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Aruba Networks, Inc. (NASDAQ:ARUN)

F1Q08 Earnings Call

November 20, 2007 5:00 pm ET

Executives

Dominic P. Orr - Aruba ChiefExecutive Officer

Steffan Tomlinson - Chief Financial Officer

Keerti Melkote - Founder and Head of Products &Partnerships

Jill Eisenstadt - IR

Analysts

Ryan Hutchinson - WR Hambrecht + Co

Inder Singh – Lehman Brothers.

Erik Suppiger - Signal Hill

Sanjiv Wadhwani - Stifel Nicolaus

Mark Sue - RBC Capital

Ehud Gelblum - JP Morgan

Bill Choi - Jefferies & Co.

Tom Li - Goldman Sachs

Anil Doradla - Caris & Company

Tim Daubenspeck - Pacific Crest Securities

Operator

Ladies and gentlemen, thank you very much for standingby and welcome to the Aruba NetworksFiscal First Quarter 2008 Earnings Call. During today’s presentation all parties will be in a listen onlymode. Following the presentation theconference will be opened for questions. As a reminder, today’s conference is being recorded Tuesday, November20, 2007. I would now like to turn thecall over to Jill Eisenstadt with Investor Relations. Please go ahead ma’am.

Jill Eisenstadt

Good afternoon and thank you for joining us on today’sconference call to discuss Aruba Network’s fiscal first quarter 2008results. This call is also beingbroadcast live over the web and can be accessed in the investor relationssection in the Aruba Networks website at www.arubanetworks.com. With me on today’s call are Dominic P. Orr,Aruba Chief Executive Officer, Steffan Tomlinson, Chief Financial Officer andKeerti Melkote, Founder and Head of Products & Partnerships.

After the market closed today, Aruba Networks issued a pressrelease announcing the results for its fiscal first quarter ended October 31,2007. If you would like a copy of therelease you can access it online at the company’s website, or you can call theBlue Shirt Group at 415-217-7722 and we will fax or email you a copy.

We would like to remind you that during the course of thisconference call Aruba Network’s management may make forward looking statements including financial projectsregarding the company’s revenues and non GAAP ETS, non GAAP gross margins, nonGAAP operating expenses, statements regarding the company’s sales momentum,growth in its customer pipeline, performance of its recently announcedproducts, industry trends and market demand for the company’s products, plansand objectives of management for future operations and other statements as tothe company’s future economic performance, financial condition or result ofoperations.

These forward looking statements are not historical factsbut rather a base on the company’s current expectations and beliefs. These statements involve a number of risksand uncertainties that could cause actual results to differ materially fromthose anticipated by these forward looking statements. These risks and uncertainties include avariety of factors, some of which are beyond our control. These forward looking statements apply as oftoday and you should not rely on them as representing our views in the futureand we undertake no obligation to update these statements after this call.

Please refer to our Annual Report on Form 10K filed with theSEC on October 12, 2007, as well as our Earnings Release posted a few minutesago to our website for a more detailed description of the risk factors that may affect ourresults. Copies of these documents maybe obtained from the SEC or by visiting the investor relations section of ourwebsite.

Also, please note that certain financial measures we use onthis call are expressed on a non GAAP basis and have been adjusted to excludecertain charges including non cash stock base and acquisition relatedexpenses. We have providedreconciliations of these non GAAP measures in the investment relations sectionof our website located at www.arubanetwork.comand in our earnings press release.

Now, I’d like to introduce Dominic Orr, President and ChiefExecutive Officer of Aruba Network. Dominic?

Dominic P. Orr

Thank you. Goodafternoon and thank you for taking the time to attend our Fiscal First QuarterResults Conference Call. We started ourfiscal year with a solid first quarter and strong momentum. Q1 revenues expanded by 91% year-over-yearwhile other competitors report a flat wireless revenue year-over-year. According to the Devo Group, we are now thesecond largest enterprise wireless land supplier world wide moving ahead ofMotorola. We had a record number of newcustomers in period and our accumulative total number of customers nowsurpasses 3,300.

Non GAAP gross margin was 68.1% reflecting the strength ofour competitor position. Recently, weannounced a major update to our product line with the addition of two newranges of multi service mobility controllers and a new line of high performance802.11 access points. The only 802.11access points that can perform optimally with existing power over Internetinfrastructures.

Our high end control, the MMC6000 is designed to [orbit] animpressive 8 gigabytes per second throughput and support for over 32,000users. Our new MMC3000 series opened upthe small and midsized enterprise market for us, supporting customers with 100– 2,000 users. This new productsignificantly extend our competitive technology lead, broadened our marketopportunity and ushered in a new era for all wireless workplaces.

We also introduced two important new securitytechnologies. One, for network accesscontrol and end point compliance; the other, for enhancing physicalsecurity. With regard to the latter, ournew video surveillance solution enables wired and wireless video cameras to beeasily integrated with an Aruba Wireless LAN or MASH network for securitymonitoring and logistic support applications.

Finally, we demonstrated strong operating leverage as nonGAAP operating income increased to $2.7 million, tripling on a sequentialbasis. Q1 revenue increased 12%sequentially, reaching $46.7 million. Importantly, this revenue growth was accomplished without any customeror vertical market concentration. Whilewe are on track with ramping with our valued added distributors we had no 10%customers or partners during the period. Our revenue growth was driven by a broad cross section of verticalmarkets including, education, government, healthcare, retail andenterprise. None of our verticalsaccounted for more than 20% of our revenues.

Overall, new customer growth was outstanding as we added arecord number of new customers across all of our verticals in the period. Key reason wins included the following: oneof the top 10 community owned electrical utilities in the United States. A leading high key services in Japan, a branch of the US Department of Agriculture,a UK Hospital with over $700 million in revenue, a woman’s retail chain with290 stores and an Ivy League University with over 22,000 students andteachers.

We won this customers in competitive bids primarily againstCISCO. Each customer extensively testedour equipment and we believe we won these projects based on superiortechnology, a lower cost of ownership and our unified mobility architecture. It is important to remember that our competitionis always incumbent whom we are trying to displace. Our exceptionally high win rate is atestament to the unique value position offered by our solutions.

Despite the record number of new customer additions, wederived 725 of our revenues from existing customers. As most of our customers order over an extendmulti quarter period. During the quarterkey repeat customers included US Airforce, Google, SAP, Saudi Ramco, and anumber of major universities. At the endof Q1, the aggregate repeat order value of our top 25 customers was over 5.7times the aggregate value of this customers’ original purchase order, clearlydemonstrating the value of winning this large order.

Revenue growth was especially strong in the second half ofthe quarter and I am pleased that the momentum has continued so far intoQ2. We enter Q2 with the largestpipeline of prospects in our company history. And, our newly announced products could extend our capabilities and opennew markets for the company. First, wenow have the right product set to deliver high performance secure wirelessnetworks at very compelling price points for small to medium sizedmarkets. We are now very encouraged byinitial feedback on the MMC3000 and of our competitiveness both with the pricepoint and feature set of these controllers.

Additionally, our new MMC6000 controllers enable to 11 endaccess points help our customers converge high performance wireless LAN,firewall enforced user access controller, cellular to WIFI integration and secureremote access into a single unified mobile network without the use of VPNs ormanaged clients. This is a complete andcompelling set of applications that no one can offer today and moves us farbeyond other mobility solutions on the market. Looking forward, this application also makes possible a new era, era ofwireless networks.

The high performance of our new 11n solution coupled withour unique layers 4 to 7 QOS in the air enable customers to deploy all wirelessworkplaces. Offering performancerivaling those of a wired network. Others share our vision of an all wireless workplace. Carnegie Mellon Universityhas long been a pioneer in wireless networking. Then University is in the process of updating its academic campus to Aruba802.11n technology managed by our new 80 gigabyte per second MMC6000controllers. Wireless technology servesto compliment and extend their wired network. Carnegie Mellon’s vision is that its updated Aruba Wireless Network willserve a wired LAN replacement for many applications on campus. It is an exciting vision of the near futureand one within which we are uniquely positioned.

A little later in the call, I will be happy to answer anyquestions that you may have but now I will turn it over to Steffan to go overthe financials in more detail.

Steffan Tomlinson

Thanks Dominic. Before I begin the discussion of our first quarter results, I would liketo note that all comments made in the prepared remarks exclude the impact ofnon cash stock base expenses unless, specifically noted. In the first quarter of fiscal 2008 non cashstock base expenses were approximately $4.5 million. In Q1 total revenue of $46.7 million grew 12%sequentially in 91% year-over-year. Product revenue of $30.5 million grew 6% sequentially and 101%year-over-year. Existing customeraccounted for 72% of sales, highlighting the strength of our install base. Professional services and support revenue of$7.3 million grew 71% sequentially and 243% year-over-year benefiting from boththe continuing growth of install base of customers with support contracts andan increase in professional services.

As expected ratable product and related services revenue of$1 million declined 4% sequentially and 70% year-over-year. Approximately 82% of our revenue came fromindirect channels in Q1. The remaining18% were direct sales. As a reminder,our indirect channels represent sales through our value added resellers,distributors, as well as strategic OEM partners. As Dominic mentioned we had no 10% customersor partners during the quarter. Approximately 69% of our sale were generated in the USwith the remaining 31% coming from international customers. Domestic sales showed nice sequential growthof 17%.

We continue to produce strong gross margins in the firstquarter. Overall, non GAAP gross marginscame in at 28.1% compared to 69% in the prior quarter. This strong performance was slightly aboveour target range for gross margins of 65-68% even with the higher mix ofservice to sales and more sales going through two tiered distributionpartners.

Non GAAP research and development expenses increased fromthe prior quarter but decreased as a percentage of revenue from 15.7% in Q407to 14.6% in Q1 of 08. Non GAAP R&Dis in line with our long term target of 15% and we will continue to addadditional R&D resources to enhance the functionality of our existingproducts and develop new ones.

Non GAAP sales and marketing expenses increased modestlyfrom the prior quarter and decreased significantly as a percentage of revenuefrom 45.0% in Q407 to 40.7% in Q108. Weexpect future sales and marketing expenses to continue to be our mostsignificant operating expense but, should continue to gradually decrease as a percentageof sales as we move towards our long term target of 27% of revenues on a nonGAAP basis.

Non GAAP G&A expenses increased in actually dollars andas a percentage of revenue from 6.2% in Q407 to 7.0% in Q108. During the quarter we incurred approximately$300,000 in legal expenses related to our lawsuit with Motorola. Non GAAP net income for the quarter wasapproximately $3.9 million or $0.04 per diluted share compared to a non GAAPnet income of $2 million in Q407 or $0.02 per diluted share or non GAAP netloss of $1.9 million or $0.14 per diluted share in Q107. The GAAP net loss for the quarter was $0.6 millionor $0.01 per diluted share compared to a GAAP net loss of $3.3 million or $0.04per share in Q407 and a GAAP net loss of $4.5 million or $0.34 per share inQ107. As we noted, our first quarter2008 GAAP results included $4.5 million of non cash stock base expenses. The Q1 non GAAP weighted average sharesoutstanding were $94.2 million on a diluted bases.

Turning to the balance sheet, we finished October with$108.6 million of cash in short term investments. This represented an increase of $3.6 million. Short term deferred revenue with $18.2 millionat quarter end compared to $16.1 million at the end of Q407.

Moving down the balance sheet, we ended Q1 with $29.5 millionof account receivable compared to $23.7 million in Q407. This reflects a strong second half to thequarter. Base sales outstanding were 57days in q1, an increase of six days from the immediately proceeding quarter andmodestly above our long term DSO target of between 50-55 days.

Inventory totaled $12.4 million at the end of Q1 increasingfrom $9 million at the end of the last quarter. Inventory terms were 4.9 down modestly from the immediately proceedingquarter.

In summary, we are pleased by our performance in Q1. Revenue, customer growth and margins showedsteady progress. On a sequential baseswe increased non GAAP operating margin and non GAAP net income margin to 5.8and 8.2 respectively. Moving forward, webelieve our market opportunity is large and growing and our pipeline is thelargest ever. Given this, we expect tosee solid sequential revenue growth in our second quarter of 2008 in the range of $50.5 million to$52 million with non GAAP EPS of $0.05 – $0.06 per diluted share.

For the full fiscal year 2008 we are raising our revenuerange from $210-$220 million with our non GAAP EPS range increasing to$0.21-$0.23 per diluted share. Withthat, let me turn the call back over to Dominic.

Dominic P. Orr

Thanks Steffan. Steffan, Keerti and I would now be happy to answer any question that youmight have. Operator, you can now openit up for questions.

Question-and-AnswerSession

Operator

(Operator Instructions) The first question comes from theline of Ryan Hutchinson with WR Hambrecht + Co. Please go ahead sir.

Ryan Hutchinson - WRHambrecht + Co

Good afternoon. Congrats on your very nice quarter. Just a couple of question here. First, the product revenue, it looks like it grew about 6% while youadded a record number, around 450 new customers in the quarter. Can you help us understand the dynamicsthere?

Dominic P. Orr

Sure. Ryan, this isDominic. First of all, I’d like to prefaceby mentioning that our product low for the quarter is 101% year-over-year whileour major competitors report a flat year-over-year growth.

Having said that, in Q1 we did experience some delays in theawards of some very large projects in the first half of the quarter. Two separate practices extended the duediligence cycle for these projects. First, the filing of the Motorola lawsuit, a lot of these large accountslike to see us make the response before they proceed with the rest of theprocurement cycle and second, the introduction by CISCO of some 802.11n productforced the management to allow this company to feel obliged to go through onceof examining the new offering and that added to the sales cycle.

We have now, both of these factors have passed now after thefirst half of Q1 and we subsequently won a number of these projects and as aresult of that the quarter in the second half was very strong and some of theseis projecting into the very strong pipeline into the Q2 as well.

Ryan Hutchinson - WRHambrecht + Co

Okay.

Steffan Tomlinson

One follow on comment, Ryan. The good news about the incremental customers we had this quarter are alot of those customers came in the second half of the quarter which provides ussome, what we call dry powder going into Q2. As you know, we get a lot of repeat orders from that existing installbase. So, adding the record number ofcustomers this quarter in the second half of the quarter is helping us goinginto Q2.

Ryan Hutchinson - WRHambrecht + Co

Just to clarify or add to that, you feel comfortable now asyou moved into the current quarter that a lot of these delays that happened inthe first part of the quarter are taking hold?

Dominic P. Orr

In fact we’re seeing, we’re closing some of those deals nowas of the first part of November.

Ryan Hutchinson - WRHambrecht + Co

Okay.

Dominic P. Orr

That added to our confidence in the pipeline.

Ryan Hutchinson - WRHambrecht + Co

Okay. And then, justin terms of how we should look at the partnerships in place, of the potentialfor new ones, typically on the server provided side, can you add any colorthere in terms of potential partnerships specifically, in the internationalmarkets in the EMEA region?

Dominic P. Orr

Sure. You have tounderstand this; when we engage a service provider typically there are threeseparate components. First of all, a lotof this service provider are themselves an end user customer and that tends tohappen first and then, what we are engaging them in is the network integrationand system integration arm of the service provider in which they really act asa value added reseller of system integration capabilities and that is going onvery well.

Then finally, because of our scalability and centralizedmanagement capabilities, most of these service providers are considering the Arubaplatform to help them introduce management services. For example in the mid tier market and thatis a lot of activities going on there. But, normally it takes a certain period of time before the serviceprovider can turn on such a management service.

Ryan Hutchinson - WRHambrecht + Co

Okay. And thenfinally, and I’ll jump back in the queue, just in terms of as this last quarteron the migration to 802.11n, any sense there in terms of the potential forpurchasing delays to date? Or, is thatessentially, more or less, a non event as it stands right now.

Dominic P. Orr

As I commented earlier, our observation was there was about45 days worth of looking around for a lot of the enterprise to see what isthis, this new situation. But, oursituation is that all of them, after examining it, decided to move on accordingto the original road map with the exception of some large university, they wantto use the funding that they have in the next 12 months to future proof thenetwork and therefore a lot of the 11n activities are happening in largeuniversities and, of course, that is our sweet pot, evidenced by ourannouncement of one of the largest and most leading university in the nation,Carnegie Mellon University who’s leading this 11n migration has chosen to adoptAruba architecture and technology.

Ryan Hutchinson - WRHambrecht + Co

Thanks

Dominic P. Orr

You’re welcome Ryan.

Operator

Thank you, sir. Thenext question comes from the line of Inder Singh with Lehman Brothers. Please go ahead with your question.

Inder Singh – LehmanBrothers.

Yes, thanks very much. Congratulations,it looks like a pretty solid quarter there.

Dominic P. Orr

Thank you.

Inder Singh – LehmanBrothers.

So, you had the confidence to actually raise your guidancefor next year, for the full year in terms of revenues and earnings. Dominic, can you comment just a little bit,or expand a little bit on your macro level comments about the spendingenvironment remaining robust? It lookslike, you know, second quarter you’re also seeing some strength here enteringthe quarter, are you surprised that you’re seeing such broad base strength inall of the verticals that you’re in and do you have fears of an impact fromsort of an economic slow down?

Secondly, can you comment a little bit on the pricingenvironment seeing that some of your competitors aren’t seeing the growth thatyou’re seeing. Are you seeing them comeinto the market with price?

Dominic P. Orr

First on the macro environment, first of all we are notseeing a slow down in spending in the enterprise for both our in store base andprospect. You have to understand thatoverall, the projects that we’re involved in are not discretionaryprojects. Enterprises have needs tosupport mobility application and mobility application normally are constrainedby security consideration and Aruba provides a veryunique user friendly approach to help them solve the mobility problem with thesecurity problem. That’s numberone.

Number two, generally what we find is customers choose us onthe ground that we have an integrated architecture in a single producttherefore reducing the orbix expenditure. But, more importantly, a lot of customer large development customerschose us because we have by far the lowest TCO, total cost of ownership. So, in general, when we face a budgetconstraint we are actually in a much more favorable situation because ourarchitectural and orbix advantage are more dramatized.

Steffan Tomlinson

On the second plan for ASPs we see no change to our ASPs,they are very solid and, you know, as far as competition in the marketplace,many of our competitors compete on price and we compete on value.

Dominic P. Orr

And, the confidence we showed in the current quarter isbased on our pipeline which, if you look at it either from the geographicperspective, number of projects, the size of projects, basically, the generalstrength and depth of the pipeline, it is at record levels in company historyas I mentioned and that gives us the confidence to move ahead with thisguidance.

Inder Singh – LehmanBrothers.

Just on the linearity and the quarter obviously, youindicated that the second half was going to be a bit stronger than the firsthalf of the quarter. How do you expectthe current quarter to shape up seeing that you’re seeing strength going intoit? Are you expecting normal seasonalitygoing into this quarter or anything unusual here?

Dominic P. Orr

I’m seeing normal seasonality, a little bit help from theback ended nature from the previous quarter which means that the first half ofthis quarter will be better than the previous.

Inder Singh – LehmanBrothers.

Great. Thank you.

Operator

Thank you, sir. Thenext question comes from the line of Erik Suppiger with Signal Hill. Please go ahead with your question.

Erik Suppiger -Signal Hill

Good afternoon. Acouple of things, you noted kind of a back ended quarter, was there any changewith lead times at the end of the quarter?

Steffan Tomlinson

There were no changes in lead time from a manufacturingstandpoint. As we mentioned early on inthe call, the slight delay was more around customers going through turn of 802.11and kicking the tires and also wanting to see our response to the Motorola suitwhich we filed on October 17th. Once those what I’ll call impediments were removed then, we startedseeing the pick up in the second half of the quarter

Erik Suppiger -Signal Hill

Okay. On the incomestatement you got other income at $726,000, where did that come from?

Steffan Tomlinson

For other income?

Erik Suppiger -Signal Hill

Yeah.

Steffan Tomlinson

That came from a revaluation of warrant which was exercisedthis quarter. So, there was a one timerevaluation of a warrant that came in that was posted to other income.

Erik Suppiger - SignalHill

Okay. Then lastly,you had made note that CISCO was flat on a year-over-year basis and the firsthalf of the quarter was somewhat slow, I guess that was more company specificbut, do you think there were any slow down in the broader market? Was there anything outside of the two issuesthat you pointed to that may have caused a slower quarter, at least for thefirst half here?

Dominic P. Orr

So, you’re looking to the overall enterprise networkinginfrastructure market, you would use Internet switches as a proxy, you wouldfind market data support that there might be some softness in the coreswitching segment but, there is absolutely no slow down in the etch switchingpart and 100% of our business is on etch.

Erik Suppiger -Signal Hill

Okay. Very well then,thank you very much.

Dominic P. Orr

You’re welcome.

Operator

Thank you, sir. Thenext question comes from the line of Sanjiv Wadhwani with Stifel Nicolaus. Please go ahead with your question.

Sanjiv Wadhwani -Stifel Nicolaus

Thank you. Just twoquick questions. Steffan, I know youmentioned in the press release and in your dialog that your exposure to variousvertical is less than 20%. Can you justtalk a little bit on the financial services. I’m guessing exposure there is pretty low but, if you can add any colorthat would be helpful.

Steffan Tomlinson

Sure. So, in thefinancial vertical we see that as less than 5% of our total revenues.

Sanjiv Wadhwani -Stifel Nicolaus

Got it. That’shelpful. Then, on the Motorola expensesfor Q1, is that sort of for a good steady state at least for the next couple ofquarters, that $300k?

Steffan Tomlinson

Our legal expenses are going to vary quarter to quarter andbecause of the variability we’re not going to be providing guidance. What we’re going to be doing is we’re goingto be reporting the actuals every quarter. Where you’re going to see an up tick, a real meaningful up tick in legalexpenses is when we approach the trial period which isn’t forecasted to beuntil late 09. So, that’s the amount ofinsight I can give you.

Sanjiv Wadhwani -Stifel Nicolaus

Got it. So, basicallylate calendar 09 essentially?

Steffan Tomlinson

Correct.

Sanjiv Wadhwani -Stifel Nicolaus

So that’s obviously a long ways away. And one last question, on the projects thatwere delayed into the second half and have obviously carried over into thefirst half of this quarter was it sort of two or three large projects? Or, there were actually multiple projects? I just wanted to get a little moregranularity on that.

Dominic P. Orr

I think, in general, I could say that some of the projectdelay in the retail segment, as you can imagine and so far the projects havebeen converted and I want to emphasis in Q1 each and every time that I am awarethat we engage with a project against Motorola, we won.

Sanjiv Wadhwani -Stifel Nicolaus

Got. Alright, that’shelpful. Thanks so much. Congratulations.

Dominic P. Orr

Thank you.

Steffan Tomlinson

Thank you.

Operator

The next question comes from the line of Mark Sue with RBCCapital. Please go ahead with yourquestion.

Mark Sue - RBCCapital

Thank you. Dominic,any thoughts on where wireless networking is in terms of the overall prioritylist for IT spending and is it moving higher and lower in terms of the rankorder of things? Recognizing that it isnot discretionary.

Dominic P. Orr

Yes. I think that weparticularly find that wireless is being used as a technology to sort outmultilevel access priority with different kind of level users such ascontractor, long term visitors, suppliers, auditors, visitors and so on andthat application has horizontal, you know, perspective and it seems like thismobile workforce is really driving that issue. Remote access is another one and also we are seeing an increasing amountof IP telephony starting to pilot over wireless as well.

Mark Sue - RBCCapital

Okay

Keerti Melkote

This is Keerti. If Imay add to that. Most of our recentdiscussions with TIO on wireless office when the concept comes up much moreoften than it use to in the past and if you take a look at the income spendingenvironment right now, wireless offers a much lower cost from an infrastructureperspective and that’s the main reason they are looking at potential for doingall wireless offices in their branch offices and other places as well.

Mark Sue - RBCCapital

Okay. Got it. Then, the inventory increase in absolutelydollars and the reduction in returns, if you can give us some further thoughtthere Steffan.

Steffan Tomlinson

Sure. On thereduction in returns, we came off of a very strong Q4 where returns were alittle bit north of five times. So in Q1the returns were actually the second highest in the company’s history and asfar as absolute dollars increasing we were basically getting ready for a big Q2and we wanted to make sure we had enough product to satisfy the demand.

Mark Sue - RBCCapital

Okay. I’ve gotit. Lastly, you said the pipeline is thelargest ever. Is that the same as thebacklog?

Dominic P. Orr

No. The way that we define pipeline is projects that we havedifferent stages of our competitive state in the sales force funnel. We measure across industry, geography and projectsize.

Mark Sue - RBCCapital

Okay. One more, juston tax rate, any thoughts on how we should model that in calendar 09 goingforward considering your NOLs at the moment?

Steffan Tomlinson

The next couple of quarters, Mark we’ll be providingguidance on long term tax rate. We’restill going through our international tax planning exercises. Once that’s completed we’ll be givingguidance.

Mark Sue - RBCCapital

Okay, that’s helpful. Thank you gentlemen.

Steffan Tomlinson

Thank you.

Dominic P. Orr

Thank you, Mark.

Operator

The next question comes from Ehud Gelblum with JPMorgan. Please go ahead with yourquestion.

Ehud Gelblum - JPMorgan

Hi thank you. Thisquestion has been answered but I just want a couple clarity, a couple things toclear up if I could. First, on the DSOs,the reason that the accounts receivables were up, was that due to the linearitypushed out to the second half of the quarter more so than normal and we shouldsee the DSOs come back down to normal in the following next quarter?

Steffan Tomlinson

That’s correct.

Ehud Gelblum - JP Morgan

Okay, that’s what I figured. I just wanted to make sure that correlate totally. Steffan, the net other income you describedit, the bump in it, was somewhat one time in nature and had to do withrevaluing the warrant. If we were to Performathat out, what would be the sort of like the after tax affect of that, if wewanted to kind of see what the P&L would look like with out that so we cankind of transition to going forward.

Steffan Tomlinson

I would look at just the non GAAP numbers as the best indicatorof the health of the business.

Ehud Gelblum - JPMorgan

No, no. I know thatthe business is very healthy but, you did $726,000 in warrant revaluation thatis not going to be there in the next quarter and I am wondering if there was atax impact, your tax rate was unusually high, I’m wondering if without thatyour tax rate would have been more normal, would have been lower? So what is the tax impact of that $726,000warrant?

Steffan Tomlinson

Sure. So, we have notdone the tax analysis and so, I can’t share that with you on the call.

Ehud Gelblum - JPMorgan

Okay. Is it right toassume it is positive? That you did paytaxes on that so the tax number would have been lower without it?

Steffan Tomlinson

That would be a correct assumption.

Ehud Gelblum - JPMorgan

Okay. That’s very helpful. The description Dominic you gave was very helpful, those two retaildeals you were working on and they got postponed, one due to the Motorolalawsuit and kind of causing confusion and the other due to the CISCO’s productannouncement. Is it right to assume thatproduct revenue would have been higher if those two events had not happened andso basically, that revenue got pushed out a little bit more into the nextquarter.

So, should we look at next quarter being a little bitunusually higher than it otherwise wouldhave? Just like this quarter, perhaps,would have been maybe lower than you otherwise would have expected it to be ifthose two kind of erogenous events hadn’t happened?

Dominic P. Orr

I would like to first clarify that it is not two deals. We sink multiple projects due to two reasons,one or the other reasons.

Ehud Gelblum - JPMorgan

Okay.

Dominic P. Orr

So it’s not like two projects.

Ehud Gelblum - JPMorgan

Okay.

Dominic P. Orr

You are, I think correct, if the quarter had been morelinear without those two factors that our product revenue from new customerwould have been higher. But, whateverroll over effect has obviously been taken into account into our guidance.

Ehud Gelblum - JPMorgan

So, there might be, I don’t know, whatever there might be ½ million- ¾ of million of guidance for nextquarter that would not have been there had this quarter been more linear? And, we should use perhaps a slightly lowernumber for next quarter to go on the third quarter, fiscal quarter after that?

Dominic P. Orr

I would say you’re giving this is a little more granularitythan probably we are ready to discuss. But, I would be fair to say that our perspectives in Q2 was very goodand then technically there is some rollover from the situations in Q1.

Ehud Gelblum - JPMorgan

Fair enough. That’svery helpful. Last thing, you mentionedthe legal situation with Motorola and that was $300,000 of the expenses andlawsuit now, I think you said the case gets heard at the end of 09 but, I mayhave missed before what happened? Didyou make a bunch of counter claims versus their original lawsuit? What physically has gone back and forthbetween you and Motorola? Where doesthat stand?

Steffan Tomlinson

Sure. Our answer andcounterclaims were filed on October 17th in which we stated thatfirst of all, we don’t infringe on any of their asserted patents and thensecondly, the asserted patents are invalid. So, Motorola’s response is due in mid December and we look forward toour day in court which we anticipate, you know, as I said before will be late2009. In the meantime we look forward tocontinued success against them in the marketplace.

Ehud Gelblum - JPMorgan

Okay, so you didn’t sue them, counter sue them, you just letit go?

Steffan Tomlinson

Not yet.

Ehud Gelblum - JPMorgan

Okay. Thank you verymuch.

Operator

Thank you. The nextquestion comes from the line of Bill Choi with Jefferies & Company. Please go ahead.

Bill Choi - Jefferies& Company

Okay. Thanks. I just wanted to go through some seasonalitythought process for the top five verticals. You guys had mentioned healthcare, education, retail, government andhigh tech and all these things have somewhat different seasonality so, if youcan kind of run through that as we head into the next quarter.

Dominic P. Orr

Obviously, we actually are in probably like 20 verticals,the ones that we highlight because in aggregate they form a big number. I think that the government seasonality iswell known and the retail seasonality is well know, I don’t think I need toembellish on that.

What we are seeing is actually the traditional seasonalityof high education is actually somewhat smoothed out because there seems to be alot of technology refresh money being available and enterprises that we’ve seenis really year round because this whole issue of mobilizing the workforce andapplications doesn’t have a seasonality to it. Let’s see, have I left out anything? Healthcare, there is no seasonality. We don’t see any seasonality.

Bill Choi - Jefferies& Company

Okay. What were, thetop five that you just went over, what were their percentage of revenue foreach of these verticals?

Dominic P. Orr

Well, we do not have a practice of breaking them out. All we can say is that the largest one ofthem was less than 20%.

Bill Choi - Jefferies& Company

Okay. Just a coupleof vision clarifications; this legal expense between the $300,000 which youincurred and the trial date in calendar 09, how do we look at the expense overthose multiple quarters?

Steffan Tomlinson

Sure. Directionally,as we get closer to trial the legal expenses will increase dramatically andother than that it will be ebbing and flowing depending on where we are in thecase. That is why, given the variabilitywe can’t really provide you guidance for next quarter, per say but, we feelthat going forward we will be calling it out on each call so you willunderstand how much we are spending.

Bill Choi - Jefferies& Company

Okay. Then, just aquestion on the repeat business from existing customers, I’m interested in themetric you guys threw out there about that top 25 customers was 5.7 times theoriginal value. Did any of these tap outalready? Or, are the subsequent ordersactually larger than the ones before? Just looking at very strong levels again of new customer additions, isthere just a level where you would expect that new customer additions to kindof tap out, or where it would even slow down? So far, it has actually accelerated? Thanks.

Dominic P. Orr

Okay. On the contrary, we see actually further expansioninstead of topping out because, a lot of these customers have multi national,multi site campuses and also, you have to understand the starting point forWIFI application which is laptop which only requires hotspot type ofcoverage.

But then, the moment that you extend that into a palmtopapplication and a dual-mode phone application suddenly the coveragedramatically has to be expanded because no hotspot application coverage is notas effective, you need to have full coverage and then we actually have seencustomers start having full inter building coverage then they want to expand tointer building and outdoor coverage and so on.

So, I think even from just a coverage point of view we arein a very early stage and a lot of this deployment. And, in addition to that, as you recall thatwe have a suite of about seven or eight applications that customersincreasingly will install once they get the minimal protection for wirelessintrusion and coverage, they will look for other mobility applications andother form of security access and mobile access and mobile void and so on. So, those are the upgrade paths for those customers. So, I do not expect that to be a topic.

Bill Choi - Jefferies& Company

So are you saying that none of those top 25 customers haveyet even peaked as far as you’ve seen the boarder pattern?

Dominic P. Orr

That’s my observation so far.

Bill Choi - Jefferies& Company

Great. Okay. Thanks.

Operator

Thank you. The nextquestion comes from the line of Brandt Thomson with Goldman Sachs. Please go ahead with your question.

Tom Li - GoldmanSachs

Hi, this is Tom Li for Brandt Thomson. I just had a question on your internationalmarket. Now, I was just wondering if youcould talk a little bit about demand in particular in Europe and then maybemore broadly any other particular regions where you’re seeing strength.

Dominic P. Orr

Europe was very strong, in fact, last quarter was the recordquarter for Europe so I’m proud of the growththere. Other internationally, ourbusiness spread in many countries and I think in each of the countries we don’thave the critical unit volume to show a trend so they tend to be, the businesstends to be lumpy swung by the big deals. So, that’s kind of my observation.

Tom Li - GoldmanSachs

Great. Within Europe,is there particular verticals where you are seeing that strength? Or, was it fairly broad based?

Dominic P. Orr

We are strong in Europe pretty much in most of the area thatwe are strong in US, namely education and healthcare, high tech company, thoseare general hotspots across the industry and also, as you can imagine, thestrength of our US federal business is now starting to spill to some of thecountries that are [inaudible] in two years.

Tom Li - GoldmanSachs

Thank you, that’s very helpful. Then, just lastly on competition, I meanclearly you talked about gaining share but I was just looking for a little morecolor in terms of which verticals – are certain verticals that you’re seeingparticular strength relative to the competition in terms of market share gains?

Dominic P. Orr

I think that it is our winning race continues to be aboutthe same in previous quarters at around 80% and if you look at why people choseus it is because we are over the largest scale and most secure end-to-end, thelower cost of ownership because of centralized management and because weprovide QOS, we unique provide QOS in the air so really, people chose usbecause of those capabilities and also because they truly have a mobilityrequirement rather than a cordless extension of an Internet cord requirementand it is really more application driven rather than industry driven.

Tom Li - GoldmanSachs

Great. Thank you.

Operator

Thank you. The nextquestion comes from the line of Anil Doradla with Caris & Company. Pleasego ahead.

Anil Doradla - Caris& Company

Yes. A quick questionon your 802.11n adoption. Did you seegreater adoption perhaps on the enterprise versus education? I mean, in terms of adoption any particularend marketing that is adopting it faster than the others?

Keerti Melkote

The adoption of 11n is primarily right now concentration inthe higher education vertical rather than in the enterprise. Enterprises are beginning to look at it butthey are ruling out AVG products today. With our Carnegie Mellon win that was the first big enterprise win andwe expect that there will be multiple wins like that in particular sector. But, that’s usually where we’re seeing mostof the demand right now for 11n.

Anil Doradla - Caris& Company

You talked about 450 new customers during the quarter. Out of those 450 what percentage perhaps werecustomers that moved from perhaps competition to Aruba? Can you give us some color on that?

Dominic P. Orr

We do not have the specific statistic at this moment so I’drather not be specific.

Anil Doradla - Caris& Company

Okay. And, what werethe number of people you hired during the quarter?

Steffan Tomlinson

We hired 34 people from last quarter and just to give youthe quick breakdown, sales and marketing ended at 221 which is an increase of22 from last quarter. R&D was 150people which was up six from the prior quarter and T&A was at 104 peoplewhich was up six from last quarter as well. So, total ended head count was 475 versus last quarter 441.

Anil Doradla - Caris& Company

Great. Yesterday Ithink there was an announcement between you and Cavium Networks about the 64 mpsprocessor. Can you throw some light asto what kind of products we’ll be seeing using that chip?

Keerti Melkote

Those chips are goinginto our 11n access points.

Anil Doradla - Caris & Company

Currently you do not use Cavium on the 11n, I presume?

Keerti Melkote

No. The currentaccess points are all completely Atheros-based. But with 11n, we areintroducing a very high performance solution using the Cavium part as well asthe Atheros radius.

Anil Doradla - Caris & Company

Does that mean you're switching from Atheros to Cavium?

Keerti Melkote

No, it doesn't. Westill use Atheros for the radial, and we using Cavium for security and thenprocessing on the access points.

Anil Doradla - Caris & Company

So you'll dual-sourcethe chips, basically?

Keerti Melkote

That's correct.

Anil Doradla - Caris & Company

From an application pipeline point of view, what kind ofapplications are you going to roll out? Because the way I looked at your Caviumannouncement is it seems that you guys seem to be getting more into theapplication space out there. Can we expect to see a suite of new applicationsgoing forward over the next couple of quarters?

Dominic P. Orr

I don't know aboutthe next couple of quarters specifically, but the primary application we sellinto today is enterprise-wide mobility network. That covers employee access,guest access and remote access. That's what we serve for the most part. Theapplications that are new and upcoming are concentrated in specific verticals.For instance, in the higher education sector, we see an interest in our videosurveillance solutions that we are going to be rolling out, along with our Meshproducts.

If you look at oil and gas, there's a lot of interest inoutdoor solutions in that sector. So there's specific applications in specificverticals, but if you were to look at the overall horizontal, enterprise-wide,it's primarily secured mobile access for employees and guests in the office andoutside of the office.

Anil Doradla - Caris & Company

Thank you very much.

Operator

Thank you. The next question comes from the line of TimDaubenspeck with Pacific Crest Securities. Please go ahead with your question.

Tim Daubenspeck - Pacific Crest Securities

Thanks. Steffan, the first question is when you guys gaveguidance last quarter, you gave quarterly EPS and full year EPS, and it did notinclude legal expense. Now you've updated full year. Does that include legalexpense?

Steffan Tomlinson

It does.

Tim Daubenspeck - Pacific Crest Securities

So was there anymajor change in any of the other items driving margins or EPS that you werebetter to offset the impact of a potential legal expense?

Steffan Tomlinson

What we do when wecome up with guidance is we look at the overall business. Now that we have factoredin the impact of the legal expenses from the Motorola lawsuit, this updatedrange takes that into consideration as well as the other factors. It's a veryfluid business, so we look at things on a quarterly basis.

Tim Daubenspeck - Pacific Crest Securities

There's enough flexibility in other areas that depending onthe variability in terms of legal expenses on a quarterly basis, you feel verycomfortable in terms of the full year EPS?

Steffan Tomlinson

Correct.

Tim Daubenspeck - Pacific Crest Securities

Did you break out stock-based compensation by OpEx lineitem?

Steffan Tomlinson

No. It's on our IRwebsite, and I can certainly walk you through it right now. Stock-basedcompensation for cost of revenues was $150,000. For research and development,it was $1.45 million. For sales and marketing, it was $2.695 million. ForG&A, it was about $910,000.

Tim Daubenspeck - Pacific Crest Securities

Great, thank you. In terms of Microsoft, U.S. Air Force andAlcatel-Lucent, you said none were 10% customers. Were they up sequentiallyagain?

Steffan Tomlinson

By and large, they were up sequentially in terms of absolutedollars. We don't talk about any specific customer, but as a class they wereall up sequentially.

Tim Daubenspeck - Pacific Crest Securities

So maybe two were up, one was down? Is that a possibility, inabsolute dollars?

Steffan Tomlinson

Absolute dollars, potentially.

Tim Daubenspeck - Pacific Crest Securities

You had better gross margins here. Was that a factor of justbetter performance in terms of manufacturing, or was the two-tier mix a littleless than you expected in the quarter?

Steffan Tomlinson

There were a number of factors. One is we are getting bettercosts from our manufacturer, which is great. We had a slightly higher mix ofsoftware revenues which helped; and the two-tier distribution system, while itshowed nice progress, we are not seeing the full impact of the two-tierdistribution system on the gross margin. We don't anticipate that until theback half of the fiscal year.

Tim Daubenspeck - Pacific Crest Securities

I think we are six months into Westcon. Can you just give usan update on where we are with their contribution? Was it material?

Steffan Tomlinson

Westcon has done very well for us. They were the firstvalue-added distributor that we signed and they have had the most traction todate, just because they've had the most time in the saddle.

As we said earlier, none of our distribution partners are a10% partner and our goal is to grow revenues as fast as we can in order to makeit very difficult for one of those partners to be a 10% partner.

Tim Daubenspeck - Pacific Crest Securities

But Westcon was a contributor of revenue over the last twoquarters or just the most recent quarter?

Steffan Tomlinson

Just the most recent quarter.

Tim Daubenspeck - Pacific Crest Securities

Great, that is all of the questions I have. Thanks a lot,guys.

Operator

That is the end of the question-and-answer session. I wouldlike to turn it back to management. Please go ahead.

Dominic P. Orr

Well again, we thank you for being on the call today andappreciate your support. We look forward to updating you on our progress in thecoming months. Happy Thanksgiving.

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Source: Aruba Networks F1Q08 (Qtr End 10/31/07) Earnings Call Transcript
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