Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Aruba Networks, Inc. (NASDAQ:ARUN)

F1Q08 Earnings Call

November 20, 2007 5:00 pm ET

Executives

Dominic P. Orr - Aruba Chief Executive 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 standing by and welcome to the Aruba Networks Fiscal First Quarter 2008 Earnings Call. During today’s presentation all parties will be in a listen only mode. Following the presentation the conference will be opened for questions. As a reminder, today’s conference is being recorded Tuesday, November 20, 2007. I would now like to turn the call over to Jill Eisenstadt with Investor Relations. Please go ahead ma’am.

Jill Eisenstadt

Good afternoon and thank you for joining us on today’s conference call to discuss Aruba Network’s fiscal first quarter 2008 results. This call is also being broadcast live over the web and can be accessed in the investor relations section 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 and Keerti Melkote, Founder and Head of Products & Partnerships.

After the market closed today, Aruba Networks issued a press release announcing the results for its fiscal first quarter ended October 31, 2007. If you would like a copy of the release you can access it online at the company’s website, or you can call the Blue 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 this conference call Aruba Network’s management may make forward looking statements including financial projects regarding the company’s revenues and non GAAP ETS, non GAAP gross margins, non GAAP operating expenses, statements regarding the company’s sales momentum, growth in its customer pipeline, performance of its recently announced products, industry trends and market demand for the company’s products, plans and objectives of management for future operations and other statements as to the company’s future economic performance, financial condition or result of operations.

These forward looking statements are not historical facts but rather a base on the company’s current expectations and beliefs. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those anticipated by these forward looking statements. These risks and uncertainties include a variety of factors, some of which are beyond our control. 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.

Please refer to our Annual Report on Form 10K filed with the SEC on October 12, 2007, as well as our Earnings Release posted a few minutes ago to our website for a more detailed description of the risk factors that may affect our results. 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 including non cash stock base and acquisition related expenses. We have provided reconciliations of these non GAAP measures in the investment relations section of our website located at www.arubanetwork.com and in our earnings press release.

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

Dominic P. Orr

Thank you. Good afternoon and thank you for taking the time to attend our Fiscal First Quarter Results Conference Call. We started our fiscal year with a solid first quarter and strong momentum. Q1 revenues expanded by 91% year-over-year while other competitors report a flat wireless revenue year-over-year. According to the Devo Group, we are now the second largest enterprise wireless land supplier world wide moving ahead of Motorola. We had a record number of new customers in period and our accumulative total number of customers now surpasses 3,300.

Non GAAP gross margin was 68.1% reflecting the strength of our competitor position. Recently, we announced a major update to our product line with the addition of two new ranges of multi service mobility controllers and a new line of high performance 802.11 access points. The only 802.11 access points that can perform optimally with existing power over Internet infrastructures.

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

We also introduced two important new security technologies. One, for network access control and end point compliance; the other, for enhancing physical security. With regard to the latter, our new video surveillance solution enables wired and wireless video cameras to be easily integrated with an Aruba Wireless LAN or MASH network for security monitoring and logistic support applications.

Finally, we demonstrated strong operating leverage as non GAAP operating income increased to $2.7 million, tripling on a sequential basis. Q1 revenue increased 12% sequentially, reaching $46.7 million. Importantly, this revenue growth was accomplished without any customer or vertical market concentration. While we 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 vertical markets including, education, government, healthcare, retail and enterprise. None of our verticals accounted for more than 20% of our revenues.

Overall, new customer growth was outstanding as we added a record number of new customers across all of our verticals in the period. Key reason wins included the following: one of 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 with 290 stores and an Ivy League University with over 22,000 students and teachers.

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

Despite the record number of new customer additions, we derived 725 of our revenues from existing customers. As most of our customers order over an extend multi quarter period. During the quarter key repeat customers included US Airforce, Google, SAP, Saudi Ramco, and a number of major universities. At the end of Q1, the aggregate repeat order value of our top 25 customers was over 5.7 times the aggregate value of this customers’ original purchase order, clearly demonstrating the value of winning this large order.

Revenue growth was especially strong in the second half of the quarter and I am pleased that the momentum has continued so far into Q2. We enter Q2 with the largest pipeline of prospects in our company history. And, our newly announced products could extend our capabilities and open new markets for the company. First, we now have the right product set to deliver high performance secure wireless networks at very compelling price points for small to medium sized markets. We are now very encouraged by initial feedback on the MMC3000 and of our competitiveness both with the price point and feature set of these controllers.

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

The high performance of our new 11n solution coupled with our unique layers 4 to 7 QOS in the air enable customers to deploy all wireless workplaces. Offering performance rivaling those of a wired network. Others share our vision of an all wireless workplace. Carnegie Mellon University has long been a pioneer in wireless networking. Then University is in the process of updating its academic campus to Aruba 802.11n technology managed by our new 80 gigabyte per second MMC6000 controllers. Wireless technology serves to compliment and extend their wired network. Carnegie Mellon’s vision is that its updated Aruba Wireless Network will serve a wired LAN replacement for many applications on campus. It is an exciting vision of the near future and one within which we are uniquely positioned.

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

Steffan Tomlinson

Thanks Dominic. Before I begin the discussion of our first quarter results, I would like to note that all comments made in the prepared remarks exclude the impact of non cash stock base expenses unless, specifically noted. In the first quarter of fiscal 2008 non cash stock 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 customer accounted 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 both the continuing growth of install base of customers with support contracts and an 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 from indirect channels in Q1. The remaining 18% 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% customers or partners during the quarter. Approximately 69% of our sale were generated in the US with the remaining 31% coming from international customers. Domestic sales showed nice sequential growth of 17%.

We continue to produce strong gross margins in the first quarter. Overall, non GAAP gross margins came in at 28.1% compared to 69% in the prior quarter. This strong performance was slightly above our target range for gross margins of 65-68% even with the higher mix of service to sales and more sales going through two tiered distribution partners.

Non GAAP research and development expenses increased from the prior quarter but decreased as a percentage of revenue from 15.7% in Q407 to 14.6% in Q1 of 08. Non GAAP R&D is in line with our long term target of 15% and we will continue to add additional R&D resources to enhance the functionality of our existing products and develop new ones.

Non GAAP sales and marketing expenses increased modestly from the prior quarter and decreased significantly as a percentage of revenue from 45.0% in Q407 to 40.7% in Q108. We expect future sales and marketing expenses to continue to be our most significant operating expense but, should continue to gradually decrease as a percentage of sales as we move towards our long term target of 27% of revenues on a non GAAP basis.

Non GAAP G&A expenses increased in actually dollars and as 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 was approximately $3.9 million or $0.04 per diluted share compared to a non GAAP net income of $2 million in Q407 or $0.02 per diluted share or non GAAP net loss of $1.9 million or $0.14 per diluted share in Q107. The GAAP net loss for the quarter was $0.6 million or $0.01 per diluted share compared to a GAAP net loss of $3.3 million or $0.04 per share in Q407 and a GAAP net loss of $4.5 million or $0.34 per share in Q107. As we noted, our first quarter 2008 GAAP results included $4.5 million of non cash stock base expenses. The Q1 non GAAP weighted average shares outstanding 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 million at quarter end compared to $16.1 million at the end of Q407.

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

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

In summary, we are pleased by our performance in Q1. Revenue, customer growth and margins showed steady progress. On a sequential bases we increased non GAAP operating margin and non GAAP net income margin to 5.8 and 8.2 respectively. Moving forward, we believe our market opportunity is large and growing and our pipeline is the largest ever. Given this, we expect to see 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 revenue range from $210-$220 million with our non GAAP EPS range increasing to $0.21-$0.23 per diluted share. With that, 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 you might have. Operator, you can now open it up for questions.

Question-and-Answer Session

Operator

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

Ryan Hutchinson - WR Hambrecht + 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 you added a record number, around 450 new customers in the quarter. Can you help us understand the dynamics there?

Dominic P. Orr

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

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

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

Ryan Hutchinson - WR Hambrecht + Co

Okay.

Steffan Tomlinson

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

Ryan Hutchinson - WR Hambrecht + Co

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

Dominic P. Orr

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

Ryan Hutchinson - WR Hambrecht + Co

Okay.

Dominic P. Orr

That added to our confidence in the pipeline.

Ryan Hutchinson - WR Hambrecht + Co

Okay. And then, just in terms of how we should look at the partnerships in place, of the potential for new ones, typically on the server provided side, can you add any color there in terms of potential partnerships specifically, in the international markets in the EMEA region?

Dominic P. Orr

Sure. You have to understand this; when we engage a service provider typically there are three separate components. First of all, a lot of this service provider are themselves an end user customer and that tends to happen first and then, what we are engaging them in is the network integration and system integration arm of the service provider in which they really act as a value added reseller of system integration capabilities and that is going on very well.

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

Ryan Hutchinson - WR Hambrecht + Co

Okay. And then finally, and I’ll jump back in the queue, just in terms of as this last quarter on the migration to 802.11n, any sense there in terms of the potential for purchasing delays to date? Or, is that essentially, more or less, a non event as it stands right now.

Dominic P. Orr

As I commented earlier, our observation was there was about 45 days worth of looking around for a lot of the enterprise to see what is this, this new situation. But, our situation is that all of them, after examining it, decided to move on according to the original road map with the exception of some large university, they want to use the funding that they have in the next 12 months to future proof the network and therefore a lot of the 11n activities are happening in large universities and, of course, that is our sweet pot, evidenced by our announcement of one of the largest and most leading university in the nation, Carnegie Mellon University who’s leading this 11n migration has chosen to adopt Aruba architecture and technology.

Ryan Hutchinson - WR Hambrecht + Co

Thanks

Dominic P. Orr

You’re welcome Ryan.

Operator

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

Inder Singh – Lehman Brothers.

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

Dominic P. Orr

Thank you.

Inder Singh – Lehman Brothers.

So, you had the confidence to actually raise your guidance for 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 spending environment remaining robust? It looks like, you know, second quarter you’re also seeing some strength here entering the quarter, are you surprised that you’re seeing such broad base strength in all of the verticals that you’re in and do you have fears of an impact from sort of an economic slow down?

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

Dominic P. Orr

First on the macro environment, first of all we are not seeing a slow down in spending in the enterprise for both our in store base and prospect. You have to understand that overall, the projects that we’re involved in are not discretionary projects. Enterprises have needs to support mobility application and mobility application normally are constrained by security consideration and Aruba provides a very unique user friendly approach to help them solve the mobility problem with the security problem. That’s number one.

Number two, generally what we find is customers choose us on the ground that we have an integrated architecture in a single product therefore reducing the orbix expenditure. But, more importantly, a lot of customer large development customers chose us because we have by far the lowest TCO, total cost of ownership. So, in general, when we face a budget constraint we are actually in a much more favorable situation because our architectural 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 is based on our pipeline which, if you look at it either from the geographic perspective, number of projects, the size of projects, basically, the general strength and depth of the pipeline, it is at record levels in company history as I mentioned and that gives us the confidence to move ahead with this guidance.

Inder Singh – Lehman Brothers.

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

Dominic P. Orr

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

Inder Singh – Lehman Brothers.

Great. Thank you.

Operator

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

Erik Suppiger - Signal Hill

Good afternoon. A couple of things, you noted kind of a back ended quarter, was there any change with lead times at the end of the quarter?

Steffan Tomlinson

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

Erik Suppiger - Signal Hill

Okay. On the income statement 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 exercised this quarter. So, there was a one time revaluation of a warrant that came in that was posted to other income.

Erik Suppiger - Signal Hill

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

Dominic P. Orr

So, you’re looking to the overall enterprise networking infrastructure market, you would use Internet switches as a proxy, you would find market data support that there might be some softness in the core switching segment but, there is absolutely no slow down in the etch switching part 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. The next question comes from the line of Sanjiv Wadhwani with Stifel Nicolaus. Please go ahead with your question.

Sanjiv Wadhwani - Stifel Nicolaus

Thank you. Just two quick questions. Steffan, I know you mentioned in the press release and in your dialog that your exposure to various vertical is less than 20%. Can you just talk a little bit on the financial services. I’m guessing exposure there is pretty low but, if you can add any color that would be helpful.

Steffan Tomlinson

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

Sanjiv Wadhwani - Stifel Nicolaus

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

Steffan Tomlinson

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

Sanjiv Wadhwani - Stifel Nicolaus

Got it. So, basically late 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 that were delayed into the second half and have obviously carried over into the first 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 more granularity on that.

Dominic P. Orr

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

Sanjiv Wadhwani - Stifel Nicolaus

Got. Alright, that’s helpful. 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 RBC Capital. Please go ahead with your question.

Mark Sue - RBC Capital

Thank you. Dominic, any thoughts on where wireless networking is in terms of the overall priority list for IT spending and is it moving higher and lower in terms of the rank order of things? Recognizing that it is not discretionary.

Dominic P. Orr

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

Mark Sue - RBC Capital

Okay

Keerti Melkote

This is Keerti. If I may add to that. Most of our recent discussions with TIO on wireless office when the concept comes up much more often than it use to in the past and if you take a look at the income spending environment right now, wireless offers a much lower cost from an infrastructure perspective and that’s the main reason they are looking at potential for doing all wireless offices in their branch offices and other places as well.

Mark Sue - RBC Capital

Okay. Got it. Then, the inventory increase in absolutely dollars and the reduction in returns, if you can give us some further thought there Steffan.

Steffan Tomlinson

Sure. On the reduction in returns, we came off of a very strong Q4 where returns were a little bit north of five times. So in Q1 the returns were actually the second highest in the company’s history and as far as absolute dollars increasing we were basically getting ready for a big Q2 and we wanted to make sure we had enough product to satisfy the demand.

Mark Sue - RBC Capital

Okay. I’ve got it. Lastly, you said the pipeline is the largest ever. Is that the same as the backlog?

Dominic P. Orr

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

Mark Sue - RBC Capital

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

Steffan Tomlinson

The next couple of quarters, Mark we’ll be providing guidance on long term tax rate. We’re still going through our international tax planning exercises. Once that’s completed we’ll be giving guidance.

Mark Sue - RBC Capital

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 JP Morgan. Please go ahead with your question.

Ehud Gelblum - JP Morgan

Hi thank you. This question has been answered but I just want a couple clarity, a couple things to clear up if I could. First, on the DSOs, the reason that the accounts receivables were up, was that due to the linearity pushed out to the second half of the quarter more so than normal and we should see 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 described it, the bump in it, was somewhat one time in nature and had to do with revaluing the warrant. If we were to Performa that out, what would be the sort of like the after tax affect of that, if we wanted to kind of see what the P&L would look like with out that so we can kind of transition to going forward.

Steffan Tomlinson

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

Ehud Gelblum - JP Morgan

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

Steffan Tomlinson

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

Ehud Gelblum - JP Morgan

Okay. Is it right to assume it is positive? That you did pay taxes on that so the tax number would have been lower without it?

Steffan Tomlinson

That would be a correct assumption.

Ehud Gelblum - JP Morgan

Okay. That’s very helpful. The description Dominic you gave was very helpful, those two retail deals you were working on and they got postponed, one due to the Motorola lawsuit and kind of causing confusion and the other due to the CISCO’s product announcement. Is it right to assume that product revenue would have been higher if those two events had not happened and so basically, that revenue got pushed out a little bit more into the next quarter.

So, should we look at next quarter being a little bit unusually higher than it otherwise would have? Just like this quarter, perhaps, would have been maybe lower than you otherwise would have expected it to be if those 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 - JP Morgan

Okay.

Dominic P. Orr

So it’s not like two projects.

Ehud Gelblum - JP Morgan

Okay.

Dominic P. Orr

You are, I think correct, if the quarter had been more linear without those two factors that our product revenue from new customer would have been higher. But, whatever roll over effect has obviously been taken into account into our guidance.

Ehud Gelblum - JP Morgan

So, there might be, I don’t know, whatever there might be ½ million - ¾ of million of guidance for next quarter that would not have been there had this quarter been more linear? And, we should use perhaps a slightly lower number 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 granularity than probably we are ready to discuss. But, I would be fair to say that our perspectives in Q2 was very good and then technically there is some rollover from the situations in Q1.

Ehud Gelblum - JP Morgan

Fair enough. That’s very helpful. Last thing, you mentioned the legal situation with Motorola and that was $300,000 of the expenses and lawsuit now, I think you said the case gets heard at the end of 09 but, I may have missed before what happened? Did you make a bunch of counter claims versus their original lawsuit? What physically has gone back and forth between you and Motorola? Where does that stand?

Steffan Tomlinson

Sure. Our answer and counterclaims were filed on October 17th in which we stated that first of all, we don’t infringe on any of their asserted patents and then secondly, the asserted patents are invalid. So, Motorola’s response is due in mid December and we look forward to our day in court which we anticipate, you know, as I said before will be late 2009. In the meantime we look forward to continued success against them in the marketplace.

Ehud Gelblum - JP Morgan

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

Steffan Tomlinson

Not yet.

Ehud Gelblum - JP Morgan

Okay. Thank you very much.

Operator

Thank you. The next question 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 seasonality thought process for the top five verticals. You guys had mentioned healthcare, education, retail, government and high tech and all these things have somewhat different seasonality so, if you can 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 is well known and the retail seasonality is well know, I don’t think I need to embellish on that.

What we are seeing is actually the traditional seasonality of high education is actually somewhat smoothed out because there seems to be a lot of technology refresh money being available and enterprises that we’ve seen is really year round because this whole issue of mobilizing the workforce and applications 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, the top five that you just went over, what were their percentage of revenue for each 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 of them was less than 20%.

Bill Choi - Jefferies & Company

Okay. Just a couple of vision clarifications; this legal expense between the $300,000 which you incurred and the trial date in calendar 09, how do we look at the expense over those multiple quarters?

Steffan Tomlinson

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

Bill Choi - Jefferies & Company

Okay. Then, just a question on the repeat business from existing customers, I’m interested in the metric you guys threw out there about that top 25 customers was 5.7 times the original value. Did any of these tap out already? Or, are the subsequent orders actually larger than the ones before? Just looking at very strong levels again of new customer additions, is there just a level where you would expect that new customer additions to kind of 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 expansion instead of topping out because, a lot of these customers have multi national, multi site campuses and also, you have to understand the starting point for WIFI application which is laptop which only requires hotspot type of coverage.

But then, the moment that you extend that into a palmtop application and a dual-mode phone application suddenly the coverage dramatically has to be expanded because no hotspot application coverage is not as effective, you need to have full coverage and then we actually have seen customers start having full inter building coverage then they want to expand to inter building and outdoor coverage and so on.

So, I think even from just a coverage point of view we are in a very early stage and a lot of this deployment. And, in addition to that, as you recall that we have a suite of about seven or eight applications that customers increasingly will install once they get the minimal protection for wireless intrusion and coverage, they will look for other mobility applications and other 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 have yet 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 next question comes from the line of Brandt Thomson with Goldman Sachs. Please go ahead with your question.

Tom Li - Goldman Sachs

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

Dominic P. Orr

Europe was very strong, in fact, last quarter was the record quarter for Europe so I’m proud of the growth there. Other internationally, our business spread in many countries and I think in each of the countries we don’t have the critical unit volume to show a trend so they tend to be, the business tends to be lumpy swung by the big deals. So, that’s kind of my observation.

Tom Li - Goldman Sachs

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 that we are strong in US, namely education and healthcare, high tech company, those are general hotspots across the industry and also, as you can imagine, the strength of our US federal business is now starting to spill to some of the countries that are [inaudible] in two years.

Tom Li - Goldman Sachs

Thank you, that’s very helpful. Then, just lastly on competition, I mean clearly you talked about gaining share but I was just looking for a little more color in terms of which verticals – are certain verticals that you’re seeing particular 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 about the same in previous quarters at around 80% and if you look at why people chose us it is because we are over the largest scale and most secure end-to-end, the lower cost of ownership because of centralized management and because we provide QOS, we unique provide QOS in the air so really, people chose us because of those capabilities and also because they truly have a mobility requirement rather than a cordless extension of an Internet cord requirement and it is really more application driven rather than industry driven.

Tom Li - Goldman Sachs

Great. Thank you.

Operator

Thank you. The next question comes from the line of Anil Doradla with Caris & Company. Please go ahead.

Anil Doradla - Caris & Company

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

Keerti Melkote

The adoption of 11n is primarily right now concentration in the higher education vertical rather than in the enterprise. Enterprises are beginning to look at it but they are ruling out AVG products today. With our Carnegie Mellon win that was the first big enterprise win and we expect that there will be multiple wins like that in particular sector. But, that’s usually where we’re seeing most of 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 were customers 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’d rather not be specific.

Anil Doradla - Caris & Company

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

Steffan Tomlinson

We hired 34 people from last quarter and just to give you the quick breakdown, sales and marketing ended at 221 which is an increase of 22 from last quarter. R&D was 150 people which was up six from the prior quarter and T&A was at 104 people which 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 I think there was an announcement between you and Cavium Networks about the 64 mps processor. Can you throw some light as to what kind of products we’ll be seeing using that chip?

Keerti Melkote

Those chips are going into our 11n access points.

Anil Doradla - Caris & Company

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

Keerti Melkote

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

Anil Doradla - Caris & Company

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

Keerti Melkote

No, it doesn't. We still use Atheros for the radial, and we using Cavium for security and then processing on the access points.

Anil Doradla - Caris & Company

So you'll dual-source the chips, basically?

Keerti Melkote

That's correct.

Anil Doradla - Caris & Company

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

Dominic P. Orr

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

If you look at oil and gas, there's a lot of interest in outdoor solutions in that sector. So there's specific applications in specific verticals, 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 and outside of the office.

Anil Doradla - Caris & Company

Thank you very much.

Operator

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

Tim Daubenspeck - Pacific Crest Securities

Thanks. Steffan, the first question is when you guys gave guidance last quarter, you gave quarterly EPS and full year EPS, and it did not include legal expense. Now you've updated full year. Does that include legal expense?

Steffan Tomlinson

It does.

Tim Daubenspeck - Pacific Crest Securities

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

Steffan Tomlinson

What we do when we come up with guidance is we look at the overall business. Now that we have factored in the impact of the legal expenses from the Motorola lawsuit, this updated range takes that into consideration as well as the other factors. It's a very fluid business, so we look at things on a quarterly basis.

Tim Daubenspeck - Pacific Crest Securities

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

Steffan Tomlinson

Correct.

Tim Daubenspeck - Pacific Crest Securities

Did you break out stock-based compensation by OpEx line item?

Steffan Tomlinson

No. It's on our IR website, and I can certainly walk you through it right now. Stock-based compensation 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. For G&A, it was about $910,000.

Tim Daubenspeck - Pacific Crest Securities

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

Steffan Tomlinson

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

Tim Daubenspeck - Pacific Crest Securities

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

Steffan Tomlinson

Absolute dollars, potentially.

Tim Daubenspeck - Pacific Crest Securities

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

Steffan Tomlinson

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

Tim Daubenspeck - Pacific Crest Securities

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

Steffan Tomlinson

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

As we said earlier, none of our distribution partners are a 10% partner and our goal is to grow revenues as fast as we can in order to make it 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 two quarters 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 would like to turn it back to management. Please go ahead.

Dominic P. Orr

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

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