Aruba Networks' (ARUN) CEO Dominic Orr on Q4 2014 Results - Earnings Call Transcript

Aug.26.14 | About: Aruba Networks, (ARUN)

Aruba Networks (NASDAQ:ARUN)

Q4 2014 Earnings Call

August 26, 2014 4:30 pm ET

Executives

Tonya Chin -

Dominic P. Orr - Chairman, Chief Executive Officer and President

Michael M. Galvin - Chief Financial Officer and Principal Accounting Officer

Keerti Melkote - Co-Founder, Chief Technology Officer and Director

Analysts

Ryan Hutchinson - Pacific Crest Securities, Inc., Research Division

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

George C. Notter - Jefferies LLC, Research Division

Mark Sue - RBC Capital Markets, LLC, Research Division

Amitabh Passi - UBS Investment Bank, Research Division

Sanjiv R. Wadhwani - Stifel, Nicolaus & Company, Incorporated, Research Division

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

Erik Suppiger - JMP Securities LLC, Research Division

Jonathan B. Ruykhaver - Stephens Inc., Research Division

Benjamin A. Reitzes - Barclays Capital, Research Division

George M. Iwanyc - Oppenheimer & Co. Inc., Research Division

Kent Schofield - Goldman Sachs Group Inc., Research Division

Matthew E. Lebo - Piper Jaffray Companies, Research Division

Rohit N. Chopra - The Buckingham Research Group Incorporated

Jeffrey Thomas Kvaal - Northland Capital Markets, Research Division

Operator

Good afternoon. My name is Kyle, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Q4 and Fiscal 2014 Earnings Conference Call. [Operator Instructions] Ms. Chin, you may begin your conference.

Tonya Chin

Good afternoon, and thank you for joining us on today's conference call to discuss Aruba Networks' fourth quarter and 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 Networks' website at www.arubanetworks.com. With me on today's call are Dominic Orr, Aruba's President and Chief Executive Officer; Keerti Melkote, Aruba's co-founder and Chief Technology Officer; and Mike Galvin, Aruba's Chief Financial Officer.

After the market closed today, Aruba Networks issued a press release announcing the financial results for its fourth quarter and fiscal year ended July 31, 2014 results. If you would like a copy of the release, you can access it in the News Releases section of the company's website. We would like to remind you that during today's call, management will be making forward-looking statements within the meaning of the Safe Harbor provision of federal securities laws regarding the company's anticipated future revenue, operating margins, tax rate, restructuring charges and other financial and business-related information.

These forward-looking statements involve a number of risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially from those anticipated by these statements. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future and we undertake no obligation to update these statements after this call.

For a detailed description of these risks and uncertainties, please refer to our most recent reports on Forms 10-K and 10-Q filed with the U.S. SEC commission on September 24, 2013, and June 4, 2014, respectively, as well as our earnings release posted a few moments ago on our website. Copies of these documents may be obtained from the SEC or visiting the Investor Relations section of 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 to these non-GAAP financial measures to GAAP financial measures in the Investor Relations section of the website and in our earnings press release.

Before I turn the call over to Dom, I'd like to add that Mike Galvin will be attending the Citi 2014 Global Tech Conference in New York on September 2, as well as the Deutsche Bank Tech Conference in Las Vegas on September 9 and we hope to see you there. Now I'll turn it over to Dom.

Dominic P. Orr

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

We closed fiscal 2014 with a strong Q4 performance, capping off a year of solid execution. Our Q4 results exceeded our guidance on all fronts. We saw bookings growth in all of our major geographies, with particular sequential strength in North America. We delivered solid year-over-year growth in all of our core verticals plus notable strength in the enterprise markets. We are also pleased with the reacceleration of our federal business. As reported by Gartner, our market share in the March 2014 quarter increased from 12.7% to 15.2%. We believe this momentum is continuing into the second calendar quarter.

Our key growth drivers continue to be our first-to-market .11ac offering, our controllerless Aruba Instant and our ClearPass Policy management solution. All these 3 areas continue to show strong year-over-year growth in Q4. In addition, our controller-based business had a record quarter, demonstrating the continuous strength of our core platform.

Our .11ac revenues have been gaining momentum over the past several quarters. Our AC sales represent 37% of total access point shipped in Q4, up from 18% just 2 quarters ago. This further highlights the share gains we are making in this rapidly growing portion of the market. On our product development front, I am pleased to report that while our AP-225 continues to set the bar for high-density, high-performance environments, our value-oriented AP-205 is now shipping in production volume. In addition, I am pleased to report that we recently started shipping another new AC product, the AP-215. This new AP is positioned at the mainstay of our .11ac portfolio, addressing customer environments that require affordable high performance.

With our full lineup of AP-205, 215, 225 and the outdoor 275 access points, Aruba now stands apart as the first and only vendor to offer a complete range of AC products across a wide range of customer segments and applications at appropriate price points. We believe this positions us well for further market share gains.

We believe the rapid emergence of .11ac is accelerating the speed at which enterprises embrace WiFi as the primary access medium for an all-wireless workplace. This is where the superior network and application performance delivered by our patented ArubaOS software becomes critical. Customers are demanding rich, reliable mobility experiences including mobile unified communication of Microsoft Lync where Aruba enjoys deep solution integration and go-to-market collaboration.

We continue to distinguish ourselves with products that deliver Stable, Secure, Simple and Smart Air solutions. To deliver the most stable environment possible, one of the world's largest biopharmaceutical companies recently selected Aruba for its global deployment of .11ac. Starting with an installation of Aruba's AP-225 at its worldwide headquarters, this customer quickly begins its roll out of .11ac to all its international locations.

Beyond Stable Air, customers are also looking for Secure Air. An example is one of the top 10 banks in the U.S. that recently began its .11ac deployment to over 2,000 branches, including access control functionality from our ClearPass solution.

For many value-conscious customers, particularly those with limited IT resources, simplicity is essential. Two recent K-12 customer engagements are great examples of our Simple Air solutions. We are deploying our user-friendly Aruba Instant solution in 2 large school districts in the western United States, each with approximately 30,000 students.

And finally, we continue to be pleased with the success of our Smart Air solutions. One of our more prominent stadium customers implemented our industry-leading wireless solutions, including the Meridian indoor location application, providing attendees with an engaging and high-quality experience. Additionally, we recently engaged with another arena customer in the Midwest that will interact with tens of thousands of fans, supporting thousands of devices and mobile apps utilizing our .11ac and ClearPass solutions. We are encouraged by the continue inroads we are making in public-facing enterprise with our Smart Air solutions, and we look forward to building on this strong momentum.

The investments we made in our go-to-market effort over the past year are paying off. A key metric that demonstrates the success of our approach is the productivity of our newly on boarded sales team members over the last 5 quarters. Our performance on this metric has exceeded our expectations in fiscal '14, and we see opportunity to continue ramp productivity throughout fiscal '15.

We have also expanded our investment in our channel and moved resources to areas with the most potential for growth, particularly to support global partnerships. Additionally, we have seen strong growth in our emerging SME business led by the strength of Aruba Instant product line, which grew well over 100% year-over-year in Q4. With this sales momentum we have built in fiscal '14, an industry-leading product portfolio, a strong outlook for fiscal '15, we will deepen our focus on delivering operating leverage to further accelerate profitability.

We believe now is the right time to refine our operating structure in order to achieve that goal. Based on extensive analysis, we have identified opportunities to optimize our cost structure by eliminating certain positions as well as shifting others to administrative center of excellence in lower-cost region with rich talent pools. We will expand our already sizable India operations, as well as build on our emerging presence in both Portland, Oregon, and Cork, Ireland. Additionally, we see much more opportunity to capitalize on our presence in China. To help facilitate this targeted expansion efforts, we will provide relocation opportunities to a limited number of employees currently based in Sunnyvale, California. We will maintain our R&D core in Sunnyvale, and we'll continue hiring R&D and other positions in Sunnyvale as well as internationally.

In conclusion, we ended fiscal 2014 with increasing momentum on many fronts, and we plan to build from this position of strength going forward. Over a year ago, we told you that the go-to-market investments we plan will drive at least 20% year-over-year revenue growth in the second half of fiscal 2014. We also shared with you our expectation to exit the year with 20% non-GAAP operating margins. We are pleased to report that these objectives have been met. Based on our cost optimization plan coupled with our expectation for strong top line growth and continued industry leadership, we are raising our non-GAAP operating margin guidance for fiscal '15 from 19% to 21% to 21% to 22%.

I will now turn the call over to Mike, who will cover the financials in more detail.

Michael M. Galvin

Thank you, Dom. In Q4 2014, total revenue was $202.9 million, representing a 7% quarter-over-quarter increase and a 33% increase year-over-year. Product revenue of $167.6 million increased 8% sequentially and 34% year-over-year. Support and professional services revenue of $35.3 million grew 5% sequentially and 26% year-over-year. U.S. revenue grew 32% year-over-year, representing 66% of total Q4 revenue; EMEA revenue grew 26% year-over-year, representing 17% of total revenue; and Asia Pacific-Japan revenue grew 49% year-over-year, representing 14% of total revenue.

Total non-GAAP gross margin in Q4 was 71.5% compared with 70.5% in Q3 and 72.5% in Q4 '13. Q4 non-GAAP product gross margin was 70.6% compared to 69.4% in Q3 and 71.3% in Q4 '13. Product gross margins in our major product categories, including APs and switches, were in our normal historical ranges. AP-225 still made up the majority of our Q4 AC access points as our AP-205s began shipping about mid-quarter. Q4 non-GAAP services gross margin was 75.7%, up from 75.6% in the prior quarter and down from 77.6% in the same period a year ago. Looking forward, we expect total non-GAAP gross margin to continue to be within our near-term target range of 71% to 73%.

Non-GAAP research and development expense was $31.5 million in Q4. As a percentage of revenue, R&D was 15.5%, down from 16.2% in Q3. Non-GAAP sales and marketing expense was $61.5 million in Q4. As a percentage of revenue, Q4 sales and marketing expense was 30.3%, down from 31.3% in Q3. Non-GAAP G&A expense was $11.4 million. As a percentage of revenue, G&A expense was 5.6%, down from 5.9% in Q3.

Total headcount at the end of Q4 was 1,754, in line with the prior quarter. Hiring continued in the quarter in our most critical path, product and sales initiatives in conjunction with quarterly attrition in our normal historical ranges. In total, Q4 non-GAAP operating expenses were $104.4 million or 51.5% of revenue compared to 53.4% of revenue in Q3. Our non-GAAP operating profit in Q4 was $40.6 million or 20.0% of revenue compared to 17.1% in Q3 and 14.7% in Q4 '13. With strong revenue growth and improved leverage in our operating model, we increased operating margin 530 basis points over the last 4 quarters.

We finished fiscal year 2014 with a full year non-GAAP tax rate of 30%, at the high end of our guidance range of 28% to 30%. We expect full year 2015 non-GAAP tax rate to be in the range of 30% to 32%. The increase in our tax rate for FY '15 is due in part to the cost optimization efforts I will explain in more detail shortly and in part due to trends we saw in the second half of fiscal '14. Both of these factors contribute to increased profit in our higher tax U.S. entity. As a reminder, our overall tax rate is subject to change, including from the projected geographic mix of the company's profitability as well as changes resulting from any new U.S. or international regulations or interpretations.

Non-GAAP net income for the quarter was $27.6 million or $0.24 per diluted share. This compares to $22.8 million or $0.20 per diluted share in Q3 and $15.8 million or $0.13 per share in Q4 '13. Our Q4 non-GAAP EPS increased 85% over Q4 of last year.

On a GAAP basis, our net loss was $4.1 million or $0.04 per share compared with a Q3 net loss of $6.4 million or $0.06 per share and a Q4 '13 net loss of $15.6 million or $0.14 a share. A full reconciliation of both GAAP and non-GAAP information is contained in our financial results press release issued this afternoon. For the full fiscal year 2014, we achieved revenue of $728.9 million, growing 21% from $600 million in fiscal '13.

Non-GAAP net income was $90.6 million, up 12% from $79.2 million in 2013. Non-GAAP EPS for fiscal '14 was $0.77, a 20% increase from $0.64 in fiscal '13. On a GAAP basis, our net loss was $29 million or $0.27 per share compared with a net loss of $31.6 million in fiscal '13 or $0.28 per share.

Next, I would like to comment on our stock-based compensation, or SBC. As I have discussed in previous quarters, we have implemented changes over the past year in our stock issuance practices. Our goal is to both reduce our SBC as a percentage of revenue as well as to moderate our stock dilution. In fiscal years '12 and '13, we had SBC of 16% of revenues in each year. In our last 2 fiscal quarters, we have begun to see the benefits of the changes in our issuance practices, reporting SBC as a percentage of revenue of 15% in Q3 and 13% in this Q4. These actions brought our full fiscal '14 SBC down to 15% of revenue. For fiscal 2015, we expect to drive further shareholder return with SBC in the range of 12% to 14%, and these improvements and that improving rate will continue in FY '16 and '17.

Now let me turn to the balance sheet. Driven by our solid results and working capital management in Q4, we generated $30.7 million in cash flow from operations. In the fourth quarter, we purchased 2.8 million shares of common stock at an average price of $18.10 per share for an aggregate purchase of approximately $50 million. The weighted average shares outstanding impact on the buyback -- of the buyback on the quarter's diluted share count was approximately 1.8 million shares. Q1 '15 will reflect the full benefit of the 2.8 million shares we repurchased. We have approximately $131 million remaining in our stock repurchase program. Net of these repurchases, cash and short-term investments at year end were $285 million, a decrease of $15.2 million from the prior quarter.

As we move forward, we plan to continue to utilize our repurchase program to negate stock dilution, balancing our capital structure needs in any given quarter. We ended Q4 with $102.3 million of accounts receivable, an increase of $6.9 million from Q3. Days sales outstanding in Q4 were 45 days, in line with 45 days in Q3 and an improvement from 55 days in Q4 '13. Our target range remains 45 to 55 days. Total deferred revenue of $180.1 million increased 1% sequentially from Q3 '14 and increased 27% year-over-year. Short-term deferred revenue of $135.2 million decreased 3% sequentially and increased 23% year-over-year. The primary changes in our deferred revenue balances are due to quarter-end inventory stocking activity at our value-added distributors.

Aruba's inventory totaled $39.8 million at the end of Q4, an increase from $2.9 million from the end of Q3. As Dom mentioned earlier, we have initiated a cost optimization program that will relocate approximately 4% of our workforce to Bangalore, India; Portland, Oregon; and Cork, Ireland. The increased allocation of resources to these locations, along with our other existing international operations in Beijing, China, and Chennai, India, will allow the company to efficiently scale its growth in talent-rich but more cost-advantaged areas.

In addition, we will reduce approximately 4% of our workforce. The reduction in force takes effect this quarter, and the relocation of jobs will take place largely over the first half of this fiscal year. The company's headquarters will remain in Sunnyvale, California.

We estimate incurring pretax restructuring charges of approximately $6 million to $8 million for employee termination benefits and related cost, as well as $2.3 million to $4.3 million in other pretax onetime restructuring costs, including temporary redundant headcount and related recruiting associated with employee transitions. These pretax charges will be excluded from our non-GAAP financial results and will be incurred over the first 3 quarters of fiscal 2015, with the majority of the charges expected in the first half of the year. With these actions and in conjunction with our continued focus and investment in our go-to-market engine and product road map, we expect to deliver non-GAAP operating margin for the full fiscal year '15 in the range of 21% to 22%, an increase from our prior guidance in March of 19% to 21%.

Moving on to our Q1 revenue and EPS guidance. We are pleased by our strong growth in Q4 and improved operating model. We expect Q1 '15 revenue to be in the range of $202 million to $205 million, an increase of 26% to 27% year-over-year. Estimating 116 million shares on a diluted basis, we expect non-GAAP EPS to be approximately $0.24 to $0.25 per share, an increase of 50% to 56% year-over-year.

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 Hutchison from Pacific Securities.

Ryan Hutchinson - Pacific Crest Securities, Inc., Research Division

Okay. Great. So first off, just on the long-term operating model. It's good to see that the operating margins are going up, but just want to get clarification on the expectation for gross margin next year. That would be my first question, and then I have one more.

Michael M. Galvin

Okay. Yes, Ryan. The gross margin range -- target range remains 71% to 73%. We feel very good about that range, especially with the performance we did this quarter, but also with the 205s and the 215s now being fully available. The range remains the same.

Ryan Hutchinson - Pacific Crest Securities, Inc., Research Division

Okay. And with regard to the access points with the new access point coming out, there's no change in the gross margin profile, correct?

Michael M. Galvin

That's correct.

Ryan Hutchinson - Pacific Crest Securities, Inc., Research Division

Okay. Great. Okay, and then the second question is just on the -- on your partnership and OEM relationships. First off, can you just update us on the progress you're making with Juniper? And then secondly, it looks like you guys maybe are working with HP. Could you maybe talk about that as well? And then just expectations for when these could both become material to revenues.

Dominic P. Orr

This is Dom. So regarding the -- our increasing breadth of partnership in what we call the open FTN campus area, that is really to address a primarily all wireless workplace where customers expect mobility controlling function to be directing the end-to-end mobility traffic and have strong support coordinated by us on the wired back-end infrastructure. And that architectural model is getting increasing acceptance, and our widened partnership scope reflects that. The Juniper relationship is working well. As you know, a lot of the ex-Trapeze customers need to migrate to .11ac, and we have the best .11ac product and also with our new commitment of making sure that the ClearPass and the AirWave management functions being fully interoperable between the Juniper product line as well as Aruba product [ph] line. We are seeing a very satisfying development of pipeline. With regard to the HP relationship, as I mentioned early on, all of Aruba's policy and network management functions are multi-vendor in nature just like ClearPass and AirWave. Aruba Central is the same, and collaboration with HP is along that multi-vendor mobility management area.

Ryan Hutchinson - Pacific Crest Securities, Inc., Research Division

Okay. Great. And then just in terms of expectations for revenue here. I mean, when could these become material? And I'll leave it there.

Dominic P. Orr

Well, obviously we have -- already baking in near term the revenue brought forth by these partnerships into our near-term guidance, and we're not guiding longer than that. What I can say, all the partnerships are working out very nicely. The HP one is still very, very preliminary stage.

Operator

Your next question comes from the line of Rod Hall from JPMorgan.

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

Dom, I just wanted to see if you can give us a little bit more color on the reorg. I mean, it seems like the business is performing pretty well. So are you guys just at a point where you feel like you need to globalize the support services a little bit more? Just kind of help us understand what crystallized the decision now and exactly what sorts of resources would be impacted?

Dominic P. Orr

Yes, so basically as we're approaching $1 billion year company, a lot of these revenues come from international. And resources wise, we have successfully globalized our R&D effort in the last 5 years to the extent that close to 60% of our resources in R&D are already outside of the Silicon Valley. And what we are doing is from the position of strength with the sales investment taking fruition. So we feel we are in a strong momentum from a market growth, market share gain, product portfolio and sales productivity point of view. This seems a good time for us to exert the same effort in globalizing all the other non-R&D functions in the company, taking advantage of lower-cost regions with rich talent pool and that is no more than that.

Michael M. Galvin

Yes, and Rod, this is Mike. Speaking from the infrastructure side of the house, too, it's a -- it's very good because it's very efficient to scale there, and it actually allows us to put more resource and more infrastructure into the business with the size we're getting. So it's an efficient good thing from our side.

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

Okay. Just maybe one quick follow-up, Dom. Could you just comment on -- I mean, our third-party data shows a huge acceleration in market growth for -- in Q4 or at least in the July quarter. So just curious, could you comment on market dynamics? I mean, what's driving that? Are you seeing better macro? And also, if you had any comments on pricing dynamics within that, that would be helpful, too.

Dominic P. Orr

Okay. So let me address the pricing dynamics as reflected in our gross margin improvement. We are not seeing any special pricing dynamics. In fact, the discount for the quarter is well within the normal range. And regarding the growth of markets, we're seeing growth in the area that we are good at. We are expanding our market shares in emerging markets, such as public-facing WiFi, and we are launching into the SME markets. So as far as Aruba is concerned, yes, our TAM is expanding. But if you're talking about overall market growth, obviously the number is still -- is out yet, but the largest market shareholder is going flat and everybody is growing. That seems to be numerically what's happening.

Operator

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

George C. Notter - Jefferies LLC, Research Division

I guess I want to get back to the discussion on the headcount of the company. So just to be clear, is it fair to say that you're not seeing anything around the corner out in the future in terms of the top line for the business that's motivating the 4% headcount reduction net on the company? It's just purely an exercise in becoming more efficient and globalizing the workforce?

Michael M. Galvin

Yes, George, the -- and I think we mentioned this in our opening comments, the critical path sales hiring and product road map hiring is continuing. This is really about getting a more efficient infrastructure and a more global presence not just for our customers but for our employees, too. We can start better serving our employees with some of these locations from an infrastructure standpoint. So the critical path items in investment are still on track.

Dominic P. Orr

And if we are seeing any worry about our top line, we would not be raising our operating margin guidance. In fact, we feel very good on the prospect. We know our product portfolio is very strong. We will continue to increase the focus and accelerate the next generation set of products. We're seeing that the sales productivity model is working out. So we will continue to supplement what we have done in the last 4 quarters with the investment, particularly in the expanding areas such as Global 2000 public-facing enterprise as well as the SME. So in order to support this extended operation, we need more actually administrative and other headcounts and this is the way we find to actually grow all functions over time at the same time.

George C. Notter - Jefferies LLC, Research Division

Got it. And then just one other clarification. So is it fair to say that Instant and ClearPass are still below 10% of sales? I noticed that you didn't break them out, so I assume they're still below that threshold. Is that fair?

Dominic P. Orr

I'm sorry. I cannot break it out, but all I can say is very strong growth on both, and ClearPass continue to lead us into account where we have no access to before. And we continue to enjoy a significant technological gap against our largest competitor in both fronts, and we are very pleased with the progress.

Operator

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

Mark Sue - RBC Capital Markets, LLC, Research Division

Question on how Aruba has been pricing your products, the controllers, access points and also ClearPass. The -- does Aruba price products as we look at markup to cost, is it priced over value? Or has it been pricing on what the market will bear? I'm trying to get to the underlying assumptions of your ability to hold gross margins because investors perceive the market as becoming more competitive, and so maybe the dynamics there on pricing and how you price.

Dominic P. Orr

So obviously, we're focusing on values that customers perceive at various price points in the dimension of providing Stable Air, Secure Air, Smart Air and do it very simply. And I think the margin, we feel, very, very good in terms of how .11ac is ramping, how the controller with the new ArubaOS releases are coming out. We really do not see any structural change in the marketplace, with the exception that now we have more software actually to sell. And by having a more complete lineup from the 205 to the 275 line, we can actually fit the pricing model as to each market we are entering to. So the people who think and talk about this market being commoditized is simply, I have to say, wrong.

Mark Sue - RBC Capital Markets, LLC, Research Division

That's helpful. And then if I look at the OpEx reduction and moving people overseas, there's actually a secondary benefit to that which is the stock-based comp, which is separate from the ongoing program to reduce dilutive securities. So with that in mind and your buyback, how should we think about longer-term earnings growth? Is 25% earnings growth kind of a reasonable number when we take a look at all those moving parts, your top line growth, your improving operating margins, your move overseas and also your buyback?

Michael M. Galvin

Yes, Mark, we don't have explicit guidance on an earnings growth number, except to say that we believe obviously the results we've shown in Q4, what we're guiding to in Q1 and the model framework for the next year is going to show very good growth. And there is absolutely a focus and an emphasis on that bottom line growth along with the top line. So it's -- and the things you pointed out are the things we're attacking to do that.

Dominic P. Orr

And as I mentioned in my scripted part of my talk that we believe with the market growth, with the value and differentiated position we have with the recipe of the go-to-market site working, we feel very good this is the time we really focus on in -- more in the increasing operating leverage, and our aspiration is to constantly quarter-over-quarter grow EPS faster even though our high prospect of top line growth.

Operator

Your next question comes from the line of Amitabh Passi from UBS.

Amitabh Passi - UBS Investment Bank, Research Division

My first question for you, the fiscal '15 operating margin guidance you gave, how to think about the sensitivity to top line performance? I'm just trying to get a sense of variable versus fixed costs? And how is it [ph] about if revenue growth is stronger than [ph] bank debt? Do you still feel you can hold the 21% to 22% [indiscernible] if things turn out to be a bit weaker? Just kind of how you're thinking about the framework?

Michael M. Galvin

Yes, that's exactly the way we're tackling the P&L. We're -- our business is -- say, roughly 2/3 of our cost structure is headcount, and we're not a heavily capital-intensive business. And so that is the -- headcount is where you generally make improvements and get leverage in the model. And so we have projected all that stuff out, top line growth, gross margin, all the elements of the P&L and frankly, have thought of sensitivities, et cetera and the objective is to drive to that 21% to 22%, just like we drove to the 20% in this quarter

Operator

You're next question comes from the line of Sanjiv Wadhwani from Stifel.

Sanjiv R. Wadhwani - Stifel, Nicolaus & Company, Incorporated, Research Division

Just a couple of questions on my side. Dom, I was wondering if the 215 access point, maybe you can just clarify what sort of the target market for that is going forward? And then just curious on Asia PAC, big growth year-on-year. Any specifics on sort of what happened in that geography, and whether we should see that momentum continuing?

Dominic P. Orr

Let me ask Keerti to answer the 215 question first.

Keerti Melkote

Sanjiv, it's Keerti here. So on the 215, we basically are introducing that with the performance characteristics of the 225, but with a little bit more affordability. So there's a couple of high-end features that we would normally expect high-density venues and so on to want we will -- we have removed those functions. So it becomes a little bit more affordable. So basically, it becomes a midrange, and we expect the 215 to basically become the mainstay of our .11ac product line. So AP-205 will be our value line, AP-225 will continue to be our top-of-the-line differentiator platform and the 215 comes right in between those 2.

Sanjiv R. Wadhwani - Stifel, Nicolaus & Company, Incorporated, Research Division

Got it. That's helpful. Gross margin wise -- sorry, just on gross margins, I mean, pretty much comparable between all 3 products? Or is there sort of a little bit of differentiation between one or the other?

Michael M. Galvin

Well, it -- as we talked about last quarter, the 205s and the 215s are kind of the workhorses of the AC line relative to our workhorses in the N line. Those have better gross margins than the premium product, and that was true in the N line also. Overall, if you look at N to AC, as we pointed out last quarter, when we look at that whole line when the whole line is out and shipping, we project overall gross margin to be about comparable to N, about flat.

Dominic P. Orr

And the fact that we have a full line actually is favorable to gross margin because we now have the right product to exactly feed in the right application so you don't need to adjust discounts and so on to feed an application. So that actually gives us some assurance as a family [indiscernible] rate to the gross margin projection.

Michael M. Galvin

And a quick context on Asia. So it did have very good year-on-year growth. And one thing you've seen in our last few quarters with Asia is after some very difficult quarters last year, you've seen, I would say, solid -- modest to solid sequential growth on those numbers during this year from a revenue perspective. That did lead to a good year-on-year revenue comparison, but we -- I think we would still categorize Asia as not robust. We're still -- it's -- I would say it's, I don't know how you'd [indiscernible]...

Dominic P. Orr

Yes, I would say if you look at the 3 major theaters, North America is still the most robust in terms of momentum and growth. Continental Europe is coming back very nicely. And Asia is good, but we certainly can -- I expect it to improve -- we would like it to improve even further. So it has a little bit more to go to catch up with the other 2 theaters. But we are pleased, obviously, with this quarter's results.

Operator

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

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

So the first question I had was, how would you compare, Dom, the visibility that you have in the business today versus, I don't know, the last few quarters or even last year? And how would you rank that?

Dominic P. Orr

So I think typically, seasonally going from Q4 to Q1, we have slightly better visibility just because the year-end process. But other than that, I think the regular business, I think, visibility is roughly the same. But what is encouraging to us are expanding new area. Like I mentioned, the -- if you look at the number of Global 2000 accounts that we have in the pipeline with ClearPass and .11ac and the all-wireless workplace kind of solutions with the new emerging but rapidly growing SME market where we're going to apply Aruba Instant and Aruba Central for that market and then the very good traction we're getting with the Smart Air solution with the public-facing enterprise. So I think in terms of those new growth area, it's encouraging. That makes the whole pipeline more robust.

Operator

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

Erik Suppiger - JMP Securities LLC, Research Division

Michael, you had said that your target is 71% to 73%. If you go back before the past 2 quarters, you were kind of in the 72% to 73% range for the most part. Is that where you would expect to be? Or do you -- can you give us any sense within that range where you might fall?

Michael M. Galvin

Erik, so the 71% to 73% has been out there for a couple of years. We feel very good about the range, and we're not getting more nuanced within that range, 71% to 73%, and we feel good about the mix and the way the market's playing out.

Operator

Your next question comes from the line of Jonathan Ruykhaver from Stephens.

Jonathan B. Ruykhaver - Stephens Inc., Research Division

You mentioned federal verticals. I'm curious, can you just talk about the activity levels there relative to your expectations? And how the Suite B cryptography and other security features influence that opportunity for you?

Dominic P. Orr

So I think for federal, Suite B continued to be a major feature where we expect -- we're winning pilots, but the deployment of those pilots, because of this large government project, is expect probably 12 months out. When I mentioned the recovery for this quarter, it reflects that in the previous quarter we practically have a stoppage of the business just because the budgets are all locked up. And now business is back to -- if I say growth and grow usual where actually budgets are variable, people are getting back to their normal procurement process. So we feel like deals are flowing again and obviously, the current quarter that we are in is traditionally a very good federal quarter as well.

Jonathan B. Ruykhaver - Stephens Inc., Research Division

Right. So given the large deal you alluded to, would you expect that business to be up sequentially in the first fiscal quarter relative to 4Q?

Dominic P. Orr

Well, actually, I want to reiterate. Some of the Suite B pilots, I expect, is going to be more of a mid-2015 calendar kind of deployment because it is just the nature of those projects. What we expect this current quarter, the federal business compared to year-over-year or the regular Q1 federal business, is back on track. And given the fact that it was really challenged a quarter ago before the previous Q4, that's where we feel the coming us to [ph] reacceleration comes from.

Operator

Your next question comes from the line of Benjamin Reitzes from Barclays.

Benjamin A. Reitzes - Barclays Capital, Research Division

Dom, I just wanted to ask about -- I mean, there's been a lot of detail in the call. I wanted to ask a lot about e-rate and any other catalysts as well. When do you see that kicking in? You might have mentioned it. And then also, there's a lot of new devices coming out this fall that are ready for AC. Do you expect that to accelerate sales or be a meaningful driver with the new devices?

Dominic P. Orr

Okay. I'll take the e-rate, and Keerti will take the AC questions. Well, as far as e-rate is concerned, there is no significant impact for our current business. We don't expect it to be impactful until the later part of 2015. So in our fiscal '15 plan, we are assuming that it will not have any impact. To the extent that it will have impact, it will be upside. And -- however, having said that, our K-12 business is very robust, and we have sort of very, very good 2 -- features and price points to attack that market. So this is a market that we actually are not ignoring at all. That's my comment on the K-12 and e-rate.

Keerti Melkote

And on the devices front, Ben, the early indications are for this handle devices with .11ac. We are seeing up to 5x improvement in performance as far as network connectivity goes. So clearly, it's a driver. And as more devices migrate over to using .11ac, we see it -- for enterprises, they really want to take advantage of the opportunity to migrate towards an all-wireless office. It's -- if you take a Samsung S5 device, it's quite unreasonable to expect a 200 megabits per second link over WiFi. That's faster than most wired connections on most desktops. So it's entirely reasonable now to take these kinds of devices and run not only data but voice and video on these devices, basically accelerating the trend towards all-wireless office. So we see that as a very positive development for the overall business.

Operator

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

George M. Iwanyc - Oppenheimer & Co. Inc., Research Division

So just on the 4% of the workforce that you hope to move to lower-cost areas, if -- have you already talked to those people? And if they are not ready to move, will you just let those heads go? Or will you be replacing them?

Michael M. Galvin

Yes, George, so those -- the employees are all being notified today, so those are happening. And like we said, there are relocation packages for the employees, and you'll always have a percentage mix of those who take it and those who don't and that's all part of our operational transition plan. There, we will have obviously a lot of active recruiting in the locations we talked about for those who don't take the relocation plans. And so you have to manage that all through the operational transition, which will happen over the next couple of quarters.

Dominic P. Orr

But the positions moving are -- if the employee cannot -- have difficulty moving, we will fill the position in the new location.

Michael M. Galvin

Yes.

Operator

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

Kent Schofield - Goldman Sachs Group Inc., Research Division

So you certainly created a nice trend line of guidance beats as of late. But you did talk about a little bit better visibility, and if I look at your guidance for the October quarter, the implied product revenue growth is fairly modest. And so just wanted to see, in part because you're getting to a larger revenue run rate, if you're starting to see some more seasonality in your first fiscal quarter? Or if there might have been some onetime sum that you saw in July that you don't expect in October. Just kind of wanted to understand the kind of Q-on-Q product revenue growth implied in your October guidance.

Michael M. Galvin

Yes, Kent, so first of all, just on that Q4 question, we definitely didn't have anything extraordinary in Q4 in terms of big deals or anything like that. It's a well-distributed quarter. So on the sequential guidance, I mean, we feel very good about the 26% to 27% growth. We are, I think, nearly raising consensus, $5 million on the quarter. So we feel good all about those things. But in the guidance and just in looking at our business as we do grow and get towards $1 billion to your point, we do see there is some emerging seasonality there that we have to be aware of. So as we look at Q1, that factors in too. But really, when you net it all out, the growth rates and the raising of guidance, we feel very good about.

Operator

Your next question comes from the line of Matt Lebo from Piper Jaffray.

Matthew E. Lebo - Piper Jaffray Companies, Research Division

Just curious, I know that you noted very solid controller-based sales and also solid Instant sales. I was curious, what -- is there a significant difference in the gross margin between those 2 products? And if we continue to see Instant sales grow as a percentage of revenue, is there any risk to the long-term gross margin?

Michael M. Galvin

Yes, yes, Matt, so as we've talked about in the past, Instant performs very well in our AP gross margin range towards the high end of that. And we've talked a lot about viewing the Instant business as an incremental part of our business and an incremental growth, and we talked about the controller-based business doing well. But those -- Instant's been growing very well and improving in our mix of business, but that's all factored into our 71% to 73% and the balancing of all those factors.

Operator

Your next question comes from the line of Rohit Chopra from Buckingham.

Rohit N. Chopra - The Buckingham Research Group Incorporated

I had a question on EMEA. You talked about it getting better, and I think on a year-over-year it was better, but it was down sequentially. Is that a macro issue? Or are there some -- any sales execution issues as we head into their slow quarters? That's my first question. I have 2 more quick ones, if you don't mind.

Michael M. Galvin

Ro, yes, so it was down a little bit quarter-on-quarter. And one thing you see if you go back through time on our numbers, I mentioned year-on-year growth in my opening comments, but sequentially, what you usually see in Q4 from us are softer sequential Q4s from both Asia and Europe and U.S. tends to be very strong sequentially in Q4. So that kind of helped pattern this quarter. Whether that's because vacations are much more liberal in Europe, I don't know, but it's a seasonal thing that we see. And so I would put that in the bucket of normal kind of sequential change. And I think as Dom might have commented earlier, Europe is solid, and it's a long way back from where it was 18, 24 months ago and I'd just -- I'd put it in a solid category.

Dominic P. Orr

Yes, and we have added a lot of resources in the European theater, and we're starting to see the productivity kicks in. So actually very pleased with how things are performing over there.

Rohit N. Chopra - The Buckingham Research Group Incorporated

I wanted to ask you a follow-up on education, a follow-up to Ben's question. Is there any way that you could provide maybe just a split, a rough percentage of what K-12 is versus higher ed? That would be the first part of that. But the main question is this, since WiFi wasn't really a funded program under e-rate before but K-12 was buying WiFi, do you anticipate any type of pause or slowdown as they sort of wait for the e-rate fiscal '15 year, which starts next year, before buying WiFi? So is there any potential for a pause? Have you talked to anybody out there or any schools saying, "You know what? Maybe we'll just try to get it subsidized by e-rate next year instead of making a purchase this year."

Dominic P. Orr

If there's any slowdown, a pause, it certainly was not within our pipeline. What we see is things are moving very well. I don't think we have been aware of any deals that people originally was going to purchase and then they say, "No. Now I'd wait a year." We don't see that. At least I'm not aware of any. We do not break out our verticals as a practice, and so higher ed and K-12 are 2 actually different verticals. So...

Michael M. Galvin

Yes, we don't break them out explicitly. One thing we have said to you guys historically, higher ed, really throughout our history, has been kind of one of our top 5 verticals. But the other thing we've said is that K-12 in the last 2-plus years has really emerged as another prominent vertical. And so whether that's the big 6 now or part of the big 6 or 7, it's definitely a good, healthy and important vertical, whereas higher ed was at the case really our whole history.

Operator

Your last question comes from the line of Jeff Kvaal from Northland.

Jeffrey Thomas Kvaal - Northland Capital Markets, Research Division

I have 2 questions, one for you, Dom, and then one for Mike. Dom, you were talking a decent amount about market share gains. It seems though AC is really the one that is driving that share gain. Do you have a sense now about what your share is if you look at the AC market on its own?

Dominic P. Orr

I believe that if you look at the market analyst like Gartner and Dell'Oro, they do break out the AC market share. So I probably would encourage you, and we can also follow up within a day or 2 with our reports out, that new number will go up and I think you'll be pleased to see the market [indiscernible]...

Jeffrey Thomas Kvaal - Northland Capital Markets, Research Division

Would it be prudent for us, Dom, to look at that and say, "Okay. Well, let's look at that number and where Aruba has been historically an N [ph]," and then use that as a way to project where your share might be a year or so from now?

Dominic P. Orr

I think a year is too soon. Obviously, our aspiration is to market transition to .11ac Wave 1, Wave 2 that our market share with .11ac hold as the whole markets shift, and that actually is one of our strategic objective. But that shift is going to happen not in 4 quarters but probably 8 to 10 quarters when the whole thing is done and most office will become primarily .11ac supported by the wire backhaul.

Jeffrey Thomas Kvaal - Northland Capital Markets, Research Division

Okay. Great, great, great. And then Mike, lastly for you, should we expect a quarter where pro forma OpEx is actually down? Or should -- would this -- your restructuring plans really constitute more of a tweaking to OpEx and therefore OpEx should continue to drift up, just perhaps not at the pace that we previously modeled?

Michael M. Galvin

I assume you're talking about dollars there.

Jeffrey Thomas Kvaal - Northland Capital Markets, Research Division

Yes.

Michael M. Galvin

So no -- yes, no explicit guidance, I guess, on quarterly dollars. But the way to think about our optimization program, Q1 is a transition quarter where we're putting those things into effect beginning today. And so when we look at our 21% to 22% for the year, the op margin should improve throughout the year to get to that weighted average outcome. But no, I guess no explicit guidance on dollars per quarter.

Jeffrey Thomas Kvaal - Northland Capital Markets, Research Division

Okay. All right. So to work backwards from the 21% to 22% and see what we get is the way to work on pro forma [ph].

Michael M. Galvin

Yes, the EPS guidance, the gross margin guidance, revenue, yes, work backwards from there.

Operator

There are no further questions. I turn it back to management.

Dominic P. Orr

Well, again, we thank you for being on the call today. I would like to take a moment to thank our very valued employees for their dedication and contribution and their commitment to make all this happen. Thank you.

Operator

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

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