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Executives

Jill Isenstadt – The Blueshirt Group.

Dominic P. Orr – Chairman of the Board, President & Chief Executive Officer

Steffan Tomlinson – Chief Financial Officer

Keerti Melkote – Chief Technology Officer & Director

Hitesh Sheth – Chief Operating Officer

Analysts

Mark Sue – RBC Capital Markets

[Tam Long] – Bank of Montreal

[Inaudible – Morgan Stanley]

Jonathan Ruykhaver – ThinkEquity

Min Park – Goldman Sachs

John Marchetti – Cowen & Company

Sanjiv Wadhwani – Stifel Nicolaus & Company

Bill Choi – Jefferies & Company

Ryan Hutchinson – Lazard Capital Markets

Rohit Chopra – Wedbush Morgan Securities, Inc.

Jeffrey Kvaal – Barclays Capital Market

Greg Mesniaeff – Needham & Company

Blaine Carroll – FTN Equity Capital Markets

Aruba Networks, Inc. (ARUN) F1Q10 Earnings Call November 19, 2009 5:00 PM ET

Operator

Welcome to the Aruba Networks first quarter 2010 earnings conference call. During today’s presentation all parties will be in a listen only mode. Following the presentation the conference will be open for questions. (Operator Instructions) This conference is being recorded today, Thursday, November 19, 2009. I would now like to turn our conference over to Ms. Jill Isenstadt with The Blueshirt Group.

Jill Isenstadt

Thank you for joining us on today’s conference call to discuss Aruba Networks’ fiscal first quarter 2010 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 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 first quarter ended October 31, 2009. If you’d like a copy of the release you can access it online at the company’s website or you can call The Blueshirt Group at 415-217-7722 and we will 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, operating expenses, non-GAAP EPS and tax rate for the second quarter of fiscal 2010, the company’s belief that it will continue to gain market share and derive significant traction from its 802.11n products, anticipated macroeconomic improvements and resulting positive impact on the company’s position in the market, acceleration of the trends towards 802.11n exclusively and expected customer demands for the company’s 802.11n products, the company’s belief that its pipeline for network right sizing and VBN solution 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 are 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 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 US generally accepted accounting principles or US GAAP requires disclosure that availability of new products, plans, features and upgrades discussed during this call are subject to change or cancellation. For more a more detailed description of these risks and uncertainties that may affect our results, please refer to the risks and uncertainties described under the caption risk factors and management’s discussion and analysis of financial conditions and results of operations in our annual report on Form 10K filed with the SEC on October 6, 2009 as well as our earnings release posted a few minutes ago on our websites.

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 expenses of acquired intangible assets and litigation settlement expense. We have provided reconciliation of these non-GAAP measures to GAAP financial measures in the investor relations section of our website located at www.ArubaNetworks.com and in our earnings press release.

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

Dominic P. Orr

Thank you for taking the time to attend our fiscal first quarter 2010 conference call. We had a very strong quarter. Increasingly the market is aligning with our vision of using mobility to drive both cost savings and productivity gains. During the quarter revenues grew approximately 10% year-over-year and 8% sequentially to a record $57.6 million. In Q1 we saw encouraging sales momentum in our main geographies.

Additionally, we saw continued strength in our core verticals and new design wins and deployments across the general enterprise. I’m also pleased with the improvement in gross margins. Non-GAAP gross margins increased sequentially and we were able to continue to drive operating leverage. Overall, we reported non-GAAP operating margins of 7.8%, a 100 basis point improvement from our fiscal Q4 and non-GAAP net income of $0.04 per share.

We have made strategic investments in R&D, broadening our pro line and investing in the future to take advantage of our strong market condition. While we remain focused on controlling expenses, I am pleased that our strong bottom line results were once again primarily a consequence of meaningful revenue growth.

Given the extraordinary last 12 months I think it is worth doing a brief review of some of the significant accomplishments that we have made in this period. First, we once again delivered strong revenue growth on a year-over-year basis. Second, unit shipments of our 11n access points now account for 42% of our total access point shipments. We have also increased our customer base by almost 40% adding over 2,400 new customers over the past 12 months.

We expanded and developed our distribution channels with indirect sales accounting for 91% of revenues given us the leverage as the market recovers and expands. Gross margins have improved by over 300 basis points as we continue to drive value to our customers. We have more than tripled our non-GAAP operating margin. We have stayed focused on our customer and improved our market leading customer service recently receiving the star award for service excellence.

We have introduced new technology innovations that further distance us from our competition and we believe we have vastly expanded our total addressable market through our LAN right sizing and virtual branch networking initiatives. We are clearly a much stronger company today than we were at the beginning of the downturn. With the economy now showing signs of life, I’m very encouraged by our stronger position in the market, with the increased market share we have won over the last 12 months.

Now, I would like to highlight some of the specific elements [inaudible] as evidenced by our increasing share according to [inaudible] Group. Our market share gains also reflected in our customer wins. During this quarter we added over 600 new customers and now have over 8,500 total customers spread across a wide range of industries and geographies. New customers in the first quarter included one of the large consumer product companies in the world, a central bank in South America, leading hospitals in the Middle East and the United Kingdom, a Fortune 500 printing company, one of the largest sports organizations in the world, virtual branch networking projects within a branch of the federal government and one of the largest retail chains in Japan. We continue to win leading universities and school districts in the United States and abroad.

This growth in new customers has been complemented by steadily increasing demand from our existing customer base. As we enter our seasonally weaker second quarter, our pipeline is robust and we are projecting sequential growth and over 22% year-over-year revenue growth for Q2. Product innovations and technology leadership continue to drive our sales and increased mind share.

This quarter we announced the release of AirWave on demand an enterprise class network management and monitoring solution deployed using a subscription based software as a service model. This cloud based service housed at a secure Aruba datacenter uses virtual instances of Aruba’s AirWave wireless management suite. By eliminating the need for customers to buy and maintain their own servers and software, AirWave on demand simplifies the task and lowers the cost of deploying wireless networks.

Our innovation was also reflected in our introduction of the AP-105 11n access point. Introducing value pricing to the industry with an enterprise class 11n access point that sells for only a small premium over ABG solutions. At the same time we also lowered the price of our flagship AP-120 series which are the first 11n access points to be FIPS 140-2 certified. We believe this is an important inflection point in the industry and we expect the trend with 11n to accelerate.

This quarter we saw 11n access point increase to 42% of shipments from roughly 30% just a quarter ago. Both the premium line and value line are doing well and both carry very healthy product margins. We believe that 11n changes the networking landscape by introducing wireless solution that delivers performance comparable or superior to wired networks. We believe that there is growing acceptance of wireless as a true alternative to Ethernet access and we believe that wireless has emerged as the de facto standard for many applications in our core verticals.

When you combine these developments with our LAN right sizing initiative and our promising virtual branch networking products, you can understand why we are confident that our total addressable market is significantly greater than it was only one or two years ago. There is no question that it still remains a challenging market, but this is an exciting time for Aruba Networks. We are confident in our traction in the marketplace and focused on our execution.

We are increasing our penetration in our core verticals and we are seeing greater adoption of our solution across the general enterprise. We continue to win market share and we have significantly strengthened our position since the beginning of the downturn. A little later in the call I will be happy to answer any questions you have and we will now turn it over to Steffan to go through the financials in more details.

Steffan Tomlinson

In Q1 2010 total revenue of $57.6 million increased 8% sequentially and 9.8% year-over-year. The year-over-year growth is especially notable because in the year ago period Safeway was a 10% customer and we had no 10% end customers in Q1 2010. Product revenue of $47.2 million increased 8.8% sequentially and 7.6% year-over-year. Professional services and support revenue of $10.1 million increased 4.8% sequentially and 24.7% year-over-year.

In Q1 approximately 91% of our revenue came from indirect channels while 9% was direct. As a reminder, our indirect channels represent sales through our VARs and distributors as well as our strategic OEM partner Alcatel Lucent. Our goal has been to move deals in to our channels and we expect a percentage of revenues from our indirect channels to be in the 85% to 90% range. During the quarter Alcatel Lucent, Avnet, Catalyst and Wescom were 10% partners.

Approximately 58% of sales were generated in the US and 42% of our sales came from international theaters. Bookings overall were robust and linearity followed our historical monthly pattern. Contributions from our international markets were strong. Non-GAAP gross margins in Q1 improved to 69.7% compared to 68.5% in the prior quarter and above our target range for non-GAAP gross margins of 65% to 68%.

Q1 non-GAAP product gross margins was 67.1% compared to 65.3% in the prior quarter. The improvement in product gross margins was in part due to favorable product and channel mix. Q1 non-GAAP services gross margins was 82.2% compared to 83.2% in the prior quarter which has been especially strong due to service renewals. Our long term non-GAAP gross target range remains at 65% to 68%.

Moving on to operating expenses, non-GAAP research and development expense was up approximately $1.6 million to the prior quarter and increased as a percentage of revenue from 15.1% in Q4 ’09 to 16.7% in Q1 2010. We continue to invest in product development to strengthen our competitive position. In Q1 R&D spending also included expenses related to certifications as we rolled out our new products. We expect R&D spending to be modestly down as a percentage of revenue in Q2.

Non-GAAP sales and marketing expenses increased by $0.7 million from the prior quarter and as expected decreased as a percentage of revenue from 38.6% in Q4 ’09 to 37.1% in Q1 2010. Non-GAAP G&A expense increased by $0.3 million and was flat with Q4 ’09 as a percentage of revenue with 8.3%. While we reached a legal settlement with Motorola during the quarter, legal expenses for Q1 did impact our G&A line in a total of approximately $800,000 or $0.01 per share.

Headcount at the end of Q1 was 560, an increase of 15 from the prior quarter. In total, operating expenses were approximately flat with the prior quarter as a percentage of revenue and 62.1% of sales on a non-GAAP basis. Our non-GAAP tax rate was 8.3% in Q1 compared to 8.2% in Q4. We expect our tax rate in Q2 to be approximately 10%.

Non-GAAP net income for the quarter was approximately $4.1 million or $0.04 per share. This compares to non-GAAP net income of $3.2 million or $0.03 per share in Q4 ’09 and non-GAAP net income of $1.4 million or $0.02 per share in Q1 ’09. GAAP and non-GAAP net income include approximately $0.01 per share worth of expenses related to the Motorola law suit. Due to the appreciation of Aruba’s stock throughout the quarter Q1 2010 weighted average shares outstanding were 100.3 million shares on a diluted basis.

The GAAP net loss for the quarter was $24.7 million or $0.28 per share compared to a GAAP net loss of $4.5 million or $0.05 per share in Q4 ’09 and a GAAP net loss of $6.4 million or $0.08 per share in Q1 ’09. Our first quarter of 2010 GAAP results included a onetime litigation settlement expense of $19.75 million, $7.8 million non-cash stock based expenses and $1.2 million or amortization expenses of acquired intangible assets.

Now, turning to the balance sheet, we finished October with cash and short term investments of $1.35 per share or $135.6 million. This represented an increase of $12.5 million from last quarter. As a reminder, the cash payment of $19.75 million related to the settlement of the Motorola law suit was paid in November after Q1 closed. Cash flow from operations was $10.5 million. We ended Q1 with $33 million of accounts receivables down slightly from the Q4 ’09 balance of $33.5 million.

Moving down the balance sheet, short term deferred revenue was at record level of $40 million at quarter end compared to $34.7 million at the end of Q4 ’09 and $28.9 million at the end of Q1 ’09. Days sales outstanding were 52 days down four days from Q4 and we believe the quality of our receivables remains excellent. Inventory totaled $9.2 million at the end of Q1 up by $0.7 million from the end of Q4. Inventory turns increased sequentially to 7.1 times from 5.8 times in Q4.

Looking ahead we are entering our seasonally weaker second quarter. At the same time we had a record first quarter, bookings are on track and our pipeline continues to grow. Balancing these factors we expect revenues in our second fiscal quarter of 2010 to be up 22% to 26% year-over-year in the range of $58 to $60 million. We expect non-GAAP EPS of approximately $0.05 per share using 100.3 million shares on a diluted basis. This includes some impact from wind down costs in the quarter from the Motorola law suit.

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

Dominic P. Orr

Steffan, Keerti, Hitesh and I would now be happy to answer any questions that you may have. Operator, you can now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Sue – RBC Capital Markets

Mark Sue – RBC Capital Markets

Maybe if you could give us your further thoughts on the revenue guidance, where we are in terms of winding down some of your largest projects and where we might be in terms of winning some of the larger deals that we can replicate similar to the Safeway size deals and just your comfort levels of the continued sequential growth as the market expands? Then separately, Stefan maybe if you can just talk about the price cuts and the lack of [impact] on gross margins and also where we go from here on gross margins?

Dominic P. Orr

Regarding to our pipeline of larger deals and deployment, first of all I think generally the advice [inaudible] of the activity in the project pipeline is our deferred revenue. Second of all, I made the comment that one of the significant developments in this quarter is we have significant design wins and traction in the general enterprise outside of our core verticals. Why I’m saying that is I want to be mindful that some of these projects while carrying much larger accounts takes a multi quarter time frame to develop and therefore looking at it from a pipeline of large project perspective I’m quite pleased with where things are at.

Regarding the new value line of 11n versus our premium line I think a credit to our engineering technology organization we were able to lead the industry with our innovations to create a true enterprise 11n offering that could address the market with a price point that is slightly above ABG solution however, the articulation of the value of the two lines are very clear with our install base and we do not see any confusion there. So, we emphasize that both of the lines have very healthy margin and therefore it actually does not concern us how things shift.

The important fact is that the momentum is shifting, the shift from ABG to 11n at this moment I believe is unstoppable and in the course of the next few quarters we will see more drastic shifts. So, I’d be very happy to let the customer chose between the premium line and the value line.

Mark Sue – RBC Capital Markets

Steffan, with that being said do we just flat line gross margins from here?

Steffan Tomlinson

Well clearly, gross margins have trended above our target range. In the near future I would say that our target range remains the same. There are going to be fluctuations on a quarterly basis but I’m very pleased with the fact that we’ve been able to introduce a robust set of new 11n products while maintaining our overall company gross margins. The fact that we’re able to lead the industry and not sacrifice gross margins is something that is very pleasant to hear.

Operator

Your next question comes from [Tam Long] – Bank of Montreal.

[Tam Long] – Bank of Montreal

Just a few quick ones here, first can you just talk about the government in the quarter, how strong was it and related to that give us your latest view on what you think about stimulus and impact on both government, healthcare and education and some of your other verticals, that’s number one. Then number two, obviously a lot of 10% partners in the quarter, are you seeing a lot more activity from the other partners that you’re involved in or even other large companies that are looking to increase their partnering as there seems to be a lot of cross over and activity between large networking and datacenter type vendors. If you can answer those two, that would be great.

Dominic P. Orr

Our federal vertical business, the results there was very pleasing however we have not been a significant beneficiary of the so called budget flush because as you recall a lot of our federal business is on a programmatic basis rather than on the deals basis so it is less influenced by the year end spending pattern. I continue to be very, very bullish about our federal business but it’s just in line with the other verticals. As you recall, we just said that our 120 series of 11n access point is the first 11n product to be FIPS certified as obviously helped in part of the federal business.

Regarding the increase of 10% partner, as you recall it has been over an 18 month effort for us to get in to a two tier distribution model or three, Wescom, Avnet and Catalyst are now getting more in to critical mass. Or, should I said we’re aligning more of our [inaudible] resellers and system integrators to source from them and with the critical mass hopeful we continue to be on track on building the support and services infrastructure that this value added distributors will provide.

[Tam Long] – Bank of Montreal

Could you just hit on the stimulus?

Dominic P. Orr

The stimulus, we have expressed opinions before which continues to be true that both the healthcare and the education sector, particularly the healthcare sector is a beneficiary of the stimulus package in the area of electronic medical record which requires mobile device and requires secure mobile access. However, there is a pipeline of projects that start with the application, then the device, then the networking infrastructure so we are seeing a lot of design activities and market development activity but I do not expect that to be a very short term upside.

Operator

Your next question comes from [Inaudible – Morgan Stanley].

[Inaudible – Morgan Stanley]

Dominic you had mentioned that the price point on .11n, it sounds like you mentioned it is converging in to ABG. Can you give us a sense of what the delta is right now and where that 42% goes over the next year or two years and what the price point between the two will look like? I’m trying to get when you do get to 60%, 70% or 80% .11n will it be at the same price point and ASP that you’re getting ABG today or will that be at a higher ASP when you get there?

Dominic P. Orr

That’s a good question. I believe what we said earlier on in earlier calls is we expect that by the middle of 2010 or slightly earlier that we expect well over 50% of the access point shipments will switch over to 11n but obviously from 30% to 42% in one quarter, we do not know what the trajectory exactly is going to be like but if you can extrapolate just a little bit, it looks like the industry is migrating even a little bit faster than our earlier expectation is. Regarding 11 versus the value line versus the generic ABG solution, our view is that there will be a spread between the two. However, the spread right now is on our pricing is somewhat between 30% and 40% but it will go down slightly but the margin will remain. That’s our belief.

[Inaudible – Morgan Stanley]

Two other things, just a housekeeping item, those four VARs that were over 10%, did you give what they are in total, how much or what percent of revenues were that? Then, on the AirWave side, one of the main reason for purchasing them I understood, besides the fact that it was a good network manager system was to allow you to convert whether it be a CISCO shop or some other places that have competitors to easily buy your access points. Do you have a sense yet what percent of your revenues this quarter and overtime and have been Greenfield where you won it versus converts from a CISCO system or others because of AirWave.

Dominic P. Orr

That’s a good point, I’ll defer the other question about numbers to Steffan but regarding the AirWave, almost to the single large customer who chose Aruba for the future, they have invested somewhat with one of our large competitors in the past and their request, why they have invested in Aruba for the future, that we ease their effort to slowly migrate to the future architecture and that was really mainly the use of AirWave.

What I’m saying is strictly speaking there is very few totally, totally Greenfield customers. Most of our larger accounts have that install path and almost – I would say a very, very high percentage of those customers wanted to keep them. The goal with AirWave is they can manage that transition at the rate they are ready to spend. I think that remained one of the key value propositions we provide.

Steffan Tomlinson

As far as the partners are concerned, we did have core partners that were 10% partners. We don’t break out exactly the percentages but I can tell you from a relative sense, each were just over 10%. Typically, Alcatel Lucent is a 10% partner for us, the difference this quarter as opposed to prior quarters was we actually had three of our [inaudible] be 10% partners which goes back to proof point in our business model where we’ve been investing with the two tier infrastructure and we’re starting to see some traction on that front.

Operator

Your next question comes from Jonathan Ruykhaver – ThinkEquity.

Jonathan Ruykhaver – ThinkEquity

On carriers, are there any kind of incentive programs in place currently to help accelerate the transition from ABG to 11n?

Dominic P. Orr

You mean like sales?

Jonathan Ruykhaver – ThinkEquity

Yes, on the sales side any particular discounting that might be going on?

Dominic P. Orr

No, I think predominate number of our 11n project is customer driven and needs driven.

Steffan Tomlinson

I think just on that point we made pricing changes on the 120 series and with the new value line of the AP-105 those were catalysts for customer adoption as well.

Jonathan Ruykhaver – ThinkEquity

So it’s a natural progression given the pricing and the value you get?

Dominic P. Orr

Yes.

Jonathan Ruykhaver – ThinkEquity

A question just related to the competitive dynamics as the market shifts to 11n, are you seeing any change in terms of how vendors are responding, how competitive vendors are across the landscape?

Dominic P. Orr

I can tell you I wake up in the morning, I think of one vendor that I go to work to compete with. Obviously here and there in some vertical we see some other competition but you can count on that our focus is strategically to fight a long term battle against one competitor.

Jonathan Ruykhaver – ThinkEquity

Then just one quick question, the sequential uptick in terms of revenue guidance, does that suggest that you’re seeing new activity, broader activity outside your core education, government, healthcare and retail verticals?

Dominic P. Orr

Yes.

Jonathan Ruykhaver – ThinkEquity

Is that the .11n access point that’s driving that?

Dominic P. Orr

I would say you can assume most of the new large project customers are thinking about 11n.

Steffan Tomlinson

Just one follow on, 11n is really a catalyst for broader networking initiatives such as right sizing, virtual branch networking and it’s those things where 11n is enabling that transition and that’s why we’re seeing adoption not only in the core verticals but in the general enterprise.

Dominic P. Orr

If you think about it there’s the traditional mobility application where you use a handheld barcode scanner that kind of thing, that does not really need 11n kind of bandwidth but if you’re looking in to a structured network for a campus new building, then you’re talking about the tradeoff between the number of Ethernet ports versus 11n. Since 11n is now multiple times faster than wired Ethernet that is where you are seeing the significant application of 11n.

Operator

Your next question comes from Min Park – Goldman Sachs.

Min Park – Goldman Sachs

Just a couple of quick questions, first on the new value line of access points, can you tell us if you saw any incremental revenue this quarter from that introduction and what gives you the confidence that the value line won’t cannibalize or isn’t already cannibalizing your premium access points?

Steffan Tomlinson

I’ll take the first part of that. We did see new revenue come from our value line access points. I’d also tell you that the AP-105 which is our value line is meant specifically to address the ABG market and facilitating that transition. With that, let me turn it over to Keerti.

Keerti Melkote

In terms of differentiation the AP-120 series is really built for flexibility so you can actually deploy that not only in indoor environments but challenging [inaudible] environments including outdoors while the AP-105 is fundamentally built for indoor deployment. Our customers understand the differentiation and those that have gone with the premium line have remained with the premium line. To Steffan’s point we are really targeting the 105 which is a value product as the transition from APG to 11n.

Hitesh Sheth

One other point that I would add to that is there is a skills performance difference between the value 105 line and the 120 line. So, when customers are looking to deploy a wireless plan of scale, especially if we’re right sizing opportunities, the 120 series is absolutely the right fit for the application.

Min Park – Goldman Sachs

Then just a quick follow up, are there any concerns or do you have any concerns about component availability of the supply chain and to what extent can that actually impact your January quarter?

Dominic P. Orr

Certainly I can tell you that in the last couple of quarters we have to spend non-trivial management energy in making sure our supply line match our demand. But, so far we have not had any significant hiccup of our business because of supply related issue but it is still pretty critical out there I can assure you.

Operator

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

John Marchetti – Cowen & Company

I was wondering if you could comment at all with some of the new broader activity you’re seeing across enterprise as opposed to just the core markets, when you’re talking about that should we read that as essentially VBN and right sizing and then within your core markets it’s just more the traditional moving towards wireless for those reasons? Or, are you seeing even within your core market if you will, people start to take up some of this VBN and right sizing type of activity.

Hitesh Sheth

I think on both those fronts, definitely we’re seeing significant interest in uptick in right sizing. I think the interesting phenomena here is to note that as we start emerging out of this downturn customers have grown accustomed to recognizing the value of mobile based solutions and it is not usual for us to see, regardless of what vertical we’re talking to, that they’ll be looking to deploy far fewer wired ports inside the network than they traditionally had so that’s the right sizing component.

As far as VBN is concerned, as enterprises look to deploy remote locations more efficiently our VBN story becomes a very attractive proposition for them so again, we’re seeing very good uptick on that as well.

John Marchetti – Cowen & Company

Then maybe just a quick follow up on the right sizing question, in the discussion that you’re having with customers do you get a sense obviously that they’ve laid off a lot of folks they do have a lot of unused ports available to them on the edge right now so it’s not really a needs based issue at this point. Is it mostly Greenfield or moving offices, those kinds of opportunities where right sizing comes in to play or are you seeing a willingness with customers on that right sizing front to even go back and now say swap out some of the equipment that they have at the LAN edge even though they may not be under any kind of an upgrade cycle or anything like that or is this really going to be an upgrade cycle kind of opportunity.

Hitesh Sheth

I think there are two points to that, first of all certainly as far as any Greenfield deployment is concerned, it’s a very logical thing for the customer to go, “You know what I have four points for office, I need no more than 2.4,” as an example. I would suggest that we don’t equate right sizing to what the customer is going to do with the employee population. Really what happens with right sizing is that any time there’s a refresh cycle for edge switching which as you know a tremendous spend that goes on every year regardless of the market conditions so to speak, now the customers every time they look at the fresh they will complete reevaluate what that spending should look like and more often than not chose to spend a lot less than they have historically.

Dominic P. Orr

Also actually we do see a certain number of facility projects related to either redistribution or reduction of human resources. When you do major restructuring, organization changes, business model changes, you actually invariable tie it back to some kind of facility reduction, consolidation and so on and those are also a subset of the opportunity.

Operator

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

Sanjiv Wadhwani – Stifel Nicolaus & Company

Two quick questions, just given the pickup in demand from outside your core verticals, I’m just trying to confirm education, healthcare and government, are they still 50% or has that dropped? Any sort of metrics surrounding that would be helpful. Then, the virtual branch office products, are you sort of willing to share any metric of how that’s doing in terms of percentage of revenues, any color on that would be helpful also.

Dominic P. Orr

A bit of correction here, I think we never said those three verticals made up 50%. What we did say in an earlier call was that each one of those verticals in one given quarter some vertical goes between 10% and 20% and some quarters some verticals go above and below. We continue to have exceeding the high win rate in our core verticals those three that you mentioned particular in education not only in high education now with respect to K-12, we continue to have success with the large hospital complex and the federal programs continue to be strong.

Steffan Tomlinson

As far as VBN is concerned we highlighted in our preferred comments a couple of initial wins with VBN when you look at VBN as a contributor to the overall pipeline it continues to grow. As we’ve stated in prior quarters the VBN initiative along with rightsizing quite frankly, we really expect to contribute in a meaningful way in the second half of our fiscal year 2010.

Sanjiv Wadhwani – Stifel Nicolaus & Company

Just as a follow up quickly for you Steffan, the large education deal from Australia did it contribute to revenues in the October quarter?

Steffan Tomlinson

It did. It absolutely did. That project is on track getting very good feedback.

Operator

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

Bill Choi – Jefferies & Company

Can you explain what might be happening here on a regional basis? By my calculation certainly international is 50% roughly, domestic was down 10%, can you talk about some of the dynamics and as far as that big deal in Australia was concerned, it was a multi quarter project, what percentage are we done with that and when do we expect that to stop contributing to revenue? Another topic if I may is really partnerships here, healthcare Perot Healthcare has been a good partner for you I guess in the past, can you just update us on the progress of partnerships and your views on partnerships versus OEMs.

Steffan Tomlinson

On a regional basis, you’re right revenues from international were more robust than domestic but when we look at it on a sales momentum standpoint and we look at bookings, we saw very strong bookings demand across all our major theaters which was very encouraging. Regarding the Australian deal, as we said in prior calls multi deal in the press releases that were issues, that roll out is suppose to go through calendar Q1 of 2010. We’re on track, as I mentioned to Sanjiv in the prior question we did recognize some revenue in the quarter from the Australian deal and it still remains a multi quarter distributor to the company but everything is on track.

Bill Choi – Jefferies & Company

What about the sequential decline in the US, can you explain that?

Steffan Tomlinson

It’s more of a timing issue than anything else. But, I’ll tell you that domestic sales from a booking standpoint where robust. Dominic do you want to talk about healthcare and Perot?

Dominic P. Orr

I think Perot, yes we have some good collaboration but the Dell Perot deal is not closed yet. I was closed that it would not be closed until early next year so they still operate as two separate companies so nothing has changed.

Operator

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

Ryan Hutchinson – Lazard Capital Markets

First off, just a question on the deferred revenue balance, it’s up again by roughly $6 million, 15% sequentially. Last quarter you ended with about $11 million in product deferred that was highlighted in your 10K filing. I guess the question is can you provide some color around that Steffan and perhaps even roughly where that number falls out when you do file the quarterly report?

Steffan Tomlinson

Sure, total short term deferred revenues is $40 million for the quarter. Of that about $16.9 million is in product and $23.1 million is in support so we had a growth in products deferred revenue of $5.4 million which was a nice healthy increase. This goes back to the commentary we’ve made around winning multi quarter deals and again, just as a refresher, if a customer has acceptance criteria to a deal that will put the deal in to deferred revenues or we have partners and customers that may be on a cash basis, that gets put in to deferred revenue. There are a mix of things that go in to it but the fact that we’ve had growth in short term deferred revenue I view it as a positive.

Ryan Hutchinson – Lazard Capital Markets

Just to follow up on that, I assume you’ve pulled down off of some of that in the most recent quarter and then it back filled and you still resulted in a increase here of over $5 million.

Steffan Tomlinson

That would be an accurate statement.

Ryan Hutchinson – Lazard Capital Markets

Then finally and I’ll jump back in the queue here, just on market share, when you look at your closest competitor, obviously they’ve had trouble in prior quarters but it was up quite a bit, over 30% quarter-over-quarter, obviously you’ve had a great quarter as well but certainly below that number. So, maybe just help us understand the differences between the two.

Dominic P. Orr

Well, it’s sort of like aligning the fiscal quarter with the calendar quarter on which basis the industry numbers are derived. Obviously, if you look at the same competitor as you referred to the last four quarters compared to us, we grew double digits every quarter year-over-year, that competitor shrank for three of the four quarters year-over-year and for the one quarter they grew, they grew in single digits. So, I think I will be very happy with that statistic going forward.

Operator

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

Rohit Chopra – Wedbush Morgan Securities, Inc.

A couple of questions here, can you talk about deal sizes and order sizes this quarter if they trended up with this quarter or flat with last quarter? I remember last quarter it was significantly up as far as the trajectory of the deal sizes? The other question was I was wondering, we talked a little bit about international, I think there were a few questions asked about it but can you talk a little bit about Europe and where you’re seeing strength and weaknesses over there please.

Steffan Tomlinson

There has been no meaningful change on a sequential basis in terms of deals size or order size. We’re actually pleased with that given the fact that Q4 we saw some nice improvement. So, for commentary on Europe I’ll turn it over to Dom.

Dominic P. Orr

Overall geographically from a bookings perspective in the last quarter we started the quarter seeing momentum in North America and returned to momentum in Asia Pac and Europe, Middle East, Africa was the last year that it has come back on line and they were coming back on strongly towards the tail end of the quarter but it looks like coming in to this quarter that momentum continues. It looks like the south and central Europe is still a little bit weak.

Operator

Your next question comes from Jeffrey Kvaal – Barclays Capital Market.

Jeffrey Kvaal – Barclays Capital Market

I was wondering, the deferred revenue balance seems to be increasing and as you said Steffan it was increasing at a pretty healthy pace but not necessarily turning in to revenue growth as rapidly as one might think. Could you help us reconcile the different growth rates there?

Steffan Tomlinson

Just as a quick refresher, I’m sure you know that deferred revenue in the short term category isn’t for one quarter out it’s for a 12 month period. So, we are seeing large deals that have come in some of which are contributing to the deferred revenue line but that revenue by definition will come out of the short term deferred category within 12 months. I think that hopefully will answer the question for you.

Operator

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

Greg Mesniaeff – Needham & Company

Steffan I was wondering if you can give us some color on the marketing agreement that was signed with Motorola in the wake of the litigation settlement and how that could potentially impact your sales and marketing expense going forward?

Steffan Tomlinson

The settlement agreement where we ended up paying $19.75 million was a onetime expense that was accounted for in our fiscal Q1. There’s no ongoing expenses related to that settlement. I want to make sure that’s clear.

Dominic P. Orr

Let me explain a little bit further, this settlement is not about the law suit per say, it is a cross licensing of the complete portfolio. Both companies are in the wireless LAN area which Motorola has quite a number of [inaudible] in this area. The second point I want to take an opportunity to clarify is we continue to believe we have not infringed and we would prevail should there be a trial. The reason that we are taking this approach that you’ve seen, in the last hour we explained to you how we are winning in the marketplace, how we are innovating and it is an opportunity because I feel if my management team doesn’t have to be continued to be dragged down in this legal issue we believe that we can pretty much [inaudible] the value by focusing on winning in the market and winning in innovation.

We’ll do that through this arrangement by which by the way Motorola obviously has very proud mobility portfolio so we continue to be competing in the wireless LAN space. I think we hear it loud and clear from our large customers that it will be actually to the benefit of us and to the industry and Motorola for us to cooperate within the broad mobility system between us and non-wireless LAN part of Motorola. That’s really the framework of our settlement.

Greg Mesniaeff – Needham & Company

I guess my question was will the cross licensing agreement lead to potentially other avenues of cooperation or joint marketing that could potentially impact your sales and marketing expense levels going forward?

Dominic P. Orr

I would say part of the ongoing discussions I do not feel we are ready to address this particular point in detail yet.

Operator

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

Blaine Carroll – FTN Equity Capital Markets

Dominic, the commentary that you had about improvement in the general enterprise, I was wondering if you could expand on that a little bit more and is it orders, is it revenue, is it activity, just what do you define as the improvement there? Then Steffan, nice job with generating cash and the cash balance and I guess the question is at what level of cash, and I understand you have to pay the $20 million out to Mot but are you comfortable with the cash balance and when do you start looking for alternatives for the cash?

Steffan Tomlinson

We’re laser focused on generating cash flow from operations and free cash flow. We feel very comfortable with the balances as they stand. As we’ve said in the past, we’ve always wanted to keep at minimum $100 million as a low threshold. Obviously, we’ve been well above that. As far as looking at alternatives, at this point we are still focused on building that cash position and we’re not ready to really discuss any plans on either uses of cash or buybacks, etc. So, I think that we’re again, just pleased with the improvement in cash and we’re going to continue to be focused on building that cash balance.

Dominic P. Orr

Regarding the successes we’re starting to see, in general that’s outside of our core verticals, it is generally in the area of winning as the next generation provider in either the access or wireless standards and the nature of this larger company is that once you get certified accepted as the standard and procurement vehicle then it will be up to the various business units and divisions as an on needed basis will start the procurement. The focus there is really to have a better large number of accounts in the pipeline and increasing the win ratio and the design wins and cultivate the account as the mobility project, the LAN right sizing project and the virtual networking projects proceed as the funding becomes available. It’s design wins that I’m focusing on.

Operator

Ladies and gentlemen that does conclude today’s question and answer session. At this time I’d like to turn the call back to Dominic Orr, Chief Executive Officer.

Dominic P. Orr

Again, we thank you for being on the call today. I’m very pleased with our execution in Q1 and optimistic about our outlook for Q2. While we are realistic about how hard it is to grow in the current market we are proud of our growth and execution over the past 12 months. We remain focused on positioning ourselves to take advantage of the opportunity ahead of us and the long term value of our growing customer base is very encouraging. Finally, to all Aruba employees I would like to take this opportunity to thank you for your dedication, your hard work and your creativity. To our customers and partners, we appreciate your loyalty and support and to all our competitors who have been on this call, with great humility and respect we look forward to seeing you again.

Operator

Ladies and gentlemen that does conclude today’s Aruba Networks first quarter 2010 earnings conference call. If you’d like to listen to a replay of today’s call please dial 303-590-3030 or 1-800-406-7325 and enter the pass code 4180658. Once again those numbers are 303-590-3030 or 1-800-406-7325 and enter the pass code 4180658. Thank you for your participation you may now disconnect.

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Source: Aruba Networks, Inc. F1Q10 (QTR End 10/31/09) Earnings Call Transcript
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