Form 10-Q
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2009
OR
     
o   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   (I.R.S. Employer
Incorporation or Organization)   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 þ No o
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 o No o
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 o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a 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 o No þ
The number of shares of the registrant’s common stock, par value $0.0001, outstanding as of June 4, 2009 was 86,369,266.
 
 

 

 


 

ARUBA NETWORKS INC.
INDEX
         
    Page No.  
 
       
PART I. FINANCIAL INFORMATION
       
 
       
       
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    19  
 
       
    32  
 
       
    32  
 
       
       
 
       
    33  
 
       
    33  
 
       
    46  
 
       
    46  
 
       
    46  
 
       
    46  
 
       
    46  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1

 

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Table of Contents

Item 1 — Consolidated Financial Statements
ARUBA NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
                 
    April 30,     July 31,  
    2009     2008  
    (in thousands, except per share data)  
ASSETS
               
Current assets
               
Cash and cash equivalents
  $ 34,777     $ 37,602  
Short-term investments
    77,006       64,130  
Accounts receivable, net
    30,733       32,679  
Inventory
    12,318       11,644  
Deferred costs
    2,754       4,317  
Prepaids and other
    2,128       3,196  
 
           
 
               
Total current assets
    159,716       153,568  
 
               
Property and equipment, net
    7,773       7,181  
Goodwill
    7,656       7,656  
Intangible assets, net
    15,325       19,027  
Deferred costs
    39       239  
Other assets
    1,159       1,130  
 
           
 
               
Total assets
  $ 191,668     $ 188,801  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities
               
Accounts payable
  $ 4,364     $ 5,844  
Accrued liabilities
    20,195       16,908  
Income taxes payable
    394       576  
Deferred revenue
    24,610       27,143  
 
           
 
               
Total current liabilities
    49,563       50,471  
 
               
Deferred revenue
    7,342       7,338  
Other long-term liabilities
    51       117  
 
           
 
               
Total liabilities
    56,956       57,926  
 
           
 
               
Commitments and contingencies (Note 13)
               
Stockholders’ equity
               
Preferred stock: $0.0001 par value; 10,000 shares authorized at April 30, 2009 and July 31, 2008, no shares issued and outstanding at April 30, 2009 and July 31, 2008
           
Common stock: $0.0001 par value; 350,000 shares authorized at April 30, 2009 and July 31, 2008; 86,212 and 82,836 shares issued and outstanding at April 30, 2009 and July 31, 2008
    9       8  
Additional paid-in capital
    271,750       249,131  
Accumulated other comprehensive income (loss)
    87       (45 )
Accumulated deficit
    (137,134 )     (118,219 )
 
           
 
               
Total stockholders’ equity
    134,712       130,875  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 191,668     $ 188,801  
 
           
See Notes to Consolidated Financial Statements.

 

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Table of Contents

ARUBA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands, except per share data)  
Revenues
                               
Product
  $ 35,822     $ 35,478     $ 118,561     $ 108,105  
Professional services and support
    9,666       6,287       26,271       19,109  
Ratable product and related professional services and support
    318       841       1,101       2,767  
 
                       
Total revenues
    45,806       42,606       145,933       129,981  
 
                               
Cost of revenues
                               
Product
    14,005       11,236       43,978       34,077  
Professional services and support
    1,814       1,650       5,585       5,853  
Ratable product and related professional services and support
    110       294       385       986  
 
                       
Total cost of revenues
    15,929       13,180       49,948       40,916  
 
                       
Gross profit
    29,877       29,426       95,985       89,065  
 
                               
Operating expenses
                               
Research and development
    9,734       9,762       30,407       27,148  
Sales and marketing
    20,251       21,230       66,519       61,755  
General and administrative
    5,854       4,730       17,154       13,325  
Acquisition related expenses
          197             197  
Restructuring expenses
                1,447        
 
                       
Total operating expenses
    35,839       35,919       115,527       102,425  
 
                       
Operating loss
    (5,962 )     (6,493 )     (19,542 )     (13,360 )
 
                               
Other income (expense), net
                               
Interest income
    368       854       1,572       3,474  
Other income (expense), net
    46       (324 )     (438 )     258  
 
                       
Total other income (expense), net
    414       530       1,134       3,732  
 
                       
 
                               
Loss before provision for income taxes
    (5,548 )     (5,963 )     (18,408 )     (9,628 )
 
                               
Provision for income taxes
    213       260       507       712  
 
                       
 
                               
Net loss
  $ (5,761 )   $ (6,223 )   $ (18,915 )   $ (10,340 )
 
                       
 
                               
Net loss per common share, basic and diluted
  $ (0.07 )   $ (0.08 )   $ (0.23 )   $ (0.13 )
 
                       
 
                               
Shares used in computing basic and diluted net loss per common share
    85,200       80,644       84,044       78,922  
 
                       
 
                               
Stock-based compensation expense included in above:
                               
Cost of revenues
  $ 230     $ 161     $ 758     $ 464  
Research and development
    1,547       1,458       5,723       4,226  
Sales and marketing
    2,401       1,839       7,793       6,248  
General and administrative
    1,355       794       3,881       2,612  
See Notes to Consolidated Financial Statements.

 

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ARUBA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
                 
    Nine months ended April 30,  
    2009     2008  
    (in thousands)  
Cash flows from operating activities
               
Net loss
  $ (18,915 )   $ (10,340 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
    7,168       3,436  
Provision for doubtful accounts
    122       149  
Write downs for excess and obsolete inventory
    3,324       823  
Compensation related to stock options and share awards
    18,155       13,550  
Net realized gain on short-term investments
    (7 )     (21 )
Accretion of purchase discounts on short-term investments
    (293 )     (1,283 )
Change in carrying value of preferred stock warrants
          (715 )
Gain on disposal of fixed assets
    (25 )      
Excess tax benefits associated with stock based compensation
    (44 )      
Changes in operating assets and liabilities:
               
Accounts receivable
    1,824       (4,101 )
Inventory
    (4,417 )     (9,380 )
Prepaids and other
    1,068       (2,755 )
Deferred costs
    1,763       721  
Other assets
    179       (372 )
Accounts payable
    (1,611 )     4,199  
Deferred revenue
    (2,528 )     5,690  
Other current and noncurrent liabilities
    3,566       3,438  
Income taxes payable
    (195 )     261  
 
           
 
               
Net cash provided by operating activities
    9,134       3,300  
 
           
 
               
Cash flows from investing activities
               
Purchases of short-term investments
    (77,783 )     (85,665 )
Proceeds from sales and maturities of short-term investments
    65,128       93,104  
Purchases of property and equipment
    (3,514 )     (4,169 )
Proceeds from sale of property and equipment
    34        
Cash paid in purchase acquisition, net of cash acquired
          (16,030 )
 
           
 
               
Net cash used in investing activities
    (16,135 )     (12,760 )
 
           
 
               
Cash flows from financing activities
               
Proceeds from issuance of common stock
    5,124       10,013  
Repurchase of common stock under stock repurchase program
    (991 )     (1,649 )
Excess tax benefits associated with stock based compensation
    44        
 
           
 
               
Net cash provided by financing activities
    4,177       8,364  
 
           
 
               
Effect of exchange rate changes on cash and cash equivalents
    (1 )     2  
 
               
Net decrease in cash and cash equivalents
    (2,825 )     (1,094 )
 
               
Cash and cash equivalents, beginning of period
    37,602       42,570  
 
           
 
               
Cash and cash equivalents, end of period
  $ 34,777     $ 41,476  
 
           
 
               
Supplemental disclosure of cash flow information
               
Income taxes paid
  $ 607     $ 468  
 
               
Supplemental disclosure of non-cash investing and financing activities
               
Common stock issued in purchase acquisition
  $     $ 7,852  
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”) was incorporated in the state of Delaware on February 11, 2002. The Company securely delivers the enterprise network to users with user-centric networks that expand the reach of traditional port-centric networks. The products the Company licenses and sells include the ArubaOS modular operating system, optional value-added software modules, a centralized mobility management system, high-performance programmable Mobility Controllers, wired and wireless access points, wireless intrusion detection tools, spectrum analyzers, and endpoint compliance solutions. The Company has offices in North America, Europe, the Middle East and the Asia Pacific region 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 accounts and transactions 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 7, 2008. The July 31, 2008 consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the US (“US”).
The accompanying unaudited consolidated financial statements have been prepared in accordance with United States 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, 2008 and include all adjustments necessary for the fair statement of the Company’s financial position as of April 30, 2009, its results of operations for the three and nine months ended April 30, 2009 and 2008, and its cash flows for the nine months ended April 30, 2009 and 2008. The results for the three and nine months ended April 30, 2009 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending July 31, 2009.
Certain prior period balances have been reclassified to conform to the current year presentation. The reclassifications did not affect previously reported net loss.
Significant Accounting Policies
Other than the adoption of the provisions of Statement of Financial Accounting Standards No. 157, Fair Value Measurements, (“SFAS 157”) effective August 1, 2008, there have been no significant changes in the Company’s accounting policies during the nine months ended April 30, 2009 as compared to the accounting policies described in the Company’s Annual Report on Form 10-K filed on October 7, 2008. In September 2006, the FASB issued SFAS 157 which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-1, Application of FASB Statement 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, which amends SFAS No. 157 to exclude accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS No. 13, Accounting for Leases. In February 2008, the FASB issued FASB issued FSP FAS No. 157-2, Effective Date of FASB Statement No. 157, (“FSP FAS 157-2”) which permitted the Company to defer the effective date of SFAS 157 until its first quarter of fiscal 2010 for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. The Company believes that the adoption of FSP FAS 157-2 for non-financial assets and liabilities will not have an impact on its consolidated financial statements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements for financial assets and financial liabilities. SFAS 157 became effective for the Company beginning on August 1, 2008. On October 10, 2008, the FASB issued FASB FSP FAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (“FSP FAS 157-3” ), which clarifies the application of SFAS 157 as it relates to the valuation of financial assets in a market that is not active for those financial assets. FSP FAS 157-3 is effective immediately and includes those periods for which financial statements have not been issued. The adoption of FSP FAS 157-3 in the quarter ended October 31, 2008, did not have an impact on the Company’s consolidated financial statements.

 

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2. Restructuring Charges
On November 14, 2008, the Company’s board of directors approved a plan to reduce the Company’s costs and streamline operations through a combination of a reduction in the Company’s work force and the closing of certain facilities. The majority of the reduction in the Company’s work force was completed in the second quarter of fiscal 2009 and the remaining reduction was completed in the third quarter of fiscal 2009. The reduction in the Company’s work force resulted in the termination of 46 employees worldwide, or about 8% of its global work force, mainly in the sales and marketing and research and development functions. Expenses associated with the work force reduction, which were comprised primarily of severance and benefits payments, as well as professional fees associated with career transition services, totaled $1.1 million. Additionally, the Company closed facilities in California and North Carolina and incurred facility exit costs of $0.3 million as a result. The restructuring expenses recorded in the second quarter of fiscal 2009 are shown in the consolidated statement of operations as restructuring expenses.
The following table provides a summary of the restructuring activities and related liabilities recorded in accrued liabilities in the consolidated balance sheet:
                                 
    Accrual as of                     Accrual as of  
    January 31,     Restructuring     Cash     April 30,  
    2009     Charges     Paid     2009  
 
                               
Three months ended April 30, 2009
                               
Severance and professional fees
  $ 283     $     $ (215 )   $ 68  
Facility exit costs
    277             (80 )     197  
 
                       
Total
  $ 560     $     $ (295 )   $ 265  
 
                       
                                 
    Accrual as of                     Accrual as of  
    July 31,     Restructuring     Cash     April 30,  
    2008     Charges     Paid     2009  
 
                               
Nine months ended April 30, 2009
                               
Severance and professional fees
  $     $ 1,138     $ (1,070 )   $ 68  
Facility exit costs
          309       (112 )     197  
 
                       
Total
  $     $ 1,447     $ (1,182 )   $ 265  
 
                       

 

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3. Intangible Assets
The following table presents details of the Company’s total purchased intangible assets:
                                 
    Estimated     Gross     Accumulated     Net Book  
As of April 30, 2009   Useful Lives     Value     Amortization     Value  
            (in thousands)  
Intangible Assets, net
                               
Existing Technology
  4 years   $ 9,283     $ (3,012 )   $ 6,271  
Patents/Core Technology
  4 years     3,046       (988 )     2,058  
Customer Contracts
    6 to 7 years       5,083       (976 )     4,107  
Support Agreements
    5 to 6 years       2,717       (606 )     2,111  
Tradenames/Trademarks
  5 years     600       (134 )     466  
Non-Compete Agreements
  2 years     712       (400 )     312  
 
                         
Total
          $ 21,441     $ (6,116 )   $ 15,325  
 
                         
                                 
    Estimated     Gross     Accumulated     Net Book  
As of July 31, 2008   Useful Lives     Value     Amortization     Value  
            (in thousands)  
Intangible Assets, net
                               
Existing Technology
  4 years   $ 9,283     $ (1,272 )   $ 8,011  
Patents/Core Technology
  4 years     3,046       (417 )     2,629  
Customer Contracts
    6 to 7 years       5,083       (349 )     4,734  
Support Agreements
    5 to 6 years       2,717       (199 )     2,518  
Tradenames/Trademarks
  5 years     600       (44 )     556  
Non-Compete Agreements
  2 years     712       (133 )     579  
 
                         
Total
          $ 21,441     $ (2,414 )   $ 19,027  
 
                         
The Company recorded $1.2 million and $3.7 million, respectively, of amortization expense related to its purchased intangible assets during the three and nine months ended April 30, 2009, and $0.7 million and $1.2 million, respectively, during the three and nine months ended April 30, 2008.
The estimated future amortization expense of purchased intangible assets as of April 30, 2009 is as follows:
         
    Amount  
    (in thousands)  
Remaining three months of fiscal 2009
  $ 1,234  
Years ending July 31, 2010
    4,804  
2011
    4,555  
2012
    2,917  
2013
    1,259  
Thereafter
    556  
 
     
Total
  $ 15,325  
 
     

 

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4. 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 that are not subject to vesting provisions. Diluted net loss per common share is calculated by giving effect to all potentially dilutive common shares, including options and common stock subject to repurchase. The following table sets forth the computation of net loss per share:
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands, except per share data)     (in thousands, except per share data)  
 
Net loss
  $ (5,761 )   $ (6,223 )   $ (18,915 )   $ (10,340 )
 
                       
 
Weighted-average common shares outstanding net of weighted-average common shares subject to repurchase
    85,200       80,644       84,044       78,922  
 
                       
 
Basic and diluted net loss per common share
  $ (0.07 )   $ (0.08 )   $ (0.23 )   $ (0.13 )
 
                       
The following outstanding options, common stock subject to repurchase, and restricted stock 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:
                 
    April 30,  
    2009     2008  
    (in thousands)  
Options to purchase common stock
    19,900       20,624  
Common stock subject to repurchase
    215       708  
Restricted stock awards
    2,954       3,287  
5. Short-term Investments
Short-term investments consist of the following:
                                 
            Gross     Gross        
    Cost     Unrealized     Unrealized     Fair  
    Basis     Gains     Losses     Value  
    (in thousands)  
Balances at April 30, 2009
                               
Corporate bonds and notes
  $ 12,704     $ 21     $ (105 )   $ 12,620  
U.S. government agency securities
    62,465       175       (4 )     62,636  
Commercial paper
    1,750                   1,750  
 
                       
Total short-term investments
  $ 76,919     $ 196     $ (109 )   $ 77,006  
 
                       
                                 
            Gross     Gross        
    Cost     Unrealized     Unrealized     Fair  
    Basis     Gains     Losses     Value  
    (in thousands)  
Balances at July 31, 2008
                               
Corporate bonds and notes
  $ 11,930     $ 5     $ (23 )   $ 11,912  
U.S. government agency securities
    44,724       19       (47 )     44,696  
Commercial paper
    7,521       1             7,522  
 
                       
Total short-term investments
  $ 64,175     $ 25     $ (70 )   $ 64,130  
 
                       

 

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The cost basis and fair value of debt securities as of April 30, 2009, by contractual maturity, are presented below:
                 
    Cost     Fair  
    Basis     Value  
    (in thousands)  
One year or less
  $ 44,178     $ 44,188  
One to two years
    32,741       32,818  
 
           
Total short-term investments
  $ 76,919     $ 77,006  
 
           
Unrealized gains and losses are recorded as a component of cumulative other comprehensive income (loss) in stockholders’ equity. If these investments are sold at a loss or are considered to have other than temporarily declined in value, a charge to operations is recorded. The specific identification method is used to determine the cost of securities disposed of, with realized gains and losses reflected in other income (expense), net.
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     12 Months or Greater     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Loss     Value     Loss     Value     Loss  
    (in thousands)     (in thousands)     (in thousands)  
April 30, 2009
                                               
Corporate bonds and notes
  $ 5,720     $ (75 )   $ 2,049     $ (30 )   $ 7,769     $ (105 )
U.S. government agency securities
    3,249       (4 )                 3,249       (4 )
 
                                   
Total
  $ 8,969     $ (79 )   $ 2,049     $ (30 )   $ 11,018     $ (109 )
 
                                   
Fair Value of Financial Instruments
Cash and cash equivalents consist primarily of bank deposits with third-party financial institutions and highly liquid money market securities with remaining maturities at date of purchase of 90 days or less. The carrying value of cash and cash equivalents as of April 30, 2009 and July 31, 2008 was approximately $34.8 million and $37.6 million, respectively, and approximates fair value.
Short-term investments consist of corporate bonds and notes, government sponsored enterprise obligations, and commercial paper. As of July 31, 2008, the short-term investments are recorded at amortized cost which approximates fair market value. Effective August 1, 2008, the fair value of the Company’s short-term investments is determined in accordance with SFAS 157, which defines fair value 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 or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability.
As a basis for considering such assumptions, SFAS 157 establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value. 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 instruments are valued based on quoted prices in markets that are not active or alternative pricing sources with reasonable levels of price transparency and include the Company’s investments in corporate bonds and notes, government sponsored enterprise obligations 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 has no level 3 instruments.

 

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As of April 30, 2009, the fair value measurements of our cash, cash equivalents and short-term investments consisted of the following:
                         
    Total     Level 1     Level 2  
    (in thousands)  
Corporate bonds and notes
  $ 12,620     $     $ 12,620  
U.S. government agency securities
    62,636             62,636  
Commercial paper
    1,750             1,750  
Money market funds
    21,893       21,893        
 
                 
Total cash equivalents and short-term investments
    98,899     $ 21,893     $ 77,006  
 
                   
Cash deposits with third-party financial institutions
    12,884                  
 
                     
Total cash, cash equivalents and short-term investments
  $ 111,783                  
 
                     
6. Balance Sheet Components
The following tables provide details of selected balance sheet items:
                 
    April 30,     July 31,  
    2009     2008  
    (in thousands)  
Accounts Receivable, net
               
Trade accounts receivable
  $ 31,226     $ 33,237  
Less: Allowance for doubtful accounts
    (493 )     (558 )
 
           
Total
  $ 30,733     $ 32,679  
 
           
                 
    April 30,     July 31,  
    2009     2008  
    (in thousands)  
Inventory
               
Raw materials
  $ 267     $ 283  
Finished goods
    12,051       11,361  
 
           
Total
  $ 12,318     $ 11,644  
 
           
                 
    April 30,     July 31,  
    2009     2008  
    (in thousands)  
Accrued Liabilities
               
Compensation and benefits
  $ 8,333     $ 8,768  
Inventory
    4,792       1,033  
Other
    7,070       7,107  
 
           
Total
  $ 20,195     $ 16,908  
 
           

 

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7. Property and Equipment, Net
Property and equipment, net consists of the following:
                         
    Estimated     April 30,     July 31,  
    Useful Lives     2009     2008  
          (in thousands)  
Property and Equipment, net
                       
Computer equipment
  2 years   $ 7,098     $ 6,197  
Computer software
  2-5 years     4,026       3,582  
Machinery and equipment
  2 years     6,621       5,032  
Furniture and fixtures
  5 years     1,725       863  
Leasehold improvements
  2-5 years     637       551  
 
                   
Total property and equipment, gross
            20,107       16,225  
Less: Accumulated depreciation and amortization
            (12,334 )     (9,044 )
 
                   
Total property and equipment, net
          $ 7,773     $ 7,181  
 
                   
8. Deferred Revenue
Deferred revenue consists of the following:
                 
    April 30,     July 31,  
    2009     2008  
    (in thousands)  
Deferred Revenue
               
Product
  $ 3,518     $ 9,351  
Professional services and support
    20,180       16,399  
Ratable product and related services and support
    912       1,393  
 
           
Total deferred revenue, current
    24,610       27,143  
 
               
Professional services and support, long-term
    7,194       6,563  
Ratable product and related services and support, long-term
    147       775  
 
           
Total deferred revenue, long-term
    7,341       7,338  
 
           
Total deferred revenue
  $ 31,951     $ 34,481  
 
           
Deferred product revenue relates to arrangements where not all revenue recognition criteria have been met. Deferred professional services and support revenue primarily represents customer payments made in advance for support contracts. Support contracts are typically billed on an annual basis in advance and revenue is recognized ratably over the support period.
Deferred ratable product and related services and support revenue consists of revenue on transactions where Vendor Specific Objective Evidence (“VSOE”) of fair value of support was not established at the date of the transactions and the entire arrangement is being recognized ratably over the support period, which typically ranges from one year to five years. Typically, the Company’s sales involve multiple elements, such as sales of products that include support, training and/or consulting services. When a sale involves multiple elements, the Company allocates the entire fee from the arrangement to each respective element based on its VSOE of fair value and recognizes revenue when each element’s revenue recognition criteria are met. VSOE of fair value for each element is established based on the sales price the Company charges when the same element is sold separately. If VSOE of fair value cannot be established for the undelivered element of an agreement, when the undelivered element is support, the entire amount of revenue from the arrangement is deferred and recognized ratably over the period that the support is delivered.
9. Income Taxes
For the three and nine months ended April 30, 2009 and 2008, the Company generated operating losses. However, while the Company generated book and tax losses, it generated operating income for foreign and state purposes.
The Company uses the asset and liability method of accounting for income taxes in accordance with FASB Statement No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Based on the available objective evidence, including the fact that the Company has generated losses since inception and continues to incur a loss, management believes it is more likely than not that the deferred tax assets will not be realized. Accordingly, management has applied a full valuation allowance against its deferred tax assets generated primarily in the U.S.

 

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On September 30, 2008, California enacted Assembly Bill 1452 which among other provisions, suspends net operating loss deductions for 2008 and 2009 and extends the carryforward period of any net operating losses not utilized due to such suspension; adopts the federal 20-year net operating loss carryforward period; phases-in the federal two-year net operating loss carryback periods beginning in 2011 and limits the utilization of tax credits to 50% of a taxpayer’s taxable income. The Company incorporated the impact of this new law to the income tax provision during the first quarter of fiscal 2009. As a result, only 50% of California tax liability was off-set by the available state research & development tax credit carryover, yielding a $64,000 tax liability as of April 30, 2009.
In addition, under the U.S. federal government’s Housing and Economic Recovery Act of 2008 (“Act”), taxpayers may claim bonus depreciation on certain qualified fixed assets placed in service from the period between April and December 2008 if they forego refundable AMT or research and development credit carryovers. The Company estimated and recognized the bonus depreciation, subject to certain limitations, based on fixed assets placed into service through the nine months ended April 30, 2009. During the nine months ended April 30, 2009, the Company recorded a net income tax benefit of $37,000 for the bonus depreciation as provided by the Act, which was netted against deferred tax assets subject to a full valuation allowance.
The Company’s only material uncertain tax position is its research and development credits. On October 3, 2008, the Emergency Economic Stabilization Act of 2008, Energy Improvement and Extension Act of 2008 and Tax Extenders and Alternative Minimum Tax Relief Act of 2008 (HR1424) was signed into law, which, as enacted, includes a provision that extends the research tax credit for two years retroactively applied for tax years beginning January 1, 2008. Due to this retroactive extension, the Company estimates an increase of approximately $0.8 million of additional uncertain tax positions relating to research credits in the next 12 months, none of which would affect its income tax expense if recognized to the extent that the Company continues to maintain a full valuation allowance against its deferred tax assets. The Company recognizes interest and penalties related to income tax matters as part of the provision for income taxes. To date, the Company has incurred no such charges.
The Company files annual income tax returns in the U.S. federal jurisdiction, various U.S. state and local jurisdictions, and in various foreign jurisdictions. The Company remains subject to tax authority review for all jurisdictions for all years.
10. Stock Benefit Plans and Common Stock
In April 2002, the Company’s board of directors adopted the 2002 Stock Plan (“2002 Plan”). In December 2006, the Company’s board of directors approved the 2007 Equity Incentive Plan (“2007 Plan”) and the Employee Stock Purchase Plan (“ESPP”). As provided by the 2007 Plan, all remaining shares reserved for issuance under the 2002 Plan were transferred to the 2007 Plan upon the closing of the Company’s initial public offering.
Stock Option Activity
The following table summarizes the information about shares available for grant and outstanding stock options activity for the nine months ended April 30, 2009:
                                         
                    Weighted     Weighted        
                    Average     Average        
    Shares             Exercise     Remaining     Aggregate  
    Available for     Number of     Price     Contractual     Intrinsic  
    Grant     Options     per Share     Term (Years)     Value  
Outstanding at July 31, 2008
    3,169,466       19,518,002     $ 4.41       7.43     $ 44,913,703  
Shares reserved for issuance
    4,141,807                                
Restricted stock awards granted
    (1,400,367 )                              
Restricted stock awards cancelled
    516,031                                
Options granted
    (8,455,675 )     8,455,675       2.90                  
Options exercised
          (1,174,859 )     1.11               3,683,391  
Options repurchased
    18,333             0.49                  
Options cancelled
    6,898,400       (6,898,400 )     7.52                  
 
                                 
Outstanding at April 30, 2009
    4,887,995       19,900,418     $ 2.88       6.91     $ 39,732,008  
 
                                 

 

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The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the fair value of the Company’s common stock on the date of each option exercise. Stock-based compensation expense recognized for stock options for the three and nine months ended April 30, 2009 was $2.8 million and $8.7 million, respectively, and $2.4 million and $8.1 million for the three and nine months ended April 30, 2008, respectively.
The following table summarizes the non-vested restricted stock awards activity for the nine months ended April 30, 2009:
                 
            Weighted Average  
            Grant Date  
            Fair Value  
    Shares     per Share  
Balance at July 31, 2008
    3,364,950     $ 6.81  
Awards granted
    1,400,367       4.21  
Awards vested
    (1,295,536 )     5.55  
Awards cancelled
    (516,031 )     6.20  
 
           
Balance at April 30, 2009
    2,953,750     $ 6.24  
 
           
The estimated fair value of restricted stock awards is based on the market price of the Company’s stock on the grant date. Stock-based compensation expense recognized for restricted stock awards for the three and nine months ended April 30, 2009 was $2.0 million and $7.5 million, respectively, and $1.2 million and $3.2 million for the three and nine months ended April 30, 2008, respectively.
Stock Option Exchange Program
On February 17, 2009, the Company commenced an exchange offer to allow certain of its employees the opportunity to exchange all or a portion of their eligible outstanding stock options for the same number of new options. The new options had an exercise price of $2.91, equal to the closing price per share of the Company’s common stock on March 17, 2009. Stock options held by eligible employees with exercise prices above this closing price were eligible for the exchange offer. Generally, all employees who hold options, other than the Company’s board members, Section 16 officers and employees located in China, France, India or the Netherlands, were eligible to participate in the program.
The number of shares of common stock subject to outstanding options did not change as a result of the exchange offer. New options issued as part of the exchange offer are subject to a new vesting schedule in which one-third of the shares subject to each new option grant will vest on the one-year anniversary of the new grant date with the remaining shares vesting in equal monthly installments over the following two years. The new options will have a maximum term of seven years following the new grant date. The Company will recognize $3.4 million in incremental stock-based compensation expense over the vesting period of the new grants. The Company recognized $0.6 million in incremental stock-based compensation expense arising from the new grants for the three and nine months ended April 30, 2009.
Employee Stock Purchase Plan Activity
During the three months ended April 30, 2009, 624,458 shares were purchased at an average per share price of $2.33. At April 30, 2009, there were 3,838,452 shares available to be issued under the ESPP. Compensation expense recognized in connection with the ESPP for the three and nine months ended April 30, 2009 was $0.7 million and $1.9 million, respectively, and $0.7 million and $2.1 million for the three and nine months ended April 30, 2008.
During the three months ended April 30, 2009, the Company modified the terms of certain existing awards under its ESPP pursuant to the reset provisions of the plan. Consequently, the Company will recognize $0.3 million in incremental stock-based compensation expense over the vesting period. The Company recognized $0.1 million in incremental stock-based compensation expense arising from the award modification for the three and nine months ended April 30, 2009.

 

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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 April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
Assumptions
                               
Risk-free interest rate
    1.8 %     2.4 %     2.0 %     3.3 %
Expected term (in years)
    4.2       4.3       4.2       4.3  
Dividend yield
                       
Volatility
    69 %     51 %     64 %     51 %
Weighted average fair value of options granted
  $ 0.67     $ 2.44     $ 0.91     $ 3.87  
Employee Stock Purchase Plan
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
Assumptions
                               
Risk-free interest rate
  0.5% to 0.9%   1.5% to 1.6%   0.5% to 0.9%   1.5% to 4.2%
Expected term (in years)
  0.5 to 2.0   0.5 to 2.0   0.5 to 2.0   0.5 to 2.0
Dividend yield
       
Volatility
  75% to 101%   47% to 65%   75% to 101%   43% to 65%
Weighted average fair value of stock purchase rights granted
  $1.37   $2.13   $1.37   $2.43
The expected term of the stock-based awards represents the period of time that the Company expects such stock-based awards to be outstanding, giving consideration to the contractual term of the awards, vesting schedules and expectations of future employee behavior. The Company gave consideration to its historical exercises, the vesting term of its options, the post vesting cancellation history of its options and the options’ contractual terms. The contractual term of options granted from inception of the Company through August 16, 2007 was generally 10 years. On August 17, 2007, the Company’s Compensation Committee revised the Company’s 2007 Plan to provide for a contractual term of seven years on all option grants on or after such date. Given the Company’s limited operating history, the Company then compared this estimated term to those of comparable companies from a representative peer group selected based on industry data to determine the expected term. The Company computes expected volatility based on its historical volatility and the historical volatility of comparable companies from a representative peer group that the Company selected based on industry data. As required by SFAS 123R, the Company made an estimate of expected forfeitures, and is recognizing stock-based compensation only for those equity awards that it expects to vest. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury Constant Maturity rate as of the date of grant.
Stock-based Expenses
The Company did not record an income tax provision benefit related to stock-based compensation during the three and nine months ended April 30, 2009 and 2008, since the Company currently maintains a full valuation allowance on its deferred tax assets.
Shares Subject to Repurchase
Certain common stock option holders have the right to exercise unvested options, subject to the right of the Company to repurchase unvested shares of common stock received upon exercise, in the event of a voluntary or involuntary termination of the stockholder’s employment. The cash received from these exercises is initially recorded as a liability and is subsequently reclassified to common stock as the shares vest. As of April 30, 2009 and July 31, 2008, respectively, a total of 215,073 and 429,570, shares of common stock were subject to repurchase by the Company at the original exercise price of the related stock option. The corresponding exercise value of $0.5 million and $0.8 million as of April 30, 2009 and July 31, 2008, respectively, is recorded in accrued liabilities. For the nine months ended April 30, 2009, the non-vested shares activity was as follows:
         
Non-Vested Shares   Shares  
Non-vested as of July 31, 2008
    429,570  
Early exercise of options
    12,500  
Vested
    (208,664 )
Forfeited
    (18,333 )
 
     
Non-vested as of April 30, 2009
    215,073  
 
     

 

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Stock Repurchase Program
On February 26, 2008, the Company announced a stock repurchase program for up to $10.0 million worth of the Company’s common stock. The Company is authorized until February 26, 2010, to make purchases in the open market and any such purchases will be funded from available working capital. The number of shares to be purchased and the timing of purchases will be based on the price of the Company’s common stock, general business and market conditions, and other investment considerations, and shall not exceed $2.5 million per quarter. Shares are retired upon repurchase. During the nine months ended April 30, 2009, the Company purchased 191,200 shares under this program for an aggregate purchase price of $1.0 million. No purchases were made under this program during the three months ended April 30, 2009. The Company is authorized to purchase up to an additional $6.9 million worth of shares under this program as of April 30, 2009. 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.
11. Comprehensive Loss
Comprehensive loss includes the following:
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
Net loss
  $ (5,761 )   $ (6,223 )   $ (18,915 )   $ (10,340 )
Change in unrealized gain/ (loss) on short-term investments
    (9 )     (192 )     132       21  
 
                       
Comprehensive loss
  $ (5,770 )   $ (6,415 )   $ (18,783 )   $ (10,319 )
 
                       
12. Segment Information and Significant Customers
The Company operates in one industry segment selling fixed and modular mobility controllers, wired and wireless access points, and related software and services.
FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. The Company has one business activity, and there are no segment managers who are held accountable for operations, operating results and plans for products or components below the consolidated unit level. Accordingly, the Company reports as a single operating segment. The Company and its Chief Executive Officer evaluate 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 United States of America and not allocated to any specific region. Therefore, geographic information is presented only for total revenue.
The following presents total revenue by geographic region:
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
United States
  $ 27,565     $ 28,081     $ 92,705     $ 87,234  
Europe, Middle East and Africa
    9,543       8,565       27,693       23,736  
Asia Pacific
    6,756       4,390       20,038       13,503  
Rest of World
    1,942       1,570       5,497       5,508  
 
                       
Total
  $ 45,806     $ 42,606     $ 145,933     $ 129,981  
 
                       

 

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13. Commitments and Contingencies
Legal Matters
On August 27, 2007, Symbol Technologies, Inc. and Wireless Valley Communications, Inc., both Motorola subsidiaries, filed suit against the Company in the Federal District Court of Delaware asserting infringement of U.S. Patent Nos. 7,173,922; 7,173,923; 6,625,454; and 6,973,622. The Company filed its response on October 17, 2007, denying the allegations and asserting counterclaims. The complaint seeks unspecified monetary damages and injunctive relief. On September 8, 2008, the Company filed an amended answer and counterclaims, asserting infringement of Aruba’s U.S. Patent Nos. 7,295,524 and 7,376,113 against Motorola, Inc. as well as its subsidiaries, Symbol Technologies, Inc. and Wireless Valley Communications, Inc. The counterclaims seek unspecified monetary damages and injunctive relief. On November 13, 2008, Motorola filed an amended complaint asserting infringement of U.S. Patent No. 7,359, 676 owned by AirDefense, Inc., another Motorola subsidiary. The trial is scheduled to commence on January 10, 2010.
Although the Company intends to vigorously defend against all of these claims, intellectual property litigation is expensive and time-consuming, regardless of the merits of any claim, and could divert management’s attention from operating the Company’s business. Because of the inherent uncertainties of litigation, the outcome of this action could be unfavorable. At this time, the Company is unable to estimate the potential financial impact this action could have on the Company.
The Company could become involved in additional litigation from time to time relating to claims arising out of its ordinary course of business. Other than described above there were no claims as of April 30, 2009 that, in the opinion of management, might have a material adverse effect on the Company’s financial position, results of operations or cash flows.
Lease Obligation
The Company leases office space under non-cancelable operating leases with various expiration dates through July 2012. The terms of certain operating leases provide for rental payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over the respective lease periods and has accrued for rent expense incurred but not paid.
Future minimum lease payments under non-cancelable operating leases are as follows:
         
    Operating  
    Leases  
    (in thousands)  
Three months remaining in fiscal 2009
  $ 859  
Year ending July 31,
       
2010
    3,428  
2011
    891  
2012
    150  
Thereafter
     
 
     
Total minimum payments
  $ 5,328  
 
     
Non-cancelable purchase commitments
The Company outsources the production of its hardware to a third-party contract manufacturer. In addition, the Company enters into various inventory related purchase commitments with this contract manufacturer and other suppliers. The Company had $9.0 million and $12.4 million in non-cancelable purchase commitments with these providers as of April 30, 2009 and July 31, 2008, respectively. The Company expects to sell all products that it has committed to purchase from these providers.
In its sales agreements, the Company may agree to indemnify its indirect sales channels and end-user customers for any expenses or liability resulting from claimed infringements of patents, trademarks or copyrights of third parties. The terms of these indemnification agreements are generally perpetual any time after execution of the agreement. The maximum amount of potential future indemnification is unlimited. To date the Company has not paid any amounts to settle claims. The Company is unable to reasonably estimate the maximum amount that could be payable under these arrangements 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 April 30, 2009 and July 31, 2008.
14. Recent Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (“SFAS 141(R)”). SFAS 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and the goodwill acquired. This statement also establishes disclosure requirements to enable the evaluation of the nature and financial effect of the business combination. The Company is required to adopt SFAS 141(R) effective August 1, 2009. The Company is currently evaluating the potential impact of this statement.

 

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In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statement (“SFAS 160”). This statement establishes accounting and reporting standards for non-controlling interests in consolidated financial statements. Early adoption is prohibited. The Company is required to adopt SFAS 160 effective August 1, 2009. Based on the Company’s current operations, it does not expect that the adoption of SFAS 160 will have a material impact on its financial position or results of operations.
In April 2008, the FASB issued a FASB Staff Position on SFAS No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under Statement 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141 (revised 2007), Business Combinations, and other U.S. generally accepted accounting principles. The Company is required to adopt FSP FAS 142-3 effective August 1, 2009. The Company is currently evaluating the potential impact of this statement.
In June 2008, the FASB issued Financial Statement of Position (“FSP”) EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. FSP EITF 03-6-1 provides that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The Company is required to adopt FSP EITF 03-6-1 effective August 1, 2009. Upon adoption, a company is required to retrospectively adjust its earnings per share data (including any amounts related to interim periods, summaries of earnings and selected financial data) to conform with the provisions of FSP EITF 03-6-1. The Company is currently evaluating the potential impact of this statement.
In April 2009, the FASB issued three FSPs related to fair value measurements, disclosures and other-than-temporary impairments. FSP FAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP FAS 157-4”), provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for an asset or liability have significantly decreased. FSP FAS 157-4 also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 115-2 and FSP FAS No. 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, amends the other-than-temporary impairment guidance in U.S. GAAP to make the guidance more operational and to improve the presentation of other-than-temporary impairments in the financial statements. Finally, FSP FAS No. 107-1 and APB No. 28-1, Interim Disclosures About Fair Value of Financial Instruments, amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments in interim financial statements as well as in annual financial statements and also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in all interim financial statements. The three FSPs are effective for periods ending after June 15, 2009. Early adoption is permitted for periods ending after March 15, 2009, however, the Company elected to adopt the FSPs during the fourth quarter of 2009. The Company is evaluating the impact, if any, the FSPs will have on its consolidated financial statements.

 

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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:
  regarding the timing and amount of expenses we expect to incur as a result of our cost reduction efforts, as well as the annualized savings we expect to realize;
 
  that revenues from our indirect channels will continue to constitute a significant majority of our future revenues;
 
  that international revenues will increase in absolute dollars compared to fiscal 2008 and increase as a percentage of total revenues in future periods;
 
  that, as our customer base grows, the proportion of our revenues represented by support revenues will increase;
 
  that we will strategically hire employees throughout the company;
 
  that we will continue to invest significantly in our research and development efforts;
 
  that research and development expenses for fiscal 2009 will increase on an absolute dollar basis and remain consistent or decrease as a percentage of revenue compared with fiscal 2008;
 
  that our operating expenses will increase at a slower rate as a result of our cost reduction measures;
 
  that we will continue to invest strategically in our sales and marketing efforts, and in particular, that we will increase the number of sales personnel worldwide;
 
  that sales and marketing expenses for fiscal 2009 will continue to be our most significant operating expense and will increase on an absolute dollar basis and decrease as a percentage of revenue compared with fiscal 2008;
 
  that we will incur significant additional legal costs related to defending ourselves against claims made by outside parties;
 
  that general and administrative expenses for fiscal 2009 will increase on an absolute dollar basis and as a percentage of revenue compared with fiscal 2008;
 
  that ratable product and related professional services and support revenues will decrease in absolute dollars and as a percentage of total revenues in future periods;
 
  that, as we expand internationally, we plan to continue to hire additional technical support personnel to support our growing international customer base; and
 
  regarding the sufficiency of our existing cash, cash equivalents, short-term investments and cash generated from operations,
as well as other statements regarding our future operations, financial condition and 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 securely deliver the enterprise network to users, wherever they work or roam, with user-centric networks that expand the reach of traditional port-centric networks. User-centric networks integrate adaptive wireless local area networks (“WLANs”), application continuity services, and identity-based security into a cohesive, high-performance system that can be deployed as an overlay to existing enterprise networks. Adaptive WLANs deliver high-performance, follow-me connectivity so users are always connected. Application continuity services enable follow-me applications that can be seamlessly accessed across WLANs and cellular networks. Identity-based security associates access policies with users, not ports, to enable follow-me security that is enforced regardless of access method or location. The products we license and sell include the ArubaOS operating system, optional value-added software modules, a centralized and vendor neutral mobility management system, high-performance programmable Mobility Controllers, wired and wireless access points, wireless intrusion detection tools, spectrum analyzers, and endpoint compliance solutions.
Our products have been sold to over 7,200 end customers worldwide (not including customers of Alcatel-Lucent, our largest channel partner), including some of the largest and most complex global organizations. We have now implemented a two-tier distribution model in most areas of the world, including the US, with value-added distributors (“VADs”) providing 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.
Our ability to increase our product revenues will depend significantly on continued growth in the market for enterprise mobility solutions, continued acceptance of our products in the marketplace, our ability to continue to attract new customers, our ability to compete against both publicly traded companies as well as privately-held competitors, and our ability to continue to sell into our installed base of existing customers. Our growth in support revenues 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 be directly affected by the continued acceptance of our products in the marketplace, as well as the timing and size of orders, product and channel mix, average selling prices, costs of our products and general economic conditions. Our ability to attain profitability will also be affected by our ability to effectively implement and generate incremental business from our two-tier distribution model, the extent to which we invest in our sales and marketing, research and development, and general and administrative resources to grow our business, and current economic conditions.
Economic conditions worldwide have negatively impacted our business. While we believe in the long-term growth prospects of the WLAN market, the deterioration in overall economic conditions, and, in particular, tightening in the credit markets and reduced spending by both enterprises and consumers have significantly impacted various industries on which we rely for purchasing our products. This has led to our customers deferring purchases in response to tighter credit, negative financial news and delayed budget approvals. For example, we have recently experienced softness in the retail vertical market, as our customers in the retail industry continue to struggle with these economic challenges.
While we have seen signs of some stabilization and improved visibility in the third quarter of fiscal 2009 relative to the first six months of fiscal 2009, the economic turmoil in the United States, the continuing credit crisis that has affected worldwide financial markets, the significant volatility in the stock markets and other current negative macroeconomic indicators, such as the global recession, or uncertainty or further weakening in key vertical or geographic markets, have resulted in reductions in capital expenditures by end-user customers for our products, longer sales cycles, the deferral or delay of purchase commitments for our products and increased competition. These factors have created significant and increasing uncertainty for the future as they could continue to negatively impact technology spending for the products and services we offer and materially adversely affect our business, operating results and financial condition.
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 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 experienced both longer sales cycles and seasonality, both of which have slowed our revenue growth, we believe that, without the effect of the current economic conditions, our revenues may have increased at a higher rate during fiscal 2009.
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, and (3) the amount of deferred revenue entering a given quarter. Our product deferred revenue is comprised of revenue associated with product orders that have shipped but where the terms of the agreement contain acceptance language or other terms that require that the revenue be deferred until all revenue recognition criteria are met, as well as those customer contracts that we entered into prior to our establishment of VSOE of fair value. We typically ship products within a reasonable time period after the receipt of an order and our ability to meet our forecasted product revenue is dependent on our ability to convert our sales pipeline into product revenues from orders received and shipped within the same fiscal quarter.

 

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On November 14, 2008, as a result of the macroeconomic downturn, our board of directors approved a plan to reduce our costs and streamline operations through a combination of a reduction in our work force and the closing of certain facilities. The majority of the reduction in our work force was completed in the second quarter of fiscal 2009 and the remaining reduction was completed in the third quarter of fiscal 2009. The reduction in our work force resulted in the termination of 46 employees worldwide, or about 8% of our global work force. Expenses associated with the work force reduction, which were comprised primarily of severance and benefits payments as well as professional fees associated with career transition services, totaled $1.1 million. Additionally, we closed facilities in California and North Carolina and incurred facility exit costs of $0.3 million as a result. These expenses were recorded in the second quarter of fiscal 2009. These cost reduction efforts, when added to our other cost control measures, resulted in a savings of approximately $2.0 million during the second quarter of fiscal 2009. We expect to realize an additional $5.0 million to $6.0 million in additional savings through the end of fiscal 2009 based on all of our cost reduction efforts.
On February 17, 2009, we commenced an exchange offer to allow certain of our employees the opportunity to exchange all or a portion of their eligible outstanding stock options for the same number of new options. The new options had an exercise price of $2.91, equal to the closing price per share of our common stock on March 17, 2009. Stock options held by eligible employees with exercise prices above this closing price were eligible for the exchange offer. Generally, all employees who hold options, other than our board members, Section 16 officers and employees located in China, France, India or the Netherlands, were eligible to participate in the program.
The number of shares of common stock subject to outstanding options did not change as a result of the exchange offer. New options issued as part of the exchange offer are subject to a new vesting schedule in which one-third of the shares subject to each new option grant will vest on the one-year anniversary of the new grant date with the remaining shares vesting in equal monthly installments over the following two years. The new options will have a maximum term of seven years following the new grant date. We will recognize $3.4 million in incremental stock-based compensation expense over the vesting period of the new grants. We recognized $0.6 million in incremental stock-based compensation expense arising from the new grants for the third quarter and first nine months of fiscal 2009.
Revenues, Cost of Revenues and Operating Expenses
Revenues
We derive our revenues from sales of our ArubaOS operating system, controllers, wired and wireless access points, application software modules, multi-vendor management solution software, and professional services and support. Professional services revenues consist of consulting and training services. Consulting services primarily consist of installation support services. Training services are instructor led courses on the use of our products. Support revenues 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, distributors and original equipment manufacturers (“OEMs”). We expect revenues from indirect channels to continue to constitute a substantial majority of our future revenues.
We sell our products to channel partners and end customers located in the Americas, Europe, the Middle East, Africa and Asia Pacific. Shipments to our channel partners that are located in the United States are classified as U.S. revenue regardless of the location of the end customer. We continue to expand into international locations and introduce our products in new markets, and we expect international revenues to increase in absolute dollars and as a percentage of total revenues in future periods. For more information about our international revenues, see Note 12 of Notes to Consolidated Financial Statements.
In 2005, we began to sell our products to Alcatel-Lucent, one of our OEMs, which, in turn, sells our products under its own brand name. Alcatel-Lucent accounted for 16.5% and 13.2% of our revenues for the three and nine months ended April 30, 2009, respectively, and 11.8% and 10.8% for the three and nine months ended April 30, 2008, respectively.
Cost of Revenues
Cost of product revenues 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 revenues consists of payments to Flextronics, our contract manufacturer. Flextronics manufactures 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 and Bangalore, India. Cost of product revenues also includes amortization expense from our purchased intangible assets.

 

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Cost of professional services and support revenues is primarily comprised of the personnel costs, including stock-based compensation, of providing technical support, including personnel costs associated with our internal support organization. In addition, we employ a third-party support vendor to complement our internal support resources, the costs of which are included within costs of professional services and support revenues.
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;
 
    new product introductions and enhancements both by us and by our competitors;
 
    product mix and average selling prices;
 
    pressure to discount our products in response to our competitor’s discounting practices;
 
    demand for our products and services;
 
    our ability to attain volume manufacturing pricing from Flextronics 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; 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 revenues from our indirect channel to continue to constitute a substantial majority of our total revenues, which, by itself, negatively impacts our gross margins.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The largest component of our operating expenses 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 all employees.
Our headcount increased from 541 employees at July 31, 2008 to 570 employees at October 31, 2008, and then declined to 531 employees at January 31, 2009 and April 30, 2009. On November 14, 2008, our board of directors approved a plan to reduce our costs and streamline operations, through a combination of a reduction in work force and closing certain facilities. As of April 30, 2009, we terminated 46 employees worldwide, or about 8% of our global work force. We completed our reduction in work force in the third quarter of fiscal 2009. Going forward, we expect to continue to strategically hire employees throughout the company as well as invest in research and development.
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 2009, we expect research and development expenses to increase on an absolute dollar basis and remain consistent or decrease as a percentage of revenue compared to fiscal 2008. However, we expect research and development expenses will increase at a slower rate as a result of our cost reduction measures.
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. Marketing programs are intended to generate revenue from new and existing customers and are expensed as incurred.

 

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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 revenues and reduces our operating margins 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 2009, we expect sales and marketing expenses to increase on an absolute dollar basis and decrease as a percentage of revenue compared to fiscal 2008. However, we expect sales and marketing expenses will increase at a slower rate as a result of our cost reduction measures.
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 new ERP system. Further, our general and administrative expenses include professional services consisting of outside legal, audit, Sarbanes-Oxley and information technology consulting costs. We expect that we will incur significant additional legal costs related to defending ourselves against claims made by outside parties, such as the claims described below in Part II, Item 1 of this report. For fiscal 2009, we expect general and administrative expenses to increase on an absolute dollar basis and as a percentage of revenue compared to fiscal 2008. However, we expect general and administrative expenses will increase at a slower rate as a result of our cost reduction measures.
Stock-Based Compensation
We recognized $5.5 million and $18.2 million of stock-based compensation for the three and nine months ended April 30, 2009, respectively, and $4.3 million and $13.6 million for the three and nine months ended April 30, 2008.
Other Income (Expense), net
Other income (expense), net includes interest income on cash balances, accretion of discount or amortization of premium on short-term investments, interest expense, and losses or gains on remeasurement of non-U.S. dollar transactions into U.S. dollars. Cash has historically been invested in money market funds and marketable securities.
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 revenues 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, stock-based compensation, inventory valuation, allowances for doubtful accounts, income taxes, and goodwill and purchased intangible assets.
Revenue Recognition
Our revenues are derived primarily from two sources: (1) product revenue, including hardware and software products, and (2) related professional services and support revenue. Support typically includes software updates, on a when and if available basis, telephone and internet access to technical support personnel and hardware support. We provide our customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period. Revenues for support services are recognized on a straight-line basis over the service contract term, which is typically between one year and five years.
We account for revenues in accordance with Statement of Position No. 97-2, Software Revenue Recognition, and all related amendments and interpretations (“SOP 97-2”) because our products are integrated with software that is essential to their functionality and because we provide unspecified software upgrades and enhancements related to the equipment through support agreements.

 

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Typically, our sales involve multiple elements, such as sales of products that include support, training and/or consulting services. When a sale involves multiple elements, we allocate the entire fee from the arrangement to each respective element based on its VSOE of fair value and recognize revenue when each element’s revenue recognition criteria are met. VSOE of fair value for each element is established based on the sales price we charge when the same element is sold separately. If VSOE of fair value cannot be established for the undelivered element of an agreement, when the undelivered element is support, the entire amount of revenue from the arrangement is deferred and recognized ratably over the period that the support is delivered. Prior to the second quarter of fiscal 2006, we had not been able to establish VSOE of fair value in accordance with SOP 97-2 at the outset of our arrangements. Accordingly, prior to the second quarter of 2006, we recognized revenue for the entire transaction ratably over the support period, as the only undelivered element was typically support.
Beginning in the second quarter of fiscal 2006, we were able to establish VSOE of fair value at the outset of our arrangements as we established a new support and services pricing policy, with different services and support offerings than were previously sold. We also began selling support services separately from our arrangements in the form of support renewals. Accordingly, beginning in the second quarter of fiscal 2006, we began recognizing product revenues upon delivery using the residual method for transactions where all other revenue recognition criteria were met. As we had not been able to establish VSOE on our prior services and support offerings, all transactions prior to the second quarter of fiscal 2006 continue to be recognized ratably over the support period.
We recognize revenue only when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable. Additionally, we recognize revenue from indirect sales channel partners upon persuasive evidence provided by our indirect channel customers of a sale to an end customer. If a sale to an end customer has not occurred by the end of the month, the goods remain in the partner’s inventory pending a sale to an end customer. This inventory is classified on the consolidated balance sheet as deferred costs until the sale to an end customer occurs and the persuasive evidence of the sale is provided. The amount of inventory held by resellers pending a sale to an end customer was $0.9 million and $1.7 million as of April 30, 2009 and July 31, 2008, respectively.
The related sale of support services to a reseller occurs when a specific sale to an end customer occurs. If the sale of support services occurs at the same time as we receive the initial purchase order from the reseller, the support services are included on that purchase order and recognized ratably over the related support period, commencing on delivery to the end customer. If the sale of support services occurs after we receive the initial purchase order, the support services for the specific product sales are purchased on a subsequent purchase order at the time the point-of-sale (“POS”) report is provided for all product sales that occurred during the month. The support services are recognized ratably over the related support period, commencing from the delivery date to each respective end customer.
PCS services that we provide to our channel partners differ from PCS that we provide to our end customers in that we are only obligated to provide support services to the channel partner directly, while the channel partner is obligated to provide support services directly to the end customer. The channel partner is obligated to provide Level 1 and Level 2 support services to the end customer, including technical support and RMA fulfillment, while our obligations are only to provide software upgrades and Level 3 technical support in the unusual scenario in which the channel partner is unable to provide the technical support that the end customer requires.
Stock-Based Compensation
We apply the provisions of SFAS No. 123R which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. Our share-based payment awards include stock options, restricted stock units and awards, and employee stock purchase plan awards. This methodology requires the use of subjective assumptions in implementing SFAS 123R, including expected stock price volatility and the estimated term of each award. We calculate the fair value of restricted stock-based on the fair market value of our stock on the date of grant. We calculate the fair value of stock options and employee stock purchase plan shares on the date of grant using the Black-Scholes option-pricing model. The determination of the fair value of stock-based payment awards using an option-pricing model is affected by our stock price, as well as assumptions regarding a number of variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rates and expected dividends. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. This model also utilizes the fair value of our common stock and requires that, at the date of grant, we use the expected term of the stock-based award, the expected volatility of the price of our common stock over the expected term, the risk free interest rate and the expected dividend yield of our common stock to determine the estimated fair value. We determine the amount of stock-based compensation expense based on awards that we ultimately expect to vest, reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In addition, compensation expense includes the effects of awards modified, repurchased or cancelled. Employee stock-based compensation related to unvested awards is being amortized on a straight-line basis.

 

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Goodwill and Intangibles
We apply SFAS No. 142, Goodwill and Other Intangible Assets and perform an annual goodwill impairment test. For purposes of impairment testing, we have determined that we have only one reporting unit. The identification and measurement of goodwill impairment involves the estimation of the fair value of the Company. These estimates of fair value are based on the best information available as of the date of the assessment, which primarily includes our market capitalization. We did not recognize impairment charges in any of the periods presented.
Purchased intangible assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets, which range from two to seven years. Long-lived assets, including intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Some factors we consider important which could trigger an impairment review include the following:
    significant underperformance relative to estimated results;
 
    significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and
 
    significant negative industry or economic trends.
Determination of recoverability of purchased intangible assets is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss is based on the fair value of the asset. We did not recognize impairment charges in any of the periods presented.
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. Additionally, changes in the technology industry occur frequently and quickly. Therefore, there can be no assurance that a charge to operations will not occur as a result of future goodwill and purchased intangible impairment tests.
Inventory Valuation
Inventory consists of hardware and related component parts and is stated at the lower of cost or market. Cost is computed using the standard cost, which approximates actual cost, on a first-in, first-out basis. We record inventory write-downs for potentially excess inventory based on forecasted demand, economic trends, technological obsolescence of our products and transition of inventory related to new product releases. If future demand or market conditions are less favorable than our projections, additional inventory write-downs could be required and would be reflected in cost of product revenues in the period the revision is made. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Inventory write-downs amounted to $1.9 million and $3.3 million in the three and nine months ended April 30, 2009, respectively, and $0.3 million and $0.8 million in the three and nine months ended April 30, 2008, respectively.
Allowances for Doubtful Accounts
We record a provision for doubtful accounts based on historical experience and a detailed assessment of the collectibility of our accounts receivable. In estimating the allowance for doubtful accounts, our management considers, among other factors, (1) the aging of the accounts receivable, including trends within and ratios involving the age of the accounts receivable, (2) our historical write-offs, (3) the credit-worthiness of each customer, (4) the economic conditions of the customer’s industry, and (5) general economic conditions, especially given the recent financial crisis in today’s economic environment. In cases where we are aware of circumstances that may impair a specific customer’s ability to meet their financial obligations to us, we record a specific allowance against amounts due from the customer, and thereby reduce the net recognized receivable to the amount we reasonably believe will be collected. The allowance for doubtful accounts was $0.5 million and $0.6 million at April 30, 2009 and July 31, 2008, respectively.
Income Taxes
We use the asset and liability method of accounting for income taxes in accordance with FASB Statement No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are recognized for deductible temporary differences, along with net operating loss carryforwards, if it is more likely than not that the tax benefits will be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences, research and credit carryforwards and net operating loss carryforwards are deductible. To the extent deferred tax assets cannot be recognized under the preceding criteria, a valuation allowance is established.

 

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Based on the available objective evidence, including the fact that we have generated losses since inception, management believes it is more likely than not that the deferred tax assets will not be realized. Accordingly, management has applied a full valuation allowance against our deferred tax assets.
Recent Accounting Pronouncements
See Note 14 of Notes to Consolidated Financial Statements for recent accounting pronouncements that could have an effect on us.
Results of Operations
The following table presents our historical operating results as a percentage of revenues for the periods indicated:
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
 
                               
Revenues:
                               
Product
    78.2 %     83.3 %     81.2 %     83.2 %
Professional services and support
    21.1 %     14.7 %     18.0 %     14.7 %
Ratable product and related professional services and support
    0.7 %     2.0 %     0.8 %     2.1 %
 
                       
 
                               
Total revenues
    100.0 %     100.0 %     100.0 %     100.0 %
 
                               
Cost of revenues:
                               
Product
    30.6 %     26.3 %     30.1 %     26.2 %
Professional services and support
    4.0 %     3.9 %     3.8 %     4.5 %
Ratable product and related professional services and support
    0.2 %     0.7 %     0.3 %     0.8 %
 
                       
 
                               
Gross margin
    65.2 %     69.1 %     65.8 %     68.5 %
 
                               
Operating expenses:
                               
Research and development
    21.2 %     22.9 %     20.8 %     20.9 %
Sales and marketing
    44.2 %     49.8 %     45.6 %     47.5 %
General and administrative
    12.8 %     11.1 %     11.8 %     10.2 %
Acquisition related expenses
    0.0 %     0.5 %     0.0 %     0.2 %
Restructuring expenses
    0.0 %     0.0 %     1.0 %     0.0 %
 
                       
 
                               
Operating margin
    (13.0 %)     (15.2 %)     (13.4 %)     (10.3 %)
 
                               
Other income (expense), net
    0.9 %     1.2 %     0.8 %     2.9 %
 
                       
 
                               
Loss before income taxes
    (12.1 %)     (14.0 %)     (12.6 %)     (7.4 %)
 
                               
Provision for income taxes
    0.5 %     0.6 %     0.4 %     0.5 %
 
                       
 
                               
Net loss
    (12.6 %)     (14.6 %)     (13.0 %)     (7.9 %)
 
                       

 

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Revenues
The following table presents our revenues, by revenue source, for the periods presented:
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
 
                               
Total revenues
  $ 45,806     $ 42,606     $ 145,933     $ 129,981  
 
                       
Type of revenues:
                               
Product
    35,822       35,478       118,561       108,105  
Professional services and support
    9,666       6,287       26,271       19,109  
Ratable product and related professional services and support
    318       841       1,101       2,767  
 
                       
Total revenues
  $ 45,806     $ 42,606     $ 145,933     $ 129,981  
 
                       
Revenues by geography:
                               
United States
    27,565       28,081       92,705       87,234  
Europe, the Middle East and Africa
    9,543       8,565       27,693       23,736  
Asia Pacific
    6,756       4,390       20,038       13,503  
Rest of World
    1,942       1,570       5,497       5,508  
 
                       
Total revenues
  $ 45,806     $ 42,606     $ 145,933     $ 129,981  
 
                       
For the third quarter of fiscal 2009, total revenues increased 7.5% over the third quarter of fiscal 2008 due to a $3.7 million increase in product and professional services and support. The increase in revenues was attributable to the continual and steady growth of the WLAN market and the significant growth in our customer base. In particular, sales in the healthcare and education verticals continued to grow in the third quarter of fiscal 2009. Further, product revenues have grown as companies continue to move toward a low-cost IT infrastructure solution, which we believe is due in part to the recent economic downturn. For the first nine months of fiscal 2009, total revenues increased 12.3% compared to the first nine months of fiscal 2008, due to a $17.6 million increase in product and related professional services and support revenues.
Ratable product and related professional services and support revenues decreased in the third quarter and first nine months of fiscal 2009 compared to the third quarter and first nine months of fiscal 2008 due to the run-off in the amortization of deferred revenue associated with those customer contracts that we entered into prior to our establishment of VSOE of fair value. We expect ratable product and related professional services and support revenues to continue to decrease in absolute dollars and as a percentage of total revenues in future periods.
In the third quarter of fiscal 2009, we derived 83.2% of our total revenues from indirect channels, which consist of VADs, VARs and OEMs, compared to 84.0% in the third quarter of fiscal 2008. For the first nine months of fiscal 2009, we derived 82.0% of our total revenues from indirect channels compared to 81.5% for the first nine months of fiscal 2008. Going forward, we expect to continue to derive a significant majority of our total revenues from indirect channels as we continue to focus on improving the ability of our indirect channel partners to more effectively market and sell our products.
Revenues from shipments to locations outside the United States increased $3.7 million during the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008 due to an increase in demand for our products as the WLAN market expanded internationally. During the first nine months of fiscal 2009, revenues from shipments outside of the United States were 36.5% of total revenues compared to 32.9% of total revenues in the first nine months of fiscal 2008. We continue to expand into international locations and introduce our products in new markets, and we expect international revenues to increase in absolute dollars compared to fiscal 2008, and increase as a percentage of total revenues in future periods.
The increase in professional services and support revenues is a result of increased product and first year support sales combined with the renewal of support contracts by existing customers. As our customer base grows, we expect the proportion of our revenues represented by support revenues to increase because substantially all of our customers purchase support when they purchase our products.

 

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Cost of Revenues and Gross Margin
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
Total revenues
  $ 45,806     $ 42,606     $ 145,933     $ 129,981  
 
                               
Cost of product
    14,005       11,236       43,978       34,077  
Cost of professional services and support
    1,814       1,650       5,585       5,853  
Cost of ratable product and related professional services and support
    110       294       385       986  
 
                       
Total cost of revenues
    15,929       13,180       49,948       40,916  
 
                       
Gross profit
  $ 29,877     $ 29,426     $ 95,985     $ 89,065  
Gross margin
    65.2 %     69.1 %     65.8 %     68.5 %
In the third quarter of fiscal 2009 cost of revenues increased 20.9% compared to the third quarter of fiscal 2008 due to a change in our product mix, an increase in inventory reserves due to the transition of inventory related to new product releases, and an increase in our product revenue. The substantial majority of our cost of product revenues consists of payments to Flextronics, our contract manufacturer. For the third quarter of fiscal 2009, payments to Flextronics and Flextronics-related costs constituted more than 75% of our cost of product revenues. In the first nine months of fiscal 2009, cost of revenues increased 22.1% compared to the first nine months of fiscal 2008, also due to the corresponding increase in our product revenues.
Cost of professional services and support revenues increased 9.9% in the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008. However, the costs did not increase at the same rate as the professional services and support revenues due to cost efficiencies in our support organization. During the first nine months of fiscal 2009, costs of professional services and support revenues decreased 4.6% compared to the first nine months of fiscal 2008. Most of the decrease was attributable to the fact that, during the first quarter of fiscal 2008, we recognized the costs associated with several significant professional services transactions for large product installations. As a result, cost of professional services and support was $0.3 million higher in the first nine months of fiscal 2008 compared to the first nine months of fiscal 2009.
Cost of ratable product and related professional services and support revenues decreased during these periods consistent with the decrease in ratable product and related professional services and support revenues.
As we expand internationally, we may incur additional costs to conform our products to comply with local laws or local product specifications. In addition, as we expand internationally, we plan to continue to hire additional technical support personnel to support our growing international customer base.
Gross margins decreased during the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008 as a result of product mix and an increase in inventory reserves due to the transition of inventory related to new product releases. For the first nine months of fiscal 2009, gross margins decreased primarily due to a large retail deal recognized in the first quarter of fiscal 2009 that had a lower gross margin, an increase in amortization expense related to the acquisition of AirWave and increases in the inventory reserves.
Research and Development Expenses
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
Research and development expenses
  $ 9,734     $ 9,762     $ 30,407     $ 27,148  
Percent of total revenues
    21.2 %     22.9 %     20.8 %     20.9 %
In the third quarter of fiscal 2009, research and development expenses decreased slightly by 0.3%, compared to the third quarter of fiscal 2008. Fees for outside engineering services decreased $0.3 million and consulting services decreased $0.1 million as we continue to streamline expenses as a result of the overall economic downturn. These decreases were partially offset by an increase in personnel and related costs of $0.2 million and an increase in depreciation expense of $0.2 million.
During the first nine months of fiscal 2009, research and development expenses increased 12.0% compared to the first nine months of fiscal 2008 primarily due to an increase of $2.2 million in personnel and related costs. Facilities expenses increased $0.4 million as a result of leasing a new building for our Sunnyvale, CA headquarters, as well as facilities-related expenses of AirWave. Depreciation expense also increased $0.6 million due to an increase in depreciable assets.

 

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Sales and Marketing Expenses
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
Sales and marketing expenses
  $ 20,251     $ 21,230     $ 66,519     $ 61,755  
Percent of total revenues
    44.2 %     49.8 %     45.6 %     47.5 %
In the third quarter of fiscal 2009, sales and marketing expenses decreased 4.6% over the third quarter of fiscal 2008 primarily due to a decrease of $0.7 million in marketing program expenses as we made a concerted effort to cut costs in this area. Personnel related expenses decreased $0.3 million as we reduced headcount in our sales and marketing departments by 21 people compared to the third quarter of fiscal 2008. As headcount decreased, recruiting fees decreased $0.2 million and costs for internal equipment demonstration kits decreased $0.3 million. These decreases in spending were partially offset by an increase in commissions of $0.4 million in line with the increase in our revenue, and an increase in amortization expense of $0.2 million due to the timing of the acquisition of AirWave towards the last half of the third quarter of fiscal 2008.
During the first nine months of fiscal 2009, sales and marketing expenses increased 7.7% over the first nine months of fiscal 2008 primarily due to an increase of $3.6 million in sales commissions as a result of the increase in revenues. Personnel and related costs increased $2.4 million. Amortization expense increased $0.9 million compared to the first nine months of fiscal 2008 and depreciation expense increased $0.3 million. These increases were partially offset by a decrease in marketing program expenses of $1.7 million. Recruiting expenses decreased $0.4 million and costs for internal equipment demonstration kits decreased $0.5 million.
General and Administrative Expenses
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
General and administrative expenses
  $ 5,854     $ 4,730     $ 17,154     $ 13,325  
Percent of total revenues
    12.8 %     11.1 %     11.8 %     10.2 %
In the third quarter of fiscal 2009, general and administrative expenses increased 23.8% over the third quarter of fiscal 2008, primarily due to an increase of $0.6 million in legal fees related to litigation. Further, personnel and related costs increased $0.6 million as a result of an increase in stock-based compensation. Outside services decreased $0.1 million as we continue to streamline expenses as a result of the overall economic downturn.
During the first nine months of fiscal 2009, general and administrative expenses increased 28.7% compared to the first nine months of fiscal 2008 primarily due to an increase of $2.0 million in legal fees related to litigation. Further, personnel and related costs increased $1.5 million as a result of an increase in stock based compensation. Professional accounting fees also increased $0.3 million related to Sarbanes-Oxley compliance costs and external audit services.
Restructuring Expenses
On November 14, 2008, as a result of the macroeconomic downturn, our board of directors approved a plan to reduce our costs and streamline operations through a combination of a reduction in our work force and the closing of certain facilities. The majority of the reduction in our work force was completed in the second quarter of fiscal 2009 while the remaining reduction was completed in the third quarter of fiscal 2009. The reduction in our work force resulted in the termination of 46 employees worldwide, or about 8% of our global work force, mainly in the sales and marketing and research and development functions. Expenses associated with the work force reduction, which were comprised primarily of severance and benefits payments as well as professional fees associated with career transition services, totaled $1.1 million. Additionally, we closed facilities in California and North Carolina and incurred facility exit costs of $0.3 million as a result. These cost reduction efforts, when added to our other cost control measures, resulted in a savings of approximately $2.0 million during the second quarter of fiscal 2009. We expect to realize an additional $5.0 million to $6.0 million in additional savings through the end of fiscal 2009 based on all of our cost reduction efforts.

 

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Other Income (Expense), Net
Other income (expense), net consists primarily of interest income, income for warrants issued in connection with equipment loans, and foreign currency exchange gains and losses.
                                 
    Three months ended April 30,     Nine months ended April 30,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
Interest income
  $ 368     $ 854     $ 1,572     $ 3,474  
Other income (expense), net
    46       (324 )     (438 )     258  
 
                       
Total other income (expense), net
  $ 414     $ 530     $ 1,134     $ 3,732  
 
                       
Interest income during the third quarter of fiscal 2009 decreased 56.9% from the third quarter of fiscal 2008 primarily due to declining interest rates. Our average yield-to-maturity rate decreased from 3.4% in the third quarter of fiscal 2008 to 1.5% in the third quarter of fiscal 2009. The rate decreased from 4.5% in the first nine months of fiscal 2008 to 2.3% in the first nine months of fiscal 2009.
Other income (expense), net increased during the during the third quarter of fiscal 2009 compared to the third quarter of fiscal 2008 as a result of an increase in foreign currency gains which was primarily driven by the remeasurement of foreign currency transactions into US dollars. During the first nine months of fiscal 2009 other income (expense), net decreased primarily due to the one-time inclusion of other income of $715,000 in the first quarter of fiscal 2008 as a result of revaluing our warrants to purchase preferred stock.
Provision for Income Taxes
For the third quarter of fiscal 2009 and 2008, we generated operating losses. However, while we generated book and tax losses, we generated operating income for foreign and state purposes resulting in additional tax provisions during the third quarter of fiscal 2009.
We use the asset and liability method of accounting for income taxes in accordance with FASB Statement No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Based on the available objective evidence, including the fact that we have generated losses since inception and continues to incur a loss, we believe it is more likely than not that the deferred tax assets will not be realized. Accordingly, we have applied a full valuation allowance against our deferred tax assets.
Liquidity and Capital Resources
                 
    As of April 30,     As of July 31,  
    2009     2008  
    (in thousands)  
Working capital
  $ 110,153     $ 103,097  
Cash and cash equivalents
  $ 34,777     $ 37,602  
Short-term investments
  $ 77,006     $ 64,130  
                 
    Nine months ended April 30,  
    2009     2008  
    (in thousands)  
Cash provided by operating activities
  $ 9,134     $ 3,300  
Cash used in investing activities
  $ (16,135 )   $ (12,760 )
Cash provided by financing activities
  $ 4,177     $ 8,364  
Cash and cash equivalents consist primarily of highly liquid investments in corporate bonds and notes, government sponsored enterprise obligations, commercial paper and other money market securities with remaining maturities at date of purchase of 90 days or less. Short-term investments consist of corporate bonds and notes, government sponsored enterprise obligations, and commercial paper. Effective August 1, 2008, fair value of short-term investments is determined in accordance with SFAS 157. Cash, cash equivalents and short-term investments increased $10.0 million in the first nine months of fiscal 2009 from $101.7 million in cash, cash equivalents and short-term investments as of July 31, 2008.
Most of our sales contracts are denominated in United States dollars including sales contracts with international customers. As such, the increase in our revenues derived from international customers has not affected our cash flows from operations as these are not affected by movement in exchange rates. As we fund our international operations, our cash and cash equivalents are affected by changes in exchange rates.

 

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Cash Flows from Operating Activities
Our cash flows from operating activities will continue to be affected principally by our working capital requirements 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. 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.
Cash provided by operating activities increased during the first nine months of fiscal 2009 compared to the first nine months of fiscal 2008 due to decreases in accounts receivable, prepaid assets, and deferred costs of goods sold as well as increases in other accrued liabilities, stock-based compensation, depreciation and amortization, and write downs in our inventory. Cash provided by operating activities was offset by an increase in inventory and a decrease in accounts payable and deferred revenues.
Cash Flows from Investing Activities
Cash used in investing activities increased during the first nine months of fiscal 2009 compared to the first nine months of fiscal 2008 largely due to the decrease in proceeds from the sale of our short-term investments. Purchases of property and equipment in the first nine months of fiscal 2009 were slightly down compared to the first nine months of fiscal 2008 due to an effort to control costs. During the first nine months of fiscal 2008, we acquired AirWave Wireless Inc. for $16.0 million.
Cash Flows from Financing Activities
Cash provided by financing activities decreased in the first nine months of fiscal 2009 compared to the first nine months of fiscal 2008. The cash proceeds from the issuance of common stock in conjunction with our 2007 Equity Incentive Plans and Employee Stock Purchase Plan decreased in the first nine months of fiscal 2009 compared to the first nine months of fiscal 2008 primarily due to the decline in the stock price. Cash outflows for the repurchase of our common stock under our stock repurchase program decreased during the first nine months of fiscal 2009 compared to the first nine months of fiscal 2008.
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 twelve months. However, we may need to raise additional capital or incur additional indebtedness to continue to fund our operations in the future. 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. Although we have no current agreements, commitments, plans, proposals or arrangements, written or otherwise, with respect to any material acquisitions, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.
Other Uses of Cash
On February 26, 2008, we announced a stock repurchase program for up to $10.0 million of our common stock. During the first quarter of fiscal 2009, we purchased 191,200 shares under this program for an aggregate purchase price of $1.0 million. No purchases were made during the second and third quarters of fiscal 2009. As of April 30, 2009, we are authorized to purchase up to an additional $6.9 million worth of shares under this program until February 26, 2010. Such purchases, if any, will be funded from available working capital. The number of shares to be purchased and the timing of purchases will be based on the price of our common stock, general business and market conditions, and other investment considerations. To the extent that we repurchase shares under this authorization, interest income may decrease as our cash, cash equivalents and short-term investments decrease.

 

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Contractual Obligations
The following is a summary of our contractual obligations as of April 30, 2009:
                                         
            Less than                     More than  
    Total     1 year     1 - 3 years     3 - 5 years     5 years  
    (in thousands)  
Operating leases
  $ 5,328     $ 3,449     $ 1,879     $     $  
Non-cancellable inventory purchase commitments (1)
    8,972       8,972                    
 
                             
Total contractual obligations
  $ 14,300     $ 12,421     $ 1,879     $     $  
 
                             
     
(1)   We outsource the production of our hardware to third-party manufacturing suppliers. We enter into various inventory related purchase agreements with these suppliers. Generally, under these agreements, 40% of the orders are cancelable by giving notice 60 days prior to the expected shipment date, and 20% of orders 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.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The ongoing global financial crisis affecting the banking system and financial markets and the going concern threats to investment banks and other financial institutions have resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and extreme volatility in many financial instrument markets.
Foreign Currency Risk
Most of our sales contracts are denominated in United States dollars, and therefore, our revenue is not subject to foreign currency risk. Certain of 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 and Japanese Yen. To date, we have not entered into any hedging contracts.
Interest Rate Sensitivity
We had cash, cash equivalents and short-term investments totaling $111.8 million and $101.7 million as of April 30, 2009 and July 31, 2008, 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% in the first nine months of fiscal 2009, our interest income on cash, cash equivalents and short-term investments would have declined approximately $0.1 million and $0.2 million during the three and nine months ended April 30, 2009, respectively, 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.
Based on our evaluation, our chief executive officer and chief financial officer concluded that, as of April 30, 2009, 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.

 

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Changes in Internal Control Over Financial Reporting
During the second quarter of fiscal 2009, we implemented a new enterprise resource planning (“ERP”) system. The implementation of the ERP system represents a material change in our internal controls over financial reporting.
Management has reviewed and evaluated the design of key controls in the new ERP system and the accuracy of the data conversion that took place during the implementation and has not uncovered a control deficiency or combination of control deficiencies that management believes meet the definition of a material weakness in internal control over financial reporting. Although management believes internal controls have been maintained or enhanced by the new ERP system, it has not completed its testing of the operating effectiveness of all key controls in the new system. As such, there is a risk such control deficiencies may exist that have not yet been identified and that could constitute, individually or in combination, a material weakness. Management will continue to evaluate the operating effectiveness of related key controls during the remainder of the fiscal year.
There were no changes in our internal control over financial reporting that occurred during the third quarter of fiscal 2009 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
On August 27, 2007, Symbol Technologies, Inc. and Wireless Valley Communications, Inc. both Motorola subsidiaries, filed suit against us in the Federal District Court of Delaware asserting infringement of U.S. Patent Nos. 7,173,922; 7,173,923; 6,625,454; and 6,973,622. We filed our response on October 17, 2007, denying the allegations and asserting counterclaims. On September 8, 2008, we filed an amended answer and counterclaims, asserting infringement of Aruba’s U.S. Patent Nos. 7,295,524 and 7,376,113 against Motorola, Inc. as well as its subsidiaries, Symbol Technologies, Inc. and Wireless Valley Communications, Inc. On November 13, 2008, Motorola filed an amended complaint asserting infringement of U.S. Patent No. 7,359, 676 owned by AirDefense, Inc., another Motorola subsidiary. The complaint and the counterclaims seek unspecified monetary damages and injunctive relief. Although we intend to vigorously defend against these claims, intellectual property litigation is expensive and time-consuming, regardless of the merits of any claim, and could divert our management’s attention from operating our business. Because of the inherent uncertainties of litigation the outcome of this action could be unfavorable. At this time, we are unable to estimate the potential financial impact this action could have on us. The trial is scheduled to commence on January 10, 2010.
We could become involved in additional litigation from time to time relating to claims arising out of our ordinary course of business. Other than described above, there were no claims as of April 30, 2009 that, in the opinion of management, might have a material adverse effect on our financial position, results of operations or cash flows.
Item 1A. Risk Factors
Risks Related to Our Business and Industry
Our business, operating results and growth rates may be adversely affected by unfavorable economic and market conditions, as well as the volatile geopolitical environment.
Economic conditions worldwide have negatively impacted our business. While we believe in the long-term growth prospects of the WLAN market, the deterioration in overall economic conditions and, in particular, tightening in the credit markets and reduced spending by both enterprises and consumers have significantly impacted various industries on which we rely for purchasing our products. This has led to reductions in capital expenditures by end-user customers for our products, longer sales cycles, the deferral or delay of purchase commitments for our products and increased competition. These factors have adversely impacted our operating results and have created significant and increasing uncertainty for the future. For example, our total revenues in the second quarter of fiscal 2009 decreased from our total revenues in the first quarter of fiscal 2009 and we have recently experienced softness in the retail vertical market as our customers in the retail industry continue to struggle with these economic challenges. In addition, our business depends on the overall demand for information technology (“IT”) and on the economic health of our current and prospective customers. 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 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, even if economic conditions improve, 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. For example, the recent worldwide economic and geopolitical turmoil, the continuing credit crisis that has affected worldwide financial markets, the significant volatility in the stock markets and other current negative macroeconomic indicators, such as the global recession or uncertainty or further weakening in key vertical or geographic markets, could negatively impact technology spending for the products and services we offer and materially adversely affect our business, operating results and financial condition. In addition, if interest rates rise, overall demand for our products and services could be further dampened and related IT spending may be reduced.

 

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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. You should consider and evaluate our prospects in light of the risks and uncertainties frequently encountered by early stage 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.
Our annual and quarterly operating results have fluctuated in the past and may fluctuate significantly in the future due to a variety of factors, many of which are outside of our control.
Furthermore, our product revenues generally reflect 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 will continue. In fact, we experienced an increase in the percentage of our orders received during the last month of our third fiscal quarter compared to prior quarters. 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.
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 two-tier distribution model;
 
    fluctuations in demand, sales cycles and prices for our products and services;
 
    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 and education vertical markets;
 
    the timing of product releases or upgrades by us or by our competitors;
 
    any significant changes in the competitive dynamics of our markets, including new entrants, or further consolidation;

 

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    our ability to control costs, including our operating expenses, and the costs of the components we purchase;
 
    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 Flextronics and our component suppliers;
 
    growth in our headcount and other related costs incurred in our customer support organization;
 
    the timing of revenue recognition in any given quarter as a result of revenue recognition rules;
 
    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 for the nine months ended April 30, 2009.
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. In this event, the trading price of our common stock could decline significantly.
We have a history of losses and may not achieve profitability in the future.
We have a history of losses and have not achieved profitability on a quarterly or annual basis. We experienced net losses of $5.8 million and $18.9 million for the three and nine months ended April 30, 2009, respectively, and $6.2 million and $10.3 million for the three and nine months ended April 30, 2008, respectively. As of April 30, 2009 and July 31, 2008, our accumulated deficit was $137.1 million and $118.2 million, respectively. We expect to incur operating losses in the future as a result of the expenses associated with the continued development and expansion of our business, including expenditures to hire additional personnel relating to sales and marketing and technology development. If we fail to increase revenues or manage our cost structure, we may not achieve or 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 revenues 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 averages four to nine months in length but can be as long as 18 months. We spend substantial time, effort and money in our sales efforts without any assurance that our efforts will produce any sales. Recently, we have experienced longer sales cycles in connection with customers evaluating our new 802.11n solution and in light of general economic conditions in certain verticals. In addition, product purchases are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. For example, during the second quarter of fiscal 2008, we experienced a significant decrease in revenues in our federal vertical market, which represents sales to United States governmental entities. We view the federal vertical as highly dependent on large transactions, and therefore we could experience significant fluctuations from period to period in this vertical. 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, revenues, growth rates and market share.
The market in which we compete is a highly competitive industry that is influenced by the following competitive factors:
    comprehensiveness of the solution;
 
    total cost of ownership;

 

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    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;
 
    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 margins, 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, revenues and prospects for growth.
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, and Motorola (through its subsidiary Symbol Technologies), as well as smaller private 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 other established and emerging companies if 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 the third-party distribution sources on which we rely do not perform their services adequately or efficiently 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 revenues 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. Recently we’ve dedicated a significant amount of effort to establish and maintain a two-tier distribution model in the Americas. The percentage of our total revenues derived from sales through our indirect channel was 83.2% and 82.0%, for the three and nine months ended April 30, 2009, respectively, and 84.0% and 81.5% for the three and nine months ended April 30, 2008, respectively. We expect that over time, indirect channel sales will continue to constitute a substantial majority of our total revenues. Accordingly, our revenues depend in large part on the effective performance of our channel partners, including our largest channel partner, Alcatel-Lucent. Alcatel-Lucent accounted for 16.5% and 13.2% of our total revenues for the three and nine months ended April 30, 2009, respectively and 11.8% and 10.8% for the three and nine months ended April 30, 2008, respectively. Our OEM supply agreement with Alcatel-Lucent provides that Alcatel-Lucent shall use reasonable commercial efforts to sell our products on a perpetual basis unless the agreement is otherwise terminated by either party. In addition, this OEM supply agreement restricts our ability to enter into channel partner relationships with other specified VADs, VARs, and OEMs without obtaining Alcatel-Lucent’s consent. Finally, the OEM supply agreement contains a “most-favored nations” clause, pursuant to which we agreed to lower the price at which we sell products to Alcatel-Lucent in the event that we agree to sell the same or similar products at a lower price to a similar customer on the same or similar terms and conditions. However, the specific terms of this “most-favored nations” clause are narrow and specific, and we have not to date incurred any obligations related to this term in the OEM supply agreement.

 

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Some of our third-party distribution sources 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 meet their financial obligations to us. If the third-party distribution sources on which we rely do not perform their services adequately or efficiently, 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 revenues, 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 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 margins to the extent revenues from such channel partners increase as a proportion of our overall revenues.
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 third-party distribution sources 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. 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 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, 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 margins. 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 sitting 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, we have developed and are currently offering for sale products that comply with the draft 802.11n wireless LAN standard (“11n”) that IEEE has not yet ratified. If IEEE fails to ratify the 11n standard, or materially modifies the current draft of the 11n standard, we likely would have to modify our products to comply with the final 11n standard, which would require additional time and expense and could cause a disruption in our ability to market and sell the affected products.

 

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As a result of the fact that we outsource the manufacturing of our products to Flextronics, 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 Flextronics, 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 Flextronics, 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 Flextronics’s financial or business condition could disrupt our ability to supply quality products to our customers and thereby have a material adverse effect on our business, revenues and financial condition.
Our orders with Flextronics represent a relatively small percentage of the overall orders received by Flextronics from its customers. As a result, fulfilling our orders may not be considered a priority in the event Flextronics is constrained in its ability to fulfill all of its customer obligations in a timely manner. We provide demand forecasts to Flextronics. If we overestimate our requirements, Flextronics may assess charges, or we may have liabilities for excess inventory, each of which could negatively affect our gross margins. 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, Flextronics 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 Flextronics in order for manufacturing to be completed and shipments to be made on a timely basis.
If Flextronics suffers an interruption in its business, or experiences delays, disruptions or quality control problems in its 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.
Flextronics purchases 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 single or limited number of suppliers for several components for our equipment and certain subassemblies and products. We rely on Flextronics 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.
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 Flextronics sources and incorporates in our hardware products are currently available only from a limited number of suppliers, with whom neither we nor Flextronics have entered into supply agreements. All of our access points incorporate components from Atheros Communications, Inc. (“Atheros”), and some of our mobility controllers incorporate components from Broadcom Corporation (“Broadcom”) and RMI Corporation. (“RMI”). We have entered into license agreements with both Atheros, Broadcom and RMI, the termination of which could have a material adverse effect on our business. Our license agreement with Atheros, Broadcom and RMI 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 Flextronics is unable to obtain these components from Atheros, Broadcom or RMI, we would be required to redesign our hardware and software in order to incorporate components from alternative sources. All of our product revenues are dependent upon the sale of products that incorporate components from either Atheros, Broadcom or RMI.
In addition, 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 Flextronics rely on our suppliers to deliver necessary components in a timely manner. We and Flextronics rely on purchase orders rather than long-term contracts with these suppliers. As a result, even if available, we or Flextronics 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.

 

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Our international sales and operations subject us to additional risks that may adversely affect our operating results.
We derive a significant portion of our revenues from customers outside the United States. We have sales and technical support personnel in numerous countries worldwide. In addition, a portion of our engineering efforts are currently handled by personnel located in India, and we expect to expand our offshore development efforts within India and possibly in other countries. We expect to continue to add personnel in additional countries. For example, we recently hired a new head of our Europe, Middle East and Asia operations. Our international operations subject us to a variety of risks, including:
    the difficulty of managing and staffing international offices and the increased travel, infrastructure and legal compliance costs associated with multiple international locations;
 
    difficulties in enforcing contracts and collecting accounts receivable, and longer payment cycles, especially in emerging markets;
 
    the need to localize our products for international customers;
 
    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;
 
    reduced protection for intellectual property rights in some countries; and
 
    increased cost of terminating international employees in some countries.
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.
We are currently subject to a lawsuit involving intellectual property claims brought by Symbol Technologies, Inc. and Wireless Valley Communications, Inc., both Motorola subsidiaries, which could cause us to incur significant additional costs or prevent us from selling our products which could adversely affect our results of operations and financial condition.
On August 27, 2007, Symbol Technologies, Inc. and Wireless Valley Communications, Inc., both Motorola subsidiaries, filed suit against us in the Federal District Court of Delaware alleging patent infringement. We have subsequently added Motorola, Inc. as a party and filed counterclaims against Motorola, Symbol and Wireless Valley, alleging infringements of our own patents. Trial is scheduled to commence in January 2010. Although we intend to vigorously defend against these claims, intellectual property litigation is expensive and time-consuming, regardless of the merits of any claim, and could divert our management’s attention from operating our business. Our legal costs may increase as the case develops and we near a trial date. The results of, and costs associated with, complex litigation matters are difficult to predict, and the uncertainty associated with a substantial unresolved lawsuit could harm our business, financial condition and reputation. Negative developments with respect to this lawsuit could cause our stock price to decline, and could have an adverse and possibly material effect on our business and results of operations.

 

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Claims by others that we infringe their proprietary technology 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. 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.
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 July 2007, we acquired Network Chemistry, Inc.’s line of RFProtect and BlueScanner wireless security products. We continue to integrate the acquired technology into our secure mobility solutions, and continue to support existing Network Chemistry customers and partners. We also completed our acquisition of AirWave Wireless, Inc in March 2008. We continue to integrate the acquired AirWave products into our secure mobility solutions, as well as provide products and continuing support to existing AirWave customers and partners. The acquisition of AirWave is our first significant acquisition, and, as a result, our ability as an organization to complete and integrate acquisitions is unproven. In the future we may acquire other 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, or such acquisitions may be viewed negatively by customers, financial markets or investors. In addition, any acquisitions that we make could lead to difficulties in integrating personnel and operations from the acquired businesses and in retaining and motivating key personnel from these businesses. 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.
Impairment of our goodwill or other assets would negatively affect our results of operations.
Our acquisition of AirWave Wireless Inc, resulted in goodwill of $7.7 million. Together with our purchase of certain assets of Network Chemistry, Inc., we have purchased intangible assets of $15.3 million as of April 30, 2009. This represents a significant portion of the assets recorded on our balance sheet. Goodwill is reviewed for impairment at least annually or sooner under certain circumstances. Other intangible assets that are deemed to have finite useful lives will continue to be 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 you 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, we may not be able to successfully grow our business.
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. For example, unless and until we hire a Vice President of Worldwide Sales, our Chief Executive Officer will fill this role in addition to his other responsibilities. Experienced management and technical, sales, marketing and support personnel in the IT industry are in high demand, and competition for their talents is intense. 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.

 

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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 by optimizing our network of channel partners. We also plan to increase offshore operations by establishing additional offshore capabilities for certain engineering functions. This future growth, if it occurs, will 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. If we do not effectively manage our growth, our business, operating results and financial condition could be adversely affected.
To accommodate the growth of our business, we implemented a new Enterprise Resource Planning (“ERP”) system in November 2008. Accordingly, we may experience problems commonly experienced by other companies in connection with such implementations, including but not limited to, potential bugs in the system, component or supply delays, training requirements and other integration challenges and delays. Any difficulties we might experience in connection with our new ERP system could have a material adverse effect on our financial reporting system and internal controls.
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, they 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 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. Our products have contained and may contain undetected errors, and/or bugs or security vulnerabilities. Some errors in our products may only be discovered after a product has been installed and used by customers. For example, a software bug was identified in January 2007 that affected certain versions of the Aruba Mobility Controller, in response to which we alerted our customers and released a patch to address the issue. Any errors, bugs, defects or security vulnerabilities discovered in our products after commercial release could result in loss of revenues or delay in revenue recognition, loss of customers, damage to our brand and reputation, 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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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. In such 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.
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 Mobility Management System 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 DSL and dial-up. Our failure to provide such additional functionality could adversely affect our business, operating results and financial condition.
New safety regulations or changes in existing safety 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.
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 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.

 

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In January 2003, the EU issued two directives relating to chemical substances in electronic products. The Waste Electrical and Electronic Equipment Directive requires producers of electrical goods to pay for specified collection, recycling, treatment and disposal of past and future covered products. EU governments were required to enact and implement legislation that complies with this directive by August 13, 2004 (such legislation together with the directive, the “WEEE Legislation”), and certain producers are financially responsible under the WEEE Legislation beginning in August 2005. The EU has issued another directive that requires electrical and electronic equipment placed on the EU market after July 1, 2006 to be free of lead, mercury, cadmium, hexavalent chromium (above a threshold limit) and brominated flame retardants. EU governments were required to enact and implement legislation that complies with this directive by August 13, 2004 (such legislation together with this directive, the “RoHS Legislation”). If we do not comply with these directives or related legislation, we may suffer a loss of revenues, be unable to sell our products in certain markets and/or countries, be subject to penalties and enforced fees and/or suffer a competitive disadvantage. Similar legislation could be enacted in other jurisdictions, including in the United States. Costs to comply with the WEEE Legislation, RoHS Legislation and/or similar future legislation, if applicable, could include costs associated with modifying our products, recycling and other waste processing costs, legal and regulatory costs and insurance costs. We have recorded and may also be required to record additional expenses for costs associated with compliance with these regulations. We cannot assure you that the costs to comply with these new laws, or with current and future environmental and worker health and safety laws will not have a material adverse effect on our results of operation, expenses and financial condition.
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 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.
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 contract manufacturer, Flextronics, is located, could have a material adverse impact on our business, operating results and financial condition. In addition, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. In addition, acts of terrorism could cause disruptions in our or our customers’ businesses or the economy as a whole. To the extent that 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;

 

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    the impact of unfavorable worldwide economic and market conditions, including the restricted credit environment impacting credit of our channel partners and end user customers and indications that these conditions have spread to other countries;
 
    falling short of guidance on our financial results;
 
    changes in estimates of our operating results 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; and
 
    adoption or modification of regulations, policies, procedures or programs applicable to our business.
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.
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.
Insiders have substantial control over us and will be able to influence corporate matters.
As of April 30, 2009, our directors and executive officers and their affiliates beneficially owned, in the aggregate, approximately 35.9% of our outstanding common stock. As a result, these stockholders will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership could limit stockholders’ ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.
We may choose to raise additional capital. Such capital may not be available, or may be available on unfavorable terms, which would adversely affect our ability to operate our business.
We expect that our existing cash balances will be sufficient to meet our working capital and capital expenditure needs for the foreseeable future. If we choose to raise additional funds, 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.
Provisions in our charter documents, Delaware law, employment arrangements with certain of our executive officers, 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 but are not limited to 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;
 
    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;

 

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    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 executive officers may be entitled to accelerated vesting of their options pursuant to the terms of their employment arrangements upon a change of control of Aruba. In addition to the arrangements currently in place with some of our executive officers, we may enter into similar arrangements in the future with other officers. Such arrangements could delay or discourage a potential acquisition of Aruba.
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 have incurred and will continue to incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.
The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq Stock Market, have imposed various requirements on public companies, including requiring changes in corporate governance practices. Our 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. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantial costs to maintain the same or similar coverage. These rules and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.
In addition, 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 fiscal year ended July 31, 2008 filed with the SEC on October 7, 2008 that our internal control over financial reporting was effective as of July 31, 2008, we must continue to monitor 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.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Sales of Unregistered Securities
None
(b) Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
         
Exhibit No.   Description
       
 
  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.

 

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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: June 9, 2009
             
    ARUBA NETWORKS, INC.    
 
           
 
  By:   /s/ Dominic P. Orr
 
Dominic P. Orr
   
 
      President, Chief Executive Officer and    
 
      Chairman of the Board of Directors    
 
      (Principal Executive Officer)    
    Dated: June 9, 2009
             
    ARUBA NETWORKS, INC.    
 
           
 
  By:   /s/ Steffan Tomlinson
 
Steffan Tomlinson
   
 
      Chief Financial Officer    
 
      (Principal Financial Officer)    

 

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EXHIBIT INDEX
         
Exhibit No.   Description
       
 
  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.

 

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