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Aruba Networks (NASDAQ:ARUN)

Q2 2011 Earnings Call

February 17, 2011 5:00 pm ET

Executives

Dominic Orr - Chairman, Chief Executive Officer and President

Jill Isenstadt -

Steffan Tomlinson - Chief Financial Officer and Principal Accounting Officer

Analysts

Mark Sue - RBC Capital Markets, LLC

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

Sanjit Singh - Wedbush Morgan

Tim Long - BMO Capital Markets U.S.

Ryan Hutchinson - Lazard Capital Markets LLC

Blaine Carroll - Hudson Securities Inc.

Lynn Um - Barclays Capital

Rajesh Ghai - ThinkEquity LLC

Stephen Patel - Gleacher & Company, Inc.

Simona Jankowski - Goldman Sachs Group Inc.

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to Aruba Networks Fiscal and Second Quarter 2011 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Nicole Gunderson, Investor Relations. Please go ahead.

Jill Isenstadt

Good afternoon, and thank you for joining us on today’s conference call to discuss Aruba Networks' fiscal second quarter 2011 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; Steffan Tomlinson, Chief Financial Officer; Keerti Melkote, Aruba’s Co-Founder and Chief Technology Officer; and Hitesh Sheth, Aruba’s Chief Operating Officer.

After the market closed today, Aruba Networks issued a press release announcing the results for its fiscal second quarter ended January 31, 2011. If you would like a copy of the release, you can access it online at the company's website, or you can call The Blueshirt Group at (415) 217-7722, and we will fax or e-mail you a copy.

We would like to remind you that during the course of this conference call, Aruba Networks' management will make forward-looking statements, including statements regarding the company's expectations regarding industry growth drivers such as the proliferation of tablets and smartphones, the company's continued ability to make targeted niche acquisitions, management transition and the company's future economic performance, pipeline, financial condition and results of operation.

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 more detailed description of these risks and uncertainties, please refer to our report on Form 10-Q filed with the SEC on December 10, 2010, as well as our earnings release posted a few minutes ago on our website. Copies of these documents may be obtained from the SEC or by visiting the Investor Relations section of our website.

Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided reconciliations of these non-GAAP financial measures to GAAP financial measures in the Investor Relations section of our website located at www.arubanetworks.com and in our earnings press release. Now I'd like to introduce Dominic Orr, President and Chief Executive Officer of Aruba networks. Dominic?

Dominic Orr

Good afternoon, and thank you for taking the time to attend our fiscal second quarter 2011 conference call. We believe we are seeing a profound shift in market trends that are driving growth of our business. First and foremost, the proliferation of smartphones and tablets in addition to laptops is radically changing how enterprises and organization approach the network edge. Second, the sharp increase in demand for multimedia-rich mobility applications, particularly video, has set a new bar for user expectation and a network that must not only connect but deliver the experiences and user demand. Third, the rise of both server and desktop virtualization has quickly increased the business relevance of the incoming wave of new mobile devices and tablets.

Together, these trends are triggering demand for new access network, one that is architected for the user, the device and application, also complexity and proliferation of ports. We believe the answer to this demand is delivering a new network edge that allows our customer to quickly deliver cloud services, reduce cost and mitigate risk for this rapidly changing mobility environment. And most of all, it is about providing a comprehensive security implementation to ensure this accelerated path to mobility is a safe one.

Aruba solutions are uniquely positioned to achieve these for our customers, and the second quarter offered clear evidence of our success as we achieved a record performance across a number of major metrics.

Revenues in Q2 increased to $93.9 million, a 50% increase over last year, which was far greater than the competition. We added well over 1,000 customers, the highest quarterly increase in our company history. Gross margins increased to 73.2% on a non-GAAP basis. Non-GAAP operating margins reached 18%, and we reported non-GAAP net income of $16.3 million or $0.14 per diluted share.

Demand was broad based as all of our major geographies were up significantly with no major concentration on a vertical basis. Average deal size increased, and we saw notable growth in the number of large potential deals in the pipeline.

We were most encouraged by the strong demand from the general enterprise and believe that we have reached a tipping point in the market as more and more enterprises grasp that the traditional approach to the network edge is outdated in an increasingly mobile world. The rise of tablets and smartphones has made the traditional approach even more obsolete as these devices typically have no Ethernet ports and limited ability to fit into legacy network infrastructures.

The phenomenon we are seeing is called BYOD or bring your own device. As a result, CIOs are quickly embracing more agile, cost-effective, self-provisioning models for end point devices. Employees from the executive level down expect to be able to use their smartphone and tablets securely and immediately, and this trend is only beginning.

Forrester predicts 82 million U.S. consumers will have tablet PCs by the year 2015 with roughly half of them being used at work. Add in over 700 million smartphones as predicted by IDC over the same period, and you have a tidal wave heading towards IT departments across the world. In Aruba, our job is to turn what can be a significant challenge for IT organizations into a compelling opportunity to deliver business value and enhance user experience.

The power of our solution to solve the challenges posed by these devices is resonating with our customers.

Our access to executive ranks within IT organizations has improved notably over the last year. We believe we offer a fundamentally different technology and value proposition than any of our competitors, one that is more optimized for the mobility-centric network.

The strength of our competitive differentiation was evident in our new customer acquisitions. Key new customers included one of the world's largest PC manufacturers, one of the largest mutual fund and financial services groups in the world, a global Internet services and media company and leading healthcare and educational institutions around the world.

Even with our success with new customers, the majority of revenue is driven by our existing customers, and we were encouraged to see an increase in our average deal size for repeat customers. We believe that our current customer base has the potential to drive significant growth for many years to come because there's a relatively low penetration rate in the base and a majority of our customers will be upgrading from abg to 11n.

One example of the changes impacting our customer base is Tennis Australia. Tennis Australia has been a customer for over a year, originally deploying a network that serves the internal operations and offers secure access to visiting press, officials and players.

This year, they decide to open the network to the public and develop new mobile applications for the smartphones and iPads used by fans attending the matches. This meant they needed a solution that offers secure user-centric access, but also was capable of scaling up to 100x normal business traffic when the Australian Open was being played.

We implemented a comprehensive indoor and outdoor wireless LAN solution that deliver optimal performance in a high-density environment during the tournament. This is a great example of using our technology to offload data traffic that clogs 3G cellular networks in public settings like stadiums.

To take advantage of the market opportunities, we continue to invest heavily in expanding our R&D effort and increasing our footprints in the market. In January, we were pleased to add Ben Gibson to our team as Chief Marketing Officer. Ben brings strong marketing and industry experience to Aruba. Previously, he was Vice President of Data Center And Virtualization Marketing at Cisco. Prior to that, headed marketing for Cisco's Enterprise Mobility Solutions. We also have been steadily increasing the breadth and depth of our sales and technical support team worldwide to drive and support future growth.

In addition to organic growth, we also will continue to make targeted niche acquisitions that complement our product solution and increase our addressable market. The integration of Azalea continues on pace, and we are seeing increasing opportunities for industrial mesh outdoor projects around the world.

This quarter, we also completed another small acquisition, Amigopod. Based in Sydney, Australia, Amigopod is a leader in network authentication solutions that allows businesses to provide time- and policy-bound network access to visitors, contractors and employees. Tennis Australia, mentioned earlier, utilize Amigopod to provide secure access to the visitors attending the tournament. We view Amigopod as another opportunity like AirWave to sell an Aruba product both in conjunction with our own technology but also into networks running our competitor's technology. We look forward to telling you more about Amigopod and other new initiatives at our Analyst Day in New York scheduled for March 16. And that is March 16.

Now before we go over a more detailed run-through of our financials, I want to refer to a press release issued by the company today in which we state that Steffan Tomlinson, our CFO, will be leaving us to join the venture capital world on March 31. A search for his replacement has begun, and we are confident that we will secure a world-class candidate in a timely manner. On behalf of all of Aruba's employees, I want to take this opportunity to thank Steffnan for his contributions to the company in the last five and a half years. His competence, his work ethic, his leadership qualities and his teamwork are exemplary. Steffan, it has been my privilege to serve with you in the last five years, and I will miss the partnership I have forged with you leading this company. I respect your desire to pursue a new career direction and, along with all your colleagues, wish you all the best. A little later in the call, I will be happy to answer any questions you may have and will now turn it over to Steffan to go through the financials in more detail.

Steffan Tomlinson

Thanks, Dominic. It's been a great honor to work with you and be part of the Aruba team since 2005. I feel fortunate having given the opportunity to work with such an exceptional group of people. This commitment to building the best company in the business is second to none.

I'd like to take this moment to extend a thank you to everyone I've worked with, both inside and outside the company. As Dom mentioned, I'll be leaving Aruba to pursue a career in venture capital. I'll be staying at Aruba through the end of March to ensure an orderly transition.

Now turning to our results. In Q2 2011, total revenue of $93.9 million increased 13% sequentially and 50% year-over-year. Product revenue of $79.1 million increased 14% sequentially and 52% year-over-year. Professional services and support revenue of $14.6 million increased 6% sequentially and 41% year-over-year. In Q2, approximately 93% of our revenue came from indirect channels while 7% was direct. As a reminder, our indirect channels represent sales through our strategic OEM partners, VARs and distributors. Approximately 67% of our revenues were generated in the U.S. while 33% came from international theaters. Demand in terms of orders was strong across all theaters. Both our core verticals and the general enterprise show strength in the quarter.

Total non-GAAP gross margin in Q2 was 73.2%, an increase of 110 basis points from Q1 and an increase of 380 basis points from Q2 2010. The increase is due in part to favorable product mix, timing of support, renewals and contracts and channel and geographic mix. In the near term, we anticipate our total non-GAAP gross margin to be approximately 70% to 71% as our OEM and International businesses are ramping. This is 200 to 300 basis points above the top end of our long-term target range at 65% to 68%.

Q2 non-GAAP product gross margin was 71.9%, up 180 basis points from the prior quarter and up 490 basis points year-over-year. Q2 non-GAAP services gross margin was 80.3% compared to 82.1% in the prior quarter and 81.6% in the same period a year ago.

Moving on to operating expense. Non-GAAP research and development expense was $15.2 million, up approximately $2.1 million from the prior quarter and up as a percentage of revenue from 15.8% in Q1 to 16.2% in Q2. We had a full-quarter impact from Azalea and added the engineering team from Amigopod. We also continued to invest heavily in new product development.

Non-GAAP sales and marketing expense increased $2.2 million to $30.1 million from the prior quarter due to marketing program spend as well as head count and commissions related to incremental revenue. Sales and marketing was down as a percentage of revenue at 32.1% in Q2 compared to 33.5% in Q1.

Non-GAAP G&A expense of $6.5 million increased by $1.5 million sequentially and was up in Q1 '11 as a percentage of revenue at 6.9%, due in part to increased expense related to outside services. Head count at the end of the quarter was 924, an increase of 56 from the prior quarter. In total, Q2 non-GAAP operating expenses were $51.8 million or 55.2% of revenue, which represented a 10-basis-point improvement from the prior quarter. Our non-GAAP tax rate was 2.6% in Q2 compared to 1.4% in Q1. We expect our tax rate in Q3 to be between 5% and 10%.

Non-GAAP net income for the quarter was approximately $16.3 million or $0.14 per share. This compares to non-GAAP net income of $13.9 million or $0.12 per share in Q1 '11 and non-GAAP net income of $6.3 million or $0.06 per share in Q2 '10. Due to the appreciation of Aruba's stock throughout the quarter, Q2 '11 weighted average shares outstanding were 116.2 million shares on a diluted basis. Due in part to a rising stock price in the quarter, on a GAAP basis, net loss was $2.8 million or $0.03 per share compared to Q1 '11 GAAP net income of $2.1 million or $0.02 per share and a Q2 '10 GAAP net loss of $4.4 million or $0.05 per share. A reconciliation of GAAP and non-GAAP information is contained in our earnings and press release issued this afternoon.

Turning to the balance sheet, we finished January with cash and short-term investments of $187.8 million, an increase of $13.4 million over the prior quarter. Cash flow from operations was $10.7 million. We ended Q2 with $54 million of accounts receivable, up from the Q1 '11 balance of $43 million. Days sales outstanding were 52 days, up five days from last quarter and up four days from Q2 '10 mainly due to linearity in the quarter. Our target range is 50 to 55 days. We believe the quality of our receivables remains excellent.

Moving down the balance sheet, total deferred revenue of $59 million increased 15.7% year-over-year and 3.5% sequentially. Short-term deferred revenue of $47.5 million increased 15.1% year-over-year and 10% sequentially. As a reminder, we remain a book-and-ship business.

Inventory totaled $18.1 million at the end of Q2, flat with the end of Q1. Inventory turns were 4.9, a small decrease from five in the prior quarter.

Let me now turn to our third quarter guidance.

In Q2, December was strong in part due to some end-of-year spending, and January was particularly strong. Our momentum in the marketplace continues, and we have a robust pipeline. Given all these factors, we expect revenues and non-GAAP EPS to increase sequentially and year-over-year. In Q3 '11, we expect Aruba's revenues to increase 38% to 42% year-over-year in the range of $95 million to $98 million. We expect non-GAAP EPS to increase on a year-over-year basis by 75% to 78% to $0.14 to $0.15 per share using approximately 120 million shares on a diluted basis. With that, let me turn the call back over to Dominic.

Dominic Orr

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

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes is the line of Simona Jankowski with Goldman Sachs.

Simona Jankowski - Goldman Sachs Group Inc.

I just wanted to ask you first on the acceleration in your customer adds. Anecdotally, can you trace that more to tablet adoption or share gains or any other factors?

Dominic Orr

In our core verticals, the past factors have been mobile applications, laptop applications, and that continued to be the case. We see that the increase that are tied to tablets is more in the general enterprise, where the smartphones and the mobile tablets have worked into the mobility projects within the general enterprise, and that is our operation.

Simona Jankowski - Goldman Sachs Group Inc.

And then the other thing I wanted to follow up on is, you mentioned that you saw larger average deal sizes for your repeat customers, and also that you think you're still pretty underpenetrated. Any sense for what your level of penetration is at existing customers?

Steffan Tomlinson

What we've said in the past is across our entire install base, we're about 30% to 40% penetrated given the current opportunity. But as we look at how the opportunity is expanding over the next year and year and a half, that penetration rate could actually be lower.

Dominic Orr

And there are really two dimensions we talk about here. One is the shifting of desktop and laptop computing to the cloud computing with the smartphone and tablet has forced the coverage model for wireless LAN from a hot zone model to ubiquitous coverage model. So we expect that will drive a significant expansion in our install base. And the second wave is the migration from the 11abg to 11n.

Operator

The next question is from the line of Ryan Hutchinson with Lazard Capital Markets.

Ryan Hutchinson - Lazard Capital Markets LLC

So I guess on the gross margins, in typical fashion, you are guiding them down sequentially, but they continue to move upwards here. So maybe, could you just talk to that in terms of how we should think about the gross margins, specifically on a product and services basis, because it looks like to get to the number you're talking about, you got to take your product gross margins below the 70% range, which is quite a big hit. And I'm assuming also that the services component should continue to improve here following the investments you've made there.

Steffan Tomlinson

Well, on the gross margin front, we've talked about our expanding relationships with our OEM partners and the expanding footprint of our International business. And in those, they have different gross margin profile than some of our normal business.

As it relates to specifically guiding on product versus service, we don't break out on a guidance standpoint. But I will tell you that we're very happy that we're above our long-term target model. The guide is 70% to 71%, and the dynamics of channel mix, geographic mix will always be somewhat of a wild card as we continue to operate.

Ryan Hutchinson - Lazard Capital Markets LLC

So I'm assuming there's some level of conservatism built into those assumptions. Then on the Dell relationship, can you just talk about where we are in the ramp? And perhaps any metrics or milestones that you've met to give us a sense on in terms of how that's progressing?

Dominic Orr

As far as the Dell relation is concerned, I want to remind everyone that when we announced relationship, we had said the relation of this nature is going to be multi-quarter in nature in terms of bring-up. So we have very well-planned, mapped out internal milestones, and against those milestone, I'm very pleased the way that we have progressed. That is a different kind of market segment that we work through with Dell on where wireless LAN is properly fitted. And as a result of those mapping, we are now doing jointly go-to-market activities, which probably in the next couple of quarters we will further increase the tractions. But obviously, we will not break out the specific quantity of sales, but it is on track and I'm pleased. And we expect that the momentum will continue to build.

Ryan Hutchinson - Lazard Capital Markets LLC

And then as it relates to that, more of a housekeeping than anything else. Steffan, you provide in your filings partner A, B, C and D. Maybe if you could provide those numbers if you have them handy, or, at a minimum just as combined entity, what it was as a percentage of total revenue. And then, as it relates to Dell, was Dell one of those partners?

Steffan Tomlinson

We have three partners that were above 10%, and Dell was not one of them this quarter. But Dell's business has been ramping, and we're very pleased with that ramp.

Operator

Your next question is from the line of Stephen Patel with Gleacher & Company.

Stephen Patel - Gleacher & Company, Inc.

On OpEx, your R&D has gone from about $11 million two quarters ago to $15 million. Can you highlight the top few areas where those incremental R&D dollars are being spent and your top priorities there?

Steffan Tomlinson

OpEx has increased in R&D for a couple of reasons. First is we made an acquisition of Azalea that we highlighted two quarters ago. And this quarter, we had the full impact of a full quarter's worth from Azalea. We've also made another smaller acquisition with Amigopod. So we have acquisitions that are layering in that are primarily R&D expense that are coming into that line.

Additionally, we are investing in new product development as we come out with new products that obviously necessitates us spending in R&D. But we feel very comfortable that we're investing adequately to capture the market opportunity going forward.

Company Speaker

And the only thing I would add to that, Steffan, would be that all our investments in R&D are really geared towards enterprise mobility. He didn't say. And we see an incredible opportunity with this trends in the marketplace right now, and we are very determined to make sure we capitalize on trends.

Stephen Patel - Gleacher & Company, Inc.

To follow up, Mobile World Congress, China Mobile talked about a large Wi-Fi hotspot deployment over the next three years, 1,000,000 hotspots. And I know Azalea in the past had a contract with China Mobile. Can you talk about your involvement there, whether that's been a contributor at all to your results now or how meaningful it could be for you in the future?

Dominic Orr

So Stephen, coincidental with the Azalea acquisition, as you might recall, we also announced a joint investment with Alcatel-Lucent in China through their subsidiary called Alcatel-Lucent Shanghai Bell. And that is the entity through which we have been very actively and successfully penetrated in this China served by the market. And I'll just stop with that.

Operator

Your next question is from the line of Sanjiv Wadhwani with Stifel Nicolaus.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

I wanted to just get a idea. International by my calculation was, I think, flat to maybe down about 2%. U.S. was up about 22%. Anything going on there or is this sort of typical quarterly gyrations? And any particular geography outside of U.S. was weak?

Steffan Tomlinson

Well, when I look at the calcs on a revenue basis, the U.S. was actually up 14% quarter-on-quarter and international was up 12%. So I can work with you on your model. So we saw strong demand across all theaters from both an order standpoint and a revenue standpoint.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

And then mix of 11n, can you talk about where that's headed now in post the Jan quarter?

Steffan Tomlinson

So last quarter, we had 81% of our units that were shipped be 11n. And that was up seven percentage points from the prior quarter. And so we've had very strong traction. We'll continue to have strong traction with 11n.

Sanjiv Wadhwani - Stifel, Nicolaus & Co., Inc.

And then Steffan, congratulations on your new venture. Just curious, any particular reason for the departure? Are you tired of dealing with Wall Street? And is the company looking internally for a replacement or is it going to be an external hire?

Steffan Tomlinson

I'll take the first part. So I wouldn’t leave Aruba what we have Aruba for another CFO opportunity because I don't think -- and I don't know of any other company with the opportunity Aruba has in front of it. I've been very honored and privileged to work here, and I actually have really had a lot of pleasure dealing with Wall Street. Dominic can comment on...

Dominic Orr

Actually, what Steffan really meant is he would never be able to find a better boss. I'm sorry to say that [ph]. And, well, I think we're in a good situation that I think that we believe that there are a lot of world-class candidates we would be able to evaluate for this job. And that would include external, internal. I do not specifically have a fixed model in mind. We're just very active.

Operator

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

Mark Sue - RBC Capital Markets, LLC

Dom, is there any end-market acceleration that you may be seeing in a particularly underpenetrated vertical? What I'm trying to do is to try and get a sense of the penetration from the smallest vertical for you and also the largest vertical, how that compares. And likewise, what is kind of the dollar difference between your smallest early deal and kind of your largest mature deal?

Dominic Orr

Mark, I think one of the -- if you look back at the last 90 days, one of the distinct phenomenon I experienced is the verticalization of wireless LAN is actually getting more fuzzy. Traditionally, if you recall, it is the high education, the retail and so on, the warehouses, the healthcare. But the distinct characteristic for the last 90 days is actually the mobility needs emerge wherever the tablet and the smartphone kind of penetrate, and that is across verticals. And that's why we emphasize general enterprise. And that is actually for us the most encouraging part.

Mark Sue - RBC Capital Markets, LLC

And would you say, Dominic, that's also similar in North America, Europe and Asia in terms of penetration, how that's becoming somewhat fuzzy?

Dominic Orr

I would say yes to the large extent. I think if you look at the Android tablet and the iPad and the iPhone, they are not available in 100% of the countries yet. But wherever they hit, we've seen the phenomenon that hits across industry. And another phenomenon we see, this is through the executive downward. So it's actually making the budget discussion actually a little easier. And as we relate to the kind of the deployment size, actually we are seeing organizations that actually have already had pilots going on, or partial implementation have accelerated the deployments for the rest of the organization. That's probably one of the biggest trends that I see in the larger companies.

Mark Sue - RBC Capital Markets, LLC

And Steffan, when you did 73% gross margins, was that a challenge to the next CFO saying, ha, try to top that?

Steffan Tomlinson

Very funny, Mark.

Dominic Orr

I think he has challenged the next CFOs to do a better job to forecast the range.

Operator

Your next question is from the line of Tim Long with Bank of Montreal.

Tim Long - BMO Capital Markets U.S.

A lot of talk, obviously, about the non-GAAP numbers here. But I'm curious, have really big spike in the stock-based compensation in the quarter. So looking at it outside of that, it looks like margins probably went down sequentially. What was the reason for that? And is this a new elevated level here? Was it somehow a one-term spike?

Steffan Tomlinson

Most of the increase is due to the appreciation of Aruba's stock price in the quarter. But we also had a couple of other elements where we had our employee stock purchase plan expense hit this quarter as well. So those are a couple of the drivers behind that. It's hard to forecast. And that's why we don't forecast our GAAP numbers, because there's variability, things that are outside of our control.

Tim Long - BMO Capital Markets U.S.

Yes, but just looking at the stock price over the year, I mean, the chart looks pretty good for you guys, linear up to the right. It didn't seem like there was that dramatic a move that we haven't seen prior quarters. It just looks like -- was there some expenditures on employees that was shifted into stock based from cash?

Steffan Tomlinson

We have a employee stock purchase plan and we have a bonus program that is paid in RCUs [ph] [44:08]. And that's also contributing to it.

Tim Long - BMO Capital Markets U.S.

Is that like December, end of year? Or why would we see it more this quarter?

Steffan Tomlinson

We have a first half, second half employee bonus program, and that first half ended in January.

Tim Long - BMO Capital Markets U.S.

And then just on to the verticals again. Just any comment on the more public sector type of businesses continue to see some large companies complaining about potential weakness there. I don't think you guys have seen it in your numbers, but if you could just comment on those verticals, that would be great.

Dominic Orr

So if you look into our government-related business, it's really very much tied to the Federal Government domestically, and a big part of this is Defense Department. That doesn't seem to have been affected. For the state and local, I think a lot of our state government-related spending is tied to education, and that doesn't seem to have been affected. And lastly, we do not participate to a large extent to the non-education, state and local government. Maybe some public hospitals and healthcare continue to be struggling. So maybe, that's why we are not seeing what other companies...

Operator

Your next question is from the line of Rajesh Ghai with ThinkEquity.

Rajesh Ghai - ThinkEquity LLC

Just a question on what's driving the business at this point in time. I was just trying to understand how much of it is being driven by your message of network rightsizing versus you know how much of it is still an overlay to the existing wired network?

Dominic Orr

I would say, like I mentioned in the beginning comment, really the increase of the cloud computing solution, coupled with the smartphone, the mobile tablets, is driving ubiquitous connectivity requirement. That really forced the issue very clearly on the rightsizing message because when -- I can tell you that despite that the IT spending seems to have recovered, at least in the enterprises that we deal with, nobody is having an increased budget on infrastructure. So given that there is a pressure of spending to support mobility, somewhere has to give. And it has not escaped a lot of people's attention that the wired infrastructure upgrade, maybe they don't need to do a full-blown upgrade, and that's the way that they balance the budget to meet all their pending needs. And that, hence, is naturally reinforcing our two-year-old campaign of rightsizing, and that's really gratifying, that coming together that way.

Rajesh Ghai - ThinkEquity LLC

And your customer count was up pretty smartly. I'm just trying to understand what the ramp is in terms of your pipeline. Can you give us a sense on how many new customers you had at the beginning, I would say, the first of the quarter versus how many you had at the end of the quarter in your pipeline?

Dominic Orr

Well, first of all, unfortunately, we don't track our business that way. So my observation is we tend not to have any intraquarter seasonality of our customer acquisition. Obviously, there are seasonality in terms of one month, two months, three bookings, but the ratio of existing customer to new customers, my observation is that there's no striking difference between the beginning of the quarter versus the end of the quarter. Is there some other question you actually want to ask via that question that maybe we can...

Rajesh Ghai - ThinkEquity LLC

Yes, I'm just trying to understand how broad is the demand getting. And I'm just trying to get a sense of a metric that you're tracking to determine how the appeal of wireless LAN is broadening as time goes by. I know you talked about the tablet proliferation, but can you also talk about in terms of interest amongst enterprises or customers that you could kind of talk about?

Dominic Orr

Right. So I think the general sentiment that I feel is that before the tablet, before the smartphone, the mobility project is an overlay. I say this as like vitamin and herbal medicine where after the tablet and the smartphone and the pressure of the high-density mobile application, it is part of an integrated solution because that is part of the aspirin that is needed to remove the headache.

Rajesh Ghai - ThinkEquity LLC

And one question on the operating margin. You already reached an 18% non-GAAP operating margin. Can you remind us of your long-term operating model? And given that you're seeing a very strong ramp in your operating margin, do you think you may revisit that operating model maybe at the Analyst Day?

Steffan Tomlinson

Our long-term target model is 19% to 20% non-GAAP operating margin. And yes, we're close to it. We've showed great progress over the last eight quarters, delivering sequential increases. We're very pleased with that. As it relates to looking at updating that model, as I said in last quarter's call, at sometime this fiscal year, we'll take a look at it. And it's very much dependent upon the business drivers, the opportunity, and we'll take all those factors into consideration.

Operator

[Operator Instructions] Your next question is from the line of Lynn Um with Barclays Capital.

Lynn Um - Barclays Capital

Just going back to the question on the verticals. I realize you don't break out the details of each vertical, but it sounds like now you're doing quite well in the general enterprise, which you spoke about earlier. Is there any way we can kind of think of, say, if your top three to four verticals are greater than 50% of your sales or, like, just kind of how this measure, how that may have shifted over the past, like, year or so?

Dominic Orr

Well, Lynn, actually, I think what we have been seeing in the previous quarter is what we consider major vertical in a given quarter is somehow contributing to somewhere between 10% to 15%, but we don't break down the revenue by very close for each specific quarter.

One trend that I can tell you is with the rise in the general enterprise, the contribution with each of our traditional call it vertical is actually gone down to the point that it is actually almost not worthwhile mentioning. That actually is one of the biggest encouragement that I've seen develop in the last two quarters.

Operator

Your next question is from the line with Rolett Chufa [ph] [52:14] with Wedbush Securities.

Sanjit Singh - Wedbush Morgan

This is Sanjit Singh for Rolett Chufa [ph] [52:20]. First, do the gross margins vary by vertical? It seems that the general enterprise has picked up in recent quarters and the gross margin has gone up. Is there anything there in terms of gross margin varying by vertical?

Steffan Tomlinson

It's more along the lines of gross margins benefiting from product mix a little bit in the near term. However, as we ramp our OEM businesses and the international businesses, there's going to be some variability there.

Sanjit Singh - Wedbush Morgan

And is there any way to quantify or at least gives a sense about the total addressable market for the 3G offload opportunity that you mentioned in your script?

Dominic Orr

So what we technologically very good at is solving high-density connectivity problem with dynamic changing of mobile devices with multimedia application. And where that core competent intersect with the so-called 3G offload market is returns on most of the pain point of service [indiscernible] [53:33] I have with the 3G spectrum is when there are high-density aggregation of users such as in arenas and stadium and conference hall. And that is where Aruba's expertise get called in the most. And a lot of these, as you can imagine, are extension of our enterprise footprint. For example, a stadium in a university on which they're already our customer. Those are the kind of environments that we find ourselves in the most, like [indiscernible] (54:08).

Company Speaker

And Rolett [ph] [54:10], the one thing I would add that’s probably worth noting is this is actually a difficult problem to solve. And as some of you may have noted in recently reported news around the Mobile World Congress in Barcelona where competing solutions failed in high-density environments. And I'll contrast that against what we did at the Australian Open where we had a very high-density deployment done in the stadium and it was very successful. So we have every reason to believe we've got the right solution for high-density deployments and in public venues in particular. And everything in healthcare is along these lines.

Sanjit Singh - Wedbush Morgan

And my last question I just have to ask this even though you guys have clearly done fantastic, just regarding the competitive environment, your largest competitor seems to be stumbling a bit in various areas. Do you anticipate anything from them or HP or Meru in terms of the competitive environment more aggressive as we go forward?

Dominic Orr

So obviously, we are not dismissing at any second any of our competitor's move. We are always very vigilant of that. But in the marketplace, invariably, we are still seeing Cisco in most of the competitive environment. And again, as in the past, the legacy retail environment, we still see Motorola. Now HP, I'm sure that with their brand and with their channel distribution, they are going to be doing well in whatever they choose to. It's just that their world and our world have not collided yet for the time being. We don't see, where we are very strong, that they have capabilities at all that open up.

Company Speaker

And furthermore, I would add that against our biggest competitors, the core focus of the business and the approach you take with customers is still dynamic [ph] [56:10]. Our largest competitor go in there, and they still think wired first. When we sell to our customers we always, always think wireless first. And that is delivering dividends, as you can see.

Operator

Our next question is from the line of Blaine Carroll with Hudson Securities.

Blaine Carroll - Hudson Securities Inc.

Dom, for you, first of all, I think Cisco put up 34% growth. You guys just put up 50% growth. Clearly, you've gained share. But as you look at the overall market, would you say that the growth rate in the market is accelerating as well? And sort of how would you quantify what the growth rate in the market is right now?

Dominic Orr

Well, definitely, the market -- my sense is the market is growing, again driven by all this influx of mobility, mobile devices into the enterprise, the BYOD phenomenon. I think the market is dynamic enough that it is hard for people to either project on an annual basis. We just need to watch it quarter-by-quarter. And the rising water level drives our boat. And just a little bit here, the 34% year-over-year growth was Cisco's product, and our equivalent number is 52% actually. But independently, we beat them healthily.

Blaine Carroll - Hudson Securities Inc.

Steffan, when you're talking about the gross margin and product mix, did you give a breakout between the mobility controls and the access point?

Steffan Tomlinson

We don't give that level of granularity because it's a system sale.

Blaine Carroll - Hudson Securities Inc.

And then when you say that it was mix, do you mean there was more mobility controls versus access points or more 11n product versus the older abg product?

Steffan Tomlinson

More 11n product is the primary driver. And we're also selling more software modules as well.

Blaine Carroll - Hudson Securities Inc.

And then lastly, Steffan, I think in the past you've talked about that in the beginning of the calendar '12 that you thought that you would be a normal taxpayer and you were going through some analysis to see if you could lower that down to 20%. Can you sort of update us on your thinking there? And what should we use for a tax rate as we're modeling out fiscal '12?

Steffan Tomlinson

We have about $97 million of NOLs right now. And what I've said in the past is, it'd probably in the second half of calendar year '12 we'd become a taxpayer. We're still in the process of evaluating alternatives. When we look at the different alternatives, should we go down the path of doing an IP cost-sharing relationship? We should be able to get an effective tax rate of call it 28% to 30%. If we don't go down that path, then it would be approximately 35%.

Blaine Carroll - Hudson Securities Inc.

So should we be using like a 15% tax rate for modeling purposes for the full year?

Steffan Tomlinson

Well, for the full year, what we talked about is a 5% to 10% tax rate for the rest of this fiscal year. And then it should scale up. We haven't really given guidance past this fiscal year on tax. I'm hopeful that either near the Analyst Day or after the Analyst Day, we'll be able to give folks a better read on what the long-term tax rate is going to be.

Operator

And that's all the time we have for questions. So I will turn it back over to management for any closing remarks.

Dominic Orr

Well, again, we thank you for being on the call today. I'd like to take a moment to thank our valued employees, customers and partners for a strong second quarter of 2011. We are pleased with our performance in the first half of our fiscal 2011. I'm very excited about the opportunities for the future. Thank you for listening. We look forward to updating you on our progress in the coming months. And for those of you who are coming on our Analyst Day, see you in New York City, March 16. Goodbye.

Operator

Ladies and gentlemen, that concludes the conference call. You may now disconnect, and thank you for your participation.

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