Ruckus Wireless' (RKUS) CEO Selina Lo on Q2 2014 Results - Earnings Call Transcript

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 |  About: Ruckus Wireless (RKUS)
by: SA Transcripts

Ruckus Wireless, Inc (NYSE:RKUS)

Q2 2014 Earnings Conference Call

July 30, 2014 17:00 ET

Executives

Nicole Noutsios - Investor Relations

Selina Lo - President and Chief Executive Officer

Seamus Hennessy - Chief Financial Officer

Analysts

Simona Jankowski - Goldman Sachs

Tim Quillin - Stephens

Rich Valera - Needham & Company

Catharine Trebnick - Dougherty

Rajesh Ghai - Macquarie

Jeff Kvaal - Northland

Mark Sue - RBC Capital Markets

Matthew Hoffman - Mizuho

Kip Clifton - Deutsche Bank

Matt Lebo - Piper Jaffray

Mike Lin - Stifel

John Lucia - JMP Securities

Operator

Good afternoon. My name is Jay and I will be your conference operator today. At this time, I would like to welcome everyone to the Ruckus Wireless Second Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I would now like to introduce Ms. Nicole Noutsios, Investor Relations. You may begin.

Nicole Noutsios - Investor Relations

Thank you for joining us on today’s conference call to discuss Ruckus Wireless’ second quarter 2014 financial results. This call is also being broadcast live over the web and could be found on the Investor Relations section of our IR website. With me on today’s call are Selina Lo, our President and Chief Executive Officer; and Seamus Hennessy, our Chief Financial Officer.

Please note that certain remarks we make on the call constitute forward-looking statements. This includes statements related to the financial expectations for the third quarter of 2014 and future periods, growth drivers to the company’s business, the pace of new and repeat customer orders, growth in customer base, competition position, future customer demand, future customer deployments, future product offerings and future anticipated cash income tax expense.

Risks and uncertainties can cause actual results or events to differ materially from those anticipated in these forward-looking statements. This includes the risks and uncertainties described from time-to-time under the caption Risk Factors and elsewhere in our filings and reports to the U.S. Securities and Exchange Commission, such as our Annual Report on Form 10-K filed with the SEC on March 3, 2014 and our quarterly report on Form 10-Q filed with SEC on May 1, 2014. Our SEC filings are available on the IR web section of the website and on the SEC’s website.

All forward-looking statements made on this call are based on information available to the company as of today. Ruckus does not assume any obligation to update the forward-looking statements stated in this call as a result of new information, future events or changes in its expectations except as required by law. In addition, we will be presenting and discussing certain non-GAAP financial measures in this presentation. For reconciliation of these non-GAAP financial measures, the corresponding GAAP measures, please see today’s press release, which is posted on our website at www.ruckuswireless.com.

With that, I will turn the call over to Selina.

Selina Lo - President and Chief Executive Officer

Thank you. Thank you for joining us today. We are very pleased with our execution in the second quarter as we continue to capitalize on the market needs for carrier class Wi-Fi. We beat both revenue and EPS guidance as well as our margin expectations. Revenue was $81 million, above our revenue guidance of $78 million to $80 million. Non-GAAP gross margin was 70%, the highest in our industry and up from 68.5% in the prior quarter. Non-GAAP operating income grew 81.2% year-over-year with operating margin of 13.7%.

We continued to gain market share according to the most recent Dell'Oro Group report published in Q2 and solidify our number three share position in the total wireless LAN market, excluding SOHO. Momentum was strong across both our service provider and enterprise businesses. In the quarter, we added 10 new service provider customers bringing our total service provider customer base to approximately 170. We added approximately 3,900 new enterprise end-customers bringing our total enterprise end-customer base to over 40,000. We also saw strong repeat sales on our existing customers. Our carrier class Wi-Fi technology was key to a number of new wins and network expansion projects in Q2.

Let me give you three examples. One, an outdoor 802.11ac deployment by one of the leading telecommunications and multimedia providers in Indonesia looking to grow our nationwide wireless broadband network for public access and managed services. Our success against the larger competitor was based on our proven track record with outdoor deployment, superior interference management technology, scalability of our SCG controller and ease of deployment of our new T300 802.11ac outdoor at this point. Example two, a managed service deployment by a Tier 1 mobile carrier in Asia to supply public Wi-Fi service at 35 public train stations while offloading traffic from the cellular data networks. The deployment also includes SPoT, our Wi-Fi location service which enables the carrier to deliver (full power) analytics to the subway operator who will use it for passenger traffic management. SPoT was the primary differentiator that helped us in this – win this business from our top competitor and a large telecom supplier.

Example three, San Francisco Unified School District deployment of Ruckus Wi-Fi including our R700 11ac access point throughout their 144 schools to enable ubiquitous Wi-Fi services, including BYOD support for students and high-definition video streaming to iPads and classroom displays. We beat out a number of competitive solutions in the customers’ real life testing in superior coverage and density, reliability, robust matching capability and ease of management. The demand for our carriers Wi-Fi solutions amongst service providers and enterprises continues to be robust and a number of drivers will further increase our market momentum. First, the SEC recently approved $2 billion injection into the E-Rate fund for 2015 and 2016 designed to narrow the Wi-Fi gap in schools and public libraries. Education specifically K-12 has been one of our top two enterprise verticals over the last five years. And we are well positioned to benefit from this funding.

Second, municipalities are installing Wi-Fi infrastructure not only for public access but also to support Smart City initiatives. Only recently the City of San Jose announced extensions of their Ruckus power – Ruckus Wi-Fi service to San Jose international airport and San Jose convention center where they will also deploy Ruckus SPoT and SmartCell Insight of SCIs our analytic engine for it’s network user application and device analytics to drive a number of Smart City applications.

In addition to San Jose, the cities of San Francisco and Mountain View in California, Lincoln, Nebraska, Gunnison, Colorado, Travers City in Michigan and a number of others are in the process of building or extending their Ruckus based Smart City networks. With our technology leadership and experience in large scale outdoor Wi-Fi we are well positioned to benefit from the increasing focus on Smart Cities and the internet of thing.

On the product front, we have been rolling out new solutions to support our business and take advantage of new market trends. In Q2 we introduced our carrier class virtualized wireless LAN controller, the virtual SmartCell Gateway which we also called as vSCG. Targeting mobile network operators, cable MSOs and managed service providers the vSCG is among the first wireless LAN solutions that embraces the network functions virtualization or NFV architecture. NFV is backed by most leading carriers to reduce their hardware cost and increase flexibility and scalability. The vSCG can scale up to 10,000 access points per instance and is designed for multi-tenancy. We believe that there is nothing of similar scale and flexibility in the wireless LAN market to-date.

The vSCG is being trialed by some of the largest operators and managed service providers in world. For example, IBM is now deploying the vSCG at select service points in its smart cloud service infrastructure to offer cloud-based wireless LAN solutions to service providers and enterprises. Our enterprise general partners are also using the vSCGs to create managed wireless LAN service offering. This expands our enterprise market reach to smaller businesses and distributed enterprises with the large number of remote locations.

Our R700 11ac product sales were strong in the quarter. In addition, we announced the T300 series one of the lightest and smallest 11ac outdoor access points in the market. The performance, density and compact form factor of the T300 are ideal for outdoor applications including Smart Cities, urban hot zones, stadiums, amusement parks, train stations, resorts and enterprise campuses. In June we celebrated our 10th anniversary and I am very proud of our contribution in making Wi-Fi simpler, better and more prolific as it becomes an indispensable component of the mobile internet infrastructure.

The next decade for Ruckus is just beginning as more users become mobile and the internet of things ushers in the new era of connectivity for billions of network devices. I look forward to Ruckus seeing as a center of this connected universe.

Now, Seamus will give you more details on our financials.

Seamus Hennessy - Chief Financial Officer

Thank you, Selina. Thank you all for joining us today. Unless specifically noted otherwise, we are discussing all numbers except for revenue on a non-GAAP business, which excludes stock-based compensation, amortization of intangibles, employer taxes in connection with stock option exercises and related non-cash income tax expense. All share accounts will be on the diluted weighted average share basis. Full reconciliation of GAAP and non-GAAP information is contained in our financial results press release issued earlier today.

As Selina mentioned, we are very pleased with our financial results and the company had a strong quarter exceeding our revenue, gross margin and EPS guidance demonstrating operating leverage in our business. Q2 revenue was a record $81 million, an increase of 26.8% year-over-year and 7.9% sequentially and above our revenue guidance range of $78 million to $80 million. Product revenue was $75.4 million, up 26.3% year-over-year and 7.5% sequentially. Services revenue was $5.6 million, up 34.2% year-over-year and 13.5% sequentially.

Following the launch of the R700 in Q1, 11ac product sales were strong in the quarter. In addition, an increase in new customer – in addition to the increased new customer wins as Selena discussed earlier, we saw strong repeat sales among our existing customer base as they expanded their networks. Geographically, Americas revenue grew 23.6% year-over-year and 3.6% sequentially and represented 51.8% of total revenue. EMEA revenue grew 29% year-over-year and 6.8% sequentially and represented 26.4% of total revenue. Asia-Pacific revenue increased 32.1% year-over-year and 21.6% sequentially and represented 21.8% of total revenue and was primarily driven by strong growth in Japan and China. Three of our North American distributors accounted in total for 41.6% of revenue in Q2. We have a diversified customer end-user revenue base and we had no end customer that accounted for 10% or more of revenue in the quarter.

In Q2, gross margins were strong at 70%, up from 67.4% in the same quarter last year and up from 68.5% in the prior quarter. Product gross margin was 71%, up from 68.9% in the same quarter last year and up from 69.8% in the prior quarter. The strong product gross margin was driven by product mix economies of scale from manufacturing and by lower warranty provisions as a percentage of revenue versus prior quarters.

Our service gross margin was 56.6%, up from 46.2% in the same quarter last year and up from 49.3% in the prior quarter and was driven by strong growth in maintenance revenue. The planned investments in our support and services organizations in 2003 are now beginning to deliver improved service gross margins.

Q2 operating expenses were 45.6% or 56.2% of revenue compared to 57.8% of revenue in the same quarter last year and 58.8% of revenue in the prior quarter. Operating expenses were up 3.2% sequentially as a result of planned investments in research and development and sales and marketing, but offset the lower general and administration expenses in the quarter. As a reminder, our general and administration expenses in dollars and as a percentage of revenue can vary quarter-to-quarter based on timing of legal accounting tax and compliance fees.

Our operating income in Q2 was a record $11.1 million or up 13.7% of revenue compared to $6.1 million or 9.6% of revenue in the same quarter last year and $7.2 million or 9.7% of revenue in the prior quarter. We are extremely pleased with the progress we have made to improve our operating leverage and move closer to our stated long-term operating goals. As we look to the future, we will continue to strike a balance between improving profitability and investing in our future growth. We feel that continued strategic investments in R&D and sales and marketing would help the company drive long-term growth and maintain our competitive strength in the marketplace.

Before I discuss non-GAAP net income and earnings per share, let me discuss our tax rate. As discussed in our Q1 earnings call, our non-GAAP tax rate is forecasted to be approximately 37%, but our anticipated cash income tax rate is expected to be less than 5% as we do not expect to pay any federal or state income taxes in at least 2014 and 2015 due to NOLs resulting from stock compensation.

Going forward we are going to report non-GAAP net income and earnings per share based on the anticipated cash income tax rate. We believe that reporting non-GAAP net income and earnings per share based on our anticipated cash income tax rate better aligns with cash flows generated from operations. A full reconciliation of historical non-GAAP net income using anticipated cash income tax methods is included in our financial results press release issued earlier today.

In addition, we are in the planning stages for international tax structure and when we implement this structure we expect our long-term anticipated cash income tax rate to be in the low to mid-20% range. Our non-GAAP anticipated cash income tax rate was approximately 2% in Q2. Non-GAAP net income for the quarter based on the anticipated cash income tax rate was $10.8 million or $0.11 per diluted share compared with $5.8 million or $0.06 per diluted share in Q2 2013. We had 95 million weighted average shares outstanding on a non-GAAP diluted basis in Q2. For comparative purposes against Q2 guidance, our non-GAAP net income based on the non-GAAP tax rate of 37% was $7 million or $0.07 per diluted share compared with $4.7 million or $0.05 per diluted share in Q2 2013 and above our Q2 guidance of $0.04 to $0.05 per diluted share.

On a GAAP basis net income for the quarter was $1.4 million or $0.02 per diluted share compared with $0.7 million or $0.01per diluted share in Q2 2013. We had 92.4 million weighted average shares outstanding on the GAAP diluted basis in Q2. Our total headcount at the end of the quarter was 871, an increase of 21 from Q1.

Now turning to the balance sheet, we finished Q2 with cash, cash equivalents, short-term investments and restricted cash totaling $175.2 million, an increase of $13.9 million from the prior quarter. Cash provided by operations was $12.3 million. We ended Q2 with $26.1 million accounts payable and accrued liabilities, a sequential increase of $0.8 million, and accrued compensation of $14.1 million, a sequential increase of $0.5 million and with $58.7 million of accounts receivable, the sequential increase of $8.9 million. The average days sales outstanding was 66, above our target range of 50 to 60 days. The DSO increase was primarily driven by $9.1 million sequential increase in deferred revenue. The increase in deferred revenue was driven by an increase of $4.4 million deferred stock which can fluctuate quarter-to-quarter and $4.7 million primarily from deferred maintenance revenue.

Now let me turn to our guidance for the third quarter of 2014. We expect third quarter 2014 revenue to be in the range of $84 million to $86 million. We now expect to deliver revenue growth of 25% to 26% year-over-year, up from the 24% to 25% year-over-year growth rate we forecasted last quarter. We expect third quarter non-GAAP earnings using a 3% anticipated cash income tax rate to be $0.09 to $0.11 per share using approximately 95 million to 97 million weighted average shares outstanding on a non-GAAP diluted basis.

We expect gross margins to be within the range of 68% to 69%, and the operating margins in the range of 11 to 13 as we expect general and administration expenses in absolute dollars to be generally in line with the same quarter last year. Our 2014 forecast of non-GAAP anticipated cash income tax rate is expected to be approximately 3%.

I will open up the line for questions. Jay, please open up the line.

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now conduct a question-and-answer session. (Operator Instructions) Our first question comes from Simona Jankowski with Goldman Sachs. Your line is open.

Simona Jankowski - Goldman Sachs

Hi. Thanks very much. I wanted to ask you first about your operating margins which were a lot better than expected, Seamus you had previously talked about targeting your long-term model of 17% to 20% by the end of 2016 at the latest, is that still your expectation or are you seeing that a little sooner now?

Seamus Hennessy

We are not updating the timing of the long-term model on this call, but we are still – our goal is to drive towards that long-term model as soon as we possibly can, but we are not updating the long-term model, but we are very proud of the fact that we made significant progress in the most recent quarter.

Simona Jankowski - Goldman Sachs

Yes. I didn’t mean updating the long-term model, but just the timeline to when you think you might reach it?

Seamus Hennessy

No, we are not updating that on this call.

Simona Jankowski - Goldman Sachs

Okay. And then just maybe more qualitatively on that topic, so you have had a lot of new products here in the last couple of quarters, the 11ac product, the virtual SCG, SPoT, SAMs et cetera. Is this an above average pace of introduction? In other words, should we be able to see a little more leverage on R&D going forward, if you had to kind of bunch up some of this spending in the last few quarters or is this just more kind of your normal pace of OpEx increases?

Selina Lo

Hi, Simona. So, the pace of product release has been pretty rapid over the last couple of quarters, and this is just because of product schedules. I expect that over the next couple of quarters, you will see some hardware announcements, but in general now the next phase is really to get our new products to add features, to get them to scale. So, R&D investment will continue as Seamus said we will optimize our expenses, however we will not sacrifice our long-term growth.

Simona Jankowski - Goldman Sachs

Great. And then just last question, what drove the acceleration of your enterprise customer additions, it was I think 3,900 in the quarter, which was up quite a bit from the past few quarters?

Selina Lo

I think that last quarter, we introduced R300, and that product did very well this quarter in Q2, and I think that, that has added momentum for us at the low end.

Simona Jankowski - Goldman Sachs

Great. Thank you.

Seamus Hennessy

Thanks, Simona.

Operator

(Operator Instructions) Our next question comes from Tim Quillin with Stephens. Your line is open.

Tim Quillin - Stephens

Hi, thank you for taking my question. With regard to gross margin in the quarter, what was the impact of the lower warranty provision in the quarter? And then you alluded to the fact that service margins are or suggested that service margins are sustainable. You were – what kind of range would you expect service margins to be in for the remainder of the year?

Seamus Hennessy

In regard to the warranty provision, we saw about a 40 basis point pickup in our estimate for warranty, because of improvements in economies of scale, it allowed us to actually revalue our existing warranty, which actually got about 40 basis point pickup. In regard to service margins, it’s generally probably in line with where were into Q2 timeframe. We’re seeing incremental improvement since the start of the year, and we expect over the long term that will continue to improve, but generally in line what it was in most recent quarter.

Tim Quillin - Stephens

Okay. And then just one follow-up question, regarding the E-Rate program. Do you have any sense of how that might trickle down to equipment spending, the timing of that and what share you might hope to get at that incremental spending? Thank you.

Selina Lo

I’ll take a stab at that. So, this – the $2 billion injection is earmarked for 2015 and 2016. And typically the process goes, schools can turn in applications and the applications will get approved somewhere between six months to two years. So, today schools can turn in their applications and I believe that we will probably see the real movement in second half of 2015. Now that said, I think that there are schools that are going to aggressively leverage and try and install equipment that they need today. So, I think that overall they have a positive impact; however the bulk of the benefit is going to come in 2015 especially the second half. In terms of what part of that is equipment, assuming that say a billion is going into 2015, which of course is not necessarily even in terms of allocation of that $2 billion over two years. However assuming that is even on $1 billion is going into 2015, we think that somewhere around 40% to 50% of that will go into Wi-Fi equipment.

Tim Quillin - Stephens

Great. Thank you.

Operator

Your next question comes from Rich Valera with Needham & Company. Your line is open.

Rich Valera - Needham & Company

Thank you. I just wanted to follow-up on the E-Rate and specifically I think you said that education was your second biggest enterprise vertical historically. Can you cut it any finer than in the net and your specifically your K-12 exposures should have how much that’s been historically. And if you think it would grow under this E-Rate plan over the next couple of years.

Selina Lo

K-12 is our strongest sub-segment within education. And our – in terms of a percentage of Ruckus revenue, education depending on the quarter varies between teens to high teens to 25% say of enterprise revenue, sorry.

Rich Valera - Needham & Company

Great. And then okay since there’s obviously a lot of M&A activity in North America, including proposed M&A activity amongst some of your customers. Just wondering if you were seeing, what you are seeing in the North American service provider side. Has there been any disruption or you’re continuing to see strong momentum in that service provider market?

Selina Lo

We continue to see momentum. One of the questions that we get actually is Time Warner Cable, who you know as one of our key customers. They continue to be a very good. Customer. They continue to spend, So that been going well.

Rich Valera - Needham & Company

All right. Thanks very much.

Seamus Hennessy

Thanks, Rich.

Operator

Your next question comes from Catharine Trebnick with Dougherty. Your line is open.

Catharine Trebnick - Dougherty

Well, thank you for taking my call, and good quarter. Could you describe, you had said three of your enterprise VARs contributed I think the number was 41.6, four of the VARs, have you disclosed those?

Seamus Hennessy

They are actually distributors it’s here in the North America (ph).

Catharine Trebnick - Dougherty

They are distributors, okay.

Seamus Hennessy

Yes, yeah.

Catharine Trebnick - Dougherty

All right, thanks. And then question on the carrier market. Would you see this quarter’s revenues was more driven by North America Cable and some instances, I notice there were a lot of Hotspot 2.0 deployments in the last quarter between all the big cable companies? And can you give us some color on the MSO activity in North America versus Europe, versus Asia-Pac? Thank you.

Selina Lo

Sure. So, just like past quarters, the MSOs continue to be a main driver of growth in the service provider segment. North America is particularly strong. However for this quarter that was – it’s pretty consistent with past quarters, the MSOs are quite strong, but we also – the MSO spending on Wi-Fi is not just a North America phenomenon. We’re seeing that in Europe, we’re also seeing that in some select countries in Asia. So, I would say that MSO segment is strong worldwide. And it’s not just MSOs I think we are seeing a lot of fixed line operators, looking at Wi-Fi as a way to expand their business. Many of them use to just sell backhaul when they are a fiber operators, just felt back haul as their main business, and a lot of them now are looking at adding Wi-Fi to the end of the fiber, and go into public access as well as managed services to the enterprise.

Catharine Trebnick - Dougherty

All right. Okay. Thank you.

Seamus Hennessy

Hi, Catharine.

Operator

Your next question comes from Rajesh Ghai with Macquarie. Your line is open.

Rajesh Ghai - Macquarie

Thanks and strong quarter. Third quarter has historically been a seasonally strong quarter in the service provider market for you. If we look back over the last two years, do you think this year could be similar and is hotspot 2.0 kind of proving to be the catalyst that you expected at the beginning of the year?

Seamus Hennessy

I didn’t catch the first question, Rajesh. Can you state again?

Rajesh Ghai - Macquarie

Sure. Third quarter has historically been a seasonally strong quarter for you in the service provider market. Do you see that any thing, any different this year and this Hotpot 2.0 standard catalyzing demand as much as you had expected at the beginning of the year?

Seamus Hennessy

So, I’ll answer the first question, Selina will answer the second question. In regards to Q2, Q3, if you enterprise is predominantly the strong quarters in Q2, Q3 predominantly because of our strong verticals n education, hospitality. We really haven’t seen seasonality with the service providers across the Board. They continue to by at a good cadence every single quarter. So, and we continue to see service providers actually be strong. And we continue to see service providers actually be strong this year and consistent throughout the year. So, I’ll answer the question about HotSpot 2.0. HotSpot 2.0 line question, you pointed is one of the reasons that is really energizing the service provider space. But actually it’s not just limited to service provider. For example in Q2 we announced that we have enabled the City of San Jose and the City of San Francisco to run roam using Hotspot 2.0 enabling their subscribers to get secure Wi-Fi access without having to sign on repeatedly. And so we are seeing a lot of enterprise interest in Hotspot 2.0 also and we expect that to continue. Now, Hotspot 2.0 alone does not change the Wi-Fi landscape in terms of the market size. However, Hotspot 2.0 is making it so easy for people to connect to Hotspot that we will continue to see usage increase as Hotspot 2.0 gets rollout. And I think that, that itself will drive the service provider to install more Wi-Fi.

Rajesh Ghai - Macquarie

And on the gross margin, Seamus, strong gross margin this quarter. You mentioned some drivers in terms of why it was the strongest quarter, any reason why you would expect any of those drivers to reverse? Why exactly are you guiding back to get normal 60% to 69% range from the 70% that you achieved this quarter?

Seamus Hennessy

It was a one-time high. And we have actually raised our gross margin guidance for the most recent quarter actually above our long-term model. So, we feel good about gross margins and the guidance we provided is that the one-time one was actually on the warranty side, which is about just roundabout 400 basis point pickup, but we have actually raised our gross margin guidance actually probably the second highest we have ever guided towards.

Rajesh Ghai - Macquarie

Great, congratulations.

Seamus Hennessy

Thanks.

Operator

Our next question comes from Jeff Kvaal with Northland. Your line is open.

Jeff Kvaal - Northland

Yes, thanks very much. I was hoping to turn the discussion towards the enterprise. I am wondering what you folks are seeing in the uptake of ac, how is that progressing now that you are aggressively in the marketplace. Do you feel – sorry, go ahead, Selina that’s fine.

Selina Lo

We felt very good about our ac uptick in Q2 and we continue to see strength in ac uptick. The majority of the ac products have been going into education, but we are starting to see hospitality as well as service providers by trailing ac now. And we expect that towards the later part of the year, we will start to see momentum with the other segment.

Jeff Kvaal – Northland

Would you say that this is going as planned? Is it going faster or slower? Are there margin differences between where you have been on end and where you are in ac, because there might be more competition or land grabs for ac?

Seamus Hennessy

We haven’t seen any margin impact. The margins are generally in line with what we saw with 11n on the ac product line. And in regards to our expectations, we definitely see that education is predominantly moving towards the 11ac. And as we have said in the past, especially with hospitality and service providers, Wi-Fi is the utility for those segments and they are in the process of trailing ac right now. And we expect they will start rolling out ac sometime next year. But on the education side, it’s definitely our expectation is and we are seeing that education is really deploying ac.

Jeff Kvaal - Northland

Thank you, Seamus.

Operator

Our next question comes from Mark Sue with RBC Capital Markets. Your line is open.

Mark Sue - RBC Capital Markets

Thank you. Seamus, maybe just on that since Ruckus was a little bit slower on the ramp with 802.11ac, considering the Atheros versus Broadcom issue. And now that you fully had ac, is there a little bit of catch up that you are sensing from your customers actually as they move forward to ac, maybe a good start there?

Seamus Hennessy

A small – a small bit of catch up, where customers were definitely waiting for us to release, but we actually released the 11ac and started shipping it in Q1 and Q2 as the full quarter for us. So, we might have seen the small pickup in Q1 – but in Q2, not much.

Mark Sue - RBC Capital Markets

Okay, that’s helpful. And then maybe Selina on the cable side, Time Warner Cable, you are very strong there, it opens the door possibly with Comcast. Any thoughts on how we should frame the opportunity or how are some of the things that you are doing to prep your opportunities at Comcast, are there things that they are waiting for from the Ruckus point of view for customization or anything work there? How we should think about that as the MSOs converge?

Selina Lo

So, for comparative reason, I really can’t talk about what we are doing within – with Comcast. Needless to say, it’s an account that we really would like to own. However, Time Warner Cable actually is still very right now independently spending and we have been doing well – very well with them quarter after quarter. And there are number of cable operators Comcast happens to be very visible because of their commitment to Wi-Fi in the public way. But there are number of operate – cable operators that present opportunity in front of us both in North America as well as in Europe and other parts of the world.

Mark Sue - RBC Capital Markets

That’s helpful. Lastly, Selina, just the early opportunity with non-traditional carriers maybe if you could give us thoughts that opportunity opening up over the – I guess for the future?

Selina Lo

So, it is amazing the – how many of these non-traditional carriers there are and they seek many different forms as I said earlier fiber operators who traditionally their business has been backhaul is now adding other business models in addition to backhaul using Wi-Fi. But we are also seeing others in the markets that are looking at using Wi-Fi as away to catch eyeballs. I mean Facebook is a good example. If you look what they have been doing with social log on. So I think that’s certainly Wi-Fi has become a very attractive way not to capture subscribers to capture users and I think that many service providers whether they are the traditional mobile services providers, fixed line service providers or content service providers are getting very interested in those eyeballs.

Mark Sue - RBC Capital Markets

Okay. Excellent, that’s helpful. Thank you and good luck.

Operator

The next question comes from Matthew Hoffman with Mizuho. Your line is open.

Matthew Hoffman - Mizuho

Hi, thanks. So Seamus it looks like you have NOL to extend at least through 2015 and it’s a tax question, so should we model the international tax structure to begin in 2016 taking the rates back up in low-20s at that point. And then second Selina, capacity the Ruckus controller, it’s been a major selling point for the company with service providers, it sounds like you are still highlighting its capacity when you moved to the virtualized product, but are there any trade-offs versus (indiscernible) controller, when you are looking versus virtual? Thanks.

Seamus Hennessy

I will tackle the first one on the tax side. So on tax side you can assume that we would not implement international tax structure any earlier than 2016 and we are going to basically align the time when we cut over – when we can actually fully utilized those NOLs in the U.S. So it could be further into 2016, but from a modeling exercise the leverage in 2016 is probably okay.

Selina Lo

So to answer your question about our controller, overall the SCG whether it’s the virtualized version or the appliance version has been very going very strong with service provider customer and actually it’s starting to go well to also become a product that’s popular with our enterprise customers. The virtual version of it is that very attractive to carriers and service and managed service providers that have decided to implement this network functions virtualization architecture and NFV architecture. The vSCG complies with that architecture, it allows the service providers number one to minimize hardware cost and number two it allows them to more flexibility as to whether they want to put more cycles on for example to control plane or the data plane. It gives some more flexibility, so we see that the – managed service providers are all very, very interested in vSCG and trailing the vSCG. Actually even our large enterprise channels they are gravitating towards the vSCG as a way to add managed services to their offering as well as many of them quite comfortable with virtualized architecture already for the other products. So the vSCG just allowed, the SCG just to fit into that architecture.

Matthew Hoffman - Mizuho

Okay. So a quick follow-up, I am sure it’s too early to talk about pricing. But how would you think about the margin structure and sales trade it sounds like there is some real added advantages in terms of flexibility for service providers and enterprises, but how should we think about that product? Thanks.

Seamus Hennessy

Yes. On the SCG, or vSCG, the vSCG is effectively software license and we priced it aggressively on the licensing side on per AP basis it’s actually equivalent between the SCG and the vSCG. And the only thing, the only trade-off is actually the physical appliance for the SCG which our offsetting is – the offset is pretty minimal and across the board. What we are actually seeing is increased interest in the vSCG and accelerated trials because of the vSCG, because it’s virtualized and supports NFV. So it’s pretty de minimis right off and minimal impact on bottom line.

Selina Lo

You can look at vSCG as also a way to help us to win more business. As an example IBM is a new partner of ours and the vSCG is one of the key drivers to help us accelerate the partnership.

Matthew Hoffman - Mizuho

Great. Thanks.

Operator

Your next question comes from Brian Modoff with Deutsche Bank. Your line is open.

Kip Clifton - Deutsche Bank

Hi, guys, its Kip filling in for Brian. I just had a couple of questions here. Selina I wonder if you could touch on you mentioned some municipal wins in your prepared remarks, I am just wondering if you could talk a little bit of user rates on your municipal Wi-Fi and what’s been the feedback around things like security and usability. And then secondly I am wondering if you could talk about MSOs in the managed services side of carriers seem to be driving service provider growth and it’s been there waiting for some time, I am just wondering what do you think is causing mobile carriers to hold off on deploying Wi-Fi to augment their license technology?

Selina Lo

Okay. So let me answer the first one first which is the Smart City Wi-Fi, you asked about usage and such. So I can’t disclose usage of some of these Wi-Fi networks because they are my customers’ network. However, I can tell you that the uptick has been really, really good in San Jose as well as San Francisco. In fact San Jose saw specific economic advantage, economics gain that they have realized because they have now Wi-Fi service in the Downtown area. In terms of performance, I have seen some speed test screens that my customers shot me, that’s amazing. People are getting upwards of 20 megabit per second, 30 megabits per second in terms of download. In some cases we have actually seen like 50 megabits per second. So my customers are pretty happy with the implementation.

Now this host Smart City deployment is started out as just Wi-Fi access for citizens or for residents of the city, but we are starting to see like in San Jose the network being used for many other purposes. One of the most prominent one is just to monitor first of all to monitor cloud traffic for all kinds of applications. So we are very excited about this opportunity and we think that Ruckus is quite well positioned because of our outdoor Wi-Fi strength. We have the technology as well as experience in deploying large scale outdoor networks and that is just the technology that allows us to easily translate to Smart Cities and take advantage of that trend now. There is a second question, why are MNOs doing managed services and not investing in 3G or 4G offload infrastructure, I think that kind of just our of your question.

Kip Clifton - Deutsche Bank

Yes. I just want do you think they are slow to adopt to augment sort of their license technology?

Selina Lo

So I don’t think that they are mutually exclusive, I think that’s something that we have explained over the last few quarters that a lot of times for an MNO, for example the example that I used in one of our wins in Q2 they have they offer managed services they actually serve multiple purposes. One is obviously for them to do – for them it’s a business with an enterprise. But also they are actually establishing offload point. So for example with this operator that I mentioned, getting the subway stations is only – really helped them offload because subway stations tend to be one of the highest concentration point of pedestrians especially pedestrians that will be using their devices. So definitely they came out – they went after that project not just for the revenue, but also for footprint for their own offload. And I think that that purpose is very much combined now. So you actually still see a lot of mobile operators that will go after in particular public venue business as a way to get – to gain footprint for offload.

Kip Clifton - Deutsche Bank

Okay, thanks. That’s helpful.

Operator

Your next question comes from Matt Lebo with Piper Jaffray. Your line is open.

Matt Lebo - Piper Jaffray

Thanks for taking my question. Just very quickly I know last quarter you spoke about the R300 and SAM’s products to target small businesses in emerging markets, I was just curious how the uptake of those has been?

Seamus Hennessy

Yes, it’s definitely been very strong and it’s helped us actually increase the number of wins and actually go down market into the S&P vertical. So, we saw very positive momentum for that product line last quarter.

Matt Lebo - Piper Jaffray

Great, thank you.

Operator

The next question comes from Sanjiv Wadhwani with Stifel. Your line is open.

Mike Lin - Stifel

Hi, this is Mike Lin calling on behalf of Sanjiv. Just to follow-up on the R300, that’s targeting smaller businesses as that sort of lower cost access point becomes as part of your business, is that going to have an impact on your gross margins?

Seamus Hennessy

Actually, the gross margin profile of that product line like all our product lines are generally in the same ballpark. So, it doesn’t have a negative impact and actually you might have a slight positive impact. We are actually seeing a significant uptick in that product line.

Selina Lo

I think that a low end product doesn’t really mean low margins. I think that’s some common misunderstanding.

Mike Lin - Stifel

Okay. And also on the 11ac sales, what percentage of sales is 11ac today versus older generation products like 11n?

Seamus Hennessy

Yes. We have never actually broken out and we are not breaking out in this call specific breakouts between products, our technologies, but we definitely saw strong adoption of 11ac especially among the education vertical and particularly among the education vertical.

Mike Lin - Stifel

Okay. And just one final question on the pricing in the market, competitively speaking, are you seeing price competition increase stay the same or get worse versus the past, especially as you have introduced so many new products by the way?

Selina Lo

So, starting the – I think price competition has increased in the 11ac area. In that, in the past with 11n, the pricing of 11n actually, there was a difference for much longer period of time versus now with 11c. However, as you could see from our gross margins, we also have the economy of scale to offset that kind of price competition. So, we have done quite well.

Mike Lin - Stifel

Okay, great. Thank you.

Seamus Hennessy

Thanks.

Operator

Our next question comes from Erik Suppiger with JMP Securities. Your line is open.

John Lucia - JMP Securities

Hey, guys. This is John for Erik. Thanks for taking the question. I wanted to drill in on the E-Rate opportunity for 2015 and ‘16, do you expect K-12 schools to slow their spending over the next couple of quarters in anticipation of receiving E-Rate funding in ‘15 and ‘16?

Selina Lo

No, we don’t expect that. In fact, a lot of them are leveraging knowing that, that’s coming. A lot of them are leveraging to implement today. Just think about how many iPads there are in a school now being used by both teachers and students. They can’t afford to wait. And frankly, in the past E-Rate has been around. And in the past two years, E-Rate has been used up before it even got applied to Wi-Fi basically just broadband just spending up on broadband has used up all the E-Rate that was allocated in the past two years. And still, there are many, many schools that are putting in Wi-Fi infrastructure through other means of funding and that tells you that, that kind of infrastructure is really needed. I think that E-Rate is going to help bridge the Wi-Fi gap, right. That’s the whole intention is that some of the schools that don’t have funding are now going to be able to build out the Wi-Fi infrastructure.

John Lucia - JMP Securities

Okay. And if half of the E-Rate funding will go to Wi-Fi vendors, that’s roughly $500 million per year and if I assume that’s almost all incremental, essentially doubles the K-12 Wi-Fi market and increases the overall market probably by around 10%. Overall, how are you expecting this to affect your top line? Would it be unreasonable to expect, there are couple of points, five points of growth for you in the other players in 2015 and 2016 and what share of that business do you expect to grab?

Seamus Hennessy

It’s a good question and long question. Actually, we see it as a great growth driver for us, but we are actually not providing 2015 guidance at this stage. What we do see is 2015 to be a key growth driver for the company.

John Lucia - JMP Securities

Okay.

Seamus Hennessy

I think in general the term got a little bigger because of that – of the E-Rate money that’s earmarked for Wi-Fi. However, a lot of detail still has to fall out. So, we have to really look at the details before we know exactly what goes into the full funding. However, I think that you can assume that the TAM got a little bigger and Ruckus has been our enterprise partners are very good with the education segment based on past successes .So, I think that this new funding is definitely good for us.

John Lucia - JMP Securities

Okay, thank you.

Operator

There are no further questions at this time. I will turn the call back to our presenters for closing comments.

Seamus Hennessy - Chief Financial Officer

Thanks everybody and we will talk to you soon.

Selina Lo - President and Chief Executive Officer

Thank you.

Operator

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

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