at year end were $414.8 million, a decrease of $26.1 million from the prior quarter.

During Q4, we completed the remainder of the $100 million share repurchase program authorized in June 2012. Also during the quarter, Aruba's Board of Directors authorized an increase of $100 million to our share repurchase program. In the fourth quarter, we purchased 3.7 million shares of common stock at an average price of $15 per share, for an aggregate purchase of approximately $55.7 million. The weighted average shares outstanding impact of the buyback and the quarter's diluted share count was approximately 1.8 million shares.

Q1 '14 will reflect the full benefit of the 3.7 million shares repurchased. We have approximately $94 million remaining in our stock repurchase program. We ended Q4 with $93.2 million of accounts receivable, an increase of $22.2 million from the Q3 '13 balance of $71 million.

Days sales outstanding were 55 days compared with 43 days in Q3 '13 and 52 days in Q4 '12. Our target range remains 50 to 55 days.

Total deferred revenue of $141.3 million increased 37% year-over-year and $22.9 million from Q3 '13. Short-term deferred revenue of $109.8 million increased 36% year-over-year and grew 23% sequentially.

The primary changes in our deferred revenue balances were due to quarter end inventory stocking orders of our value-added distributors. Aruba's inventory totaled $28.9 million at the end of Q4, an increase of $1 million from the end of Q3.

Moving on to our guidance for Q1 '14. We are pleased to -- we are pleased by our solid Q4 performance and momentum entering Q1 '14, especially in light of continued softness in our Asia Pacific service provider business. We plan to make focused investments in product differentiation and growing our sales engine. As a result, we expect to return to 20% or better revenue growth in the second half of fiscal 2014, and return to 20% operating margins exiting fiscal 2014.

In Q1 '14, we expect revenue to be in the range of $156 million to $158 million, an increase of 8% to 9% year-over-year and 2% to 3% sequentially. Estimating 124 million shares, on a diluted basis, we expect non-GAAP EPS to be approximately $0.13 to $0.14 per share.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Ryan Hutchinson with Lazard.

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

I guess my question really is to explore the competitive dynamics and what's changed. If you look at their results, recognizing you had to peel back the onion and sort of parse out the different segments, but it still looks as if they might be gaining share. So I just wanted to understand that. What gives you confidence, from a competitive standpoint, that these deals will continue to close, and specifically, what exactly are you guys seeing with respect to the 3850 platform?

Dominic P. Orr

First of all, yes, we need to sort out the apples and oranges then the tangerines. There's carrier SB and that is the SMB service by the Meraki and then there is the enterprise portion. As you have heard from Mike, for North America, our core business grew 15% year-over-year; European theater of 25% year-over-year; and we believe from our feel, from our encountering, ourself and the numbers, that we have not lost market share. I have not seen a single report, yet, that we have lost a deal because of this 3850. There is definitely a lot of talk about unified access, but one can take an approach of unified access at a physical level, like our largest competitor is doing, or we can look at a unified access between wireless and remote, and the policy management lacks control layer levels, which is what we are doing, which is highly endorsed by the Gartner Group.

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

Okay. And then just as a follow-up, just so I fully grasp this. If you look at the Asia PAC revenue, what impact has that had on the business, on the service provider side, and what exactly is going on there and would you expect that to close?

Dominic P. Orr

Okay. So, first of all, our booking momentum in Q4, across all theater, North America, EMEA and Asia-Pacific, outside of service provider, are very strong and such momentum seemed to have continued into Q1. Obviously, we are still early in the Q1 cycle and we would not comment more about that. From order booking momentum, we are seeing that our strategy is working, that our value proposition for the enterprise target market segment is returning. And, actually, our Asia Pacific booking for enterprise is very strong. In fact, it is the strongest of all 3 theater total for Q4. So as regarding the service provider, I want to emphasize that we, primarily, are targeting for the service part of who's evaluating the layer 4-7. We have a few big service provider partner in Asia and we are subjected to the procurement cycle and lack of statistical average for this few large service provider customers, and right now, we are modeling according to our basic enterprise business.

Operator

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

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

I have one question and then a follow-up. Just on the competitive side again, I know you mentioned that your win rates are back to sort of historical rates. And I'm just curious, when you look at your largest competitor, did you see a change in their behavior in the quarter or was their behavior the same and perhaps your execution improved during the quarter versus the April quarter? Any color on that? And then I have a follow up.

Dominic P. Orr

Yes, okay. So I first want to remind everybody that we did mention there are 4 factors impacting our Q3 results. First was macro; second is the service provider, Asia Pacific comparable; third was the competitive tactics of our largest competitor; and then fourth is ClearPass and wireless LAN go-to-market we saw as balanced. As regarding the third factor, which was dwelled on with a lot of attention, which is the competitive tactics, from a sales and financial perspective, affected on us by our largest competitor. We have saw, clearly, a big trend, and in fact, in April, that affect deals closure in the same quarter. We have seen continued such behavior, but we have seen that our value proposition and the total cost of ownership proposition after we brought the attention to the business executive level, after delay of Stan [ph]. And as a result, the majority of this deal are retained in the pipeline, and in fact, over half of these deals have been closed in Q4 and the other half we are actively working on. So we adjusted, somewhat, our sales tactic and the competitors tactic has not changed, but as shown before, it can, in fact, only a trend; and in fact, not lasting.

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

Got it. Just a follow-up. Back in the February time frame, around Mobile World Congress, you announced a Wi-Fi offload offering in Japan, with 7-Eleven and NTT. I was wondering if you give an update on that deployment. I think it was about 15% done when you had announced it and I'm wondering if that's one of the reasons why you're seeing a weakness in the Asian market. And then related to that, Starbucks is refreshing its Wi-Fi infrastructure here, and checks are showing that Google is going to go with Aruba. I was wondering if you could comment on that and I'm wondering if you're seeing any opportunities of that kind in the U.S., and globally, with restaurants perhaps moving more towards Wi-Fi to enhance customer experience.

Dominic P. Orr

Obviously, we can only comment on our end customers' positions and deployment status per their agreement. I think, out of respect for our Asian service provider customer, which we really did not have the clearance, that I cannot really comment on the state of the deployment. But I can comment that, in general, this large deals do come in cycles. And regarding the specific North America, the Starbucks, Google deal, all I can tell you is Aruba products were provided, and to be provided, to replace the incumbent for the rollout of the Wi-Fi services in all the Starbucks in the United States. This is just starting and it is going to be a multi-quarter effort.

Michael M. Galvin

And, Sanjiv, just your question, too, on the Japan business. I mean, there's no doubt to that. That plays a part in the numbers, in terms of year-on-year comparisons for Q3 and Q4, yes.

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

Got it, okay. Dom, any color on this Starbucks opportunity? Is it sort of as large as what you saw with 7-Eleven in Japan? Any color on sizing would be helpful.

Dominic P. Orr

Well, I really cannot comment on the size yet. I think you probably can count the number of stores as best as I can, and there will be much better coverage. All I can tell you is we have finished all the Canadian Starbucks stores, which is a small fraction of what is in North America, and we're starting on the U.S. portion just now.

Operator

Our next question comes from the line of Jason Ader from William Blair.

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

I wanted to just -- Dom, I want to get this in three. What do you attribute the abrupt turnaround in the business in Q4? I mean, obviously, this is a very different call than we heard the last time around. So I wanted to get to specifics, whether its macro or it's competitive tactics or it's new products? And then, also, I want to get your sense of whether maybe you just got a little bit kind of over-rotated to the negative on the last call.

Dominic P. Orr

Jason, once again, I refer back to my earlier comment, that we really, in the prepared script last quarter, to explain our difficulty with 4 factors. I think the Q&A focused, exclusively, 1 of the 4 factors, then it is my fault not have managed that Q&A better to give a balanced perspective, and I'd like to revisit those 4 factors again. The macro, we are seeing, actually, some slight improvement, at least in our business, in the enterprise segment, in all theaters, including the European theater. And, in fact, we are quite comfortable about the growth projection there. So the macro is helping, at least not hurting us as it might have the effect on the other companies. The second is the service provider comparable is still difficult. In fact, it was more difficult in Q4 than Q3, and it will continue to be a factor but not as severe in this fiscal year, and hopefully it will turn around but we really cannot view our case on the lumpiness of that business. The ClearPass wireless LAN, the go-to-market resources, we did for 2, 3 quarters to overfavor the go-to-market resources and field staffing for ClearPass. Which, absolutely, we still believe are the right thing to do, but we just got caught in a difficult environment where the top line growth has not allowed us incremental expense. But since then, we have somewhat tuned up and refocused, and have been aggressively adding resources for our core wireless LAN business, which we believe, really, is on a very strong kind of perspective because of the 11ac early market feedback, the initial successes of the public-facing enterprise after the Meridian acquisition and the momentum for Aruba Instant. All that added to our conviction that when we can reach the deal, we can win. And so, lastly, the competitive tactics front. Our largest competitor can only do so much, to do the so-called architectural offer, which really is a combined multiproduct line in the sales and financial tactics. We prevailed with our Layer 4-7 unique capability and the overall total cost of ownership. So there was a transient difficulty but we feel that with our new approach to the market we can see business as usual.

Michael M. Galvin

Yes, Jason. Yes, we have felt the competitive tactics, obviously, before, in the other kind of economic tight times that we've been through. And the thing that we've seen is that they do rattle the cage for a little bit but they tend not to stick. You have to work a little harder just because the overall environment's harder, but the win rate continues to stay within our historical range.

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

And just a quick follow-up for you, Mike. We heard, during the quarter, that there was some product shortages, and I wanted to get an update on that and whether that affected your ability to actually ship product in the quarter.

Michael M. Galvin

Yes, we've got -- there's an ebb and flow to every quarter. And in terms of our ability to, I guess, ship and generate revenue, we have nothing to report on that front, and we go through -- you manage your supply chain every 90 days and according to where the deal flow is going, et cetera, so we continue to do that. But we -- you can, at times, especially after maybe some significant deals in a particular SKU, obviously, you have to get your supply chain filled and get the inventory back in. But, really, nothing unusual to report there.

Dominic P. Orr

So I would add just one comment. We really have to do a kind of observation. It seems that the marketplace, because of the high-density deployment and the BYOD deployment and proliferation of mobile devices are now favoring the 3-stream version of 11n versus the 2-stream, so it's a kind of a high-end access point. That is where we see a little bit of pressure to deliver. And also the one unexpected effect of 11ac AP is it just -- it turns out the way 11ac is implemented, you actually can increase performance of 11n client. So, actually, because of that, 11ac uptake was a bit faster than we actually anticipated.

Operator

[Operator Instructions] Our next question comes from the line of George Notter with Jefferies.

George C. Notter - Jefferies LLC, Research Division

I wanted to ask you about the DSO calculation, I think it was up a little bit sequentially. Can you talk about that? Was that driven by linearity? Was that driven by refreshes on service contracts? Was it seasonality? Any incremental insights you can give us there would be great.

Michael M. Galvin

Yes, sure George. Yes, so it was 55 days, which is at the high end of our range. And really, after just about 1 year of significant performance well below the range. If you look back at Q4 of last year, it was 52 days, and really, something you can look to and it actually ties to our deferred revenue is -- I said in the past that our stocking distributors, which are a significant part of the business, they've placed most of their big orders right near the end of the quarter. And there are timing differences at the end of the quarter with whether they that shipment right away or they take it early in the next quarter. So you can get some lumpiness on that, and our deferred revenue shows that, with a significant growth, and there were a significant amount of orders in the last week of the quarter. And, frankly, that does tie to the DSO. You get a spike in NAR along with those orders, so that contributed to it. Otherwise, nothing overly significant in terms of change to linearity, et cetera.

Operator

Our next question comes from the line of Brent Bracelin with Pacific Crest.

Brent A. Bracelin - Pacific Crest Securities, Inc., Research Division

One follow-up on deferred revenue and then one on OpEx. On deferred revenue, obviously, you saw the high sequential increase I think in most 6, 7 quarters here. You talked a little bit about just timing wise. Could you talk a little bit about what the distributors are stocking? Is it 802.11AC inventory, is it Aruba Instant? Any sort of color on why you kind of saw a timing and what, specifically, products are driving kind of the upside in deferred revenue? And then, secondarily, on OpEx, obviously you've seen 2 quarters now where you've seen OpEx increase as a percentage of revenue. You did talk about operating margin expansion as you exit this next fiscal year. Why couldn't you see more operating leverage sooner?

Michael M. Galvin

Yes. The deferred revenue, the product mix, I would say is really -- it's pretty broad-based and similar to, really, what the company is selling right now. And I think some of the things Dom mentioned, I mean we're getting the 11ac control APs, having had a nice uptick, the 3-stream APs absolutely are in demand. Our new AC controller, the 7200 series. But, really, I would say the distributors, the stocking distributors, are really pretty representative of our overall business, and so they're going through whatever product transitions we're going through at any given time. But those are some of the highlights. The switches had a good quarter, and then we talked ClearPass and Instant doubling year-over-year, so pretty broad-based. With regards to OpEx -- and really Op margin -- so we've talked about it, we talked about last quarter, we are definitely seeing the path, in terms of our product platform and expanding the go-to-market engine, and we're doing that because we believe in the market opportunity and what we're going after. That is a little bit heavier in the first half of the year, so the ramp on that -- and I pegged exiting FY '14 or Q4 as being a 20% operating margin, a return to that level, and so it's a little more gradual in the first half because we are investing pretty aggressively. But, basically, if you draw a ramp to that end, emphasizing the second of a little more, that's how you get there and that's where we're going to get our leverage from. But we're kind of not taking our eye off the ball in terms of the investments we want to do in the near-term.

Operator

Our next question comes from the line of Erik Suppiger with GMP Securities.

Erik Suppiger - JMP Securities LLC, Research Division

One point of clarification. You said growing more than 20% in the second half. Are you saying one of the quarters will be faster than 20% year-on-year growth or the entire second half will be faster than the 20% growth?

Dominic P. Orr

We are saying that, starting sometime in the second half, our business run rate will get back to 20% year-over-year or better.

Michael M. Galvin

So, maybe said a different way, Q3 or Q4 will have better than 20% revenue growth or both.

Erik Suppiger - JMP Securities LLC, Research Division

Okay. And then questions on -- you talked about Instant and ClearPass doubling year-on-year. Can you give us a sense for either the current contribution or if you're looking for 20% year-on-year growth at the end of fiscal '14? What contribution does it have to that when you're modeling that out?

Dominic P. Orr

Erik, actually, we don't look at our business that way. We, basically, as a wireless LAN business, that in fact our customers are mixing and matching controller base, wireless LAN and Instant, depending on different network configuration and topology, and particularly leveraging our, what we call the hybrid control architecture, where you deploy Instant at the edge and having the control in the center to provide such things as location services and Layer 4-7 services. So what we can say is that, from a product line perspective, the controller base, wireless LAN, also, is growing. In fact, it's growing in all theaters if you look at the [indiscernible] specific as an enterprise sector. So we believe that the way that we model our business is really a number of accounts and the kind of buying behavior in each account rather than depending on each of the product lines. Mindful that our Aruba Instant product line, even though it has the capability to go to downstream to the SMB and so on where the other cloud-based Wi-Fi offerings are, in our go-to-market activity right now, we are still restricting that product set in our distributor enterprise and managed service partners' space. So, even with that, we are reporting booking rate in Q4 of over doubling year-over-year, and obviously, that has escaped our attention, that with appropriate go-to-market funding and activities, that we could use that to expand our market as well.

Keerti Melkote

And in regards to the ClearPass aspect as well, I can tell you that the MOVE architecture is probably taking hold, and in the majority of our new account wins, ClearPass is a critical component of the architecture, which is what is pointing to the doubling in the core bookings of ClearPass as well.

Erik Suppiger - JMP Securities LLC, Research Division

Okay, then last question. Was there much turnover in the sales organization for the last quarter?

Michael M. Galvin

No, nothing out of the realm to report. The headcount growth this quarter was a little bit lower than our more recent quarters. And, really, Q4 was a little more of a recalibration and optimization quarter overall, so you see the net headcount going up a little bit less. But as we've been talking about, we are definitely investing in that headcount and that includes the first half of this year coming up.

Operator

[Operator Instructions] Our next question comes from the line of Kent Schofield with Goldman Sachs.

Kent Schofield - Goldman Sachs Group Inc., Research Division

On the guidance for the back half of this year, looking for 20% growth on your -- or one or both of the quarters. Are you referring to total revenue or product revenue?

Michael M. Galvin

We refer to total revenue on that.

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

Okay, okay. I just wanted to clarify that. And then, when you think about getting to that goal, how much of that is looking at headcount additions in sales and marketing and getting them to ramp versus maybe looking at the macro or some sort of product benefit from 802.11ac, if there's some way that you could help us kind of parse that out some.

Dominic P. Orr

Sure. I think, typically, we expand our field headcount in the first half of the year more aggressively than the second half, and normally it takes about 3 quarters for a new team in the new territory to ramp. So our current assessment is that we have a very good product platform. Obviously, you always have to keep up, quarter after quarter, in the leadership position. But the significant investment is in the go-to-market, in lead generation and territory coverage in areas where we do not see any macro impact. And just to clarify, we're not saying that there will be a transient 20% year-over-year growth quarter popping up somewhere. We are saying that we have a trajectory that will take us to that level and we are not tying ourselves down to is it Q3 or is it Q4, and that's why we say second half.

Kent Schofield - Goldman Sachs Group Inc., Research Division

Got it, got it. And then as a follow-up, on the 7200 series, now that that's been out for a good chunk of time, has that been growing in line with your expectations? Has it been growing better? If you could just give us a little bit of granularity there.

Dominic P. Orr

Yes, it has been growing per our expectation. And, Mike, our expectation, further, is that, associated with the ramp line of 11ac, the 7200 with the larger capacity will actually be tied to that growth as well.

Operator

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

Ameet Prabhu - RBC Capital Markets, LLC, Research Division

This is Ameet Prabhu calling in behalf of Mark Sue. Could you provide some color on the response to your .11ac solution? And could you maybe just compare your expectations for the pace and duration for the upgrade cycle, the cycle trajectory the last time around?

Dominic P. Orr

Yes. So, .11ac, I would say we are in the early stages of the upgrade cycle. Clearly, we introduced the product in quarter, so we have had less than 1 full quarter of experience of shipping .11ac, but the initial trends are quite encouraging. A lot of the early traction, as you can expect, has come from the education sector. And as we look to the rest of FY '14, clearly, it's one of the key growth drivers that we have identified, the transition to .11ac. And the timeline of transition, we expect it to be very similar to the 11n transition, with the early adopter markets going first. The large campuses and then the rest of the market following that. One thing to point is that industry expectation is by Christmas time I see the number of well over 47% of new mobile devices introduced will have .11ac connections, and sort of expectation is that [indiscernible] will bring these devices back to work. You will see in the spring of 2014 will be where you'll see a kind of a more widespread demand for this market.

Ameet Prabhu - RBC Capital Markets, LLC, Research Division

And just in terms of the drivers for the 20% year-over-year growth, could you maybe rank all of the factors, adoption of .11ac, ClearPass, public-facing enterprise and Instant?

Dominic P. Orr

Yes, those are the 4 key drivers for us to propel back to the high-growth. But, obviously, the very important, continue expansion of sales and support capacity. That's very key.

Operator

And our next question comes from the line of Tavis McCourt with Raymond James.

Tavis C. McCourt - Raymond James & Associates, Inc., Research Division

Can you talk about if there was any revenue in the quarter from the acquisition? And then maybe a little bit more background, Dominic, on where you are in kind of the public-facing enterprise market today, competitively, and how big that market is in your mind and how this changes your position there?

Michael M. Galvin

Yes, Tavis, the revenue in the quarter from Meridian, was very, very negligible. Kind of off the radar, but we are very happy. Dom talked about one significant win that we had this quarter, and there are others, and so we're definitely optimistic about the ramp, and really, the differentiation that it's providing us in our selling pattern. But, just pure quantitatively, and the revenue in Q3 was really a non-contributor.

Dominic P. Orr

So regarding the development of public-facing enterprise, obviously, this is an area where Layer 4-7 is very important to differentiate the multimedia traffic, to have ClearPass kind of capability to administer the separation of guest versus insider firewall traffic and location-based, Wi-Fi-based GPS applications allowed you to let the business and the venue owner to use Wi-Fi as a media for customer interactions, and therefore, this is a market that is growing very fast, and also a market that we feel that we are very, very optimally suited. Last quarter, when we announced the Meridian acquisition, we mentioned that in our largest competitors' installed base, the top of their public-facing enterprise customers are all tied to the Meridian applications. So, with that acquisition, we actually own the technology now in that space. So this is a very comforting position for us.

Operator

We have only time for 2 more questions. Our next question comes from the line of Amitabh Passi of UBS.

Amitabh Passi - UBS Investment Bank, Research Division

Mike, first question for you was just around your product gross margins. They continue to sort of inch downwards, and this is despite ClearPass. I think you said sales doubled year-over-year. Just trying to understand some of the dynamics in the product gross margin side. What's causing some amount of downward pressure?

Michael M. Galvin

Yes, Amitabh. So, yes, the product GM was really very slightly down in the quarter. Really, the last 2 quarters. If you look at our history and the quarterly variation of our product GMs, very much within the kind of variance range we see. So there was the typical -- you get, obviously, the product mix issues, you get the geography mix and then there's always influence if you've got some big deals in there. So we raised that gross margin guidance range at Analyst Day in March, and we feel solidly about performing within that range.

Amitabh Passi - UBS Investment Bank, Research Division

And just a couple of quick ones for me. On the back half, 20%-plus growth on the top line. What is giving you that conviction you can get back there? You said specific project wins, your pipeline. I'm just trying to get a better sense of why you have such confidence given some of the shaky macro.

Dominic P. Orr

Well, first of all, we feel in the last 90 days that, at least the geography that we're working with, the mobility space seems to be a little bit less sensitive to macro. We're also very, very connected in our differentiation in .11ac, in the public-facing enterprise with Meridian, Aruba Instant and ClearPass. And our data show that when we can reach the deal, the chance is much, much, much likely that we win it. And so it is really up to us to organize our go-to-market engine, our sales engine and our service engine to reach that. So I would say, from all planning perspective, right now, we are sales capacity bound, not anything else.

Amitabh Passi - UBS Investment Bank, Research Division

Dom, is most of that coming from North America or do you see other geographies participating as well?

Dominic P. Orr

Well, actually, this is worldwide. Obviously, there are pockets of global geography we will not -- in that same. But, I would say that of our regions, about 3 dozen regions out there, well over 70% of the region, we feel when we add more resources, 6 to 9 months later we will return the investment. We have very, very strong conviction on that.

Operator

And our final question comes from the line of Rod Hall with JPMorgan.

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

Just a couple of questions, I guess, or a question and a follow-up. First of all, can you talk a little bit more about the -- I mean, OpEx is spiking here, sales and marketing's up quite a bit, another 2% of revenues from last quarter, R&D is going up as well. It sounds like the guidance kind of implies you've working it all through yet a stabilization of your operating margin at much lower-level. But it feels like if I just drew the trends up through Q4, I feel like that operating cost is increasing. So can you just comment on that and maybe on the underlying pricing dynamics you're seeing out there? And then I've got one follow-up.

Michael M. Galvin

Okay. Yes, so the OpEx, I mean, it's to one degree, it's kind of simple math. I mean, we hit an air pocket in Q3, on the revenue, and we're coming out of that. We, effectively, are investing to the roadmap and the path that we had conviction on that Analyst Day, right? And now, obviously, if any business situation persists over a sustained time, you've got to adapt to that. But that's really not the way we're seeing it right now. So we are investing on that ramp and on that path, and we took a little bit more of a hit this quarter. But, really, we're saying that leverage and that ramp is now going to return, go forward from here. And we've looked closely at what that investment portfolio looks like and what we need to do, and we've pegged that 20%, exiting FY '14, to get. Because, I mean, we can't run at these levels at a sustained time period on an Op margin, is my feeling and our feelings. So that's why we pegged the 20%.

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

Okay. And then, Mike, could you just -- my follow up is on the accounts payable. I mean, it's way up as well. DSOs are way up on our calculation. Can you just comment on what's going on there a little bit? And then that's the end of my questions.

Michael M. Galvin

Yes, the accounts payable and accrued liabilities are up. You did see a jump in that last Q4 also. Part of that contribution is our settlement payable for the lawsuit. So that has a significant impact on it. But, actually, we had some fortunate timing, frankly, of some of those AP and accrued liabilities, in terms of when they were due. And by fortune, I mean they weren't due in the quarter. So we got a little more of a spike in that, that are normal trend, and that helped our cash flow, which was very strong. And so I think, looking at Q1, if we were to pay the settlement in that quarter and not have some of the timing advantages we had in Q4, there'd be a little more pressure on cash flow from operations, but still returning to the very strong levels we have outside of the very high level we had this quarter.

Operator

Thank you. I would now like to turn the conference back over to Dominic Orr for closing remarks. Please, go ahead.

Dominic P. Orr

Thank you. Again, we thank you for being on the call today. I'd like to take a moment to thank all of you on your support, and our value employees, customers and partners for their dedication, commitment and hard work. Look forward to our next update with you next quarter. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude our conference for today. If you would like to listen to a replay of today's call, please dial (303) 590-3030 or 1 (800) 406-7325 with access code 4629617. Thank you for your participation. You may now disconnect.

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Aruba Networks (ARUN): FQ4 EPS of $0.12 beats by $0.01. Revenue of $153.1M beats by $3.77M. (PR)