Aruba Networks' (ARUN) CEO Dominic Orr on Q3 2014 Results - Earnings Call Transcript

May.22.14 | About: Aruba Networks, (ARUN)

Aruba Networks (NASDAQ:ARUN)

Q3 2014 Earnings Conference Call

May 22, 2014 4:30 PM ET

Executives

Maria Riley - IR, The Blueshirt Group

Dominic Orr - President and CEO

Keerti Melkote - Co-Founder, Chief Technology Officer

Mike Galvin - Chief Financial Officer

Analysts

Ryan Hutchinson - Pacific Crest Securities

Mark Sue - RBC Capital Markets

Erik Suppiger - JMP Securities

Jeff Kvaal - Northland Securities

Jason Ader - William Blair

George Notter - Jefferies

George Iwanyc – Oppenheimer

Kent Schofield - Goldman Sachs

Operator

Good afternoon. My name is Tatiana, and I will be your conference operator today. At this time, I would like to welcome everyone to the Aruba Networks Q3 Earnings Announcements Conference Call. (Operator Instructions) Thank you.

Maria Riley with The Blueshirt Group, you may begin your conference.

Maria Riley

Good afternoon, and thank you for joining us on today's conference call to discuss Aruba Networks’ third quarter of fiscal year 2014 results. This call is also being broadcast live over the web and can be accessed in the Investor Relations section of the Aruba website.

Joining me 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 third quarter of fiscal 2014. If you'd like a copy of the release, you can access it in the News Releases section of the company's website.

I'd 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 our business and financial outlook, including our anticipated growth rate, operating margin and target gross margin. 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. We undertake no obligation to update these statements after this call. For a more detailed description of these risks and uncertainties, please refer to our most recent report on Form 10-K filed with the SEC on September 24, 2013, as well as our most recent Form 10-Q filed with the SEC on March 6, 2014, in addition to our earnings release posted a few minutes ago on our website.

Also, please note that unless otherwise specifically noted, all financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the Supplementary Materials section of our IR website, as well as in our press release table.

Lastly, I'd like to announce our planned attendance at the following conferences: The Cowen Annual TMT Conference in New York City on May 29; BofA Merrill Lynch Tech Conference on June 3 in San Francisco, and the William Blair Growth Stock Conference in Chicago on June 10. We look forward to seeing you there.

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

Dominic Orr

Thank you, Maria. Good afternoon and thank you for joining us to review our fiscal Q3 results.

I am excited to report, we delivered a record quarter, growing revenue 28% year-over-year to $188.8 million, well above our guidance and achieving the goal we set nine months ago to return to over 20% year over year growth by the second half of fiscal 2014.

We believe our exceptional top line performance this quarter reflects the strength of our differentiated architecture and product portfolio and the incremental investment we made in extending our sales and channel capacity.

Momentum accelerated both sequentially and year over year. We performed well across a broad set of verticals. And in an encouraging sign for market share gains, we saw particular strength in enterprise. We’re seeing Aruba’s stories and value proposition resonate in all levels of our customer’s organizations, extending to vice president and CIO levels.

These executives are increasingly asking us how they can deliver a secure mobile environment for the rapidly emerging GenMobile. They want to know how their IT organization can be a key partner for the business to attract and retain this talent.

Our role is to introduce the innovations to make this business outcome easy and affordable. Mobility is about data and information in the air. So we asked our customers if they believe the air is stable, secure, simple and smart enough to meet GenMobile requirement.

I will now discuss our business performance this quarter in the context of this four Aruba value proposition. First, we asked our customers if the air is stable enough to handle the proliferation of mobile users, their multiplying devices and their applications.

This is all about 11ac. We beat our competitors to market with our 11ac solution and the momentum has continued even as others have tried to catch up. In Q3, demand for 11ac solution exceeded our expectations and outpaced our forecast. Our flagship 11ac access point 225 is the fastest ramping access point in Aruba’s history. And we believe we have captured and gained market share.

In Q3, we took 11ac beyond our traditional early adopter companies to the broad enterprise market and fast follow-on market such as K-12. We worked hard with this momentum as we believe these early design wins represented tremendous long term opportunity to generate repeat business as customers expanded AC’s footprint and implement additional Aruba solutions.

We also asked customers if the air is secure enough to keep up with the new realities of BYOD, cloud, and mobile. Our ClearPass access management platform enables self-service help desk for employees and guests to securely connect to their business.

ClearPass is also addressing an upgrade cycle where customers are looking to replace end-of-life authentication product from our largest competitor. Driven by this trend, ClearPass bookings again grew in the high double-digit year-over-year. Our next step is to integrate with top MDM vendors, so customers can look to a single approach to manage device access, policy and control.

We also asked customers if the air is simple. Is deploying pervasive wireless to support mobile application easy for IT? On this front, Aruba instant bookings again grew in excess of 100% year over year. We believe we are gaining significant shares in the mid market and we are excited to see this business scale as we ramp up our small to medium enterprise channel.

Finally, we asked our customers if the air is smart. This is about Aruba’s core differentiation, leveraging layer 4 to 7 user device application and location context to bring to life new employee and customer mobile experiences. Here we’re starting to have discussions that bridge IT organizations with the emerging role of a chief digital officer who is focused on delivering such experiences.

There are two key areas to highlight on the smart air front. The first is mobile customer engagement solutions for public facing enterprises where we are seeing strong interest. Across a variety of verticals, marketing and technology are converging and delivering deeper levels of customer engagement and loyalty.

We entered into a number of new engagements for our solutions during the quarter, including a gaming management company that deploy the Meridian customer engagement application and an international cruise line.

The second is the all wireless workplace which is particularly exciting for Aruba as it strikes at the heart of our largest competitor’s latency portfolio of switching IP telephony and expensive video conferencing system. Our collaboration with Microsoft Lync significantly alters the networking infrastructure landscape, increasing the need for 11ac wireless. We are seeing this all wireless workplace effect across industries, but particularly in larger enterprise deals.

Notable wins include a multinational technology company, a major financial service firm, a leading cloud software company and a global management consulting and IT services company.

In summary, Q3 was a pivotal quarter for Aruba. We executed successfully on our sales expansion plan. Our new hires are meeting our productivity expectations, our headstart in 11ac gives us a front-runner position.

Finally, Q3 was about winning and grabbing market share. I want to thank the entire Aruba team, including our employees and partners for all their hard work.

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

Mike Galvin

Thank you, Dom. In Q3 ’14 total revenue was $188.8 million, representing an increase of 7% sequentially and 28% year-over-year. Product revenue of $155.2 million increased 9% sequentially and 28% year-over-year.

As we mentioned last quarter, our Q2 ’14 services revenue included a large professional services engagement which was not going to repeat in Q3. With that context, professional services and support revenue of $33.6 million declined 3% sequentially but grew a strong 29% year-over-year.

On a [pure] [ph] revenue basis we showed a balanced sequential and year-on-year growth across the geographies. Third quarter U.S. revenue grew 5% sequentially and 31% year-over-year, representing 63% of total Q3 ’14 revenue.

EMEA revenue increased 12% sequentially and 34% year-over-year, representing 20% of total revenue. Asia Pacific grew 11% sequentially and 19% year over year, representing 14% of total revenue.

Total non-GAAP gross margin was 70.5% in Q3 compared with 72.2% in Q2 ‘14 and 72.3% in Q3 ’13. Q3 non-GAAP product gross margin was 69.4% compared with 71.6% in the prior quarter and 71.5% a year ago. The decrease in product gross margin was driven primarily by two factors in the quarter, both of which we believe are positive factors that speak to the success of our 11ac and switch product lines.

First, 11ac demand exceeded our expectations across all segments of the market. In Q3, this demand extended into the value segment of the market. We made the decision to win this incremental business using our premium AP-225 access point, ahead of this quarter’s introduction of our lower-priced AP-205.

For Q4 and beyond, we now have 11ac portfolio appropriately priced and cost configured to win both the premium and the value segments of the market at good gross margins.

The second gross margin factor in the quarter was better than anticipated switch revenue, driven by our customers’ desire to deploy our integrated wireless and wired access platform. And as I have said before, our switch revenue was at the lower end of our gross margin profile.

Looking forward, our target gross margin range remains 71% to 73%. We expect Q4 gross margin to improve to the lower end of that range as volume ramps for our new AP-205 access point. We expect to see further improvement by Q1 ’15.

Q3 non-GAAP services gross margin was 75.6% compared with 74.8% in the prior quarter and 76% in the same period a year ago and consistent with our recent historical ranges.

Q3 non-GAAP research and development expense was $30.6 million. As a percentage of revenue, R&D decreased to 16.2% compared with 17% in the prior quarter and a year ago.

Non-GAAP sales and marketing expense was $59.1 million in Q3. As a percentage of revenue, sales and marketing expense was 31.3%, down from 32.9% in the prior quarter. We will continue to invest in our go-to-market engine where we see the best return on net investment, adding topline growth while improving our leverage as we showed in Q3.

Non-GAAP G&A expense was $11.1 million in Q3. As a percentage of revenue, G&A expense in Q3 ‘14 was 5.9% compared to 5.7% in Q2 ’14. Our G&A expense as a percentage of revenue can vary quarter to quarter based on the timing of legal, accounting, tax and compliance fees. We expect G&A expense to continue to perform in our target range of 5% to 6%.

Total headcount at the end of April was 1755 compared to 1687 at the end of Q2, an increase of 68 heads. While we continued to invest in our go to market engine, we invested in headcount across the organization per our stated plan for the second half of FY ’14.

In total, Q3 non-GAAP operating expenses $100.8 million or 53.4% of revenue, down from 55.6% of revenue in Q2 ’14. We made strong progress in the quarter improving our leverage and moving closer to our stated operating goals.

In Q3 ’14, our non-GAAP operating profit was $32.3 million or 17.1% of revenue compared with 16.7% in Q2 ‘14 and 16.5% in Q3 ’13. Consistent with our guidance, we expect to realize continued operating leverage to achieve 20% non-GAAP operating margin in Q4 ’14.

Our non-GAAP tax rate for the quarter was 29.3%. As a reminder, our overall tax rate is subject to change, including the projected geographic mix of the company's revenue as well as changes resulting from any new U.S. or international regulations or interpretations. Our target range remains 28% to 30% for FY ’14.

Non-GAAP net income for the quarter was $22.8 million or $0.20 per diluted share. This compares to $21.4 million or $0.18 per diluted share in Q2 ‘14 and $14 million or $0.11 per diluted share in Q3 ’13.

On a GAAP basis, our net loss was $6.4 million or $0.06 per share compared with a Q2 ’14 net loss of $10.7 million or $0.10 per share and a Q3 ‘13 net loss of $20.2 million or $0.18 per share.

A reconciliation of both GAAP and non-GAAP information is contained in our press release issued this afternoon and also available in the supplemental financial information located on the front page of our IR website.

Now let me turn to the balance sheet. Cash and short-term investments at the end of April were $300.2 million, an increase of $21.9 million from the prior quarter.

Cash flow from operations was $27.4 million during the quarter. Once again we were active in our stock buyback program during the quarter, purchasing 950,000 shares at a total purchase price of $19.5 million. The weighted-average shares outstanding impact of the buyback on the quarter’s diluted share count was approximately 527,000 shares.

At the end of the quarter we had approximately 181 million remaining on our share repurchase plan. We will continue to evaluate our capital structure and cash needs and repurchase our stock when those variables are aligned.

We ended Q3 with $95.3 million of accounts receivable, an increase of $13.2 million from Q2 ’14. Days sales outstanding were 45 days compared with 42 days in Q2 ’14 and 43 days in Q3 ’13. Our target range for DSO remains 45 to 55 days.

Total deferred revenue of $178.5 million increased 2% from Q2 ‘14 and was up 51% from Q3 ’13. Short-term deferred revenue of $138.7 million increased 4% sequentially and 55% year-over-year. Our deferred revenue balances primarily consist of inventory stocking demand by our value added distributors, annual maintenance contracts from our customers and transactions which have certain acceptance or deployment provisions and will be recognized as revenue in the future.

While all three factors contributed the year-on-year increase, the largest dollar factor is increased inventory stocking orders from our distributors. As a reminder, we recognize revenue on sell-through by our distributors to end customers. Aruba’s inventory totaled $36.9 million at the end of Q3, a decrease of $0.5 million from the end of Q2.

Moving on to guidance. We're pleased by our continued execution and momentum and we're encouraged by the dynamics we see in the market. In Q4, we expect revenue to be in the range of $192 million to $196 million, an increase of 2% to 4% sequentially and 25% to 28% year-over-year. Estimating 117 million shares on a diluted basis, we expect non-GAAP EPS to be approximately $0.22 to $0.23 per share.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Ryan Hutchinson from Pacific Crest Securities.

Ryan Hutchinson - Pacific Crest Securities

So I guess the question is on the gross margins. This is a biggest revenue beat [ph] I have seen in a number of quarters and understand the reasons for the decline due to the value segment as well as the switch. But just add some color around that. Can you provide some information on what you mean with respect to the value segment of the market? And then two, what the switching margins are in the relative mix compared to both of those that will be helpful?

Mike Galvin

Yes, Ryan, so the value segment of the market, what we are talking about there are some of the lower price points in the market. Dom mentioned in his opening paragraphs that K-12 was part of that, that can also include state and local government or aspects of SME. So that’s what we’re talking about there.

And then your question on switching, I think was, what were the margins – and what was the second part of it?

Ryan Hutchinson - Pacific Crest Securities

Yes, just relative to the rest of the business, what do the switch margins look like compared to the rest of the business?

Mike Galvin

Okay. They are definitely on the lower end of our range of our company profile, and historically I have said several times that they are in the 50% to 60% range as a normal part of our business.

Keerti Melkote

And Ryan, on the value segment, we actually have a new product AP-205 we talked about which is optimized for that portion of the market. Typically what we see in the access point in a market is there is a premium segment which is priced around the 12.95 list price and that’s the AP 225. And in the value segment the pricing is under 6.95 price point. We went up to the value segment of the market with a premium product and we’re going to be the first to market with a product that is optimized for the value segment and we intend to ramp this in this quarter.

Dominic Orr

And this is Dom, on the follow-on, well, traditionally we see when the access point move to a new technology, it takes a certain number of quarters to move the adoptions from the more early adopter segment like high education and high-tech campuses. What we observed this quarter was that the 11ac adoption curve actually moved faster to the follow up segment and we made a decision that we -- because of our strong AC momentum we don't want to let a quarter go by before our value priced access point come and we want to continue that momentum and that contributed to the financial results that you saw.

Ryan Hutchinson - Pacific Crest Securities

And then as a follow up to that, I mean obviously when you gave the guidance, it didn’t incorporate that. So what changed and then what gives you the confidence? I think in your prepared remarks you talked about it going back to historicals and then more importantly increasing, I believe you said thereafter. So just trying to understand that, because I think that's the biggest question that investors have tonight.

Mike Galvin

Yes, so Ryan, first of all, we feel very good about the results both the top and bottom line which we did guide to. In a given quarter, our pipeline is 3x the size of the business that we’re going to close in any given quarter. And so the reality is some things do happen obviously month three things is always the little bit heavier weighted month in the quarter. And so dynamics come through and frankly the AC demand was -- has been strong all along and when that lower segment came up and strategic deals we wanted to win, it was a little bit ahead but slightly ahead of that 205 access point. And so that was the dynamic and some of that evolved during the quarter. But again we feel good about the bottom line and the top line.

Dominic Orr

And I just want to make sure it is clear. Independent of this extra opportunity we went after, we would have strongly deepened our own guidance in all metrics of the P&L and this is strictly a decision for us to go aggressive to go capture – to leverage our 11ac momentum to extend and capture the extra demand that we are seeing that is emerging from the adjacent market. And the confidence that we have on the gross margin profile is because the 205 is available to order and we will be shipping well within this Q4. So we feel very competitive on price, capability and as well as gross margin with this new segment of the business. And that coupled with our investment in the mid tier channel and our beginning ramp with the new channel distributor partner in this space like Ingram Micro give us the full confidence this will be an incrementally and equally would grow our gross margin segment of the business that we are expanding into.

Operator

Your next one comes from the line of Mark Sue from RBC Capital Markets.

Mark Sue - RBC Capital Markets

Thank you. Gentlemen, if I could ask why wouldn't a premium segment customer not purchase a value product as you move into that market? How do you keep that segmentation? And then if I look at the product gross margins of the 205 series, how should we think about that as we look into the overall corporate average? Should we, for example, see a quick snapback in overall gross margins as you roll out the volumes of the 205 series?

Keerti Melkote

Sure, Mark, I can take the first one and I will have actually Mike take the second one. On the differentiation front, the 225 is really designed for high-performance, very high performance, very high density type deployments. And typically you will see these in large enterprises, venues like stadiums, airport and so on and as well as higher ed classrooms where you have hundreds of students in a place. Where you don't see this is typically in K-12 classrooms and retail stores, warehouses where the densities are far lower and coverage is probably more important. And those segments is where the value segment access point is going to be the actual product and for the higher end, it will be the 225. By the way, it is the same story when we roll out 11n, so it’s now different.

And from a software perspective more importantly, you do get the capabilities like ClientMatch and the overall manageability proposition that we differentiate on is equally applicable to both the premium segment and the value segment and that's why we expect to do very well even in the value segment.

Mark Sue - RBC Capital Markets

Would you say that the market, that value segment is growing faster than the regular traditional enterprise market?

Dominic Orr

I would say that the value segment is where we traditionally play in very strong and gaining market share. Traditionally we have not been as aggressive in this phase of the technology curve to attack the value segment. But we’re leveraging of our very, very strong momentum to gain market share by being more aggressive with couple of the go-to-market efforts that we have launched. So that that is a incremental market share capture plan.

Mike Galvin

Yeah, and Mark, just some data on the 205. So the 205 is a healthy jump in gross margin from the 225, priced appropriately into the segment, the segment it’s going after. And as I mentioned in my opening remarks, that will ramp during this quarter. So it will still be a bit of a transition quarter in Q4, but then fully out there for Q1 ’15.

And just a thought on the overall AC line versus N, I mean if you look back on our N line, we actually first came out with the 125 which is the analogy to the 225, the 205 is comparable to 105 and then we have more coming. And what N did on that evolution for our access points, those gross margins got better with every access point. And the 105 was a stair-step up from the 225. So that’s part of the evolution that went on with N and as our product management teams had scoped out kind of the full AC transition when that full line of access points is out there, that basically they map it to -- really a on-target or in line gross margin profile as the N.

Dominic Orr

And if your question is whether some of our traditional core vertical customer with the large campus or so on will switch to from the 225 to 205, the answer is no. It’s very clearly technical.

Operator

Your next question comes from the line of Erik Suppiger from JMP Securities.

Erik Suppiger - JMP Securities

Wanted to just understand who is it that was addressing the AC market where you didn’t want to lose opportunities, was that Cisco, was it 2700, or was that some of the cloud providers like Aerohive, what was the dynamics behind this?

Dominic Orr

Well, the dynamic is basically – it’s not really any new competitor in the 11ac landscape, it’s competitors that we beat with 11n, now we beat with 11ac. So that’s not an issue. The issue is just that we are seeing that 11ac adoption curve from the early adopter segment is moving a couple of quarters earlier than we expected to the general market and we want to make sure and we capture that – our early adopter market momentum into the mainstream market. That's really the main [inaudible].

Mike Galvin

It hit a little bit ahead of our roadmap basically.

Dominic Orr

And from a competitive perspective, there is no one at this price point in the market right now. We chose to enter the market, started to see the demand. We started to see the demand for 11ac. We otherwise would have fulfilled it with 11n but customers were asking for 11ac for this, so we decided to go after the segment with our premium product line ahead of the AP-205. And as we said earlier, we’re going to be attacking this market with the 205 moving forward.

It is primarily us being very responsive as we see the early demand getting more widespread and we want to make sure that we keep the same leadership in the adjacent N [ph].

Erik Suppiger - JMP Securities

Cisco is reporting their AC 3700 product which is their high end product, it’s their fastest growing access point in the history. And then when they [ph] can introduce the 2700, have you seen any competitive changes and why they have – Cisco will move out there, are you suggesting that did not play a factor in [inaudible]?

Dominic Orr

I think our largest competitor’s growth or lack thereof speaks for itself. I think if there is any competition, probably it is internal to themselves. And as far as we are concerned, our 11ac platform continues to win great review and we expect to continue to win market share, both on top of our stable air capability and our smart air capability and secure air capability. So we are not seeing any new competitive dynamics with their product mix. Whatever they say, I think is internal to themselves.

Erik Suppiger - JMP Securities

Okay and lastly, just on the switching revenues, can you give us some perspective on how we might want to think of that as a growth driver? Is that something that is going to materially grow faster than your regular revenue, is that something kind of the opportunity of ClearPass and Instant or is that something that’s going to remain your relatively small segment of your revenues?

Dominic Orr

I would say the whole switching discussion has to be in light of the context of the forward looking or enterprise offers where the customers [indiscernible] is not looking at wireless as an overlay to the wire infrastructure but it is truly building a multimedia mobile network where wireless is key – the primary component and supported by a FTN oriented open campus switching infrastructure and those of you who have attended our analyst day in Las Vegas you probably remember we have a [clock] industry, the initiative of open FTN switching campus partnership with Alcatel-Lucent, Arista, Brocade and Dell where Aruba’s smart air context within our control – is acting as the controller for the whole campus and in situation where customers still want to have the integrated management with AirWave and so on with Aruba products on the wired side, we obviously would like to provide the solution. But a lot of our pipeline in this rapidly growing all wireless office areas actually developed in conjunction with our aforementioned partners and that actually is becoming increasingly exciting area for the industry where the incumbent, the number one incumbent is really going to be in a more, less powerful position.

Mike Galvin

Yeah, Erik, and just a context on the switch business after Dom is, one thing we’ve said a lot over the last couple years is the switch is a follow-on part of our sales and it's not a leading part of the sale like the rest of the platforms. So it's fulfilling strategic needs to Aruba's WLAN customers and we have been selling the switch for a couple years now and sometimes there are very good strategic reasons with our customers to take some strategic deals on the switch side. Doesn’t happen every quarter but it happened this quarter, we had some instances of it.

Operator

The next one comes from the line of Jeff Kvaal from Northland.

Jeff Kvaal - Northland Securities

My first question is a clarification on the understanding of incremental revenue. It seems as though that the revenue is certainly ahead of expectations for both the April quarter and for the July quarter. The EPS though is generally in line with where the expectations were. So that suggests me that there is very little incremental operating income generated by the revenues that you chose to take late in the quarter, a commentary on that would be helpful. And then, secondarily could you help us understand what is happening with the channel inventory? Why is that higher than it has been? Is that sustainable or should we expect that to normalize over time?

Mike Galvin

Okay, yeah, hey Jeff. So on the leverage, again we delivered on the bottom line this quarter. Our guide next quarter is actually a slightly guide up on current consensus. So we feel good about where that's going. We’ve kind of laid out the gross margin, including what happens as we go over Q4 and then into Q1. So we feel good about the leverage and where the model is going. We feel good about the gross margin range and then what we're doing and driving on the OpEx side. So our goal and plans are to continue that.

On the channel inventory side, yeah, you’ve seen for probably, I don’t know the exact amount of quarters, but it’s definitely a year, year and a half where that growth has outpaced our revenue growth in most quarters. And really what's going on there is we’ve moved more of our channel to stocking distributors. So a bigger percentage of our accounts receivable, if you will, is going into stocking distributors. So as we take them on, for instance, a couple of quarters ago, we took on Ingram, right? So that becomes an incremental stocking distributor in the equation. So that is why the deferred revenue growth recently has outpaced the revenue growth. And just a reminder, that’s -- those distribution partners manage their inventory very tightly and we recognize on sell-through. So it's pretty straightforward.

Keerti Melkote

The incremental market share that we took, right now the market is in a transition from 11n to 11ac. And we see any customers that we get in this transition typically have a long tail as Dom talked about, right? So what we’re getting is the initial design wins with 11ac and we expect these customers to continue to buy the rest of our kit over time. So this represents very meaningful incremental revenue for us over time.

Jeff Kvaal - Northland Securities

Thank you, Keerti, thank you Mike.

Operator

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

Jason Ader - William Blair

When I look at the revenue guidance, Mike, for next quarter, I am assuming some slight uptick in service – the service line. It looks like the product side at least in the midpoint of your guidance would be up only slightly a couple percent sequentially. And July is your fiscal year-end quarter and it's typically a strong education buying seasonal. I am trying to understand, did you pull in some revenue in April and that's why because of these AC deals that you talked about and that’s why the July quarter’s sequential product growth would not be as maybe it’s been historically, can you help us understand that dynamic?

And then just as a follow-up, wanted to see if you could help us with percentage of your volume coming from AC, any kind of a ballpark there, I know you don’t give exact numbers. But just some, something to give us a sense.

Mike Galvin

Okay, yes, Jason, on the revenue guidance, a couple things, we feel good about the dollar increase of that guidance over current consensus. Obviously we feel good about the year-on-year growth rate. But we actually guided to almost that exact kind of dynamic this past Q3. And so hopefully we can go out and execute and do get things again in Q4, but we feel like it’s a prudent number to put out, there is good dollar raise above guidance and it’s good year-on-year growth.

Dominic Orr

And Jason, this is Dom. No, we did not pull in any revenue.

Jason Ader - William Blair

And then on the AC volumes?

Mike Galvin

Yeah, we don't have the explicit breakouts but I will say they are meaningful and they are ahead and we have been saying, they are a healthy chunk ahead of the 11n conversion pace. So it’s – they are meaningful contributors and it’s only going in one direction. So we expect that to continue.

Operator

Your next question comes from the line of George Notter from Jefferies.

George Notter - Jefferies

I wanted to ask also about gross margins. I guess I'm wondering if you got some ASP benefit again this quarter on 802.11ac. I would imagine that would have been a positive impact on gross margins. I guess I'm just wondering how pricing on APs as you make this transition, would have factored into the gross margin formula this quarter? And then same question for next quarter. I would imagine you expect that, that would be a tailwind in terms of margins?

Mike Galvin

Yeah, George, so we’ve had – it’s been a slight benefit on ASPs from AC. Obviously we talked about the selling into the value segment this quarter with the 225. But overall outside of that there has been a slight premium on ACs. And with our product management group, there's going to be the several more AC access points coming out over the next year and when they look at it overall they look at a pretty comparable over time, right, when it’s fully out there and deployed, a fairly comparable ASP, kind of COGS, gross margin picture, when it goes out there. The 205 is definitely good for that gross margin, as we get out of the shoot but that’s kind of the dynamic on it, short-term and longer-term.

George Notter - Jefferies

I guess I'm wondering if you look at the overall -- the presumption here is that the transition to AC is certainly happening faster than you anticipated. So I know there was a period there where you guys were talking about AC units having a 20% premium over 802.11n units. And I guess I would have imagined you'd be able to keep some of that premium longer as you go through the transition. Again, I understand that traditionally you guys wind up in the same place in terms of ASPs from the start of the transition to the end of a transition, but I guess I would have thought maybe you'd gotten some more help on gross margins this past quarter or two. So it sounds like in the end, because you're going downstream, doing more of the value stuff, net, net, the gross margin has trended down a bit here?

Dominic Orr

It’s actually – this is Dom – I guess what Mike was saying is that as we roll out – if you look into like a 8 to 10 quarter horizon, you true-up [ph] the different level of product, you will have a benefit with the right product at the right price point of a modest ASP gain and also as you mature your learning curve in the cost and volume side, like any new product, every quarter you will get efficiency out of your supply chain. And what we have seen actually for this last quarter, the market absorption curve is a bit ahead of the value, the supply-chain, cost optimization curve. And because the forecast is – the actual demand is so much ahead of forecast, you have to involve in some context for guiding cost and also try to burden the P&L a bit. But all those still to stabilize and as those factors stabilize we will get the margin back, set of factors [ph].

Operator

Due to time constraints, please only ask one question. The next one comes from the line of Ben Reitzes from Barclays.

Unidentified Analyst

Hi, this is Trevor in for Ben. I was wondering if you could discuss the Cloud Central offering and how that’s playing into the success of the Instant and then touch on how the Ingram Micro relationship is helping the ramp there and when we should expect to see that being a material driver?

Dominic Orr

So first of all, this is Dom. The Ingram Micro relationship is heading off to a very good start. I already set expectations several quarters ago, new market like this and with a new partner is going to take time to ramp. So while we are very positive about that, there is a lot more growth to come on that front. And also I want to highlight that Aruba Instant is very very uniquely positioned against anything in the marketplace and that’s because it is part of our core wireless LAN [ph] offering that you really can combine cloud based management versus virtual controller and a physical controller, hybrid control environment. So customer has a very flexible architectural fit, so the cloud management aspect is one element of the concerned [ph] application, and I will let Keerti to comment further on that.

Keerti Melkote

So Aruba Central is the newest way to manage Aruba Instant as Dom said. We have basically 3 ways to manage it. One is a standalone way with a virtual controller which is built in. We can manage Aruba Instant using AirWave which is an on-time management product. We've had that for a while. Aruba Central, we introduced a couple of quarters ago and it’s beginning to ramp. It’s the third way to manage Aruba Instant and across all these segments as Dom said and as we spoke, Aruba Instant is doing extremely well and it’s bringing incremental market share to us, which otherwise wouldn’t have had as we talked about before.

Dominic Orr

And architecture is very important part because as compared to our largest competitor, where you have two worlds that could never connect between the cloud management and on-premise management, but we have an architecture that lets you go back and forth, or even a hybrid combination, really powerful differentiator.

Operator

The next question comes from the line of George Iwanyc from Oppenheimer.

George Iwanyc – Oppenheimer

Thank you for taking my questions. So with the incremental market share that you expect to get from Instant and from the value segment, when you look at calendar 2015, do you see your mix shifting somewhat lower and over the next 12 months?

Dominic Orr

Obviously we would not like to comment on market share. We defer to the market share companies –

Mike Galvin

And keep in mind too as we’re talking about this, some things in the value segment we’ve sold into K-12 historically, we’ve sold into state local government historically, we just didn’t get caught a little short with the right product to sell into that market. So that’s a key part of this whole thing, right, is the roadmap was a little bit behind the demand and that’s turning out to be kind of the trend case for AC, it’s just – it’s moving faster along than we thought, but as Keerti said, we are the first out with that appropriately priced product.

George Iwanyc – Oppenheimer

And then just following up on that, when you look at the Wave 2 ac products coming out over the next year, is that still worked into your product roadmap and you don't anticipate a similar type of margin step back temporarily when that transition happens?

Dominic Orr

What transition you’re referring to –

Keerti Melkote

We expect Wave 2 products to come out again at the premium side of the market as we introduce them sometime next year and work its way further into the roadmap. It’s too early frankly to talk about gross margin considerations for Wave 2 to be honest with you. We expect -- typically for product transitions like those we start at the premium side and work our way down to the value side.

Dominic Orr

And the Wave 2 transition is not going to be happening like the way that we have seen because the Wave 2 transition requires a whole wiring infrastructure upgrade in the wiring closet and so that will be by definition a much more limited transition and well paced.

Operator

Your last question comes from the line of Kent Schofield from Goldman Sachs.

Kent Schofield - Goldman Sachs

Just to clarify, I think Mike mentioned the fact that we are going to work back to the low end of the gross margin guidance, the 71% to 73% for this next quarter and should start to see that to continue. We have been really focused on the access point transition here and the switches, I mean is there any other reasons outside of those two that we shouldn't be able to get back to the high end of the range in that October quarter?

Mike Galvin

Well I guess for a first statement is the other dynamics in the quarter, product mix, geographic mix, were in our normal quarterly fluctuations. And we guided 71% to 73% and we feel good about that range. And we talked a lot about the dynamics in that with the product mixes and the different make-ups but that’s the range we’ve guided to and we feel good about that.

Dominic Orr

And there is really no any other reason for us to believe that we will not be back into that range.

Kent Schofield - Goldman Sachs

And then maybe if I step back, Dom, you've been talking -- and Keerti, as well -- you've been talking a lot about the all-wireless workplace and how that's kind of bubbled back up recently. Could you just help us understand, I mean that was obviously a big push of yours, call it, two, three years back, as well; can you help us understand how much of your business today is getting driven by that all-wireless workplace maybe relative to what you saw two or three years ago and maybe some of the -- maybe some of what that's driven by with the AC and everything?

Keerti Melkote

Yeah, I can give you a qualitative assessment. I mean if you take a sampling of pretty much every customer discussion that we’re having lately, every one of them leads with this all wireless workplace conversation. And I think that’s a result of multiple things happening in the market. It is the device transition going from laptops to mobile devices. It is the workforce expectation, we talked about it in the context of the GenMobile workforce where the expectation is to stay connected wherever you are. And I think this has not gone blind in the CIO side, right? They look at their current infrastructure investment going on the desktop side, saying I am going to outfit my desktop with wired phones and desktop devices, only to not be used. So they want to right size that portion of the investment and as I said quantitatively, compared to 3 years ago a much higher percentage of conversations are leading with this all wireless workplace at discussion.

Dominic Orr

And what’s particularly encouraging is we're finding proportionally more of this discussion for the larger enterprise, for the Fortune 500, Global 2000 which is definitely a positive sign.

Operator

We don’t have time for any additional questions. So I will now pass the call over to Mr. Orr for closing remarks.

Dominic Orr

Well thank you. I like to once again thank our employees and partners to work so hard to deliver this exciting quarter. But I also want to thank all of you in the investment community who believe in us, who have the patience to stick with our plan and give us the room to get to the results that we achieved. We will continue to work on the plans that we articulated to you and we look forward to update you in our next quarter's and earnings call as well as in the financial conferences.

Operator

This concludes today’s conference call. You may now disconnect.

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Aruba Networks (ARUN): FQ3 EPS of $0.20 in-line. Revenue of $188.8M (+28.3% Y/Y) beats by $8M. Shares +4.7%.