10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 31, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number: 001-33347

 

 

Aruba Networks, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   02-0579097

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

1344 Crossman Ave.

Sunnyvale, California 94089-1113

(408) 227-4500

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares of the registrant’s common stock, par value $0.0001, outstanding as of November 30, 2012 was 112,473,246.

 

 

 


Table of Contents

ARUBA NETWORKS, INC.

INDEX

 

     Page
No.
 

PART 1. FINANCIAL INFORMATION

  

Item 1. Consolidated Financial Statements (unaudited)

  

Consolidated Balance Sheets as of October 31, 2012 and July 31, 2012

     3   

Consolidated Statements of Comprehensive Income for the three months ended October 31, 2012 and 2011

     4   

Consolidated Statements of Cash Flows for the three months ended October 31, 2012 and 2011

     5   

Notes to Consolidated Financial Statements

     6   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     19   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     30   

Item 4. Controls and Procedures

     30   

PART II. OTHER INFORMATION

  

Item 1. Legal Proceedings

     31   

Item 1A. Risk Factors

     31   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     45   

Item 3. Defaults Upon Senior Securities

     46   

Item 4. Mine Safety Disclosure

     46   

Item 5. Other Information

     46   

Item 6. Exhibits

     47   

Exhibit 10.1

 

Exhibit 10.2

 

Exhibit 10.3

 

Exhibit 10.4

Exhibit 31.1

  

Exhibit 31.2

  

Exhibit 32.1

  

EX-101 INSTANCE DOCUMENT

  

EX-101 SCHEMA DOCUMENT

  

EX-101 CALCULATION LINKBASE DOCUMENT

  

EX-101 LABELS LINKBASE DOCUMENT

  

EX-101 PRESENTATION LINKBASE DOCUMENT

  

EX-101 DEFINITION LINKBASE DOCUMENT

  

 

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Table of Contents
Item 1. Consolidated Financial Statements

ARUBA NETWORKS, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited)

 

     October 31,     July 31,  
     2012     2012  
     (in thousands, except per share data)  

ASSETS

    

Current assets

    

Cash and cash equivalents

   $ 157,319      $ 133,629   

Short-term investments

     220,187        212,601   

Accounts receivable, net

     73,016        80,190   

Inventory, net

     28,164        22,202   

Deferred cost of revenue

     11,176        11,241   

Prepaids and other

     19,513        18,996   

Deferred income tax assets, current

     35,328        34,584   
  

 

 

   

 

 

 

Total current assets

     544,703        513,443   

Property and equipment, net

     22,688        19,901   

Goodwill

     56,947        56,947   

Intangible assets, net

     25,115        27,036   

Deferred income tax assets, non-current

     19,794        20,664   

Other non-current assets

     9,446        10,905   
  

 

 

   

 

 

 

Total assets

   $ 678,693      $ 648,896   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities

    

Accounts payable

   $ 11,769      $ 22,504   

Accrued liabilities

     57,409        52,375   

Income taxes payable

     4,553        2,032   

Deferred revenue, current

     88,230        80,602   
  

 

 

   

 

 

 

Total current liabilities

     161,961        157,513   

Deferred revenue, non-current

     25,670        22,375   

Other non-current liabilities

     1,391        2,118   
  

 

 

   

 

 

 

Total liabilities

     189,022        182,006   
  

 

 

   

 

 

 

Commitments and contingencies (Note 13)

    

Stockholders’ equity

    

Common stock: $0.0001 par value; 350,000 shares authorized at October 31, and July 31, 2012; 113,049 and 111,529 shares issued and outstanding at October 31, and July 31, 2012, respectively

     11        11   

Additional paid-in capital

     605,693        582,077   

Accumulated other comprehensive loss

     (1,414     (1,405

Accumulated deficit

     (114,619     (113,793
  

 

 

   

 

 

 

Total stockholders’ equity

     489,671        466,890   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 678,693      $ 648,896   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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Table of Contents

ARUBA NETWORKS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

 

     Three months ended October 31,  
     2012     2011  
     (in thousands, except per share data)  

Revenue

    

Product

   $ 119,222      $ 101,131   

Professional services and support

     25,260        18,220   
  

 

 

   

 

 

 

Total revenue

     144,482        119,351   

Cost of revenue

    

Product

     36,161        32,068   

Professional services and support

     5,957        4,546   
  

 

 

   

 

 

 

Total cost of revenue

     42,118        36,614   
  

 

 

   

 

 

 

Gross profit

     102,364        82,737   

Operating expenses

    

Research and development

     31,963        24,468   

Sales and marketing

     53,919        45,615   

General and administrative

     11,951        11,100   
  

 

 

   

 

 

 

Total operating expenses

     97,833        81,183   
  

 

 

   

 

 

 

Operating income

     4,531        1,554   

Other income, net

    

Interest income

     316        276   

Other income, net

     276        827   
  

 

 

   

 

 

 

Total other income, net

     592        1,103   
  

 

 

   

 

 

 

Income before provision for income taxes

     5,123        2,657   

Provision for income taxes

     5,949        3,124   
  

 

 

   

 

 

 

Net loss

   $ (826   $ (467
  

 

 

   

 

 

 

Other comprehensive loss:

    

Foreign currency translation gain, net of tax

     19        254   

Unrealized loss on short-term investments, net of tax

     (28     (46
  

 

 

   

 

 

 

Comprehensive loss

   $ (835   $ (259
  

 

 

   

 

 

 

Shares used in computing net loss per common share—basic

     111,976        105,937   
  

 

 

   

 

 

 

Net loss per common share—basic

   $ (0.01   $ (0.00
  

 

 

   

 

 

 

Shares used in computing net loss per common share—diluted

     111,976        105,937   
  

 

 

   

 

 

 

Net loss per common share—diluted

   $ (0.01   $ (0.00
  

 

 

   

 

 

 

Stock-based compensation expense included in above:

    

Cost of revenue

   $ 1,501      $ 1,259   

Research and development

     8,427        7,417   

Sales and marketing

     8,745        7,938   

General and administrative

     3,889        2,651   
  

 

 

   

 

 

 

Total

   $ 22,562      $ 19,265   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements.

 

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ARUBA NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

     Three months ended October 31,  
     2012     2011  
     (in thousands)  

Cash flows from operating activities

    

Net loss

   $ (826   $ (467

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation and amortization

     5,051        4,079   

Provision for doubtful accounts

     117        12   

Write-downs for excess and obsolete inventory

     1,868        1,403   

Stock-based compensation expense

     22,562        19,265   

Accretion of purchase discounts on short-term investments

     263        308   

Change in carrying value of contingent rights liability

     (401     (918

Deferred income taxes

     126        13,362   

Recovery of escrow funds

     —          (702

Excess tax benefit associated with stock-based compensation

     (925     (8,318

Changes in operating assets and liabilities:

    

Accounts receivable

     7,057        590   

Inventory

     (8,602     2,345   

Prepaids and other

     208        (6,849

Deferred costs

     65        (3,990

Other assets

     1,459        (14,727

Accounts payable

     (10,524     4,997   

Deferred revenue

     10,923        22,830   

Other current and non-current liabilities

     5,326        (25,896

Income taxes payable

     3,163        9,220   
  

 

 

   

 

 

 

Net cash provided by operating activities

     36,910        16,544   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchases of short-term investments

     (67,037     (53,351

Proceeds from sales of short-term investments

     20,252        7,523   

Proceeds from maturities of short-term investments

     38,166        14,000   

Purchases of property and equipment

     (5,357     (3,417
  

 

 

   

 

 

 

Net cash used in investing activities

     (13,976     (35,245
  

 

 

   

 

 

 

Cash flows from financing activities

    

Proceeds from issuance of common stock

     11,336        10,856   

Repurchases of common stock under stock repurchase program

     (11,524     —     

Excess tax benefit associated with stock-based compensation

     925        8,318   
  

 

 

   

 

 

 

Net cash provided by financing activities

     737        19,174   
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     19        (5

Net increase in cash and cash equivalents

     23,690        468   

Cash and cash equivalents, beginning of period

     133,629        80,773   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 157,319      $ 81,241   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information

    

Income taxes paid

   $ 1,180      $ 453   

See Notes to Consolidated Financial Statements.

 

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ARUBA NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. The Company and its Significant Accounting Policies

The Company

Aruba Networks, Inc. (the “Company”), incorporated in the state of Delaware on February 11, 2002, is a leading provider of next-generation network access solutions for the mobile enterprise. Its Mobile Virtual Enterprise (“MOVE”) architecture leverages the Company’s diverse products (including our ArubaOS operating system, controllers, wireless access points, switches, application software modules, and multi-vendor management solution software) to unify wired and wireless network infrastructures into one seamless access solution for corporate headquarters, mobile business professionals, remote workers and guests. The Company derives its revenue from sales of its ArubaOS operating system, controllers, wireless access points, switches, application software modules, multi-vendor management solution software, and professional services and support. The Company has offices in Americas, Europe, the Middle East and the Asia Pacific regions and employs staff around the world.

Basis of Presentation

The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances, transactions and cash flows have been eliminated. The accompanying statements are unaudited and should be read in conjunction with the audited Consolidated Financial Statements and related notes contained in the Company’s Annual Report on Form 10-K filed on October 11, 2012. The July 31, 2012 Consolidated Balance Sheet data were derived from audited financial statements but do not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S.”).

The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). They do not include all of the financial information and footnotes required by GAAP for complete financial statements. The Company believes the unaudited Consolidated Financial Statements have been prepared on the same basis as its audited financial statements as of and for the year ended July 31, 2012 and include all adjustments necessary for the fair statement of the Company’s financial position as of October 31, 2012, its consolidated comprehensive income for the three months ended October 31, 2012 and 2011, and its cash flows for the three months ended October 31, 2012 and 2011. The results for the three months ended October 31, 2012 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending July 31, 2013.

There have been no significant changes in the Company’s accounting policies during the three months ended October 31, 2012, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended July 31, 2012.

Prior Period Adjustments

In the three months ended October 31, 2012, the Company recorded an out-of-period adjustment to correct an error that increases the Provision for Income Taxes by $1.8 million which related to the quarter ended July 31, 2012. The impact of this correction would have resulted in an increase in net loss of $1.8 million for the quarter and year ended July 31, 2012. The Company has assessed the impact of this adjustment on previously reported financial statements and to projected fiscal 2013 results and concluded that the adjustment is not material, either individually, or in the aggregate. On that basis, the Company has recorded the adjustment in the three months ended October 31, 2012.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation. As of July 31, 2012 and 2011, accrued trade payables of $14.7 million and $16.7 million, respectively have been reclassified from accrued liabilities to accounts payable in order to provide improved disclosure relating to invoices that have been received as of the reporting period-ends but have not yet been processed. The corresponding amount included within Accounts Payable as of October 31, 2012 is $9.1 million.

 

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Table of Contents

The following table discloses the amounts as previously filed and the amounts after the reclassification.

 

     As of July 31, 2012      As of July 31, 2011  
     As  Previously
Filed
     Reclassified
Amount
    As
Reclassified
     As  Previously
Filed
     Reclassified
Amount
    As
Reclassified
 
     (in thousands)      (in thousands)  

Current liabilities

               

Accounts payable

   $ 7,807       $ 14,697      $ 22,504       $ 11,278       $ 16,704      $ 27,982   

Accrued liabilities

     67,072         (14,697     52,375         61,461         (16,704     44,757   

In addition, the ratable product and related professional services and support revenue and the related cost of revenue in fiscal 2012 have been reclassified to professional services and support revenue and related cost of revenue, both of which are recorded in the revenue and cost of revenue sections of the Consolidated Statements of Comprehensive Income, respectively. We believe the ratable product and related professional services and support revenue and related cost of revenue are not material to total revenue and cost of revenue, and the nature of these amounts are consistent with professional services and support revenue and related cost of revenue. The amount for the prior period has been reclassified to conform with the current year presentation.

Recent Accounting Pronouncements

In July 2012, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2012-02, Intangibles—Goodwill and Other (Topic 350)— Testing Indefinite-Lived Intangible Assets for Impairment (“ASU 2012-02”), to simplify how entities, both public and nonpublic, test indefinite-lived intangible assets other than goodwill for impairment. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The Company is currently evaluating the impact of its pending adoption of ASU 2012-12 on its Consolidated Financial Statements.

2. Fair Value of Financial Instruments

Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be either recorded or disclosed at fair value, the Company considers the principal or most advantageous market in which it would transact, and it also considers assumptions that market participants would use when pricing the asset or liability.

The Company determines the fair values of its financial instruments based on a three-level fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The classification of a financial asset or liability within the hierarchy is based upon the lowest level input that is significant to the fair value measurement. The fair value hierarchy prioritizes the inputs into three levels that may be used to measure fair value:

Level 1 — Quoted prices in active markets for identical assets or liabilities.

Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.

Level 3 — Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Such unobservable inputs include an estimated discount rate used in our discounted present value analysis of future cash flows, which reflects our estimate of debt with similar terms in the current credit markets. As there is currently minimal activity in such markets, the actual rate could be materially different.

Cash and cash equivalents consist primarily of bank deposits with third-party financial institutions and highly liquid money market securities with original maturities at date of purchase of 90 days or less and are stated at cost, which approximates fair value.

Short-term investments are recorded at fair value, defined as the exit price in the principal market in which the Company would transact representing the amount that would be received to sell an asset in an orderly transaction between market participants.

Level 1 instruments are valued based on quoted market prices in active markets for identical instruments and include the Company’s investments in money market funds.

Level 2 securities are valued using quoted market prices for similar instruments, nonbinding market prices that are corroborated by observable market data, or discounted cash flow techniques and include the Company’s investments in certain corporate bonds, U.S. government agency securities, U.S. treasury bills, and commercial paper.

Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. The Company classified its contingent rights liability as a Level 3 liability (See Note 3—Contingent Rights Liability Arising from Business Combinations, for details). This liability was estimated using a lattice model and was based on significant inputs not observable in the market and thus represented a Level 3 instrument.

 

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There were no transfers between different levels during the three months ended October 31, 2012.

The following table presents the Company’s fair value measurements that are measured at the estimated fair value, on a recurring basis, categorized in accordance with the fair value hierarchy:

 

     Level 1      Level 2      Level 3      Total  
     (in thousands)  
As of October 31, 2012            
Assets            

Corporate bonds

   $ —         $ 50,112       $ —         $ 50,112   

U.S. government agency securities

     —           103,152         —           103,152   

U.S. treasury bills

     —           41,055         —           41,055   

Commercial paper

     —           17,833         —           17,833   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cash equivalents and short-term investments

   $ —         $ 212,152       $ —         $ 212,152   

Certificates of deposit

     8,035         —           —           8,035   

Cash deposits with third-party financial institutions

     157,319         —           —           157,319   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured and recorded at fair value

   $ 165,354       $ 212,152       $ —         $ 377,506   
  

 

 

    

 

 

    

 

 

    

 

 

 
Liabilities            

Contingent rights liability related to the Azalea acquisition

   $ —         $ —         $ 1,264       $ 1,264   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities measured and recorded at fair value

   $ —         $ —         $ 1,264       $ 1,264   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Level 1      Level 2      Level 3      Total  
     (in thousands)  
As of July 31, 2012            
Assets            

Corporate bonds

   $ —         $ 47,128       $ —         $ 47,128   

U.S. government agency securities

     —           105,429         —           105,429   

U.S. treasury bills

     —           43,930         —           43,930   

Commercial paper

     —           7,282         —           7,282   

Money market funds

     3,843         —           —           3,843   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total cash equivalents and short-term investments

   $ 3,843       $ 203,769       $ —         $ 207,612   

Certificates of deposit

     8,832         —           —           8,832   

Cash deposits with third-party financial institutions

     129,786         —           —           129,786   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets measured and recorded at fair value

   $ 142,461       $ 203,769       $ —         $ 346,230   
  

 

 

    

 

 

    

 

 

    

 

 

 
Liabilities            

Contingent rights liability related to the Azalea acquisition

   $ —         $ —         $ 1,665       $ 1,665   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities measured and recorded at fair value

   $ —         $ —         $ 1,665       $ 1,665   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table represents the change in the contingent rights liability related to the Azalea acquisition (see Note 3 – Contingent Rights Liability from Business Combinations, for details):

 

     Level 3 Amount  
     (in thousands)  
As of July 31, 2011    $ 5,888   

Adjustments to fair value

     (2,318

Shares settlement

     (1,905
  

 

 

 

As of July 31, 2012

   $ 1,665   

Adjustments to fair value

     (401
  

 

 

 

As of October 31, 2012

   $ 1,264   
  

 

 

 

The fair values of accounts receivable, accounts payable, and accrued liabilities approximate their carrying values due to their short-term nature.

 

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Assets and Liabilities Measured at Fair Value on a Non-recurring Basis

As of October 31 and July 31, 2012, the Company had no assets or liabilities measured at fair value on a non-recurring basis.

3. Contingent Rights Liability Arising from Business Combinations

On September 2, 2010, the Company completed its acquisition of Azalea Networks (“Azalea”) for a total purchase price of $42.0 million. Contingent rights were issued to each Azalea shareholder as part of the purchase consideration. For each share received, the Azalea shareholder also received a right to receive an amount of cash equal to the shortfall generated if a share was sold below the target value within the payment period, as specified in the arrangement. For shares not held in escrow, the payment period began August 1, 2011 and ended on December 31, 2011. The rights related to these shares were subsequently converted to shares after this period. For shares held in escrow, the period for making escrow claims expired on April 1, 2012. The Company made claims against all of the escrow shares prior to the claim period expiration, and currently the escrow shares remain in escrow pending the resolution of the Company’s claims. The rights related to the escrow shares are subject to forfeiture in certain circumstances. At the acquisition date, the Company recorded a liability for the estimated fair value of the contingent rights of $9.5 million. This liability was estimated using a lattice model and was based on significant inputs not observed in the market and thus represented a Level 3 instrument. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. The inputs included:

 

   

stock price as of the valuation date;

 

   

strike price of the contingent right;

 

   

maximum payoff per share;

 

   

number of shares held in escrow;

 

   

exercise period;

 

   

historical volatility of the Company’s stock price based on weekly stock price returns; and

 

   

risk-free rate interpolated from the Constant Maturity Treasury Rate.

The change in fair value from the acquisition date to October 31, 2012 was primarily driven by changes in the Company’s stock price, the settlement date, and the claim activities that have taken place. Gains and losses on the re-measurement of the contingent rights liability are included in other income, net. As the fair value of the contingent rights liability will largely be determined based on the Company’s closing stock price as of future fiscal period-ends, it is not possible to determine a probable range of possible outcomes of the valuation of the contingent rights liability. However, as of October 31, 2012, the maximum contingent rights liability was no more than $1.3 million related to the shares still held in escrow, as defined in the acquisition agreement. For the three months ended October 31, 2012 and 2011, the Company recorded other income of $0.4 million and $0.9 million due to the revaluation of the contingent rights liability, respectively.

 

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4. Goodwill and Intangible Assets

The following table presents details of the Company’s goodwill:

 

     Amount  
     (in thousands)  

As of July 31, 2011

   $ 33,143   

Goodwill acquired in acquisitions

     23,804   
  

 

 

 

As of July 31, 2012

   $ 56,947   

Changes in goodwill

     —     
  

 

 

 

As of October 31, 2012

   $ 56,947   
  

 

 

 

The following table presents details of the Company’s total purchased intangible assets:

 

     Estimated    Gross      Accumulated     Net  
     Useful Lives    Value      Amortization     Value  
     (in thousands, except estimated useful lives)  

As of October 31, 2012

          

Existing technology

   2 to 7 years    $ 35,183       $ (17,196   $ 17,987   

Patents/core technology

   4 to 6 years      6,806         (4,211     2,595   

Customer contracts

   6 to 7 years      7,233         (4,622     2,611   

Support agreements

   5 to 6 years      2,917         (2,569     348   

Tradenames/trademarks

   1 to 5 years      750         (703     47   

Non-compete agreements

   2 years      912         (825     87   
     

 

 

    

 

 

   

 

 

 

Sub-total

      $ 53,801       $ (30,126   $ 23,675   

In-process research and development

        1,440         —          1,440   
     

 

 

    

 

 

   

 

 

 

Total

      $ 55,241       $ (30,126   $ 25,115   
     

 

 

    

 

 

   

 

 

 
     Estimated    Gross      Accumulated     Net  
     Useful Lives    Value      Amortization     Value  
     (in thousands, except estimated useful lives)  

As of July 31, 2012

          

Existing technology

   2 to 7 years    $ 35,183       $ (15,931   $ 19,252   

Patents/core technology

   4 to 6 years      6,806         (4,041     2,765   

Customer contracts

   6 to 7 years      7,233         (4,321     2,912   

Support agreements

   5 to 6 years      2,917         (2,425     492   

Tradenames/trademarks

   1 to 5 years      750         (673     77   

Non-compete agreements

   2 years      912         (814     98   
     

 

 

    

 

 

   

 

 

 

Sub-total

      $ 53,801       $ (28,205   $ 25,596   

In-process research and development

        1,440         —          1,440   
     

 

 

    

 

 

   

 

 

 

Total

      $ 55,241       $ (28,205   $ 27,036   
     

 

 

    

 

 

   

 

 

 

 

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Amortization expense is recorded in the Consolidated Statements of Comprehensive Income under the following:

 

     Three months ended October 31,  
     2012      2011  
     (in thousands)  

Cost of product revenues

   $ 1,436       $ 1,352   

Cost of professional services and support revenues

     135         135   

Sales and marketing

     344         358   

Research & development

     6         —     
  

 

 

    

 

 

 

Total amortization expense

   $ 1,921       $ 1,845   
  

 

 

    

 

 

 

The following table consists of estimated future amortization expense of purchased intangible assets as of October 31, 2012. The purchased intangible assets include in-process research and development assets of $1.4 million as of October 31, 2012, that will be amortized when the projects related to those assets are complete. These assets are expected to be placed into service in fiscal 2013 and will be amortized over their remaining useful life upon completion.

 

     Amount  
     (in thousands)  

Remaining nine months of fiscal 2013

   $ 5,512   

Years ending July 31,

  

2014

     6,724   

2015

     5,952   

2016

     2,812   

2017

     1,208   

Thereafter

     1,467   
  

 

 

 

Total

   $ 23,675   
  

 

 

 

5. Net Loss Per Common Share

Basic net loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is calculated by giving effect to all potentially dilutive common shares, including stock options and awards, unless the result is anti-dilutive. The following tables set forth the computation of net loss per share:

 

     Three months ended October 31,  
     2012     2011  
     (in thousands, except per share data)  

Net loss

   $ (826   $ (467
  

 

 

   

 

 

 

Weighted-average common shares outstanding—basic

     111,976        105,937   

Dilutive effect of potential common shares

     —          —     
  

 

 

   

 

 

 

Weighted-average common shares outstanding—diluted

     111,976        105,937   

Net loss per share—basic

   $ (0.01   $ (0.00
  

 

 

   

 

 

 

Net loss per share—diluted

   $ (0.01   $ (0.00
  

 

 

   

 

 

 

The following outstanding stock options and awards were excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an anti-dilutive effect.

 

     Three months ended October 31,  
     2012      2011  
     (in thousands)  

Options to purchase common stock

     1,748         1,941   

Restricted stock awards

     2,454         1,475   

Contingently issuable shares

     530         —     

Employee stock purchase plan

     74         —     

 

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6. Short-Term Investments

Short-term investments consist of the following:

 

     Cost Basis      Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  
     (in thousands)  

As of October 31, 2012

          

Corporate bonds

   $ 50,015       $ 99       $ (2   $ 50,112   

U.S. government agency securities

     103,083         70         (1     103,152   

U.S. treasury bills

     41,041         14         —          41,055   

Commercial paper

     17,827         7         (1     17,833   

Certificates of deposit

     8,016         19         —          8,035   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total short-term investments

   $ 219,982       $ 209       $ (4   $ 220,187   
  

 

 

    

 

 

    

 

 

   

 

 

 
     Cost Basis      Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  
     (in thousands)  

As of July 31, 2012

          

Corporate bonds

   $ 47,011       $ 118       $ (1   $ 47,128   

U.S. government agency securities

     105,358         79         (8     105,429   

U.S. treasury bills

     43,896         34         —          43,930   

Commercial paper

     7,280         2         —          7,282   

Certificates of deposit

     8,805         27         —          8,832   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total short-term investments

   $ 212,350       $ 260       $ (9   $ 212,601   
  

 

 

    

 

 

    

 

 

   

 

 

 

The cost basis and fair value of debt securities by contractual maturity are presented below:

 

     Cost
Basis
     Fair
Value
 
     (in thousands)  

As of October 31, 2012

     

One year or less

   $ 109,464       $ 109,588   

One to two years

     110,518         110,599   
  

 

 

    

 

 

 

Total short-term investments

   $ 219,982       $ 220,187   
  

 

 

    

 

 

 
     Cost
Basis
     Fair
Value
 
     (in thousands)  

As of July 31, 2012

     

One year or less

   $ 102,675       $ 102,794   

One to two years

     109,675         109,807   
  

 

 

    

 

 

 

Total short-term investments

   $ 212,350       $ 212,601   
  

 

 

    

 

 

 

The Company reviews the individual securities in its portfolio to determine whether a decline in a security’s fair value below the amortized cost basis is other-than-temporary. The Company determined that as of October 31, 2012 and July 31, 2012, there were no investments in its portfolio that were other-than-temporarily impaired.

 

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The following table summarizes the fair value and gross unrealized losses of the Company’s investments with unrealized losses aggregated by type of investment instrument and length of time that individual securities have been in a continuous unrealized loss position:

 

     Less than 12 Months  
     Fair
Value
     Unrealized
Loss
 
     (in thousands)  

As of October 31, 2012

     

Corporate bonds

   $ 3,918       $ (2

U.S. government agency securities

     23,290         (1

Commercial paper

     2,099         (1
  

 

 

    

 

 

 
   $ 29,307       $ (4
  

 

 

    

 

 

 
     Less than 12 Months  
     Fair
Value
     Unrealized
Loss
 
     (in thousands)  

As of July 31, 2012

     

Corporate bonds

   $ 3,922       $ (1

U.S. government agency securities

     44,105         (8
  

 

 

    

 

 

 
   $ 48,027       $ (9
  

 

 

    

 

 

 

As of October 31, 2012 and July 31, 2012, no securities were in a continuous unrealized loss position for more than twelve months.

7. Balance Sheet Components

The following tables provide details of selected balance sheet items:

 

     October 31,      July 31,  
     2012      2012  
     (in thousands)  

Inventory, net

     

Raw materials

   $ 373       $ 269   

Finished goods

     27,791         21,933   
  

 

 

    

 

 

 

Total

   $ 28,164       $ 22,202   
  

 

 

    

 

 

 
     October 31,      July 31,  
     2012      2012  
     (in thousands)  

Accrued Liabilities

     

Compensation and benefits

   $ 19,175       $ 20,054   

Marketing

     22,204         15,191   

Contingent rights

     1,264         1,665   

Other

     14,766         15,465   
  

 

 

    

 

 

 

Total

   $ 57,409       $ 52,375   
  

 

 

    

 

 

 

 

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8. Property and Equipment, Net

Property and equipment, net consists of the following:

 

     Estimated
Useful Lives
   October 31,
2012
    July 31,
2012
 
     (in thousands, except estimated useful lives)  

Computer equipment

   2 years    $ 17,195      $ 16,893   

Computer software

   2 to 5 years      7,927        7,560   

Machinery and equipment

   2 years      25,048        19,965   

Furniture and fixtures

   5 years      4,027        3,952   

Leasehold improvements

   1 to 6 years      4,932        4,847   
     

 

 

   

 

 

 

Total property and equipment, gross

        59,129        53,217   

Less: Accumulated depreciation

        (36,441     (33,316
     

 

 

   

 

 

 

Total property and equipment, net

      $ 22,688      $ 19,901   
     

 

 

   

 

 

 

9. Deferred Revenue

Deferred revenue consists of the following:

 

     October 31,      July 31,  
     2012      2012  
     (in thousands)  

Product

   $ 32,599       $ 28,215   

Professional services and support

     55,631         52,387   
  

 

 

    

 

 

 

Total deferred revenue, current

     88,230         80,602   

Professional services and support, long-term

     25,670         22,375   
  

 

 

    

 

 

 

Total deferred revenue, long-term

     25,670         22,375   
  

 

 

    

 

 

 

Total deferred revenue

   $ 113,900       $ 102,977   
  

 

 

    

 

 

 

Deferred product revenue relates to arrangements where not all revenue recognition criteria have been met. The increase in deferred product revenue from July 31, 2012 to October 31, 2012 was primarily due to the timing of orders from the Company’s value added distributors (“VADs”) replenishing their stock to fulfill expected future orders. Deferred professional services and support revenue primarily represents customer payments made in advance for support contracts. Support contracts are typically billed in advance and revenue is recognized ratably over the support period, typically one to five years.

10. Income Taxes

The Company’s effective tax rate was 116.1% and 117.6% for the three months ended October 31, 2012 and 2011, respectively. The Company’s income tax provision consists of federal, foreign, and state income taxes. The provision for income taxes was $5.9 million and $3.1 million for the three months ended October 31, 2012 and 2011, respectively.

The Company’s effective tax rate differs from the federal statutory rate of 35% due to state taxes and significant permanent differences. Significant permanent differences arise primarily from taxes in foreign jurisdictions with a tax rate different from the U.S. federal statutory rate, stock-based compensation expense, research and development (“R&D”) credits, certain acquisition related items, and the amortization of deferred tax charges related to the intercompany sale of intellectual property rights. During the first quarter of fiscal 2013, the Company utilized a portion of its net operating loss carry-forwards and R&D credits and recorded the associated change in net deferred tax assets on its Consolidated Balance Sheets.

In fiscal 2012, the Company implemented a new structure of its corporate organization to more closely align its corporate organization with the international nature of its business activities and to reduce its overall effective tax rate through changes in how it develops and uses its intellectual property and the structure of its international procurement and sales, including by entering into transfer-pricing arrangements that establish transfer prices for its intercompany transactions.

 

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The Company also recorded a deferred charge during the first quarter of fiscal 2012 related to the deferral of income tax expense on intercompany profits that resulted from the sale of its intellectual property rights outside of North and South America to its Irish subsidiary. The deferred charge is included in prepaid and other assets and other non-current assets on the Consolidated Balance Sheets. As of October 31, 2012, the balance in prepaid and other assets was $7.6 million, and $6.8 million in other non-current assets. The deferred charge is amortized as a component of income tax expense over three to five years, depending upon the economic life of the intellectual property.

11. Equity Incentive Plans

Stock Option Activity

The following table summarizes the information about shares available for grant and outstanding stock option activity:

 

           Options Outstanding                
                 Weighted             Weighted         
                 Average      Weighted      Average         
     Shares           Exercise      Average      Remaining      Aggregate  
     Available for     Number of     Price      Fair Value      Contractual      Intrinsic  
     Grant     Shares     per Share      per Share      Term (Years)      Value  

As of July 31, 2011

     274,103        18,164,944      $ 6.59            5.0       $ 297,688,111   

Shares reserved for issuance

     5,245,243        —                

Restricted stock awards granted

     (7,713,936     —                

Restricted stock awards forfeited

     1,579,751        —                

Options granted

     (177,568     177,568        23.71       $ 13.08         

Options exercised

     —          (3,753,478     5.71               56,578,795   

Options cancelled

     1,325,003        (1,325,003     10.87            
  

 

 

   

 

 

   

 

 

          

As of July 31, 2012

     532,596        13,264,031      $ 6.63            3.9         112,867,587   
  

 

 

   

 

 

   

 

 

          

Shares reserved for issuance

     5,576,433        —                

Restricted stock awards granted

     (2,833,295     —                

Restricted stock awards forfeited

     387,315        —                

Options exercised

     —          (920,248     5.68               12,380,136   

Options cancelled

     113,955        (113,955     15.89            
  

 

 

   

 

 

   

 

 

          

As of October 31, 2012

     3,777,004        12,229,828      $ 6.62            3.7         146,885,379   
  

 

 

   

 

 

   

 

 

          

Restricted Stock Award Activity

The following table summarizes the non-vested restricted stock awards outstanding:

 

           Weighted Average  
           Grant Date  
           Fair Value  
     Shares     per Share  

As of July 31, 2011

     5,093,839      $ 20.98   

Awards granted

     7,713,936        19.34   

Awards vested

     (2,805,343     20.29   

Awards forfeited

     (1,579,751     22.15   
  

 

 

   

 

 

 

As of July 31, 2012

     8,422,681      $ 19.49   

Awards granted

     2,833,295        18.70   

Awards vested

     (841,244     19.35   

Awards forfeited

     (387,315     20.73   
  

 

 

   

 

 

 

As of October 31, 2012

     10,027,417      $ 19.23   
  

 

 

   

 

 

 

 

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Table of Contents

Fair Value Disclosures

The fair value of each option grant is estimated on the date of grant using the Black-Scholes model with the following weighted average assumptions:

Employee Stock Options

 

     Three months
ended October 31,
 
     2011  

Risk-free interest rate

     1.2

Expected term (in years)

     4.0   

Dividend yield

     0

Volatility

     74

There were no stock option grants during the three months ended October 31, 2012. The Company granted 150,000 stock options during the three months ended October 31, 2011.

Employee Stock Purchase Plan

 

    

Three months ended October 31,

    

2012

  

2011

Risk-free interest rates

   0.1% to 0.2%    0.1% to 0.2%

Expected term (in years)

   0.5 to 2.0    0.5 to 2.0

Dividend yield

   0%    0%

Volatility

   54% to 63%    58% to 77%

 

Purchase date    September 1, 2012      September 1, 2011  

Shares issued

     348,520         409,920   

Weighted average purchase price per share

   $ 16.65       $ 14.88   

Stock-based Compensation Expenses

The following table presents stock-based compensation expense by award-type:

 

     Three months ended October 31,  
     2012      2011  
     (in thousands)  

Stock options

   $ 2,723       $ 4,375   

Stock awards

     17,300         13,108   

Employee stock purchase plan

     2,539         1,782   
  

 

 

    

 

 

 

Total

   $ 22,562       $ 19,265   
  

 

 

    

 

 

 

Included in the stock awards stock-based compensation expense the Company recorded $3.5 million and $2.8 million in the three months ended October 31, 2012 and 2011, respectively, associated with its Executive Officer Bonus Plan and the Corporate Bonus Plan.

Stock Repurchase Program

On June 13, 2012, the Company announced a stock repurchase program for up to $100.0 million of our common stock. The Company is authorized to make repurchases in the open market until June 6, 2014, and any such repurchases will be funded from available working capital. The number of share repurchases and the timing of repurchases are based on the price of its common stock, general business and market conditions, and other investment considerations. Shares are retired upon repurchase. The Company’s policy related to repurchases of its common stock is to charge any excess of cost over par value entirely to additional paid-in capital.

 

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Table of Contents

During the three months ended October 31, 2012, the Company repurchased a total of 590,141 shares for a total purchase price of $11.5 million. As of October 31, 2012, the Company repurchased a cumulative total of 1,998,645 shares for a total purchase price of $31.4 million, with $68.6 million remaining authorized under the stock repurchase program.

12. Segment Information and Significant Customers

The Company operates in one reportable segment—selling fixed and modular mobility controllers, wired and wireless access points, and related software and services.

A reportable segment is defined as a component of an enterprise for which separate financial information is available and is evaluated regularly by the chief operating decision maker, or decision making group, for resource allocation and for assessing performance. The Company’s chief operating decision maker is its chief executive officer (“CEO”), who reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. Since the Company has one business segment, the Company reports a single operating segment and the CEO evaluates performance based primarily on revenue in the geographic locations in which the Company operates. Revenue is attributed by geographic location based on the ship-to location of the Company’s customers. The Company’s assets are primarily located in the U.S. and not allocated to any specific region.

The following presents total revenue by geographic region:

 

     Three months ended October 31,  
     2012      2011  
     (in thousands)  

United States

   $ 92,752       $ 80,919   

Europe, Middle East and Africa

     21,550         18,098   

Asia Pacific and Japan

     24,653         17,600   

Rest of World

     5,527         2,734   
  

 

 

    

 

 

 

Total

   $ 144,482       $ 119,351   
  

 

 

    

 

 

 

The Company’s product revenue was $119.2 million and $101.2 million for three months ended October 31, 2012 and 2011, respectively. Professional services and support revenue was $25.3 million and $18.2 million in the same periods.

The following table presents significant channel partners contributing revenue in excess of 10% of total revenue (* indicates less than 10%):

 

     Three months ended October 31,  
     2012     2011  

ScanSource, Inc. (“Catalyst”)

     20.2     20.9

Avnet Logistics U.S. LP

     *        15.9

The following table presents significant channel partners as a percentage of total accounts receivable (*indicates less than 10%):

 

     October 31,     July 31,  
     2012     2012  

ScanSource, Inc. (“Catalyst”)

     24.1     15.7

Synnex Corp.

     13.1     *   

Avnet Logistics U.S. LP

     *        19.0

 

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Table of Contents

13. Commitments and Contingencies

Legal Matters

The Company is involved in disputes, litigation, and other legal actions. While the Company currently believes that there are no existing claims or proceedings that are likely to have a material adverse effect on its financial position, the outcome of these matters is currently not determinable. There are many uncertainties associated with any litigation and these actions or other third-party claims against the Company may cause the Company to incur costly litigation and/or substantial settlement charges. In addition, the resolution of any patent related litigation may require the Company to make royalty payments, which could adversely affect gross margins in future periods. If any of those events were to occur, the Company’s business, financial condition, results of operations, and cash flows could be adversely affected. The actual liability in any such matters may be materially different from the Company’s estimates, which could result in the need to adjust the liability and record additional expenses.

Lease Obligations

The Company leases office spaces under non-cancelable operating leases with various expiration dates through March 2018. The terms of certain operating leases provide for rental payments on a graduated scale. Future minimum lease payments under non-cancelable operating leases are as follows:

 

     Operating  
     Leases  
     (in thousands)  

Remaining nine months of fiscal 2013

   $ 4,235   

Year ending July 31,

  

2014

     5,756   

2015

     5,552   

2016

     5,060   

2017

     876   

2018

     44   
  

 

 

 

Total minimum payments

   $ 21,523   
  

 

 

 

Non-cancelable purchase commitments

The Company outsources the production of its hardware to third-party contract manufacturers, and enters into various inventory-related purchase commitments with these contract manufacturers and other suppliers. In addition, from time to time, the Company also enters into significant information technology and marketing agreements with its vendors, which are non-cancelable. The Company had $35.7 million and $46.1 million in non-cancelable purchase commitments as of October 31, 2012 and July 31, 2012, respectively. The Company expects to sell all products that it has committed to purchase from its third-party contract manufacturers and other suppliers.

Warranties

The warranty liability is included as a component of accrued liabilities on the Consolidated Balance Sheets. Changes in the warranty liability are as follows:

 

     Warranty
Amount
 
     (in thousands)  

As of July 31, 2012

   $ 818   

Provision

     182   

Obligations fulfilled during period

     (184
  

 

 

 
As of October 31, 2012    $ 816   
  

 

 

 
     Warranty
Amount
 
     (in thousands)  
As of July 31, 2011    $ 404   

Provision

     236   

Obligations fulfilled during period

     (106
  

 

 

 
As of October 31, 2011    $ 534   
  

 

 

 

Indemnification

In its sales agreements, the Company may agree to indemnify its indirect sales channels and end user customers for certain expenses or liability resulting from claimed infringements of patents, trademarks or copyrights of third parties. The terms of these indemnification provisions are generally perpetual any time after execution of the agreement. The agreements generally limit the scope of the available remedies in a variety of industry-standard methods, including, but not limited to, product usage and geography-based limitations, a right to control the defense or settlement of any claim, and a right to replace or modify the infringing products to make them non-infringing. In certain circumstances, the Company may be subject to uncapped indemnity obligations. To date the Company has not paid any amounts to settle claims or defend lawsuits pursuant to such indemnification provisions. The Company believes the likelihood of such claims is remote and is unable to reasonably estimate the maximum amount that could be payable under these provisions since these obligations are not capped but are conditional to the unique facts and circumstances involved. Accordingly, the Company has no liabilities recorded for these agreements as of October 31, 2012 and July 31, 2012.

 

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Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, among other things, statements concerning our expectations:

 

   

that revenue from our indirect channels will continue to constitute a significant majority of our future revenue;

 

   

that competition will intensify in the future as other companies introduce new products in the same markets we serve or intend to enter;

 

   

that our product offerings associated with our Mobile Virtual Enterprise (“MOVE”) architecture, including our new ClearPass and Aruba Instant products,, will enable broader networking initiatives by both our current and potential customers;

 

   

regarding the growth of our offshore operations and the establishment of additional offshore capabilities for certain general and administrative functions;

 

   

that, within our indirect channel, sales through our value-added distributors (“VADs”) and original equipment manufacturers (“OEMs”) will continue to be significant;

 

   

that international revenue will increase in absolute dollars and remain approximately consistent or increase as a percentage of total revenue in fiscal 2013 compared to fiscal 2012;

 

   

that research and development expenses for fiscal 2013 will increase on an absolute dollar basis and remain consistent or increase as a percentage of revenue compared to fiscal 2012;

 

   

regarding continued momentum in our “MOVE” architecture initiatives, including network rightsizing, and adoption of our ClearPass access management system and Aruba Instant;

 

   

that sales and marketing expenses for fiscal 2013 will continue to be our most significant operating expense and will increase on an absolute dollar basis and remain consistent or decrease as a percentage of revenue compared to fiscal 2012;

 

   

that general and administrative expenses for fiscal 2013 will increase in absolute dollars and decrease as a percentage of revenue compared to fiscal 2012; regarding the sufficiency of our existing cash, cash equivalents, short-term investments and cash generated from operations;

 

   

that we will ensure the safety and preservation of our invested funds by limiting default risk, market risk and reinvestment risk; and

 

   

that we will increase our market penetration and extend our geographic reach through our network of channel partners,

as well as other statements regarding our future operations, financial condition, prospects and business strategies. These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report, and in particular, the risks discussed under the heading “Risk Factors” in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

 

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The following discussion and analysis of our financial condition and results of operations should be read together with our Consolidated Financial Statements and related notes included elsewhere in this report.

Overview

We are a leading provider of next-generation network access solutions for the mobile enterprise. Our MOVE architecture leverages Aruba’s diverse products (including our ArubaOS operating system, controllers, wireless access points, switches, application software modules, and multi-vendor management solution software) to unify wired and wireless network infrastructures into one seamless access solution for traveling business professionals, remote workers, corporate headquarters employees and guests. With the Aruba MOVE architecture, access privileges are linked to a user’s identity and context. That means an enterprise workforce has consistent, secure access to network resources based on who they are, where they are, what devices and applications they are using, and how they are connected.

Our products provide a unique approach that is driven by mobility and the proliferation of Wi-Fi-enabled mobile devices. These devices – which have no Ethernet port – are connecting to enterprise networks in unprecedented numbers and will quickly surpass desktop connections. Aruba meets this challenge by eliminating the cost and complexity of managing separate wired and wireless access policies. In fact, with Aruba, customers need fewer ports and consequently less equipment in the wiring closet – effectively rightsizing our customers’ access infrastructure.

Aruba’s MOVE architecture provides context-aware networking for the post-PC era. Mobility network services are delivered centrally from the data center across thin network access devices or on-ramps. At the heart of Aruba MOVE, a single set of mobility network services manages security, policy and network performance for every user and device on the network. This mobility- and user-centric approach makes it possible to re-architect the access network to simultaneously provide workforce mobility and reduce costs. To connect users into the network, whether at work, home, or on the road, Aruba access on-ramps include wireless, wired, and VPN products. Device configuration, security policies, and reporting are centrally managed, effectively making installation a zero-touch experience.

A key new addition to our MOVE architecture is our ClearPass Access Management System. Ideal for BYOD provisioning and onboarding, ClearPass makes it easy for IT-issued and personal mobile devices to securely connect to any network. By centralizing access policies across the entire network, ClearPass automates differentiated user and device access, policy management and the provisioning of devices for secure network access and posture assessment. This ensures that each user has the right access privileges based on who they are and what device they are using. ClearPass is essential when increasing numbers of consumer devices – Windows, Mac OS X, iOS, Android and Linux – connect to the network and access is required by a broader range of users – employees, visitors, customers and contractors.

Another key addition to the MOVE architecture is Aruba Instant, a controller-less Wi-Fi solution that combines ease-of-use and cost-effectiveness with best-in-class security, resiliency and intelligence. In Aruba Instant mode, a single access point is dynamically elected to manage the other Aruba Instant APs in the WLAN, while the free Aruba Activate service offers zero-touch provisioning and cloud-based inventory management. Our customers simply power-up one Aruba Instant AP and it automatically obtains its configuration and becomes operational. To grow the network, customers simply plug in additional access points. The entire deployment process is substantially simplified, saving our customers’ time and operational expenses.

Our products have been sold to over 20,000 customers worldwide, including some of the largest and most complex global organizations. We have implemented a two-tier distribution model in most areas of the world, including the United States, with value added distributors (“VADs”) and original equipment manufacturers (“OEMs”) selling our portfolio of products, including a variety of our support services, to a diverse number of value added resellers (“VARs”). Our focus continues to be management of our channel including selection and growth of high prospect partners, activation of our VARs and VADs through active training and field collaboration, and evolution of our channel programs in consultation with our partners.

Major Trends Affecting Our Financial Results

Worldwide Economic Conditions

Our business depends on the overall demand for IT initiatives and on the economic health and general willingness of our current and prospective customers to make capital commitments. If the conditions in the U.S., European and global economic environments remain uncertain or continue to be volatile, or if they deteriorate further, our business, operating results, and financial condition may be materially adversely affected. Economic weakness, customer financial difficulties and constrained spending on IT initiatives have resulted, and may in the future result, in challenging and delayed sales cycles and could negatively impact our ability to forecast future periods. In particular, we cannot be assured of the level of IT spending, the deterioration of which could have a material adverse effect on our results of operations and growth rates.

 

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Revenue

Our ability to increase our product revenue will depend significantly on continued growth in the market for enterprise mobility and remote networking solutions, continued acceptance of our products in the marketplace, our ability to continue to attract new customers, our ability to compete, the willingness of customers to displace wired networks with wireless LANs, and our ability to continue to sell into our installed base of existing customers. Our growth in support revenue is dependent upon increasing the number of products under support contracts, which is dependent on both growing our installed base of customers and renewing existing support contracts. Our future profitability and rate of growth, if any, will also be directly affected by the timing and size of orders, product and channel mix, average selling prices, costs of our products, our ability to effectively implement and generate incremental business from our two-tier distribution model, general economic conditions, and the extent to which we invest in our sales and marketing, research and development, and general and administrative resources.

The revenue growth that we have experienced has been driven primarily by an expansion of our customer base coupled with increased purchases from existing customers. We believe the growth we have experienced is the result of business enterprises and other organizations needing to provide secure mobility to their users in a manner that we believe is more cost effective than the traditional approach of using port-centric networks. While we have seen slower revenue growth rate over the last fiscal year, our revenue grew 21% in the first quarter of fiscal 2013 compared to the same period in fiscal 2012. We believe that our product offerings associated with our Mobile Virtual Enterprise (“MOVE”) architecture, including our new ClearPass and Aruba Instant products, will enable broader networking initiatives by both our current and potential customers in the future. Each quarter, our ability to meet our product revenue expectations is dependent upon (1) new orders received, shipped, and recognized in a given quarter, (2) the amount of orders booked but not shipped in the prior quarter that are shipped in the current quarter, and (3) the amount of deferred revenue entering a given quarter. Our product deferred revenue is comprised of:

 

   

product orders that have shipped but where the terms of the agreement, typically with our large customers, contain acceptance terms and conditions or other terms that require that the revenue be deferred until all revenue recognition criteria are met; and

 

   

product orders shipped to our VADs and OEMs for which we have not yet received persuasive evidence of sell-through from the VADs or OEMs.

We typically ship products within 10 days after the receipt of an order.

Costs and Expenses

Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The largest component of our operating expenses in each of these categories is personnel costs. Personnel costs consist of salaries, benefits and incentive compensation for our employees, including commissions for sales personnel and stock-based compensation for employees. As of October 31, 2012, we had 1,293 employees worldwide compared to 1,223 employees at July 31, 2012. The increase in employees is the most significant driver behind the increase in costs and operating expenses in the three months ended October 31, 2012. Going forward, we expect to continue to hire employees throughout the company.

Stock Repurchase

On June 13, 2012, we announced a stock repurchase program for up to $100.0 million of our common stock. We are authorized to make repurchases in the open market until June 6, 2014, and any such repurchases will be funded from available working capital. The number of share repurchases and the timing of repurchases are based on the price of our common stock, general business and market conditions, and other investment considerations. Shares are retired upon repurchase. Our policy related to repurchases of our common stock is to charge any excess of cost over par value entirely to additional paid-in capital.

During the three months ended October 31, 2012, we repurchased a total of 590,141 shares for a total purchase price of $11.5 million. As of October 31, 2012, we repurchased a cumulative total of 1,998,645 shares for a total purchase price of $31.4 million, with $68.6 million remaining authorized under the stock repurchase program.

 

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Revenue, Cost of Revenue and Operating Expenses

Revenue

We derive our revenue from sales of our ArubaOS operating system, controllers, wired and wireless access points, switches, application software modules, multi-vendor management solution software, and professional services and support. Professional services revenue consists of consulting and training services. Consulting services primarily consist of installation support services. Training services are typically instructor led courses on the use of our products. Support services typically consist of software updates, on a when-and-if available basis, telephone and internet access to technical support personnel and hardware support. We provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.

We sell our products directly through our sales force and indirectly through VADs, VARs, and OEMs. We expect revenue from indirect channels to continue to constitute a significant majority of our future revenue.

We sell our products to channel partners and end customers located in the Americas, Europe, the Middle East, Africa and Asia Pacific. We continue to expand into international locations and introduce our products in new markets, and we expect international revenue to increase in absolute dollars and remain consistent or increase as a percentage of total revenue in fiscal 2013 compared to fiscal 2012. For more information about our international revenue, see Note 12 of the Notes to Consolidated Financial Statements.

Cost of Revenue

Cost of product revenue consists primarily of manufacturing costs for our products, shipping and logistics costs, and expenses for inventory obsolescence and warranty obligations. We utilize third parties to manufacture our products and perform shipping logistics. We have outsourced the substantial majority of our manufacturing, repair and supply chain operations. Accordingly, the substantial majority of our cost of product revenue consists of payments to our contract manufacturers. Our contractor manufacturers produce our products in China and Singapore using quality assurance programs and standards that we jointly established. Manufacturing, engineering and documentation controls are conducted at our facilities in Sunnyvale, California, Bangalore, India and Beijing, China. Cost of product revenue also includes amortization expense from our purchased intangible assets.

Cost of professional services and support revenue is primarily comprised of personnel costs, including stock-based compensation, of providing technical support, including personnel costs associated with our internal support organization. In addition, we engage a third-party support vendor to complement our internal support resources, the costs of which are included within costs of professional services and support revenue.

Gross Margin

Our gross margin has been, and will continue to be, affected by a variety of factors, including:

 

   

the proportion of our products that are sold through direct versus indirect channels;

 

   

product mix and average selling prices;

 

   

new product introductions, such as the new ClearPass and Aruba Instant additions to our MOVE architecture, and product enhancements made by us as well as those made by our competitors;

 

   

pressure to discount our products in response to our competitors’ discounting practices;

 

   

mix of revenue attributed to our international regions;

 

   

demand for our products and services;

 

   

our ability to attain volume manufacturing pricing from our contract manufacturers and our component suppliers;

 

   

losses associated with excess and obsolete inventory;

 

   

growth in our headcount and other related costs incurred in our customer support organization;

 

   

costs associated with manufacturing overhead;

 

   

our ability to manage freight costs; and

 

   

amortization expense from our purchased intangible assets.

Due to higher net effective discounts for products sold through our indirect channel, our overall gross margins for indirect channel sales are typically lower than those associated with direct sales. We expect product revenue from our indirect channel to continue to constitute a significant majority of our total revenue, which, by itself, negatively impacts our gross margins. Further, we expect that within our indirect channel, sales through our VADs and OEMs will continue to be significant, which will negatively impact our gross margin as VADs and OEMs generally experience a larger net effective discount than our other channel partners.

Research and Development Expenses

Research and development expenses primarily consist of personnel costs and facilities costs. We expense research and development expenses as incurred. We are devoting substantial resources to the continued development of additional functionality for existing products and the development of new products. We intend to continue to invest significantly in our research and development efforts because we believe it is essential to maintaining our competitive position. For fiscal 2013, we expect research and development expenses to increase on an absolute dollar basis and remain consistent or increase as a percentage of revenue compared to fiscal 2012.

 

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Sales and Marketing Expenses

Sales and marketing expenses represent the largest component of our operating expenses and primarily consist of personnel costs, sales commissions, marketing programs and facilities costs. A portion of the amortization expense related to our purchased intangible assets is also included in sales and marketing expenses. Marketing programs are intended to generate revenue from new and existing customers and are expensed as incurred. We plan to continue to invest strategically in sales and marketing with the intent to add new customers and increase penetration within our existing customer base, expand our domestic and international sales and marketing activities, build brand awareness and sponsor additional marketing events. We expect future sales and marketing expenses to continue to be our most significant operating expense. Generally, sales personnel are not immediately productive, and thus, the increase in sales and marketing expenses that we experience as we hire additional sales personnel is not expected to immediately result in increased revenue. As a result, these expenses will reduce our operating margin until such sales personnel become productive and generate revenue. Accordingly, the timing of sales personnel hiring and the rate at which they become productive will affect our future performance. For fiscal 2013, we expect sales and marketing expenses to increase on an absolute dollar basis and remain consistent or decrease as a percentage of revenue compared to fiscal 2012.

General and Administrative Expenses

General and administrative expenses primarily consist of personnel and facilities costs related to our executive, finance, human resource, information technology and legal organizations, as well as insurance, investor relations, and IT infrastructure costs related to our enterprise resource planning (“ERP”) system. Further, our general and administrative expenses include professional services consisting of outside legal, audit, Sarbanes-Oxley and IT consulting costs. We have incurred in the past, and may continue to incur, significant legal costs defending ourselves against claims made by third parties. These expenses are expected to continue as part of our ongoing operations and depending on the timing and outcome of lawsuits and the legal process, could have a significant impact on our financial statements. For fiscal 2013, we expect general and administrative expenses to increase in absolute dollars and decrease as a percentage of revenue compared to fiscal 2012. However, fluctuations in professional services can cause an increase in any particular quarter.

Other Income, net

Other income, net includes interest income on cash balances, accretion of discount or amortization of premium on short-term investments, losses or gains on foreign exchange rate changes, and in connection with our acquisition of Azalea in September 2010, changes in the fair value of our contingent rights liability.

Critical Accounting Policies

Our Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). These accounting principles require us to make estimates and judgments that affect the reported amounts of assets and liabilities as of the date of the Consolidated Financial Statements, as well as the reported amounts of revenue and expenses during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based upon information available to us at the time that these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, our Consolidated Financial Statements will be affected. The accounting policies that reflect our more significant estimates and judgments and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include revenue recognition, share-based compensation, inventory valuation, allowance for doubtful accounts, impairment of goodwill and intangible assets, and accounting for income taxes. Our critical accounting policies are disclosed in our Form 10-K for the year ended July 31, 2012. There were no material changes to our critical accounting policies during the first quarter of fiscal 2013.

 

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Results of Operations

The following table presents our historical operating results as a percentage of revenue for the periods indicated:

 

     Three months ended October 31,  
     2012     2011  

Revenue:

    

Product

     82.5     84.7

Professional services and support

     17.5     15.3
  

 

 

   

 

 

 

Total revenue

     100.0     100.0

Cost of revenue:

    

Product

     25.0     26.9

Professional services and support

     4.2     3.8
  

 

 

   

 

 

 

Gross margin

     70.8     69.3

Operating expenses:

    

Research and development

     22.1     20.5

Sales and marketing

     37.3     38.2

General and administrative

     8.3     9.3
  

 

 

   

 

 

 

Total operating expenses

     67.7     68.0
  

 

 

   

 

 

 

Operating margin

     3.1     1.3

Other income, net

    

Interest income

     0.2     0.2

Other income, net

     0.2     0.7
  

 

 

   

 

 

 

Income before provision for income taxes

     3.5     2.2

Provision for income taxes

     4.1     2.6
  

 

 

   

 

 

 

Net loss

     (0.6 %)      (0.4 %) 
  

 

 

   

 

 

 

 

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Revenue

The following table presents our revenue, by revenue source, for the periods presented:

 

     Three months ended October 31,  
     2012     2011  
     (in thousands)  

Total revenue

   $ 144,482      $ 119,351   
  

 

 

   

 

 

 

Type of revenue:

    

Product

   $ 119,222      $ 101,131   

Professional services and support

     25,260        18,220   
  

 

 

   

 

 

 

Total revenue

   $ 144,482      $ 119,351   
  

 

 

   

 

 

 

% revenue by type:

    

Product

     82.5     84.7

Professional services and support

     17.5     15.3

Revenue by geography:

    

United States

   $ 92,752      $ 80,919   

Europe, the Middle East and Africa

     21,550        18,098   

Asia Pacific and Japan

     24,653        17,600   

Rest of World

     5,527        2,734   
  

 

 

   

 

 

 

Total revenue

   $ 144,482      $ 119,351   
  

 

 

   

 

 

 

% revenue by geography:

    

United States

     64.2     67.8

Europe, the Middle East and Africa

     14.9     15.2

Asia Pacific and Japan

     17.1     14.7

Rest of World

     3.8     2.3

Total revenue by sales channel:

    

Indirect

   $ 133,652      $ 115,153   

Direct

     10,830        4,198   
  

 

 

   

 

 

 

Total revenue

   $ 144,482      $ 119,351   
  

 

 

   

 

 

 

% revenue by sales channel:

    

Indirect

     92.5     96.5

Direct

     7.5     3.5

During the first quarter of fiscal 2013, total revenue increased $25.1 million, or 21.1%, over the first quarter of fiscal 2012. An increase in product revenue of 17.9% during the first quarter of fiscal 2013 compared to the first quarter of fiscal 2012 drove the overall increase in total revenue.

The rapid proliferation of Wi-Fi enabled mobile devices, the increase in demand for multimedia-rich mobility applications, and the rise of both server and desktop virtualization is driving the increase in demand for our products. Our MOVE architecture continues to gain momentum as companies move toward a new access network, resulting in significant growth in the sales of our access point products, and an increase in hardware product sales. We continue to add new customers each quarter. As of October 31, 2012, our cumulative customer total was over 20,000.

Professional services and support revenue increased 38.6% during the first quarter of fiscal 2013 compared to the same period in fiscal 2012. This increase is primarily a result of both increased product and first year support sales, and the renewal of support contracts by existing customers as our customer base continues to grow.

Revenue from our indirect sales channel increased during the first quarter of fiscal 2013 compared to the first quarter of fiscal 2012 as we continue to derive a significant majority of our total revenue from indirect channels which is consistent with our focus on improving the efficiency of marketing and selling our product through the indirect channels. We expect to continue rely on our indirect sales channel to manage smaller-sized deals and our direct sales team to focus more on winning large customers to improve the efficiency of marketing and selling our products.

 

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Revenue from shipments to locations outside the United States increased during the first quarter of fiscal 2013 compared to the same period of fiscal 2012 due to increased demand across all non-U.S. regions. In terms of actual dollars, our international revenue increased 34.6% when compared to the same period ended October 31, 2011. As a percentage of total revenue, international revenue increased slightly as the demand is primarily driven by the Asia Pacific region. We continue to expand into international locations and introduce our products in new markets, and we expect international revenue to increase in absolute dollars and remain approximately consistent as a percentage of total revenue in fiscal 2013 compared to fiscal 2012.

Cost of Revenue and Gross Margin

 

     Three months ended October 31,  
     2012     2011  
     (in thousands)  

Total revenue

   $ 144,482      $ 119,351   
  

 

 

   

 

 

 

Cost of product

   $ 36,161      $ 32,068   

Cost of professional services and support

     5,957        4,546   
  

 

 

   

 

 

 

Total cost of revenue

     42,118        36,614   
  

 

 

   

 

 

 

Gross profit

   $ 102,364      $ 82,737   
  

 

 

   

 

 

 

Gross margin

     70.8     69.3

During the first quarter of fiscal 2013, total cost of revenue increased 15.0% compared to the same period in fiscal 2012. This increase was primarily due to the corresponding increase in our product revenue. The substantial majority of our cost of product revenue consists of payments to our contract manufacturers.

Cost of professional services and support revenue increased 31.0% during the first quarter of fiscal 2013 compared to the same period in fiscal 2012. This increase was primarily due to increased outside services as we expanded our customer support call centers, as well as increased training to accommodate the expansion of our business. Stock-based compensation increased $0.2 million.

As we expand internationally, we may incur additional costs to conform our products to comply with local laws or local product specifications. In addition, we plan to continue to hire additional personnel to support our growing international customer base which would increase our cost of professional services and support.

Gross margins increased 150 basis points to 70.8% during the first quarter of fiscal 2013 compared to 69.3% in the first quarter of fiscal 2012. This increase is primarily due to improved product margin as our product mix was favorable towards higher margin products and improved professional services and support margin as we grew our professional services and support revenue while controlling the increase in our professional services and support cost of revenue. Additionally, as a percentage of total revenue, professional services and support, which has higher margin percentage, increased relative to product; thus, our overall gross margin improved in the first quarter of fiscal 2013 compared to first quarter of fiscal 2012.

Research and Development Expenses

 

     Three months ended October 31,  
     2012     2011  
     (in thousands)  

Research and development expenses

   $ 31,963      $ 24,468   

Percent of total revenue

     22.1     20.5

During the first quarter of fiscal 2013, research and development expenses increased 30.6% compared to the first quarter of fiscal 2012, primarily due to an increase of $4.3 million in personnel and related costs, including an increase in salaries and wages of $2.2 million and an increase in stock-based compensation of $1.0 million. The increase is directly related to an increase in headcount. Facilities and IT-related expenses related to our worldwide research and development efforts also increased $1.7 million, of which $1.4 million is to support business growth and $0.3 million is due to increased allocations, which were previously classified in General and Administrative expenses.

 

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Sales and Marketing Expenses

 

     Three months ended October 31,  
     2012     2011  
     (in thousands)  

Sales and marketing expenses

   $ 53,919      $ 45,615   

Percent of total revenue

     37.3     38.2

During the first quarter of fiscal 2013, sales and marketing expenses increased 18.2% compared to the first quarter of fiscal 2012. Personnel and related costs increased $6.5 million primarily due to an increase in headcount. These costs include an increase in commissions of $1.4 million and an increase in stock-based compensation of $0.8 million. Cost for travel and expenses also increased by $0.6 million. Facilities and IT-related expenses related to our worldwide sales and marketing efforts also increased $1.0 million, of which $0.6 million is to support business growth and $0.4 million is due to increased allocations, which were previously classified in General and Administrative expenses.

General and Administrative Expenses

 

     Three months ended October 31,  
     2012     2011  
     (in thousands)  

General and administrative expenses

   $ 11,951      $ 11,100   

Percent of total revenue

     8.3     9.3

General and administrative expenses during the first quarter of fiscal 2013 increased 7.7% compared to the first quarter of fiscal 2012. Personnel and related costs increased $2.0 million primarily due to an increase in headcount. These personnel costs include an increase in stock-based compensation of $1.2 million. The increase in expense was partially offset by a decrease in allocation expenses charged to General and Administrative expenses of $0.8 million and a decrease of $0.2 million in professional services.

Other Income, Net

 

     Three months ended October 31,  
     2012      2011  
     (in thousands)  

Interest income

   $ 316       $ 276   

Other income, net

     276         827   
  

 

 

    

 

 

 

Total other income, net

   $ 592       $ 1,103   
  

 

 

    

 

 

 

Interest income increased slightly during the first quarter of fiscal 2013 compared to the first quarter of fiscal 2012. The increase was primarily due to higher cash and investment balances in interest-earning accounts. Our average interest-earning cash and investment balance for the first quarter of fiscal 2013 was $230.8 million compared to $190.0 million for the first quarter of fiscal 2012.

Other income, net decreased during the first quarter of fiscal 2013 compared to the first quarter of fiscal 2012 primarily as a result of the change in the valuation of our contingent rights liability related to the acquisition of Azalea. The change in valuation resulted in other income of $0.4 million and $0.9 million for the first quarter of fiscal 2013 and 2012, respectively. See Note 3 of the Notes to Consolidated Financial Statements for further discussion.

Provision for Income Taxes

The provision for income taxes was $5.9 million and $3.1 million for the first quarter of fiscal 2013 and 2012, respectively. This increase includes a $1.8 million adjustment recorded for prior period income tax expense. Our income tax provision consists of federal, foreign and state income taxes. Our effective tax rate was 116.1% during this period.

 

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Our effective tax rate differs from the federal statutory rate due to state taxes and significant permanent differences primarily from taxes in foreign jurisdictions with a tax rate different than the U.S. federal statutory rate, stock-based compensation expense, R&D credits, certain acquisition related items and the amortization of deferred tax charges related to the intercompany sale of intellectual property rights. During the first quarter of fiscal 2013, we utilized a portion of our net operating loss (“NOL”) carry-forwards and R&D credits and recorded the associated change in net deferred tax assets on our Consolidated Balance Sheets.

In fiscal 2012, we implemented a new structure of our corporate organization to more closely align our corporate organization with the international nature of our business activities and to reduce our overall effective tax rate through changes in how we develop and use our intellectual property and the structure of our international procurement and sales, including by entering into transfer-pricing arrangements that establish transfer prices for our intercompany transactions.

We also recorded a deferred charge during the first quarter of fiscal 2012 related to the deferral of income tax expense on intercompany profits that resulted from the sale of our intellectual property rights outside of North and South America to our Irish subsidiary. The deferred charge is included in prepaid and other assets and other non-current assets on the Consolidated Balance Sheets. As of October 31, 2012, the balance in prepaid and other assets was $7.6 million, and $6.8 million in other non-current assets. The deferred charge is amortized as a component of income tax expense over three to five years, depending upon the economic life of the intellectual property.

Our effective tax rate in fiscal 2013 and in future periods may fluctuate on a quarterly basis. The effective tax rate could be affected by such things as the geographic distribution of our worldwide earnings or losses, our stock-based compensation expense, changes in the valuation of our deferred tax assets, changes in actual results versus our estimates, or changes in tax laws, regulations, accounting principles, or interpretations thereof.

As of July 31, 2012, we had NOL carry-forwards of $164.1 million and $142.1 million for federal and state income tax purposes, respectively. We also had research and credit carry-forwards of $17.2 million for federal and $20.7 million for state income tax purposes as of July 31, 2012. During the first quarter of fiscal 2013, we generated federal income tax NOL carry-forwards of $2.6 million. During the first quarter of fiscal 2013, we generated state income tax NOL carry-forwards of $1.2 million for state income tax purposes. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain.

If not utilized, the federal and state NOL and federal tax credit carry-forwards will begin to expire between 2013 and 2023. Utilization of these NOL and credit carry-forwards may be subject to an annual limitation due to provisions of the Internal Revenue Code of 1986, as amended, that are applicable if we have experienced an “ownership change” in the past, or if an ownership change occurs in the future.

We continuously monitor the circumstances impacting the expected realization of our deferred tax assets. As of October 31, 2012, based on available positive evidence, we determined that all of our deferred tax assets would be more likely than not realizable in the near future. Deferred tax liabilities have not been recognized for undistributed earnings from our foreign subsidiaries because we expect our U.S. operations will have sufficient cash for current and future business activities. Therefore, it is our intention to indefinitely reinvest such undistributed earnings outside the U.S. in the respective foreign entities.

We recognize in the Consolidated Financial Statements only those tax positions determined to be more likely than not of being sustained. We recorded a net increase of $0.4 million to the unrecognized tax benefits related to tax positions taken in the first quarter of fiscal 2013 and no change to the liability for positions taken prior to the first quarter of fiscal 2013. Additionally we did not make any reclassifications between current taxes payable and long-term taxes payable.

 

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Liquidity and Capital Resources

 

     October 31,     July 31,  
     2012     2012  
     (in thousands)  

Working capital

   $ 382,742      $ 355,930   

Cash and cash equivalents

     157,319        133,629   

Short-term investments

   $ 220,187      $ 212,601   
     Three months ended October 31,  
     2012     2011  
     (in thousands)  

Cash provided by operating activities

   $ 36,910      $ 16,544   

Cash used in investing activities

     (13,976     (35,245

Cash provided by financing activities

   $ 737      $ 19,174   

As of October 31, 2012, our principal sources of liquidity were our cash, cash equivalents and short-term investments. Cash and cash equivalents are primarily comprised of cash, sweep funds and money market funds with an original maturity of 90 days or less at the time of the purchase. Short-term investments include corporate bonds, U.S. government agency securities, U.S. treasury bills, commercial paper, and certificates of deposit. Cash, cash equivalents and short-term investments increased $31.3 million during the first quarter of fiscal 2013 to $377.5 million as of October 31, 2012. As of October 31, 2012, we had $49.4 million of cash and cash equivalents held outside the United States. Historically, we have required capital principally to fund our working capital needs and acquisition activities. It is our investment policy to invest excess cash in a manner that preserves capital, provides liquidity and maintains appropriate diversification and optimizes current income within our policy’s framework. We are averse to principal loss and will ensure the safety and preservation of our invested funds by limiting default risk, market risk and reinvestment risk. Our investment policy is designed to prevent fluctuations in market value which materially affect our financial results.

Cash Flows from Operating Activities

Our cash flows from operating activities will continue to be affected principally by our profitability, working capital requirements, the continued growth in revenue and cash collections and the extent to which we increase spending on personnel. The timing of hiring sales personnel in particular affects cash flows as there is a lag between the hiring of sales personnel and the generation of revenue and cash flows from sales personnel. In the future, we also anticipate achieving cash tax savings and a reduction in our overall effective tax rate as a result of the new structure of our corporate organization implemented in fiscal 2012. Our largest source of operating cash flows is cash collections from our customers. Our primary uses of cash from operating activities are for personnel related expenditures, purchases of inventory, and rent payments.

During the first quarter of fiscal 2013, net cash provided by operating activities increased $20.4 million compared to the first quarter of fiscal 2012. This increase is primarily attributable to an increase from the change in operating assets and liabilities. Cash from operations after adjusting for non-cash items, including changes in deferred income taxes, stock-based compensation and the related tax benefits, is flat with the prior year period.

Cash Flows from Investing Activities

Cash used in investing activities during the first quarter of fiscal 2013 decreased $21.3 million compared to the first quarter of fiscal 2012. Although we continue to invest our excess cash balances in short-term investments, the timing of maturities and reinvestment can vary from quarter to quarter. Some of the proceeds from the sale and maturity of these investments were used to purchase property and equipment of $5.4 million during the first quarter of fiscal 2013.

Cash Flows from Financing Activities

Cash provided by financing activities decreased $18.4 million during the first quarter of fiscal 2013 compared to the first quarter of fiscal 2012. The decrease was primarily the result of the stock repurchases during the current period of $11.5 million.

Based on our current cash, cash equivalents and short-term investments we expect that we will have sufficient resources to fund our operations for the next 12 months. However, we may need to raise additional capital or incur indebtedness to fund our operations or support acquisition activity. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of expansion into new territories, the timing of introductions of new products and enhancements to existing products, and the continuing market acceptance of our products and potential future acquisitions.

 

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Contractual Obligations & Commitments

Operating leases & purchase obligations

The following is a summary of our contractual obligations & commitments:

 

     Total      Less than  1
year
     1 - 3 years      3 - 5 years      More than
5 years
 
     (in thousands)  

Operating leases

   $ 21,523       $ 4,235       $ 16,368       $ 920       $ —     

Purchase obligations (1)

   $ 35,675         25,134         7,900         600         2,041   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 57,198       $ 29,369       $ 24,268       $ 1,520       $ 2,041   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Purchasing obligations represent contractual amounts that will be due to purchase goods and services to be used in our operations, and exclude contractual amounts that are cancelable without penalty. The contractual amounts are related principally to inventory, information technology and marketing related purchase agreements. We outsource the production of our hardware to various third-party manufacturing suppliers, one of which is our main contract manufacturer. Under the agreement with our main contract manufacturer, 40% of the order quantities can be rescheduled or are cancelable by giving notice 60 days prior to the expected shipment date, and 20% of the order quantities can be rescheduled or are cancelable by giving notice 30 days prior to the expected shipment date. Orders are not cancelable within 30 days prior to the expected shipment date.

Off-Balance Sheet Arrangements

As of October 31, 2012 and July 31, 2012, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Foreign Currency Risk

Most of our sales contracts are denominated in U.S. Dollars, and therefore, our revenue is not subject to significant foreign currency risk. Our operating expenses and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British Pound, Euro, Indian Rupee, and Chinese Yuan. To date, we have not entered into any hedging contracts because expenses in foreign currencies have been insignificant, and exchange rate fluctuations have had little impact on our operating results and cash flows.

Interest Rate Sensitivity

We had cash, cash equivalents and short-term investments totaling $377.5 million and $346.2 million as of October 31, 2012, and July 31, 2012, respectively. The cash, cash equivalents and short-term investments are held for working capital purposes. We do not use derivative financial instruments in our investment portfolio. We have an investment portfolio of fixed income securities that are classified as “available-for-sale securities.” These securities, like all fixed income instruments, are subject to interest rate risk and will fall in value if market interest rates increase. We attempt to limit this exposure by investing primarily in short-term securities. Due to the short duration and conservative nature of our investment portfolio, a movement of 10% in market interest rates would not have a material impact on our operating results and the total value of the portfolio over the next fiscal year. If overall interest rates had fallen by 10% during the first quarter of fiscal 2013, our interest income on cash, cash equivalents and short-term investments would have declined approximately $0.1 million assuming consistent investment levels.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as amended (the “Exchange Act”). In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

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Based on our evaluation, our chief executive officer and chief financial officer concluded that, as of October 31, 2012, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the first quarter of fiscal 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Internal control over financial reporting means a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time, we are involved in claims and legal proceedings that arise in the ordinary course of business. We expect that the number and significance of these matters will increase as our business expands. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements which, if required, may not be available on terms favorable to us or at all. If management believes that a loss arising from these matters is probable and can be reasonably estimated, we record the amount of the loss. As additional information becomes available, any potential liability related to these matters is assessed and the estimates revised. Based on currently available information, management does not believe that the ultimate outcomes of these unresolved matters, individually and in the aggregate, are likely to have a material adverse effect on our financial position, liquidity or results of operations. However, litigation is subject to inherent uncertainties, and our view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on our financial position and results of operations or liquidity for the period in which the unfavorable outcome occurs or becomes probable, and potentially in future periods.

 

Item 1A. Risk Factors

Set forth below and elsewhere in this report, and in other documents we file with the SEC, are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report and in our other public statements. Because of the following factors, as well as other factors affecting our financial condition and operating results, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.

Risks Related to Our Business and Industry

Our business, operating results and growth rates may be adversely affected by unfavorable economic and market conditions.

Our business depends on the overall demand for IT and on the economic health and general willingness of our current and prospective customers to make capital commitments. If the conditions in the U.S., European and global economic environments remain uncertain or continue to be volatile, or if they deteriorate further, our business, operating results, and financial condition may be materially adversely affected. Economic weakness, customer financial difficulties and constrained spending on IT initiatives have resulted, and may in the future result, in challenging and delayed sales cycles and could negatively impact our ability to forecast future periods. In particular, we cannot be assured of the level of IT spending, the deterioration of which could have a material adverse effect on our results of operations and growth rates. The purchase of our products or willingness to replace existing infrastructure in some vertical markets may be discretionary and may involve a significant commitment of capital and other resources. Therefore, weak economic conditions, or a reduction in IT spending would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and services, and reduced unit sales. A reduction in IT spending could occur or persist even if economic conditions improve. In addition, if interest rates rise or foreign exchange rates weaken for our international customers, overall demand for our products and services could be further dampened, and related IT spending may be reduced. Furthermore, any increase in worldwide commodity prices may result in higher component prices and increased shipping costs, both of which may negatively impact our financial results.

 

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We compete in new and rapidly evolving markets and have a limited operating history, which makes it difficult to predict our future operating results.

We were incorporated in February 2002 and began commercial shipments of our products in June 2003. As a result of our limited operating history, it is very difficult to forecast our future operating results. In addition, we operate in an industry characterized by rapid technological change. Our prospects should be considered and evaluated in light of the risks and uncertainties frequently encountered by companies in rapidly evolving markets characterized by rapid technological change, changing customer needs, evolving industry standards and frequent introductions of new products and services. These risks and difficulties include challenges in accurate financial planning as a result of limited historical data and the uncertainties resulting from having had a relatively limited time period in which to implement and evaluate our business strategies as compared to older companies with longer operating histories.

In addition, our products are designed to be compatible with industry standards for secure communications over wireless and wireline networks. As we encounter changing standards, customer requirements and competitive pressures, we likely will be required to reposition our product and service offerings and introduce new products and services. We may not be successful in doing so in a timely and appropriately responsive manner, or at all. Our failure to address these risks and difficulties successfully could materially harm our business and operating results.

Our operating results may fluctuate significantly, which makes our future results difficult to predict and could cause our operating results to fall below expectations or our guidance.

Our annual and quarterly operating results have fluctuated in the past and may fluctuate significantly in the future, which makes it difficult for us to predict. Our operating results may fluctuate due to a variety of factors, many of which are outside of our control, including the changing and volatile U.S., European and global economic environments, any of which may cause our stock price to fluctuate. As a result, comparing our operating results on a period-to-period basis may not be meaningful. Investors should not rely on our past results as an indication of our future performance.

Furthermore, our product revenue generally reflects orders shipped in the same quarter they are received, and a substantial portion of our orders are often received in the last month of each fiscal quarter, a trend that we expect to continue. As a result, if we are unable to ship orders received in the last month of each fiscal quarter, even though we may have business indicators about customer demand during a quarter, we may experience revenue shortfalls, and such shortfalls may materially adversely affect our earnings because we may not be able to adequately and timely adjust our expense levels. For example, in our third quarter of fiscal 2012, we experienced a higher than normal percentage of orders in the third month of the quarter, which put increased pressure on our operations to fulfill orders in a timely manner. If this occurs in future quarters, our revenue performance could be affected, and we may fail to meet securities analysts’ and investors’ expectations, which may cause the price of our stock to decline.

In addition to other risk factors listed in this “Risk Factors” section, factors that may cause our operating results to fluctuate include:

 

  the impact of unfavorable worldwide economic and market conditions, including the restricted credit environment impacting the credit of our channel partners and end user customers;

 

  our ability to develop and maintain our relationships with our VARs, VADs, OEMs and other partners;

 

  fluctuations in demand, sales cycles and prices for our products and services;

 

  the amount of orders booked but not shipped in prior quarters that are shipped in the current quarter;

 

  reductions in customers’ budgets for information technology purchases and delays in their purchasing cycles;

 

  the sale of our products in the timeframes we anticipate, including the number and size of orders in each quarter;

 

  our ability to develop, introduce and ship in a timely manner, new products and product enhancements that meet customer requirements;

 

  our dependence on several large vertical markets, including the government, healthcare, retail, enterprise and education vertical markets;

 

  the timing of product releases or upgrades by us or our competitors;

 

  any significant changes in the competitive dynamics of our markets, including new entrants, or further consolidation;

 

  our ability to control costs, including our operating expenses, and the costs of the components we purchase;

 

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  product mix and average selling prices, as well as increased discounting of products by us and our competitors;

 

  the proportion of our products that are sold through direct versus indirect channels;

 

  our ability to maintain volume manufacturing pricing from our contract manufacturers and component suppliers;

 

  our contract manufacturers and component suppliers’ ability to meet our product demand forecasts;

 

  the potential need to record incremental inventory reserves for products that may become obsolete due to our new product introductions;

 

  growth in our headcount and other related costs incurred in our customer support organization;

 

  changing market conditions, including current and potential customer consolidation;

 

  any decision to increase or decrease operating expenses in response to changes in the marketplace or perceived marketplace opportunities;

 

  our ability to derive benefits from our investments in sales, marketing, engineering or other activities;

 

  volatility in our stock price, which may lead to higher stock compensation expenses;

 

  fluctuations in our effective tax rate, changes in the valuation of our deferred tax assets or liabilities, changes in actual results versus our estimates, or changes in tax laws, regulations, accounting principles, or interpretations thereof;

 

  the timing of revenue recognition in any given quarter as a result of timing of the orders meeting the relevant revenue recognition criteria;

 

  the regulatory environment for the certification and sale of our products; and

 

  seasonal demand for our products, some of which may not be currently evident due to our revenue growth during fiscal 2010, 2011 and 2012.

As a result, our quarterly operating results are difficult to predict even in the near term. In one or more future quarterly periods, our operating results may fall below the expectations of securities analysts and investors or below any guidance we may provide to the market. In this event, the trading price of our common stock could decline significantly. Such a stock price decline could occur even when we have met our publicly stated revenue and/or earnings guidance.

We expect our gross margin to vary over time and our recent level of product gross margin may not be sustainable.

Our product gross margin vary from quarter to quarter and the recent level of gross margin may not be sustainable and may be adversely affected in the future by numerous factors, including product or sales channel mix shifts, the percentage of revenue from international regions, increased price competition, increases in material or labor costs, excess product component or obsolescence charges from our contract manufacturers, write-downs for obsolete or excess inventory, increased costs due to changes in component pricing or charges incurred due to component holding periods if our forecasts do not accurately anticipate product demand, warranty-related issues, product discounting, freight charges, or our introduction of new products or new product platforms or entry into new markets with different pricing and cost structures. As a result of any of these factors, or other factors, our gross margin may be adversely affected, which in turn would harm our operating results.

Our products are highly technical and may contain undetected hardware errors or software bugs, which could cause harm to our reputation and adversely affect our business.

Our products are highly technical and complex and, when deployed, are critical to the operation of many networks. We have focused, and intend to focus in the future, on getting our new products to market quickly. Due to our rapid product introductions, defects and bugs that may be contained in our products may not have manifested. Our products have contained and may contain undetected errors, bugs or security vulnerabilities when our products are first introduced and as new versions are released. Some errors in our products may only be discovered after a product has been installed and used by customers. Any errors, bugs, defects or security vulnerabilities discovered in our products after commercial release could result in loss of revenue or delay in revenue recognition, loss of current or prospective customers, damage to our brand and reputation, reduction in the market acceptance of our new products or new versions of our products, increased development costs, incurrence of product reengineering expenses, increased inventory costs and increased service and warranty cost, any of which could adversely affect our business, operating results and financial condition. In addition, we could face claims for product liability, tort or breach of warranty, including claims relating to changes to our products made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.

 

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If we fail to manage future growth effectively, our business would be harmed.

We have expanded our operations significantly since inception and anticipate that further significant expansion will be required. We intend to increase our market penetration and extend our geographic reach through our network of channel partners. We also plan to increase offshore operations by establishing additional offshore capabilities for certain engineering and general and administrative functions. This growth has placed and, if it continues, will further place significant demands on our management, infrastructure and other resources. To manage any future growth, we will need to hire, integrate and retain highly skilled and motivated employees. We will also need to continue to improve and expand our information technology and financial infrastructure, operating and administrative systems and controls, and continue to manage headcount, capital and processes in an efficient manner. To keep pace with the growth in our business, we will be required to make significant investments in our information technology infrastructure. Further, we will continuously enhance our information technology infrastructure to address any actual or potential deficiencies in our IT systems and related control environment. We recently identified several deficiencies in our IT systems. If we fail to improve our systems and processes in general, and our information technology systems and these deficiencies in particular, to keep pace with our growth, or if our systems and processes fail to operate in the intended manner, we could experience a material weakness in our internal control over financial reporting, or be unable to manage the growth of our business, accurately forecast our revenue, expenses and earnings, or prevent certain losses. Any future growth would add complexity to our organization and require effective coordination within our organization. If we do not effectively manage our growth, our business, operating results and financial condition could be adversely affected.

If we do not achieve increased tax benefits as a result of our new corporate structure, our financial condition and operating results could be adversely affected.

We implemented a new structure of our corporate organization during the first quarter of fiscal 2012 to more closely align our corporate organization with the international nature of our business activities and to reduce our overall effective tax rate through changes in how we develop and use our intellectual property and the structure of our international procurement and sales, including by entering into transfer-pricing arrangements that establish transfer prices for our intercompany transactions. We anticipate achieving a reduction in our overall effective tax rate in the future as a result. There can be no assurance that the taxing authorities of the jurisdictions in which we operate or to which we are otherwise deemed to have sufficient tax nexus will not challenge the tax benefits that we expect to realize as a result of the new structure. In addition, future changes to U.S. or non-U.S. tax laws, including proposed legislation to reform U.S. taxation of international business activities, would negatively impact the anticipated tax benefits of the new structure. Any benefits to our tax rate will also depend on our ability to operate our business in a manner consistent with the new structure of our corporate organization and applicable taxing provisions, including by eliminating the amount of cash distributed to us by our subsidiaries. If the intended tax treatment is not accepted by the applicable taxing authorities, changes in tax law negatively impact the structure or we do not operate our business consistent with the new structure and applicable tax provisions, we may fail to achieve the financial efficiencies that we anticipate as a result of the new structure, and our future operating results and financial condition may be negatively impacted.

Changes in our tax rates could adversely affect our future results.

We are a U.S. based multinational company subject to tax in multiple U.S. and foreign tax jurisdictions. Unanticipated changes in our tax rates could affect our future results of operations. Our future effective tax rates, which are difficult to predict, could be unfavorably affected by the mix of international revenue, nondeductible stock-based compensation, changes in research and development tax credit laws, earnings being lower than anticipated in jurisdictions where we have lower statutory rates and being higher than anticipated in jurisdictions where we have higher statutory rates, transfer pricing adjustments, not meeting the terms and conditions of tax holidays or incentives, changes in the valuation of our deferred tax assets and liabilities, changes in actual results versus our estimates, or changes in tax laws, regulations, accounting principles or interpretations thereof. Further, the accounting for stock compensation expense in accordance with Accounting Standards Codification Topic 718 Stock Compensation and uncertain tax positions in accordance with Accounting Standards Codification Topic 740 Income Taxes could result in more unpredictability and variability to our future effective tax rates.

We are also subject to the periodic examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. We may underestimate the outcome of such examinations which, if significant, would have a material adverse effect on our results of operations and financial condition.

 

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In our recent history we have incurred net losses and we may not sustain profitability in the future.

We have a history of losses, with a few quarters of profitability during fiscal 2012 and 2011. We experienced net loss of $0.8 million and $0.5 million for first quarter of fiscal 2013 and fiscal 2012, respectively, net loss of $8.9 million for fiscal 2012 and net income of $70.7 million for fiscal 2011. As of October 31, 2012 and July 31, 2012, our accumulated deficit was $114.6 million and $113.8 million, respectively. Expenses associated with the continued development and expansion of our business, including expenditures to hire additional personnel for sales and marketing and technology development, could limit our ability to sustain operating profits. If we fail to increase revenue or manage our cost structure, we may not sustain profitability in the future. As a result, our business could be harmed, and our stock price could decline.

Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our sales are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate significantly.

The timing of our revenue is difficult to predict. Our sales efforts involve educating our customers about the use and benefits of our products, including the technical capabilities of our products and the potential cost savings achieved by organizations that utilize our products. Customers typically undertake a significant evaluation process, which frequently involves not only our products but also those of our competitors and can result in a lengthy sales cycle, which typically ranges four to nine months in length but can be as long as 18 months. For example, we recently introduced Aruba ClearPass, a new product that is designed to securely provision and onboard iOS, Android, Mac OS X and Windows 7 Mobile devices on any network. Because this is a new product offering, potential customers may require a lengthy evaluation period before they make a purchase decision. We spend substantial time, effort and money in our sales efforts without any assurance that our efforts will produce any sales. Even after making the decision to purchase, customers may deploy our products slowly and deliberately. In addition, product purchases are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. Specifically, we view the federal vertical as highly dependent on large transactions, and therefore we could experience fluctuations from period to period in this vertical. Customers may also defer purchases as a result of anticipated or announced releases of new products or enhancements by our competitors or by us. Product purchases could be delayed by the volatile U.S., European and global economic environments, which have introduced additional risk into our ability to accurately forecast sales in a particular quarter. If sales expected from a specific customer for a particular quarter are not realized in that quarter or at all, our business, operating results and financial condition could be materially adversely affected.

The market in which we compete is highly competitive, and competitive pressures from existing and new companies may have a material adverse effect on our business, revenue, growth rates and market share.

The market in which we compete is highly competitive and is influenced by the following competitive factors:

 

  comprehensiveness of the solution;

 

  performance of software and hardware products;

 

  ability to deploy easily into existing networks;

 

  interoperability with other devices;

 

  scalability of solution;

 

  ability to provide secure mobile access to the network;

 

  speed of mobile connectivity offering;

 

  initial price, total cost of ownership, and return-on-investment;

 

  ability to allow centralized management of products; and

 

  ability to obtain regulatory and other industry certifications.

We expect competition to intensify in the future as other companies introduce new products in the same markets we serve or intend to enter and as the market continues to consolidate. This competition could result in increased pricing pressure, reduced profit margin, increased sales and marketing expenses and failure to increase, or the loss of, market share, any of which would likely seriously harm our business, operating results or financial condition. If we do not keep pace with product and technology advances, there could be a material adverse effect on our competitive position, revenue and prospects for growth.

 

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Competitive products may in the future have better performance, more and/or better features, lower prices and broader acceptance than our products. A number of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we do. Potential customers may prefer to purchase from their existing suppliers rather than a new supplier, regardless of product performance or features. Currently, we compete with a number of large and well established public companies, including Cisco Systems (primarily through its Wireless Networking Business Unit), Hewlett-Packard and Motorola, as well as smaller companies and new market entrants, any of which could reduce our market share, require us to lower our prices, or both.

We expect increased competition from our current competitors, as well as other established and emerging companies, as our market continues to develop and expand. Our channel partners could market products and services that compete with our products and services. In addition, some of our competitors have made acquisitions or entered into partnerships or other strategic relationships with one another to offer a more comprehensive solution than they individually had offered. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry and as companies enter into partnerships or are acquired. Many of the companies driving this consolidation trend have significantly greater financial, technical and other resources than we do and are better positioned to acquire and offer complementary products and technologies. The companies resulting from these possible consolidations may create more compelling product offerings and be able to offer greater pricing flexibility, making it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs, technology or product functionality. Continued industry consolidation may adversely impact customers’ perceptions of the viability of smaller and even medium-sized technology companies and, consequently, customers’ willingness to purchase from such companies. These pressures could materially adversely affect our business, operating results and financial condition.

We sell a majority of our products through VADs, VARs, and OEMs. If these channel partners on which we rely do not perform their services adequately or efficiently, or if they exit the industry, are acquired by a competitor, or have financial difficulties, there could be a material adverse effect on our revenue and our cash flow.

Our future success is highly dependent upon establishing and maintaining successful relationships with a variety of VADs, VARs, and OEMs, which we refer to as our indirect channel. We have dedicated a significant amount of effort to increase the use of our VADs and VARs in each of our theatres of operations. The percentage of our total revenue fulfilled from sales through our indirect channel was 92.5% and 96.5% for the first quarter of fiscal 2013 and fiscal 2012, respectively. We expect that over time, indirect channel sales will continue to constitute a significant majority of our total revenue. Accordingly, our revenue depends in large part on the effective performance of our channel partners. The table below represents the percentage of total revenue from our top channel partners (*represents less than 10%):

 

     Three months ended October 31,  
     2012     2011  

ScanSource, Inc. (“Catalyst”)

     20.2     20.9

Avnet Logistics U.S. LP

     *        15.9

Our agreements with our channel partners generally provide that they use reasonable commercial efforts to sell our products on a perpetual basis unless the agreement is otherwise terminated by either party. Our agreements with our top channel partners, ScanSource, Inc., Synnex Corp, and Avnet Logistics U.S. LP, automatically renew each year for one year terms unless written notification of termination is received at least 60 days to 180 days prior to the end of the term then in effect. In addition, our agreement with ScanSource, Inc. contains a most-favored nation clause, pursuant to which we represent that the price charged and the terms offered to the channel partner will be no less favorable than those made available to other channel partners who purchase similar quantities. However, the scope of such most-favored nation clause is narrow and specific, and we have not to date incurred any obligations related to such term in the agreement.

 

 

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Some of our indirect channel partners may have insufficient financial resources and may not be able to withstand changes in worldwide business conditions, including economic downturns, abide by our inventory and credit requirements, or have the ability to meet their financial obligations to us. The table below represents the percentage of total accounts receivable from our top channel partners (*represents less than 10%):

 

     October 31,     July 31,  
     2012     2012  

ScanSource, Inc. (“Catalyst”)

     24.1     15.7

Synnex Corp.

     13.1     *   

Avnet Logistics U.S. LP

     *        19.0

If the indirect channel partners on which we rely do not perform their services adequately or efficiently, fail to meet their obligations to us, or if they exit the industry and we are not able to quickly find adequate replacements, there could be a material adverse effect on our revenue, cash flow and market share. By relying on these indirect channels, we may have less contact with the end users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing customer requirements and respond to evolving customer needs. In addition, our indirect channel partners may receive pricing terms that allow for volume discounts off of list prices for the products they purchase from us, which reduce our margin to the extent revenue from such channel partners increases as a proportion of our overall revenue.

Recruiting and retaining qualified channel partners and training them in our technology and product offerings requires significant time and resources. In order to develop and expand our distribution channel, we must continue to scale and improve our processes and procedures that support our channel partners, including investment in systems and training, and those processes and procedures may become increasingly complex and difficult to manage. We have no minimum purchase commitments with any of our VADs, VARs, or OEMs, and our contracts with these channel partners do not prohibit them from offering products or services that compete with ours or from terminating our contract on short notice. Our competitors may be effective in providing incentives to existing and potential channel partners to favor their products or to prevent or reduce sales of our products. Our channel partners may choose not to focus primarily on the sale of our products or offer our products at all. Our failure to establish and maintain successful relationships with indirect channel partners would likely materially adversely affect our business, operating results and financial condition.

We depend upon the development of new products and enhancements to our existing products. If we fail to predict and respond to emerging technological trends and our customers’ changing needs, we may not be able to remain competitive.

We may not be able to anticipate future market needs or be able to develop new products or product enhancements to meet such needs, either on a timely basis or at all. For example, we anticipate a need to continue to increase the mobility of our solution, and certain customers have delayed, and may in the future delay, purchases of our products until either new versions of those products are available or the customer evaluations are completed. If we fail to develop new products or product enhancements, our business could be adversely affected, especially if our competitors are able to introduce solutions with such increased functionality. In addition, as new mobile applications are introduced, our success may depend on our ability to provide a solution that supports these applications.

We are active in the research and development of new products and technologies and enhancing our current products. However, research and development in the enterprise mobility industry is complex and filled with uncertainty. If we expend a significant amount of resources on research and development and our efforts do not lead to the successful introduction of high quality products that are competitive in the marketplace, there could be a material adverse effect on our business, operating results, financial condition and market share. In addition, it is common for research and development projects to encounter delays due to unforeseen problems, resulting in low initial volume production, fewer product features than originally considered desirable and higher production costs than initially budgeted, which may result in lost market opportunities. In addition, any new products or product enhancements that we introduce may not achieve any significant degree of market acceptance or be accepted into our sales channel by our channel partners. There could be a material adverse effect on our business, operating results, financial condition and market share due to such delays or deficiencies in the development, quality, manufacturing and delivery of new products.

Once a product is in the marketplace, its selling price often decreases over the life of the product, especially after a new competitive product is publicly announced. To lessen the effect of price decreases, our product management team attempts to reduce development and manufacturing costs in order to maintain or improve our margin. However, if cost reductions do not occur in a timely manner, there could be a material adverse effect on our operating results and market share. Further, the introduction of new products may decrease the demand for older products currently included in our inventory balances. As a result, we may need to record incremental inventory reserves for the older products that we do not expect to sell. This may have a material adverse effect on our operating results and market share.

We manufacture our products to comply with standards established by various standards bodies, including the Institute of Electrical and Electronics Engineers, Inc. (“IEEE”). If we are not able to adapt to new or changing standards that are ratified by these bodies, our ability to sell our products may be adversely affected. For example, prior to the ratification of the 802.11n wireless LAN standard (“11n”) by the IEEE in 2009, we had been developing and were offering for sale products that complied with the draft standard that the IEEE had not yet ratified. Although the IEEE ratified the 11n standard and did not modify the draft of the 11n standard, the IEEE could modify the standard in the future. We remain subject to any changes adopted by various standards bodies, which would require us to modify our products to comply with the new standards, require additional time and expense and could cause a disruption in our ability to market and sell the affected products.

 

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We may engage in future acquisitions that could disrupt our business, cause dilution to our stockholders and harm our business, operating results and financial condition.

In the future we may acquire businesses, products or technologies. However, we may not be able to find suitable acquisition candidates, and we may not be able to complete acquisitions on favorable terms, if at all. If we do complete acquisitions, we may not ultimately strengthen our competitive position or achieve our goals. These acquisitions and any future acquisitions may be viewed negatively by customers, financial markets or investors. In addition, these acquisitions and any future acquisitions that we may make could lead to difficulties in integrating personnel and operations from the acquired businesses and in retaining and motivating key personnel from these businesses. We may also encounter difficulties in maintaining uniform standards, controls, procedures and policies across locations, or in managing geographically or culturally diverse locations. We may experience significant problems with acquired or integrated product quality. We may also experience significant liabilities associated with acquired or integrated technology. Acquisitions may disrupt our ongoing operations, divert management from day-to-day responsibilities, increase our expenses and adversely impact our business, operating results and financial condition. Future acquisitions may reduce our cash available for operations and other uses and could result in an increase in amortization expense related to identifiable assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt, which could harm our business, operating results and financial condition.

As a result of the fact that we outsource the manufacturing of our products to contract manufacturers, we do not have the ability to ensure quality control over the manufacturing process. Furthermore, if there are significant changes in the financial or business condition of our contract manufacturers, our ability to supply quality products to our customers may be disrupted.

As a result of the fact that we outsource the manufacturing of our products to contract manufacturers, we are subject to the risk of supplier failure and customer dissatisfaction with the quality or performance of our products. Quality or performance failures of our products or changes in the financial or business condition of our contract manufacturers could disrupt our ability to supply quality products to our customers and thereby have a material adverse effect on our business, revenue and financial condition.

We rely on purchase orders or long-term contracts with our contract manufacturers. Some of our contract manufacturers are not obligated to supply products to us for any specific period, in any specific quantity or at any specific price. Our orders with our contract manufacturers represent a relatively small percentage of the overall orders received by them from their customers. As a result, fulfilling our orders may not be considered a priority in the event our contract manufacturers are constrained in their abilities to fulfill all of their customer obligations in a timely manner. We provide demand forecasts to our contract manufacturers. To the extent that any such demand forecast is binding, if we overestimate our requirements, our contract manufacturers may assess charges, or we may have liabilities for excess inventory, each of which could negatively affect our gross margin. Conversely, because lead times for required materials and components vary significantly and depend on factors such as the specific supplier, contract terms and the demand for each component at a given time, if we underestimate our requirements, our contract manufacturers may have inadequate materials and components required to produce our products. This could result in an interruption of the manufacturing of our products, delays in shipments and deferral or loss of revenue. In addition, on occasion we have underestimated our requirements, and, as a result, we have been required to pay additional fees to our contract manufacturers in order for manufacturing to be completed and shipments to be made on a timely basis.

It is time consuming and costly to qualify and implement contract manufacturer relationships. If any of our contract manufacturers suffer an interruption in their business, or experiences delays, disruptions or quality control problems in their manufacturing operations, or we have to change or add additional contract manufacturers, our ability to ship products to our customers would be delayed, and our business, operating results and financial condition would be adversely affected. In addition, the majority of our manufacturing is performed overseas and is therefore subject to risks associated with doing business in other countries.

Our contract manufacturers purchase some components, subassemblies and products from a single supplier or a limited number of suppliers, and with respect to some of these suppliers, we have entered into license agreements that allow us to use their components in our products. The loss of any of these suppliers or the termination of any of these license agreements may cause us to incur additional set-up costs, result in delays in manufacturing and delivering our products, or cause us to carry excess or obsolete inventory.

Shortages in components that we use in our products are possible, and our ability to predict the availability of such components may be limited. While components and supplies are generally available from a variety of sources, we currently depend on a limited number of suppliers for several components for our equipment and certain subassemblies and products. We rely on our contract manufacturers to obtain the components, subassemblies and products necessary for the manufacture of our products, including those components, subassemblies and products that are only available from a single supplier or a limited number of suppliers.

 

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For example, our solution incorporates both software products and hardware products, including a series of high-performance programmable mobility controllers and a line of wired and wireless access points. The chipsets that our contract manufacturers source and incorporate in our hardware products are currently available only from a limited number of suppliers, with whom neither we nor our contract manufacturers have entered into supply agreements. All of our access points incorporate components from Atheros, and some of our mobility controllers incorporate components from Broadcom Corporation (“Broadcom”) and Netlogic Microsystems Inc. (“Netlogic”). We have entered into license agreements with Atheros, Broadcom and Netlogic, the termination of which could have a material adverse effect on our business. Our license agreements with Atheros, Broadcom and Netlogic have perpetual terms in that they will automatically be renewed for successive one-year periods unless the agreement is terminated prior to the end of the then-current term. As there are no other sources for identical components, in the event that our contract manufacturers are unable to obtain these components from Atheros, Broadcom or Netlogic, we would be required to redesign our hardware and software in order to incorporate components from alternative sources. All of our product revenue is dependent upon the sale of products that incorporate components from Atheros, Broadcom or Netlogic.

In addition, increased demand by third parties for the components, subassemblies and products we use in our products may lead to decreased availability and higher prices for those components, subassemblies and products. For certain components, subassemblies and products for which there are multiple sources, we are still subject to potential price increases and limited availability due to market demand for such components, subassemblies and products. In the past, unexpected demand for communication products caused worldwide shortages of certain electronic parts. If such shortages occur in the future, our business would be adversely affected. We carry very little to no inventory of our product components, and we and our contract manufacturers rely on our suppliers to deliver necessary components in a timely manner. We and our contract manufacturers rely on purchase orders rather than long-term contracts with these suppliers. As a result, even if available, we or our contract manufacturers may not be able to secure sufficient components at reasonable prices or of acceptable quality to build products in a timely manner and, therefore, may not be able to meet customer demands for our products, which would have a material adverse effect on our business, operating results and financial condition.

Our international sales and operations subject us to additional risks that may adversely affect our operating results.

We derive a significant portion of our revenue from customers outside the United States. We have sales and technical support personnel in numerous countries worldwide. In addition, our product configuration and fulfillment are handled in Singapore and a portion of our engineering and order management efforts are currently handled by personnel located in India and China, and we expect to expand our offshore development efforts within India and China and possibly in other countries. We expect to continue to add personnel in additional countries. Our international operations subject us to a variety of risks, including:

 

   

the difficulty and cost of managing and staffing international offices and the increased travel, infrastructure and legal compliance costs associated with multiple international locations;

 

   

the difficulty in enforcing contracts and collecting accounts receivable, and longer payment cycles, especially in emerging markets;

 

   

the need to localize our products for international customers;

 

   

unfavorable changes in tax treaties or laws;

 

   

tariffs and trade barriers, export regulations and other regulatory or contractual limitations on our ability to sell or develop our products in certain foreign markets;

 

   

increased exposure to foreign currency exchange rate risk;

 

   

increased exposure to political and economic instability, war and terrorism;

 

   

limited protection for intellectual property rights in some countries; and

 

   

increased cost of terminating international employees in some countries.

Moreover, local laws and customs in many countries differ significantly from those in the United States. In many foreign countries, particularly in those with developing economies, it is common for others to engage in business practices that are prohibited by our internal policies and procedures or U.S. regulations applicable to us. There can be no assurance that our employees, contractors, and agents will not take actions in violation of our policies and procedures, which are designed to ensure compliance with U.S. and foreign laws and policies. Violations of laws or key control policies by our employees, contractors, or agents could result in financial reporting problems, fines, penalties, or prohibition on the importation or exportation of our products, and could have a material adverse effect on our business, financial condition and results of operations.

 

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Foreign currencies periodically experience rapid fluctuations in value against the U.S. dollar. Any foreign currency devaluation against the U.S. dollar increases the real cost of our products to our customers and partners in foreign markets where we sell in U.S. dollars, which has resulted in the past and may result in the future in delayed or cancelled purchases of our products and, as a result, lower revenue. In addition, this increase in cost increases the risk to us that we will be unable to collect amounts owed to us by such customers or partners, which in turn would impact our revenue and could materially adversely impact our business and financial results. Any devaluation may also lead us to more aggressively discount our prices in foreign markets in order to maintain competitive pricing, which would negatively impact our revenue and gross margin. Conversely, a weakened U.S. dollar could increase the cost of local operating expenses and procurement of raw materials to the extent we purchase components in foreign currencies.

As we continue to expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Our failure to manage any of these risks successfully could harm our international operations and reduce our international sales, adversely affecting our business, operating results and financial condition.

If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.

We depend on our ability to protect our proprietary technology. We protect our proprietary information and technology through licensing agreements, third-party nondisclosure agreements and other contractual provisions, as well as through patent, trademark, copyright and trade secret laws in the United States and similar laws in other countries. There can be no assurance that these protections will be available in all cases or will be adequate to prevent our competitors from copying, reverse engineering or otherwise obtaining and using our technology, proprietary rights or products. For example, the laws of certain countries in which our products are manufactured or licensed do not protect our proprietary rights to the same extent as the laws of the United States. In addition, third parties may seek to challenge, invalidate or circumvent our patents, trademarks, copyrights and trade secrets, or applications for any of the foregoing. There can be no assurance that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology or design around our proprietary rights. In each case, our ability to compete could be significantly impaired. To prevent substantial unauthorized use of our intellectual property rights, it may be necessary to prosecute actions for infringement and/or misappropriation of our proprietary rights against third parties. Any such action could result in significant costs and diversion of our resources and management’s attention, and there can be no assurance that we will be successful in such action. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property.

Claims by others that we infringe their intellectual property rights could harm our business.

Third parties have asserted and may in the future assert claims of infringement of intellectual property rights against us or against our customers or channel partners for which we may be liable. Due to the rapid pace of technological change in our industry, much of our business and many of our products rely on proprietary technologies of third parties, and we may not be able to obtain, or continue to obtain, licenses from such third parties on reasonable terms. Technology companies frequently enter into litigation based on allegations of patent infringement or other violations of intellectual property rights. In addition, patent holding companies seek to monetize patents they have purchased or otherwise obtained. As our business expands and the number of products and competitors in our market increases and overlaps occur, we expect that infringement claims may increase in number and significance. Intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we cannot be certain that we will be successful in defending ourselves against intellectual property claims. Furthermore, a successful claimant could secure a judgment that requires us to pay substantial damages or prevents us from distributing certain products or performing certain services. In addition, we might be required to seek a license for the use of such intellectual property, which may not be available on commercially acceptable terms or at all. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements.

 

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Impairment of our goodwill or other assets would negatively affect our results of operations.

Our acquisitions have resulted in total goodwill of $56.9 million and intangible assets of $25.1 million as of October 31, 2012. Goodwill is reviewed for impairment at least annually or sooner under certain circumstances. Other intangible assets that are deemed to have finite useful lives are amortized over their useful lives but must be reviewed for impairment when events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Screening for and assessing whether impairment indicators exist, or if events or changes in circumstances have occurred, including market conditions, operating fundamentals, competition and general economic conditions, requires significant judgment. Therefore, we cannot assure investors that a charge to operations will not occur as a result of future goodwill and intangible asset impairment tests. If impairment is deemed to exist, we would write down the recorded value of these intangible assets to their fair values. If and when these write-downs do occur, they could harm our business, financial condition, and results of operations.

If we lose members of our senior management or are unable to recruit and retain key employees on a cost-effective basis, or if we fail to effectively integrate new officers or key personnel into our organization, our business could be harmed.

Our success is substantially dependent upon the performance of our senior management. All of our executive officers are at-will employees, and we do not maintain any key-man life insurance policies. The loss of the services of any members of our management team may significantly delay or prevent the achievement of our product development and other business objectives and could harm our business. Our success also is substantially dependent upon our ability to attract additional personnel for all areas of our organization, particularly in our sales, research and development, and customer service departments. Experienced management and technical, sales, marketing and support personnel in the IT industry are in high demand, and competition for their talents is intense. Additionally, fluctuations or a sustained decrease in the price of our stock could affect our ability to attract and retain such personnel. When our stock price declines, our equity incentive awards may lose retention value, which may negatively affect our ability to attract and retain such personnel. We may not be successful in attracting and retaining such personnel on a timely basis, on competitive terms, or at all. The loss of, or the inability to recruit, such employees could have a material adverse effect on our business.

Our future performance will depend in part on our ability to successfully integrate any new executive officers or key personnel into our management team and develop an effective working relationship among senior management. When key personnel depart the company, we have needed to transition their responsibilities to both current and new employees within the organization. If we fail to integrate any executive officer or key personnel whom we may hire in the future, and create effective working relationships among them and other members of management, our business operating results and financial condition could be adversely affected.

Our ability to sell our products is highly dependent on the quality of our support and services offerings, and our failure to offer high quality support and services would have a material adverse effect on our sales and results of operations.

Once our products are deployed within our end customers’ networks, our customers depend on our support organization to resolve any issues relating to our products. A high level of support is critical for the successful marketing and sale of our products. If we or our channel partners do not effectively assist our end customers in deploying our products, succeed in helping our end customers quickly resolve post-deployment issues, or provide effective ongoing support, it would adversely affect our ability to sell our products to existing customers and could harm our reputation with potential customers. In addition, as we expand our operations internationally, our support organization will face additional challenges, including those associated with delivering support, training and documentation in languages other than English. As a result, our failure, or the failure of our channel partners, to maintain high quality support and services would have a material adverse effect on our business, operating results and financial condition.

Enterprises are increasingly concerned with the security of their data, and to the extent they elect to encrypt data between the end user and the server, our products will become less effective.

Our products depend on the ability to identify applications. Our products currently do not identify applications if the data is encrypted as it passes through our mobility controllers. Since most organizations currently encrypt most of their data transmissions only between sites and not on the LAN, the data is not encrypted when it passes through our mobility controllers. If more organizations elect to encrypt their data transmissions from the end user to the server, our products will offer limited benefits unless we have been successful in incorporating additional functionality into our products that address those encrypted transmissions. At the same time, if our products do not provide the level of network security expected by our customers, our reputation and brand would be damaged, and we would expect to experience decreased sales. Our failure to provide such additional functionality and expected level of network security could adversely affect our business, operating results and financial condition.

Our use of open source software could impose limitations on our ability to commercialize our products.

We incorporate open source software into our products. Although we monitor our use of open source closely, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. We could also be subject to similar conditions or restrictions should there be any changes in the licensing terms of the open source software incorporated into our products. In either event, we could be required to seek licenses from third parties in order to continue offering our products, to re-engineer our products or to discontinue the sale of our products in the event re-engineering cannot be accomplished on a timely basis, any of which could adversely affect our business, operating results and financial condition.

 

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We rely on the availability of third-party licenses.

Many of our products are designed to include software or other intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various aspects of these products. There can be no assurance that the necessary licenses would be available on acceptable terms, if at all. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could have a material adverse effect on our business, operating results, and financial condition. Moreover, the inclusion in our products of software or other intellectual property licensed from third parties on a nonexclusive basis could limit our ability to protect our proprietary rights in our products.

Enterprises may have slow WAN connections between some of their locations that may cause our products to become less effective.

Our mobility controllers and network management software were initially designed to function at LAN-like speeds in an office building or campus environment. In order to function appropriately, our mobility controllers synchronize with each other over network links. The ability of our products to synchronize may be limited by slow or congested data-links, including digital subscriber line (“DSL”) and dial-up. Our failure to provide such additional functionality could adversely affect our business, operating results and financial condition.

New regulations or changes in existing regulations related to our products may result in unanticipated costs or liabilities, which could have a material adverse effect on our business, results of operations and future sales, and could place additional burdens on the operations of our business.

Our products are subject to governmental regulations in a variety of jurisdictions. If any of our products becomes subject to new regulations or if any of our products becomes specifically regulated by additional government entities, compliance with such regulations could become more burdensome, and there could be a material adverse effect on our business and results of operations. For example, radio emissions are subject to regulation in the United States and in other countries in which we do business. In the United States, various federal agencies including the Center for Devices and Radiological Health of the Food and Drug Administration, the Federal Communications Commission, the Occupational Safety and Health Administration and various state agencies have promulgated regulations that concern the use of radio/electromagnetic emissions standards. Member countries of the European Union (“EU”) have enacted similar standards concerning electrical safety and electromagnetic compatibility and emissions, and chemical substances and use standards.

If any of our products becomes subject to new regulations or if any of our products becomes specifically regulated by additional government entities, compliance with such regulations could become more burdensome, and there could be a material adverse effect on our business and our results of operations.

In addition, our wireless communication products operate through the transmission of radio signals. Currently, operation of these products in specified frequency bands does not require licensing by regulatory authorities. Regulatory changes restricting the use of frequency bands or allocating available frequencies could become more burdensome and could have a material adverse effect on our business, results of operations and future sales.

Compliance with environmental matters and worker health and safety laws could be costly, and noncompliance with these laws could have a material adverse effect on our results of operations, expenses and financial condition.

Some of our operations use substances regulated under various federal, state, local and international laws governing the environment and worker health and safety, including those governing the discharge of pollutants into the ground, air and water, the management and disposal of hazardous substances and wastes, and the cleanup of contaminated sites. Some of our products are subject to various federal, state, local and international laws governing chemical substances in electronic products. We could be subject to increased costs, fines, civil or criminal sanctions, third-party property damage or personal injury claims if we violate or become liable under environmental and/or worker health and safety laws.

In addition, rules adopted by the SEC implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act impose diligence and disclosure requirements regarding the use of “conflict” minerals mined from the Democratic Republic of Congo and adjoining countries in our products. Compliance with these rules is likely to result in additional cost and expense, including for due diligence to determine and verify the sources of any conflict minerals used in our products, in addition to the cost of remediation and other changes to products, processes, or sources of supply as a consequence of such verification activities. These rules may also affect the sourcing and availability of minerals used in the manufacture of our products, as there may be only a limited number of suppliers offering “conflict free” metals that can be used in our products.

 

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We are subject to governmental export and import controls that could subject us to liability or impair our ability to compete in international markets.

Because we incorporate encryption technology into our products, our products are subject to U.S. export controls and may be exported outside the United States only with the required level of export license or through an export license exception. In addition, various countries regulate the import of certain encryption technology and radio frequency transmission equipment and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in export and import regulations may increase the cost of building and selling our products, create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. Any decreased use of our products or limitation on our ability to export or sell our products would harm our business, operating results and financial condition.

We incur significant costs as a result of operating as a public company, and our Board of Directors and management devote substantial time to compliance initiatives.

We incur significant legal, accounting and other expenses as a public company, including costs resulting from regulations regarding corporate governance practices and costs relating to compliance with the Sarbanes-Oxley Act. For example, the listing requirements of the Nasdaq Stock Market’s Global Select Market require that we satisfy certain corporate governance requirements relating to independent directors, audit committees, distribution of annual and interim reports, stockholder meetings, stockholder approvals, solicitation of proxies, conflicts of interest, stockholder voting rights and codes of conduct. In addition, the Dodd-Frank Wall Street Reform and Consumer Protection Act contains various provisions applicable to the corporate governance functions of public companies. Our Board of Directors, management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations have increased our legal and financial compliance costs and will make some activities more time consuming and costly. Moreover, these rules and regulations and their associated costs both in terms of time and expense could make it more difficult for us to attract, recruit and retain qualified persons to serve on our Board of Directors, our board committees or as executive officers or other key personnel.

Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by manmade problems such as computer viruses or terrorism.

Our corporate headquarters are located in the San Francisco Bay Area, a region known for seismic activity. A significant natural disaster, such as an earthquake, fire or a flood, occurring at our headquarters or in either China or Singapore, where our major contract manufacturers are located, could have a material adverse impact on our business, operating results and financial condition. In addition, our support operations are largely concentrated in a single location in India. A natural catastrophe in this location can bring down our support operation. Our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. In addition, natural disasters, acts of terrorism or war could cause disruptions in our or our customers’ businesses or the economy as a whole. We also rely on information technology systems to communicate among our workforce and with third parties. Any disruption to our communications, whether caused by a natural disaster or by manmade problems, such as power disruptions, could adversely affect our business. To the extent that any such disruptions result in delays or cancellations of customer orders, or the deployment of our products, our business, operating results and financial condition would be adversely affected.

Risks Related to Ownership of our Common Stock

Our stock price may be volatile.

The trading price of our common stock has been and may continue to be volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. Factors that could affect the trading price of our common stock could include:

 

   

variations in our operating results;

 

   

announcements of technological innovations, new products or product enhancements, strategic alliances or significant agreements by us or by our competitors;

 

   

the gain or loss of significant customers;

 

   

recruitment or departure of key personnel;

 

   

the impact of unfavorable worldwide economic and market conditions;

 

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variations between our actual financial results and the published expectations of analysts;

 

   

developments or disputes concerning our intellectual property or other proprietary rights;

 

   

commencement of, or our involvement in, litigation;

 

   

announcements by or about us regarding events or news adverse to our business;

 

   

the loss or bankruptcy of any of our major customers, distribution partners or suppliers;

 

   

variations in the operating results of other publicly traded corporations deemed by investors to be in our peer group;

 

   

an announced acquisition of or by a competitor, or an announced acquisition of or by us;

 

   

rumors and market speculation involving us or other companies in our industry;

 

   

providing estimates of our future operating results, or changes in these estimates, either by us or by any securities analysts who follow our common stock, or changes in recommendations by any securities analysts who follow our common stock;

 

   

significant sales, or announcement of significant sales, of our common stock by us or our stockholders;

 

   

adoption or modification of regulations, policies, procedures or programs applicable to our business; and

 

   

other events or factors, including those resulting from war, incidents of terrorism or responses to these events.

In addition, the stock market in general, and the market for technology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may seriously affect the market price of our common stock, regardless of our actual operating performance. In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources. All of these factors could cause the market price of our common stock to decline, and investors may lose some or all of the value of their investment.

If securities or industry analysts do not publish research or reports about our business, or if they issue an adverse or misleading opinion regarding our stock, our stock price and trading volume could decline.

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If any of the analysts who cover us issue an adverse or misleading opinion regarding our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

We may choose to raise additional capital. Such capital may not be available, or may be available on unfavorable terms, which may dilute the ownership of our common stock.

If we choose to raise additional funds through public or private debt or equity financings, due to unforeseen circumstances or material expenditures, we cannot be certain that we will be able to obtain additional financing on favorable terms, if at all, and any additional financings could result in additional dilution to our existing stockholders. In addition, capital raised through debt financing may require us to make periodic interest payments and may impose potentially restrictive covenants on the conduct of our business.

Provisions in our charter documents, Delaware law, employment arrangements with certain of our executives, and our OEM supply agreement with Alcatel-Lucent could discourage a takeover that stockholders may consider favorable.

Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

 

   

our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;

 

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our stockholders may not act by written consent or call special stockholders’ meetings; as a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions other than at annual stockholders’ meetings or special stockholders’ meetings called by the board of directors, the chairman of the board, the Chief Executive Officer or the president;

 

   

our certificate of incorporation prohibits cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;

 

   

stockholders must provide advance notice and additional disclosures in order to nominate individuals for election to the board of directors or to propose matters that can be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of our company; and

 

   

our board of directors may issue, without stockholder approval, shares of undesignated preferred stock; the ability to issue undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us.

As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us.

Certain of our executives may be entitled to accelerated vesting of their stock options pursuant to the terms of their employment arrangements upon a change of control of our company. In addition to the arrangements currently in place with some of our executives, we may enter into similar arrangements in the future with other executives. Such arrangements could delay or discourage a potential acquisition of our company.

In addition, our OEM supply agreement with Alcatel-Lucent provides that, in the event of a change of control that would cause Alcatel-Lucent to purchase our products from an entity that is an Alcatel-Lucent competitor, we must, without additional consideration, (1) provide Alcatel-Lucent with any information required by Alcatel-Lucent to make, test and support the products that we distribute through our OEM relationship with Alcatel-Lucent, including all hardware designs and software source code, and (2) otherwise cooperate with Alcatel-Lucent to transition the manufacturing, testing and support of these products to Alcatel-Lucent. We are also obligated to promptly inform Alcatel-Lucent if and when we receive an inquiry concerning a bona fide proposal or offer to effect a change of control and will not enter into negotiations concerning a change of control without such prior notice to Alcatel-Lucent. Each of these provisions could delay or result in a discount to the proceeds our stockholders would otherwise receive upon a change of control or could discourage a third party from making a change of control offer.

We are required to evaluate our internal control over financial reporting under the Sarbanes-Oxley Act of 2002 and any adverse results from such evaluation could result in a loss of investor confidence in our financial reports and have an adverse effect on our stock price.

The Sarbanes-Oxley Act requires us to furnish a report by our management on our internal control over financial reporting. Such report contains, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. While we were able to assert in our Form 10-K for the year ended July 31, 2012, filed on October 11, 2012, that our internal control over financial reporting was effective as of July 31, 2012, we had to delay the filing of our Form 10-K for the year ended July 31, 2012 as we were not able to timely complete our assessment of the review, analysis and testing of the design and operating effectiveness of our internal control over financial reporting as a result of several deficiencies identified in our IT systems, which we are currently in the process of remediating. We must continue to monitor, enhance and assess our internal control over financial reporting. If we are unable to assert in any future reporting period that our internal control over financial reporting is effective (or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our stock price.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) Sales of Unregistered Securities

None.

 

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(b) Purchases of Equity Securities by the Issuer and Affiliated Purchasers

On June 13, 2012, we announced a stock repurchase program for up to $100.0 million of our common stock. We are authorized to make repurchases in the open market until June 6, 2014, and any such repurchases will be funded from available working capital. The number of share repurchases and the timing of repurchases are based on the price of our common stock, general business and market conditions, and other investment considerations. Shares are retired upon repurchase. Our policy related to repurchases of our common stock is to charge any excess of cost over par value entirely to additional paid-in capital.

During the three months ended October 31, 2012, we repurchased a total of 590,141 shares for a total purchase price of $11.5 million. As of October 31, 2012, we repurchased a cumulative total of 1,998,645 shares for a total purchase price of $31.4 million, with $68.6 million remaining authorized under the stock repurchase program.

Common stock repurchase activity under our repurchase program during the first quarter of fiscal 2013 was as follows (in thousands, except per share amounts):

 

                          Maximum Approximate  
            Average Price      Total Number of      Dollar Value of Shares  
     Total Number of      Paid      Shares Purchased As Part      That May Yet Be Purchased  
     Shares Purchased      Per Share      of Publicly Announced Program      Under the Program  
     (in thousand, except per share price)  

Period

           

August 1, 2012—August 31, 2012

     —         $ —           —         $  80,115   

September 1, 2012—September 30, 2012

     79,437         19.96         79,437         78,529   

October 1, 2012—October 31, 2012

     510,704         19.44         510,704         68,603   
  

 

 

    

 

 

    

 

 

    

Total

     590,141       $ 19.51         590,141      
  

 

 

    

 

 

    

 

 

    

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 4. Mine Safety Disclosure

Not applicable.

 

Item 5. Other Information

None.

 

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Item 6. Exhibits

 

10.1   Addendum to Manufacturing Agreement, effective as of January 16, 2012, between Registrant and SerComm Corporation (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q, Commission File No. 001-33347, filed on June 7, 2012)
10.2†   Distributor Agreement (Stocking), effective as of September 29, 2011, between Registrant and SYNNEX Corporation (the “Synnex Distributor Agreement”)
10.3†   Amendment to the Synnex Distributor Agreement, dated as of April 11, 2012, between Registrant and SYNNEX Corporation
10.4†   Amendment No. 2 to the Synnex Distributor Agreement, dated as of November 12, 2012, between Registrant and SYNNEX Corporation
31.1   Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
31.2   Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1+   Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS+   XBRL Instance Document
101.SCH+   XBRL Taxonomy Extension Schema Document
101.DEF+   XBRL Taxonomy Extension Definition Linkbase Document
101.CAL+   XBRL Taxonomy Calculation Linkbase Document
101.LAB+   XBRL Taxonomy Label Linkbase Document
101.PRE+   XBRL Taxonomy Extension Presentation Linkbase Document

 

Confidential treatment has been requested for portions of this exhibit.

 

+ Furnished and not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Aruba Networks, Inc. under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: December 7, 2012

 

ARUBA NETWORKS, INC.

By:

  /s/ Dominic P. Orr
 

 

  Dominic P. Orr
 

President and Chief Executive Officer

(Principal Executive Officer)

Dated: December 7, 2012

 

ARUBA NETWORKS, INC.

By:

  /s/ Michael M. Galvin
 

 

  Michael M. Galvin
 

Chief Financial Officer

(Principal Financial Officer)

 

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EXHIBIT INDEX

 

10.1    Addendum to Manufacturing Agreement, effective as of January 16, 2012, between Registrant and SerComm Corporation (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q, Commission File No. 001-33347, filed on June 7, 2012)
10.2†    Distributor Agreement (Stocking), effective as of September 29, 2011, between Registrant and SYNNEX Corporation (the “Synnex Distributor Agreement”)
10.3†    Amendment to the Synnex Distributor Agreement, dated as of April 11, 2012, between Registrant and SYNNEX Corporation
10.4†    Amendment No. 2 to the Synnex Distributor Agreement, dated as of November 12, 2012, between Registrant and SYNNEX Corporation
31.1    Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
31.2    Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 +    Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS +    XBRL Instance Document
101.SCH +    XBRL Taxonomy Extension Schema Document
101.DEF +    XBRL Taxonomy Extension Definition Linkbase Document
101.CAL +    XBRL Taxonomy Calculation Linkbase Document
101.LAB +    XBRL Taxonomy Label Linkbase Document
101.PRE +    XBRL Taxonomy Extension Presentation Linkbase Document

 

Confidential treatment has been requested for portions of this exhibit.

 

+ Furnished and not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Aruba Networks, Inc. under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

 

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