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 October 31, 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
(State or Other Jurisdiction of
Incorporation or Organization)
  02-0579097
(I.R.S. Employer
Identification Number)
1344 Crossman Ave.
Sunnyvale, California 94089-1113
(408) 227-4500

(Address, including zip code, and telephone number,
including area code, of registrant’s principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes 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
(Do not check if a smaller reporting company)
  Smaller reporting company o
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 November 30, 2009 was 88,422,996.
 
 

 

 


 

ARUBA NETWORKS INC.
INDEX
         
    Page No.  
 
       
PART I. FINANCIAL INFORMATION
       
 
       
    3  
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    18  
 
       
    28  
 
       
    28  
 
       
       
 
       
    29  
 
       
    29  
 
       
    42  
 
       
    42  
 
       
    42  
 
       
    42  
 
       
    42  
 
       
 Exhibit 10.2
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1

 

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Item 1. Consolidated Financial Statements
ARUBA NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
                 
    October 31,     July 31,  
    2009     2009  
    (in thousands, except per share data)  
ASSETS
               
Current assets
               
Cash and cash equivalents
  $ 44,056     $ 41,298  
Short-term investments
    91,556       81,839  
Accounts receivable, net
    32,978       33,466  
Inventory
    9,154       8,450  
Deferred costs
    6,964       5,152  
Prepaids and other
    3,201       2,350  
 
           
 
               
Total current assets
    187,909       172,555  
 
               
Property and equipment, net
    7,026       7,426  
Goodwill
    7,656       7,656  
Intangible assets, net
    12,858       14,091  
Other assets
    1,434       1,326  
 
           
 
               
Total assets
  $ 216,883     $ 203,054  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities
               
Accounts payable
  $ 2,330     $ 930  
Accrued liabilities
    40,244       20,722  
Income taxes payable
    743       610  
Deferred revenue
    39,973       34,654  
 
           
 
               
Total current liabilities
    83,290       56,916  
 
               
Deferred revenue
    9,543       8,524  
Other long-term liabilities
    647       29  
 
           
 
               
Total liabilities
    93,480       65,469  
 
           
 
               
Commitments and contingencies (Note 12)
               
Stockholders’ equity
               
Common stock: $0.0001 par value; 350,000 shares authorized at October 31, 2009 and July 31, 2009; 88,257 and 86,744 shares issued and outstanding at October 31, 2009 and July 31, 2009
    9       9  
Additional paid-in capital
    289,492       279,026  
Accumulated other comprehensive income
    210       182  
Accumulated deficit
    (166,308 )     (141,632 )
 
           
 
               
Total stockholders’ equity
    123,403       137,585  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 216,883     $ 203,054  
 
           
See Notes to Consolidated Financial Statements.

 

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ARUBA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands, except per share data)  
Revenues
               
Product
  $ 47,198     $ 43,868  
Professional services and support
    10,143       8,137  
Ratable product and related professional services and support
    255       441  
 
           
Total revenues
    57,596       52,446  
 
               
Cost of revenues
               
Product
    16,432       16,605  
Professional services and support
    2,079       1,933  
Ratable product and related professional services and support
    86       155  
 
           
Total cost of revenues
    18,597       18,693  
 
           
Gross profit
    38,999       33,753  
 
               
Operating expenses
               
Research and development
    11,796       10,423  
Sales and marketing
    24,740       24,661  
General and administrative
    7,132       5,285  
Litigation settlement expense
    19,750        
 
           
Total operating expenses
    63,418       40,369  
 
           
Operating loss
    (24,419 )     (6,616 )
 
               
Other income (expense), net
               
Interest income
    211       648  
Other income (expense), net
    (96 )     (316 )
 
           
Total other income (expense), net
    115       332  
 
           
 
               
Loss before provision for income taxes
    (24,304 )     (6,284 )
 
               
Provision for income taxes
    372       93  
 
           
 
               
Net loss
  $ (24,676 )   $ (6,377 )
 
           
 
               
Net loss per common share, basic and diluted
  $ (0.28 )   $ (0.08 )
 
           
 
               
Shares used in computing basic and diluted net loss per common share
    87,489       83,071  
 
           
 
               
Stock-based compensation expense included in above:
               
Cost of revenues
  $ 318     $ 266  
Research and development
    2,131       2,103  
Sales and marketing
    3,021       2,790  
General and administrative
  $ 2,349     $ 1,334  
See Notes to Consolidated Financial Statements.

 

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ARUBA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands)  
Cash flows from operating activities
               
Net loss
  $ (24,676 )   $ (6,377 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
    2,494       2,268  
Provision for doubtful accounts
    21       40  
Write downs for excess and obsolete inventory
    446       851  
Compensation related to stock options and share awards
    7,819       6,493  
Accretion/ (amortization) of purchase discounts on short-term investments
    81       (104 )
Loss/ (gain) on disposal of fixed assets
    8       (20 )
Excess tax benefit associated with stock-based compensation
    (46 )      
Changes in operating assets and liabilities:
               
Accounts receivable
    467       358  
Inventory
    (1,469 )     (3,552 )
Prepaids and other
    (850 )     754  
Deferred costs
    (1,816 )     201  
Other assets
    36       219  
Accounts payable
    1,346       1,328  
Deferred revenue
    6,339       2,064  
Other current and noncurrent liabilities
    20,107       1,028  
Income taxes payable
    179       24  
 
           
 
               
Net cash provided by operating activities
    10,486       5,575  
 
           
 
               
Cash flows from investing activities
               
Purchases of short-term investments
    (15,730 )     (11,446 )
Proceeds from sales and maturities of short-term investments
    5,820       12,241  
Purchases of property and equipment
    (497 )     (1,070 )
 
           
 
               
Net cash used in investing activities
    (10,407 )     (275 )
 
           
 
               
Cash flows from financing activities
               
Proceeds from issuance of common stock
    2,631       3,134  
Repurchase of common stock under stock repurchase program
          (991 )
Excess tax benefit associated with stock-based compensation
    46        
 
           
 
               
Net cash provided by financing activities
    2,677       2,143  
 
           
 
               
Effect of exchange rate changes on cash and cash equivalents
    2        
 
               
Net increase in cash and cash equivalents
    2,758       7,443  
 
               
Cash and cash equivalents, beginning of period
    41,298       37,602  
 
           
 
               
Cash and cash equivalents, end of period
  $ 44,056     $ 45,045  
 
           
 
               
Supplemental disclosure of cash flow information
               
Income taxes paid
  $ 281     $ 48  
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 6, 2009. The July 31, 2009 consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States (“U.S.”).
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). They do not include all of the financial information and footnotes required by GAAP for complete financial statements. The Company believes the unaudited consolidated financial statements have been prepared on the same basis as its audited financial statements as of and for the year ended July 31, 2009 and include all adjustments necessary for the fair statement of the Company’s financial position as of October 31, 2009, its results of operations for the three months ended October 31, 2009 and 2008, and its cash flows for the three months ended October 31, 2009 and 2008. The results for the three months ended October 31, 2009 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending July 31, 2010.
Certain prior period balances have been reclassified to conform to the current year presentation. The reclassifications did not affect previously reported net loss.
The Company has evaluated subsequent events through December 4, 2009, which is the date these consolidated financial statements were issued.
2. Intangible Assets
The following table presents details of the Company’s total purchased intangible assets:
                                 
    Estimated   Gross     Accumulated     Net  
As of October 31, 2009   Useful Lives   Value     Amortization     Value  
            (in thousands)  
Intangible Assets, net
                               
Existing Technology
  4 years   $ 9,283     $ (4,173 )   $ 5,110  
Patents/Core Technology
  4 years     3,046       (1,369 )     1,677  
Customer Contracts
    6 to 7 years       5,083       (1,394 )     3,689  
Support Agreements
    5 to 6 years       2,717       (877 )     1,840  
Tradenames/Trademarks
  5 years     600       (193 )     407  
Non-Compete Agreements
  2 years     712       (577 )     135  
 
                         
Total
          $ 21,441     $ (8,583 )   $ 12,858  
 
                         

 

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    Estimated   Gross     Accumulated     Net  
As of July 31, 2009   Useful Lives   Value     Amortization     Value  
            (in thousands)  
Intangible Assets, net
                               
Existing Technology
  4 years   $ 9,283     $ (3,593 )   $ 5,690  
Patents/Core Technology
  4 years     3,046       (1,178 )     1,868  
Customer Contracts
    6 to 7 years       5,083       (1,185 )     3,898  
Support Agreements
    5 to 6 years       2,717       (741 )     1,976  
Tradenames/Trademarks
  5 years     600       (164 )     436  
Non-Compete Agreements
  2 years     712       (489 )     223  
 
                         
Total
          $ 21,441     $ (7,350 )   $ 14,091  
 
                         
The Company recorded approximately $1.2 million of amortization expense related to its purchased intangible assets during each of the three months ended October 31, 2009 and 2008.
The estimated future amortization expense of purchased intangible assets as of October 31, 2009 is as follows:
         
    Amount  
    (in thousands)  
Remaining nine months of fiscal 2010
  $ 3,571  
Years ending July 31,
       
2011
    4,555  
2012
    2,917  
2013
    1,259  
2014
    556  
 
     
Total
  $ 12,858  
 
     
3. Net Loss Per Common Share
Basic net loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is calculated by giving effect to all potentially dilutive common shares, including options and common stock subject to repurchase unless the result is anti-dilutive. The following table sets forth the computation of net loss per share:
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands, except per share data)  
 
               
Net loss
  $ (24,676 )   $ (6,377 )
 
           
 
               
Weighted-average common shares outstanding net of weighted-average common shares subject to repurchase
    87,489       83,071  
 
           
 
               
Basic and diluted net loss per common share
  $ (0.28 )   $ (0.08 )
 
           
Common shares subject to repurchase are included in other accrued liabilities in the consolidated balance sheets.

 

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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:
                 
    As of October 31,  
    2009     2008  
    (in thousands)  
Options to purchase common stock
    22,391       18,645  
Common stock subject to repurchase
    111       327  
Restricted stock awards
    2,784       3,725  
4. Short-term Investments
Short-term investments consist of the following:
                                 
            Gross     Gross        
    Cost     Unrealized     Unrealized     Fair  
    Basis     Gains     Losses     Value  
    (in thousands)  
Balance at October 31, 2009
                               
Corporate bonds and notes
  $ 8,869     $ 42     $ (1 )   $ 8,910  
U.S. government agency securities
    70,216       149             70,365  
U.S. treasury bills
    5,985       8             5,993  
Commercial paper
    6,276       12             6,288  
 
                       
Total short-term investments
  $ 91,346     $ 211     $ (1 )   $ 91,556  
 
                       
                                 
            Gross     Gross        
    Cost     Unrealized     Unrealized     Fair  
    Basis     Gains     Losses     Value  
            (in thousands)          
Balance at July 31, 2009
                               
Corporate bonds and notes
  $ 10,667     $ 41     $     $ 10,708  
U.S. government agency securities
    63,720       144       (6 )     63,858  
U.S. treasury bills
    995       1             996  
Commercial paper
    6,275       3       (1 )     6,277  
 
                       
Total short-term investments
  $ 81,657     $ 189     $ (7 )   $ 81,839  
 
                       
The cost basis and fair value of debt securities as of October 31, 2009, by contractual maturity, are presented below:
                 
    Cost     Fair  
    Basis     Value  
    (in thousands)  
October 31, 2009
               
One year or less
  $ 83,534     $ 83,708  
One to two years
    7,812       7,848  
 
           
Total short-term investments
  $ 91,346     $ 91,556  
 
           
The Company reviews the individual securities in its portfolio to determine whether a decline in a security’s fair value below the amortized cost basis is other than temporary. The Company determined that there were no investments in its portfolio, related to credit losses or otherwise, that were other-than temporarily impaired during the three months ended October 31, 2009.

 

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The following table summarizes the fair value and gross unrealized losses of the Company’s investments with unrealized losses aggregated by type of investment instrument and length of time that individual securities have been in a continuous unrealized loss position:
                 
    Less than 12 Months  
    Fair     Unrealized  
    Value     Loss  
    (in thousands)  
October 31, 2009
               
Corporate bonds and notes
  $ 2,400     $ (1 )
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 October 31, 2009 and July 31, 2009 was approximately $44.1 million and $41.3 million, respectively, and approximated fair value.
Short-term investments consist of corporate bonds and notes, U.S government agency securities, U.S. treasury bills, and commercial paper and is recorded at fair value. The Company 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. 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, U.S. government agency securities, treasury bills and commercial paper. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. The Company has no level 3 instruments.
As of October 31, 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
  $ 8,910     $     $ 8,910  
U.S. government agency securities
    70,365             70,365  
U.S. treasury bills
    5,993             5,993  
Commercial paper
    6,288             6,288  
Money market funds
    22,887       22,887        
 
                 
Total cash equivalents and short-term investments
    114,443     $ 22,887     $ 91,556  
 
                   
Cash deposits with third-party financial institutions
    21,169                  
 
                     
Total cash, cash equivalents and short-term investments
  $ 135,612                  
 
                     

 

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5. Balance Sheet Components
The following tables provide details of selected balance sheet items:
                 
    October 31,     July 31,  
    2009     2009  
    (in thousands)  
Accounts Receivable, net
               
Trade accounts receivable
  $ 33,378     $ 33,856  
Less: Allowance for doubtful accounts
    (400 )     (390 )
 
           
Total
  $ 32,978     $ 33,466  
 
           
                 
    October 31,     July 31,  
    2009     2009  
    (in thousands)  
Inventory
               
Raw materials
  $ 448     $ 486  
Finished goods
    8,706       7,964  
 
           
Total
  $ 9,154     $ 8,450  
 
           
                 
    October 31,     July 31,  
    2009     2009  
    (in thousands)  
Accrued Liabilities
               
Compensation and benefits
  $ 6,462     $ 6,777  
Inventory
    5,782       5,145  
Litigation settlement
    19,750        
Other
    8,250       8,800  
 
           
Total
  $ 40,244     $ 20,722  
 
           
6. Property and Equipment, Net
Property and equipment, net consists of the following:
                         
    Estimated   October 31,     July 31,  
    Useful Lives   2009     2009  
            (in thousands)  
Property and Equipment, net
                       
Computer equipment
  2 years   $ 7,008     $ 7,220  
Computer software
  2- 5 years     4,379       4,175  
Machinery and equipment
  2 years     7,623       7,160  
Furniture and fixtures
  5 years     1,765       1,765  
Leasehold improvements
  2-5 years     647       637  
 
                   
Total property and equipment, gross
            21,422       20,957  
Less: Accumulated depreciation and amortization
            (14,396 )     (13,531 )
 
                   
Total property and equipment, net
          $ 7,026     $ 7,426  
 
                   

 

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7. Deferred Revenue
Deferred revenue consists of the following:
                 
    October 31,     July 31,  
    2009     2009  
    (in thousands)  
Deferred Revenue
               
Product
  $ 16,435     $ 10,911  
Professional services and support
    23,019       23,006  
Ratable product and related services and support
    519       737  
 
           
Total deferred revenue, current
    39,973       34,654  
 
               
Professional services and support, long-term
    9,543       8,487  
Ratable product and related services and support, long-term
          37  
 
           
Total deferred revenue, long-term
    9,543       8,524  
 
           
Total deferred revenue
  $ 49,516     $ 43,178  
 
           
Deferred product revenue relates to arrangements where not all revenue recognition criteria have been met. The increase in deferred product revenue was primarily due to a $4.6 million increase in the amount of inventory stocked by the Company’s value-added distributors (“VADs”), in line with the Company’s overall indirect channel strategy. The Company will not recognize revenue for the deferred product revenue held by the VADs until it receives persuasive evidence from the VADs of a sale to an end customer.
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 has not been established and the entire arrangement is being recognized ratably over the support period, which typically ranges from one year to five years.
8. Income Taxes
For the three months ended October 31, 2009 and 2008, the Company generated operating losses. However, while the Company generated consolidated book and federal tax losses for the three months ended October 31, 2009, it generated taxable income in certain foreign jurisdictions. For the three months ended October 31, 2008, the Company generated consolidated book losses but generated taxable income in most U.S. and foreign jurisdictions.
The Company uses the asset and liability method of 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.
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.
9. Equity Incentive 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.

 

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Stock Option Activity
The following table summarizes the information about shares available for grant and outstanding stock option activity for the three months ended October 31, 2009:
                                                 
            Options Outstanding              
                    Weighted             Weighted        
                    Average     Weighted     Average        
    Shares             Exercise     Average     Remaining     Aggregate  
    Available for     Number of     Price     Fair Value     Contractual     Intrinsic  
    Grant     Shares     per Share     per Share     Term (Years)     Value  
Balance at July 31, 2009
    2,808,576       21,541,915     $ 3.32               6.68     $ 120,621,047  
Shares reserved for issuance
    4,337,195                                        
Restricted stock awards granted
    (346,068 )                                      
Restricted stock awards cancelled
    65,592                                        
Options granted
    (1,249,830 )     1,249,830       8.15     $ 4.51                  
Options exercised
          (305,876 )     2.12                       2,097,421  
Options cancelled
    94,806       (94,806 )     5.05                          
 
                                         
Balance at October 31, 2009
    5,710,271       22,391,063     $ 3.60               6.42     $ 96,102,807  
 
                                         
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 months ended October 31, 2009 and 2008 was $3.2 million and $3.1 million, respectively.
Restricted Stock Award Activity
The following table summarizes the non-vested restricted stock awards activity for the three months ended October 31, 2009:
                 
            Weighted Average  
            Grant Date  
            Fair Value  
    Shares     per Share  
Balance at July 31, 2009
    2,859,284     $ 6.21  
Awards granted
    346,068       8.82  
Awards vested
    (355,559 )     6.59  
Awards cancelled
    (65,592 )     5.13  
 
           
Balance at October 31, 2009
    2,784,201     $ 6.51  
 
           
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 months ended October 31, 2009 and 2008 was $3.8 million and $2.9 million, respectively.
Employee Stock Purchase Plan Activity
During the three months ended October 31, 2009, 851,949 shares were purchased at an average per share price of $2.34. Compensation expense recognized in connection with the ESPP for the three months ended October 31, 2009 and 2008 was $0.8 million and $0.5 million, respectively.
During the three months ended October 31, 2009, the Company modified the terms of certain existing awards under its ESPP as a result of employees who previously participated in ESPP and subsequently elected to increase their contribution. Consequently, the Company will recognize $1.2 million in incremental stock-based compensation expense over the vesting period. The Company recognized $0.2 million in incremental stock-based compensation expense arising from the award modification for the three months ended October 31, 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 October 31,  
    2009     2008  
Assumptions
               
Risk-free interest rate
    1.9 %     2.6 %
Expected term (in years)
    4.3       4.2  
Dividend yield
           
Volatility
    70 %     57 %
Employee Stock Purchase Plan
                 
    Three months ended October 31,  
    2009     2008  
Assumptions
               
Risk-free interest rate
    0.2% - 1.0 %     1.9% - 2.3 %
Expected term (in years)
    0.5 - 2.0       0.5 - 2.0  
Dividend yield
           
Volatility
    63% - 81 %     53% - 69 %
Weighted average fair value of stock purchase rights granted
  $ 2.82 - $4.55     $ 2.00 - $2.79  
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 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, the selection of which was based on industry data to determine the expected term. Similarly, the Company computes expected volatility based on its historical volatility and the historical volatility of these comparable companies. 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
Total stock-based compensation for the three months ended October 31, 2009 and 2008 was $7.8 million and $6.5 million, respectively. The Company did not capitalize stock-based compensation during the three months ended October 31, 2009, due to the amount qualifying for capitalization being immaterial.
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. The Company did not make any purchases under this program during the three months ended October 31, 2009. The Company is authorized to purchase up to an additional $5.0 million worth of shares under this program as of October 31, 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.

 

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10. Comprehensive Loss
Comprehensive loss includes the following:
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands)  
Net loss
  $ (24,676 )   $ (6,377 )
Change in unrealized gain/ (loss) on short-term investments
    28       (118 )
 
           
Comprehensive loss
  $ (24,648 )   $ (6,495 )
 
           
     
11. 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.
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 U.S. 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 October 31,  
    2009     2008  
    (in thousands)  
United States
  $ 33,616     $ 35,720  
Europe, Middle East and Africa
    7,632       9,090  
Asia Pacific
    12,506       5,621  
Rest of World (including Japan)
    3,842       2,015  
 
           
Total
  $ 57,596     $ 52,446  
 
           
The following table presents significant channel partners as a percentage of total revenues:
                 
    Three months ended October 31,  
    2009     2008  
 
Alcatel-Lucent
    10.6 %     9.9 %
Avnet Logistics, U.S. LP
    11.8 %     6.8 %
ScanSource, Inc. (Catalyst)
    13.3 %     7.5 %
Westcon Group, Inc.
    11.2 %     5.8 %
12. 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 sought 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 (collectively “Motorola”). The counterclaims sought 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. On November 4, 2009, the Company entered into a Patent Cross License and Settlement Agreement (the “Settlement Agreement”) with Motorola. Pursuant to the Settlement Agreement, the Company and Motorola agreed to:
    jointly execute and file dismissals of patent infringement actions brought in the United States District Court for the District of Delaware involving U.S. Patent Nos. 7,173,922; 7,173,923; 6,973,622; 6,625,454; and 7,359,676; 7,295,524 and 7,376,113;

 

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    release one another of all claims;
    provide one another with seven year licenses to each of their respective 802.11 Wireless LAN patent portfolios; and
    provide one another a covenant not to assert any patent claims against one another’s current products and commercially reasonable extensions thereof for four years.
As part of the Settlement Agreement, the Company agreed to pay Motorola $19.8 million.
The determination of the appropriate accounting treatment for the Settlement Agreement depends to a large extent upon the ability to reliably value the benefits received. This, in turn, requires that significant judgment be exercised in arriving at certain estimates and assumptions. The elements of the Settlement Agreement that potentially represented benefits to the Company were comprised of 1) a general release of any and all asserted and potential infringement claims, 2) license grants to each asserted patent, and 3) a dismissal of the litigation between the two parties. The Company concluded that there was no potential future use of the subject license grants as the Company does not plan to utilize the license grants in any current or future products, and the general release and litigation dismissal benefits were period costs with no future use. Therefore, the Company ascribed no future value to the Settlement Agreement. As a result, the Company recorded a $19.8 million charge during the first quarter of fiscal 2010 for book and tax purposes.
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 October 31, 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 2016. 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)  
Nine months remaining in fiscal 2010
  $ 3,103  
Year Ending July 31,
       
2011
    2,321  
2012
    1,967  
2013
    2,017  
2014
    2,077  
2015
    2,141  
Thereafter
    2,203  
 
     
Total minimum payments
  $ 15,829  
 
     
Non-cancelable purchase commitments
The Company outsources the production of its hardware to third-party contract manufacturers. In addition, the Company enters into various inventory related purchase commitments with its contract manufacturers and other suppliers. The Company had $16.4 million and $14.9 million in non-cancelable purchase commitments with these providers as of October 31, 2009 and July 31, 2009, respectively. The Company expects to sell all products that it has committed to purchase from these providers.

 

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Warranties
The Company provides for future warranty costs upon product delivery. The specific terms and conditions of those warranties vary depending upon the product sold and country in which the Company does business. In the case of hardware, the warranties are generally for 12-15 months from the date of purchase. Beginning in the fourth quarter of fiscal year 2009, the Company announced a lifetime warranty program on certain access points, in which customers are entitled to a lifetime warranty on certain access points purchased subsequent to the announcement of the program.
The Company warrants that any media on which its software products are recorded will be free from defects in materials and workmanship under normal use for a period of 90 days from the date the products are delivered to the end customer. In addition, the Company warrants that its hardware products will substantially conform to the Company’s published specifications. Historically, the Company has experienced minimal warranty costs. Factors that affect the Company’s warranty liability include the number of installed units, historical experience and management’s judgment regarding anticipated rates of warranty claims and cost per claim. The Company assesses the adequacy of its recorded warranty liabilities every period and makes adjustments to the liability as necessary.
The warranty liability is included as a component of accrued liabilities on the balance sheet. Changes in the warranty liability are as follows:
         
    Warranty  
    Amount  
    (in thousands)  
Balance as of July 31, 2008
  $ 125  
Provision
    256  
Obligations fulfilled during period
    (223 )
 
     
Balance as of July 31, 2009
    158  
Provision
    95  
Obligations fulfilled during period
    (51 )
 
     
Balance as of October 31, 2009
  $ 202  
 
     
Indemnifications
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 or defend lawsuits. 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 October 31, 2009 and July 31, 2009.
13. Recent Accounting Pronouncements
In October 2009, FASB issued Accounting Standards Update (ASU) No. 2009-14, Topic 985: Certain Revenue Arrangements That Include Software Elements (a Consensus of the FASB Emerging Issues Task Force Issue (EITF)). ASU No. 2009-14 modifies ASC 985-605, Software Revenue, such that the following products would be considered non-software deliverables and therefore excluded from the scope of ASC 985-605:
    Tangible products that contain software elements and non-software elements that function together to deliver the tangible product’s essential functionality.
    Undelivered elements that are essential to the above described tangible product’s functionality.
In October 2009, FASB issued ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple Deliverable Revenue Arrangements (a Consensus of the FASB EITF). ASU No. 2009-13 modifies ASC 605-25, Revenue Recognition — Multiple-Element Arrangements (formerly EITF 00-21). ASU No. 2009-13 requires an entity to allocate the revenue at the inception of an arrangement to all of its deliverables based on their relative selling prices. This guidance eliminates the residual method of allocation of revenue in multiple deliverable arrangements and requires the allocation of revenue based on the relative-selling-price method. The determination of the selling price for each deliverable requires the use of a hierarchy designed to maximize the use of available objective evidence, including, VSOE, third party evidence of selling price (TPE), or estimated selling price (ESP).

 

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ASU No. 2009-13 and ASU No. 2009-14 must be adopted no later than the beginning of the Company’s fiscal year 2011 and early adoption is allowed and may be adopted either under the prospective method, whereby the guidance will apply to all revenue arrangements entered into or materially modified after the effective date, or under the retrospective application, whereby the guidance will apply to all revenue arrangements for all periods presented. An entity may elect to adopt ASU No. 2009-13 and ASU No. 2009-14 in a period other than their first reporting period of a fiscal year under the prospective method but must adjust the revenue of prior reported periods such that all new revenue arrangements entered into, or materially modified, during the fiscal year of adoption are accounted for under this guidance.
The adoption of ASU No. 2009-13 and ASU No. 2009-14 will allow the separation of deliverables under more arrangements which may result in less revenue deferral. For such arrangements, the application of the relative-selling price method of allocating the revenue of an arrangement and the elimination of the residual method of allocation may result in a different reallocation of revenue from product revenue, which is recognized upon delivery, to support revenue, which is recognized ratably over the support period.
The Company is currently evaluating the impact of these pronouncements on its financial position and results of operations.
On July 1, 2009, the FASB launched the “FASB Accounting Standards Codification” (the “FASB ASC”) as the single source of authoritative non-governmental U.S. GAAP. The FASB ASC did not change current U.S. GAAP, but simplified user access to all authoritative U.S. GAAP by organizing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents were superseded and all other accounting literature not included in the FASB ASC is now considered non-authoritative. The FASB ASC was effective for the Company’s financial statements for the quarter ended October 31, 2009. The adoption of the FASB ASC did not have an impact on the Company’s 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:
    that revenues from our indirect channels will continue to constitute a significant majority of our future revenues;
    that competition will intensify in the future as other companies introduce new products in the same markets we serve or intend to enter;
    that our product offerings, in particular our products that incorporate 802.11n wireless LAN standard technologies, will enable broader networking initiatives by both our current and potential customers;
    regarding the growth of our offshore operations and the establishment of additional offshore capabilities for certain general and administrative functions;
    that, within our indirect channel, sales through our VADs will grow, which will negatively impact our gross margins as VADs experience a larger net effective discount than our other channel partners;
    that international revenues will increase in absolute dollars compared to fiscal 2009 and remain consistent as a percentage of total revenues in future periods;
    that, as our customer base grows over time, 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 2010 will increase on an absolute dollar basis and remain consistent or decrease as a percentage of revenue compared with fiscal 2009;
    that we will continue 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;
    that we will continue to invest strategically in our sales and marketing efforts;
    that sales and marketing expenses for fiscal 2010 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 2009;
    that general and administrative expenses for fiscal 2010 will increase on an absolute dollar basis and decrease as a percentage of revenue compared with fiscal 2009;
    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 may incur additional costs to conform our products to comply with local laws and product specifications and plan to continue to hire additional technical support personnel to support our growing international customer base;
    regarding the sufficiency of our existing cash, cash equivalents, short-term investments and cash generated from operations, and
    that we will increase our market penetration and extend our geographic reach through our network of channel partners,

 

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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 I, 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.
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, using a combination of solutions. Our adaptive 802.11n solutions optimize themselves to ensure that users are always within reach of mission-critical information. By rightsizing expensive wired LANs with our high-speed 802.11n solution, users can potentially reduce both capital and operating expenses. Identity-based security assigns access policies to users, enforcing those policies whenever and wherever a network is accessed. Our Virtual Branch Networking solutions for branch offices, fixed telecommuters, and satellite facilities ensure uninterrupted remote access to applications. Finally, our multi-vendor network management solutions provide a single point of control while managing both legacy and new wireless networks from us and our competitors. 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 8,500 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 implemented a two-tier distribution model in most areas of the world, including the United States, with VADs selling our portfolio of products, including a variety of our support services, to a diverse number of value-added resellers (“VARs”). Our focus continues to be management of our channel including selection and growth of high prospect partners, activation of our VARs and VADs through active training and field collaboration, and evolution of our channel programs in consultation with our partners.
Our ability to increase our product revenues will depend significantly on continued growth in the market for enterprise mobility and remote networking solutions, continued acceptance of our products in the marketplace, our ability to continue to attract new customers, our ability to compete, the willingness of customers to displace wired networks with wireless LANs, in particular, wireless LANs that utilize our 802.11n solution, 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 future 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.
While we are starting to see improvements in the overall macroeconomic 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 our customers deferring purchases in response to tighter credit, negative financial news and delayed budget approvals. For example, we have continued to experience softness in the retail market, as our customers in that industry continue to struggle with these economic challenges.
While we continued to see signs of stabilization and improved visibility in the first quarter of fiscal 2010 relative to 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.

 

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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, our product offerings, in particular our products that incorporate 802.11n wireless LAN standard technologies, will enable broader networking initiatives by both our current and potential customers.
Each quarter, our ability to meet our product revenue expectations is dependent upon (1) new orders received, shipped, and recognized in a given quarter, (2) the amount of orders booked but not shipped in the prior quarter that are shipped in the current quarter, and (3) the amount of deferred revenue entering a given quarter. Our ability to meet our forecasted revenue is dependent, as well as the amount of revenue that we recognize for our larger products from our deferred revenue, on our ability to convert our sales pipeline into product revenues from orders received and shipped within the same fiscal 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 terms and conditions 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.
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, and original equipment manufacturers (“OEMs”). We expect revenues from indirect channels to continue to constitute a significant 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 remain consistent with fiscal 2009 as a percentage of total revenues in future periods. For more information about our international revenues, see Note 11 of Notes to Consolidated Financial Statements.
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 largest 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.
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;
 
    product mix and average selling prices;

 

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    new product introductions, such as our new value-priced, high performance 802.11n access point, and enhancements both by us and by our competitors;
 
    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;
 
    costs associated with manufacturing overhead; 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 significant majority of our total revenues, which, by itself, negatively impacts our gross margins. Further, we expect that within our indirect channel, sales through our VADs will grow which will negatively impact our gross margins as VADs experience a larger net effective discount than our other channel partners.
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 545 employees at July 31, 2009 to 560 employees at October 31, 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 2010, 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 2009.
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.
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 2010, we expect sales and marketing expenses to increase on an absolute dollar basis and decrease as a percentage of revenue compared to fiscal 2009.
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 information technology (“IT”) infrastructure costs related to our ERP system. Further, our general and administrative expenses include professional services consisting of outside legal, audit, Sarbanes-Oxley and information technology consulting costs. We have incurred in the past, and continue to incur, significant legal costs defending ourselves against claims made by third parties. These expenses are expected to continue as part of our ongoing operations and depending on the timing and outcome of lawsuits and the legal process, can have a significant impact on our financial statements. For fiscal 2010, we expect general and administrative expenses to increase on an absolute dollar basis and decrease as a percentage of revenue compared to fiscal 2009.

 

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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, 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. 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.
Our critical accounting policies are disclosed in our Form 10-K for the year ended July 31, 2009. There were no material changes to our critical accounting policies during the first quarter of fiscal 2010.
Recent Accounting Pronouncements
See Note 13 of Notes to Consolidated Financial Statements for recent accounting pronouncements that could have an effect on us.

 

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Results of Operations
The following table presents our historical operating results as a percentage of revenues for the periods indicated:
                 
    Three months ended October 31,  
    2009     2008  
 
Revenues:
               
Product
    82.0 %     83.7 %
Professional services and support
    17.6 %     15.5 %
Ratable product and related professional services and support
    0.4 %     0.8 %
 
           
 
               
Total revenues
    100.0 %     100.0 %
 
               
Cost of revenues:
               
Product
    28.5 %     31.6 %
Professional services and support
    3.6 %     3.7 %
Ratable product and related professional services and support
    0.2 %     0.3 %
 
           
 
               
Gross margin
    67.7 %     64.4 %
 
               
Operating expenses:
               
Research and development
    20.5 %     19.9 %
Sales and marketing
    42.9 %     47.0 %
General and administrative
    12.4 %     10.1 %
Litigation settlement
    34.3 %     0.0 %
 
           
 
               
Operating margin
    (42.4 %)     (12.6 %)
 
               
Other income (expense), net
    0.2 %     0.6 %
 
           
 
               
Loss before income taxes
    (42.2 %)     (12.0 %)
 
               
Provision for income taxes
    0.6 %     0.2 %
 
           
 
               
Net loss
    (42.8 %)     (12.2 %)
 
           
Revenues
The following table presents our revenues, by revenue source, for the periods presented:
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands)  
 
               
Total revenues
  $ 57,596     $ 52,446  
 
           
Type of revenues:
               
Product
    47,198       43,868  
Professional services and support
    10,143       8,137  
Ratable product and related professional services and support
    255       441  
 
           
Total revenues
  $ 57,596     $ 52,446  
 
           
Revenues by geography:
               
United States
    33,616       35,720  
Europe, the Middle East and Africa
    7,632       9,090  
Asia Pacific
    12,506       5,621  
Rest of World (including Japan)
    3,842       2,015  
 
           
Total revenues
  $ 57,596     $ 52,446  
 
           
During the first quarter of fiscal 2010, total revenues increased 9.8% over the first quarter of fiscal 2009 due to a $5.3 million increase in product and professional services and support revenues. The increase in revenues was attributable to the continual and steady growth of the WLAN market and the significant growth in our customer base as we added approximately 600 new customers during the first quarter of fiscal 2010.

 

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Our product revenues were bolstered by an increase in revenue related to our 802.11n access points. 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.
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 over time, 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.
Ratable product and related professional services and support revenues decreased in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 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 first quarter of fiscal 2010, we derived 91.4% of our total revenues from indirect channels, which consist of VADs, VARs and OEMs. In the same period of fiscal 2009, we derived 78.0% of our total revenues was generated from indirect channels, and was unusually low due to a large deal with a direct customer. Overall, the percentage of revenue from our indirect channels continues to grow as we see increased leverage from partner relationships. 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 efficiency of marketing and selling of our products through these channels.
Revenues from shipments to locations outside the United States increased $7.3 million during the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 largely due to the strength of the VADs in the international markets. Most notably, revenue in our Asia Pacific region grew 122.5% year over year due to significantly improved market presence by one of our VADs, especially in the education vertical. 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 2009, and remain consistent with fiscal 2009 as a percentage of total revenues in future periods.
Cost of Revenues and Gross Margin
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands)  
Total revenues
  $ 57,596     $ 52,446  
 
           
 
               
Cost of product
    16,432       16,605  
Cost of professional services and support
    2,079       1,933  
Cost of ratable product and related professional services and support
    86       155  
 
           
Total cost of revenues
    18,597       18,693  
 
           
Gross profit
  $ 38,999     $ 33,753  
 
           
Gross margin
    67.7 %     64.4 %
During the first quarter of fiscal 2010 cost of revenues remained relatively flat compared to the first quarter of fiscal 2009. The substantial majority of our cost of product revenues consists of payments to Flextronics, our largest contract manufacturer. For the first quarter of fiscal 2010, payments to Flextronics and Flextronics-related costs constituted more than 75% of our cost of product revenues.
Cost of professional services and support revenues increased 7.6% during the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 due to the increase in professional services and support revenue. We have benefitted from economies of scale within our professional services department which has kept our costs down despite the large increase in professional services and support revenues.
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, we plan to continue to hire additional technical support personnel to support our growing international customer base.

 

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Gross margins increased 3.3% during the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 due to several factors. During the first quarter of fiscal 2009, we had lower margins due to the large retail deal we recognized during the quarter which had a lower gross margin profile and increased freight costs. Excluding the effect of this transaction, revenues grew year-over-year while our manufacturing overhead has remained consistent as we have gained efficiencies in our operations, thereby improving our gross margin. Additionally, we also benefited from a change in product mix in the first quarter of fiscal 2010 as our new 802.11n products that we shipped during the quarter had a higher gross margin profile.
Research and Development Expenses
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands)  
Research and development expenses
  $ 11,796     $ 10,423  
Percent of total revenues
    20.5 %     19.9 %
During the first quarter of fiscal 2010, research and development expenses increased 13.2% compared to the first quarter of fiscal 2009, primarily due to an increase of $0.7 million in personnel and related costs. Expenses for consulting and outside agencies increased by $0.5 million due to design and compliance work for our new low-priced access point and our new controllers. Depreciation expense increased $0.2 million due to an increase in fixtures, machinery and equipment used to design and test new products. Facilities expenses also increased $0.2 million. These increases were partially offset by a decrease in recruiting expenses of $0.1 million due to our cost-cutting efforts.
Sales and Marketing Expenses
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands)  
Sales and marketing expenses
  $ 24,740     $ 24,661  
Percent of total revenues
    42.9 %     47.0 %
Sales and marketing expenses remained relatively flat during the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009. Marketing expenses increased $0.4 million related to new product launches during the first quarter of fiscal 2010. This increase was partially offset by a decrease in personnel expenses of $0.2 million, primarily driven by a decrease in travel and entertainment expenses, and a decrease of $0.1 million in recruiting expenses as part of our cost-control efforts.
General and Administrative Expenses
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands)  
General and administrative expenses
  $ 7,132     $ 5,285  
Percent of total revenues
    12.4 %     10.1 %
During the first quarter of fiscal 2010, general and administrative expenses increased 34.9% compared to the first quarter of fiscal 2009, primarily due to an increase of $1.6 million in personnel expenses, including $1.0 million in stock-based compensation. Legal and accounting fees increased $0.2 million compared to the first quarter of fiscal 2009 primarily due to legal fees associated with litigation. Facilities expenses also increased $0.2 million.
Litigation Settlement
On November 4, 2009, we entered into a Patent Cross License and Settlement Agreement (the “Settlement Agreement”) with Motorola. Pursuant to the Settlement Agreement, we and Motorola agreed to:
    jointly execute and file dismissals of patent infringement actions brought in the United States District Court for the District of Delaware involving U.S. Patent Nos. 7,173,922; 7,173,923; 6,973,622; 6,625,454; and 7,359,676; 7,295,524 and 7,376,113;
    release one another of all claims;
    provide one another with seven year licenses to each of our respective 802.11 Wireless LAN patent portfolios; and
    provide one another a covenant not to assert any patent claims against one another’s current products and commercially reasonable extensions thereof for four years.
As part of the Settlement Agreement, we agreed to pay Motorola $19.8 million. The one-time expense is shown on the Consolidated Statement of Operations as litigation settlement expense. See Note 12 of our Notes to Consolidated Financial Statements for further discussion.

 

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Other Income (Expense), Net
Other income (expense), net consists primarily of interest income and foreign currency exchange gains and losses.
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands)  
Interest income
  $ 211     $ 648  
Other income (expense), net
    (96 )     (316 )
 
           
Total other income (expense), net
  $ 115     $ 332  
 
           
Interest income during the first quarter of fiscal 2010 decreased 67.4% from the first quarter of fiscal 2009, primarily due to declining interest rates. Our average yield-to-maturity rate decreased from 3.02% in the first quarter of fiscal 2009 to 0.74% in the first quarter of fiscal 2010.
Other income (expense), net increased during the during the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 as a result of an increase in foreign currency gains which was primarily driven by the remeasurement of foreign currency transactions into U.S. dollars.
Provision for Income Taxes
Since inception, we have incurred operating losses. However, while we generated book losses, we generated operating income for foreign tax purposes resulting in tax provisions during the first quarter of fiscal 2010. As of July 31, 2009, we had net operating loss carryforwards of $84.1 million and $71.1 million for federal and state income tax purposes, respectively. We also had research and credit carryforwards of $6.0 million for federal and $5.7 million for state income tax purposes as of July 31, 2009. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, all federal and state deferred tax assets have been fully offset by a valuation allowance. If not utilized, the federal and state net operating loss and tax credit carryforwards will expire between 2013 and 2022. Utilization of these net operating losses and credit carryforwards may be subject to an annual limitation due to provisions of the Internal Revenue Code of 1986, as amended, that are applicable if we have experienced an “ownership change” in the past, or if an ownership change occurs in the future. See Note 8 of Notes to Consolidated Financial Statements.
Liquidity and Capital Resources
                 
    October 31,     July 31,  
    2009     2009  
    (in thousands)  
Working capital
  $ 104,619     $ 115,639  
Cash and cash equivalents
    44,056       41,298  
Short-term investments
  $ 91,556     $ 81,839  
                 
    Three months ended October 31,  
    2009     2008  
    (in thousands)  
Cash provided by operating activities
  $ 10,486     $ 5,575  
Cash used in investing activities
    (10,407 )     (275 )
Cash provided by financing activities
  $ 2,677     $ 2,143  
Cash and cash equivalents are comprised of cash, sweep funds and money market funds with an original maturity of 90 days or less at the time of the purchase. Short-term investments include corporate bonds, U.S. government agency securities, U.S. treasury bills, commercial paper and other money market securities. Cash, cash equivalents and short-term investments increased $12.5 million during the first quarter of fiscal 2010 from $123.1 million in cash, cash equivalents and short-term investments as of July 31, 2009 to $135.6 million as of October 31, 2009. In November 2009, pursuant to the Settlement Agreement with Motorola, the Company made a one-time payment to Motorola for $19.8 million. See Note 12 of our Notes to Consolidated Financial Statements for further discussion.

 

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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.
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 $4.9 million during the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009 due to increases in accounts payable, deferred revenue and other accrued liabilities, as well as an increase in the amount of non-cash adjustments relating to stock-based compensation and depreciation and amortization. Cash provided by operating activities was offset by increases in inventory and deferred costs, as well as a larger net loss compared to the first quarter of fiscal 2009.
Cash Flows from Investing Activities
Cash used in investing activities during the first quarter of fiscal 2010 increased $10.1 million compared to the first quarter of fiscal 2009. We used the proceeds from the sale of our short-term investments, as well as some of the cash generated from our operating activities, to reinvest in additional short-term investments. Purchases of property and equipment in the first quarter of fiscal 2010 were slightly down compared to the first quarter of fiscal 2009 due to an effort to control costs.
Cash Flows from Financing Activities
Cash provided by financing activities increased slightly in the first quarter of fiscal 2010 compared to the first quarter of fiscal 2009. The cash proceeds from the issuance of common stock in conjunction with our 2007 Equity Incentive Plan and Employee Stock Purchase Plan were slightly lower in the first quarter of fiscal 2010 but we did not repurchase any shares of our common stock under our stock repurchase program in the first quarter of fiscal 2010. During the first quarter of fiscal 2009, we purchased $1.0 million under this program.
Based on our current cash, cash equivalents and short-term investments we expect that we will have sufficient resources to fund our operations for the next 12 months. However, we may need to raise additional capital or incur 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 first quarter of fiscal 2010. As of July 31, 2009, we were authorized to purchase up to an additional $5.0 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:
                                         
            Less than     1 - 3     3 - 5     More than  
    Total     1 year     years     years     5 years  
    (in thousands)  
Operating leases
  $ 15,828     $ 3,103     $ 4,288     $ 4,094     $ 4,343  
Non-cancellable inventory purchase commitments (1)
    17,282       17,282                    
 
                             
Total contractual obligations
  $ 33,110     $ 20,385     $ 4,288     $ 4,094     $ 4,343  
 
                             
     
(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
Foreign Currency Risk
Most of our sales contracts are denominated in United States dollars, and therefore, our revenue is not subject to significant foreign currency risk. Our operating expenses and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British Pound, Euro and Japanese Yen. To date, we have not entered into any hedging contracts because expenses in foreign currencies have been insignificant to date, and exchange rate fluctuations have had little impact on our operating results and cash flows.
Interest Rate Sensitivity
We had cash, cash equivalents and short-term investments totaling $135.6 million and $123.1 million at October 31, 2009 and July 31, 2009, 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 quarter of fiscal 2010, our interest income on cash, cash equivalents and short-term investments would have declined immaterially 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 October 31, 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.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the first quarter of fiscal 2010 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.

 

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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. The complaint sought unspecified monetary damages and injunctive relief. 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. The counterclaims sought 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.
On November 4, 2009, we entered into a Patent Cross License and Settlement Agreement (the “Settlement Agreement”) with Motorola. Pursuant to the Settlement Agreement, we and Motorola agreed to:
    jointly execute and file dismissals of patent infringement actions brought in the United States District Court for the District of Delaware involving U.S. Patent Nos. 7,173,922; 7,173,923; 6,973,622; 6,625,454; and 7,359,676; 7,295,524 and 7,376,113;
    release one another of all claims;
    provide one another with seven year licenses to each of their respective 802.11 Wireless LAN patent portfolios;
    provide one another a covenant not to assert any patent claims against one another’s current products and commercially reasonable extensions thereof for four years.
As part of the Settlement Agreement, we agreed to pay Motorola $19.8 million.
The determination of the appropriate accounting treatment for the Settlement Agreement depends to a large extent upon the ability to reliably value the benefits received. This, in turn, requires that significant judgment be exercised in arriving at certain estimates and assumptions. The elements of the Settlement Agreement which potentially represented benefits to us comprised of 1) a general release of any and all asserted and potential infringement claims, 2) license grants to each asserted patent, and 3) a dismissal of the litigation between the two parties. Accordingly, we concluded that there was no potential future use of the subject license grants and the general release and litigation dismissal benefits were period costs with no future use. Therefore, we ascribed no future value to the Settlement Agreement. As a result, we recorded a $19.8 million charge during the first quarter of fiscal 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 October 31, 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.
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, increased competition, and the deferral or delay of reviews by end user customers of their existing infrastructure that could have otherwise driven demand for our products. 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 and third quarters of fiscal 2009 decreased sequentially. In addition, our business depends on the overall demand for 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 or willingness to replace existing infrastructure in some vertical markets may be discretionary and may involve a significant commitment of capital and other resources. Therefore, weak economic conditions, or a reduction in IT spending would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and services, and reduced unit sales. In addition, if interest rates rise or foreign exchange rates weaken for our international customers, overall demand for our products and services could be further dampened, and related IT spending may be reduced.

 

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We compete in new and rapidly evolving markets and have a limited operating history, which makes it difficult to predict our future operating results.
We were incorporated in February 2002 and began commercial shipments of our products in June 2003. As a result of our limited operating history, it is very difficult to forecast our future operating results. In addition, we operate in an industry characterized by rapid technological change. Our prospects should be considered and evaluated in light of the risks and uncertainties frequently encountered by 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 may continue. As a result, if we are unable to ship orders received in the last month of each fiscal quarter, even though we may have business indicators about customer demand during a quarter, we may experience revenue shortfalls, and such shortfalls may materially adversely affect our earnings because we may not be able to adequately and timely adjust our expense levels.
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 relationship with our VARs, VADs, OEMs and other partners;
 
    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;
 
    our ability to control costs, including our operating expenses, and the costs of the components we purchase;

 

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    product mix and average selling prices, as well as increased discounting of products by us and our competitors;
 
    the proportion of our products that are sold through direct versus indirect channels;
 
    our ability to maintain volume manufacturing pricing from Flextronics and our component suppliers;
 
    our contract manufacturers and component suppliers ability to meet our product demand forecasts;
 
    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 during the first quarter of fiscal 2010.
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 $24.7 million and $6.4 million for the first quarter of fiscal 2010 and 2009, respectively. As of October 31, 2009 and July 31, 2009, our accumulated deficit was $166.3 million and $141.6 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. Over the last year, 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 revenue 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 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.

 

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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 highly competitive and is influenced by the following competitive factors:
    comprehensiveness of the solution;
 
    performance of software and hardware products;
 
    ability to deploy easily into existing networks;
 
    interoperability with other devices;
 
    scalability of solution;
 
    ability to provide secure mobile access to the network;
 
    speed of mobile connectivity offering;
 
    return on investment;
 
    ability to allow centralized management of products; and
 
    ability to obtain regulatory and other industry certifications.
We expect competition to intensify in the future as other companies introduce new products in the same markets we serve or intend to enter and as the market continues to consolidate. This competition could result in increased pricing pressure, reduced profit 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), Motorola and Hewlett-Packard, 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 these channel partners on which we rely do not perform their services adequately or efficiently, or if they exit the industry or have financial difficulties, 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. In recent quarters, we have dedicated a significant amount of effort to increase the use of our VADs and VARs in each of our theatres of operations. The percentage of our total revenues fulfilled from sales through our indirect channel was 91.4% and 78.0% for the first quarter of fiscal 2010 and 2009, respectively. We expect that over time, indirect channel sales will continue to constitute a significant majority of our total revenues. Accordingly, our revenues depend in large part on the effective performance of our channel partners. Several of our channel partners accounted for more than 10% of total revenues for the first quarter of fiscal 2010. The table below represents the percentage of total revenues our top channel partners contributed:
                 
    Three months ended October 31,  
    2009     2008  
 
 
Alcatel-Lucent
    10.6 %     9.9 %
Avnet Logistics, U.S. LP
    11.8 %     6.8 %
ScanSource, Inc. (Catalyst)
    13.3 %     7.5 %
Westcon Group, Inc.
    11.2 %     5.8 %

 

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Our agreements with our partners provide that they use reasonable commercial efforts to sell our products on a perpetual basis unless the agreement is otherwise terminated by either party. Finally, the agreement with Alcatel-Lucent 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 agreement.
Some of our indirect channel partners may have insufficient financial resources and may not be able to withstand changes in worldwide business conditions, including economic downturns, abide by our inventory and credit requirements, or have the ability to meet their financial obligations to us. As of October 31, 2009, two of our channel partners accounted for more than 10% of accounts receivable. Westcon Group, Inc. accounted for 26.0% and Alcatel-Lucent accounted for 10.8% of total accounts receivable. As of July 31, 2009, Westcon Group, Inc. accounted for 23.0% and Alcatel-Lucent accounted for 19.1% of total accounts receivable. If the indirect channel partners on which we rely do not perform their services adequately or efficiently, fail to meet their obligations to us, or if they exit the industry and we are not able to quickly find adequate replacements, there could be a material adverse effect on our 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 indirect channel partners may receive pricing terms that allow for volume discounts off of list prices for the products they purchase from us, which reduce our 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 indirect channel partners would likely materially adversely affect our business, operating results and financial condition.
We depend upon the development of new products and enhancements to our existing products. If we fail to predict and respond to emerging technological trends and our customers’ changing needs, we may not be able to remain competitive.
We may not be able to anticipate future market needs or be able to develop new products or product enhancements to meet such needs. 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, as of July 31, 2009, we had been developing and were offering for sale products that complied with the draft 802.11n wireless LAN standard (“11n”) that the IEEE had not yet ratified. Although subsequent to our fiscal year end, the IEEE ratified the 11n standard and did not modify the draft of the 11n standard the IEEE could modify the standard in the future. We remain subject to any changes adopted by various standards bodies, which would require us to modify our products to comply with the new standards, require additional time and expense and could cause a disruption in our ability to market and sell the affected products.

 

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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 Corporation (“Atheros”), and some of our mobility controllers incorporate components from Broadcom Corporation (“Broadcom”) and RMI Corporation (“RMI”). We have entered into license agreements with 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 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. 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.
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.

 

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We may engage in future acquisitions that could disrupt our business, cause dilution to our stockholders and harm our business, operating results and financial condition.
In 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. In March 2008, we completed our acquisition of AirWave Wireless, Inc. 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 $12.9 million as of October 31, 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.
If we fail to manage future growth effectively, our business would be harmed.
We have expanded our operations significantly since inception and anticipate that further significant expansion will be required. We intend to increase our market penetration and extend our geographic reach through our network of channel partners. We also plan to increase offshore operations by establishing additional offshore capabilities for certain engineering 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 an 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 ERP system could have a material adverse effect on our financial reporting system and internal controls.

 

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

 

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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.
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.

 

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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 largest 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;
 
    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 October 31, 2009, our directors and executive officers and their affiliates beneficially owned, in the aggregate, approximately 26.4% 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.

 

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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;
 
    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.

 

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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, 2009 filed on October 6, 2009, that our internal control over financial reporting was effective as of July 31, 2009, 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
       
 
  10.1    
Patent Cross License and Settlement Agreement dated November 4, 2009 (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on November 6, 2009).
       
 
  10.2    
Amendment #2 to OEM Supply Agreement, dated February 22, 2007, between Registrant and Alcatel USA Sourcing, Inc. (fka Alcatel Internetworking, Inc.)*
       
 
  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.
     
*   Confidential treatment has been requested for portions of this exhibit.

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: December 4, 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: December 4, 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
       
 
  10.1    
Patent Cross License and Settlement Agreement dated November 4, 2009 (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on November 6, 2009).
       
 
  10.2    
Amendment #2 to OEM Supply Agreement, dated February 22, 2007, between Registrant and Alcatel USA Sourcing, Inc. (fka Alcatel Internetworking, Inc.)*
       
 
  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.
     
*   Confidential treatment has been requested for portions of this exhibit.

 

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