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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
    For the fiscal year ended July 31, 2007
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 No.)
 
1322 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)
 
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.0001
Securities registered pursuant to 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Act).
 
Large accelerated filer o      Accelerated filer o     Non-accelerated filer þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)  Yes o     No þ
 
As of January 31, 2007, the last business day of our most recently completed second fiscal quarter, our common stock was not listed on any exchange or over-the-counter market. Our common stock began trading on the Nasdaq Global Market on March 27, 2007. At July 31, 2007, the aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant (based upon the closing sale price of such shares on the Nasdaq Global Market on July 31, 2007) was approximately $569,830,883. Shares of the Registrant’s Common Stock held by each executive officer and director and by each entity or person that, to the Registrant’s knowledge, owned 5% or more of the Registrant’s outstanding Common Stock as of January 31, 2007 have been excluded in that such persons may be deemed to be affiliates of the Registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
 
The number of outstanding shares of the Registrant’s Common Stock, $0.0001 par value, was 78,959,223 shares as of September 30, 2007.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Proxy Statement for the Registrant’s 2007 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.
 


 

 
TABLE OF CONTENTS
 
             
        Page
 
  Business   4
  Risk Factors   11
  Unresolved Staff Comments   24
  Properties   25
  Legal Proceedings   25
  Submission of Matters to a Vote of Security Holders   25
 
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   26
  Selected Consolidated Financial Data   28
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   29
  Quantitative and Qualitative Disclosures About Market Risk   46
  Consolidated Financial Statements and Supplementary Data   47
  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure   78
  Controls and Procedures   78
  Other Information   78
 
  Directors, Executive Officers and Corporate Governance   78
  Executive Compensation   78
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   79
  Certain Relationships and Related Transactions, and Director Independence   79
  Principal Accountant Fees and Services   79
 
  Exhibits and Financial Statement Schedule   79
  80
  81
 EXHIBIT 21.1
 EXHIBIT 23.1
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1


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PART I
 
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 we will continue to expand our product offerings and solution capabilities and plan to dedicate significant resources to these continued research and development efforts;
 
  •  that revenues from our indirect channels will continue to constitute a majority of our future revenues and may represent an increasing proportion of our future product revenues;
 
  •  that international revenues may increase in absolute dollars and as a percentage of total revenues in future periods as we expand into international locations and introduce our products in new markets;
 
  •  that, as our customer base grows, we expect the proportion of our revenues represented by services revenues to increase;
 
  •  that we expect a modest impact on our gross margins if our product mix continues to change and product revenues from our indirect channel increases and represents a greater proportion of our future product revenues;
 
  •  that we will hire a significant number of new employees in future periods;
 
  •  that we will continue to invest significantly in research and development, sales and marketing, and general and administrative, and incur expenses relating thereto,
 
  •  that we will continue to invest significantly in our research and development efforts, which we believe are essential to maintaining our competitive position;
 
  •  that we will continue to invest significantly in our sales and marketing efforts, which we believe will generate future business;
 
  •  that we will incur significant additional accounting and legal costs related to compliance with SEC rules and regulations, in addition to other public company costs;
 
  •  regarding the amounts of the remaining deferred revenue associated with ratable product and professional services and support revenues that we expect to amortize over future periods;
 
  •  regarding the sufficiency of our existing cash, cash equivalents, marketable securities and cash generated from operations; and
 
  •  regarding the potential benefits to be obtained from integrating acquired products into our existing product line.
 
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.


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ITEM 1.   BUSINESS
 
Overview
 
We securely deliver the enterprise network to users, wherever they work or roam, by providing user-centric networks that expand the reach of traditional port-centric networks. User-centric networks integrate adaptive wireless local area networks (WLANs), application continuity services, and identity-based security into a cohesive, high-performance system that can be deployed as an overlay to existing enterprise networks. Adaptive WLANs deliver high-performance, follow-me connectivity so users are always connected. Application continuity services enable follow-me applications that can be seamlessly accessed across WLAN and cellular networks. Identity-based security associates access policies with users, not ports, to enable follow-me security that is enforced regardless of access method or location.
 
The products we license and sell include the ArubaOS 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.
 
We were founded in February 2002 and are headquartered in Sunnyvale, California.
 
On July 20, 2007, we acquired Network Chemistry’s line of RFProtect and BlueScanner wireless security products. Network Chemistry, a privately-held company, provides solutions for automated wireless vulnerability management. The acquisition of Network Chemistry’s line of wireless security products enhances our existing offerings in the wired and wireless security space. We plan to integrate the acquired RFProtect suite of solutions into our secure mobility solutions. The combined solutions will ultimately provide a comprehensive wireless security system solution for our wireless networking customers.
 
Industry Background
 
End-users are increasingly mobile and are dependent on having access to their enterprise network in order to perform their jobs effectively regardless of their location. In addition, they are becoming increasingly accustomed to the conveniences of personalized mobile computing and communications through the frequent use of devices such as mobile phones and laptop computers, and are demanding a similar mobile experience with regard to enterprise resources. At the same time, enterprises are deploying wireless networks to maintain their competitiveness, increase productivity and improve resource management. New applications are being introduced that are based on enterprise mobility solutions. These applications include enterprise fixed mobile convergence, or FMC, which provides seamless handoff of voice calls between cellular and enterprise VoIP networks, and location-based services such as asset tracking and inventory management. Enterprise mobility solutions today can reduce IT support costs relative to fixed networks in areas such as facilities adds, moves, and changes. Further, all-wireless buildings can potentially significantly reduce the cost of installing new network infrastructure such as cabling, LAN switches, and appliances and blade-based switches that separately manage security and application delivery.
 
Enterprises that desire to deliver secure enterprise mobility solutions must address the following challenges:
 
  •  Integrating security and mobility — Security remains one of the largest hurdles to be solved before an enterprise accepts the widespread deployment of mobility solutions. Radio airwaves cannot be confined within a building’s walls, and this presents a challenge to traditional physical security models that were designed for wired networks. Network access privileges and permissions must be clearly defined on a per-user basis to enable secure access and application delivery policies for mobile users using an open medium. Finally, unauthorized rogue access points deployed by employees can circumvent network security and must be detected and prevented;
 
  •  Delivering applications in a mobile environment — Many applications are designed for delivery over a fixed network and may perform sub-optimally in a mobile environment. Enterprise mobility solutions must ensure application persistence for mission-critical data, as well as for latency-sensitive voice and video applications. Enabling a network to recognize and adapt to an application — so-called application awareness — allows more effective delivery of data, voice and video by prioritizing traffic on a per-user basis;


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  •  System integration — Enterprise mobility solutions require more than basic wireless access. Security, application, network, and radio frequency (RF) management services are required for comprehensive enterprise mobility and are implemented in separate elements in most existing networks. This increases the complexity of deployment and integration, limits scalability, and requires expensive upgrades to the existing infrastructure;
 
  •  Scalability and management — Enterprise mobility solutions need to cost-effectively scale to support large numbers of concurrent users. Centralized management and control enables enterprise IT departments to reduce personnel and other support costs associated with enterprise mobility solutions; and
 
  •  Support for emerging mobile applications — Enterprise mobility solutions need to be highly flexible and adaptable to support emerging mobile applications, such as enterprise FMC and location-based services, without degrading the performance of, or causing significant disruption to, existing operations.
 
Our User-Centric Networks
 
We believe that our user-centric networks are fundamentally different from alternative enterprise mobility solutions. In traditional enterprise networks, users are connected to the network via physical ports using cables. In such port-centric architectures, network access policies and application delivery priorities are defined for ports, assuming a static association of a user to a port. To enable user mobility, enterprises typically either have opened access to these fixed ports so any user can connect from any port, or have deployed WLANs, each of which reduces network security and application performance. Enterprises also commonly deploy VPNs to secure mobile access, which increases cost and complexity while often degrading the user experience and application performance. None of these alternatives addresses the fundamental challenge of creating and applying user-based network access control and application delivery policies and priorities consistently across wireless and wireline networks at local and remote locations.
 
Our user-centric networks allow users to roam across the enterprise and to remote locations that have an Internet connection, while maintaining secure, high-performance access to network applications. Using our architecture, IT departments can manage network access, and enforce the policies governing application delivery and security, from a single integrated point-of-control. Our user-centric networks deliver the following benefits:
 
  •  Follow-Me Connectivity — Our adaptive WLANs ensure that users always have high performance wireless connections even in dense deployments, and noisy RF environments. Our adaptive WLANs support 802.11n and 802.11a/b/g, scale for campus applications while remaining cost-effective for branch deployments, can be used both indoors and outdoors, and support secure enterprise mesh for completely wireless networking;
 
  •  Follow-Me Security — Our identity-based security integrates user-based security and mobility in a single solution, enabling users to securely roam across an extended enterprise network including the headquarters or main campus, remote office locations, hotels, and home offices. End-users at any of these locations experience the same login procedure and network access rights, while IT departments are assured that security and application delivery policies are consistently applied to all users. Our networks provide these benefits without requiring IT departments to deploy additional services such as VPNs or access control firewalls;
 
  •  Follow-Me Applications — Our application continuity ensures a consistent user experience wherever a user connects or roams within the extended enterprise network. Most existing enterprise applications are designed for delivery in a fixed port-centric network in which dedicated bandwidth is typically provided to each user. The performance of these applications often degrades in most mobile environments in which bandwidth is shared among a group of users. Our user-centric network is application-aware, and the network dynamically adjusts to improve the performance of applications delivered in a mobile enterprise environment. IT managers can use our architecture to implement policies that prioritize and optimize data, voice and video services based on the specific user and/or the application being delivered;
 
  •  Ease of deployment and integration — Traditional approaches to enterprise mobility require a number of changes to the underlying network infrastructure. We have designed our architecture as a non-disruptive overlay to existing enterprise networks, allowing quick deployment and preserving existing infrastructure


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  investments. In addition, we have integrated all of the disparate elements of enterprise mobility — security, application, network and RF management services — into a single architecture, making it easy for IT departments to deploy our solution together with existing networks and security infrastructure;
 
  •  Cost-effective scalability — We believe our architecture provides industry leading scalability, designed to support up to 100,000 concurrent users from a single centralized point of control. In addition, our integrated solution reduces the amount and type of equipment required to enable mobility within a given location. As a result, our architecture enhances management efficiency and reduces equipment and personnel costs, allowing enterprise IT managers to scale enterprise mobility solutions in a cost-effective manner; and
 
  •  Flexible platform for emerging mobile applications — Our mobility solution architecture combines the flexibility of modular software with high performance, programmable hardware. This combination enables us to rapidly introduce new applications, such as integrating wireless LANs and enterprise FMC, and location-based services to track users and assets.
 
Our Strategy
 
Our goal is to establish our solution as the standard approach to enabling secure mobility for global education, enterprise, finance, government, healthcare, hospitality, and retail applications. We believe that the following key elements of our strategy will help us maintain our competitive advantage:
 
  •  Drive adoption across the enterprise — Most enterprises initially deploy our solutions at corporate headquarters or main campus locations. Our strategy is to drive further penetration and deployment of our solutions to extended enterprise locations, across corporate, government or educational campuses, as well as branch and home offices. We intend to do so by emphasizing the scalability and cost-efficiency of our approach. We also expect to achieve greater penetration into enterprises by deploying business-continuity solutions that provide network access from remote locations, and by supporting new mobile devices, such as dual-mode handsets, as these devices are increasingly being adopted by enterprise users.
 
  •  Maintain and extend our software offerings — We believe that our software technology is a key competitive differentiator. We intend to continue enhancing our ArubaOS operating system and centralized mobility management system to maintain our position as a technology innovator. We are also developing additional software modules to extend the functionality and performance of our ArubaOS operating system. These new modules include Mobile VoIP and location-based services, as well as additional security modules.
 
  •  Utilize channel partners to expand our global market penetration — We intend to increase our market penetration and extend our geographic reach through our network of channel partners. In late 2007 we partnered with three leading value-added distributors as part of a program to increase our reach into value-added resellers. We plan to expand our growing channel footprint and will tailor training and support programs to help drive this expansion.
 
  •  Realize increased operating efficiencies — We currently outsource our hardware manufacturing to Flextronics, an overseas contract manufacturer, and have established our own offshore research and development and customer support capabilities. We plan to continue to realize increased operating efficiencies by growing these offshore operations and by establishing additional offshore capabilities for certain general and administrative functions; and
 
  •  Expand our base of technology partners — The enterprise mobility market is a complex value chain that includes security solutions, management tools, connectivity devices, and mobility applications. We will continue to work with technology companies that are developing leading-edge solutions in these areas to enhance the functionality and drive adoption of our user-centric networks within the markets we serve.
 
Products
 
Our user-centric network architecture integrates our ArubaOS operating system, a number of optional value-add software modules, a centralized mobility management system, a series of high-performance programmable Mobility


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Controllers, and a line of wired and wireless access points. Our products are typically deployed as an overlay on top of legacy port-centric networks, minimizing the need to replace or reconfigure existing IT equipment.
 
ArubaOS
 
ArubaOS is a modular and flexible operating system that forms the core of our user-centric network architecture. Installed on our Mobility Controllers, the ArubaOS brings together network, security, application and RF management services to give network managers a centralized point-of-control over the access points, mobile users and mobile devices. ArubaOS enables the hardware capabilities found in our Mobility Controllers, including high-speed authentication, scalable encryption and decryption, and dedicated packet processing. The functionality of ArubaOS can be further extended using a number of additional licensed software modules.
 
Additional Software Modules for ArubaOS
 
To extend the base capabilities of ArubaOS, we offer a number of licensed software modules for ArubaOS. These software modules unlock additional functionality of ArubaOS, including:
 
  •  Policy enforcement firewall — delivers user and group policy enforcement. Policies can be centrally defined and enforced on a per-user or per-group basis, following users as they move throughout the enterprise network;
 
  •  Wireless intrusion protection — identifies and protects against malicious attacks on wireless networks, as well as vulnerabilities caused by unauthorized access points and client devices;
 
  •  Remote AP — extends the enterprise network to small branch offices and home offices that have a wired Internet connection. Remote AP software, coupled with any Aruba access point, allows seamless connectivity at home or other remote locations;
 
  •  VPN server — extends the mobile enterprise network to large branch offices and individual users over the public Internet, eliminating the need for separate external VPN equipment;
 
  •  External services interface — delivers a set of control and management interfaces to seamlessly integrate third-party network devices, incremental software modules, and services into user-centric networks;
 
  •  Wireless Mesh— lets any Aruba access point connect wirelessly to other Aruba access points to provide LAN-to-LAN bridging, outdoor coverage without wires, or wireless offices or workspaces, and
 
  •  xSec — provides wired and wireless Federal Information Processing Standard (FIPS) 140-2 validated encryption technology designed for high-security networks.
 
Aruba Mobility Management System
 
The Aruba Mobility Management System, or MMS, reduces total cost of ownership by reducing the need for additional personnel to manage our solution. The MMS automatically discovers, monitors, and manages hundreds of Mobility Controllers and thousands of access points and users simultaneously from a single console. It complements the centralized management capabilities built into our mobility controllers, and provides a single reference point to track users and client devices, identify rogue devices, plan new deployments, enable rapid troubleshooting of client issues, and visualize RF coverage patterns across the entire network. MMS software can be deployed on any PC platform or as part of an Aruba Mobility Controller.
 
Aruba Mobility Controllers
 
Our high-performance Mobility Controllers are purpose-built to run ArubaOS and its associated software modules, and can scale to meet the needs of large networks and handle the high throughput needs of emerging 802.11n wireless networks. All Mobility Controllers share a common hardware architecture that includes a dedicated control processor, a high-performance programmable network processor unit, and a unique programmable encryption engine. Mobility Controllers aggregate network traffic from access points, process it using our software controls, and deliver it to the network.


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Our line of Mobility Controllers includes multiple models, sized and priced to support the varying requirements of different sizes of mobile enterprise networks, from small offices and retail stores to branch and regional offices to large campuses and corporate headquarters.
 
Wireless Access Points and Wired Access Concentrators
 
Our wireless access points and wired access concentrators serve as on-ramps that aggregate user traffic onto the enterprise network and direct this traffic to mobility controllers. In addition to providing network access, our wireless access points provide security monitoring services for wireless networks. Wireless access points, available in indoor and outdoor versions, provide connectivity to clients based on the IEEE 802.11 “Wi-Fi” standard, which is supported by a broad array of consumer and commercial devices.
 
Wired access concentrators are designed for use in conference rooms, auditoriums, public areas, and certain home applications in which secure wired network access is required. Wired access concentrators connect to client devices using standard Ethernet protocol and forward network traffic to an Aruba Mobility Controller which enforce identity-based security and mobility policies.
 
Our user-centric network architecture also enables secure mobility over third-party wireless access points and wired network switches.
 
Customers
 
Our products have been sold to over 2,850 end customers worldwide (excluding end-customers of Alcatel-Lucent, our largest channel partner) in most major industries including finance, retail, hospitality, technology, manufacturing, media, healthcare, education, utilities, telecom, government, transportation, engineering and construction. Our products are deployed in a wide range of organizations from small organizations to large multinational corporations, including:
 
         
United States
 
EMEA
 
Asia Pacific
 
Microsoft
  SAP   NTT Data Corporation
The Ohio State University
  Saudi Aramco   Queensland Railway
United States Air Force
  BAA   Pu Dong International Airport (Shanghai)
California State University
       
Google
       
Yale
       
 
End user customers purchase our products directly from us and through our value-added resellers (VARs), distributors and OEMs. For a description of our revenues based on our customers’ geographic locations, see Note 13 of Notes to Consolidated Financial Statements.
 
Sales and Marketing
 
We sell our products and support directly through our sales force and indirectly through our VARs, distributors and OEMs:
 
  •  Our sales force — We have a sales force in the Americas, Europe, Middle East and Africa (EMEA) and the Asia Pacific (APAC) region who are responsible for managing all direct as well as channel business within a geographic territory.
 
  •  VARs, distributors and OEMs — As of July 31 2007, we had over 200 channel partners worldwide. Our VARs, distributors and OEMs market and sell our products to a broad array of organizations. Some of these VARs also purchase our solutions and offer them to their end customers as a managed service.
 
Our marketing activities include lead generation, tele-sales, advertising, website operations, direct marketing, and public relations, as well as participation at technology conferences and trade shows.


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Customer Service, Support and Training
 
We offer tiered customer service and support programs that encompass hardware, software, and access to future software upgrades on a when-and-if available basis. In order to better serve our customers, we have support centers in Sunnyvale, California and Chennai, India available to respond 24x7x365. Service and support for end customers of our VARs, distributors and OEMs are typically provided by these channel partners, to whom we provide backup support. Our training department conducts basic and advanced courses on-site at customer locations, third-party regional training facilities, and at our headquarters training facility in Sunnyvale, California. As part of our training program, we offer the Aruba Certified Mobility Professional and Expert (Aruba CMP or Aruba CMX) programs, which certify that participants have successfully completed the program and passed written and practical exams covering our products, networking, and wireless technologies.
 
Research and Development
 
Continued investment in research and development is critical to our business. To this end, we have assembled a team of engineers with expertise in various fields, including networking, security and RF. Our research and development efforts are focused in Sunnyvale, California, although we are expanding our research and development team in Bangalore, India. We have invested significant time and financial resources into the development of our user-centric networking architecture including our ArubaOS software platform. We will continue to expand our product offerings and solutions capabilities in the future and plan to dedicate significant resources to these continued research and development efforts. We are developing additional software modules to enhance the functionality and performance of our ArubaOS operating system. These new modules include Mobile VoIP and location-based services, as well as additional security modules. We also intend to continue to enhance our ArubaOS operating system.
 
Manufacturing
 
We outsource the manufacturing of our hardware products to Flextronics which helps us to optimize our operations by lowering costs and reducing time to market.
 
Our products are primarily manufactured in Flextronics’ Shanghai, China facility. We also utilize Flextronics’ facility in Singapore for manufacturing production, as well as a fulfillment and logistics hub for all customer shipments destined for APAC and EMEA locations. We operate a logistics center in California for all customer shipments destined to locations in the Americas. We also perform rigorous in-house quality control inspection and testing at our Sunnyvale, California facilities to ensure the reliability of our hardware components.
 
We utilize components from many suppliers. Whenever possible, we strive to have multiple sources for these components to ensure continuous supply. We work in conjunction with the extensive supply chain management organization at Flextronics to select and utilize suppliers with established delivery and quality track records. We source a limited number of components that are technically unique and only available from specific suppliers, and neither we nor Flextronics have entered into supply agreements with any of these suppliers. In these cases, we typically maintain a close direct relationship with these suppliers to ensure that supply meets our requirements including, in some cases, entering into license agreements that allow us to incorporate certain of their components into our products.
 
We also incorporate certain generally available software programs into our Aruba Mobile Edge Architecture pursuant to license agreements with third parties. We have also entered into license agreements with Atheros Communications, Inc. and Broadcom Corporation, each of which is a sole supplier of certain components used by Flextronics, our contract manufacturer, in the manufacture of our products.
 
Although the contract manufacturing services required to manufacture and assemble our products may be readily available from a number of established manufacturers, it is time consuming and costly to qualify and implement contract manufacturer relationships. Therefore, if Flextronics or sole source suppliers suffer an interruption in their businesses, or experience delays, disruptions or quality control problems in their manufacturing operations, or we have to change or add additional contract manufacturers or suppliers of our sole sourced


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components, our ability to ship products to our customers would be delayed, and our business, operating results and financial condition would be adversely affected.
 
Competition
 
The market for secure mobility products is highly competitive and constantly evolving. We believe that we compete primarily on the basis of providing a comprehensive solution that enables mobility, security, and the delivery of converged application services. We believe other principal competitive factors in our market include the total cost of ownership, performance of software and hardware products, ability to deploy easily into existing networks, interoperability of networks with other devices, ability to easily scale, ability to provide secure mobile access to the network, speed of mobile connectivity, and ability to allow the centralized management of networks. Our competitive position also depends on our ability to innovate technology and adapt to meet the evolving needs of our customers. We expect competition to intensify in the future as other companies introduce new products in the same markets we serve or intend to enter. 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.
 
Our primary competitors include Cisco Systems, primarily through its Wireless Networking Business Unit, and Motorola (through its subsidiary Symbol Technologies). We also face competition from a number of smaller private companies and new market entrants.
 
Intellectual Property
 
Our success as a company depends critically upon our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including patents, trade secrets, copyrights and trademarks, as well as customary contractual protections.
 
We have been granted a United States patent for a system and a method for monitoring and enforcing policy within a wireless network, which was issued in October 2005 and will expire in 2022. We have also been granted a United States patent for a system and method for positioning and calibrating wireless network devices, which was issued in February 2007 and will expire in 2024. We have over 30 provisional and non-provisional patent applications pending in the United States. We intend to file counterparts for these patents and patent applications in other jurisdictions around the world as appropriate.
 
Our registered trademarks in the United States are ARUBA NETWORKS, ARUBA WIRELESS NETWORKS and ARUBA THE MOBILE EDGE COMPANY. We have United States trademark applications pending to register ARUBA MOBILITY MANAGEMENT SYSTEM, MOBILE EDGE ARCHITECTURE and PEOPLE MOVE. NETWORKS MUST FOLLOW. We have filed international trademark applications for the marks ARUBA NETWORKS, ARUBA THE MOBILE EDGE COMPANY and PEOPLE MOVE. NETWORKS MUST FOLLOW.
 
In addition to the foregoing protections, we generally control access to and use of our proprietary software and other confidential information through the use of internal and external controls, including contractual protections with employees, contractors, customers and partners, and our software is protected by United States and international copyright laws.
 
Corporate Information
 
We were incorporated in Delaware in February 2002. Our principal executive offices are located at 1322 Crossman Ave., Sunnyvale, California 94089-1113, and our telephone number is (408) 227-4500. Our website address is www.arubanetworks.com.
 
Employees
 
As of July 31, 2007, we had approximately 441 employees in offices in North America, Europe, the Middle East and the Asia Pacific region, of which 199 were engaged in sales and marketing, 144 were engaged in research


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and development, 43 were engaged in general and administrative functions, 33 were engaged in customer services and 22 were engaged in operations. None of our employees are represented by labor unions, and we consider current employee relations to be good.
 
Website Posting of SEC Filings
 
Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports are available, free of charge, on our website and can be accessed by clicking on the “Company/Investor Relations” tab. Further, a copy of this annual report on Form 10-K is located at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov.
 
ITEM 1A.   RISK FACTORS
 
Risks Related to Our Business and Industry
 
We compete in new and rapidly evolving markets and have a limited operating history, which makes it difficult to predict our future operating results.
 
We were incorporated in February 2002 and began commercial shipments of our products in June 2003. As a result of our limited operating history, it is very difficult to forecast our future operating results. In addition, we operate in an industry characterized by rapid technological change. You should consider and evaluate our prospects in light of the risks and uncertainties frequently encountered by early stage companies in rapidly evolving markets characterized by rapid technological change, changing customer needs, evolving industry standards and frequent introductions of new products and services. These risks and difficulties include challenges in accurate financial planning as a result of limited historical data and the uncertainties resulting from having had a relatively limited time period in which to implement and evaluate our business strategies as compared to older companies with longer operating histories.
 
In addition, our products are designed to be compatible with industry standards for secure communications over wireless and wireline networks. As we encounter changing standards, customer requirements and competitive pressures, we likely will be required to reposition our product and service offerings and introduce new products and services. We may not be successful in doing so in a timely and appropriately responsive manner, or at all. Our failure to address these risks and difficulties successfully could materially harm our business and operating results.
 
Our operating results may fluctuate significantly, which makes our future results difficult to predict and could cause our operating results to fall below expectations.
 
Our annual and quarterly operating results have fluctuated in the past and may fluctuate significantly in the future due to a variety of factors, many of which are outside of our control. In addition, beginning in November 2005, we began recognizing product revenues upon delivery using the residual method for transactions where all other revenue recognition criteria were met. As a result, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results, in particular, the absolute dollar growth in our revenues on a year-over-year basis, as an indication of our future performance.
 
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. 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 substantially adversely affect our earnings because we may not be able to adequately and timely adjust our expense levels.


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In addition to other risk factors listed in this “Risk Factors” section, factors that may cause our operating results to fluctuate include:
 
  •  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;
 
  •  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;
 
  •  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 attain volume manufacturing pricing from Flextronics Sales and Marketing North Asia (L) Ltd. and our component suppliers;
 
  •  growth in our headcount and other related costs incurred in our customer support organization;
 
  •  the timing of revenue recognition in any given quarter as a result of revenue recognition rules;
 
  •  the regulatory environment for the certification and sale of our products;
 
  •  seasonal demand for our products, some of which may not be currently evident due to our revenue growth; and
 
  •  general economic conditions in our domestic and international markets.
 
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, and we anticipate that we will incur net losses for at least the next several quarters. We experienced net losses of $24.4 million, $12.0 million, and $32.6 million for the years ended July 31, 2007, 2006 and 2005. As of July 31, 2007, our accumulated deficit was $101.1 million. 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,


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which frequently involves not only our products but also those of our competitors and can result in a lengthy sales cycle, which typically averages three to six 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. In addition, product purchases are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. If sales expected from a specific customer for a particular quarter are not realized in that quarter or at all, our business, operating results and financial condition could be materially adversely affected.
 
The market in which we compete is highly competitive, and competitive pressures from existing and new companies may have a material adverse effect on our business, revenues, growth rates and market share.
 
The market in which we compete is a highly competitive industry that is influenced by the following competitive factors:
 
  •  comprehensiveness of the solution;
 
  •  total cost of ownership;
 
  •  performance of software and hardware products;
 
  •  ability to deploy easily into existing networks;
 
  •  interoperability with other devices;
 
  •  scalability of solution;
 
  •  ability to provide secure mobile access to the network;
 
  •  speed of mobile connectivity offering;
 
  •  ability to allow centralized management of products; and
 
  •  ability to obtain regulatory and other industry certifications.
 
We expect competition to intensify in the future as other companies introduce new products in the same markets we serve or intend to enter. This competition could result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and failure to increase, or the loss of, market share, any of which would likely seriously harm our business, operating results or financial condition. If we do not keep pace with product and technology advances, there could be a material adverse effect on our competitive position, revenues and prospects for growth.
 
A number of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we do. Potential customers may prefer to purchase from their existing suppliers rather than a new supplier, regardless of product performance or features. Currently, we compete with a number of large and well established public companies, including Cisco Systems, primarily through its Wireless Networking Business Unit, and Motorola (through its subsidiary Symbol Technologies), as well as smaller private companies and new market entrants, any of which could reduce our market share, require us to lower our prices, or both.
 
We expect increased competition from other established and emerging companies if our market continues to develop and expand. For example, 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,


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customers’ willingness to purchase from such companies. These pressures could 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. If we fail to do so, 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. In addition, customers may delay purchases of existing products until the new or improved versions of those products are available.
 
We manufacture our products to comply with standards established by various standards bodies, including the Institute of Electrical and Electronics Engineers, Inc. (“IEEE”). If we are not able to adapt to new or changing standards that are ratified by these bodies, our ability to sell our products may be adversely affected. For example, we are currently developing products that comply with the draft 802.11n wireless LAN standard (“11n”) that IEEE has not yet ratified. If IEEE fails to ratify the 11n standard, or materially modifies the current draft of the 11n standard, we likely would have to modify our products to comply with the final 11n standard, which would require additional time and expense and could cause a disruption in our ability to market and sell the affected products.
 
Our business, operating results and growth rates may be adversely affected by unfavorable economic and market conditions, as well as the volatile geopolitical environment.
 
Our business depends on the overall demand for information technology, or IT, and on the economic health of our current and prospective customers. Our current business and operating plan assumes that economic activity in general, and IT spending in particular, will at least remain at current levels. However, 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 is often discretionary and may involve a significant commitment of capital and other resources. Therefore, weak economic conditions, or a reduction in IT spending, even if economic conditions improve, would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and services, and reduced unit sales. If interest rates rise, overall demand could be further dampened and related IT spending may be reduced.


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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.
 
Our contract manufacturer, Flextronics, purchases some components, subassemblies and products from a single supplier or a limited number of suppliers, and with respect to some of these suppliers, we have entered into license agreements that allow us to use their components in our products. The loss of any of these suppliers or the termination of any of these license agreements may cause us to incur additional set-up costs, result in delays in manufacturing and delivering our products, or cause us to carry excess or obsolete inventory.
 
Shortages in components that we use in our products are possible, and our ability to predict the availability of such components may be limited. While components and supplies are generally available from a variety of sources, we currently depend on a single or limited number of suppliers for several components for our equipment and certain subassemblies and products. We rely on Flextronics to obtain the components, subassemblies and products necessary for the manufacture of our products, including those components, subassemblies and products that are only available from a single supplier or a limited number of suppliers.
 
For example, our solution incorporates both software products and hardware products, including a series of high-performance programmable mobility controllers and a line of wired and wireless access points. The chipsets that Flextronics sources and incorporates in our hardware products are currently available only from a limited number of suppliers, with whom neither we nor Flextronics have entered into supply agreements. All of our access points incorporate components from Atheros Communications, Inc., and all of our mobility controllers incorporate components from Broadcom Corporation. We have entered into license agreements with both Atheros and Broadcom, the termination of which could have a material adverse effect on our business. Our license agreement with Atheros and Broadcom 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 was unable to obtain these components from Atheros or Broadcom, we would be required to redesign our hardware and software in order to incorporate components from


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alternative sources. All of our product revenues are dependent upon the sale of products that incorporate components from either Atheros or Broadcom.
 
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 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.
 
We sell a majority of our products through VARs, distributors and OEMs. If the third-party distribution sources on which we rely do not perform their services adequately or efficiently or if they exit the industry, and we are not able to quickly find adequate replacements, there could be a material adverse effect on our revenues.
 
Our future success is highly dependent upon establishing and maintaining successful relationships with a variety of VARs, distributors and OEMs, which we refer to as our indirect channel. For the years ended July 31, 2007, 2006 and 2005, 82.8%, 79.2% and 74.6% of our revenues, respectively, were derived from sales through our indirect channel, and we expect indirect channel sales to increase as a percentage of our total revenues. Accordingly, our revenues depend in large part on the effective performance of these channel partners, including our largest channel partner, Alcatel-Lucent. For the years ended July 31, 2007, and 2006, Alcatel-Lucent accounted for 12.5% and 15.6% of our total revenues, respectively. Our OEM supply agreement with Alcatel-Lucent provides that Alcatel-Lucent shall use reasonable commercial efforts to sell our products on a perpetual basis unless otherwise terminated by either party. In addition, this OEM supply agreement restricts our ability to enter into channel partner relationships with other specified VARs, distributors and OEMs without obtaining Alcatel-Lucent’s consent. Finally, the OEM supply agreement contains a “most-favored nations” clause, pursuant to which we agreed to lower the price at which we sell products to Alcatel-Lucent in the event that we agree to sell the same or similar products at a lower price to a similar customer on the same or similar terms and conditions. However, the specific terms of this “most-favored nations” clause are narrow and specific, and we have not to date incurred any obligations related to this term in the OEM supply agreement.
 
Some of our third-party distribution sources may have insufficient financial resources and may not be able to withstand changes in worldwide business conditions, including economic downturns, or abide by our inventory and credit requirements. If the third-party distribution sources on which we rely do not perform their services adequately or efficiently, or if they exit the industry and we are not able to quickly find adequate replacements, there could be a material adverse effect on our revenues and market share. By relying on these indirect channels, we may have less contact with the end users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing customer requirements and respond to evolving customer needs. In addition, our channel partners may receive pricing terms that allow for volume discounts off of list prices for the products they purchase from us, which reduce our margins to the extent revenues from such channel partners increase as a proportion of our overall revenues.
 
Recruiting and retaining qualified channel partners and training them in our technology and product offerings requires significant time and resources. In order to develop and expand our distribution channel, we must continue to scale and improve our processes and procedures that support our channel partners, including investment in systems and training, and those processes and procedures may become increasingly complex and difficult to manage. We have no minimum purchase commitments with any of our VARs, distributors 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


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failure to establish and maintain successful relationships with third-party distribution sources would likely materially adversely affect our business, operating results and financial condition.
 
Our international sales and operations subject us to additional risks that may adversely affect our operating results.
 
We derive a significant portion of our 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 and general and administrative functions 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; and
 
  •  reduced protection for intellectual property rights 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


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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 the number of products and competitors in our market increases and overlaps occur, we expect that infringement claims may increase. Any claim of infringement by a third party, even those without merit, could cause us to incur substantial costs defending against the claim and could distract our management from our business. 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 of these events could seriously harm our business, operating results and financial condition.
 
We are currently subject to a lawsuit involving intellectual property claims brought by Symbol Technologies, Inc. and Wireless Valley Communications, Inc., both Motorola subsidiaries, in the Federal District Court of Delaware which could cause us to incur significant additional costs or prevent us from selling our product which could adversely affect our results of operations and financial condition.
 
On August 27, 2007, Symbol Technologies, Inc. and Wireless Valley Communications, Inc., both Motorola subsidiaries, filed suit against us in the Federal District Court of Delaware alleging patent infringement. Although we intend to vigorously defend against these claims, intellectual property litigation is expensive and time-consuming, regardless of the merits of any claim, and could divert our management’s attention from operating our business. Our legal costs may increase as the case develops and we near a trial date. The results of, and costs associated with, complex litigation matters are difficult to predict, and the uncertainty associated with a substantial unresolved lawsuit could harm our business, financial condition and reputation. Negative developments with respect to this lawsuit could cause our stock price to decline, and could have an adverse and possibly material effect on our business and results of operations.
 
Intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we cannot assure you that we will be successful in defending ourselves against intellectual property claims. If we were to discover that our products infringe the intellectual property rights of others, we would need to obtain licenses from these parties or substantially reengineer our products in order to avoid infringement. We might not be able to obtain the necessary licenses on acceptable terms, or at all, or be able to reengineer our products successfully. Moreover, if we lose the suit, we could be required to pay substantial damages and/or be enjoined from using or selling the infringing products or technology. Any of the foregoing could cause us to incur significant costs and prevent us from selling our products which could adversely affect our results of operations and financial condition.
 
We expect that the number and significance of claims and legal proceedings that assert patent infringement claims or other intellectual property rights covering our products will increase as our business expands. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements.
 
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.
 
We recently announced the acquisition of Network Chemistry, Inc.’s line of RFProtect and BlueScanner wireless security products. We plan to integrate the newly acquired products into our secure mobility solutions, as well as provide products and continuing support to existing Network Chemistry customers and partners. This is our first 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,


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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.
 
If we fail to effectively integrate our new officers into our organization, our business could be harmed.
 
Many of our current officers have recently joined us. As a result, our executive team has not worked together as a group for a significant period of time. Our future performance will depend in part on our ability to successfully integrate our newly hired executive officers into our management team and develop an effective working relationship among senior management. If we fail to integrate these individuals and create effective working relationships among them and other members of management, our business, operating results and financial condition could be adversely affected.
 
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 by expanding our network of channel partners by adding additional sales personnel who will be dedicated to supporting this growing channel footprint. We also plan to increase offshore operations by establishing additional offshore capabilities for certain engineering and general and administrative 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.
 
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.


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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.
 
Enterprises may have slow WAN connections between some of their locations that may cause our products to become less effective.
 
Our Mobility Controllers and Mobility Management System were initially designed to function at LAN-like speeds in an office building or campus environment. In order to function appropriately, our Mobility Controllers synchronize with each other over network links. The ability of our products to synchronize may be limited by slow or congested data-links, including DSL and dial-up. Our failure to provide such additional functionality could adversely affect our business, operating results and financial condition.
 
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, bugs or security vulnerabilities. Some errors in our products may only be discovered after a product has been installed and used by customers. For example, a software bug was identified in January 2007 that affected certain versions of the Aruba Mobility Controller, in response to which we alerted our customers and released a patch to address the issue. Any errors, bugs, defects or security vulnerabilities discovered in our products after commercial release could result in loss of revenues or delay in revenue recognition, loss of customers, damage to our brand and reputation, and increased service and warranty cost, any of which could adversely affect our business, operating results and financial condition. In addition, we could face claims for product liability, tort or breach of warranty, including claims relating to changes to our products made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.
 
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.


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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.
 
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, or the 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


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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 have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations.
 
Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by manmade problems such as computer viruses or terrorism.
 
Our corporate headquarters are located in the San Francisco Bay Area, a region known for seismic activity. A significant natural disaster, such as an earthquake, fire or a flood, occurring at our headquarters or in China, where our contract manufacturer, Flextronics, is located, could have a material adverse impact on our business, operating results and financial condition. In addition, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. In addition, acts of terrorism could cause disruptions in our or our customers’ businesses or the economy as a whole. To the extent that such disruptions result in delays or cancellations of customer orders, or the deployment of our products, our business, operating results and financial condition would be adversely affected.
 
Risks Related to Ownership of our Common Stock
 
Our stock price may be volatile.
 
The trading price of our common stock may 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;
 
  •  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


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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 July 31, 2007, our directors and executive officers and their affiliates beneficially owned, in the aggregate, approximately 48.5% 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 your ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.
 
We may choose to raise additional capital, which may not be available, which would adversely affect our ability to operate our business.
 
We expect that the net proceeds from our initial public offering, together with 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 and our OEM supply agreement with Alcatel-Lucent could discourage a takeover that stockholders may consider favorable.
 
Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:
 
  •  our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;
 
  •  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 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.


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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.
 
In addition, our OEM supply agreement with Alcatel-Lucent provides that, in the event of a change of control that would cause Alcatel-Lucent to purchase our products from an entity that is an Alcatel-Lucent competitor, we must, without additional consideration, (1) provide Alcatel-Lucent with any information required by Alcatel-Lucent to make, test and support the products that we distribute through our OEM relationship with Alcatel-Lucent, including all hardware designs and software source code, and (2) otherwise cooperate with Alcatel-Lucent to transition the manufacturing, testing and support of these products to Alcatel-Lucent. We are also obligated to promptly inform Alcatel-Lucent if and when we receive an inquiry concerning a bona fide proposal or offer to effect a change of control and will not enter into negotiations concerning a change of control without such prior notice to Alcatel-Lucent. Each of these provisions could delay or result in a discount to the proceeds our stockholders would otherwise receive upon a change of control or could discourage a third party from making a change of control offer.
 
We have incurred and will continue to incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.
 
The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq Stock Market, have imposed various new requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these new compliance initiatives. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, we expect these new 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, among other things, that we assess the effectiveness of our internal control over financial reporting annually and disclosure controls and procedures quarterly. In particular, for the fiscal year ending on July 31, 2008, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the subsequent testing by our independent registered public accounting firm that must be performed for the fiscal year ending on July 31, 2008, may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses. Our compliance with Section 404 will require that we incur substantial accounting expense and expend significant management time on compliance related issues. We will evaluate the need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge. Moreover, if we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline, and we could be subject to sanctions or investigations by the Nasdaq Stock Market, the Securities and Exchange Commission or other regulatory authorities, which would require additional financial and management resources.
 
ITEM 1B.   UNRESOLVED STAFF COMMENTS
 
Not applicable.


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ITEM 2.   PROPERTIES
 
We have approximately 52,325 square feet of office space in Sunnyvale, California pursuant to a lease that expires in August 2010. We also lease approximately 43,500 square feet of warehouse space in Sunnyvale, California pursuant to a lease that expires in September 2010. We also maintain customer service centers, sales offices and research and development facilities in multiple locations worldwide. See Note 14 of our Notes to Consolidated Financial Statements for information regarding our lease obligations.
 
We believe that our current facilities are suitable and adequate to meet our current needs, and we intend to add new facilities or expand existing facilities as we add employees. We believe that suitable additional or substitute space will be available as needed to accommodate expansion of our operations.
 
ITEM 3.   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 alleging patent infringement. Although we intend to vigorously defend against these claims, intellectual property litigation is expensive and time-consuming, regardless of the merits of any claim, and could divert our management’s attention from operating our business.
 
We could become involved in additional litigation from time to time relating to claims arising out of our ordinary course of business.
 
ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted to a vote of our security holders during the quarter ended July 31, 2007.


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PART II
 
ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES
 
Our common stock has been listed on the Nasdaq Global Market under the symbol “ARUN” since our initial public offering in March 2007. The following table sets forth, for the periods indicated, the high and low intra-day prices for our common stock as reported on the Nasdaq Global Market.
 
                 
    High     Low  
 
2007
               
Third Quarter (beginning March 27, 2007)
  $ 14.67     $ 13.50  
Fourth Quarter
  $ 23.78     $ 13.47  
 
As of September 21, 2007 the number of stockholders of record of our common stock was 393.
 
The equity compensation plan information required by this item, which includes a summary of the number of outstanding options granted to employees and directors, as well as the number of securities remaining available for future issuances, under our compensation plans as of July 31, 2007, is incorporated by reference to our Proxy Statement for our 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended July 31, 2007
 
Sales of Unregistered Securities
 
The following sets forth information regarding unregistered securities sold by us in fiscal year 2007:
 
  •  In September 2006, we sold an aggregate of 1,619,725 shares of our Series D preferred stock to a total of 31 accredited investors at $6.5443 per share, for aggregate proceeds of $10,599,985. We believe the issuance of the Series D preferred stock was deemed to be exempt from registration under the Securities Act of 1933 in reliance on Section 4(2) of the Securities Act of 1933 as transactions by an issuer not involving any public offering. The recipients of Series D preferred stock represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates and other instruments issued in such transactions. The sales of these securities were made without general solicitation or advertising. Each share of Series D preferred stock was convertible, at the option of the holder, at any time after the date of issuance of such share, to common stock using an initial conversion rate of 1:1, subject to adjustments for future dilution and each share and was automatically convertible into shares of common stock at the conversion rate then in effect immediately upon the sale of our common stock in a firmly committed underwritten public offering with gross offering proceeds of at least $20,000,000. In addition, each share of Series D redeemable convertible preferred stock was automatically convertible into shares of common stock at the conversion rate then in effect for the Series D redeemable convertible preferred stock upon the date specified by written consent or agreement of the holders of at least 662/3% of the then outstanding shares of Series D redeemable convertible preferred stock (voting as a separate class).
 
  •  In May 2007, we issued 113,770 shares of our common stock in connection with a cashless exercise of warrants to purchase 120,814 shares of our common stock at an exercise price ranging from $0.67 to $1.20 per share. We believe this transaction was exempt from the registration requirements of the Securities Act of 1933, as amended, in reliance on Section 4(2) thereof or Regulation D promulgated thereunder, as a transaction by an issuer not involving a public offering.
 
  •  On March 27, 2007, we contributed 100,000 shares of our common stock to a charitable foundation. Other than the payment of the par value of the shares by the charitable foundation, which was $10, we received no cash consideration at the time such shares were issued. We believe the issuance was exempt from the registration requirements of the Securities Act in reliance on Section 4(2) thereof, as transactions by an issuer not involving a public offering. The charitable foundation agreed that the shares would be subject to the standard restrictions applicable to a private placement of securities under applicable state and federal


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  securities laws, and appropriate legends were affixed to the share certificate issued to the charitable foundation.
 
  •  Upon the closing of our initial public offering on March 30, 2007, we issued 318,181 shares of our common stock to Microsoft Corporation in consummation of a stock issuance agreement that we entered into with Microsoft in June 2005. We received no cash consideration at the time such shares were issued. We believe the issuance was exempt from the registration requirements of the Securities Act in reliance on Section 4(2) thereof, as transactions by an issuer not involving a public offering. Microsoft Corporation agreed that the shares would be subject to the standard restrictions applicable to a private placement of securities under applicable state and federal securities laws, and appropriate legends were affixed to the share certificate issued to Microsoft Corporation. We believe that Microsoft received adequate information about us or had access, through its relationship with us, to such information.
 
Use of Proceeds from Public Offering of Common Stock
 
On March 26, 2007, our registration statements (Nos. 333-139419 and 333-141592) on Form S-1 were declared effective for our initial public offering, pursuant to which we registered the offering and sale of an aggregate of 9,200,000 shares of common stock, including the underwriters’ over-allotment option, at a public offering price of $11.00 per share. The offering, which closed on March 30, 2007, did not terminate until after the sale of all of the shares registered on the registration statement. The managing underwriters were Goldman, Sachs & Co., Lehman Brothers Inc, J.P. Morgan Securities Inc. and RBC Capital Markets Corporation.
 
As a result of the offering, we received net proceeds of approximately $91.8 million, after deducting underwriting discounts and commissions of $7.1 million and additional offering-related expenses of approximately $2.3 million. No payments for such expenses were made directly or indirectly to (i) any of our officers or directors or their associates, (ii) any persons owning 10% or more of any class of our equity securities, or (iii) any of our affiliates. We anticipate that we will use the net proceeds from the IPO for general corporate purposes, which may include expansion of our domestic and international sales and marketing organizations, investments in our infrastructure to support our growth, further development and expansion of our service offerings and possible acquisitions of complementary businesses, technologies or other assets. Pending such uses, we plan to invest the net proceeds in short-term investments. There has been no material change in the planned use of proceeds from our IPO from that described in the final prospectus filed with the SEC pursuant to Rule 424(b).
 
Dividend Policy
 
We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future.
 
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
                                 
                Total Number of
    Maximum Number
 
                Shares Purchased as
    of Shares That May
 
                Part of Publicly
    Yet be Purchased
 
    Total Number of
    Average Price
    Announced Plans or
    Under the Plans or
 
    Shares Purchased(1)     Paid per Share     Programs     Programs  
 
May 1 - May 31, 2007
        $              
June 1 - June 30, 2007
    650     $ 2.33              
July 1 - July 31, 2007
    14,062     $ 1.25              
                                 
Total
    14,712     $ 1.30              
                                 
 
 
(1) Represents unvested shares of common stock repurchased by us upon the termination of employment or service pursuant to the provisions of our 2002 Stock Plan.


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ITEM 6.   SELECTED CONSOLIDATED FINANCIAL DATA
 
You should read the following selected consolidated historical financial data below in conjunction with the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements, related notes and schedule, and other financial information included in this Form 10-K. The selected consolidated financial data in this section is not intended to replace the consolidated financial statements and is qualified in its entirety by the consolidated financial statements and related notes and schedule included in this Form 10-K.
 
                                         
    Years Ended July 31,  
    2007     2006     2005     2004     2003  
    (In thousands)  
 
Consolidated Statements of Operations Data:
                                       
Revenues:
                                       
Product
  $ 107,939     $ 43,171     $     $     $  
Professional services and support
    12,847       2,985                    
Ratable product and related professional services and support
    6,713       26,347       12,043       1,147       3  
                                         
Total Revenues
    127,499       72,503       12,043       1,147       3  
Cost of revenues(1):
                                       
Product
    36,035       16,904                    
Professional services and support
    4,863       2,409                    
Ratable product and related professional services and support
    2,470       10,572       9,077       2,696       126  
                                         
Total cost of revenues
    43,368       29,885       9,077       2,696       126  
                                         
Gross profit (loss)
    84,131       42,618       2,966       (1,549 )     (123 )
Operating expenses:
                                       
Research and development(1)
    25,654       14,130       9,353       6,982       5,743  
Sales and marketing(1)
    60,115       33,765       22,369       11,277       1,449  
General and administrative(1)
    14,600       5,963       3,576       2,531       1,488  
In-process research and development
    632                          
                                         
Total operating expenses
    101,001       53,858       35,298       20,790       8,680  
                                         
Operating loss
    (16,870 )     (11,240 )     (32,332 )     (22,339 )     (8,803 )
Other income (expense), net
    (7,137 )     (529 )     (147 )     (129 )     8  
                                         
Loss before provision for income taxes and cumulative effect of change in accounting principle
    (24,007 )     (11,769 )     (32,479 )     (22,468 )     (8,795 )
Provision for income taxes
    375       306       156       34        
                                         
Loss before cumulative effect of change in accounting principle
    (24,382 )     (12,075 )     (32,635 )     (22,502 )     (8,795 )
Cumulative effect of change in accounting principle
          66                      
                                         
Net loss
  $ (24,382 )   $ (12,009 )   $ (32,635 )   $ (22,502 )   $ (8,795 )
                                         
Net loss per common share; basic and diluted
  $ (0.70 )   $ (1.07 )   $ (4.66 )   $ (6.35 )   $ (7.96 )
 
 
(1) Includes stock-based compensation as follows:
 


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    Years Ended July 31,  
    2007     2006     2005     2004     2003  
    (In thousands)  
 
Cost of revenues
  $ 327     $ 34     $ 23     $ 5     $  
Research and development
    2,925       259       179       42        
Sales and marketing
    4,362       749       678       272       9  
General and administrative
    5,103       213       194       71       4  
                                         
Total stock-based compensation
  $ 12,717     $ 1,255     $ 1,074     $ 390     $ 13  
                                         
 
                                         
    As of July 31,  
    2007     2006     2005     2004     2003  
    (In thousands)  
 
Consolidated Balance Sheet Data:
                                       
Cash and cash equivalents
  $ 42,570     $ 9,263     $ 4,293     $ 27,390     $ 915  
Working capital (deficit)
    109,496       (10,472 )     (884 )     26,749       265  
Total assets
    152,133       38,017       30,337       38,273       2,762  
Equipment loans payable
          613       1,867       2,885       1,550  
Deposit for Series D redeemable convertible preferred stock
          19,329                    
Redeemable convertible preferred stock
          58,009       58,009       56,310       9,450  
Common stock and additional paid-in-capital
    213,553       6,077       4,831       2,241       146  
Total stockholders’ equity (deficit)
  $ 112,487     $ (73,000 )   $ (62,459 )   $ (31,137 )   $ (9,420 )
 
ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read together with our Consolidated Financial Statements and related notes included elsewhere in this report.
 
Overview
 
We securely deliver the enterprise network to users, wherever they work or roam, with user-centric networks that expand the reach of traditional port-centric networks. User-centric networks integrate adaptive wireless local area networks (WLANs), application continuity services, and identity-based security into a cohesive, high-performance system that can be deployed as an overlay to existing enterprise networks. Adaptive WLANs deliver high-performance, follow-me connectivity so users are always connected. Application continuity services enable follow-me applications that can be seamlessly accessed across WLAN and cellular networks. Identity-based security associates access policies with users, not ports, to enable follow-me security that is enforced regardless of access method or location. The products we license and sell include the ArubaOS operating system, optional value-added software modules, a centralized mobility management system, high-performance programmable Mobility Controllers, wired and wireless access points, wireless intrusion detection tools, spectrum analyzers, and endpoint compliance solutions.
 
We began commercial shipments of our products in June 2003. Since that time, our products have been sold to more than 2,850 end customers worldwide, including some of the largest and most complex global organizations. Our product revenue growth rate will depend significantly on continued growth in the market for enterprise mobility solutions, our ability to continue to attract new customers and our ability to compete against more established companies in the market. Our growth in professional services and 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

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by the continued acceptance of our products in the marketplace, as well as the timing and size of orders, product and channel mix, average selling prices, costs of our products and general economic conditions. Our ability to attain profitability will also be affected by the extent to which we invest in our sales and marketing, research and development, and general and administrative resources to grow our business
 
In March 2007, we completed our initial public offering, or IPO, of common stock in which we issued and sold 9,200,000 shares of our common stock, including 1,200,000 shares sold pursuant to the underwriters’ exercise of their over-allotment option, at an issue price of $11.00 per share. We raised a total of $101.2 million in gross proceeds from the IPO, or approximately $91.8 million in net proceeds after deducting underwriting discounts and commissions of $7.1 million and other offering costs of $2.3 million. Upon the closing of the IPO, all shares of redeemable convertible preferred stock outstanding automatically converted into 49,681,883 shares of common stock and 318,181 shares of our common stock were issued to Microsoft in consummation of a stock issuance agreement that we entered into with Microsoft in June 2005. Subsequent to the IPO and the associated conversion of our outstanding redeemable convertible preferred stock to common stock, warrants to purchase 677,106 shares of redeemable convertible preferred stock were converted to warrants to purchase an equivalent number of shares of our common stock and the related carrying value of such warrants was reclassified to additional paid-in-capital, and the warrants are no longer subject to remeasurement.
 
We were incorporated in Delaware in 2002 and are headquartered in Sunnyvale, California. We have offices in North America, Europe, the Middle East and Asia Pacific, and employ staff around the world.
 
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, and professional services and support. Professional services revenues consist of consulting and training services. Product support typically includes software updates, on a when and if available basis, telephone and internet access to technical support personnel and hardware support. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period. Consulting services primarily consist of installation support services. Training services are instructor led courses on the use of our products. Consulting and training revenues to date have been insignificant.
 
Our revenues have grown rapidly since we began commercial shipments of our products in June 2003. Comparisons of our revenues since then are significantly affected by the fact that we only began recognizing product revenues upon delivery using the residual method for transactions in which all other revenue recognition criteria are met, in the three months ended January 31, 2006. As we have not been able to establish vendor specific objective evidence, or VSOE, on our prior services and support offerings, all transactions prior to the three months ended January 31, 2006 continue to be recognized ratably over the support period. See “Critical Accounting Policies — Revenue Recognition.”
 
Our revenue growth has been driven primarily by an expansion of our customer base coupled with increased purchases from existing customers. We believe the market for our products has grown due to the increased demand of business enterprises to provide secure mobility to their users.
 
We sell our products directly through our sales force and indirectly through VARs, distributors and OEMs. We expect revenues from indirect channels to continue to constitute a substantial majority of our future revenues and an increasingly greater proportion of our future product revenues.
 
We sell our products to channel partners and end customers located in the Americas, Europe, the Middle East, Africa and Asia Pacific. Shipments to our channel partners that are located in the United States are classified as U.S. revenue regardless of the location of the end customer. We continue to expand into international locations and introduce our products in new markets, and we expect international revenues to increase in absolute dollars and as a percentage of total revenues in future periods. For more information about our international revenues, see Note 13 of Notes to Consolidated Financial Statements.


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In 2005, we began to sell our products to Alcatel-Lucent, one of our OEMs which, in turn, sells our products under its own brand name. For fiscal years 2007 and 2006, Alcatel-Lucent accounted for 12.5% and 15.6% of our revenues, respectively.
 
Cost of Revenues
 
Cost of product revenues consists primarily of manufacturing costs for our products, shipping and logistics costs, and expenses for inventory obsolescence and warranty obligations. We utilize third parties to manufacture our products and perform shipping logistics. We have outsourced the significant majority of our manufacturing, repair and supply chain operations. Accordingly, the substantial majority of our cost of revenues consists of payments to Flextronics, our contract manufacturer. Flextronics manufactures our products in China and Singapore using quality assurance programs and standards that we jointly established. Manufacturing, engineering and documentation controls are conducted at our facilities in Sunnyvale, California and Bangalore, India. Cost of professional services and support revenues is primarily comprised of the personnel costs of providing technical support, including personnel costs associated with our internal support organization. In addition, during fiscal 2006, we hired a third-party support vendor to complement our internal support resources, the costs of which are included within costs of professional services and support revenues.
 
Gross Margin
 
Our gross margin has been, and will continue to be, affected by a variety of factors, including:
 
  •  the proportion of our products that are sold through direct versus indirect channels;
 
  •  new product introductions and enhancements both by us and by our competitors;
 
  •  product mix and average selling prices;
 
  •  demand for our products and services;
 
  •  our ability to attain volume manufacturing pricing from Flextronics and our component suppliers; and
 
  •  growth in our headcount and other related costs incurred in our customer support organization.
 
Due to higher discounts given to the 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 increase as a proportion of our total product revenues, which, by itself, negatively impacts our gross margins. However, over the past several quarters we have experienced a favorable change in our product mix as we sold more higher-margin products, which contributed to improved overall gross margins.
 
Operating Expenses
 
Operating expenses consist of research and development, sales and marketing, general and administrative and in-process research and development 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.
 
We grew from 282 employees at July 31, 2006 to approximately 441 employees at July 31, 2007. We expect to continue to hire a significant number of new employees to support our growth. The timing of these additional hires could materially affect our operating expenses, both in absolute dollars and as a percentage of revenue, in any particular period.
 
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. However, as a percentage of revenue, we expect research and development expenses to decrease.


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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 heavily in sales and marketing by increasing the number of sales personnel worldwide 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. However, as a percentage of revenue, we expect sales and marketing expenses to decrease.
 
General and administrative expenses primarily consist of personnel and facilities costs related to our executive, finance, human resource, information technology and legal organizations, and fees for professional services. Professional services consist of outside legal, audit, and Sarbanes-Oxley and information technology consulting costs. We expect that we will incur significant additional accounting and legal costs related to compliance with rules and regulations implemented by the Securities and Exchange Commission, as well as additional insurance, investor relations and other costs associated with being a public company. However, as a percentage of revenue, we expect general and administrative expenses to decrease.
 
In-process research and development expenses relate to the acquisition of Network Chemistry, Inc.’s line of RFProtect and BlueScanner wireless security products, which we purchased in July 2007. In-process research and development expenses were expensed upon the consummation of the acquisition. See Note 3 of our Notes to Consolidated Financial Statements for a further discussion.
 
Stock-Based Expense
 
Effective August 1, 2006, we began measuring and recognizing expense for all stock-based payments at fair value, in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004) Share Based Payment, or SFAS 123R. For fiscal 2007, 2006 and 2005, we recognized $12.7 million, $1.3 million and $1.1 million, respectively, in stock-based expense.
 
Other Income (Expense), net
 
Other income (expense), net includes interest income on cash balances, interest expense on our outstanding debt and losses or gains on conversion of non-U.S. dollar transactions into U.S. dollars. Cash has historically been invested in money market funds. The largest component of other income (expense), net in fiscal 2007, 2006 and 2005, was the adjustment to record our outstanding preferred stock warrants at fair value. As described below, subsequent to our IPO, we are no longer required to remeasure these warrants to fair value.
 
Our Relationship with Microsoft
 
Our strategic relationship with Microsoft began in June 2005, when Microsoft chose our products for a worldwide deployment, pursuant to which Microsoft has installed our products in various sites in the United States, Asia and Europe. As part of the relationship, we support Microsoft’s Network Access Protection (NAP) architecture for enterprise security and provide interoperability with Microsoft products such as Internet Authentication Server (IAS) and Network Policy Server (NPS). In addition, we entered into a Stock Issuance Agreement with Microsoft pursuant to which we agreed to issue Microsoft the number of shares of our common stock determined by dividing up to $3.5 million by the actual per share public offering price in the event of a firmly underwritten IPO or up to $5.0 million of consideration in connection with a change of control occurring prior to an IPO based on the cumulative level of purchases by Microsoft. Accordingly, the amount of consideration was not fixed but rather increased directly with the cumulative level of product purchases. As of July 31, 2006, the cumulative product and support sales to Microsoft were $2.0 million and were carried as a long-term liability until we issued the shares of common stock to Microsoft under the stock issuance agreement. During the year ended July 31, 2007, we completed


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a firmly underwritten IPO at which time the cumulative sales to Microsoft exceeded $3.5 million. Therefore, upon the closing of the IPO and in recognition of the $3.5 million in cumulative sales to Microsoft, 318,181 shares of our common stock were issued under the stock issuance agreement. Further, for the cumulative sales in excess of $3.5 million, we recognized revenue of $5.9 million in fiscal 2007.
 
Critical Accounting Policies
 
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). These accounting principles require us to make estimates and judgments that can 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, fair value of warrants to purchase redeemable convertible preferred stock, inventory valuation, allowances for doubtful accounts and income taxes.
 
Revenue Recognition
 
Our revenues are derived primarily from two sources: (1) product revenue, including hardware and software products, and (2) related professional services and support revenue. Support typically includes software updates, on a when and if available basis, telephone and internet access to technical support personnel and hardware support. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period. Revenues for support services are recognized on a straight-line basis over the service contract term, which is typically between one year and five years.
 
We account for revenues in accordance with Statement of Position No. 97-2, “Software Revenue Recognition,” and all related amendments and interpretations, or SOP 97-2, because our products are integrated with software that is essential to their functionality and because we provide unspecified software upgrades and enhancements related to the equipment through support agreements. Typically, our sales involve multiple elements, such as sales of products that include support, training and/or consulting services. When a sale involves multiple elements, we allocate the entire fee from the arrangement to each respective element based on its VSOE of fair value and recognize revenue when each element’s revenue recognition criteria are met. VSOE of fair value for each element is established based on the sales price we charge when the same element is sold separately. If VSOE of fair value cannot be established for the undelivered element of an agreement, when the undelivered element is support, the entire amount of revenue from the arrangement is deferred and recognized ratably over the period that the support is delivered. Prior to the second quarter of fiscal 2006, we had not been able to establish VSOE of fair value in accordance with SOP 97-2 at the outset of our arrangements. Accordingly, prior to the second quarter of fiscal 2006 we recognized revenue on our transactions’ entire arrangement fees ratably over the support period, as the only undelivered element was typically support.
 
Beginning in the second quarter of fiscal 2006, we were able to establish VSOE of fair value at the outset of our arrangements as we established a new support and services pricing policy, with different services and support offerings than were previously sold. We also began selling support services separately from our arrangements in the form of support renewals. Accordingly, beginning in the second quarter of fiscal 2006, we began recognizing product revenues upon delivery using the residual method, for transactions where all other revenue recognition criteria were met. As we have not been able to establish VSOE on our prior services and support offerings, all transactions prior to the second quarter of fiscal 2006 continue to be recognized ratably over the support period.
 
We recognize revenue only when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectibility is probable. However, determining whether and when some of these criteria have been satisfied often involves assumptions and judgments that can have a significant impact on the timing and amount of revenue we report.


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Stock-Based Compensation
 
Effective August 1, 2006, we adopted SFAS No. 123R, Share-Based Payment, or SFAS 123R, using the modified prospective transition method, which requires the measurement and recognition of compensation expense beginning August 1, 2006 for all share-based payment awards made to employees and directors based on estimated fair values. This methodology requires the use of subjective assumptions in implementing SFAS 123R, including expected stock price volatility and the estimated term of each award. Under SFAS 123R, we estimate the fair value of stock options granted using the Black-Scholes option-pricing model and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. This model also utilizes the fair value of our common stock and requires that, at the date of grant, we use the expected term of the stock-based award, the expected volatility of the price of our common stock over the expected term, risk free interest rates and expected dividend yield of our common stock to determine the estimated fair value. We determined the amount of stock-based compensation expense in the year ended July 31, 2007, based on awards that we ultimately expect to vest, reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Compensation expense includes awards granted prior to, but not yet vested as of July 31, 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for awards granted subsequent to July 31, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. In addition, compensation expense includes the effects of awards modified, repurchased or cancelled since the adoption of SFAS 123R. For purposes of SFAS 123R, employee stock-based compensation related to both unvested awards granted prior to August 1, 2006 and awards granted on or after August 1, 2006 are being amortized on a straight-line basis, which is consistent with the methodology used historically for pro forma purposes under SFAS 123.
 
As a result of adopting SFAS 123R on August 1, 2006, during fiscal 2007, our net loss was $7.2 million greater than if we had continued to account for stock-based compensation under APB 25, and our basic and diluted net loss per share for the year ended July 31, 2007 was higher by $0.21.
 
Had the expenses for our stock-based compensation plans in fiscal 2006 and 2005 been determined based on the fair value of the options at the grant date of the awards consistent with the provisions of SFAS 123 for the periods set forth below, our net loss would have been increased to the pro forma amounts indicated below:
 
                 
    Years Ended July 31,  
    2006     2005  
    (In thousands, except per share amounts)  
 
Net loss, as reported
  $ (12,009 )   $ (32,635 )
Add: Employee stock-based compensation expense included in reported net loss
    1,028       644  
Less: Total employee stock-based compensation expense determined under the fair value method
    (2,642 )     (984 )
                 
Pro forma, net loss
  $ (13,623 )   $ (32,975 )
                 
Basic and diluted net loss per share
               
As reported
  $ (1.07 )   $ (4.66 )
Pro forma
  $ (1.22 )   $ (4.71 )


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The fair value of each option was estimated on the date of grant using the Black-Scholes model with the following average assumptions:
 
                 
    Years Ended July 31,  
    2006     2005  
 
Assumptions
               
Risk-free interest rate
    4.6 %     3.6 %
Expected term (in years)
    4.0       4.0  
Dividend yield
           
Volatility
    70 %     100 %
Weighted average fair value of options granted
  $ 1.20     $ 0.80  
 
We account for equity instruments issued in exchange for the receipt of goods or services from non-employees in accordance with the consensus reached by the EITF in Issue No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Costs are measured at the fair market value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of the date on which there first exists a firm commitment for performance by the provider of goods or services or on the date performance is completed, using the Black-Scholes model.
 
Fair Value of Warrants to Purchase Redeemable Convertible Preferred Stock
 
On June 29, 2005, the FASB issued Staff Position 150-5, Issuer’s Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable, or FSP 150-5. FSP 150-5 requires us to classify our outstanding preferred stock warrants as liabilities on our balance sheet and record adjustments to the value of our preferred stock warrants in our statement of operations to reflect their fair value at each reporting period. We previously accounted for such warrants in accordance with EITF Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Good or Services, or EITF 96-18.
 
We adopted FSP 150-5 in the first quarter of fiscal 2006 and accounted for the cumulative effect of the change in accounting principle as of August 1, 2005. The impact of the change in accounting principle was to record a cumulative gain of $66,000, or $0.01 per share, as of August 1, 2005. In fiscal years 2007 and 2006, we recorded $9.0 million and $667,000, respectively, of additional expense as other expense, net to reflect the further increase in fair value during the period. Upon the closing of our initial public offering, these warrants were converted into warrants to purchase shares of our common stock and, as a result, were no longer subject to FSP 150-5. At that time, the then-current aggregate fair value of these warrants was reclassified from current liabilities to additional paid-in capital, a component of stockholders’ deficit, and we ceased to record any related periodic fair value adjustments.
 
Inventory Valuation
 
Inventory consists of hardware and related component parts and is stated at the lower of cost or market. Cost is computed using the standard cost, which approximates actual cost, on a first-in, first-out basis. We record inventory write-downs for potentially excess inventory based on forecasted demand, economic trends and technological obsolescence of our products. If future demand or market conditions are less favorable than our projections, additional inventory write-downs could be required and would be reflected in cost of product revenues in the period the revision is made. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Inventory write-downs amounted to $1.1 million, $939,000 and $1.2 million in fiscal years 2007, 2006 and 2005, respectively.


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Allowances for Doubtful Accounts
 
We record a provision for doubtful accounts based on historical experience and a detailed assessment of the collectibility of our accounts receivable. In estimating the allowance for doubtful accounts, our management considers, among other factors, (1) the aging of the accounts receivable, including trends within and ratios involving the age of the accounts receivable, (2) our historical write-offs, (3) the credit-worthiness of each customer, (4) the economic conditions of the customer’s industry, and (5) general economic conditions. In cases where we are aware of circumstances that may impair a specific customer’s ability to meet their financial obligations to us, we record a specific allowance against amounts due from the customer, and thereby reduce the net recognized receivable to the amount we reasonably believe will be collected. The allowance for doubtful accounts was $507,000 and $352,000 at July 31, 2007 and 2006, respectively.
 
Income Taxes
 
We use the asset and liability method of accounting for income taxes in accordance with FASB Statement No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are recognized for deductible temporary differences, along with net operating loss carryforwards, if it is more likely than not that the tax benefits will be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. To the extent deferred tax assets cannot be recognized under the preceding criteria, a valuation allowance is established.
 
Based on the available objective evidence, including the fact that we have generated losses since inception, management believes it is more likely than not that the deferred tax assets will not be realized. Accordingly, management has applied a full valuation allowance against our deferred tax assets.
 
Recent Accounting Pronouncements
 
See Note 1 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:
 
                         
    Years Ended July 31,  
    2007     2006     2005  
 
Revenues:
                       
Product
    84.6 %     59.6 %      
Professional services and support
    10.1 %     4.1 %      
Ratable product and related professional services and support
    5.3 %     36.3 %     100.0 %
Cost of revenues:
                       
Product
    28.3 %     23.3 %      
Professional services and support
    3.8 %     3.3 %      
Ratable product and related professional services and support
    1.9 %     14.6 %     75.4 %
                         
Gross margin
    66.0 %     58.8 %     24.6 %
Operating expenses:
                       
Research and development
    20.1 %     19.5 %     77.7 %
Sales and marketing
    47.1 %     46.6 %     185.7 %
General and administrative
    11.5 %     8.2 %     29.7 %
In-process research and development
    0.5 %            
                         
Operating margin
    (13.2 )%     (15.5 )%     (268.5 )%
Other expense, net
    (5.6 )%     (0.7 )%     (1.2 )%
                         
Loss before income taxes and cumulative effect of change in accounting principle
    (18.8 )%     (16.2 )%     (269.7 )%
Provision for income taxes
    0.3 %     0.4 %     1.3 %
                         
Loss before cumulative effect of change in accounting principle
    (19.1 )%     (16.6 )%     (271.0 )%
Cumulative effect of change in accounting principle
          0.1 %      
                         
Net loss
    (19.1 )%     (16.5 )%     (271.0 %)
                         


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Revenues
 
The following table presents our revenues, by revenue source, for the periods presented:
 
                         
    Years Ended July 31,  
    2007     2006     2005  
    (In thousands)  
 
Total revenues
  $ 127,499     $ 72,503     $ 12,043  
                         
Type of revenues:
                       
Product
    107,939       43,171        
Professional services and support revenues
    12,847       2,985        
Ratable product and related professional services and support
    6,713       26,347       12,043  
                         
Total revenues
  $ 127,499     $ 72,503     $ 12,043  
                         
Revenues by geography:
                       
United States
    84,878       53,132       8,791  
Europe, the Middle East and Africa
    20,710       7,711       1,325  
Asia Pacific
    13,301       7,232       1,566  
Rest of World (including Japan)
    8,610       4,428       361  
                         
Total revenues
  $ 127,499     $ 72,503     $ 12,043  
                         
 
Prior to the second quarter of fiscal 2006, we recognized revenue from sales of our products ratably over the term of the support contract with each customer, which is typically one to five years. Beginning in the second quarter of fiscal 2006, when we were able to establish VSOE of fair value, we began recognizing revenue upon shipment of our products, for transactions where all other criteria for revenue recognition were satisfied. Professional services and support revenues primarily represent support contracts and are recognized ratably over the contractual period, which is typically one to five years. Because of the change in the timing of our revenue recognition in the second quarter of fiscal 2006, comparisons of the absolute dollar growth in our revenues on a year-over-year basis are not meaningful.
 
For fiscal 2007, total revenues increased 75.9% over fiscal 2006 due to a $74.6 million increase in product and related professional services and support sales to new and existing customers as the market’s acceptance of WLAN products continued to grow. This increase was partially offset by a $19.6 million decrease in ratable product and related professional services and support revenues.
 
The decrease in ratable product and related professional services and support revenues in fiscal 2007 compared to fiscal 2006 was 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. At July 31, 2007, we had $5.6 million in deferred revenue associated with ratable product and professional services and support revenues, of which $3.4 million, $1.4 million, $737,000, and $37,000 will be amortized to revenue in fiscal 2008, 2009, 2010 and 2011, respectively.
 
In fiscal 2007, we derived 82.8% of our product revenues from indirect channels, which consist of value-added resellers, OEMs and other distributors, compared to 79.2% in fiscal 2006. We expect to continue to derive a significant majority of our product revenues from indirect channels as a result of our focus on expanding our indirect channel sales.
 
We generated 33.4% of our revenues in fiscal 2007 from shipments to locations outside the United States, compared to 26.7% in fiscal 2006. We continue to expand into international locations and introduce our products in new markets, and we expect international revenues to increase in absolute dollars and as a percentage of total revenues in future periods.
 
Substantially all of our customers purchase support when they purchase our products. The increase in professional services and support revenues is a result of increased product and first year support sales combined


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with the renewal of support contracts by existing customers. As our customer base grows, we expect the proportion of our revenues represented by support revenues to increase.
 
Total revenues increased in fiscal 2006 over fiscal 2005 due to an increase in product and related professional services sales to new and existing customers, both domestically and internationally. The fact that we began to use the residual method to recognize revenues beginning in the second quarter of fiscal 2006 makes comparisons between these periods not meaningful on an absolute dollar basis. We generated 26.7% of our revenues in fiscal 2006 from shipments to locations outside the United States, compared to 27.0% in fiscal 2005.
 
As a percentage of total revenues, professional services and support revenues decreased in fiscal 2006 compared to fiscal 2005 due to the fact that we began to recognize product revenues upon shipment in the second quarter of fiscal 2006, which resulted in a substantial increase in product revenue. The increase in ratable product and related professional services and support revenue in fiscal 2006 compared with fiscal 2005 was due to an increase in product and related professional services sales to new and existing customers.
 
Cost of Revenues and Gross Margin
 
The following table presents our revenues and cost of revenues, by revenue source, for the periods presented:
 
                         
    Years Ended July 31,  
    2007     2006     2005  
    (In thousands)  
 
Total revenues
  $ 127,499     $ 72,503     $ 12,043  
Cost of product
    36,035       16,904        
Cost of professional services and support
    4,863       2,409        
Cost of ratable product and related professional services and support
    2,470       10,572       9,077  
                         
Total cost of revenues
    43,368       29,885       9,077  
                         
Gross profit
  $ 84,131     $ 42,618     $ 2,966  
Gross margin
    66.0 %     58.8 %     24.6 %
 
In fiscal 2007 cost of revenues increased 45.1% compared to fiscal 2006 primarily due to a corresponding increase in our product revenues. The substantial majority of our cost of product revenues consists of payments to Flextronics, our contract manufacturer. For fiscal 2007, payments to Flextronics and Flextronics-related costs constituted more than 75% of our cost of product revenues in fiscal 2007 and 2006.
 
Cost of professional services and support revenues increased during this period as professional services and support revenues doubled and we added more technical support headcount domestically and abroad to support our growing customer base. Cost of ratable product and related support and services decreased during this period consistent with the decrease in ratable product and related professional services and support revenues.
 
As we expand internationally, we may incur additional costs to conform our products to comply with local laws or local product specifications. In addition, as we expand internationally, we plan to continue to hire additional technical support personnel to support our growing international customer base.
 
Gross margins improved for fiscal 2007 compared to fiscal 2006 due to an increase in our revenues, which grew at a higher rate than the associated costs, primarily as a result of a favorable change in our product mix as we sold more higher-margin products. In addition, we were able to gain some economic efficiencies with Flextronics and in our internal manufacturing operation.
 
The increase in total cost of revenues in fiscal 2006 compared to fiscal 2005 was due to increased shipments of our products to customers. Gross margin increased in fiscal 2006 compared to fiscal 2005, due to the significant increase in our revenues, which grew at a higher rate than the associated costs.


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Research and Development Expenses
 
                         
    Years Ended July 31,
    2007   2006   2005
    (In thousands)
 
Research and development expenses
  $ 25,654     $ 14,130     $ 9,353  
Percent of total revenue
    20.1 %     19.5 %     77.7 %
 
In fiscal 2007, research and development expenses increased 81.6% or $11.5 million, compared to fiscal 2006, primarily due to an increase of $9.2 million in personnel and related costs, including an increase of $2.7 million in stock-based compensation as a result of our adoption of SFAS 123R on August 1, 2006. Headcount increased by 62 employees, a 75.6% increase. We continue to hire more employees in research and development in order to develop additional functionality for existing products and develop new products in an effort to remain competitive.
 
In fiscal 2006, research and development expenses increased 51.1% over fiscal 2005, primarily due to an increase of $3.3 million in personnel and related costs as a result of increased headcount, $579,000 in temporary labor and consulting services and $617,000 of facilities costs related to additional space at our headquarters and sales offices.
 
Sales and Marketing Expenses
 
                         
    Years Ended July 31,
    2007   2006   2005
    (In thousands)
 
Sales and marketing expenses
  $ 60,115     $ 33,765     $ 22,369  
Percent of total revenue
    47.1 %     46.6 %     185.7 %
 
In fiscal 2007, sales and marketing expenses increased 78.0% over fiscal 2006, due to an increase of $11.7 million in personnel and related costs, including an increase of $3.6 million in stock-based compensation. We increased our headcount in sales and marketing by 59 employees to support our growing business. Further, sales commissions increased $7.0 million due to the increase in revenue and headcount. We also increased our marketing programs by $3.3 million primarily for lead generation and demonstration tools.
 
In fiscal 2006, sales and marketing expenses increased 50.9% over fiscal 2005, primarily due to an increase of $8.0 million in personnel and related costs as a result of increased headcount, $1.3 million in marketing programs and $1.2 million in travel and entertainment expenses.
 
General and Administrative Expenses
 
                         
    Years Ended July 31,
    2007   2006   2005
    (In thousands)
 
General and administrative expenses
  $ 14,600     $ 5,963     $ 3,576  
Percent of total revenue
    11.5 %     8.2 %     29.7 %
 
In fiscal 2007, general and administrative expenses increased 144.8% over fiscal 2006, primarily due to an increase of $7.3 million in personnel and related costs as a result of increased headcount, including $4.9 million in stock-based compensation and $646,000 in professional fees associated with legal and audit services.
 
In fiscal 2006, general and administrative expenses increased 66.8% over fiscal 2005, primarily due to an increase of $1.3 million in personnel and related costs as a result of increased headcount and $826,000 in professional services fees associated with legal and audit services and Sarbanes-Oxley consulting expenses.
 
In-Process Research and Development
 
On July 20, 2007 we acquired Network Chemistry, Inc.’s line of RFProtect and BlueScanner wireless security products. Network Chemistry, a privately-held company, provides solutions for automated wireless vulnerability management. The acquisition of Network Chemistry’s line of wireless security products enhances our existing


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offerings in the wired and wireless security space. We plan to integrate the acquired RFProtect suite of solutions into our secure mobility solutions. We believe that the combined solutions will ultimately provide a comprehensive wireless security system solution for our wireless networking customers. This transaction was accounted for as a business combination. The purchase price of $4.6 million was paid in cash.
 
In-process research and development related to our acquisition in the amount of $632,000 was expensed upon the consummation of the acquisition in fiscal 2007 because technological feasibility had not been established and no future alternative uses existed. In-process research and development efforts related to feature enhancements and functional improvements to the underlying technology. This development project is intended to add new functionalities necessary to address evolving customer needs, and drive market acceptance of the acquired products. The acquired in-process technology is at a stage of development that requires further research and development to determine technical feasibility and commercial viability. Because the in-process research and development is not yet complete and not yet generating revenue and profits, there is risk that the developments will not be completed and/or not competitive with other products using alternative technologies that offer comparable functionalities.
 
Other Expense, Net
 
Other expense, net consists primarily of interest income, interest expense, expense for warrants issued in connection with equipment loans, and foreign currency exchange gains and losses.
 
                         
    Years Ended July 31,  
    2007     2006     2005  
    (In thousands)  
 
Interest income
  $ 2,221     $ 551     $ 350  
Interest expense
    (88 )     (315 )     (443 )
Other
    (9,270 )     (765 )     (54 )
                         
Total other expense, net
  $ (7,137 )   $ (529 )   $ (147 )
                         
 
Other expense, net increased $6.6 million in fiscal 2007 compared to fiscal 2006. The increase is primarily due an increase of $8.3 million in warrant expense resulting from FSP 150-5, which requires us to classify our preferred stock warrants as liabilities and adjust the carrying value to fair value each period. The increase in expense was partially offset by an increase in interest income of $1.7 million due to the increase in our cash, cash equivalents and short-term investment balances.
 
In fiscal 2006, other expense, net increased compared to fiscal 2005, primarily as a result of the $667,000 in expense we recognized as a result of our adoption of FSP 150-5 in fiscal 2006, partially offset by an increase of $201,000 in interest income due to rising average cash balances and a decrease of $128,000 in interest expense due to the decline in the outstanding balance of our equipment loans. Interest income increased in fiscal 2006 as we received net proceeds of $19.2 million as a deposit for the issuance of 2,953,571 shares of Series D redeemable convertible preferred stock.
 
Provision for Income Taxes
 
Since inception, we have incurred operating losses, and, accordingly, we have not recorded a provision for income taxes for any of the periods presented other than franchise tax and foreign provisions for income tax. As of July 31, 2007, we had net operating loss carryforwards of $52.1 million and $46.5 million for federal and state income tax purposes, respectively. We also had federal research and development tax credit carryforwards of approximately $3.3 million and state research and development tax credit carryforwards of approximately $2.9 million as of July 31, 2007. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the 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


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experienced an “ownership change” in the past, or if an ownership change occurs in the future. See Note 9 of Notes to Consolidated Financial Statements.
 
Quarterly Fluctuations in Operating Results
 
The following table sets forth our unaudited quarterly consolidated statement of operations data for each of the eight quarters ended July 31, 2007. In management’s opinion, the data has been prepared on the same basis as the audited consolidated financial statements included in this report, and reflects all necessary adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of this data. The results of historical periods are not necessarily indicative of the results of operations for a full year or any future period.
 
                                 
    For the Three Months Ended  
2007
  July 31,     April 30,     January 31,     October 31,  
    (In thousands, except per share data)  
 
Revenues
                               
Product
  $ 36,394     $ 29,777     $ 22,662     $ 19,106  
Professional services and support
    4,254       3,816       2,656       2,121  
Ratable product and related professional services and support
    1,038       1,068       1,329       3,278  
                                 
Total revenues
    41,686       34,661       26,647       24,505  
Cost of revenues
                               
Product
    11,251       8,921       8,562       7,301  
Professional services and support
    1,420       1,138       1,131       1,174  
Ratable product and related professional services and support
    382       397       505       1,186  
                                 
Total cost of revenues
    13,053       10,456       10,198       9,661  
                                 
Gross profit
    28,633       24,205       16,449       14,844  
Operating expenses
                               
Research and development
    7,902       6,890       5,771       5,091  
Sales and marketing
    20,921       16,240       12,146       10,808  
General and administrative
    3,703       4,889       3,395       2,613  
In-process research and development
    632                    
                                 
Total operating expenses
    33,158       28,019       21,312       18,512  
                                 
Operating loss
    (4,525 )     (3,814 )     (4,863 )     (3,668 )
Other income (expense), net
    1,257       (5,390 )     (2,250 )     (754 )
                                 
Loss before provision for income taxes
    (3,268 )     (9,204 )     (7,113 )     (4,422 )
Provision for income taxes
    82       82       123       88  
                                 
Net loss
  $ (3,350 )   $ (9,286 )   $ (7,236 )   $ (4,510 )
                                 
Net loss per common share, basic and diluted
  $ (0.04 )   $ (0.26 )   $ (0.52 )   $ (0.34 )
                                 
 


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    For the Three Months Ended  
2006
  July 31,     April 30,     January 31,     October 31,  
    (In thousands, except per share data)  
 
Revenues
                               
Product
  $ 16,819     $ 13,308     $ 13,044     $  
Professional services and support
    1,576       969       440        
Ratable product and related professional services and support
    5,503       6,673       7,396       6,775  
                                 
Total revenues
    23,898       20,950       20,880       6,775  
Cost of revenues
                               
Product
    6,476       5,278       5,150        
Professional services and support
    825       779       805        
Ratable product and related professional services and support
    1,904       2,288       2,586       3,794  
                                 
Total cost of revenues
    9,205       8,345       8,541       3,794  
                                 
Gross profit
    14,693       12,605       12,339       2,981  
Operating expenses
                               
Research and development
    3,753       3,760       3,344       3,273  
Sales and marketing
    10,180       8,664       7,772       7,149  
General and administrative
    1,934       1,639       1,274       1,116  
                                 
Total operating expenses
    15,867       14,063       12,390       11,538  
                                 
Operating loss
    (1,174 )     (1,458 )     (51 )     (8,557 )
Other income (expense), net
    (53 )     15       (447 )     (45 )
                                 
Loss before provision for income taxes and cumulative effect of change in accounting principle
    (1,227 )     (1,443 )     (498 )     (8,602 )
Provision for income taxes
    218       82       8       (3 )
                                 
Loss before cumulative effect of change in accounting principle
    (1,445 )     (1,525 )     (506 )     (8,599 )
Cumulative effect of change in accounting principle
                      66  
                                 
Net loss
  $ (1,445 )   $ (1,525 )   $ (506 )   $ (8,533 )
                                 
Net loss per common share, basic and diluted
  $ (0.11 )   $ (0.13 )   $ (0.05 )   $ (0.88 )
                                 
 
Our operating results may fluctuate due to a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance.
 
Our revenues have increased sequentially in each of the quarters presented, due to increases in the number of products sold to new and existing customers, international expansion, and, beginning in the second quarter of fiscal 2006, the recognition of product revenue upon shipment due to the establishment of VSOE of fair value of undelivered products in our arrangements. This increase was offset by the quarterly decrease in the amortization of deferred revenue associated with those customer contracts that we entered into prior to establishment of VSOE of fair value.
 
Prior to the second quarter of fiscal 2006, we recognized revenue on our transactions’ entire arrangement fees ratably over the term of the support period, of one to five years. Subsequent to the second quarter of fiscal 2006, the

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dollar value of revenue and percentage of total revenue derived from such arrangements that are recognized ratably has decreased, and we expect it will continue to decrease each quarter until the related support periods have ended.
 
Operating expenses in all quarters increased sequentially as we continued to add headcount and related costs to accommodate the growing business on a quarterly basis.
 
In the first quarter of fiscal 2006, we adopted FSP 150-5, which subjects warrants to the requirements in Statement 150, regardless of the timing of the redemption feature or the redemption price and requires us to classify the warrants on our preferred stock as liabilities and adjust our warrant instruments to fair value at each reporting period. We recorded a $66,000 cumulative gain on adoption as of August 1, 2005, reflecting the fair value of the warrants as of that date, and $67,000, $516,000, $22,000, $62,000, $784,000, $2.3 million, and $5.9 million of expense was recorded in other income (expense), net in the quarters ended October 31, 2005, January 31, 2006, April 30, 2006, July 31, 2006, October 31, 2006, January 31, 2007 and April 30, 2007, respectively, to reflect the increase in fair value of the warrants. Subsequent to the IPO and the associated conversion of our outstanding redeemable convertible preferred stock to common stock, the warrants to purchase shares of redeemable convertible preferred stock were converted to warrants to purchase an equivalent number of shares of our common stock and the related carrying value of such warrants was reclassified to and additional paid-in-capital, and the warrants are no longer subject to remeasurement.
 
Liquidity and Capital Resources
 
                 
    As of July 31,  
    2007     2006  
    (In thousands)  
 
Working capital (deficit)
  $ 109,496     $ (10,472 )
Cash and cash equivalents
  $ 42,570     $ 9,263  
Short-term investments
  $ 62,430     $  
 
                         
    Years Ended July 31,  
    2007     2006     2005  
    (In thousands)  
 
Cash used in operating activities
  $ (4,348 )   $ (13,519 )   $ (22,803 )
Cash used in investing activities
    (70,350 )     (1,192 )     (1,194 )
Cash provided by financing activities
    107,920       19,678       910  
 
Since our inception in February 2002 through our initial public offering in March 2007, we funded our operations primarily with proceeds from issuances of redeemable convertible preferred stock, which provided us with aggregate net proceeds of $87.8 million. We also funded purchases of equipment with various equipment loans.
 
In March 2007, we completed our initial public offering which provided us with approximately $91.8 million in net proceeds after deducting underwriting discounts and commissions of $7.1 million and other offering costs of $2.3 million.
 
Most of our sales contracts are denominated in United States dollars, and as such, the increase in our revenues derived from international customers has not affected our cash flows from operations. As we fund our international operations, our cash and cash equivalents are affected by changes in exchange rates. To date, the foreign currency effect on our cash and cash equivalents has been immaterial.
 
Cash Flows from Operating Activities
 
We have experienced negative cash flows from operations as we have continued to expand our business and build our infrastructure domestically and internationally. 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 as our business grows. 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. To a lesser


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extent, the start up costs associated with international expansion have also negatively affected our cash flows from operations. 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, rent payments and technology costs.
 
Cash used in operating activities decreased in fiscal 2007, compared to fiscal 2006 due to increases in non-cash activities, such as stock-based compensation and the increase in fair value of our warrants, and increases in other current and noncurrent liabilities, deferred revenue and accounts receivable, offset by decreases in deferred costs and accounts payable.
 
Cash used in operating activities decreased in fiscal 2006 compared to fiscal 2005 mainly due to higher gross margins, which resulted from economic efficiencies we were able to gain through our contract manufacturing relationship with Flextronics.
 
Cash Flows from Investing Activities
 
Cash used in investing activities increased in fiscal 2007, compared to fiscal 2006 due to our purchases of short-term investments. We hold the proceeds from our initial public offering in cash, cash equivalents and short-term investments. Net cash used in investing activities also increased as a result of our purchase of a business from Network Chemistry, Inc. in the last quarter of fiscal 2007.
 
Cash used in investing activities was relatively consistent in fiscal 2006 compared to fiscal 2005.
 
Cash Flows from Financing Activities
 
Prior to our IPO in March 2007, we had financed our operations primarily with net proceeds from private sales of redeemable convertible preferred stock totaling $87.8 million.
 
In March 2007, we completed our initial public offering which provided us with approximately $91.8 million in net proceeds.
 
Based on our current cash, cash equivalents and short-term investments we expect that we will have sufficient resources to fund our operations for the next twelve months. However, we may need to raise additional capital or incur additional indebtedness to continue to fund our operations in the future. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of expansion into new territories, the timing of introductions of new products and enhancements to existing products, and the continuing market acceptance of our products. Although we have no current agreements, commitments, plans, proposals or arrangements, written or otherwise, with respect to any material acquisitions, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.
 
Contractual Obligations
 
The following is a summary of our contractual obligations, including the renewal of the Sunnyvale, California lease in September 2007:
 
                                                         
                                        More
 
                                        Than
 
    Total     2008     2009     2010     2011     2012     5 Years  
    (In thousands)  
 
Operating leases
  $ 3,558     $ 1,153     $ 1,064     $ 1,044     $ 284     $ 13     $  
Non-cancellable inventory purchase commitments(1)
    8,259       8,259                                
                                                         
Total contractual obligations
  $ 11,817     $ 9,412     $ 1,064     $ 1,044     $ 284     $ 13     $  
                                                         
 
 
(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


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cancelable by giving notice 30 days prior to the expected shipment date. Orders are not cancelable within 30 days prior to the expected shipment date.
 
Off-Balance Sheet Arrangements
 
At July 31, 2007 and 2006, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
 
ITEM 7A.   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 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 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% by 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.


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ITEM 8.   CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
Index to Consolidated Financial Statements
 
         
    Page
 
  48
  49
  50
  51
  52
  53


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of
Aruba Networks, Inc.
 
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, redeemable convertible preferred stock and stockholders’ equity (deficit), and cash flows, present fairly, in all material respects, the financial position of Aruba Networks, Inc. and its subsidiaries at July 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2007, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
As discussed in Note 1 to the consolidated financial statements, in accordance with the adoption of Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS 123R”), the Company changed the manner in which it accounts for share-based compensation in the year ended July 31, 2007.
 
/s/  PricewaterhouseCoopers LLP
 
San Jose, California
October 10, 2007


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ARUBA NETWORKS, INC.
 
CONSOLIDATED BALANCE SHEETS
 
                 
    As of July 31,  
    2007     2006  
    (In thousands, except per share data)  
 
ASSETS
Current assets
               
Cash and cash equivalents
  $ 42,570     $ 9,263  
Short-term investments
    62,430        
Accounts receivable, net
    23,722       13,296  
Inventory
    8,991       6,093  
Deferred costs
    3,217       3,360  
Prepaids and other
    2,432       1,758  
                 
Total current assets
    143,362       33,770  
Property and equipment, net
    3,709       1,971  
Intangible assets, net
    3,912        
Deferred costs
    722       1,960  
Other assets
    428       316  
                 
Total assets
  $ 152,133     $ 38,017  
                 
 
LIABILITIES, REDEEMABLE CONVERTIBLE
PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities
               
Accounts payable
  $ 2,201     $ 4,385  
Accrued liabilities
    15,317       8,062  
Income taxes payable
    281       216  
Equipment loans payable
          613  
Deposit for Series D redeemable convertible preferred stock
          19,329  
Deferred revenue
    16,067       11,637  
                 
Total current liabilities
    33,866       44,242  
Deferred revenue
    5,780       6,803  
Other long-term liabilities
          1,963  
                 
Total liabilities
    39,646       53,008  
                 
Commitments and contingencies (Note 14)
               
Redeemable convertible preferred stock: $0.0001 par value; 0 and 46,445 shares authorized at July 31, 2007 and 2006; 0 and 45,108 shares issued and outstanding at July 31, 2007 and 2006 ; liquidation preference: $0 and $58,213 at July 31, 2007 and 2006
          58,009  
                 
Stockholders’ equity (deficit)
               
Preferred stock: $0.0001 par value; 10,000 and 0 shares authorized at July 31, 2007 and 2006, no shares issued and outstanding at July 31, 2007 and 2006
           
Common stock: $0.0001 par value; 350,000 and 95,440 shares authorized at July 31, 2007 and 2006; 76,927 and 15,257 shares issued and outstanding at July 31, 2007 and 2006;
    8       2  
Additional paid-in capital
    213,545       6,075  
Deferred stock-based compensation
          (2,364 )
Accumulated other comprehensive income
    29        
Accumulated deficit
    (101,095 )     (76,713 )
                 
Total stockholders’ equity (deficit)
    112,487       (73,000 )
                 
Total liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)
  $ 152,133     $ 38,017  
                 
 
The accompanying notes are an integral part of the consolidated financial statements.


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ARUBA NETWORKS, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
                         
    Years Ended July 31,  
    2007     2006     2005  
    (In thousands, except per share data)  
 
Revenues
                       
Product
  $ 107,939     $ 43,171     $  
Professional services and support
    12,847       2,985        
Ratable product and related professional services and support
    6,713       26,347       12,043  
                         
Total revenues
    127,499       72,503       12,043  
Cost of revenues
                       
Product
    36,035       16,904        
Professional services and support
    4,863       2,409        
Ratable product and related professional services and support
    2,470       10,572       9,077  
                         
Total cost of revenues
    43,368       29,885       9,077  
                         
Gross profit
    84,131       42,618       2,966  
Operating expenses
                       
Research and development
    25,654       14,130       9,353  
Sales and marketing
    60,115       33,765       22,369  
General and administrative
    14,600       5,963       3,576  
In-process research and development
    632              
                         
Total operating expenses
    101,001       53,858       35,298  
                         
Operating loss
    (16,870 )     (11,240 )     (32,332 )
Other income (expense), net
                       
Interest income
    2,221       551       350  
Interest expense
    (88 )     (315 )     (443 )
Other income (expense), net
    (9,270 )     (765 )     (54 )
                         
Total other expense, net
    (7,137 )     (529 )     (147 )
                         
Loss before provision for income taxes and cumulative effect of change in accounting principle
    (24,007 )     (11,769 )     (32,479 )
Provision for income taxes
    375       306       156  
                         
Loss before cumulative effect of change in accounting principle
    (24,382 )     (12,075 )     (32,635 )
Cumulative effect of change in accounting principle
          66        
                         
Net loss
  $ (24,382 )   $ (12,009 )   $ (32,635 )
                         
Net loss per common share, basic and diluted
  $ (0.70 )   $ (1.07 )   $ (4.66 )
                         
Shares used in computing basic and diluted net loss per common share
    34,808       11,211       6,999  
                         
Stock-based compensation expense included in above:
                       
Cost of revenues
  $ 327     $ 34     $ 23  
Research and development
    2,925       259       179  
Sales and marketing
    4,362       749       678  
General and administrative
    5,103       213       194  
 
The accompanying notes are an integral part of the consolidated financial statements.


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ARUBA NETWORKS, INC.
 
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS’ EQUITY (DEFICIT)
 
                                                                                           
                                                      Accumulated
             
    Reedemable
                              Additional
    Deferred
    Other
             
    Convertible Preferred Stock       Preferred Stock     Common Stock     Paid-in
    Stock-Based
    Comprehensive
    Accumulated
       
    Shares     Amount       Shares     Amount     Shares     Amount     Capital     Compensation     Income     Deficit     Total  
    (In thousands)  
Balance at July 31, 2004
    44,297     $ 56,310             $       14,586     $ 2     $ 2,239     $ (1,309 )   $     $ (32,069 )   $ (31,137 )
Issuance of Series C redeemable convertible preferred stock, net of issuance costs of $31
    811       1,699                                                          
Fair value of shares issued to employees
                              31             8                         8  
Fair value of stock options issued to non-employees
                                          327                         327  
Exercise of common stock options
                              761             420                         420  
Repurchase of common stock
                              (655 )           (77 )                       (77 )
Deferred compensation related to issuance of common stock options, net
                                          1,912       (1,912 )                  
Amortization of deferred stock-based compensation
                                                635                   635  
Net loss
                                                            (32,635 )     (32,635 )
                                                                                           
Balance at July 31, 2005
    45,108       58,009                     14,723       2       4,829       (2,586 )           (64,704 )     (62,459 )
Fair value of shares issued to employees
                              3             2                         2  
Fair value of shares issued to non-employees
                              16             24                         24  
Fair value of stock options issued to non-employees
                                          306                         306  
Exercise of common stock options
                              1,896             612                         612  
Repurchase of common stock
                              (1,381 )           (162 )                       (162 )
Deferred compensation related to issuance of common stock options, net
                                          804       (804 )                  
Amortization of deferred stock-based compensation
                                                1,026                   1,026  
Reclassification of preferred stock warrants to liability
                                                  (340 )                       (340 )
Cumulative effect of change in accounting principle related to preferred stock warrants
                                                            66       66  
Net loss
                                                            (12,075 )     (12,075 )
                                                                                           
Balance at July 31, 2006
    45,108       58,009                     15,257       2       6,075       (2,364 )           (76,713 )     (73,000 )
Comprehensive loss:
                                                                                         
Unrealized gain on short-term investments
                                                      29             29  
Net loss
                                                            (24,382 )     (24,382 )
                                                                                           
Total comprehensive loss
                                                                                      (24,353 )
                                                                                           
Issuance of Series D redeemable convertible preferred stock, net of issuance costs of $127
    4,573       29,829                                                          
Conversion of redeemable convertible preferred stock into common stock upon completion of initial public offering
    (49,681 )     (87,838 )                   49,681       5       87,833                         87,838  
Proceeds from initial public offering of common stock, net of issuance costs of $2,307
                              9,200       1       91,808                         91,809  
Fair value of shares issued to employees
                              44             245                         245  
Fair value of shares issued to non-employees
                              50             534                         534  
Fair value of stock options issued to non-employees
                                          577                         577  
Fair value of of shares issued to charitable foundation
                              100             1,415                         1,415  
Exercise of common stock options
                              2,339             4,112                         4,112  
Exercise of warrants
                              114                                      
Repurchase of common stock
                              (176 )           (70 )                       (70 )
Reclassification of liability relating to preferred stock warrants upon conversion of such warrants to common stock warrants in connection with initial public offering
                                          9,933                         9,933  
Issuance of common stock under stock issuance agreement with customer
                              318             3,500                         3,500  
Reclassification of unamortized stock-based compensation upon adoption of SFAS 123R
                                          (2,364 )     2,364                    
Stock-based compensation expense related to stock options issued to employees
                                          9,947                         9,947  
                                                                                           
Balance at July 31, 2007
        $             $       76,927     $ 8     $ 213,545     $     $ 29     $ (101,095 )   $ 112,487  
                                                                                           
 
                                                                                         
 
The accompanying notes are an integral part of the consolidated financial statements.


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ARUBA NETWORKS, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                         
    Years Ended July 31,  
    2007     2006     2005  
    (In thousands)  
 
Cash flows from operating activities
                       
Net loss
  $ (24,382 )   $ (12,009 )   $ (32,635 )
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Depreciation and amortization
    2,008       1,549       1,156  
Provision for doubtful accounts
    199       254       138  
Write downs for excess and obsolete inventory
    1,110       939       1,238  
Compensation related to stock options and share awards
    11,302       1,255       1,074  
Net realized gains on short-term investments
          (1 )     (37 )
Stock issued to charitable foundation
    1,415              
Non-cash interest expense
    44       167       180  
Accretion of purchase discounts on short-term investments
    (388 )            
Change in carrying value of preferred stock warrant liability
    8,992       601        
Loss on disposal of fixed assets
    5       6        
In-process research and development
    632              
Changes in operating assets and liabilities, net of acquisition
                       
Accounts receivable
    (10,550 )     (4,737 )     (6,539 )
Inventory
    (3,955 )     (3,110 )     (2,159 )
Prepaids and other
    (774 )     (650 )     (352 )
Deferred costs
    1,381       4,479       (7,389 )
Other assets
    (112 )     (216 )     (96 )
Accounts payable
    (2,184 )     147       3,222  
Deferred revenue
    3,322       (3,921 )     16,508  
Other current and noncurrent liabilities
    7,522       1,528       2,893  
Income taxes payable
    65       200       (5 )
                         
Net cash used in operating activities
    (4,348 )     (13,519 )     (22,803 )
                         
Cash flows from investing activities
                       
Purchases of short-term investments
    (67,757 )           (7,874 )
Proceeds from sales and maturities of short-term investments
    5,744       900       8,012  
Purchases of property and equipment
    (3,737 )     (2,092 )     (1,332 )
Cash paid in connection with business acquisition
    (4,600 )            
                         
Net cash used in investing activities
    (70,350 )     (1,192 )     (1,194 )
                         
Cash flows from financing activities
                       
Repayments on equipment loan obligations
    (654 )     (1,358 )     (1,132 )
Deposit for Series D redeemable convertible preferred stock, net (Note 10)
          19,232        
Cash received under stock issuance agreement (Note 11)
    2,130       1,354        
Proceeds from issuance of redeemable convertible preferred stock, net
    10,597             1,699  
Proceeds from initial public offering, net
    91,809              
Proceeds from issuance of common stock
    4,038       450       343  
                         
Net cash provided by financing activities
    107,920       19,678       910  
                         
Effect of exchange rate changes on cash and cash equivalents
    85       3       (10 )
Net increase (decrease) in cash and cash equivalents
    33,307       4,970       (23,097 )
Cash and cash equivalents, beginning of period
    9,263       4,293       27,390  
                         
Cash and cash equivalents, end of period
  $ 42,570     $ 9,263     $ 4,293  
                         
Supplemental disclosures of cash flow information
                       
Income taxes paid
  $ 294     $ 161     $ 96  
Interest paid
    37       136       254  
Supplemental disclosure of non-cash investing and financing activities
                       
Reclassification of warrant liability to equity upon initial public offering
  $ 9,933     $     $  
Reclassification of non-current liability to equity upon initial public offering
    3,500              
 
The accompanying notes are an integral part of the consolidated financial statements.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
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.
 
Initial Public Offering
 
In March 2007, the Company completed its initial public offering, or IPO, of common stock in which it issued and sold 9,200,000 shares of common stock, at a public offering price of $11.00 per share. The Company raised a total of $101.2 million in gross proceeds from the IPO, or approximately $91.8 million in net proceeds after deducting underwriting discounts and commissions of $7.1 million and other offering costs of $2.3 million. Upon the closing of the IPO, all shares of outstanding redeemable convertible preferred stock automatically converted into 49,681,883 shares of common stock and 318,181 shares of the Company’s common stock were issued under a stock issuance agreement with Microsoft. Subsequent to the IPO and the associated conversion of the Company’s outstanding redeemable convertible preferred stock to common stock, warrants to purchase 677,106 shares of redeemable convertible preferred stock were converted to warrants to purchase an equivalent number of shares of the Company’s common stock and the related carrying value of such warrants was reclassified to additional paid-in-capital, and the warrants are no longer subject to remeasurement.
 
The Company’s Certificate of Incorporation, as restated on March 30, 2007, authorizes the issuance of 350,000,000 shares of common stock with $0.0001 par value per share.
 
Significant Accounting Policies
 
Basis of Presentation
 
The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
 
Principles of Consolidation
 
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.
 
Use of Estimates
 
The preparation of these financial statements requires that the Company make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to provisions for doubtful accounts, inventory, useful lives of property and equipment, useful lives of intangible assets, income taxes, and the valuation of equity instruments and contingencies, amongst others. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ significantly from the estimates made by management with respect to these and other items.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Foreign Currency Accounting
 
While the majority of the Company’s contracts are denominated in United States dollars, the Company has operating expenses in various foreign currencies. The functional currency of the Company’s subsidiaries in the United Kingdom, Netherlands, Germany, Canada, India, Singapore, Hong Kong, Australia and Japan is the U.S. dollar. Monetary assets and liabilities are translated using the current exchange rate at the balance sheet date. Nonmonetary assets and liabilities and capital accounts are translated using historical exchange rates. Revenues and expenses are translated using the average exchange rates in effect during the period. Foreign currency translation gains and losses, which have not been material to date, are included in the consolidated statements of operations.
 
Risks and Uncertainties
 
The Company is subject to all of the risks inherent in an early stage business operating in the networking and communications industry. These risks include, but are not limited to, a limited operating history, new and rapidly evolving markets, a lengthy sales cycle, dependence on the development of new products and services, unfavorable economic and market conditions, competition from larger and more established companies, limited management resources, dependence on a limited number of contract manufacturers and suppliers, and the changing nature of the networking and communications industry. Failure by the Company to anticipate or to respond adequately to technological developments in its industry, changes in customer or supplier requirements, or changes in regulatory requirements or industry standards, or any significant delays in the development or introduction of products and services, would have a material adverse effect on the Company’s business and operating results.
 
Fair Value of Financial Instruments
 
The reported amounts of the Company’s financial instruments including cash and cash equivalents, short-term investments, accounts receivable and accounts payable approximate fair value due to their short maturities. The reported amounts of equipment loan obligations approximate fair value as the interest rates on these instruments approximate borrowing rates available to the Company for loans with similar terms.
 
Cash and Cash Equivalents
 
The Company considers all highly liquid marketable securities purchased with an original maturity of 90 days or less at the time of purchase to be cash equivalents. Cash and cash equivalents is comprised of U.S. government and asset-backed securities, commercial paper, and money market funds and are stated at cost, which approximates fair value. The Company deposits cash and cash equivalents with high credit quality financial institutions.
 
Short-Term Investments
 
Short-term investments comprise marketable securities that consist primarily of U.S. government, asset-backed and auction-rate securities, and commercial paper with original maturities beyond 90 days. As the Company views all securities as representing the investment of funds available for current operations, and management has the ability and intent, if necessary, to liquidate any of these investments in order to meet the Company’s liquidity needs within the next twelve months, the short-term investments are classified as current assets. The Company’s policy is to protect the value of its investment portfolio and minimize principal risk by earning returns based on current interest rates. All of the Company’s marketable securities are classified as available-for-sale securities in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting For Certain Investments in Debt and Equity Securities and are carried at fair market value with unrealized gains and losses, net of taxes, reported as a separate component of stockholders’ equity. Realized gains and losses and declines in value of securities judged to be other than temporary are included in interest income, net, based on the specific identification method. The Company did not hold any short-term investments as of July 31, 2006.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Concentrations of Credit Risk
 
Financial instruments that potentially subject the Company to a concentration of credit risk include cash, cash equivalents and short-term investments. The Company has not experienced any losses on its deposits of its cash and cash equivalents, and its short-term investments.
 
The Company’s accounts receivable are derived from revenue earned from customers located in the Americas, Europe, the Middle East, Africa and Asia Pacific. The Company performs ongoing credit evaluations of its customers’ financial condition and, generally, requires no collateral from its customers. The Company maintains a provision for doubtful accounts receivable based upon the expected collectibility of accounts receivable and to date such losses have been within management’s expectations. No customer accounted for more than 10% of accounts receivable as of July 31, 2007. One customer accounted for 21.9% of accounts receivable at July 31, 2006, and 12.5% and 15.6% of total revenues for the years ended July 31, 2007 and 2006, respectively. No customer accounted for more than 10% of total revenues for the year ended July 31, 2005.
 
Provision for Doubtful Accounts
 
The Company records a provision for doubtful accounts based on historical experience and a detailed assessment of the collectibility of its accounts receivable. In estimating the allowance for doubtful accounts, management considers, among other factors, (i) the aging of the accounts receivable, including trends within and ratios involving the age of the accounts receivable, (ii) the Company’s historical write-offs, (iii) the credit-worthiness of each customer, (iv) the economic conditions of the customer’s industry, and (v) general economic conditions. In cases where the Company is aware of circumstances that may impair a specific customer’s ability to meet their financial obligations to it, the Company records a specific allowance against amounts due from the customer, and thereby reduces the net recognized receivable to the amount it reasonably believes will be collected.
 
Charges to the allowance for doubtful accounts were $199,000, $254,000 and $138,000 for the years ended July 31, 2007, 2006 and 2005, respectively.
 
Inventory
 
Inventory consists of hardware and related component parts and is stated at the lower of cost or market. Cost is computed using the standard cost, which approximates actual cost, on a first-in, first-out basis. The Company records inventory write-downs for potentially excess inventory based on forecasted demand, economic trends and technological obsolescence of its products. At the point of loss recognition, a new, lower-cost basis for that inventory is established, and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Inventory write-downs are reflected as cost of product revenues and amounted to approximately $1.1 million, $939,000, and $1.2 million, for the years ended July 31, 2007, 2006 and 2005, respectively.
 
Deferred Costs
 
When the Company’s products have been delivered, but the product revenue associated with the arrangement has been deferred as a result of not meeting the revenue recognition criteria in SOP 97-2 (see “Revenue Recognition” below), the Company also defers the related inventory costs for the delivered items.
 
Property and Equipment, Net
 
Property and equipment, net are stated at historical cost less accumulated depreciation. Depreciation is computed using the straight-line method over the shorter of the estimated useful lives of the respective assets, generally two to five years, or the lease term, if applicable. Leasehold improvements are recorded at cost with any reimbursement from the landlord being accounted for as part of rent expense using the straight-line method over the lease term.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Upon retirement or sale, the cost of assets disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to the statement of operations. Expenditures for maintenance and repairs are charged to expense as incurred.
 
Impairment of Long-lived Assets
 
Intangible assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets, which range from several months to eight years. Intangible assets determined to have indefinite useful lives are not amortized. Long-lived assets, including intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of an impairment loss for long-lived assets that management expects to hold and use are based on the fair value of the asset. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less costs to sell.
 
Revenue Recognition
 
The Company’s networking and communications products are integrated with software that is essential to the functionality of the equipment. Further, the Company provides unspecified software upgrades and enhancements related to the equipment through support agreements. Accordingly, the Company accounts for revenue in accordance with Statement of Position No. 97-2, Software Revenue Recognition, and all related amendments and interpretations (“SOP 97-2”).
 
The Company’s revenue is derived primarily from two sources: (i) product revenue, including hardware and software products, and (ii) related professional services and support revenue. Product support typically includes software updates, on a when and if available basis, telephone and internet access to technical support personnel and hardware support. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period. Revenue for support services is recognized on a straight-line basis over the support period, which typically ranges from one year to five years.
 
Typically, the Company’s sales involve multiple elements, such as sales of products that include support. When a sale involves multiple elements, the Company allocates the entire fee from the arrangement to each respective element based on its Vendor Specific Objective Evidence (“VSOE”) of fair value and recognizes revenue when each element’s revenue recognition criteria are met. VSOE of fair value for each element is established based on the price charged when the same element is sold separately. If VSOE of fair value cannot be established for the undelivered element of an agreement and the only undelivered element is support, the entire amount of revenue from the arrangement is deferred and recognized ratably over the period that the support is delivered. Prior to the second quarter of fiscal 2006, the Company had not established VSOE of fair value in accordance with SOP 97-2 at the outset of its arrangements. Accordingly, the Company recognized revenue on its transactions’ entire arrangement fees during this period ratably over the support period, as the only undelivered element was support.
 
Beginning in the second quarter of fiscal 2006, the Company established VSOE of fair value at the outset of its arrangements as it established a new support and services pricing policy, with different service and support offerings than were previously sold and began selling support services separately from its arrangements in the form of support renewals. Accordingly, beginning in the second quarter of fiscal 2006, the Company recognizes product revenue upon delivery using the residual method, assuming that all other revenue recognition criteria were met. As the Company had not been able to establish VSOE on its previous services and support offerings, all transactions prior to the second quarter of fiscal 2006 continue to be recognized ratably over the support period.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The Company recognizes revenue only when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is probable. The Company evaluates each of these criteria as follows:
 
  •  Evidence of an arrangement:  Contracts and/or customer purchase orders are used to determine the existence of an arrangement.
 
  •  Delivery:  Delivery is considered to occur when the ordered equipment and the media containing the licensed programs are provided to a common carrier and title has transferred or, in the case of electronic delivery of the licensed programs, the customer is given access to download the programs. The Company recognizes revenue from indirect sales channels upon persuasive evidence provided by the reseller of a sale to the end customer.
 
  •  Fixed or determinable fee:  The Company assesses whether fees are fixed or determinable at the time of sale. The Company only considers the fee to be fixed or determinable if the fee is not subject to refund or adjustment. The Company’s payment terms may vary based on the country in which the agreement is executed and the credit standing of the individual customer, among other factors. If the arrangement fee is not fixed or determinable, revenue is recognized as amounts become due and payable. In instances where final acceptance of the product, system, or solution is specified by the customer, revenue is deferred until all acceptance criteria have been met.
 
  •  Collection is deemed probable:  Collection is deemed probable if the Company expects that the customer will be able to pay amounts under the arrangement as payments become due. If the Company determines that collection is not probable, it defers the revenue and recognizes the revenue upon cash collection.
 
Shipping charges billed to customers are included in product revenues and the related shipping costs are included in cost of product revenues.
 
Stock-Based Compensation
 
Prior to August 1, 2006, the Company accounted for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), Financial Accounting Standards Board’s (“FASB”) Interpretation No. 44 Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25 (“FIN 44”) and FIN 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, and had adopted the disclosure provisions of Statement of Financial Accounting Standards (“SFAS”) SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) and SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure (“SFAS 148”).
 
Effective August 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment (“SFAS 123R”) , using the modified prospective transition method, which requires the measurement and recognition of compensation expense based on estimated fair values beginning August 1, 2006 for all share-based payment awards made to employees and directors. The adoption of SFAS 123R did not affect previously reported periods. Therefore, the Company’s financial statements for the prior periods do not reflect any restated amounts. Under SFAS 123R, the Company estimates the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. This model also utilizes the fair value of common stock and requires that, at the date of grant, the Company use the expected term of the stock-based award, the expected volatility of the price of its common stock, the risk free interest rate and the expected dividend yield of its common stock to determine the estimated fair value. The Company determined the amount of stock-based compensation expense in the year ended July 31, 2007, based on awards ultimately expected to vest, reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Compensation expense includes awards granted


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
prior to, but not yet vested as of July 31, 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for awards granted subsequent to July 31, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. In addition, compensation expense includes the effects of awards modified, repurchased or cancelled since the adoption of SFAS 123R. For purposes of SFAS 123R, employee stock-based compensation related to both unvested awards granted prior to August 1, 2006 and awards granted on or after August 1, 2006 is being amortized on a straight-line basis, which is consistent with the methodology used historically for pro forma purposes under SFAS 123. See Note 12 for a further discussion of stock-based compensation.
 
The Company accounts for equity instruments issued in exchange for the receipt of goods or services from non-employees in accordance with the consensus reached by the Emerging Issues Task Force (“EITF”) in Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. Costs are measured at the fair market value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. The value of equity instruments issued for consideration other than employee services is determined on the earlier of the date on which there first exists a firm commitment for performance by the provider of goods or services or on the date performance is complete, using the Black-Scholes pricing model.
 
Capitalized Software Development Costs
 
The Company accounts for software development costs intended for sale in accordance with SFAS No. 86, Accounting for Costs of Computer Software to be Sold, Leased, or Otherwise Marketed (“SFAS 86”). SFAS 86 requires product development costs to be charged to expense as incurred until technological feasibility is attained and all other research and development activities for the hardware components of the product have been completed. Technological feasibility is attained when the planning, design and testing phase related to the development of the Company’s software has been completed and the software has been determined viable for its intended use, which typically occurs when beta testing commences. The time between the attainment of technological feasibility and the completion of software development has historically been relatively short with immaterial amounts of development costs incurred during this period. Accordingly, the Company has not capitalized any software development costs.
 
Advertising
 
All advertising costs are expensed as incurred. Advertising expenses were $416,000, $200,000 and $97,000 for the years ended July 31, 2007, 2006 and 2005, respectively.
 
Income Taxes
 
The Company uses the asset and liability method of accounting for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are recognized for deductible temporary differences, along with net operating loss carryforwards, if it is more likely than not that the tax benefits will be realized. To the extent a deferred tax asset cannot be recognized under the preceding criteria, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.
 
Comprehensive Income (Loss)
 
Comprehensive income (loss) consists of other comprehensive income (loss) and net loss. Other comprehensive income (loss) consists of gains and losses that are not recorded in the statements of operations, but instead are recorded directly to stockholders’ equity (deficit).


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Recent Accounting Pronouncements
 
In July 2006, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 48, Accounting for the Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in tax positions. This interpretation requires that the Company recognize in its financial statements, the impact of a tax position, if that position is more likely than not of being sustained, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of the Company’s 2008 fiscal year, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening accumulated deficit. In May 2007, the FASB issued FASB Staff Position FIN 48-1, “Definition of ’Settlement’ in FASB Interpretation No. 48” (“FSP FIN 48-1”). FSP FIN 48-1 provides guidance on how a company should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. FSP FIN 48-1 is effective upon initial adoption of FIN 48, which the Company will adopt in the first quarter of fiscal year 2008. The Company is currently assessing the impact, if any, of adopting this standard on the Company’s financial position, cash flows and results of operations.
 
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. As a result of SFAS 157 there is now a common definition of fair value to be used throughout GAAP. The FASB believes that the new standard will make the measurement of fair value more consistent and comparable and improve disclosures about those measures. The Company is required to adopt SFAS 157 effective August 1, 2008. The Company does not believe the adoption of SFAS 157 will have a material effect on its financial position, cash flows or results of operations.
 
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. The Company is currently evaluating the potential impact of this statement.
 
2.   Change in Accounting Principle
 
On June 29, 2005, the FASB issued Staff Position 150-5, Issuer’s Accounting under FASB Statement No. 150 (“SFAS 150”) for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable (“FSP 150-5”). FSP 150-5 requires the Company to classify its outstanding preferred stock warrants as liabilities on its balance sheet and record adjustments to the value of its preferred stock warrants in its statements of operations to reflect their fair value at each reporting period. The Company previously accounted for such warrants in accordance with EITF Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services (“EITF 96-18”).
 
The Company adopted FSP 150-5 in the first quarter of fiscal 2006 and recorded the cumulative effect of the change in accounting principle as of August 1, 2005, which resulted in a gain of $66,000, or $0.01 per share. In fiscal 2006, the Company also recorded $667,000 of additional expense as other expense, net to reflect the increase in fair value between August 1, 2005 and July 31, 2006. In the year ended July 31, 2007, the Company recorded $9.0 million of additional expense as other expense, net to reflect the further increase in fair value between August 1, 2006 and March 30, 2007. Upon the closing of the Company’s IPO on March 30, 2007 and the associated conversion of the Company’s outstanding redeemable convertible preferred stock to common stock, the warrants to purchase shares of redeemable convertible preferred stock were converted to warrants to purchase an equivalent number of shares of the Company’s common stock and the related carrying value of such warrants was reclassified to additional paid-in-capital, and the warrants are no longer subject to remeasurement.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
3.   Network Chemistry, Inc. Acquisition
 
On July 20, 2007 the Company acquired Network Chemistry, Inc.’s line of RFProtect and BlueScanner wireless security products. Network Chemistry, a privately-held company, provides solutions for automated wireless vulnerability management. The acquisition of Network Chemistry’s line of wireless security products enhances the Company’s existing offerings in the wired and wireless security space. The Company plans to integrate the acquired RFProtect suite of solutions into its secure mobility solutions. The combined solutions are expected to provide a comprehensive wireless security system solution for the Company’s wireless networking customers.
 
This transaction was accounted for as a business combination and the results of operations of the acquired business have been included in the consolidated financial statements since the date of acquisition. The purchase price of $4.6 million was paid in cash. Management allocated the purchase price to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date, giving consideration to an independent appraisal. The historical results of the acquired business prior to the acquisition were not material to the Company’s results of operations and, accordingly, pro forma results of operations have not been presented.
 
The following table summarizes the purchase price allocation (in thousands, except estimated useful lives):
 
             
          Estimated
    Amount     Useful Lives
 
Tangible assets acquired
  $ 140      
In-process research and development
    632      
Amortizable intangible assets:
           
Developed technology and patents
    3,401     4 years
Customer contracts
    483     7 years
Support and non-compete agreements
    29     2 to 6 years
             
Total assets acquired
    4,685      
Liabilities assumed
    (85 )    
             
Total consideration
  $ 4,600      
             
 
The estimated future amortization expense of intangible assets is $907,000, $935,000, $929,000, $929,000, $72,000 and $141,000 for the years ending July 31, 2008, 2009, 2010, 2011, 2012 and thereafter.
 
In-process research and development is expensed upon acquisition because technological feasibility had not been established and no future alternative uses exist. The $632,000 allocated to in-process research and development was recorded in “In-process research and development” in the consolidated statement of operations. In-process research and development efforts as of the acquisition date related to feature enhancements and functional improvements to the underlying technology. This development project is intended to add new functionalities necessary to address evolving customer needs and drive market acceptance of the acquired products. The acquired in-process technology is at a stage of development that requires further research and development to determine technical feasibility and commercial viability. Developing new products and functionalities is time-consuming, costly, and complex. Because the in-process research and development is not yet complete and not yet generating revenue and profits, there is risk that the developments will not be completed and/or not competitive with other products using alternative technologies that offer comparable functionalities.
 
The fair value assigned to in-process research and development was determined using the income approach, under which the Company considered the importance of products under development to its overall development plans, estimated the costs to develop the purchased in-process research and development into commercially viable products, estimated the resulting net cash flows from the products when completed and discounted the net cash flows to their present values. The Company used a discount rate of 27.0% in the present value calculations, which


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
was derived from a weighted-average cost of capital analysis, adjusted to reflect additional risks related to the products’ development and success as well as the products’ stage of completion. The estimates used in valuing in-process research and development were based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. These assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Accordingly, actual results may vary from the projected results.
 
4.   Net Loss Per Common Share
 
Basic net loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period that are not subject to vesting provisions. Diluted net loss per common share is calculated by giving effect to all potential dilutive common shares, including options, common stock subject to repurchase, warrants and redeemable convertible preferred stock. The following table sets forth the computation of net loss per share:
 
                         
    Years Ended July 31,  
    2007     2006     2005  
    (In thousands, except per share data)  
 
Net loss
  $ (24,382 )   $ (12,009 )   $ (32,635 )
                         
Weighted-average common shares outstanding net of weighted-average common shares subject to repurchase
    34,808       11,211       6,999  
                         
Basic and diluted net loss per common share
  $ (0.70 )   $ (1.07 )   $ (4.66 )
                         
 
The following outstanding options, common stock subject to repurchase, redeemable convertible preferred stock, redeemable convertible preferred stock warrants and common stock warrants were excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an antidilutive effect:
 
                         
    Years Ended July 31,  
    2007     2006     2005  
 
Options to purchase common stock
    21,917,611       14,992,764       4,500,883  
Common stock subject to repurchase
    1,046,599       2,245,686       5,463,848  
Redeemable convertible preferred stock (as converted basis)
          45,107,887       45,107,887  
Redeemable convertible preferred stock warrants (as converted basis)
          677,106       677,106  
Common stock warrants
    556,292              
 
5.   Short-Term Investments
 
Short-term investments consist of the following:
 
                                 
          Gross
    Gross
       
    Cost
    Unrealized
    Unrealized
    Fair
 
    Basis     Gains     Losses     Value  
          (In thousands)        
 
Balance at July 31, 2007
                               
Auction rate securities
  $ 5,209     $     $     $ 5,209  
U.S. government agency securities
    47,387       23             47,410  
Asset-backed securities
    4,518       5             4,523  
Commercial paper
    5,287       1             5,288  
                                 
Total short-term investments
  $ 62,401     $ 29     $     $ 62,430  
                                 


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
There were no short-term investments as of July 31, 2006.
 
The cost basis and fair value of available-for-sale securities as of July 31, 2007, by contractual maturity, are presented below:
 
                 
    Cost
    Fair
 
    Basis     Value  
    (In thousands)  
 
One year or less
  $ 48,722     $ 48,737  
Over one year
    13,679       13,693  
                 
Total short-term investments
  $ 62,401     $ 62,430  
                 
 
As of July 31, 2007, all of the Company’s short-term investments were classified as available-for-sale and certain investments had contractual maturities of greater than one year. However, management has the ability and intent, if necessary, to liquidate any of these investments in order to meet the Company’s liquidity needs within the next twelve months. Accordingly, all investments are classified as current assets on the consolidated balance sheets.
 
The Company invests in securities that are rated investment grade or better. The Company has determined that unrealized losses are temporary as the duration of the decline in value of investments has been short, the extent of the decline, in both dollars and as a percentage of costs, is not significant, and the Company has the ability to hold the investments until recovery, if necessary.
 
Unrealized gains and losses are recorded as a component of cumulative other comprehensive income (loss) in stockholders’ equity. If these investments are sold at a loss or are considered to have other than temporarily declined in value, a charge to operations is recorded. The specific identification method is used to determine the cost of securities disposed of, with realized gains and losses reflected in other income (expense), net. There were no realized gains or losses recorded during fiscal 2007.
 
6.   Balance Sheet Components
 
The following tables provide details of selected balance sheet items:
 
                 
    As of July 31,  
    2007     2006  
    (In thousands)  
 
Accounts Receivable, Net
               
Trade accounts receivable
  $ 24,229     $ 13,648  
Less: Allowance for doubtful accounts
    (507 )     (352 )
                 
Total
  $ 23,722     $ 13,296  
                 
 
                 
    As of July 31,  
    2007     2006  
    (In thousands)  
 
Inventory
               
Raw materials
  $ 543     $ 449  
Work in process
    167       9  
Finished goods
    8,281       5,635  
                 
Total
  $ 8,991     $ 6,093  
                 
 


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
                 
    As of July 31,  
    2007     2006  
    (In thousands)  
 
Accrued Liabilities
               
Compensation and benefits
  $ 7,017     $ 2,427  
Inventory
    3,444       755  
Preferred stock warrants
          941  
Other
    4,856       3,939  
                 
Total
  $ 15,317     $ 8,062  
                 
 
7.   Property and Equipment, Net
 
Property and equipment, net consists of the following:
 
                         
    Estimated
    As of July 31,  
    Useful Lives     2007     2006  
          (In thousands)  
 
Property and Equipment, Net
                       
Computer equipment
    2 years     $ 3,846     $ 2,093  
Computer software
    2 years       1,587       830  
Machinery and equipment
    2 years       3,454       2,562  
Furniture and fixtures
    5 years       426       223  
Leasehold improvements
    2-5 years       232       106  
                         
Total property and equipment gross
            9,545       5,814  
Less: Accumulated depreciation and amortization
            (5,836 )     (3,843 )
                         
Total property and equipment net
          $ 3,709     $ 1,971  
                         
 
Depreciation and amortization expense totaled $2.0 million, $1.5 million and $1.2 million for the years ended July 31, 2007, 2006 and 2005, respectively.
 
8.   Deferred Revenue
 
Deferred revenue consists of the following:
 
                 
    As of July 31,  
    2007     2006  
    (In thousands)  
 
Deferred Revenue
               
Product
  $ 2,587     $ 1,108  
Professional services and support
    10,021       3,674  
Ratable product and related services and support
    3,459       6,855  
                 
Total deferred revenue, current
    16,067       11,637  
Professional services and support, long-term
    3,618       1,175  
Ratable product and related services and support, long-term
    2,162       5,628  
                 
Total deferred revenue, long-term
    5,780       6,803  
                 
Total deferred revenue
  $ 21,847     $ 18,440  
                 

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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Deferred product revenue relates to arrangements where not all revenue recognition criteria have been met. Deferred professional services and support revenue primarily represents customer payments made in advance for support contracts. Support contracts are typically billed on an annual basis in advance and revenue is recognized ratably over the support period.
 
Deferred ratable product and related services and support revenue consists of revenue on transactions where Vendor Specific Objective Evidence (“VSOE”) of fair value of support 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. Typically, the Company’s sales involve multiple elements, such as sales of products that include support, training and/or consulting services. When a sale involves multiple elements, the Company allocates the entire fee from the arrangement to each respective element based on its VSOE of fair value and recognizes revenue when each element’s revenue recognition criteria are met. VSOE of fair value for each element is established based on the sales price the Company charges when the same element is sold separately. If VSOE of fair value cannot be established for the undelivered element of an agreement, when the undelivered element is support, the entire amount of revenue from the arrangement is deferred and recognized ratably over the period that the support is delivered.
 
At July 31, 2007, the Company had $5.8 million in long-term deferred revenue, of which $3.4 million, $1.7 million, $361,000, $113,000 and $163,000 will be amortized to revenue in fiscal 2008, 2009, 2010, 2011 and 2012, respectively.
 
9.   Income Taxes
 
The components of the provision for income taxes for the years ended July 31, 2007, 2006 and 2005 are as follows:
 
                         
    Years Ended July 31,  
    2007     2006     2005  
    (In thousands)  
 
Current
                       
State
  $ 25     $ 10     $ 9  
Foreign
    350       296       147  
                         
Total provision for income taxes
  $ 375     $ 306     $ 156  
                         
 
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities as of July 31, 2007 and 2006 are as follows:
 
                 
    As of July 31,  
    2007     2006  
    (In thousands)  
 
Deferred tax assets
               
Net operating loss carryforwards
  $ 20,255     $ 19,683  
Research and development credits
    5,267       2,471  
Accruals and reserves
    9,509       6,193  
Depreciation and amortization
    2,460       2,519  
                 
Total deferred tax assets
    37,491       30,866  
Valuation allowance
    (37,491 )     (30,866 )
                 
Net deferred tax assets
  $     $  
                 
 
In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
is dependent upon the generation of future taxable income during the periods in which those temporary differences and net operating loss carryforwards are deductible.
 
Based on the available objective evidence, including the fact that the Company has generated losses in the U.S. since inception, management believes it is more likely than not that the net deferred tax assets will not be realized. Accordingly, management has applied a full valuation allowance against its deferred tax assets as of the fiscal years ended July 31, 2007 and 2006. The valuation allowance increased approximately $6.6 million, $4.7 million and $12.6 million during the years ended July 31, 2007, 2006 and 2005, respectively.
 
The differences between the provision for (benefit from) income taxes computed at the federal statutory rate of 34% and the Company’s actual provision for income taxes for 2007, 2006 and 2005, are as follows:
 
                         
    Years Ended July 31,  
    2007     2006     2005  
 
Federal income tax expense (benefit)
    (34.0 )%     (34.0 )%     (34.0 )%
Stock compensation and warrant expense
    18.7 %     %     %
State income tax (benefit), net of federal benefit
    (3.9 )%     (6.2 )%     (4.5 )%
Foreign taxes
    1.3 %     0.6 %     0.0 %
Non-deductible expenses
    0.7 %     5.2 %     1.5 %
Research and developments credits
    28.4 %     (2.8 )%     (1.3 )%
Change in valuation allowance
    (9.6 )%     39.8 %     38.8 %
                         
Total provision for income taxes
    1.6 %     2.6 %     0.5 %
                         
 
As of the fiscal years ended 2007, 2006 and 2005, the Company had $52.1 million, $50.7 million and $46.7 million, respectively, of Federal and $46.5 million, $44.8 million and $41.4 million, respectively, of state net operating loss carryforwards available to reduce future taxable income which will begin to expire in 2022 and 2013 for Federal and state tax purposes, respectively.
 
The Company has research credit carryforwards for the fiscal years ended 2007, 2006 and 2005 of approximately $3.3 million, $1.5 million and $1.2 million, respectively, for Federal and $2.9 million, $1.5 million and $932,000, respectively, for state income tax purposes. If not utilized, the Federal carryforwards will expire in various amounts beginning in 2022. The California credit can be carried forward indefinitely.
 
Deferred tax liabilities have not been recognized for undistributed earnings for foreign subsidiaries because it is management’s intention to reinvest such undistributed earnings outside the U.S.
 
The Internal Revenue Code limits the use of net operating loss and tax credit carryforwards in certain situations where changes occur in the stock ownership of a company. In the event the Company has had a change in ownership, utilization of the carryforwards could be restricted.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
10.   Redeemable Convertible Preferred Stock
 
Prior to the initial public offering in March 2007, the Company’s Certificate of Incorporation authorized the issuance of up to 51,084,551 shares of redeemable convertible preferred stock, with $0.0001 par value. Redeemable convertible preferred stock at July 31, 2006 consisted of the following:
 
                                 
    Shares              
          Issued and
    Liquidation
    Proceeds Net of
 
Series
  Authorized     Outstanding     Preference     Issuance Costs  
                (In thousands)  
 
A
    14,444,551       14,262,748     $ 9,513     $ 9,450  
B
    19,000,000       18,333,333       22,000       21,957  
C
    13,000,000       12,511,806       26,700       26,602  
                                 
      46,444,551       45,107,887     $ 58,213     $ 58,009  
                                 
 
In September 2005 and September 2006, the Company entered into Series D preferred stock purchase agreements with various purchasers in which the Company agreed to issue 4,573,296 shares of Series D redeemable convertible preferred stock. During this time, the Company determined that it inadvertently did not receive all requisite stockholder approvals for the issuance of the shares and subsequently obtained stockholder approvals in December 2006, at which time the Company issued a total of 4,573,296 shares at $6.5443 per share. Total cash consideration for the Series D redeemable convertible preferred stock, which also represents its liquidation preference, was $29.9 million, of which $19.3 million and $10.6 million was received in September 2005 and September 2006, respectively. The Company recorded the gross proceeds received as a deposit for Series D redeemable convertible preferred stock within current liabilities on the balance sheets until such time as the Company received requisite stockholder approval. The Company also recorded related deferred issuance costs of $97,000 as of July 31, 2006 within prepaids and other on the balance sheets.
 
On December 10, 2006, the Company’s Board of Directors approved the filing of a Restated Certificate of Incorporation (the “Restated Certificate”) to create and authorize the issuance of up to 4,640,000 shares of Series D redeemable convertible preferred stock and increase the number of authorized shares of common stock to 95,440,000 shares, subject to stockholder approval. On December 13, 2006, the Company’s stockholders approved, and the Company filed, the Restated Certificate. At that time, the Company issued 4,573,296 shares of Series D redeemable convertible preferred stock at $6.5443 per share. These shares were issued in full satisfaction of the Company’s obligations under the Series D preferred stock purchase agreements entered into in September 2005 and September 2006. Upon receiving stockholder approval, the Company reclassified the deposit to redeemable convertible preferred stock in the consolidated balance sheets. The Company recorded a loss of $26,000 arising from the difference between the fair value of the shares issued and the carrying value of the deposit for Series D redeemable convertible preferred stock in its consolidated statement of operations for the year ended July 31, 2007.
 
Upon the closing of the IPO in March 2007, all shares of outstanding redeemable convertible preferred stock automatically converted into 49,681,883 shares of common stock.
 
Warrants for Redeemable Convertible Preferred Stock
 
During 2003 and 2004, in connection with equipment loan agreements (Note 14), the Company issued two lessors fully vested warrants to purchase redeemable convertible preferred stock at exercise prices ranging from $0.67 to $2.13 per share.
 
Subsequent to the IPO in March 2007, and the associated conversion of the Company’s outstanding redeemable convertible preferred stock to common stock, the warrants to purchase shares of redeemable convertible preferred stock were converted to warrants to purchase an equivalent number of shares of the Company’s common stock.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
In May 2007, the Company issued 113,770 shares of common stock in connection with a cashless or net exercise of warrants to purchase 120,814 shares of common stock at exercise prices ranging from $0.67 to $1.20 per share.
 
As of July 31, 2007, outstanding warrants to purchase common stock were as follows:
 
                         
          Exercise
    Number of Shares
 
Issue Date
  Term     Price     Underlying Warrant  
 
March 3, 2003
    7 years     $ 0.67       144,303  
May 18, 2004
    7 years     $ 1.20       263,889  
May 18, 2004
    7 years     $ 2.13       148,100  
 
11.   Capital Stock
 
The Company’s Restated Certificate of Incorporation, as amended and restated in March 2007, authorizes the issuance of 350,000,000 shares of common stock with $0.0001 par value per share and 10,000,000 shares of preferred stock with $0.0001 par value per share. As of July 31, 2007, the Company had reserved 38,965,837 shares of common stock for issuance under its stock plans.
 
Certain common stock option holders have the right to exercise unvested options, subject to a repurchase right held by the Company, in the event of a voluntary or involuntary termination of employment of the shareholder. The cash received from these exercises is initially recorded as a liability and is subsequently reclassified to common stock as the shares vest. As of July 31, 2007, 2006 and 2005, a total of 1,046,599, 2,245,686 and 5,345,934, respectively, shares of common stock were subject to repurchase by the Company at the original exercise price of the related stock option. The corresponding exercise value of $1.4 million, $1.4 million and $599,000 as of July 31, 2007, 2006 and 2005, respectively, is recorded in accrued liabilities.
 
The activity for the year ended July 31, 2007 of non-vested shares acquired through early exercise of unvested options granted to employees is as follows:
 
         
Non-Vested Shares
  Shares  
 
Non-vested as of July 31, 2006
    2,245,686  
Early exercise of options
    1,577,348  
Vested
    (2,600,714 )
Forfeited
    (175,721 )
         
Non-vested as of July 31, 2007
    1,046,599  
         
 
In July 2005, the Company entered into a Stock Issuance Agreement with Microsoft, a customer, pursuant to which the Company agreed to issue Microsoft the number of shares of its common stock determined by dividing up to $3.5 million by the actual per share public offering price in the event of a firmly underwritten IPO or up to $5.0 million of consideration in connection with a change of control occurring prior to an IPO based on the cumulative level of purchases by Microsoft. Accordingly, the amount of consideration was not fixed but rather increased directly with the cumulative level of product purchases. As of July 31, 2006, the cumulative product and support sales to Microsoft were $2.0 million and were carried as a long-term liability until the Company issued the shares of common stock to Microsoft under the stock issuance agreement. During the year ended July 31, 2007, the Company completed a firmly underwritten IPO at which time the cumulative sales to Microsoft exceeded $3.5 million. Therefore, upon the closing of the IPO and in recognition of the $3.5 million in cumulative sales to Microsoft, 318,181 shares of the Company’s common stock were issued under the stock issuance agreement. Further, for the cumulative sales in excess of $3.5 million, the Company recognized revenue of $5.9 million during the year ended July 31, 2007.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
In March 2007, the Company completed its initial public offering of common stock in which it issued and sold 9,200,000 shares of common stock, at a public offering price of $11.00 per share. The Company raised a total of $101.2 million in gross proceeds from the IPO, or approximately $91.8 million in net proceeds after deducting underwriting discounts and commissions of $7.1 million and other offering costs of $2.3 million.
 
12.   Stock Option and Other Benefit Plans
 
2002 Stock Plan
 
The Company’s 2002 Stock Plan (“2002 Plan”) was adopted by its board of directors and approved by its stockholders in April 2002. The 2002 Plan provides for the grant of incentive stock options to the Company’s employees and any parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options to the Company’s employees, outside directors and consultants and any parent and subsidiary corporation’s employees and consultants. The administration and features of the 2002 Plan and the terms of the options granted thereunder are substantially similar to the corresponding features of the 2007 Equity Incentive Plan, including with respect to “change in control” transactions as described below.
 
As provided by the 2007 Equity Incentive Plan, 3,881,664 shares, representing all remaining shares reserved for issuance under the 2002 Plan were transferred to the 2007 Plan upon the closing of the IPO. However, the plan will continue to govern the terms and conditions of the outstanding awards previously granted under the 2002 Plan.
 
2007 Equity Incentive Plan
 
In December 2006, the Company’s board of directors approved the 2007 Equity Incentive Plan (the “2007 Plan”). The 2007 Plan provides for the grant of incentive stock options to employees and any parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance shares and deferred stock units to the Company’s employees, directors, consultants and its parent and subsidiary corporations’ employees and consultants.
 
The Company reserved the following shares of common stock for issuance under the 2007 Plan:
 
  •  all shares of the Company’s common stock reserved under the 2002 Plan which have been reserved but are not issued or subject to outstanding grants, up to a maximum of 7,000,000 shares; and
 
  •  any shares of common stock issued under the 2002 Plan that are returned to the 2002 Plan as a result of the termination of options or that are repurchased by the Company pursuant to the terms of the plan, up to a maximum of 10,000,000 shares.
 
As provided by the 2007 Plan, 3,881,664 shares, representing all remaining shares reserved for issuance under the 2002 Plan were transferred to the 2007 Plan upon the closing of the IPO.
 
Additionally, the Company’s 2007 Plan provides for annual increases in the number of shares available for issuance thereunder on the first day of each fiscal year, beginning with fiscal 2008, equal to the lesser of:
 
  •  5% of the outstanding shares of the Company’s common stock on the last day of the immediately preceding fiscal year; or
 
  •  15,000,000 shares.
 
As of July 31, 2007, 38,965,837 shares were reserved for future grants under the 2007 Plan.
 
Incentive and nonstatutory stock options under the 2007 Plan may be granted at prices not less than 100% of the closing price of the stock on the Nasdaq Global Market as of the date of grant. For options granted to an employee who owns more than 10% of the voting power of all classes of stock of the Company, the exercise price shall be no less than 110% of the estimated value of the stock at the date of grant. Options generally vest over a four year period and expire no later than ten years after the date of grant.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Restricted stock awards granted under the 2007 Plan are shares of common stock that vest in accordance with terms and conditions established by the plan administrator. The plan administrator will determine the number of shares of restricted stock granted to any employee, director, or consultant. The plan administrator may impose whatever conditions to vesting it determines to be appropriate. Shares of restricted stock that do not vest are subject to the Company’s right of repurchase or forfeiture.
 
Restricted stock units (RSUs) granted under the 2007 Plan are awards that will result in a payment to a participant only if performance goals established by the plan administrator are achieved or the awards otherwise vest. The plan administrator will determine the terms and conditions of restricted stock units, including vesting criteria and the form and timing of payment. Payment for restricted stock units will be made in shares of the Company’s common stock.
 
Stock appreciation rights granted under the 2007 Plan allow the recipient to receive the appreciation, if any, in the fair market value of common stock between the date of grant and the exercise date. The plan administrator determines the terms and conditions of stock appreciation rights, including when these rights become exercisable. Payment for stock appreciation rights will be made in shares of the Company’s common stock. Stock appreciation rights expire under the same rules that apply to stock options. As of July 31, 2007, the Company has not granted any stock appreciation rights.
 
Performance shares granted under the 2007 Plan are awards that will result in a payment to a participant only if performance goals established by the plan administrator are achieved or the awards otherwise vest. The plan administrator shall determine the number of shares and the conditions that must be satisfied, which typically are based principally on achievement of performance milestones, but may include a service-based component.
 
Deferred stock units may be granted under the 2007 Plan which can be restricted stock, restricted stock unit or performance share awards that are paid out in installments or on a deferred basis, in accordance with rules established by the plan administrator.
 
Employee Stock Purchase Plan
 
In December 2006, the Company’s board of directors approved the Employee Stock Purchase Plan (ESPP). Under the Employee Stock Purchase Plan, the Company can grant stock purchase rights to all eligible employees during a 2 year offering period with purchase dates at the end of each 6-month purchase period. The first offering period under the ESPP commenced in March 2007. Shares are purchased through employees’ payroll deductions, up to a maximum of 15% of employees’ compensation for each purchase period, at purchase prices equal to 85% of the lesser of the fair market value of the Company’s common stock at the first trading day of the applicable offering period or the purchase date. No participant may purchase more than $25,000 worth of common stock or 2,000 shares of common stock in any one calendar year. The ESPP is compensatory and results in compensation expense under SFAS 123R. A total of 1,000,000 shares of common stock have been reserved for issuance under the 2007 Employee Stock Purchase Plan. For the year ended July 31, 2007, ESPP compensation expense was $628,000.


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ARUBA NETWORKS, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Stock Option Activity
 
The following table summarizes information about stock options outstanding:
 
                                                 
          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, 2004
    1,767,973       2,060,195     $ 0.13                          
Issuance of share awards
    (31,250 )                                    
Shares reserved for issuance
    2,500,000                                      
Options granted at less than fair value(2)
    (3,668,479 )     3,668,479       0.35     $ 0.80                  
Options exercised
          (761,124 )     0.24                     $ 83,187  
Options repurchased
    655,468             0.12                          
Options cancelled
    466,667       (466,667 )     0.24