Aruba Networks' CEO Discusses Q2 2012 Results - Earnings Call Transcript

Feb.16.12 | About: Aruba Networks, (ARUN)

Aruba Networks (NASDAQ:ARUN)

Q2 2012 Earnings Call

February 16, 2012 5:00 pm ET

Executives

Maria Riley - Director

Dominic P. Orr - Chairman, Chief Executive Officer, President and Chairman of Corporate Development Committee

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

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

Hitesh Sheth - Chief Operating Officer

Analysts

Kent Schofield - Goldman Sachs Group Inc., Research Division

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

Mark Sue - RBC Capital Markets, LLC, Research Division

Jeffrey T. Kvaal - Barclays Capital, Research Division

Brian T. Modoff - Deutsche Bank AG, Research Division

George C. Notter - Jefferies & Company, Inc., Research Division

Jack Monti - UBS Investment Bank, Research Division

William H. Choi - Janney Montgomery Scott LLC, Research Division

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

Rohit N. Chopra - Wedbush Securities Inc., Research Division

Erik Suppiger - JMP Securities LLC, Research Division

Rajesh Ghai - ThinkEquity LLC, Research Division

Operator

Good day, ladies and gentlemen. Thank you for standing by, welcome to the Aruba Networks' Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, February 16, 2012. I would now like to turn the conference over to Ms. Maria Riley of Investor Relations. Please go ahead, ma'am.

Maria Riley

Good afternoon, and thank you for joining us on today's conference call to discuss Aruba Networks' fiscal second quarter 2012 results. This call is also being broadcast live over the web and can be accessed in the Investor Relations section of the Aruba network website at www.arubanetworks.com. With me on today's call are Dominic Orr, Aruba's President and Chief Executive Officer; Mike Galvin, Aruba's Chief Financial Officer; Keerti Melkote, Aruba's Co-Founder and Chief Strategy Officer; and Hitesh Sheth, Aruba's Chief Operating Officer. After the market close today, Aruba Networks issued a press release announcing the results for its fiscal second quarter, ended January 31, 2012. 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 the rapid proliferation of mobile devices, BYOD and IT spend; customer adoption of our MOVE architecture, Mobility Access Switches and software solutions; and the company's future economic performance, pipelines, financial conditions, tax rates and results of operations. 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 quarterly report on Form 10-Q filed with the SEC on December 8, 2011, 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.

Before I turn the call over to Dominic, I'd like to invite you to attend our 2012 Analyst Day in New York City on March 28. If you would like to attend, please RSVP by e-mailing me at maria@blueshirtgroup.com. I'll now introduce Dominic Orr, President and Chief Executive Officer of Aruba Networks. Dominic?

Dominic P. Orr

Thank you. Good afternoon, and thank you for taking the time to attend our second quarter fiscal 2012 conference call. We achieved our 11th consecutive quarter of record revenue in Q2. The rapid proliferation of mobile devices and BYOD or bring-your-own-device in the workplace continues to fuel Aruba's growth. Q2 revenue grew 35% year-over-year and 6% sequentially to $126.3 million, and we delivered the highest non-GAAP gross margin and operating margin in the company's history.

During the quarter, we had strong sequential bookings across all theaters. Our key verticals performed well in the quarter. In addition, over the last couple of years, the group mobile general enterprise business has been a key driver for our growth in general and this continued in Q2. Our software solutions, including AirWave and Amigopod also performed well in the quarter. And while it is still very early, we have seen some significant design wins involving our Mobility Access Switches, and are encouraged by the interest we see across our install base.

In Q2, we added over 1,500 new customers, one of our strongest quarters ever of new customer acquisitions, bringing our cumulative customer total to over 19,000. Recent key wins included: A substantial software solution win featuring Amigopod and AirWave with one of the world's largest technology companies; a wireless and wired installation enabling BYOD on a massive scale for one of the world's largest media conglomerates; adoption of a wireless and wired architecture in a large university in the United States; an outdoor mesh installation for a major port in the Pacific Northwest; a large installation of our virtual controller solution, Aruba Instant, in over 1,000 stores for a large retail chain; and a substantial managed services win with one of the largest service providers in the world.

Additionally, one of our long-term enterprise customers has taken this edge network to an entirely new level of density and performance to support their rollout of 15,000 iPads for the sales force. These wins reflect the adoption of our MOVE architecture of customers deploying it, [indiscernible] on edge networks. Mobility is no longer an option for IT spending. IT managers have to address a tidal wave of rapidly growing issues, the proliferation of mobile devices, BYOD, the rise of mobile apps and adoption of video. Each of these issues alone puts great stress on the network and on the IT staff. Combined, they are forcing fundamental change. These are the issues we address with our mobility-centric approach to network edge.

Our differentiation in security, scalability, RF optimization and mobility software has been built over the last 10 years and continues to help us win. We're also pleased to see early interest in the software solutions we added via the Avenda acquisition. To address BYOD, IT departments cannot be expected to rip out part of the existing infrastructure and replace them with an expensive and confusing array of networking appliances.

Aruba's Avenda portfolio can be deployed on any existing network from any vendor, wired or wireless, as a nondisruptive solution. It also automates time-consuming policy management and device provisioning paths, enabling IT to -- on board and control mobile devices at lower cost and with less complexity. This new capability allows us to maintain our leadership position, explain our value proposition and strike directly at the heart of BYOD spend points.

To recap, we are pleased with our financial performance and our continued growth. We believe our differentiated approach to the network edge position us to meet consistent market gains as IT managers try to manage the rapid proliferation of mobile devices and BYOD. We will continue to broaden and strengthen our strategy and framework around our MOVE architecture, both through internal development and technology acquisitions.

For those of you that have been following us for a while, you might know that this month marks our 10-year anniversary as a company. I'm looking forward to sharing with you our vision for our next 10 years at our upcoming Analyst Day on March 28 in New York City.

I will now turn the call over to Mike who will discuss the particulars of our Q2 financial performance and outlook for Q3. Mike?

Michael M. Galvin

Thanks, Dom. In Q2 2012, total revenue of $126.3 million increased 6% sequentially and 35% year-over-year. Product revenue of $106 million increased 5% sequentially and 34% year-over-year. Professional services and support revenue of $20.1 million increased 11% sequentially and 38% year-over-year.

As Dom mentioned, we had strong sequential bookings momentum across all 3 theaters. U.S. revenue grew approximately 27% year-over-year, representing approximately 61% of total Q2 revenue. International revenue grew 48% year-over-year, representing approximately 39% of total revenue for Q2. Total non-GAAP gross margin in Q2 was 74.2%, an increase of 260 basis points from Q1 '12. The strength in gross margin was primarily driven by strong software sales, improved AP gross margins, our restructured China service provider business and our ratio of direct to indirect sales.

While we expect to continue to see large software sales, we do expect this business to be lumpy as we continue to ramp our software business. Further, we expect our ratio of indirect sales to overall sales to return to historical levels. As such, we expect Q3 '12 gross margin to be in the range of 70% to 72%.

Q2 non-GAAP product gross margin was 73.2%, a 310 basis point increase from Q1 '12 and a 130 basis point increase from Q2 '11. Q2 non-GAAP services gross margin was 79.3% compared with 80.2% in the prior quarter and 80.3% in the same period a year ago.

Moving on to operating expenses. I'd like to note that we closed the Avenda acquisition on November 30, 2011. Accordingly, our operating expenses include 2 months of Avenda expenses, which primarily consist of research and development cost. Non-GAAP research and development expense was $19.2 million, up 120 basis points as a percentage of revenue from the prior quarter. R&D expenses will vary from quarter-to-quarter due to the timing of our programs, and we expect R&D as a percentage of revenue to be consistent with our recent history. Non-GAAP sales and marketing expense increased to $38.7 million from $37.1 million in the prior quarter. Sales and marketing decreased 40 basis points as a percentage of revenue to 30.7% compared with 31.1% in Q1.

We will continue to invest heavily in our sales and marketing efforts while also showing leverage in our operating model. Non-GAAP G&A expense of $9.2 million increased 30 basis points as a percentage of revenue to 7.3%. The increase was primarily due to legal and professional service fees. Total headcount at the end of Q2 was 1,193, an increase of 56 from the prior quarter.

In total, Q2 non-GAAP operating expenses were $67.1 million or 53.2% of revenue, an increase of 110 basis points from Q1 '12. While we will continue to make investments in the business, we expect to grow revenue faster than expenses as a general trend. Our non-GAAP operating profit in Q2 was $26.5 million or 21% of revenue, an increase of 150 basis points from the prior quarter.

Our non-GAAP tax rate of 29.0% was within our guidance range of 28% to 29% and in line with Q1. As we have previously discussed, our overall tax rate is subject to change, including from the projected geographic mix of the company's revenue, as well as changes resulting from any new U.S. or international regulations or interpretations. Over the near term, we expect the non-GAAP tax rate to continue to be in the range of 28% to 29%.

Non-GAAP net income for the quarter was approximately $19.4 million or $0.16 per diluted share. This compares to $16.7 million or $0.14 per diluted share in Q1 '12 and $16.3 million or $0.14 per share in Q2 '11. The weighted average shares outstanding were 120 million on a diluted basis. On a GAAP basis, net loss was $11.4 million or $0.11 per share compared with a Q1 '12 net loss of $0.5 million or $0.00 per share and a Q2 '11 net loss of $2.8 million or $0.03 on a per share basis. A full reconciliation of GAAP and non-GAAP information is contained in our financial results press release issued this afternoon.

Turning to the balance sheet. We finished Q2 with cash and short-term investments of $275.8 million, an increase of $10 million over the prior quarter. Cash flow from operations was a record $25.7 million. Excluding the cash portion of the acquisition payment for Avenda of approximately $21.1 million, total cash increased approximately $31.1 million in Q2 '12. We ended Q2 with $69.2 million of accounts receivable, up from the Q1 '12 balance of $67.2 million. Days sales outstanding were 49 days, better than our target range, which remains 50 to 55 days.

Moving down the balance sheet, total deferred revenue of $90.8 million increased 54% year-over-year and in line with Q1 '12. Short-term deferred revenue of $72.6 million increased 53% year-over-year and decreased 4% sequentially. The primary reason for the decrease in short-term deferred revenue was a decrease in inventory held by our distributors relative to Q1 '12. Aruba inventory totaled $24.5 million at the end of Q2, a decrease of $1.2 million from the end of Q1. Inventory turns on an average inventory basis were 4.5 compared with 4.3 in the prior quarter.

Let me now turn to our third quarter of fiscal 2012 guidance. We expect Q3 '12 revenue to be in the range of $130 million to $132 million, an increase of 23% to 25% year-over-year or 3% to 5% sequentially. As a reminder, Q3 of last year included China's service provider hotspot revenue that we are no longer pursuing as a business. We expect non-GAAP EPS to be approximately $0.16 per share, using 122 million shares on a diluted basis.

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

Dominic P. Orr

Thanks, Mike. Well Mike, Keerti and Hitesh and I would now be happy to answer any questions that you might have. Operator, you can now open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Kent Schofield with Goldman Sachs.

Kent Schofield - Goldman Sachs Group Inc., Research Division

Can you talk a little bit about some of the design wins on the mobility switch side in terms of what sort of deployments, whether its verticals or geos that you're seeing some pickup there? And then also, if you could touch upon -- if I look at the math for the q-on-q growth, domestically it looks like it was down slightly quarter-on-quarter. So if you could just talk a little bit about the dynamics there.

Dominic P. Orr

Okay. I'll pick the first part and Mike can pick the second part, Kent. Regarding the mobility switch design wins, as we had planned for and explained before, we believe this is going to start among install base and also the leading customer with the mobile campus, which really is the high-tech enterprises and education. And as expected, these actually are the leading frontier for the combined wireless mobile edge network deployment and design wins we are seeing. Of course, there are exceptions like the one that we mentioned about the global media conglomerate company has started to do the combined design as well. But the main thrust is in those two verticals.

Michael M. Galvin

Kent, with regards to the Americas' revenue growth, as we've discussed in the past, we do have some timing nuances with our revenue versus our bookings flow. And I think as we've talked about in the last several quarters including Q2, our international bookings momentum has been very strong, particularly in Europe. And so, part of the revenue dynamics in any quarter is the timing of that recognition. And so some of the strong international growth that we're seeing this quarter is from that strength we had recently. And also, it's important to note that Q4, Q1 is a -- are strong in the U.S. for both the fed and our higher education business, and those downtick a little bit when you get to Q2.

Operator

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

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

A couple of questions here. So first, just on the gross margins. I mean clearly, we're at record levels here, certainly much better than expected at 74% versus the guidance of 70% to 71%. You've got a long-term target there of 65% to 68%. I guess first off, if you could walk through what you touched on the prepared remarks, the components of the makeup there with respect to the uptick, whether -- with respect to software improved, AP, gross margins, restructuring, et cetera, and what contributed what? And then, is it really time to revisit the 65% to 68% gross margin target now that you're out of the carrier Wi-Fi offload market?

Michael M. Galvin

Yes, Ryan, so a lot of points in there. But to just start off, obviously we feel very good about the performance. With regards with -- to the range that we've given, we also feel very good about the 70% to 72%. It's obviously an increase from our recent guidance ranges. In terms of the components that went into the performance this quarter, the AP gross margins, as we've talked about previously, have been strong and improving. And we definitely feel good about those and expect those to continue. So that is a component that we see as ongoing. A few of the other components, we did feel or a little bit unique to the quarter we just ended starting with -- as you guys know, we've restructured our China kind of hotspot service provider business over the last few quarters. We've been tailing that down. We still have some remaining benefit from that in Q2 but going into Q3, that benefit is materially gone.

Dominic P. Orr

In the form of licensing.

Michael M. Galvin

Yes, yes, in the form of the restructured licensing revenue. The other thing that I mentioned was the strong software sales. And first of all, it's a -- we do believe it's a great testament to our new software solutions and the traction we're getting there. The dynamic in Q2 was that the reality was there were some sizable deals in there from a software perspective that makes us feel good about the future, but it is a bit of a lumpy business still here in the early days and we don't -- we can't necessarily project that out into Q3 for some of those bigger deals to continue. And then the final piece was -- as you guys know, we're an indirect business, and we have been very heavily a 95%-type indirect business for a couple of years now. In this particular quarter, we had kind of an abnormal jump. Our direct end customer business this quarter was 12% as opposed to about 5%, which it've been averaging. Those direct end customers do tend to come with better gross margins. We don't see that as a trend. We see that as some dynamics that happened in this quarter, and we expect those percentages to go back to their historical norms. So when you combine all that together, that's where we come out with the guidance for the next quarter. Again, we feel very positive about the gross margin overall and the dynamics that we're seeing. We don't have an explicit change to the long-term model. I guess, we can always question how long is long term, but we definitely are trying to convey confidence in the gross margin in the near -- kind of in the near and mid-term.

Ryan Hutchinson - Lazard Capital Markets LLC, Research Division

Great, okay. And then the second question, maybe for Keerti, is there appears to be a growing concern around controller-less technology and the impact that this may have on really the architects of -- architectures, I should say, of wireless networks moving forward. And the thought being that potentially it cannibalizes your mobility control of revenue, which I believe, is roughly 40%, if I have that right. So maybe if one of you could address that and walk us through why or why that not -- that doesn't impact your business here, near-term or even long-term. And then just squeeze in, where is the buyback?

Keerti Melkote

I'll talk to the controller-less aspect of the business. I mean, if you look at the wireless LAN market overall, there's been a small portion of the market, maybe 15% to 20% of the market that has stayed with the so-called side AP or autonomous AP model. And that -- I mean, while the rest of the market transition to this controller-based architectures, the smaller networks where you just needed 1, 2, 3, single-digit number of access points never really transition to the controller-based architectures. And we think that's an unmet opportunity and incremental opportunity for us. So what we did was take our controller architecture and the software capabilities around the controller and embedded that inside the access point. And that's what we are doing with same product as with the virtual controller capability. And so the design win that we mentioned in the script represents basically a large chain, a retail chain that selected Aruba, primarily because of the virtual controller architecture. And they will continue to use our mobility controller in the campuses and distribution centers. So it represents to us at least an incremental opportunity that we've not historically served. And more importantly, the virtual controller capable access points that we shipped can be upgraded to be a fully controller-based architecture. And we are the only company in the industry to enable that kind of capability, giving us the full breadth, if you will, of features that the customers are looking for. So in that sense, the controller-less market that you're talking about is an incremental opportunity for us that we have certainly not served before.

Dominic P. Orr

So I like to just add on one word here. There's no such thing as controller-less network. Any network that we know of how to build except for a single AP at your home needs some control functions to coordinate between multiple entities. So the question is how much control processing power you need? Either if you need a robust design or large network, you will have purpose built platform to do the controller. You can do the controller in the cloud. And then that's an issue of what about if the cloud goes down, what happens to your local access point. You can choose to do with the controller on a PC, but then there's a performance issue. And some companies, including this new approach Aruba is taking with the incident, is saying that for small-sized network where the processing power of an access point in its spare time is enough to the control function, then you can put a so-called virtual controller function inside the AP. But theoretically I can, Ryan, put a controller into your iPhone or your android phone, but it can probably control a very miserable number of APs, right? So there's no such thing as controller-less wireless LAN that exists for more than one AP.

Hitesh Sheth

Ryan, this is Hitesh. Just one additional point, if I may, which is, if you look at our business and if you think about -- one of the questions here is what is the impact on our business per se. If you look at the number of the controllers we have shipped in the last quarter, the segment of the market where this is really applicable where you can have a virtualized controller, has been for small wireless LAN, as Dom just mentioned. And in that segment, if you look at the small controls that we shipped, we have experienced no degradation in the number of units we've been shipping. Any incremental sales we've achieved here with respect to our system is truly incremental and it is not -- it has not been a replacement sale for our controllers.

Operator

[Operator Instructions] Our next question is from the line of Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets, LLC, Research Division

Dom, the rate of growth for your revenues, it's still above competitors but it still seems to be slowing somewhat a bit year-over-year, 53% to 35% and now guidance is 23% to 25%. Can you touch on why that might be? Is it seasonality? Is it the impact of large numbers? Is it competition? And maybe if you've seen anything change in terms of your business linearity or order sizes?

Dominic P. Orr

Well, so first of all, the guidance, if you look into -- I think Mike did mention that Q2 a year ago happened to be the...

Michael M. Galvin

Q3 '11.

Dominic P. Orr

Q3 last year, I'm sorry, happened to be the peak of our ramp of the China service provider business, which since then we have changed in the licensing model in our way to exit it because we do not see in that market they value anything more than hotspot connectivity. And if you take that piece of the business out, our guidance actually is roughly about -- just over 30% year-over-year, and that is really within the range of our historical guidance. And if you really look at the competitive momentum and so on, it's actually a competitive issue, our guidance quarter-over-quarter will not be also in the same range as we have historically. So I think those are the 2 factors I would like to mention. So fundamentally, to net it out, the company has made an experiment into the Chinese service provider market for a couple of quarters. We've seen that we have revenue benefit, but we do not have overall gross margin benefit. And due to the feedback of investors and analysts and our own market and business analysis, we decided it is better for Aruba to concentrate in area of our core competence, which is the user access control, the QoS in the air and the BYOD management and so on. And those are not leading us to the hotspot market. And that really what you're seeing is an adjustment of that strategy.

Mark Sue - RBC Capital Markets, LLC, Research Division

Okay. So from everything your customers are telling you, the -- what we saw with the commoditization of the hotspot market, that is just solely for that market, it should not spill over into the Enterprise segment, or can that change? Is there a graying of the area where people just want to get onto the network very quickly for the enterprises, so they are likely to seek alternatives, lower cost alternatives or do you think that happens?

Dominic P. Orr

That is absolutely true, but I also want to drill down a little bit on the service provider market. We're not saying that we're not getting into the service provider or even a service provider hotspot market in general globally. In fact, as you noticed, that we have announced one of the notable wins is a managed service win, significant managed service win for a world-class service provider providing for their customer management of 15,000 hotspots, right, of the -- in that situation. But in that situation, they use the Qos' features, they use BYOD features, they use the quality QoS features. And so they absolutely appreciate the value that Aruba provide as compared to the other end of the market, which is the wireless ISP kind of market in the developing country that is a market that is very low margin served by companies like Ubiquiti. So I think the particular issue we talked about is the China service provider market, which in first stroke, we thought would be a little bit more like the developed country market. And what we quickly found out, when we had the successes and they get to the market is they actually have more than nature of this developing country, the ISPs market. And that is why we think this is not of the business model that we want to chase after. But we will continue to chase after service provider, Mark. Managed services or hotspot or our internal network that is of appropriate business model and that they value our software solutions and so on. So I want to clarify that.

Operator

Our next question is from the line of Jeff Kvaal with Barclays Capital.

Jeffrey T. Kvaal - Barclays Capital, Research Division

Dom, I was wondering if you could spend a little bit more time talking about exactly which software elements were more in demand for you this quarter? And then also, why this quarter? I mean, some of these software packages you've had around for a little while, and what was the inflection point? Secondly, Dom, if you wouldn't mind going a little bit more into the carrier space, I mean it does seem as though there's a little bit more activity there in lightRadio was talking about this week as well from Alcatel.

Dominic P. Orr

Okay. Jeff, your line was very choppy. So let me just repeat what I believe we hear. You want us to tell you about a little bit more detail of the component of software that is taking up?

Jeffrey T. Kvaal - Barclays Capital, Research Division

Yes.

Dominic P. Orr

And then you also want us to dive down a little bit of the segmentation of the carrier markets, specifically relating to the Alcatel-Lucent's recent announcement of the lightRadio venture and so on. Is that the gist of your question?

Jeffrey T. Kvaal - Barclays Capital, Research Division

Yes. And for software, not just once but why now versus last quarter or next quarter or last year?

Dominic P. Orr

Got it. So for software, historically, the software progression, we see customers and say they want our security software and as well as -- such as Wireless Intrusion Protection and secure access the policy enforcement software. And then they want our network management software in a multi-vendor environment that is provided by AirWave. And then with the Amigopod acquisition, we extended the software services to administration and on-boarding of both BYOD devices, the certification of that and also the guest access, extensive guest access component. And then finally with the Avenda acquisition, the customer want to have a broad-based unified Policy Management of not only mobile devices but laptops and desktops, wireless and wired multi-vendor. So that is the kind of progression of the software acquisition. The recent ramp of some of the major software has a lot to do with BYOD. As a company being flooded with BYOD applications, they run out of IT staff to support the operations. And because our software allows them to automate the BYOD process and that led to an uptick of the pipeline of such kind of software projects. So the second question is a little bit dissection of the carrier business. Generally, we are doing very well in the carrier internal infrastructure business. Because a carrier is no different from any large, hi-tech, multinational company. And as such, as part of the dominance we are exerting in that segment, we actually are providing a lot of carriers for the internal IT infrastructure, so number one. Number two is a carrier as a managed service provider for enterprises and university and healthcare system and so on. We are doing very well with carrier in that business but fundamentally, they are still promoting carrier grade -- I mean, enterprise grade products into these enterprises providing managed services. And then the third class is carrier as a system integration partner and reseller, and that is an ongoing business.

The last part is the so-called 3G outflow business, and that is where we divided into the pure carry infrastructure 3G outlook, particularly in the developing countries. That is the part that we're saying that we find that the pressure to offload from the seller network is so much that the carrier basically is saying that I just want pure connectivity, dump the video and so on into the Wi-Fi. Until I satisfy that need, I would not need anything else. And therefore, it becomes a pure connectivity market with no QoS conservation, no security conservation and so on. And that is a market that we decided not to participate. Now a bit to the Alcatel-Lucent announcement, as you know, Alcatel-Lucent has 2 components: the carrier component business units and the enterprise business units, of which we have a partnership. Our partnership with the enterprise business unit with Alcatel-Lucent actually is doing very well. The business actually has a big uptake to the extent that they are not -- this quarter, for the first time in a long time now, they are listed as our 10% partner. So I'm very, very pleased with the development of that business. Their carrier infrastructure business is really attacking the 3G outflow part of the business. And what they have announced in the light way -- the announcement is actually interoperability with a lot of wireless LAN vendor, and of which Aruba is one. And so we are fully certified and with Alcatel-Lucent carrier side to go with them as a partner. As the business case decide whether we would or would not be interested in some of those projects, depending on business model.

Operator

And our next question is from the line of Brian Modoff with Deutsche Bank.

Brian T. Modoff - Deutsche Bank AG, Research Division

So as you kind of expand your International business, are you starting to run into the Ubiquitis of the world more often now in the market?

Dominic P. Orr

No, not at all. Because as I mentioned earlier on, we do not participate in the wireless ISP market in predominantly around the world. And that seems to be from our perspective, the sphere of activity at Ubiquiti. As you know, there is roughly a 30% gross margin difference between that marketplace and the marketplace that we're attacking.

Brian T. Modoff - Deutsche Bank AG, Research Division

But can you talk a little bit about pricing trends, and how do you see the global pricing environment for your products? Obviously, your gross margins were better but just in general, what are you seeing on the side of your business?

Michael M. Galvin

Yes, we don't talk explicitly about ESPs, but in terms of discounting trends, et cetera, we really see it pretty consistent with kind of business as usual, if you will. Obviously, we're not having any gross margin degradation from pricing pressure. And so that's really remained in consistent ranges with where we've been at.

Dominic P. Orr

In fact, a significant portion of the gross margin over performance is really coming from the access points themselves. So better technology, better value and better cost reduction programs. So we're not seeing pressure at this moment.

Operator

Our next question is from the line of George Notter with Jefferies & Company.

George C. Notter - Jefferies & Company, Inc., Research Division

I have an operating margin question. You guys have talked about reinvesting in the company more aggressively as you kind of pop above the 20% operating margin level. Here in this quarter, you're above that threshold. You're talking about operating leverage in the business going forward. Can you talk a little bit more about how you see that margin structure going forward? Is it still the case that you'd elect to reinvest in the business, or is it possible to see margins kind of tip up above 20% going forward?

Michael M. Galvin

Yes, George. So yes, this is our first quarter to report above our target model. We do -- we absolutely believe in the leverage -- in our model on a go-forward basis. Although what we've said pretty consistently is that, that leverage will be much more gradual than it's been in the past. We've obviously had a very strong run up to this point. And the reason for that is the investment in the business. Whether it's through acquisitions, key investment strategies in the OpEx line, the leverage that we might see there would be a lot more gradual. And so that's the context we're at.

Dominic P. Orr

And to add 2 more further comments. So one is as we mentioned a couple of times already, the 74% gross margin, we believe there is a couple of components there that might not be repeatable. So we don't feel this is prudent until we see a constant improvement of gross margin, that we change any of our spending pattern or operating margin model. Secondly is as stated in our script, we were continuously, actively looking for technology acquisition. And as the nature of this acquisition in such a way that once we do an acquisition, we will have a bulge in R&D expense, in operating expense. So we have that any given point in time to consider room to absorb this kind of operating margin expansion.

Operator

And our next question is from the line of Jack Monti with UBS.

Jack Monti - UBS Investment Bank, Research Division

I guess first, I was trying to think about the competition, Cisco announced the new Internet 3600. And I was just curious how long your sales force has seen that in the field, if you thought that may change the competitive environment? And I was also hoping if you can maybe comment on the deferred revenue, so like in current basis in total it was down a little bit quarter-on-quarter. I was just curious what you saw there.

Dominic P. Orr

Yes, so I'll take the 3600. We've seen that pop up in the last quarter or so, and to us -- I mean, competitive dynamics-wise is no different than in the past in the sense that it is yet another access point that it's going to come with. In fact in this particular space, they are playing catch-up to us with stream level and technology that we introduced almost a year ago. So we've been in this market operating for quite a while, and they're catching up. And frankly, the differentiation is not at the access point level anymore. In that, you could add a little bit of tweaks on hardware. Differentiation in RF optimization software is where the market is moving to. And the proliferation of devices, more importantly the coverage model for Wi-Fi is going away. People are looking at capacity as the new way to design network. And when people come out and talk about having better coverage and access points, it really doesn't resonate with a lot of customers because they're going from -- it used to be 10, 12 devices per access point to maybe 50 devices per access point now. And so they're looking at how to divide it up, divide the airspace up amongst the greater number of access points. And so the capacity model and the RF optimization software is where the whole differentiation is going to be.

Michael M. Galvin

Jack, with regards to the short-term deferred revenue, it did go down slightly sequentially. As we discussed a little bit last quarter, where we had a significant uptick last quarter, the primary variability in that short-term deferred revenue is without a doubt now our U.S. adds really inventory management and kind of stocking orders that they do, which are primarily right near the end of the quarter. So it's pretty logical in terms of -- as they bleed down their inventory through the quarter. They do put the orders in right near the quarter end, and there's just some variability in terms of that snapshot at the end of the quarter as to whether they take delivery on those early in the next month or at the end of the prior quarter. And so in general though, the deferred revenue balances from those U.S. adds will generally map to the U.S. business and the growth and health of the U.S. business. Because it's a balance sheet balance and it's a little choppy at quarter ends, a little bit of a rolling quarter average smooths that out a little bit. But that was the primary reason for the short downtick this quarter and the jump last quarter.

Operator

Our next question is from the line of Bill Choi with Janney Capital Market.

William H. Choi - Janney Montgomery Scott LLC, Research Division

My questions are primarily on the software here. Can you talk about the rough mix of software now as an overall sale. So I guess historically, you've talked about software modules and managing software being about 25% mobility controller and access point kind of evenly split with the rest. Is that structurally moving up? And in terms of tax rate, if you could talk about what that is and more importantly, what you're seeing for Amigopod and AirWave type of penetration into competitors' wireless LAN installed base?

Michael M. Galvin

Bill, yes, we don't break out the percentages explicitly. And that's again largely because of the platform sale that we're pursuing and selling on. There's no question though that the software services and the addition of the AirWave and the Amigopod and the Avenda-type of acquisitions is very positive for us. And it's a platform that we can sell on a much broader context now. And so we're definitely happy with the trends there.

Dominic P. Orr

And for your question about the leverage into non-Aruba wireless infrastructure account, definitely with the new BYOD capability, we can solve the problem across all wired and wireless infrastructure. And as I indicated in my script, we do have a substantial sell into AirWave and the Amigopod combination into a large high-tech company which actually make networking increments themselves. So you can see that, that is a -- they are truly a multi-vendor end market.

William H. Choi - Janney Montgomery Scott LLC, Research Division

Also, can you give Avenda contribution? I imagine it's relatively small, but contribution of that and just confirm that was probably dilutive in the quarter.

Michael M. Galvin

Yes, Bill. So as we mentioned last quarter, the Avenda contribution on the top line this quarter was, I can say, de minimus, immaterial, as expected. The EPS -- I'm sorry, the OpEx load, if you will, that we took in the quarter was modest impact on EPS, and I can definitely say less than $0.01 of impact to that.

Operator

And our next question is from the line of Sanjiv Wadhwani of Stifel, Nicolaus.

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

I wanted to just confirm that Alcatel-Lucent was a 10% customer in the quarter. And then just on the software piece, I wanted to clarify, these additional deployments that you saw this quarter, was that with customers that had already deployed your products, or were they actually going in with sort of new deployments? And then last question on the managed service win with the service provider, any clarity whether that's U.S., Europe or outside the U.S. and what kind of opportunities do you see going forward in that environment?

Michael M. Galvin

Yes, I'll take the first one real quickly, just that -- so Alcatel was a 10% customer this quarter after not being one last quarter. And the other 2 10% customers were Avnet and Catalyst, which have been pretty consistent.

Dominic P. Orr

And for the software sales, it is into both our install base and acquiring new major customers. Both are very active.

Michael M. Galvin

Could you repeat the managed services question?

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

Just wanted to see if that was a U.S. service provider or was that international, and what kind of opportunities do you see in that market going forward?

Dominic P. Orr

We see actually a strong opportunity in that market internationally first, particularly in North Asia and North Europe.

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

So it's fair to say this win was outside of the U.S.?

Dominic P. Orr

Yes, it is.

Operator

And our next question is from the line of Rohit Chopra with Wedbush Securities.

Rohit N. Chopra - Wedbush Securities Inc., Research Division

I wanted to ask about the international market. It looks like international is now 39% of revenue. It was 32% last quarter. If you could add a little bit of color on what you're seeing in the international market, specifically Europe? And then the second question would be, you talked a lot about Alcatel, but can you give us a sense of Dell and where we are in that ramp and why they haven't performed to a 10% customer yet?

Michael M. Galvin

Yes, I'll give just a quick context on the numbers, then maybe Dom can flavor that in. So the International business, and as we talked about, the bookings momentum there has been strong the last couple of quarters. And that definitely revealed itself in the revenue strength this quarter. A quick commentary on Dell is that we continue to be happy with the progress there, both in what Dell is doing for us in the mid-tier and in the larger enterprise and that continues to have traction, and we're pretty pleased with that.

Dominic P. Orr

I think the Dell effort actually was on track if you look at the last notable quarters. I did perceive there was some distraction of the networking business units for a few months after the forced planned merger. But I think it will come back actually stronger because now there's more focus on the networking business. As regarding to a little bit more granular view of the international market, actually both our developed international market are growing well, plus we have new geographies that we did not do business with that now, since 2 quarters ago, we put people there and opened up offices. These offices are now kicking in. So part of the international growth is really the territory that we open up 2 or 3 quarters ago are now finally contributing.

Operator

And our next question is from the line of Erik Suppiger with JMP Securities.

Erik Suppiger - JMP Securities LLC, Research Division

First off, can you describe or quantify the benefit that the gross margin had from the licensing agreement with Alcatel?

Michael M. Galvin

Yes, Erik. Yes, so the impact of that and just for everybody, we restructured into more of a pure licensing agreement for a couple of quarters to kind of transition out of that business. And so it effectively goes to kind of 100% gross margin but much, much smaller revenue level, obviously, on kind of a royalty basis. And over the last couple of quarters, that has had just kind of single, low to mid-single-digits impact on gross margin.

Erik Suppiger - JMP Securities LLC, Research Division

How much was it in the...

Michael M. Galvin

In decimal, I'm sorry, decimal single digits, yes.

Erik Suppiger - JMP Securities LLC, Research Division

So a percentage or a portion of 1%?

Michael M. Galvin

Yes, 0.25% to 0.5% type of range.

Erik Suppiger - JMP Securities LLC, Research Division

Okay, and then -- so then secondly, what is the hiring plan? You've been hiring fairly aggressively in past quarters. This quarter, you added 56, which I assume includes about 27 from Avenda. What is the outlook for hiring at this point?

Michael M. Galvin

Yes, those numbers are correct. And in any given quarter, I talked about this quarter for instance, the R&D expense, and we did have some -- we have 2 things in R&D. We had the significant programmatic spend increase, and we also had the addition of Avenda, right? So within any given quarter, we do make investment trade-offs and in certain quarters, if we do think things are going to be a little heavier on the programmatic spend, we've got to manage the P&L. So we'll modulate that kind of headcount a little bit. But absolutely, headcount growth and investment will continue and that's kind of the key engine of the company.

Dominic P. Orr

Plus, traditionally for our field operations, Q2, Q3 tend to be a little bit of -- lighter whereas Q4, Q1 around the fiscal year kickoff tend to be the heaviest. So there's a little bit of seasonality in there.

Operator

And our next question is from the line of Rajesh Ghai with Thinkequity.

Rajesh Ghai - ThinkEquity LLC, Research Division

I wanted to follow-up on Mark Sue's question earlier on the slowing growth. I understand you restructured your service provider business. I was wondering if you could give us a sense of what the continuing business contributed in the year-ago quarter, that's the third quarter of 2011, so that we can make appropriate comparison on the growth rate for the continuing business.

Michael M. Galvin

Yes. As I think Dom mentioned, if you take out that impact, our guidance would've been right around 30%, 29% to 31%. But essentially, the bulk of that China hotspot business occurred in Q3 and Q4 of last year. And it was really pretty similar numbers in each quarter in the $5 million to $6 million range of revenue.

Rajesh Ghai - ThinkEquity LLC, Research Division

What was the impact in the second quarter of the January quarter?

Michael M. Galvin

Of -- a year ago?

Rajesh Ghai - ThinkEquity LLC, Research Division

Yes.

Michael M. Galvin

Yes, so actually our -- it was less. It was just starting to build at that point but as a reference point for instance, our growth this quarter was 35%. If you take out the impacts of that year-on-year, we would've grown 37% in this quarter that we just recorded.

Operator

Ladies and gentlemen, we are out of time. I would now like to turn the call back over to management for closing remarks.

Dominic P. Orr

Well again, we thank you for being on the call today. It has been a fantastic 10 years for Aruba. And I'd like to take a moment to thank our valued employees, our loyal customers and partners for their dedication, commitment and hard work. We're excited about the opportunity for next decade and beyond. And for those of you who want to come to our Analyst Day, see you there in New York City, March 28. Goodbye.

Operator

Thank you. And ladies and gentlemen, that does conclude the conference for today. Thank you for your participation, and you may now disconnect.

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