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Aruba Networks, Inc. (NASDAQ:ARUN)

F4Q08 Earnings Call

August 28, 2008 5:00 pm ET

Executives

Jill Eisenstadt - Investor Relations

Dominic Orr - Chairman, President, Chief Executive Officer

Steffan Tomlinson - Chief Financial Officer

Keerti Melkote - Founder and Chief Technology Officer

Analysts

Ryan Hutchinson - Lazard Capital

Greg Mesniaeff - Needham & Company

Ehud Gelblum - J.P. Morgan

Jeff Kell – Lehman Brothers

Thomas Lee - Goldman Sachs

Mark Sue - RBC Capital Markets

Erik Suppiger - Signal Hill

Sanjiv Wadhwani - Stifel Nicolaus

Bill Choi - Jefferies

Eric Kainer - ThinkPanmure

Blaine Carroll - FTN Midwest Securities

Operator

Welcome to the Aruba Networks fourth quarter fiscal conference call. (Operator Instructions) I would now like to turn the conference over to Jill Eisenstadt of Investor Relations.

Jill Eisenstadt

Thank you for joining us on today’s conference call to discuss Aruba Network’s fiscal fourth quarter and full year 2008 result. This call is also being broadcast live over the web and can be accessed in the Investor Relations section of the Aruba Network’s website at www.arubanetworks.com.

With me on today’s call are Dominic Orr, Aruba’s Chief Executive Officer; Steffan Tomlinson, Chief Financial Officer and Keerti Melkote, Founder and Chief Technology Officer.

After the market closed today, Aruba Network’s issued a press release announcing the results for its fiscal fourth quarter and full year ended July 31, 2008. If you’d 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 statements regarding our revenue and EPS forecast for the fiscal fourth quarter and fiscal year 2009. Our expectations regarding the range of our non-GAAP gross margins and the impact of seasonality on our results of operations, product shipments in our fiscal fourth quarter form which we expect to recognize revenue in the fiscal first quarter of 2009.

Momentum in our business across various verticals including retail and government, the strength of our sales pipeline and the continued growth of our business and the market opportunity and other statements as the company’s future economic performance, financial condition or results of operation.

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

Please refer to the risks and uncertainties described under the captions Risk Factors, and Managements Discussion and Analysis of Financial Condition and Results of Operations, in our quarterly report on form 10-Q filled with the SEC on June 6, 2008 as well as our earnings release posted a few minutes ago on our website, for a more detailed description of these risks and uncertainties 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. 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.

Also, please note that certain financial measures we use on this call are expressed on a non-GAAP basis and has been adjusted to exclude certain charges, including non-cash, stock-based expenses in process research and development expenses, revaluation of warrants to fair value and acquisition related expenses.

We have provided reconciliations of these non-GAAP measures to GAAP financial measures in the Investor Relations section of our website located at www.arubanetworks.com and in our earning pres release.

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

Dominic Orr

We believe that the demand for wireless LAN technology continues to grow, for the vast majority of our customers we are a need-to-have solution that solves existing problems in a cost effective and often cost saving manner and we have seen this need for wireless LAN technology expand into more and more verticals.

For example, markets like financial services and the general enterprise markets are just starting to adopt our technology, giving us opportunity to grow this vertical even in a tough market. The impact of this broad market base and the growing interest in our technology and solutions is reflected in our fiscal fourth quarter results.

Some key highlights include, record revenues $48.3 million, a 13% sequential increase from the previous quarter, record bookings which was strong across all geographic theaters. New customer growth that was the highest in history, the competitive win ratio that remain at about 80%, gross margin which was again above our target range and a recurrent to non-GAAP profitability.

Existing customers were a big part of our success, increasing strongly on a sequential basis. Our customers typically have rolled out schedule that stretch over the multiple quarters, if not years and even some of our customers whose network deployments are closed completion continue to buy products and take add functionality and services to the existing installations.

Complementing the strong demand from our base, we added a record number of new customers in the quarter, over 700 bringing our cumulative count over 5000 customers. In addition, we added approximately 400 customers from our AirWave acquisition, bringing our total customer camp to over 5400.

We are very encouraged about the prospectus and strength of our business. The level of interest in our solutions, our expanded customer base and the size of our pipeline are all significantly greater than it was a year ago. In addition, we have already incorporated into our forecasting model that sales cycles are longer than they were a year ago in some of our markets.

The higher education market was an early adopter of advanced wireless LAN solutions, and this vertical was a strong contributor in Q4. Q4 and Q1 are typically our strongest seasonal periods for this vertical and this year is no exception. During this quarter, we announced major new domestic and international universities like Caltech and International Islamic University Malaysia to our roster of the customers and we also experience continued strength in the K-12 market.

Many school districts are adopting our solution for its scalability, ease of deployment, ability to be managed from a central location and lower IT operating costs. Complementing the strength of education market was a broad based demand for our products across many of other verticals. A number of verticals picked up nicely during the quarter including the enterprise market.

New customer wins included the largest natural gas utility in Japan, a European Postal services, one of the largest professional services company in the world, a leading domestic wireless carrier, a leading hospital system in Texas, a global rental car company and one of the world’s largest investment management companies. During the quarter, we also announced a number of new deployments. This included deploying equipment for used at roughly 2000 new hotspots serving 350 Hong Kong government premises.

Additionally we have started rolling out our technology to all 109 of Norway’s and Embassies around the world and our products were incorporated into the first line of network to achieve high security restricted level certification in connection with the United Kingdom, Defence Fixed Network.

We are also very pleased with some recent big wins in the retail and federal factors, two verticals that have been most challenging over the last couple of quarters. This wins increased our momentum for fiscal 2009.

Our record new customer growth and high win rate are a testament to our competitive strength in what we believe is a highly differentiated solution. For example, this past quarter our remote access technology was recognized as the wireless security product of the year by Techworld.

Targeted at organizations with teleworkers, traveling executives, branch offices, first responder of business continuity requirements that remote networking solutions offers instant on secured connectivity. We also continue to invest in and expand our distribution channels with all of our channel partners contributing in the quarter.

We also had a promising quarter outside of the U.S. with notable strength and demand in Europe and Asia Pacific. We continue to expand internationally and appointed a new Head of Sales for Europe, Middle East and Africa to further that expansion. Overall, we continue to make progress and gain momentum.

The diversity of demand was a key factor in our performance, and we believe that more and more companies are recognizing the benefits of our technology. As our industry continues to consolidate, we believe we are emerging as the clear alternative to Cisco and our win rate against our biggest competitor remain strong.

We believe this is because, we have a unified solution based on a unique architectural approach. This approach leads to significant advantages in terms of total cost of ownership, providing secure Follow-Me connectivity, and increasing user productivity. I believe our competitive position has never been stronger and we are leading the industry in innovation.

Given the strength and demand in Q4 and the opportunities for future growth, we continue to make investment in R&D, sales and marketing to grow our business. Importantly we are gaining new customers, expanding our distribution and the long term value of our new and existing customers makes us very optimistic for the future.

Little later in the call I’ll be happy to answer any questions you may have and we’ll now turn it over to Steffan to go over the financials in more detail.

Steffan Tomlinson

In Q4 total revenue of $48.3 million increased 13% sequentially and 16% year-over-year. Product revenue of $40.4 million increased 14% sequentially and 11% year-over-year. Professional services and support revenue of $7.1 million increased 11% sequentially and 68% year-over-year, as expected ratable product and related services revenue of $700,000 declined 17% sequentially and 33% year-over-year.

In Q4 existing customers accounted for 66% of sales, approximately 78% of our sales came from indirect channels, while 22% were direct. As a reminder, our indirect channels represent sales to our VARs and distributors, as well as our strategic OEM partner Alcatel-Lucent. We had no 10% end customers in the quarter and Alcatel-Lucent and Wescon were both 10% partners. Approximately 65% of our sales were generated in the U.S. with the remaining 35% coming from international customers.

We had strong bookings across all geographies, particularly in Asia Pacific and Europe. We continue to produce strong gross margins in the fourth quarter. Overall, non-GAAP gross margins came in at 68.7% compared to 70.7% in the prior quarter partly due to channel and product mix, as we sold a higher number of DP’s in this quarter. Q4 margins were steadily and helpfully above our target range for our gross margin target of 65% to 68%.

Moving forward, we expect gross margins to be in our target range as more sales go through our two tier distribution partners. Non-GAAP research and development expenses was flat with the prior quarter in actual dollars and decreased as a percentage of revenue from 19.5% in Q3 ‘08 to 17.1% in Q4 ‘08. Non-GAAP sales and marketing expenses increased by approximately $1.9 million from the prior quarter and included year-end commissions.

Sales and marketing decreased as a percentage of revenue from 45.2% in Q3 ‘08 to 43.9% in Q4 ‘08. Non-GAAP G&A expenses decreased by approximately $300,000 and as a percentage of revenue from 9.2% in Q3 ‘08 to 7.5% in Q4 ‘08. While we are not breaking out AirWave as a separate line item, the increase in operating expenses during the fourth quarter was primarily related to having our first full quarter with AirWave.

Additionally, legal expenses related to our lawsuit with Motorola continue to impact our G&A line. Looking forward, we expect to decrease expenses as a percentage of sales, although increase expenses in actual dollars to take advantage of the opportunities in the market place.

Non-GAAP net income for the quarter was approximately $0.2 million or $0.00 per share compared to a non-GAAP net loss of $1.1 million in Q3 ’08 or $0.01 per share and a non-GAAP net income of $2 million or $0.02 per share in Q4 ’07 which excluded non-cash stock based expenses and in process research and development expenses. GAAP and non-GAAP net income includes approximately $0.01 per share worth of expenses related to the Motorola lawsuit.

In Q4 ’08 non-GAAP weighted average shares outstanding were $88.9 million on a diluted basis. The GAAP net loss for the quarter was $6.8 million or $0.08 per share compared to a GAAP net loss of $6.2 million or $0.08 per share in Q3 ’08 and a GAAP net loss of $3.4 million or $0.04 per share in Q4 ’07. Our fourth quarter of 2008 GAAP results included $5.7 million of non cash stock based expenses and $1.2 million of acquisition related expenses.

Turning to the balance sheet we finished July with $101.7 million of cash in short-term investments. This represented an increase of $3.9 million from the last quarter. Short-term deferred revenue was $27.1 million at quarter end compared to $22.5 million at the end of Q3 ’08.

Moving down the balance sheet we ended Q4 with 32.7 of accounts receivable, up from $28.6 million in Q3 ’08. Day sales outstanding were 61 days an increase of 1 day from Q3 and above our long-term DSO target of between 50 and 55 days. The increase in DSO’s was related to product shipments which we respect to recognize in the next three months. We expect DSO’s to decrease next quarter. Inventory totaled $11.6 million at the end of Q4 decreasing from $16.5 million at the end of last quarter. Inventory turns increased from 2.7 to 4.5.

Now turning to guidance, I will be giving guidance for the first quarter and full year of fiscal 2009 for the first time. We continue to believe that our market opportunity is large and growing, even in the current macro economic environment. Our pipeline is strong and momentum was encouraging throughout the fourth quarter.

As Tom highlighted we also plan to increase our investment in R&D and continue building out our International sales and marketing teams along with normal G&A spending related to being a public company. Given all these factors we expect to see revenue in our first fiscal quarter 2009 in the range of $50 million to $52 million with non-GAAP EPS of approximately $0.01 per diluted share.

For the year, we generally expect normal seasonality with the fourth quarter, our strongest quarter and the second quarter being a little tougher. Overall even in a tough economic environment, we expect to see continued growth and our fiscal 2009 guidance is for annual revenues of $220 million to $230 million with non-GAAP EPS of $0.12 to $0.15 per share. This guidance includes approximately $0.04 per share related to ramping up of legal expenses primarily for our Motorola lawsuit. With that let me turn the call back over to Dominic.

Dominic Orr

Steffan, Keerti and I would now be happy to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ryan Hutchinson from Lazard Capital.

Ryan Hutchinson - Lazard Capital

First a clarification of on a couple of questions; just a clarification for Steffan on the guidance; you talked about, Q1 being $50 million to $52 million, Q2 being a little bit tougher, but if I heard you right I think you expect to continue at sequential revenue growth through the remainder of 2009, is that fair?

Steffan Tomlinson

That is fair and that’s correct.

Ryan Hutchinson - Lazard Capital

Okay great and then just to comment here on the general landscape given the recent activity in the networking and storage markets that we’ve seen, specifically the consolidation in the enterprise wireless LAN market with HP acquiring one of your private competitors Colubris and then Brocade’s announcement to acquire foundry, obliviously they are at a relationship there with Marou, so I guess really the question I’m trying to get at is just have you seen any changes there on the competitive side, has that at all impacted you guys over the last few weeks and do you expect it to in the future?

Dominic Orr

So, let me comment on the two specific acquisitions and also the general competitive environment. HP ProCurve and Aruba really do not overlap; they are strong in the mid-year and the SOHO channel and I think that SOHO and Colubris will give them an extended portfolio in that area. The HP enterprise sales forces currently do not overlap with the HP ProCurve channel, so that is no impact to us.

Our perception and understanding of the Brocade foundry mergers driven primarily, almost exclusive in the datacenter issue, so we have not seen any impact at all to our sales momentum at the actual network and in general I would say the orders consolidation actually clear up the marketing noise. I think when you get onto the deal which is emerging more and more then Aruba is clearly perceived as the alternative to Cisco, we get invited and sit at the table more frequently than ever at this moment.

Ryan Hutchinson - Lazard Capital

And then one final one from me; just on the retail and government wins you referenced in the prepared remarks, just a general sense in terms of size, what the typical deployment for these wins looks like you think over the next couple of quarters and then the impact that I’d think that the retail wins could have potentially on your gross margins given that they still remain at the high-end of your target model?

Dominic Orr

So, for the Q4 actual results itself both the retail and federal market numerically we’re not among to top verticals; however, we from a demand and win rational point of view that was a very exciting quarter for us. We have several significant wins in this two sectors that in this sectors the deployment cycle typical is one or two quarter or maybe even three quarters out, especially with those number of quarters and so that impact revenue for those wins have not been accounted for yet.

Ryan Hutchinson - Lazard Capital

Okay and the potential impact to gross margins, is it…?

Dominic Orr

One general assignment that I have, if I could summarize the last quarter of the singular biggest assignment that I have on the business is actually the spread over the enthusiasm of our technology and solutions to the other vertical and to the general enterprise, due to the extent that internally now -- actually myself I even dropped the term core vertical that we used to use because now we really are having strong momentums across all verticals. So, in fact I do not expect even though with these strong wins because now we have such a balanced portfolio that it will be a significant impact.

Steffan Tomlinson

Ryan, we still feel comfortable with the 65% to 68% range. Knowing that retail typically has a little bit of a lower gross margin profile, we still feel comfortable with the 65% to 68% guidance.

Operator

Your next question comes from Greg Mesniaeff from Needham & Company.

Greg Mesniaeff - Needham & Company

I have a question on the educational vertical. It appears with the DSOs being a little bit above your target range that the quarter was somewhat back ended loaded and I’m assuming that quite a bit of that was educational institutions watering ahead of the academic year. I’m wondering if that’s the case and also what percentage of that verticals business is Greenfield versus upgrading existing installations perhaps from G to N?

Steffan Tomlinson

Sure, so when we look at the linearity in the quarter, actually the linearity was very nice; it wasn’t as back end loaded as we were anticipating. The reason for the increase in DSOs was because of the deferred revenue going up largely unrelated to education. When we look at whether or note the education market is more Greenfield opportunity versus a kind of a replacement of G access points and N access points, we’re seeing both, but high ed in general tends to be on the plank of wanting to go with the latest ingredients, so we do you 11n being a driver for the education vertical.

Greg Mesniaeff - Needham & Company

And as far as the healthcare vertical, any commentary there?

Dominic Orr

We still are very active of the space in that market and it is definitely one market we will continue to pay attention to and it is one market that it also not very seasonal, so it is part of our focus.

Operator

Your next question comes from Ehud Gelblum from J.P. Morgan.

Ehud Gelblum - J.P. Morgan

A couple of things if I could; one it’s tough when you talked about the gross margin targets still being there at 55 to 68 and you may have said this and I missed it; did you reiterate or mention the operating margin target that you spoke about in the past and do you still talk about 19% to 20%. Did you say that and I missed it or…?

Steffan Tomlinson

We haven’t updated the overall operating margin target yet. We so feel relatively bullish around being able to be in, call it 19% to 20% target and we haven’t given further guidance on the call.

Ehud Gelblum - J.P. Morgan

So, you are reiterating that as well, not just the gross margin target.

Steffan Tomlinson

Correct.

Ehud Gelblum - J.P. Morgan

The gross margin obviously you’re still operating above it and I assume the main lever there is the move from further into your direct and indirect and further in to your distribution; what’s the timeframe that we should be thinking about on the operating margin target and what should we be looking at, perhaps should operating margins scale as we go through the year and is there a sense you can give us as to where we should be sort of as we exit 2009 and start going in to 2010?

Steffan Tomlinson

Well first I wanted to just talk about the impact of the channel and distribution mix on gross margins this quarter. That did play a role but the bigger role was around the concentration of access points, so access points trended a little bit higher as a percent of total revenue and that laid us down in addition to some of the channel mix.

Now as far as giving guidance on operating margin, as we exit the year we don’t provide operating margin target guidance, but as you can see with our EPS estimates of $0.12 to $0.15 and that’s also including $0.04 of Motorola litigation expenses, we should be able to have a ramp in overall profitability throughout the full year.

Ehud Gelblum - J.P. Morgan

Okay, the access points and impacting on gross margin as well and your gross margins was still very strong, so you’re saying your gross margins could have been a little bit stronger than that?

Steffan Tomlinson

Correct.

Ehud Gelblum - J.P. Morgan

As you do see the split of your direct and indirect kind of moves and your gross margin fall into your 65% to 68% target range. What should we be looking at this footprint in direct and indirect? Right now you’re 78%, 22%; where does that go when you get into your gross margin range?

Steffan Tomlinson

85% indirect, 15% direct.

Ehud Gelblum - J.P. Morgan

Dominic you did a great job I really appreciate it, giving us a sense as to which geographies are doing strong, doing better. You said Europe and Asia were doing particularly well in the booking side. What are you seeing in the U.S., you said all bookings were strong across all geographies, I assume that includes the U.S. but then you made it sound as though Europe and Asia were particularly even stronger.

Did U.S. at least have a book-to-bill above one? What are the trends that you are seeing in the U.S.? If you can give us maybe a comparison between the lead times in the U.S. versus Europe and Asia; something to give us a senses as to what inning of the downturn in the U.S.; are we still sort of in the beginning, are we in the middle or are we kind of nearing an end in the U.S. Should we maybe in a couple of quarters start seeing the U.S. rejoin Europe and Asia with reflective strength.

Dominic Orr

Okay, so first of all in the U.S. the demand is very strong as well and the strength of the U.S. demand is trending on with more verticals that they’re interested in our products and technology. The comment to the strength in the Asia-Pac and Europe is because they’re coming in from the lower base, so you’re seeing that the stronger booking and also in the U.S. we tend to having a little bit shorter book shift in the cycle. So, I’m exceedingly pleased with our booking momentum in the U.S. as well so I don’t want the comment to be listened to.

Ehud Gelblum - J.P. Morgan

Was the U.S. -- did they have the same book-to-bill as Europe and Asia?

Steffan Tomlinson

We had very strong sequential growth in the U.S. and we don’t really comment on book-to-bill, but I think the strongest sequential growth points to the health of the U.S. market.

Dominic Orr

It is all around a very satisfactory quarter in that regard.

Operator

Your next question comes from Jeff Kell from Lehman Brothers.

Jeff Kell – Lehman Brothers

I’ve got two questions; one is would you mind commenting a little bit on the Federal vertical and how we should think about that? And then secondarily, it wasn’t entirely clear to me if you guys were onboard with the target operating margin, were you reiterating that or not and then either way what kind of revenue levels do you think we should be thinking about to get there; thank you.

Dominic Orr

I’ll take the first one and I’ll let Steffan take the second one. Regarding the U.S. Federal segment it was not one of the top segments for the quarter from a numerical point of view in terms of revenue, but it was an exciting quarter for that segment because of several very significant design wins that I expect to be very, very helpful in our fiscal ’09 numbers in that vertical.

Steffan Tomlinson

On the operating margin target, we basically said that 19% to 20% is a reasonable operating margin target just to drive towards. We haven’t given an update in terms of revenue or timing of that.

Operator

Your next question comes from Thomas Lee from Goldman Sachs.

Thomas Lee - Goldman Sachs

I know in the past you talked about the size of your initial orders were decreasing despite increases in the number of customer wins. I was just wondering, have seen a change in that front over the last three months and then specifically maybe which verticals maybe are you seeing customers appetite for spending increasing?

Steffan Tomlinson

Order size went down modestly from new customers; however, given the fact that we’ve linked over 700 new customers out of the Aruba business we believe this is encouraging over the longer term, because the lifetime value of larger customers hadn’t changed meaning we have more upside.

Relative to verticals that have been opening up as a pocket book, we’ve seen very good demand out of the industrial enterprise, we’ve seen very good attraction out of financials, so as Don had mentioned we are seeing very good broad based adoption of the technology outside that what we would call the traditional verticals that had shown a lot of growth for us in the past. So, we’re seeing a much more balanced growth across many more verticals.

Thomas Lee - Goldman Sachs

In terms of overall sales cycles, has there been a change on that front or is it still relatively same as the past couple of quarters?

Steffan Tomlinson

Same as the past couple of quarters.

Thomas Lee - Goldman Sachs

Okay, thank you and then just on the 802.11n, I have question on the 802.11n; I mean is it fair to assume that the valuation period is continuing or is that pretty much over for a number to your customers and is that some part of what’s driving some of the greater adoption that you’re seeing in certain verticals like the education?

Keerti Melkote

We see 11n evaluation cycles to be slightly longer than AVG because of new technology. So, there is typically a piloting period that happens and in terms of verticals clearly the education vertical is the primary driver for 11n growth at this point, but I do want to point out as Don and Steffan have mentioned that for larger opportunities even in the broader enterprise vertical, you’re seeing the migration of projects to the 11n technology.

Thomas Lee - Goldman Sachs

And then just a last question I had on the competitive landscape; I guess specifically in regards to Cisco you made the commentary that you’re increasingly being invited to the table, which is great to see, but I guess has there been any change on their front or is it pretty much Business As Usual from a Cisco perspective as you see them in terms of them being aggressive with whatever type of tactics that they might try to deploy and then related to that I’m just curious to know, has customer reaction been any different as you get invited to a number of RFP’s?

Dominic Orr

So, Cisco has always being a very effective competitor should I say and we have not seen any difference. It’s just that the fact that we are now increasing our opportunities into other verticals particularly General Enterprise our opportunity to go ahead on with Cisco has increased, but with respect to each engagement we haven’t like significant changed the recipe in both sides.

Operator

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

Mark Sue - RBC Capital Markets

Dominic you commentary seems to have change for the products from a nice to have to a must have; where is the change coming from? Is it anecdotal comments from customers or is there some data you could share with us as it relates to the increased importance of wireless and the grand scheme of things.

Dominic Orr

So let me just give you an example of the emerging business in the financial sector. As you probably are well aware there are quite a number of merger and acquisition happening in this space. So speaking, when you have that kind of a motivation in the user community the network design of traditional port-centric network actually lags behind and we view it as just a customer base like that, a user-centric network design using wireless LAN is a much more cost effective way to address the mobile employees virtual corporation, merged companies and so called guest access, the whole suite of issues is just a very cost effective way of solving problems both on the CapEx and an OpEx point of view and time for new solution implementations point of view.

Mark Sue - RBC Capital Markets

Okay, that’s helpful and Steffan the legal expense is that a higher estimate than what you were originally planning for next year. Is $0.04 a worse case scenario or a base case scenario and separately what’s the share count that we should be assuming for the $0.12 to $0.15?

Steffan Tomlinson

Motorola is the base case scenario. As far as share count is considered we ended the quarter with $88.9 million on a diluted basis. From a modeling standpoint you said putting about $6 million shares throughout the year, so that give you the guidance on share count.

Mark Sue - RBC Capital Markets

Okay, so 88 plus $6 million for the entire year and then last is ASP trends sequentially?

Steffan Tomlinson

ASP’s remains relatively flat.

Operator

Your next question comes from Erik Suppiger from Signal Hill.

Erik Suppiger - Signal Hill

First off, what was the reason for deferring a larger portion of revenue than typical and am I correct, you expect to recognize some of that deferred piece next quarter?

Dominic Orr

There is no reason in particular other than there were just very strong demand at the end of the quarter that got pushed into deferred revenue and there were some deals that we had one that have multiple quarter deployments, so we feel that deferred revenue is healthy and we feel that it showed a nice sequential growth.

Erik Suppiger - Signal Hill

Is that a product that is sitting in the channel or is that a product that’s been deployed and is just waiting for some milestone at the customer before you can recognize it?

Steffan Tomlinson

It’s definitely the ladder and in the other part of the deferred revenue remember is support revenue. So, we have support revenue that’s in there plus product revenue and we don’t breakout the mix between support and products in deferred revenue.

Erik Suppiger - Signal Hill

So, you said you had some good orders at the end, does that mean that you’ve got some good service renewals at the end of the quarter?

Steffan Tomlinson

We have a combination of all good things at the end of the quarter.

Erik Suppiger - Signal Hill

Okay, 802.11n it sounds like it’s taking a little bit longer on the sales cycle; did it fall below 20% of your shipments this quarter, because I think you said it was 20% last quarter?

Steffan Tomlinson

Last quarter we said it was approximately 20%; it was relatively the same as last quarter.

Erik Suppiger - Signal Hill

In terms of the verticals, one that you haven’t talked too much about is service provider; did you see any activity with service providers in the quarter?

Dominic Orr

Our design centers is a global 2000 and our service provider has been an active component of our go to market strategy in that, they use our equipment to provide managed services for the end customers. So, we’re looking at them more as a channel to implement projects. I’ll give you an example; for the Hong Kong Government project, our service provider partner is PCCW, but they are the ones who provide basically the enterprise services for all the Hotspots and in this case the end-user customer is the entire Hong Kong government.

Erik Suppiger - Signal Hill

Was the increase in deferred revenue associated with any service provider business?

Dominic Orr

No, not at all.

Erik Suppiger - Signal Hill

Okay, then lastly on the Motorola, did you breakout what the legal cost was in the quarter?

Steffan Tomlinson

We didn’t specifically; although we gave it in terms of it was approximately a penny EPS.

Operator

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

Sanjiv Wadhwani - Stifel Nicolaus

Just a clarification and a question for Steffan, the EPS guidance for 2009, I’m guessing that’s not fully taxed and we should be probably assuming about 300,000 or so per quarter in taxes.

Steffan Tomlinson

The effective tax rate on a non-GAAP basis, you should model in at 14% to 15% for the year on a non-GAAP basis.

Sanjiv Wadhwani - Stifel Nicolaus

And then another question; if you look at the federal vertical it’s been short of lumpy over the last three quarters; Dominic you mentioned that you had some good wins in the July quarter, do you expect any meaningful deployment in the October quarter and a ramp up in that vertical in October given that it’s fiscal year end for the federal government.

Dominic Orr

Our expectation in the next six months is that some of the deployments will happen.

Sanjiv Wadhwani - Stifel Nicolaus

So we should sort of expect the federal vertical to kind of ramp up a little bit at least in the October and the Jan quarter.

Dominic Orr

I think that’s a fair expectation.

Operator

Your next question comes from Bill Choi from Jefferies.

Bill Choi – Jefferies

Just on the commentary around the vertical, can you give a little more granular color on what education was as a percentage of total? I mean it was roughly about 20% in the past, it sounds like that was the area of the strength, so it was significantly higher than 20, if you can kind of review that and then just in terms of the seasonal strength obviously it’s Q4 and Q1, how does that look like on a monthly basis?

When does that start kind of winding down and as we look at the strong Kindergartens to 12, can you just provide us with some thoughts about generally the states funding for these projects. As we look into the New Year obviously some of the property taxes are going to be under pressure and then I have a quick follow up after that.

Dominic Orr

Okay so first of all we don’t breakout specifically percentage for verticals. What I can say is that the trend for Q4 and my expectation for Q1 is no different from the last year and the year before last. Regarding the month-to-month I think if you look at our quarter it’s really from April to sort of Q4 to Q1, its April to September. I would say that in our experience they all are strong months within the buying season and with respect to K-12 funding, all the projects that we are invoking in the pipeline seem to be well under projects; I do not have more visibility beyond the next quarter or two, so that’s where I think things sit.

Bill Choi – Jefferies

Just a clarification on that September; does the order start to wind down in September or does that really start down in October and essentially deployments largely are all done in August?

Dominic Orr

Actually I apologies, what I meant earlier was throughout the six months of our two quarters, that will be April to October. There is not enough trend where we can tell you that one month is stronger than the other. I think if you say fiscally speaking, publicly the holiday months tend to be higher deployment months, but the deployment tend not to try to exactly the procurement months I think.

Bill Choi – Jefferies

What’s kind of the lead time or the lag time in ordering deployment?

Dominic Orr

Okay, so if you look in to the deployment windows of education market, they are summer holiday, winter holiday and spring holiday. So there’s like three periods rights and my experience is probably I would say the people would like to order 60 days to 90 days before or even some of them, 30 days before, the long pole is not the ordering the long pole is the facility and each organization a different arrangement of the facility people, so that’s why it is very hard for me to sit here and predict what it is.

As you recall a lot of our deals in education, we go through channel partners, so obviously the channel partners has to order the equipment, some of them is shorter stated time, some of them is longer stated time, so this is just kind of all over the place, it’s very, very hard for me to generalize that.

Operator

Your next question comes from Eric Kainer from Thinkpanmure.

Eric Kainer – ThinkPanmure

First question is about the EAL-2 certification that you achieved in the quarter. I wonder if you can tell us whether there were any designs waiting on that certification, when this might start impacting federal government revenues.

Keerti Melkote

Yes for the EAL-2 certification, in fact we were the first to achieve that in the marketplace and it’s a pretty significant certification for large scale Wireless LAN Deployments. So, in fact based on that we’ve had some design wins in this last quarter as Dominic has mentioned and the expectation is that over the next couple of quarters, we’ll have these deployments begin.

Eric Kainer – ThinkPanmure

The next is really about, whether you saw any change as far as the demand drivers from an application perspective, specifically obviously what I’m thinking about is voice over Wireless LAN, whether you’ve seen any pickup there or indeed whether you would have exposure to that?

Keerti Melkote

In terms of an application in the general enterprise, I would say Guest Access is probably a pretty significant application that is driving demand. Voice is picking up in certain verticals where it’s absolutely critical like hospitality and healthcare and others, but in horizontal enterprise we are still not seeing a broad enough churn for voice yet. We’re seeing some early pilots outside of the U.S. Outside of the U.S. there is certainly demand and there is some deployment, but not in the mainstream.

Eric Kainer – ThinkPanmure

Okay, as we move to certification of N, I wonder if you also see any later demand building there that should come very quickly once we get certification.

Keerti Melkote

At this point there is no evidence that suggest that folks are actually waiting for certification. We are seeing a strong demand for 11n technologies and that’s primarily being driven by the fact that 11n technology as it stands today is certified by the Wi-Fi LANs. So, in short ability is virtually guaranteed and customers are comfortable with that.

Operator

Your final question comes from Blaine Carroll from FTN Midwest Securities.

Blaine Carroll - FTN Midwest Securities

Steffan on the cost of goods sold line or in your gross margin, is there any either positive impact that you’re seeing from lower materials costs or maybe some headwinds that you’re facing due to the increased freight costs that have been going on over the last couple of quarters; any give and takes in that line?

Steffan Tomlinson

We’ve had definitely some headwinds on the freight costs and we’re trying to put as much on the board as opposed to the Air as possible. As far as positive things that are going in our favor we have a great manufacturing off steam that is driving costs down from a material standpoint, but I’d say net-net the freight costs and some of the materials costs have increased and as you know we’re going to give product transition as well. So, we have new products coming in the market. So, I’d say net-net there has been a little bit of pressure on COGS, but that’s kind of inline with our expectations.

Blaine Carroll - FTN Midwest Securities

And then as the U.S. dollar has strengthened and your international business has gotten better, is there any impact there in the revenue line?

Steffan Tomlinson

Haven’t seen that yet.

Blaine Carroll - FTN Midwest Securities

And then Dominic, you talked about sort of the sales cycle lengthening and it’s in your guidance and so forth, but what type of visibility do you have going into the quarter and I’m actually a little bit surprised that the early part of this quarter isn’t more front-end loaded because of the educational vertical?

Dominic Orr

Regarding education vertical as I explain to Bill, we really seen things kind of spread across, it’s not like one or two very strong month, it is really a season and we did have a pretty uniform quarter in terms of orders and not just for education, but I think the whole trending on off the other verticals is encouraging too.

Now in terms of the sales cycle I have to say, the retail industry and the finance industry now that we’ve learned to figure out how that works they are lengthier cycles than some of the other verticals and as we get adjusted to our way of forecasting that is part of the model. So, I feel very comfortable about our forecast and our pipeline adjusted to this longer sales cycle project.

Blaine Carroll - FTN Midwest Securities

Well, we’re pretty much through August at this point and has August rolled out like you would have expected?

Steffan Tomlinson

Obviously I can’t comment on the current quarter, but I think in general the market momentum I see across the various industries, obviously they don’t map to Aruba’s fiscal quarter. I have seen nothing change in the August timeframe in terms of all these possible momentum in the other sector in the General Enterprise that it’s indicated to me that what we saw in the last fiscal quarter is a one quarter phenomenon.

Operator

Thank you and at this time I’d like to hand back to management for any closing remarks..

Dominic Orr

Well I want to thank everyone again for taking time for our conference call and wish everyone have a happy Labor Day weekend.

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Source: Aruba Networks Inc F4Q08 (Qtr End 07/31/08) Earnings Call Transcript
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