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Aruba Networks 10-Q 2011
Form 10-Q
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2011
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 001-33347
Aruba Networks, Inc.
(Exact name of registrant as specified in its charter)
     
     
Delaware   02-0579097
(State or Other Jurisdiction of   (I.R.S. Employer
Incorporation or Organization)   Identification Number)
1344 Crossman Ave.
Sunnyvale, California 94089-1113
(408) 227-4500
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The number of shares of the registrant’s common stock, par value $0.0001, outstanding as of February 28, 2011 was 100,802,006.
 
 

 

 


 

ARUBA NETWORKS INC.
INDEX
         
    Page No.  
       
 
       
       
 
       
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    31  
 
       
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    32  
 
       
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    43  
 
       
    43  
 
       
    43  
 
       
    43  
 
       
    44  
 
       
 Exhibit 10.2
 Exhibit 10.3
 Exhibit 10.4
 Exhibit 10.5
 Exhibit 10.6
 Exhibit 10.7
 Exhibit 10.8
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

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Item 1.   Consolidated Financial Statements
ARUBA NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
                 
    January 31,     July 31,  
    2011     2010  
    (in thousands, except per share data)  
ASSETS
               
Current assets
               
Cash and cash equivalents
  $ 49,258     $ 31,254  
Short-term investments
    138,568       124,167  
Accounts receivable, net
    53,965       41,269  
Inventory
    18,091       15,159  
Deferred costs
    6,382       5,451  
Prepaids and other
    3,480       5,108  
 
           
 
               
Total current assets
    269,744       222,408  
 
               
Property and equipment, net
    12,367       9,919  
Goodwill
    33,143       7,656  
Intangible assets, net
    24,983       9,287  
Other assets
    2,175       1,437  
 
           
 
               
Total assets
  $ 342,412     $ 250,707  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities
               
Accounts payable
  $ 8,660     $ 8,082  
Accrued liabilities
    52,464       36,458  
Income taxes payable
    549       519  
Deferred revenue, current
    47,516       43,422  
 
           
 
               
Total current liabilities
    109,189       88,481  
 
               
Deferred revenue, long-term
    11,452       10,976  
Other long-term liabilities
    585       595  
 
           
 
               
Total liabilities
    121,226       100,052  
 
           
 
               
Commitments and contingencies (Note 13)
               
Stockholders’ equity
               
Common stock: $0.0001 par value; 350,000 shares authorized at January 31, 2011 and July 31, 2010 , respectively; 99,961 and 93,606 shares issued and outstanding at January 31, 2011 and July 31, 2010, respectively
    10       9  
Additional paid-in capital
    397,385       326,178  
Accumulated other comprehensive income
    119       98  
Accumulated deficit
    (176,328 )     (175,630 )
 
           
 
               
Total stockholders’ equity
    221,186       150,655  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 342,412     $ 250,707  
 
           
See Notes to Consolidated Financial Statements.

 

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ARUBA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands, except per share data)     (in thousands, except per share data)  
Revenues
                               
Product
  $ 79,100     $ 52,078     $ 148,304     $ 99,276  
Professional services and support
    14,602       10,362       28,402       20,504  
Ratable product and related professional services and support
    156       215       299       471  
 
                       
Total revenues
    93,858       62,655       177,005       120,251  
 
                               
Cost of revenues
                               
Product
    24,173       18,103       46,236       34,535  
Professional services and support
    3,542       2,157       6,448       4,236  
Ratable product and related professional services and support
          68       9       154  
 
                       
Total cost of revenues
    27,715       20,328       52,693       38,925  
 
                       
Gross profit
    66,143       42,327       124,312       81,326  
 
                               
Operating expenses
                               
Research and development
    21,608       12,042       38,722       23,838  
Sales and marketing
    36,936       26,576       70,350       51,316  
General and administrative
    10,183       7,628       17,371       14,760  
Litigation reserves
          500             20,250  
 
                       
Total operating expenses
    68,727       46,746       126,443       110,164  
 
                       
Operating loss
    (2,584 )     (4,419 )     (2,131 )     (28,838 )
 
                               
Other income (expense), net
                               
Interest income
    240       187       474       398  
Other income (expense), net
    (61 )     (148 )     1,583       (244 )
 
                       
Total other income (expense), net
    179       39       2,057       154  
 
                       
 
                               
Loss before provision for income taxes
    (2,405 )     (4,380 )     (74 )     (28,684 )
 
                               
Provision for income taxes
    428       47       624       419  
 
                       
 
                               
Net loss
  $ (2,833 )   $ (4,427 )   $ (698 )   $ (29,103 )
 
                       
 
                               
Shares used in computing net loss per common share- basic and diluted
    98,795       88,572       97,416       88,030  
 
                       
 
                               
Net loss per common share- basic and diluted
  $ (0.03 )   $ (0.05 )   $ (0.01 )   $ (0.33 )
 
                       
 
                               
Stock-based compensation expense included in above:
                               
Cost of revenues
  $ 938     $ 310     $ 1,413     $ 629  
Research and development
    5,953       2,594       9,854       4,724  
Sales and marketing
    6,151       3,385       11,254       6,406  
General and administrative
  $ 3,622     $ 2,715     $ 5,712     $ 5,064  
See Notes to Consolidated Financial Statements.

 

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ARUBA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
                 
    Six months ended January 31,  
    2011     2010  
    (in thousands)  
Cash flows from operating activities
               
Net loss
  $ (698 )   $ (29,103 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
    7,198       5,006  
Provision for (benefit from) doubtful accounts
    (26 )     222  
Write downs for excess and obsolete inventory
    1,386       917  
Stock-based compensation expense
    28,233       16,823  
Accretion of purchase discounts on short-term investments
    668       203  
Loss/ (gain) on disposal of fixed assets
    (6 )     28  
Change in carrying value of contingent rights liability
    (2,105 )      
Excess tax benefit associated with stock-based compensation
    (231 )     (161 )
Changes in operating assets and liabilities:
               
Accounts receivable
    (10,144 )     (495 )
Inventory
    (3,110 )     (5,795 )
Prepaids and other
    (136 )     (1,145 )
Deferred costs
    (930 )     (1,872 )
Other assets
    (479 )     181  
Accounts payable
    (2,922 )     346  
Deferred revenue
    3,230       7,794  
Other current and noncurrent liabilities
    5,499       11,334  
Income taxes payable
    104       225  
 
           
 
               
Net cash provided by operating activities
    25,531       4,508  
 
           
 
               
Cash flows from investing activities
               
Purchases of short-term investments
    (59,188 )     (32,922 )
Proceeds from sales of short-term investments
    17,376        
Proceeds from maturities of short-term investments
    26,480       23,820  
Purchases of property and equipment
    (4,263 )     (2,428 )
Cash paid in purchase acquisitions, net of cash acquired
    (4,303 )      
 
           
 
               
Net cash used in investing activities
    (23,898 )     (11,530 )
 
           
 
               
Cash flows from financing activities
               
Proceeds from issuance of common stock
    16,138       4,010  
Repurchases of unvested common stock
          (36 )
Excess tax benefit associated with stock-based compensation
    231       161  
 
           
 
               
Net cash provided by financing activities
    16,369       4,135  
 
           
 
               
Effect of exchange rate changes on cash and cash equivalents
    2        
 
               
Net increase (decrease) in cash and cash equivalents
    18,004       (2,887 )
 
               
Cash and cash equivalents, beginning of period
    31,254       41,298  
 
           
 
               
Cash and cash equivalents, end of period
  $ 49,258     $ 38,411  
 
           
 
               
Supplemental disclosure of cash flow information
               
Income taxes paid
  $ 590     $ 478  
 
               
Supplemental disclosure of non-cash investing and financing activities
               
Common stock issued for purchase acquisition
  $ 30,691     $  
Contingent rights issued for purchase acquisition
  $ 9,486     $  
See Notes to Consolidated Financial Statements.

 

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ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. The Company and its Significant Accounting Policies
The Company
Aruba Networks, Inc. (the “Company”) was incorporated in the state of Delaware on February 11, 2002. The Company securely connects local and remote users to corporate IT resources via distributed enterprise networks. The Company’s portfolio of campus, branch office, teleworker, and mobile solutions simplifies operations and provides secure access to all corporate applications and services — regardless of a user’s device, location, or network. The products the Company licenses and sells include high-speed 802.11n wireless local area networks, Virtual Branching Networking solutions for branch offices and teleworkers, and network operations tools, including spectrum analyzers, wireless intrusion prevention systems, and the AirWave Wireless Management Suite for managing wired, wireless, and mobile device networks. The Company has offices in North America, Europe, the Middle East and the Asia Pacific region and employs staff around the world.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. The accompanying statements are unaudited and should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K filed on September 24, 2010. The July 31, 2010 consolidated balance sheet data were derived from audited financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States (“U.S.”) of America.
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). They do not include all of the financial information and footnotes required by GAAP for complete financial statements. The Company believes the unaudited consolidated financial statements have been prepared on the same basis as its audited financial statements as of and for the year ended July 31, 2010 and include all adjustments necessary for the fair statement of the Company’s financial position as of January 31, 2011, its results of operations for the three and six months ended January 31, 2011 and 2010, and its cash flows for the six months ended January 31, 2011 and 2010. The results for the three and six months ended January 31, 2011 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending July 31, 2011.
Other than the adoption of the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Accounting Standards Update (“ASU”) 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements, there have been no significant changes in the Company’s accounting policies during the three and six months ended January 31, 2011, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended July 31, 2010.
Revenue Recognition
In October 2009, the FASB amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple-element revenue arrangements to:
  (i)   provide updated guidance on how the elements in a multiple-element arrangement should be separated, and how the consideration should be allocated;
 
  (ii)   require an entity to allocate revenue amongst the elements in an arrangement using estimated selling prices (“ESP”) if a vendor does not have vendor-specific objective evidence (“VSOE”) of the selling price or third-party evidence (“TPE”) of the selling price; and
 
  (iii)   eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.
The Company adopted this accounting guidance at the beginning of its first quarter of fiscal 2011 on a prospective basis for applicable arrangements originating or materially modified after July 31, 2010. The impact of this adoption was not material to the Company’s financial position and results of operations in the three and six months ended January 31, 2011.

 

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This guidance does not generally change the units of accounting for the Company’s revenue transactions. Most non-software products and services qualify as separate units of accounting because they have value to the customer on a stand-alone basis and the Company’s revenue arrangements generally do not include a right of return relative to delivered products.
The majority of the Company’s products are hardware appliances containing software components that function together to provide the essential functionality of the product. Therefore, the Company’s hardware appliances are considered non-software elements and are not subject to the industry-specific software revenue recognition guidance.
The Company’s product revenue also includes revenue from the sale of stand-alone software products. Stand-alone software products may operate on the Company’s hardware appliance, but are not considered essential to the functionality of the hardware. Sales of stand-alone software generally include a perpetual license to the Company’s software. Sales of stand-alone software continue to be subject to the industry-specific software revenue recognition guidance.
For all arrangements originating or materially modified after July 31, 2010, the Company recognizes revenue in accordance with the amended accounting guidance. Certain arrangements with multiple-elements may continue to have stand-alone software elements that are subject to the existing software revenue recognition guidance along with non-software elements that are subject to the amended revenue accounting guidance. The revenue for these multiple element arrangements is allocated to the stand-alone software elements as a group and the non-software elements based on the relative selling prices of all of the elements in the arrangement using the fair value hierarchy in the amended revenue accounting guidance.
For sales of stand-alone software after July 31, 2010 and for all transactions entered into prior to the first quarter of 2011, the Company recognizes revenue based on software revenue recognition guidance. Under the software revenue recognition guidance, the Company uses the residual method to recognize revenue when a product agreement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists. In the majority of the Company’s contracts, the only element that remains undelivered at the time of delivery of the product is support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the contract fee is recognized as product revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is generally deferred and recognized when delivery of those elements occurs or when fair value can be established. When the undelivered element for which the Company does not have VSOE of fair value is support, revenue for the entire arrangement is bundled and recognized ratably over the support period.
VSOE for elements of an arrangement is based upon the normal pricing and discounting practices for those services when sold separately, and VSOE for support services is measured by the stand-alone renewal rate offered to the customer. In determining VSOE, the Company requires that a substantial majority of the selling prices for an element falls within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates. In addition, the Company considers major service groups, geographies, customer classifications, and other variables in determining VSOE.
The Company is typically not able to determine TPE for the Company’s products or services. TPE is determined based on competitor prices for similar elements when sold separately. Generally, the Company’s go-to-market strategy differs from that of the Company’s peers and the Company’s offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, the Company is unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.
When the Company is unable to establish selling price of its non-software elements using VSOE or TPE, the Company uses ESP in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. The Company determines ESP for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies, customer classes and distribution channels.
The Company regularly reviews VSOE and ESP and maintains internal controls over the establishment and updates of these estimates. There was not a material impact during the second quarter or first six months of fiscal 2011, nor does the Company currently expect a material impact in the near term from changes in VSOE or ESP.
Product revenue consists of revenue from sales of the Company’s hardware appliances and perpetual software licenses. The Company recognizes product revenue when all of the following have occurred: (1) the Company has entered into a legally binding arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is reasonably assured.
For sales to direct end-users and channel partners, including value-added resellers, value-added distributors, and OEMs, the Company recognizes product revenue upon delivery, assuming all other revenue recognition criteria are met. For the Company’s hardware appliances, delivery occurs upon transfer of title and risk of loss, which is generally upon shipment. It is the Company’s practice to identify an end-user prior to shipment to a channel partner. For end-users and channel partners, the Company generally has no significant obligations for future performance such as rights of return or pricing credits. A portion of the Company’s sales are made through distributors under agreements allowing for stocking of the Company’s products in their inventory, pricing credits and limited rights of return for stock rotation. Product revenue on sales made through these distributors is initially deferred and revenue is recognized upon sell-through as reported by the distributors to the Company. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.

 

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Support and services offerings consist of support agreements, professional services, and training. Support services include repair and replacement of defective hardware appliances, software updates and access to technical support personnel. 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 service contract term, which is typically one to five years. Professional services are recognized upon delivery or completion of performance. Professional service arrangements are typically short-term in nature and are largely completed within 90 days from the start of service. Training services are recognized upon delivery of the training.
The Company’s fees are typically considered to be fixed or determinable at the inception of an arrangement, generally based on specific products and quantities to be delivered. Substantially all of the Company’s contracts do not include rights of return or acceptance provisions. To the extent that the Company’s agreements contain such terms, the Company recognizes revenue once the customer has accepted, or once the acceptance provisions or right of return lapses. Payment terms to customers generally range from net 30 to 60 days. In the event payment terms are provided that differ from the Company’s standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized when the payments become due, provided the remaining criteria for revenue recognition have been met.
The Company assesses the ability to collect from its customers based on a number of factors, including credit worthiness of the customer and past transaction history of the customer. If the customer is not deemed credit worthy, the Company defers revenue from the arrangement until payment is received and all other revenue recognition criteria have been met.
2. Acquisitions
On September 2, 2010, the Company completed its acquisition of Azalea Networks (“Azalea”) for a total purchase price of $42.0 million. Azalea is a leading supplier of outdoor mesh networks and includes an operations center in Beijing, China which will complement the Company’s existing research and development centers. The results of Azalea’s operations have been included in the Consolidated Financial Statements since the acquisition date.
The tangible and intangible assets acquired and liabilities assumed were recorded at fair value on the acquisition date.
The purchase price consisted of the following (in thousands):
         
Stock (1,524,517 shares at $18.82)
  $ 28,691  
Cash
    1,808  
Contingent rights
    9,486  
Advance on purchase price
    2,000  
 
     
Total consideration
  $ 41,985  
 
     
The purchase price was allocated to the assets acquired and liabilities assumed based on management’s estimates of their fair values on the acquisition date. The excess of the purchase consideration over the fair value of the net assets acquired was allocated to goodwill. Goodwill is not being amortized but reviewed annually for impairment, or more frequently if impairment indicators arise. In part, goodwill reflected the competitive advantages the Company expected to realize from Azalea’s standing in the China service provider industry as well as Azalea’s product differentiation.

 

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The following table summarizes the estimated purchase price allocation (in thousands, except estimated useful lives). Estimates of liabilities are subject to change, pending the Company’s final review of Azalea’s obligations.
                 
Cash and cash equivalents
  $ 550          
Accounts receivable
    2,525          
Inventory
    1,794          
Prepaids and other assets
    331          
Property and equipment
    265          
 
             
Total tangible assets acquired
    5,465          
 
               
 
          Estimated
Amortizable intangible assets:
          Useful Lives
Existing technology
    11,800     5 years
Patents/core technology
    2,300     6 years
Customer contracts
    1,800     6 years
Tradenames/trademarks
    100     1 year
Non-compete agreements
    100     2 years
In-process research and development
    900          
Goodwill
    24,842          
 
             
Total assets acquired
    47,307          
 
               
Liabilities
    (5,322 )        
 
             
Total liabilities assumed
    (5,322 )        
 
             
Total
  $ 41,985          
 
             
The purchased intangible assets have a weighted average useful life of 5.2 years from the date of the acquisition.
A portion of the purchase price was allocated to developed product technology and in-process research and development (“IPR&D”). They were identified and valued through an analysis of data provided by Azalea concerning developmental products, their stage of development, the time and resources needed to complete them, target markets, their expected income generating ability and associated risks. The Income Approach, which is based on the premise that the value of an asset is the present value of its future earning capacity, was the primary valuation technique employed. A discount rate of 16% was applied to developed product technology and IPR&D. The Company recognizes IPR&D at fair value as of the acquisition date, and subsequently accounts for it as an indefinite-lived intangible asset until completion or abandonment of the associated research and development efforts. IPR&D is tested for impairment during the period it is considered an indefinite lived asset.
Developed product technology, which includes products that are already technologically feasible, is primarily comprised of a portfolio of outdoor mesh routers. Developmental projects that had not reached technological feasibility are recognized as identifiable intangible assets. The principal project at the acquisition date relates to developing multi-radio outdoor mesh routers for the core network for even the largest enterprises. This technology would enable faster internet access for higher throughput performance, covering greater distances for both mesh and video networks. The Company expects to incur an immaterial amount of post-acquisition costs during fiscal 2011. The Company expects to complete all work by the end of fiscal 2011.
The Company expensed $0.7 million of acquisition-related costs incurred as general and administrative expenses in the Consolidated Statements of Operations in the period the expense was incurred.
Based on its evaluation of the materiality of Azalea’s stand-alone financial statements to the Consolidated Financial Statements of Aruba Networks taken as a whole, the Company determined that the acquisition does not meet the requirements needed to disclose pro forma financial statements for the acquisition.
Contingent Rights Liability
Contingent rights were issued to each Azalea shareholder as part of the purchase consideration. For each share received, the Azalea shareholder also received a right to receive an amount of cash equal to the shortfall generated if a share is sold below the target value within the payment period, as specified in the arrangement. For shares not held in escrow, the payment period begins August 1, 2011 and ends on December 31, 2011. For shares held in escrow the payment period begins April 2, 2012 and ends on May 1, 2012. The rights are subject to forfeiture in certain circumstances.

 

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At the acquisition date, the Company recorded a liability for the estimated fair value of the contingent rights of $9.5 million. This liability was estimated using a lattice model and was based on significant inputs not observed in the market and thus represented a Level 3 instrument. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. The inputs included:
    stock price as of the valuation date;
 
    strike price of the contingent right;
 
    maximum payoff per share;
 
    number of shares held in and outside of escrow;
 
    exercise period;
 
    historical volatility of the Company’s stock price based on weekly stock price returns; and
 
    risk-free rate interpolated from the Constant Maturity Treasury Rate.
The change in fair value from the acquisition date to January 31, 2011 was primarily driven by an increase in the Company’s stock price. Gains and losses on the remeasurement of the contingent rights liability are included in other income (expense), net. As the fair value of the contingent rights liability will largely be determined based on the Company’s closing stock price as of future fiscal periods, it is not possible to determine a probable range of possible outcomes of the valuation of the contingent rights liability. However, the maximum contingent rights liability will be no more than $13.5 million as defined in the acquisition agreement.
The following table represents the change in the contingent rights liability:
         
    Level 3  
    Amount  
    (in thousands)  
Balance as of July 31, 2010
  $  
Acquisition date fair value measurement
    9,486  
Adjustments to fair value
    (2,105 )
 
     
Balance as of January 31, 2011
  $ 7,381  
 
     
On November 19, 2010, the Company entered into an agreement with an Australian-based company, pursuant to which Aruba acquired substantially all of the assets of the Australian-based company. The acquisition was completed on December 3, 2010. The total consideration was $3.0 million and resulted in additional goodwill of $0.6 million.
3. Goodwill and Intangible Assets
The following table presents details of the Company’s goodwill:
         
    Amount  
    (in thousands)  
As of July 31, 2010
  $ 7,656  
Goodwill acquired in acquisition
    25,487  
 
     
As of January 31, 2011
  $ 33,143  
 
     

 

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The following table presents details of the Company’s total purchased intangible assets:
                                 
    Estimated     Gross     Accumulated     Net  
    Useful Lives     Value     Amortization     Value  
    (in thousands, except estimated useful lives)  
As of January 31, 2011
                               
Existing technology
    4 to 5 years     $ 22,383     $ (8,111 )   $ 14,272  
In-process research and development
  NA     1,200             1,200  
Patents/core technology
    4 to 6 years       5,846       (2,494 )     3,352  
Customer contracts
    6 to 7 years       6,933       (2,565 )     4,368  
Support agreements
    5 to 6 years       2,917       (1,561 )     1,356  
Tradenames/trademarks
    1 to 5 years       750       (394 )     356  
Non-compete agreements
  2 years     812       (733 )     79  
 
                         
Total
          $ 40,841     $ (15,858 )   $ 24,983  
 
                         
                                 
    Estimated     Gross     Accumulated     Net  
    Useful Lives     Value     Amortization     Value  
    (in thousands, except estimated useful lives)  
As of July 31, 2010
                               
Existing technology
  4 years   $ 9,283     $ (5,914 )   $ 3,369  
Patents/core technology
  4 years     3,046       (1,940 )     1,106  
Customer contracts
    6 to 7 years       5,083       (2,020 )     3,063  
Support agreements
    5 to 6 years       2,717       (1,284 )     1,433  
Tradenames/trademarks
  5 years     600       (284 )     316  
Non-compete agreements
  2 years     712       (712 )      
 
                         
Total
          $ 21,441     $ (12,154 )   $ 9,287  
 
                         
Amortization expense is recorded in the Consolidated Statements of Operations under the following:
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
Cost of product revenues
  $ 1,524     $ 771     $ 2,752     $ 1,541  
Cost of professional services and support revenues
    130       135       270       270  
Sales and marketing
    367       327       682       654  
 
                       
Total amortiztaion expense
  $ 2,021     $ 1,233     $ 3,704     $ 2,465  
 
                       
The estimated future amortization expense of purchased intangible assets as of January 31, 2011 is as follows:
         
    Amount  
    (in thousands)  
Remaining six months of fiscal 2011
  $ 4,111  
Years ending July 31,
       
2012
    6,490  
2013
    4,752  
2014
    4,049  
2015
    3,277  
Thereafter
    1,104  
 
     
Total
  $ 23,783  
 
     

 

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4. Net Loss Per Common Share
Basic net loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is calculated by giving effect to all potentially dilutive common shares, including stock options and awards, unless the result is anti-dilutive. The following tables set forth the computation of net loss per share:
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands, except per share data)     (in thousands, except per share data)  
 
                               
Net loss
  $ (2,833 )   $ (4,427 )   $ (698 )   $ (29,103 )
 
                       
 
                               
Weighted-average common shares outstanding net of weighted-average common shares subject to repurchase
    98,795       88,572       97,416       88,030  
 
                       
 
                               
Basic and diluted net loss per common share
  $ (0.03 )   $ (0.05 )   $ (0.01 )   $ (0.33 )
 
                       
The following outstanding stock options and restricted stock awards were excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an anti-dilutive effect.
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
Options to purchase common stock
    1,987       5,813       1,504       4,454  
Restricted stock awards
    104       154       530       211  
5. Short-term Investments
Short-term investments consist of the following:
                                 
            Gross     Gross        
    Cost     Unrealized     Unrealized     Fair  
    Basis     Gains     Losses     Value  
    (in thousands)  
As of January 31, 2011
                               
Corporate bonds and notes
  $ 33,850     $ 84     $ (7 )   $ 33,927  
U.S. government agency securities
    70,412       64       (5 )     70,471  
U.S. treasury bills
    29,400       57             29,457  
Commercial paper
    2,445       3             2,448  
Certificates of deposit
    2,260       5             2,265  
 
                       
Total short-term investments
  $ 138,367     $ 213     $ (12 )   $ 138,568  
 
                       

 

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            Gross     Gross        
    Cost     Unrealized     Unrealized     Fair  
    Basis     Gains     Losses     Value  
    (in thousands)  
As of July 31, 2010
                               
Corporate bonds and notes
  $ 23,802     $ 69     $ (4 )   $ 23,867  
U.S. government agency securities
    80,683       78       (9 )     80,752  
U.S. treasury bills
    12,816       57             12,873  
Commercial paper
    4,495                   4,495  
Certificates of deposit
    2,179       1             2,180  
 
                       
Total short-term investments
  $ 123,975     $ 205     $ (13 )   $ 124,167  
 
                       
The cost basis and fair value of debt securities by contractual maturity, are presented below:
                 
    Cost     Fair  
    Basis     Value  
    (in thousands)  
As of January 31, 2011
               
One year or less
  $ 77,624     $ 77,737  
One to two years
    60,743       60,831  
 
           
Total short-term investments
  $ 138,367     $ 138,568  
 
           
The Company reviews the individual securities in its portfolio to determine whether a decline in a security’s fair value below the amortized cost basis is other than temporary. The Company determined that there were no investments in its portfolio, related to credit losses or otherwise, that were other-than temporarily impaired during the first six months of fiscal 2011 or 2010.
The following table summarizes the fair value and gross unrealized losses of the Company’s investments with unrealized losses aggregated by type of investment instrument and length of time that individual securities have been in a continuous unrealized loss position:
                 
    Less than 12 Months  
    Fair     Unrealized  
    Value     Loss  
    (in thousands)  
As of January 31, 2011
               
Corporate bonds and notes
  $ 8,553     $ (7 )
U.S. government agency securities
    6,522       (5 )
 
           
 
  $ 15,075     $ (12 )
 
           
Fair Value of Financial Instruments
Cash and cash equivalents consist primarily of bank deposits with third-party financial institutions and highly liquid money market securities with original maturities at date of purchase of 90 days or less and are stated at cost which approximates fair value.
Short-term investments are recorded at fair value, defined as the exit price in the principal market in which the Company would transact representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Level 1 instruments are valued based on quoted market prices in active markets for identical instruments and include the Company’s investments in money market funds. Level 2 securities are valued using quoted market prices for similar instruments, nonbinding market prices that are corroborated by observable market data, or discounted cash flow techniques and include the Company’s investments in corporate bonds and notes, U.S. government agency securities, treasury bills, and commercial paper. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. The Company has no short-term investments classified as Level 3 instruments.

 

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As of January 31, 2011, the fair value measurements of the Company’s cash, cash equivalents and short-term investments consisted of the following:
                         
    Total     Level 1     Level 2  
    (in thousands)  
Corporate bonds and notes
  $ 33,927             $ 33,927  
U.S. government agency securities
    70,471               70,471  
U.S. treasury bills
    29,457               29,457  
Commercial paper
    2,448               2,448  
Money market funds
    10,889       10,889          
 
                 
Total cash equivalents and short-term investments
    147,192     $ 10,889     $ 136,303  
 
                   
Certificates of deposit
    2,265                  
Cash deposits with third-party financial institutions
    38,369                  
 
                     
Total cash, cash equivalents and short-term investments
  $ 187,826                  
 
                     
6. Balance Sheet Components
The following tables provide details of selected balance sheet items:
                 
    January 31,     July 31,  
    2011     2010  
    (in thousands)  
Accounts Receivable, net
               
Trade accounts receivable
  $ 54,267     $ 41,731  
Less: Allowance for doubtful accounts
    (302 )     (462 )
 
           
Total
  $ 53,965     $ 41,269  
 
           
                 
    January 31,     July 31,  
    2011     2010  
    (in thousands)  
Inventory
               
Raw materials
  $ 189     $ 294  
Finished goods
    17,902       14,865  
 
           
Total
  $ 18,091     $ 15,159  
 
           
                 
    January 31,     July 31,  
    2011     2010  
    (in thousands)  
Accrued Liabilities
               
Compensation and benefits
  $ 17,643     $ 11,363  
Inventory
    12,558       9,381  
Marketing
    5,917       7,176  
Contingent rights
    7,381        
Other
    8,965       8,538  
 
           
Total
  $ 52,464     $ 36,458  
 
           

 

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7. Property and Equipment, Net
Property and equipment, net consists of the following:
                         
    Estimated     January 31,     July 31,  
    Useful Lives     2011     2010  
    (in thousands, except estimated useful lives)  
 
                       
Computer equipment
  2 years   $ 11,503     $ 7,993  
Computer software
  2-5 years     4,802       4,558  
Machinery and equipment
  2 years     11,735       10,441  
Furniture and fixtures
  5 years     2,889       2,397  
Leasehold improvements
  2-6 years     2,400       2,174  
 
                 
Total property and equipment, gross
            33,329       27,563  
Less: Accumulated depreciation and amortization
            (20,962 )     (17,644 )
 
                 
Total property and equipment, net
          $ 12,367     $ 9,919  
 
                   
8. Deferred Revenue
Deferred revenue consists of the following:
                 
    January 31,     July 31,  
    2011     2010  
    (in thousands)  
 
Product
  $ 15,797     $ 16,087  
Professional services and support
    31,157       27,298  
Ratable product and related services and support
    562       37  
 
           
Total deferred revenue, current
    47,516       43,422  
 
               
Professional services and support, long-term
    10,937       10,976  
Ratable product and related services and support, long-term
    515        
 
           
Total deferred revenue, long-term
    11,452       10,976  
 
           
Total deferred revenue
  $ 58,968     $ 54,398  
 
           
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, typically one to five years.
Deferred ratable product and related services and support revenue consists of revenue on transactions where 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 three years. The increase in ratable product and related services and support is due to the acquisition of Azalea Networks.
9. Income Taxes
For the three and six months ended January 31, 2011, the Company generated operating losses. The Company also generated book and taxable income in U.S. and specific foreign jurisdictions for the three and six months ended January 31, 2011, without consideration of windfall tax benefits. For the three and six months ended January 31, 2010, the Company generated consolidated book losses but generated taxable income in most U.S. and foreign jurisdictions.

 

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10. Equity Incentive Plans
Stock Option Activity
The following table summarizes the information about shares available for grant and outstanding stock option activity:
                                                 
            Options Outstanding              
                    Weighted             Weighted        
                    Average     Weighted     Average        
    Shares             Exercise     Average     Remaining     Aggregate  
    Available for     Number of     Price     Fair Value     Contractual     Intrinsic  
    Grant     Shares     per Share     per Share     Term (Years)     Value  
As of July 31, 2010
    635,877       23,640,524     $ 5.00               5.9     $ 283,285,534  
Shares reserved for issuance
    4,680,314                                        
Restricted stock awards granted
    (3,324,744 )                                      
Restricted stock awards cancelled
    195,832                                        
Options granted
    (1,853,890 )     1,853,890       21.88     $ 11.70                  
Options exercised
          (3,132,387 )     4.20                       55,388,318  
Options cancelled
    408,136       (408,136 )     10.18                          
 
                                         
As of January 31, 2011
    741,525       21,953,891     $ 6.44               5.5     $ 333,225,492  
 
                                         
The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the fair value of the Company’s common stock on the date of each option exercise. Stock-based compensation expense recognized for stock options was $5.3 million and $9.7 million for the three and six months ended January 31, 2011, respectively. Stock-based compensation expense recognized for stock options was $4.0 million and $7.2 million for the three and six months ended January 31, 2010, respectively.
Restricted Stock Award Activity
The following table summarizes the non-vested restricted stock awards activity:
                 
            Weighted Average  
            Grant Date  
            Fair Value  
    Shares     per Share  
As of July 31, 2010
    2,215,932     $ 9.74  
Awards granted
    3,324,744       22.28  
Awards vested
    (620,748 )     12.07  
Awards cancelled
    (195,832 )     13.45  
 
           
As of January 31, 2011
    4,724,096     $ 18.11  
 
           
The estimated fair value of restricted stock awards is based on the market price of the Company’s stock on the grant date. Stock-based compensation expense recognized for restricted stock awards for the three and six months ended January 31, 2011 was $9.9 million and $15.5 million, respectively. Stock-based compensation expense recognized for restricted stock awards for the three and six months ended January 31, 2010 was $4.1 million and $7.9 million, respectively.
Employee Stock Purchase Plan Activity
Stock-based compensation expense recognized in connection with the ESPP for the three and six months ended January 31, 2011 was $1.5 million and $3.0 million, respectively. Compensation expense recognized in connection with the ESPP for the three and six months ended January 31, 2010 was $0.9 million and $1.7 million, respectively.

 

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Fair Value Disclosures
The fair value of each option grant is estimated on the date of grant using the Black-Scholes model with the following weighted average assumptions:
Employee Stock Options
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
 
                               
Risk-free interest rate
    1.5 %     1.7 %     1.6 %     1.8 %
Expected term (in years)
    4.0       4.3       4.0       4.3  
Dividend yield
    0       0       0       0  
Volatility
    71 %     71 %     70 %     71 %
Employee Stock Purchase Plan
                 
    Three and six months ended     Three and six months ended  
    January 31, 2011     January 31, 2010  
 
               
Risk-free interest rate
  0.2% to 1.0%   0.2% to 1.0%
Expected term (in years)
  0.5 - 2.0   0.5 - 2.0
Dividend yield
  0   0
Volatility
  41% to 101%   63% to 81%
The expected term of the stock-based awards represents the period of time that the Company expects such stock-based awards to be outstanding, giving consideration to the contractual term of the awards, vesting schedules and expectations of future employee behavior. The Company gave consideration to its historical exercises, the vesting term of its stock options, the post vesting cancellation history of its stock options and the stock options’ contractual terms. The contractual term of stock options granted is generally seven years. The Company computes expected volatility based on its historical volatility and the historical volatility of comparable companies. The Company made an estimate of expected forfeitures, and is recognizing stock-based compensation only for those equity awards that it expects to vest. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury Constant Maturity rate as of the date of grant.
Stock-based Compensation Expenses
Total stock-based compensation expense for the three and six months ended January 31, 2011 was $16.7 million and $28.2 million, respectively. Total stock-based compensation expense for the three and six months ended January 31, 2010 was $9.0 million and $16.8 million, respectively. The Company did not capitalize stock-based compensation during the three and six months ended January 31, 2011 and 2010, due to the amount qualifying for capitalization being immaterial.
11. Comprehensive Income (Loss)
Comprehensive income (loss) includes the following:
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
Net loss
  $ (2,833 )   $ (4,427 )   $ (698 )   $ (29,103 )
Change in unrealized gains on short term investments, net of taxes
    (55 )     (17 )     21       10  
 
                       
Total
  $ (2,888 )   $ (4,444 )   $ (677 )   $ (29,093 )
 
                       
12. Segment Information and Significant Customers
The Company operates in one industry segment selling fixed and modular mobility controllers, wired and wireless access points, and related software and services.
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. The Company has one business activity, and there are no segment managers who are held accountable for operations, operating results and plans for products or components below the consolidated unit level. Accordingly, the Company reports as a single operating segment. The Company and its Chief Executive Officer evaluate performance based primarily on revenue in the geographic locations in which the Company operates. Revenue is attributed by geographic location based on the ship-to location of the Company’s customers. The Company’s assets are primarily located in the U.S. and not allocated to any specific region. Therefore, geographic information is presented only for total revenue.

 

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The following presents total revenue by geographic region:
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
United States
  $ 60,387     $ 38,660     $ 112,139     $ 72,276  
Europe, Middle East and Africa
    15,704       10,036       28,857       17,668  
Asia Pacific
    15,168       11,326       29,674       23,832  
Rest of World
    2,599       2,633       6,335       6,475  
 
                       
Total
  $ 93,858     $ 62,655     $ 177,005     $ 120,251  
 
                       
The following table presents significant channel partners as a percentage of total revenues:
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
 
                               
ScanSource, Inc. (Catalyst)
    17.1 %     13.9 %     18.6 %     13.6 %
Alcatel-Lucent
    15.7 %     13.3 %     13.6 %     12.0 %
Avnet Logistics U.S. LP
    15.7 %     16.1 %     15.1 %     14.1 %
13. Commitments and Contingencies
Legal Matters
The Company could become involved in litigation from time to time relating to claims arising out of its ordinary course of business. There were no claims as of January 31, 2011 that, in the opinion of management, might have a material adverse effect on the Company’s financial position, results of operations or cash flows.
During the first quarter of fiscal 2010, the Company entered into a Patent Cross License and Settlement Agreement with Motorola. As part of the Settlement Agreement, the Company agreed to pay Motorola $19.8 million. During the second quarter of fiscal 2010, the Company recorded an additional reserve of $0.5 million related to a legal matter.
Lease Obligation
The Company leases office space under non-cancelable operating leases with various expiration dates through July 2016. The terms of certain operating leases provide for rental payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over the respective lease periods and has accrued for rent expense incurred but not paid.
Future minimum lease payments under non-cancelable operating leases are as follows:
         
    Operating  
    Leases  
    (in thousands)  
 
       
Six months remaining in fiscal 2011
  $ 1,776  
Year ending July 31,
       
2012
    3,447  
2013
    3,149  
2014
    2,820  
2015
    2,809  
2016
    2,442  
 
     
Total minimum payments
  $ 16,443  
 
     

 

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Non-cancelable purchase commitments
The Company outsources the production of its hardware to third-party contract manufacturers. In addition, the Company enters into various inventory related purchase commitments with its contract manufacturers and other suppliers. The Company had $23.7 million and $20.3 million in non-cancelable purchase commitments with these providers as of January 31, 2011 and July 31, 2010, respectively. The Company expects to sell all products that it has committed to purchase from these providers.
Warranties
The Company provides for future warranty costs upon product delivery. The specific terms and conditions of those warranties vary depending upon the product sold and country in which the Company does business. In the case of hardware, the warranties are generally for 12-15 months from the date of purchase. The Company also has a lifetime warranty program on certain access points purchased subsequent to the announcement of the program.
The Company warrants that any media on which its software products are recorded will be free from defects in materials and workmanship under normal use for a period of 90 days from the date the products are delivered to the end customer. In addition, the Company warrants that its hardware products will substantially conform to the Company’s published specifications. Historically, the Company has experienced minimal warranty costs. Factors that affect the Company’s warranty liability include the number of installed units, historical experience and management’s judgment regarding anticipated rates of warranty claims and cost per claim. The Company assesses the adequacy of its recorded warranty liabilities every reporting period and makes adjustments to the liability as necessary.
The warranty liability is included as a component of accrued liabilities on the balance sheet. Changes in the warranty liability are as follows:
         
    Warranty  
    Amount  
    (in thousands)  
As of July 31, 2010
  $ 210  
Provision
    186  
Obligations fulfilled during period
    (112 )
 
     
As of January 31, 2011
  $ 284  
 
     
Indemnifications
In its sales agreements, the Company may agree to indemnify its indirect sales channels and end user customers for any expenses or liability resulting from claimed infringements of patents, trademarks or copyrights of third parties. The terms of these indemnification agreements are generally perpetual any time after execution of the agreement. The maximum amount of potential future indemnification is unlimited. To date the Company has not paid any amounts to settle claims or defend lawsuits pursuant to any indemnification obligation. The Company is unable to reasonably estimate the maximum amount that could be payable under these arrangements since these obligations are not capped but are conditional to the unique facts and circumstances involved. Accordingly, the Company has no liabilities recorded for these agreements as of January 31, 2011 and July 31, 2010.

 

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, among other things, statements concerning our expectations:
  that revenues from our indirect channels will continue to constitute a significant majority of our future revenues;
 
  that our product offerings, in particular our products that incorporate 802.11n wireless LAN standard technologies, will enable broader networking initiatives by both our current and potential customers;
 
  that, within our indirect channel, sales through our VADs will grow, which will negatively impact our gross margins as VADs experience a larger net effective discount than our other channel partners;
 
  that international revenues will remain consistent or increase in absolute dollars and remain consistent or decrease as a percentage of total revenues in fiscal 2011 compared to fiscal 2010;
 
  that we will continue to hire employees throughout the company;
 
  that we will continue to invest significantly in our research and development efforts;
 
  that research and development expenses for fiscal 2011 will increase on an absolute dollar basis and as a percentage of revenue compared to fiscal 2010;
 
  that we will continue to invest strategically in our sales and marketing efforts;
 
  that sales and marketing expenses for fiscal 2011 will continue to be our most significant operating expense and will increase on an absolute dollar basis and decrease as a percentage of revenue compared to fiscal 2010;
 
  that general and administrative expenses for fiscal 2011 will increase on an absolute dollar basis and decrease as a percentage of revenue compared to fiscal 2010;
 
  that ratable product and related professional services and support revenues will decrease in absolute dollars and as a percentage of total revenues in future periods;
 
  that, as we expand internationally, we may incur additional costs to conform our products to comply with local laws and product specifications, and we plan to continue to hire additional technical support personnel to support our growing international customer base;
 
  regarding the sufficiency of our existing cash, cash equivalents, short-term investments and cash generated from operations, and
 
  that we will increase our market penetration and extend our geographic reach through our network of channel partners,
as well as other statements regarding our future operations, financial condition and prospects and business strategies. These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report, and in particular, the risks discussed under the heading “Risk Factors” in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included elsewhere in this report.
Overview
We are a global leader in distributed enterprise networks that securely connect local and remote users to corporate IT resources. Our award-winning portfolio of campus, branch office, teleworker, and mobile solutions simplify operations and provide secure access to all corporate applications and services — regardless of a user’s device, location, or network. The result is improved productivity and lower capital and operating costs.

 

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Our product portfolio encompasses: industry-leading high-speed 802.11a/b/g/n WLANs, Virtual Branching Networking solutions for branch offices and teleworkers, network operations tools, including spectrum analyzers, wireless intrusion prevention systems, and the AirWave Wireless Management Suite for managing wired, wireless, and mobile device networks. These products are key to our rightsizing initiative which allows companies to move toward a low-cost IT infrastructure solution by funding wireless projects rather than wired LANs.
Our products have been sold to over 12,000 end customers worldwide (not including customers of Alcatel-Lucent), including some of the largest and most complex global organizations. We have implemented a two-tier distribution model in most areas of the world, including the United States, with VADs selling our portfolio of products, including a variety of our support services, to a diverse number of VARs. Our focus continues to be management of our channel including selection and growth of high prospect partners, activation of our VARs and VADs through active training and field collaboration, and evolution of our channel programs in consultation with our partners.
Our ability to increase our product revenues will depend significantly on continued growth in the market for enterprise mobility and remote networking solutions, continued acceptance of our products in the marketplace, our ability to continue to attract new customers, our ability to compete, the willingness of customers to displace wired networks with wireless LANs, in particular, wireless LANs that utilize our 802.11n solution, and our ability to continue to sell into our installed base of existing customers. Our growth in support revenues is dependent upon increasing the number of products under support contracts, which is dependent on both growing our installed base of customers and renewing existing support contracts. Our future profitability and rate of growth, if any, will be directly affected by the continued acceptance of our products in the marketplace, as well as the timing and size of orders, product and channel mix, average selling prices, costs of our products and general economic conditions. Our future profitability will also be affected by our ability to effectively implement and generate incremental business from our two-tier distribution model, the extent to which we invest in our sales and marketing, research and development, and general and administrative resources to grow our business, and current economic conditions.
While our revenues have increased over several quarters, economic conditions worldwide have negatively impacted our business. We believe in the long-term growth prospects of the WLAN market, but the deterioration in overall economic conditions and in particular, tightening in the credit markets and reduced spending by both enterprises and consumers have significantly impacted various industries on which we rely for purchasing our products. This has led to our customers deferring purchases in response to tighter credit, negative financial news and delayed budget approvals. These factors could create significant and increasing uncertainty for the future if they continue to negatively impact technology spending for the products and services we offer, which would have a material adverse effect on our business, operating results and financial condition.
The revenue growth that we have experienced has been driven primarily by an expansion of our customer base coupled with increased purchases from existing customers. We believe the growth we have experienced is the result of business enterprises needing to provide secure mobility to their users in a manner that we believe is more cost effective than the traditional approach of using port-centric networks. While we have experienced both longer sales cycles and seasonality, both of which have slowed our revenue growth, we believe that our product offerings, in particular our products that incorporate 802.11n wireless LAN standard technologies, will enable broader networking initiatives by both our current and potential customers in the future.
Each quarter, our ability to meet our product revenue expectations is dependent upon (1) new orders received, shipped, and recognized in a given quarter, (2) the amount of orders booked but not shipped in the prior quarter that are shipped in the current quarter, and (3) the amount of deferred revenue entering a given quarter. Our product deferred revenue is comprised of:
  product orders that have shipped but where the terms of the agreement, typically with our large customers, contain acceptance terms and conditions or other terms that require that the revenue be deferred until all revenue recognition criteria are met; and
 
  product orders shipped to our VADs and OEMs for which we have not yet received persuasive evidence from the VADs or OEMs of a sale to an end customer.
We typically ship products within a reasonable time period after the receipt of an order.
On November 19, 2010, we entered into an agreement with an Australian-based company, pursuant to which we acquired substantially all of the assets of the Australian-based company. The acquisition was completed on December 3, 2010. The total consideration was $3.0 million and resulted in additional goodwill of $0.6 million.
On September 2, 2010, we completed our acquisition of Azalea Networks for a total purchase price of $42.0 million which included common stock, cash, and contingent rights. Azalea is a leading supplier of outdoor mesh networks and includes an operations center in Beijing, China that will complement our existing research and development centers. As part of the acquisition, we recorded $5.5 million of tangible assets, $17.0 million of intangible assets and $24.8 million of goodwill. We recorded a liability for the estimated fair value of the contingent rights which was based on significant inputs not observed in the market and thus represents a Level 3 instrument. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect our own assumptions in measuring fair value. Gains and losses on the remeasurement of the liability are included in other income (expense), net.

 

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Revenues, Cost of Revenues and Operating Expenses
Revenues
We derive our revenues from sales of our ArubaOS operating system, controllers, wired and wireless access points, application software modules, multi-vendor management solution software, and professional services and support. Professional services revenues consist of consulting and training services. Consulting services primarily consist of installation support services. Training services are instructor led courses on the use of our products. Support services typically consist of software updates, on a when-and-if available basis, telephone and internet access to technical support personnel and hardware support. We provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.
We sell our products directly through our sales force and indirectly through VADs, VARs, and OEMs. We expect revenues from indirect channels to continue to constitute a significant majority of our future revenues.
We sell our products to channel partners and end customers located in the Americas, Europe, the Middle East, Africa and Asia Pacific. We continue to expand into international locations and introduce our products in new markets, and we expect international revenues to remain consistent or increase in absolute dollars and remain consistent or decrease as a percentage of total revenues in fiscal 2011 compared to fiscal 2010. For more information about our international revenues, see Note 12 of the Notes to Consolidated Financial Statements.
Cost of Revenues
Cost of product revenues consists primarily of manufacturing costs for our products, shipping and logistics costs, and expenses for inventory obsolescence and warranty obligations. We utilize third parties to manufacture our products and perform shipping logistics. We have outsourced the substantial majority of our manufacturing, repair and supply chain operations. Accordingly, the substantial majority of our cost of revenues consists of payments to our contract manufacturers. Our contractor manufacturers produce our products in China and Singapore using quality assurance programs and standards that we jointly established. Manufacturing, engineering and documentation controls are conducted at our facilities in Sunnyvale, California, Bangalore, India and Beijing, China. Cost of product revenues also includes amortization expense from our purchased intangible assets.
Cost of professional services and support revenues is primarily comprised of personnel costs, including stock-based compensation, of providing technical support, including personnel costs associated with our internal support organization. In addition, we employ a third-party support vendor to complement our internal support resources, the costs of which are included within costs of professional services and support revenues.
Gross Margin
Our gross margin has been, and will continue to be, affected by a variety of factors, including:
  the proportion of our products that are sold through direct versus indirect channels;
 
  product mix and average selling prices;
 
  new product introductions, such as our value-priced, high performance 802.11n access point and Azalea’s outdoor mesh network products, and product enhancements made by us as well as those made by our competitors;
 
  pressure to discount our products in response to our competitor’s discounting practices;
 
  demand for our products and services;
 
  our ability to attain volume manufacturing pricing from our contract manufacturers and our component suppliers;
 
  losses associated with excess and obsolete inventory;
 
  growth in our headcount and other related costs incurred in our customer support organization;
 
  costs associated with manufacturing overhead;
 
  our ability to manage freight costs; and
 
  amortization expense from our purchased intangible assets.

 

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Due to higher net effective discounts for products sold through our indirect channel, our overall gross margins for indirect channel sales are typically lower than those associated with direct sales. We expect product revenues from our indirect channel to continue to constitute a significant majority of our total revenues, which, by itself, negatively impacts our gross margins. Further, we expect that within our indirect channel, sales through our VADs will grow, which will negatively impact our gross margins as VADs experience a larger net effective discount than our other channel partners.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The largest component of our operating expenses is personnel costs. Personnel costs consist of salaries, benefits and incentive compensation for our employees, including commissions for sales personnel and stock-based compensation for all employees.
Our total headcount increased to 924 at January 31, 2011 from 868 at October 31, 2010 and 681 at July 31, 2010. Going forward, we expect to continue to hire employees throughout the company.
Research and development expenses primarily consist of personnel costs and facilities costs. We expense research and development expenses as incurred. We are devoting substantial resources to the continued development of additional functionality for existing products and the development of new products. We intend to continue to invest significantly in our research and development efforts because we believe it is essential to maintaining our competitive position. For fiscal 2011, we expect research and development expenses to increase on an absolute dollar basis and as a percentage of revenue compared to fiscal 2010.
Sales and marketing expenses represent the largest component of our operating expenses and primarily consist of personnel costs, sales commissions, marketing programs and facilities costs. Marketing programs are intended to generate revenue from new and existing customers and are expensed as incurred. We plan to continue to invest strategically in sales and marketing with the intent to add new customers and increase penetration within our existing customer base, expand our domestic and international sales and marketing activities, build brand awareness and sponsor additional marketing events. We expect future sales and marketing expenses to continue to be our most significant operating expense. Generally, sales personnel are not immediately productive, and thus, the increase in sales and marketing expenses that we experience as we hire additional sales personnel is not expected to immediately result in increased revenues. As a result, these expenses will reduce our operating margins until such sales personnel become productive and generate revenue. Accordingly, the timing of sales personnel hiring and the rate at which they become productive will affect our future performance. For fiscal 2011, we expect sales and marketing expenses to increase on an absolute dollar basis and decrease as a percentage of revenue compared to fiscal 2010.
General and administrative expenses primarily consist of personnel and facilities costs related to our executive, finance, human resource, information technology and legal organizations, as well as insurance, investor relations, and IT infrastructure costs related to our ERP system. Further, our general and administrative expenses include professional services consisting of outside legal, audit, Sarbanes-Oxley and information technology consulting costs. We have incurred in the past, and may continue to incur, significant legal costs defending ourselves against claims made by third parties. These expenses are expected to continue as part of our ongoing operations and depending on the timing and outcome of lawsuits and the legal process, could have a significant impact on our financial statements. For fiscal 2011, we expect general and administrative expenses to increase on an absolute dollar basis and decrease as a percentage of revenue compared to fiscal 2010.
Other Income (Expense), net
Other income (expense), net includes interest income on cash balances, accretion of discount or amortization of premium on short-term investments, losses or gains on remeasurement of non-U.S. dollar transactions into U.S. dollars, and in connection with our acquisition of Azalea in September 2010, changes in the fair value of our contingent rights liability. Cash has historically been invested in money market funds and marketable securities.
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make estimates and judgments that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based on information available to us at the time that these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, our consolidated financial statements will be affected. The accounting policies that reflect our more significant estimates and judgments and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include revenue recognition, stock-based compensation, inventory valuation, allowances for doubtful accounts, income taxes, and goodwill and purchased intangible assets.

 

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Our critical accounting policies are disclosed in our Form 10-K for the year ended July 31, 2010. There were no material changes to our critical accounting policies during the first six months of fiscal 2011 except for the adoption of ASU 2009-13 and ASU 2009-14. In October 2009, the FASB amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple-element revenue arrangements to:
(i)   provide updated guidance on how the elements in a multiple-element arrangement should be separated, and how the consideration should be allocated;
 
(ii)   require an entity to allocate revenue amongst the elements in an arrangement using estimated selling price (“ESP”) if a vendor does not have VSOE of the selling price or third-party evidence (“TPE”) of the selling price; and
 
(iii)   eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.
We adopted this accounting guidance at the beginning of our first quarter of fiscal 2011 on a prospective basis for applicable arrangements originating or materially modified after July 31, 2010. The impact of this adoption was not material to our financial position and results of operations for the first six months of fiscal 2011.
This guidance does not generally change the units of accounting for our revenue transactions. Most non-software products and services qualify as separate units of accounting because they have value to the customer on a stand-alone basis and our revenue arrangements generally do not include a general right of return relative to delivered products.
The majority of our products are hardware appliances containing software components that function together to provide the essential functionality of the product. Therefore, our hardware appliances are considered non-software elements and are not subject to the industry-specific software revenue recognition guidance.
Our product revenue also includes revenue from the sale of stand-alone software products. Stand-alone software products may operate on our hardware appliance, but are not considered essential to the functionality of the hardware. Sales of stand-alone software generally include a perpetual license to our software. Sales of stand-alone software continue to be subject to the industry-specific software revenue recognition guidance.
For all arrangements originating or materially modified after July 31, 2010, we recognize revenue in accordance with the amended accounting guidance. Certain arrangements with multiple-elements may continue to have stand-alone software elements that are subject to the existing software revenue recognition guidance along with non-software elements that are subject to the amended revenue accounting guidance. The revenue for these multiple deliverable arrangements is allocated to the stand-alone software elements as a group and the non-software elements based on the relative selling prices of all of the elements in the arrangement using the fair value hierarchy in the amended revenue accounting guidance.
For sales of stand-alone software after July 31, 2010 and for all transactions entered into prior to the first quarter of 2011, we recognize revenue based on software revenue recognition guidance. Under the software revenue recognition guidance, we use the residual method to recognize revenue when a product agreement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists. In the majority of our contracts, the only element that remains undelivered at the time of delivery of the product is support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the contract fee is recognized as product revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is generally deferred and recognized when delivery of those elements occurs or when fair value can be established. When the undelivered element for which we do not have VSOE of fair value is support, revenue for the entire arrangement is bundled and recognized ratably over the support period.
VSOE for elements of an arrangement is based upon the normal pricing and discounting practices for those services when sold separately, and VSOE for support services is measured by the stand-alone renewal rate offered to the customer. In determining VSOE, we require that a substantial majority of the selling prices for an element falls within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates. In addition, we consider major service groups, geographies, customer classifications, and other variables in determining VSOE.
We are typically not able to determine TPE for our products or services. TPE is determined based on competitor prices for similar elements when sold separately. Generally, our go-to-market strategy differs from that of our peers and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.
When we are unable to establish selling price of our non-software elements using VSOE or TPE, we use ESP in our allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine ESP for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies, customer classes and distribution channels.
We regularly review VSOE and ESP and maintain internal controls over the establishment and updates of these estimates. There was not a material impact during the second quarter or first six months of fiscal 2011, nor do we currently expect a material impact in the near term from changes in VSOE or ESP.

 

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Product revenue consists of revenue from sales of our hardware appliances and perpetual software licenses. We recognize product revenue when all of the following have occurred: (1) we have entered into a legally binding arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is reasonably assured.
For sales to direct end-users and channel partners, including value-added resellers, value-added distributors, and OEMs, we recognize product revenue upon delivery, assuming all other revenue recognition criteria are met. For our hardware appliances, delivery occurs upon transfer of title and risk of loss, which is generally upon shipment. It is our practice to identify an end-user prior to shipment to a channel partner. For end-users and channel partners, we generally have no significant obligations for future performance such as rights of return or pricing credits. A portion of our sales are made through distributors under agreements allowing for stocking of our products in their inventory, pricing credits and limited rights of return for stock rotation. Product revenue on sales made through these distributors is initially deferred and revenue is recognized upon sell-through as reported by the distributors to us. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.
Support and services offerings consist of support agreements, professional services, and training. Support services include repair and replacement of defective hardware appliances, software updates and access to technical support personnel. 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 service contract term, which is typically one to five years. Professional services are recognized upon delivery or completion of performance. Professional service arrangements are typically short term in nature and are largely completed within 90 days from the start of service. Training services are recognized upon delivery of the training.
Our fees are typically considered to be fixed or determinable at the inception of an arrangement, generally based on specific products and quantities to be delivered. Substantially all of our contracts do not include rights of return or acceptance provisions. To the extent that our agreements contain such terms, we recognize revenue once the customer has accepted, or once the acceptance provisions or right of return lapses. Payment terms to customers generally range from net 30 to 60 days. In the event payment terms are provided that differ from our standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized when the payments become due, provided the remaining criteria for revenue recognition have been met.
We assess the ability to collect from our customers based on a number of factors, including credit worthiness of the customer and past transaction history of the customer. If the customer is not deemed credit worthy, we defer revenue from the arrangement until payment is received and all other revenue recognition criteria have been met.

 

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Results of Operations
The following table presents our historical operating results as a percentage of revenues for the periods indicated:
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
 
Revenues:
                               
Product
    84.3 %     83.1 %     83.8 %     82.6 %
Professional services and support
    15.5 %     16.5 %     16.0 %     17.0 %
Ratable product and related professional services and support
    0.2 %     0.4 %     0.2 %     0.4 %
 
 
                       
Total revenues
    100.0 %     100.0 %     100.0 %     100.0 %
 
                               
Cost of revenues:
                               
Product
    25.7 %     28.9 %     26.1 %     28.7 %
Professional services and support
    3.8 %     3.4 %     3.7 %     3.5 %
Ratable product and related professional services and support
    0.0 %     0.1 %     0.0 %     0.2 %
 
                       
 
Gross margin
    70.5 %     67.6 %     70.2 %     67.6 %
 
                               
Operating expenses:
                               
Research and development
    23.0 %     19.2 %     21.9 %     19.8 %
Sales and marketing
    39.4 %     42.5 %     39.7 %     42.7 %
General and administrative
    10.9 %     12.2 %     9.8 %     12.3 %
Litigation reserves
    0.0 %     0.8 %     0.0 %     16.8 %
 
                       
 
Total operating expenses
    73.3 %     74.7 %     71.4 %     91.6 %
 
                       
Operating margin
    (2.8 %)     (7.1 %)     (1.2 %)     (24.0 %)
 
                               
Other income (expense), net
                               
Interest income
    0.3 %     0.3 %     0.3 %     0.3 %
Other income (expense), net
    (0.1 %)     (0.2 %)     0.9 %     (0.2 %)
 
                       
 
                               
Income (loss) before income taxes
    (2.6 %)     (7.0 %)     0.0 %     (23.9 %)
 
                               
Provision for income taxes
    0.4 %     0.1 %     0.4 %     0.3 %
 
                       
 
                               
Net income (loss)
    (3.0 %)     (7.1 %)     (0.4 %)     (24.2 %)
 
                       

 

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Revenues
The following table presents our revenues, by revenue source, for the periods presented:
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
 
Total revenues
  $ 93,858     $ 62,655     $ 177,005     $ 120,251  
 
                       
Type of revenues:
                               
Product
    79,100       52,078       148,304       99,276  
Professional services and support
    14,602       10,362       28,402       20,504  
Ratable product and related professional services and support
    156       215       299       471  
 
                       
Total revenues
  $ 93,858     $ 62,655     $ 177,005     $ 120,251  
 
                       
Revenues by geography:
                               
United States
    60,387       38,660       112,139       72,276  
Europe, the Middle East and Africa
    15,704       10,036       28,857       17,668  
Asia Pacific
    15,168       11,326       29,674       23,832  
Rest of World
    2,599       2,633       6,335       6,475  
 
                       
Total revenues
  $ 93,858     $ 62,655     $ 177,005     $ 120,251  
 
                       
During the second quarter of fiscal 2011, total revenues increased 49.8% over the second quarter of fiscal 2010 due to a $31.3 million increase in product and professional services and support revenues. During the first six months of fiscal 2011, total revenues increased 47.2% compared to the first six months of fiscal 2010. The increase in revenues in the second quarter and the first six months of fiscal 2011 was attributable to strong demand across all of our key verticals and major geographies, and the significant growth in our customer base. We added over 1,000 new customers during the second quarter of fiscal 2011 and nearly 2,000 in the first six months of fiscal 2011. Our right-sizing initiative continues to gain momentum as companies move toward a new access network. The rapid proliferation of wi-fi enabled mobile devices, the increase in demand for multimedia-rich mobility applications, and the rise of both server and desktop virtualization is driving this trend.
Product revenues increased 51.9% during the first quarter of fiscal 2011 compared to the same period in fiscal 2010, and 49.4% during the first six months of fiscal 2011 compared to the same period in fiscal 2010. Our product revenues were bolstered by an increase in revenue related to our 802.11n access points as new customers are rolling out 802.11n networks almost exclusively. The increase in professional services and support revenues is a result of increased product and first year support sales combined with the renewal of support contracts by existing customers as customers continue to see value in our support services.
Ratable product and related professional services and support revenues decreased in the second quarter and first six months of fiscal 2011 compared to the same periods in fiscal 2010 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. The current balance of ratable deferred revenue, and subsequent ratable revenue, relates entirely to our acquisition of Azalea. 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.
We derived 93.3% of our total revenues from indirect channels, which consist of VADs, VARs and OEMs, during the second quarter of fiscal 2011, and 91.6% of our total revenues from indirect channels during the first six months of fiscal 2011. We generated 90.5% of our total revenues from indirect channels during the second quarter of fiscal 2010, and 90.9% of our total revenues from indirect channels during the first six months of fiscal 2010. Going forward, we expect to continue to derive a significant majority of our total revenues from indirect channels as we continue to focus on improving the efficiency of marketing and selling our products through these channels.
Revenues from shipments to locations outside the United States increased $9.5 million during the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010 largely due to strong demand across all of our international markets. During the first six months of fiscal 2011, international revenues increased $16.9 million compared to the first six months of fiscal 2010. We continue to expand into international locations and introduce our products in new markets, and we expect international revenues to remain consistent or increase in absolute dollars, and remain consistent or decrease as a percentage of total revenues in fiscal 2011 compared to fiscal 2010.

 

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Cost of Revenues and Gross Margin
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
 
Total revenues
  $ 93,858     $ 62,655     $ 177,005     $ 120,251  
 
                       
 
                               
Cost of product
    24,173       18,103       46,236       34,535  
Cost of professional services and support
    3,542       2,157       6,448       4,236  
Cost of ratable product and related professional services and support
          68       9       154  
 
                       
Total cost of revenues
    27,715       20,328       52,693       38,925  
 
                       
Gross profit
  $ 66,143     $ 42,327     $ 124,312     $ 81,326  
 
                       
Gross margin
    70.5 %     67.6 %     70.2 %     67.6 %
During the second quarter of fiscal 2011 cost of revenues increased 36.3% compared to the second quarter of fiscal 2010 due to the corresponding increase in our product revenue. The substantial majority of our cost of product revenues consists of payments to Flextronics, our largest contract manufacturer. For the second quarter of fiscal 2011, payments to Flextronics and Flextronics-related costs constituted more than 70% of our cost of product revenues. In the first six months of fiscal 2011, cost of revenues increased 35.4% compared to the first six months of fiscal 2010.
Cost of professional services and support revenues increased 64.2% during the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010, and 52.2% during the first six months of fiscal 2011 compared to the same period in fiscal 2010. These increases were primarily due to an increase in headcount in our support and professional services organization to meet the growing demand for these services. Further, these costs increased due to the acquisition of Azalea in September 2010.
Cost of ratable product and related professional services and support revenues decreased during these periods consistent with the decrease in ratable product and related professional services and support revenues.
As we expand internationally, we may incur additional costs to conform our products to comply with local laws or local product specifications. In addition, we plan to continue to hire additional technical support personnel to support our growing international customer base.
Gross margins increased 2.9% during the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010, and 2.6% in the first six months of fiscal 2011 compared to the first six months of 2010. The increase is due in part to favorable product mix, timing of support renewals and contracts, and channel and geographic mix.
Research and Development Expenses
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
Research and development expenses
  $ 21,608     $ 12,042     $ 38,722     $ 23,838  
Percent of total revenues
    23.0 %     19.2 %     21.9 %     19.8 %
During the second quarter of fiscal 2011, research and development expenses increased 79.4% compared to the second quarter of fiscal 2010, primarily due to an increase of $8.2 million in personnel and related costs, including an increase in stock-based compensation of $3.8 million. We added 167 employees to our research and development team year over year, including 52 employees from our acquisition of Azalea Networks as we continue to invest heavily in product development. Consequently, facilities expenses increased by $0.6 million. Expenses for consulting and outside agencies increased by $0.6 million due to design and compliance work for our 11n access point and controllers. Depreciation expenses increased $0.3 million due to an increase in tooling and equipment used in research and development activities.
During the first six months of fiscal 2011, research and development expenses increased 62.4% compared to the first six months of fiscal 2010, primarily due to an increase of $11.9 million in personnel and related costs, including an increase in stock-based compensation of $5.6 million. The increase is directly related to our increase in headcount. Facilities expenses increased $1.3 million also due to the increase in headcount and the acquisition of Azalea facilities. Expenses for consulting and outside agencies increased by $1.3 million and depreciation expenses increased $0.5 million.

 

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Sales and Marketing Expenses
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
Sales and marketing expenses
  $ 36,936     $ 26,576     $ 70,350     $ 51,316  
Percent of total revenues
    39.4 %     42.5 %     39.7 %     42.7 %
Sales and marketing expenses increased 39.0% during the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010. Personnel and related costs increased $7.2 million primarily due to an increase in headcount of 88 new employees, including 6 employees from our Azalea acquisition. An increase in stock-based compensation of $3.1 million contributed to the increase in personnel and related costs. Consequently, facilities expenses increased $0.4 million. Commission expense increased $1.7 million year over year corresponding to the increase in revenue. Marketing expenses increased $0.7 million due to new product launches and user-group conventions we hosted. Recruiting expenses increased $0.2 million and costs for internal demonstration equipment increased $0.2 million, both due to the increase in headcount.
During the first six months of fiscal 2011, sales and marketing expenses increased 37.1% compared to the first six months of fiscal 2010. Personnel and related costs increased $12.5 million primarily due to the increase in headcount. An increase in stock-based compensation of $5.3 million contributed to the increase in personnel and related costs. Consequently, facilities expenses increased $0.7 million. Commission expense increased $3.5 million corresponding to the increase in revenue. Marketing expenses increased $1.5 million due to new product launches and user-group conventions we hosted. Recruiting expenses increased $0.5 million and costs for internal demonstration equipment increased $0.2 million, both due to the increase in headcount.
General and Administrative Expenses
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
General and administrative expenses
  $ 10,183     $ 7,628     $ 17,371     $ 14,760  
Percent of total revenues
    10.9 %     12.2 %     9.8 %     12.3 %
During the first quarter of fiscal 2011, general and administrative increased 33.5% compared to the first quarter of fiscal 2010. Personnel expenses increased $2.0 million due to an increase in headcount of 34 new employees, including 7 employees from our Azalea acquisition. An increase in stock-based compensation of $1.0 million contributed to the increase in personnel and related costs. Consequently, facilities increased by $0.3 million. Fees for accounting services increased $0.2 million primarily due to additional work related to our acquisitions.
General and administrative expenses in the first six months of fiscal 2011 increased 17.7% compared to the same period in fiscal 2010. Personnel expenses increased $2.l million due to the increase in headcount and an increase in stock-based compensation of $0.8 million. Facilities expenses increased $0.4 million also due to the increase in headcount. Fees for accounting services increased $0.3 million and temporary labor expenses increased $0.1 million. These increases were offset by a decrease of $0.4 million in legal fees as we completed the litigation with Motorola in the first quarter of fiscal 2010.
Litigation Reserves
During the first quarter of fiscal 2010, we entered into a Patent Cross License and Settlement Agreement with Motorola. As part of the Settlement Agreement, we agreed to pay Motorola $19.8 million. During the second quarter of fiscal 2010, we recorded an additional reserve of $0.5 million related to a legal matter. There were no similar transactions in fiscal 2011.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income and foreign currency exchange gains and losses.
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
    (in thousands)     (in thousands)  
Interest income
  $ 240     $ 187     $ 474     $ 398  
Other income (expense), net
    (61 )     (148 )     1,583       (244 )
 
                       
Total other income (expense), net
  $ 179     $ 39     $ 2,057     $ 154  
 
                       

 

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Interest income increased slightly during the second quarter and first six months of fiscal 2011 compared to the same periods in fiscal 2010. The increases are primarily due to higher cash and investment balances in interest-earning accounts. Our average interest-earning cash and investment balance for the second quarter of fiscal 2011 was $143.4 million compared to $113.6 million for the second quarter of fiscal 2010. Our average interest-earning cash and investment balance for the first six months of fiscal 2011 was $141.8 million compared to $106.0 million for the same period in fiscal 2010
Other income (expense), net increased during the second quarter of fiscal 2011 compared to the second quarter of fiscal 2010 due to foreign currency gains and losses driven by the remeasurement of foreign currency transactions into U.S. dollars. For the first six months of fiscal 2011, other income (expense), net increased $1.8 million compared to the first six months of fiscal 2010 primarily as a result of the change in the valuation of our contingent rights liability related to the acquisition of Azalea Networks. See Note 2 of the Notes to Consolidated Financial Statements for a further discussion.
Provision for Income Taxes
For the first and second quarter of fiscal 2011 we generated operating income and operating loss, respectively. We also generated book and taxable income in the U.S. and specific foreign jurisdictions for the first and second quarters of fiscal 2011 without consideration of windfall tax benefits. For the first and second quarters of fiscal 2010, we generated consolidated book losses but generated taxable income in most U.S. and foreign jurisdictions.
Liquidity and Capital Resources
                 
    January 31,     July 31,  
    2011     2010  
    (in thousands)  
Working capital
  $ 160,555     $ 133,927  
Cash and cash equivalents
    49,258       31,254  
Short-term investments
  $ 138,568     $ 124,167  
                 
    Six months ended Janaury 31,  
    2011     2010  
    (in thousands)  
Cash provided by operating activities
  $ 25,531     $ 4,508  
Cash used in investing activities
    (23,898 )     (11,530 )
Cash provided by financing activities
  $ 16,369     $ 4,135  
Cash and cash equivalents are comprised of cash, sweep funds and money market funds with an original maturity of 90 days or less at the time of the purchase. Short-term investments include corporate bonds and notes, U.S. government agency securities, U.S. treasury bills, commercial paper and other money market securities. Cash, cash equivalents and short-term investments increased $32.4 million during the first six months of fiscal 2011 from $155.4 million as of July 31, 2010 to $187.8 million as of January 31, 2011.
Most of our sales contracts are denominated in United States dollars including sales contracts with international customers. As such, the increase in our revenues derived from international customers has not affected our cash flows from operations as these are not affected by movement in exchange rates. As we fund our international operations, our cash and cash equivalents are affected by changes in exchange rates.
Cash Flows from Operating Activities
Our cash flows from operating activities will continue to be affected principally by our working capital requirements and the extent to which we increase spending on personnel. The timing of hiring sales personnel in particular affects cash flows as there is a lag between the hiring of sales personnel and the generation of revenue and cash flows from sales personnel. Our largest source of operating cash flows is cash collections from our customers. Our primary uses of cash from operating activities are for personnel related expenditures, purchases of inventory, and rent payments.
Cash provided by operating activities increased $21.0 million during the first six months of fiscal 2011 compared to the first six months of fiscal 2010 due to increases in deferred revenue and other accrued liabilities, an increase in the amount of non-cash adjustments relating to stock-based compensation and depreciation and amortization, and write-downs for excess and obsolete inventory. Cash provided by operating activities was offset by increases in accounts receivable, inventory, and the non-cash adjustment for the change in the carrying value of our contingent liability resulting from the Azalea Networks acquisition.
Cash Flows from Investing Activities
Cash used in investing activities during the first six months of fiscal 2011 increased $12.4 million compared to the first six months of fiscal 2010. We continue to invest our excess cash balances in short-term investments. Some of the proceeds from the sale and maturity of these investments were used to purchase property and equipment of $4.3 million during the first six months of fiscal 2011. Further, we completed two acquisitions during the first six months of fiscal 2011 for a total of $4.3 million in cash, net of cash received. See Note 2 of the Notes to Consolidated Financial Statements.

 

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Cash Flows from Financing Activities
Cash provided by financing activities increased $12.2 million in the first six months of fiscal 2011 compared to the first six months of fiscal 2010. The cash proceeds from the issuance of common stock in conjunction with our 2007 Equity Incentive Plan and Employee Stock Purchase Plan increased substantially year over year primarily due to increased exercises of stock options by our employees as a result of the increase in our stock price, and the increase in the amount of contributions to our Employee Stock Purchase Plan.
Based on our current cash, cash equivalents and short-term investments we expect that we will have sufficient resources to fund our operations for the next 12 months. However, we may need to raise additional capital or incur additional indebtedness to continue to fund our operations in the future. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of expansion into new territories, the timing of introductions of new products and enhancements to existing products, and the continuing market acceptance of our products. Although we have no current agreements, commitments, plans, proposals or arrangements, written or otherwise, with respect to any material acquisitions, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.
Contractual Obligations
The following is a summary of our contractual obligations:
                                         
            Less than                     More than  
    Total     1 year     1 - 3 years     3 - 5 years     5 years  
    (in thousands)  
Operating leases
  $ 16,443     $ 3,507     $ 6,265     $ 5,440     $ 1,231  
Non-cancellable inventory purchase commitments (1)
    23,734       23,734                    
 
                             
Total contractual obligations
  $ 40,177     $ 27,241     $ 6,265     $ 5,440     $ 1,231  
 
                             
     
(1)   We outsource the production of our hardware to third-party manufacturing suppliers. We enter into various inventory related purchase agreements with these suppliers. Under the agreement with our main contract manufacturer, 40% of the order quantities can be rescheduled or are cancelable by giving notice 60 days prior to the expected shipment date, and 20% of the order quantities can be rescheduled or are cancelable by giving notice 30 days prior to the expected shipment date. Orders are not cancelable within 30 days prior to the expected shipment date.
Item 3.   Quantitative and Qualitative Disclosures about Market Risk
Foreign Currency Risk
Most of our sales contracts are denominated in United States dollars, and therefore, our revenue is not subject to significant foreign currency risk. Our operating expenses and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the British Pound, Euro and Japanese Yen. To date, we have not entered into any hedging contracts because expenses in foreign currencies have been insignificant to date, and exchange rate fluctuations have had little impact on our operating results and cash flows.
Interest Rate Sensitivity
We had cash, cash equivalents and short-term investments totaling $187.8 million and $155.4 million at January 31, 2011 and July 31, 2010, respectively. The cash, cash equivalents and short-term investments are held for working capital purposes. We do not use derivative financial instruments in our investment portfolio. We have an investment portfolio of fixed income securities that are classified as “available-for-sale securities.” These securities, like all fixed income instruments, are subject to interest rate risk and will fall in value if market interest rates increase. We attempt to limit this exposure by investing primarily in short-term securities. Due to the short duration and conservative nature of our investment portfolio, a movement of 10% in market interest rates would not have a material impact on our operating results and the total value of the portfolio over the next fiscal year. If overall interest rates had fallen by 10% in fiscal 2010, our interest income on cash, cash equivalents and short-term investments would have declined less than $0.1 million assuming consistent investment levels.

 

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Item 4.   Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as amended (the “Exchange Act”). In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Based on our evaluation, our chief executive officer and chief financial officer concluded that, as of January 31, 2011, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the second quarter of fiscal 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Internal control over financial reporting means a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
PART II. OTHER INFORMATION
Item 1.   Legal Proceedings
From time to time, we are involved in claims and legal proceedings that arise in the ordinary course of business. We expect that the number and significance of these matters will increase as our business expands. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements which, if required, may not be available on terms favorable to us or at all. If management believes that a loss arising from these matters is probable and can be reasonably estimated, we record the amount of the loss. As additional information becomes available, any potential liability related to these matters is assessed and the estimates revised. Based on currently available information, management does not believe that the ultimate outcomes of these unresolved matters, individually and in the aggregate, are likely to have a material adverse effect on our financial position, liquidity or results of operations. However, litigation is subject to inherent uncertainties, and our view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a material adverse impact on our financial position and results of operations or liquidity for the period in which the unfavorable outcome occurs or becomes probable, and potentially in future periods.
Item 1A.   Risk Factors
Risks Related to Our Business and Industry
Our business, operating results and growth rates may be adversely affected by unfavorable economic and market conditions.
While we have seen improvements in the overall macroeconomic environment and our revenues have increased, economic conditions worldwide have negatively impacted our business in our recent history. We believe in the long-term growth prospects of the WLAN market, but the deterioration in overall economic conditions and, in particular, tightening in the credit markets and reduced spending by both enterprises and consumers have significantly impacted various industries on which we rely for purchasing our products. This has led to reductions in capital expenditures by end user customers for our products, longer sales cycles, the deferral or delay of purchase commitments for our products, increased competition, and the deferral or delay of reviews by end user customers of their existing infrastructure that could have otherwise driven demand for our products. These factors have impacted our operating results and could create uncertainty for the future. For example, as the U.S. and global economies weakened, in the second and third quarters of fiscal 2009, our total revenues decreased sequentially over the same period. In addition, our business depends on the overall demand for IT and on the economic health of our current and prospective customers. We cannot be assured of the level of IT spending, the deterioration of which could have a material adverse effect on our results of operations and growth rates. The purchase of our products or willingness to replace existing infrastructure in some vertical markets may be discretionary and may involve a significant commitment of capital and other resources. Therefore, weak economic conditions, or a reduction in IT spending would likely adversely impact our business, operating results and financial condition in a number of ways, including longer sales cycles, lower prices for our products and services, and reduced unit sales. In addition, if interest rates rise or foreign exchange rates weaken for our international customers, overall demand for our products and services could be further dampened, and related IT spending may be reduced.

 

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We compete in new and rapidly evolving markets and have a limited operating history, which makes it difficult to predict our future operating results.
We were incorporated in February 2002 and began commercial shipments of our products in June 2003. As a result of our limited operating history, it is very difficult to forecast our future operating results. In addition, we operate in an industry characterized by rapid technological change. Our prospects should be considered and evaluated in light of the risks and uncertainties frequently encountered by companies in rapidly evolving markets characterized by rapid technological change, changing customer needs, evolving industry standards and frequent introductions of new products and services. These risks and difficulties include challenges in accurate financial planning as a result of limited historical data and the uncertainties resulting from having had a relatively limited time period in which to implement and evaluate our business strategies as compared to older companies with longer operating histories.
In addition, our products are designed to be compatible with industry standards for secure communications over wireless and wireline networks. As we encounter changing standards, customer requirements and competitive pressures, we likely will be required to reposition our product and service offerings and introduce new products and services. We may not be successful in doing so in a timely and appropriately responsive manner, or at all. Our failure to address these risks and difficulties successfully could materially harm our business and operating results.
Our operating results may fluctuate significantly, which makes our future results difficult to predict and could cause our operating results to fall below expectations.
Our annual and quarterly operating results have fluctuated in the past and may fluctuate significantly in the future due to a variety of factors, many of which are outside of our control.
Furthermore, our product revenues generally reflect orders shipped in the same quarter they are received, and a substantial portion of our orders are often received in the last month of each fiscal quarter, a trend that may continue. As a result, if we are unable to ship orders received in the last month of each fiscal quarter, even though we may have business indicators about customer demand during a quarter, we may experience revenue shortfalls, and such shortfalls may materially adversely affect our earnings because we may not be able to adequately and timely adjust our expense levels.
In addition to other risk factors listed in this “Risk Factors” section, factors that may cause our operating results to fluctuate include:
  the impact of unfavorable worldwide economic and market conditions, including the restricted credit environment impacting the credit of our channel partners and end user customers;
 
  our ability to develop and maintain our relationship with our VARs, VADs, OEMs and other partners;
 
  fluctuations in demand, sales cycles and prices for our products and services;
 
  reductions in customers’ budgets for information technology purchases and delays in their purchasing cycles;
 
  the sale of our products in the timeframes we anticipate, including the number and size of orders in each quarter;
 
  our ability to develop, introduce and ship in a timely manner, new products and product enhancements that meet customer requirements;
 
  our dependence on several large vertical markets, including the government, healthcare and education vertical markets;
 
  the timing of product releases or upgrades by us or by our competitors;
 
  any significant changes in the competitive dynamics of our markets, including new entrants, or further consolidation;
 
  our ability to control costs, including our operating expenses, and the costs of the components we purchase;
 
  product mix and average selling prices, as well as increased discounting of products by us and our competitors;
 
  the proportion of our products that are sold through direct versus indirect channels;
 
  our ability to maintain volume manufacturing pricing from our contract manufacturers, and our component suppliers;
 
  our contract manufacturers and component suppliers ability to meet our product demand forecasts;
 
  the potential need to record incremental inventory reserves for products that may become obsolete due to our new product introductions;
 
  growth in our headcount and other related costs incurred in our customer support organization;
 
  the timing of revenue recognition in any given quarter as a result of revenue recognition rules;
 
  the regulatory environment for the certification and sale of our products; and
 
  seasonal demand for our products, some of which may not be currently evident due to our revenue growth during fiscal 2010 and 2011.

 

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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 or sustain profitability in the future.
We have a history of losses and only achieved profitability during the fourth quarter of fiscal 2010 and first quarter of fiscal 2011. We experienced net losses of $2.8 million and $0.7 million for the second quarter and first six months of fiscal 2011, respectively. We experienced net losses of $4.4 million and $29.1 million for the second quarter and first six months of fiscal 2010, respectively. As of January 31, 2011 and July 31, 2010, our accumulated deficit was $176.3 million and $175.6 million, respectively. Expenses associated with the continued development and expansion of our business, including expenditures to hire additional personnel for sales and marketing and technology development, could limit our ability to sustain operating profits. If we fail to increase revenues or manage our cost structure, we may not sustain profitability in the future. As a result, our business could be harmed, and our stock price could decline.
Our sales cycles can be long and unpredictable, and our sales efforts require considerable time and expense. As a result, our sales are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate significantly.
The timing of our revenues is difficult to predict. Our sales efforts involve educating our customers about the use and benefits of our products, including the technical capabilities of our products and the potential cost savings achieved by organizations that utilize our products. Customers typically undertake a significant evaluation process, which frequently involves not only our products but also those of our competitors and can result in a lengthy sales cycle, which typically ranges four to nine months in length but can be as long as 18 months. We spend substantial time, effort and money in our sales efforts without any assurance that our efforts will produce any sales. Over the last year, we have experienced longer sales cycles in connection with customers evaluating our 802.11n solution and in light of general economic conditions in certain verticals. In addition, product purchases are frequently subject to budget constraints, multiple approvals, and unplanned administrative, processing and other delays. Specifically, we view the federal vertical as highly dependent on large transactions, and therefore we could experience fluctuations from period to period in this vertical. 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 highly competitive and is influenced by the following competitive factors:
  comprehensiveness of the solution;
 
  performance of software and hardware products;
 
  ability to deploy easily into existing networks;
 
  interoperability with other devices;
 
  scalability of solution;
 
  ability to provide secure mobile access to the network;
 
  speed of mobile connectivity offering;
 
  return on investment;
 
  ability to allow centralized management of products; and
 
  ability to obtain regulatory and other industry certifications.
We expect competition to intensify in the future as other companies introduce new products in the same markets we serve or intend to enter and as the market continues to consolidate. This competition could result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and failure to increase, or the loss of, market share, any of which would likely seriously harm our business, operating results or financial condition. If we do not keep pace with product and technology advances, there could be a material adverse effect on our competitive position, revenues and prospects for growth.

 

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A number of our current or potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we do. Potential customers may prefer to purchase from their existing suppliers rather than a new supplier, regardless of product performance or features. Currently, we compete with a number of large and well established public companies, including Cisco Systems (primarily through its Wireless Networking Business Unit), Hewlett-Packard and Motorola, as well as smaller companies and new market entrants, any of which could reduce our market share, require us to lower our prices, or both.
We expect increased competition from other established and emerging companies if our market continues to develop and expand. Our channel partners could market products and services that compete with our products and services. In addition, some of our competitors have made acquisitions or entered into partnerships or other strategic relationships with one another to offer a more comprehensive solution than they individually had offered. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry and as companies enter into partnerships or are acquired. Many of the companies driving this consolidation trend have significantly greater financial, technical and other resources than we do and are better positioned to acquire and offer complementary products and technologies. The companies resulting from these possible consolidations may create more compelling product offerings and be able to offer greater pricing flexibility, making it more difficult for us to compete effectively, including on the basis of price, sales and marketing programs, technology or product functionality. Continued industry consolidation may adversely impact customers’ perceptions of the viability of smaller and even medium-sized technology companies and, consequently, customers’ willingness to purchase from such companies. These pressures could materially adversely affect our business, operating results and financial condition.
We sell a majority of our products through VADs, VARs, and OEMs. If these channel partners on which we rely do not perform their services adequately or efficiently, or if they exit the industry or have financial difficulties, there could be a material adverse effect on our revenues and our cash flow.
Our future success is highly dependent upon establishing and maintaining successful relationships with a variety of VADs, VARs, and OEMs, which we refer to as our indirect channel. We have dedicated a significant amount of effort to increase the use of our VADs and VARs in each of our theatres of operations. The percentage of our total revenues fulfilled from sales through our indirect channel was 93.3% and 91.6% for the three and six months ended January 31, 2011, respectively. The percentage of our total revenues fulfilled from sales through our indirect channel was 90.5% and 90.9% for the three and six months ended January 31, 2010, respectively. We expect that over time, indirect channel sales will continue to constitute a significant majority of our total revenues. Accordingly, our revenues depend in large part on the effective performance of our channel partners. Three of our channel partners accounted for more than 10% of total revenues for the second quarter of fiscal 2011. The table below represents the percentage of total revenues from our top channel partners:
                                 
    Three months ended January 31,     Six months ended January 31,  
    2011     2010     2011     2010  
 
ScanSource, Inc. (Catalyst)
    17.1 %     13.9 %     18.6 %     13.6 %
Alcatel-Lucent
    15.7 %     13.3 %     13.6 %     12.0 %
Avnet Logistics U.S. LP
    15.7 %     16.1 %     15.1 %     14.1 %
Our agreements with our partners provide that they use reasonable commercial efforts to sell our products on a perpetual basis unless the agreement is otherwise terminated by either party. Our agreement with Alcatel-Lucent contains a “most-favored nations” clause, pursuant to which we agreed to lower the price at which we sell products to Alcatel-Lucent in the event that we agree to sell the same or similar products at a lower price to a similar customer on the same or similar terms and conditions. However, the specific terms of this “most-favored nations” clause are narrow and specific, and we have not to date incurred any obligations related to this term in the agreement.
Some of our indirect channel partners may have insufficient financial resources and may not be able to withstand changes in worldwide business conditions, including economic downturns, abide by our inventory and credit requirements, or have the ability to meet their financial obligations to us. As of January 31, 2011, three of our channel partners individually accounted for more than 10% of accounts receivable. ScanSource, Inc. (“Catalyst”) accounted for 16.1%, Avnet Logistics U.S. LP (“Avnet”) accounted for 15.7% and Alcatel-Lucent accounted for 11.7% of total accounts receivable. As of July 31, 2010, Catalyst accounted for 31.6% and Avnet accounted for 18.2% of total accounts receivable. If the indirect channel partners on which we rely do not perform their services adequately or efficiently, fail to meet their obligations to us, or if they exit the industry and we are not able to quickly find adequate replacements, there could be a material adverse effect on our revenues, cash flow and market share. By relying on these indirect channels, we may have less contact with the end users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing customer requirements and respond to evolving customer needs. In addition, our indirect channel partners may receive pricing terms that allow for volume discounts off of list prices for the products they purchase from us, which reduce our margins to the extent revenues from such channel partners increase as a proportion of our overall revenues.

 

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Recruiting and retaining qualified channel partners and training them in our technology and product offerings requires significant time and resources. In order to develop and expand our distribution channel, we must continue to scale and improve our processes and procedures that support our channel partners, including investment in systems and training, and those processes and procedures may become increasingly complex and difficult to manage. We have no minimum purchase commitments with any of our VADs, VARs, or OEMs, and our contracts with these channel partners do not prohibit them from offering products or services that compete with ours or from terminating our contract on short notice. Our competitors may be effective in providing incentives to existing and potential channel partners to favor their products or to prevent or reduce sales of our products. Our channel partners may choose not to focus primarily on the sale of our products or offer our products at all. Our failure to establish and maintain successful relationships with indirect channel partners would likely materially adversely affect our business, operating results and financial condition.
We depend upon the development of new products and enhancements to our existing products. If we fail to predict and respond to emerging technological trends and our customers’ changing needs, we may not be able to remain competitive.
We may not be able to anticipate future market needs or be able to develop new products or product enhancements to meet such needs. For example, we anticipate a need to continue to increase the mobility of our solution, and certain customers have delayed, and may in the future delay, purchases of our products until either new versions of those products are available or the customer evaluations are completed. If we fail to develop new products or product enhancements, our business could be adversely affected, especially if our competitors are able to introduce solutions with such increased functionality. In addition, as new mobile applications are introduced, our success may depend on our ability to provide a solution that supports these applications.
We are active in the research and development of new products and technologies and enhancing our current products. However, research and development in the enterprise mobility industry is complex and filled with uncertainty. If we expend a significant amount of resources on research and development and our efforts do not lead to the successful introduction of products that are competitive in the marketplace, there could be a material adverse effect on our business, operating results, financial condition and market share. In addition, it is common for research and development projects to encounter delays due to unforeseen problems, resulting in low initial volume production, fewer product features than originally considered desirable and higher production costs than initially budgeted, which may result in lost market opportunities. In addition, any new products or product enhancements that we introduce may not achieve any significant degree of market acceptance or be accepted into our sales channel by our channel partners. There could be a material adverse effect on our business, operating results, financial condition and market share due to such delays or deficiencies in the development, manufacturing and delivery of new products.
Once a product is in the marketplace, its selling price often decreases over the life of the product, especially after a new competitive product is publicly announced. To lessen the effect of price decreases, our product management team attempts to reduce development and manufacturing costs in order to maintain or improve our margins. However, if cost reductions do not occur in a timely manner, there could be a material adverse effect on our operating results and market share. Further, the introduction of new products may decrease the demand for older products currently included in our inventory balances. As a result, we may need to record incremental inventory reserves for the older products that we do not expect to sell. This may have a material adverse effect on our operating results and market share.
We manufacture our products to comply with standards established by various standards bodies, including the Institute of Electrical and Electronics Engineers, Inc. (“IEEE”). If we are not able to adapt to new or changing standards that are ratified by these bodies, our ability to sell our products may be adversely affected. For example, prior to the ratification of the 802.11n wireless LAN standard (“11n”) by the IEEE in 2009, we had been developing and were offering for sale products that complied with the draft standard that the IEEE had not yet ratified. Although the IEEE ratified the 11n standard and did not modify the draft of the 11n standard, the IEEE could modify the standard in the future. We remain subject to any changes adopted by various standards bodies, which would require us to modify our products to comply with the new standards, require additional time and expense and could cause a disruption in our ability to market and sell the affected products.
We may engage in future acquisitions that could disrupt our business, cause dilution to our stockholders and harm our business, operating results and financial condition.
In December 2010, we completed our acquisition of substantially all of the assets of an Australian company and in September 2010, we completed our acquisition of Azalea Networks. We are currently integrating the acquired products into our secure mobility solutions, as well as providing products and continuing support to existing customers and partners of the acquired businesses. The acquisition of Azalea was our first significant international acquisition, and, as a result, our ability as an organization to complete and integrate international 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. These acquisitions and future acquisitions may be viewed negatively by customers, financial markets or investors. In addition, these acquisitions any future acquisitions that we make could lead to difficulties in integrating personnel and operations from the acquired businesses and in retaining and motivating key personnel from these businesses. Acquisitions may disrupt our ongoing operations, divert management from day-to-day responsibilities, increase our expenses and adversely impact our business, operating results and financial condition. Future acquisitions may reduce our cash available for operations and other uses and could result in an increase in amortization expense related to identifiable assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt, which could harm our business, operating results and financial condition.

 

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As a result of the fact that we outsource the manufacturing of our products to contract manufacturers, we do not have the ability to ensure quality control over the manufacturing process. Furthermore, if there are significant changes in the financial or business condition of our contract manufacturers, our ability to supply quality products to our customers may be disrupted.
As a result of the fact that we outsource the manufacturing of our products to contract manufacturers, we are subject to the risk of supplier failure and customer dissatisfaction with the quality or performance of our products. Quality or performance failures of our products or changes in the financial or business condition of our contract manufacturers could disrupt our ability to supply quality products to our customers and thereby have a material adverse effect on our business, revenues and financial condition.
Our orders with our contract manufacturers represent a relatively small percentage of the overall orders received by them from their customers. As a result, fulfilling our orders may not be considered a priority in the event our contract manufacturers are constrained in their abilities to fulfill all of their customer obligations in a timely manner. We provide demand forecasts to our contract manufacturers. If we overestimate our requirements, our contract manufacturers may assess charges, or we may have liabilities for excess inventory, each of which could negatively affect our gross 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, our contract manufacturers may have inadequate materials and components required to produce our products. This could result in an interruption of the manufacturing of our products, delays in shipments and deferral or loss of revenue. In addition, on occasion we have underestimated our requirements, and, as a result, we have been required to pay additional fees to our contract manufacturers in order for manufacturing to be completed and shipments to be made on a timely basis.
If any of our contract manufacturers suffer an interruption in their business, or experiences delays, disruptions or quality control problems in their manufacturing operations, or we have to change or add additional contract manufacturers, our ability to ship products to our customers would be delayed, and our business, operating results and financial condition would be adversely affected.
Our contract manufacturers purchase some components, subassemblies and products from a single supplier or a limited number of suppliers, and with respect to some of these suppliers, we have entered into license agreements that allow us to use their components in our products. The loss of any of these suppliers or the termination of any of these license agreements may cause us to incur additional set-up costs, result in delays in manufacturing and delivering our products, or cause us to carry excess or obsolete inventory.
Shortages in components that we use in our products are possible, and our ability to predict the availability of such components may be limited. While components and supplies are generally available from a variety of sources, we currently depend on a limited number of suppliers for several components for our equipment and certain subassemblies and products. We rely on our contract manufacturers to obtain the components, subassemblies and products necessary for the manufacture of our products, including those components, subassemblies and products that are only available from a single supplier or a limited number of suppliers.
For example, our solution incorporates both software products and hardware products, including a series of high-performance programmable mobility controllers and a line of wired and wireless access points. The chipsets that our contract manufacturers source and incorporate in our hardware products are currently available only from a limited number of suppliers, with whom neither we nor our contract manufacturers have entered into supply agreements. All of our access points incorporate components from Atheros, and some of our mobility controllers incorporate components from Broadcom and Netlogic. We have entered into license agreements with Atheros, Broadcom and Netlogic, the termination of which could have a material adverse effect on our business. Our license agreements with Atheros, Broadcom and Netlogic have perpetual terms in that they will automatically be renewed for successive one-year periods unless the agreement is terminated prior to the end of the then-current term. As there are no other sources for identical components, in the event that our contract manufacturers are unable to obtain these components from Atheros, Broadcom or Netlogic, we would be required to redesign our hardware and software in order to incorporate components from alternative sources. All of our product revenues are dependent upon the sale of products that incorporate components from Atheros, Broadcom or Netlogic.
In addition, for certain components, subassemblies and products for which there are multiple sources, we are still subject to potential price increases and limited availability due to market demand for such components, subassemblies and products. In the past, unexpected demand for communication products caused worldwide shortages of certain electronic parts. If such shortages occur in the future, our business would be adversely affected. We carry very little to no inventory of our product components, and we and our contract manufacturers rely on our suppliers to deliver necessary components in a timely manner. We and our contract manufacturers rely on purchase orders rather than long-term contracts with these suppliers. As a result, even if available, we or our contract manufacturers may not be able to secure sufficient components at reasonable prices or of acceptable quality to build products in a timely manner and, therefore, may not be able to meet customer demands for our products, which would have a material adverse effect on our business, operating results and financial condition.

 

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Our international sales and operations subject us to additional risks that may adversely affect our operating results.
We derive a significant portion of our revenues from customers outside the United States. We have sales and technical support personnel in numerous countries worldwide. In addition, a portion of our engineering and order management efforts are currently handled by personnel located in India and China, and we expect to expand our offshore development efforts within India and China and possibly in other countries. We expect to continue to add personnel in additional countries. Our international operations subject us to a variety of risks, including:
  the difficulty 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;
 
  limited protection for intellectual property rights in some countries; and
 
  increased cost of terminating international employees in some countries.
As we continue to expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these and other risks associated with our international operations. Our failure to manage any of these risks successfully could harm our international operations and reduce our international sales, adversely affecting our business, operating results and financial condition.
If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.
We depend on our ability to protect our proprietary technology. We protect our proprietary information and technology through licensing agreements, third-party nondisclosure agreements and other contractual provisions, as well as through patent, trademark, copyright and trade secret laws in the United States and similar laws in other countries. There can be no assurance that these protections will be available in all cases or will be adequate to prevent our competitors from copying, reverse engineering or otherwise obtaining and using our technology, proprietary rights or products. For example, the laws of certain countries in which our products are manufactured or licensed do not protect our proprietary rights to the same extent as the laws of the United States. In addition, third parties may seek to challenge, invalidate or circumvent our patents, trademarks, copyrights and trade secrets, or applications for any of the foregoing. There can be no assurance that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology or design around our proprietary rights. In each case, our ability to compete could be significantly impaired. To prevent substantial unauthorized use of our intellectual property rights, it may be necessary to prosecute actions for infringement and/or misappropriation of our proprietary rights against third parties. Any such action could result in significant costs and diversion of our resources and management’s attention, and there can be no assurance that we will be successful in such action. Furthermore, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforce their intellectual property rights than we do. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property.
Claims by others that we infringe their proprietary technology could harm our business.
Third parties have asserted and may in the future assert claims of infringement of intellectual property rights against us or against our customers or channel partners for which we may be liable. For example, in August 2007, Symbol Technologies, Inc. and Wireless Valley Communications, Inc., both subsidiaries of Motorola, Inc., filed suit against us asserting infringement of certain U.S. patents, and, in November 2009, we entered into a settlement agreement with Motorola, Inc., Symbol Technologies, Inc. and Wireless Valley Communications, Inc. (collectively “Motorola”), pursuant to which we paid Motorola $19.8 million. Due to the rapid pace of technological change in our industry, much of our business and many of our products rely on proprietary technologies of third parties, and we may not be able to obtain, or continue to obtain, licenses from such third parties on reasonable terms. As our business expands and the number of products and competitors in our market increases and overlaps occur, we expect that infringement claims may increase in number and significance. Intellectual property lawsuits are subject to inherent uncertainties due to the complexity of the technical issues involved, and we cannot be certain that we will be successful in defending ourselves against intellectual property claims. Furthermore, a successful claimant could secure a judgment that requires us to pay substantial damages or prevents us from distributing certain products or performing certain services. In addition, we might be required to seek a license for the use of such intellectual property, which may not be available on commercially acceptable terms or at all. Alternatively, we may be required to develop non-infringing technology, which could require significant effort and expense and may ultimately not be successful. Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or require us to enter into royalty or licensing agreements.
Impairment of our goodwill or other assets would negatively affect our results of operations.
Our acquisitions have resulted in total goodwill of $33.1 million and intangible assets of $25.0 million as of January 31, 2011. Goodwill is reviewed for impairment at least annually or sooner under certain circumstances. Other intangible assets that are deemed to have finite useful lives are amortized over their useful lives but must be reviewed for impairment when events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Screening for and assessing whether impairment indicators exist, or if events or changes in circumstances have occurred, including market conditions, operating fundamentals, competition and general economic conditions, requires significant judgment. Therefore, we cannot assure you that a charge to operations will not occur as a result of future goodwill and intangible asset impairment tests. If impairment is deemed to exist, we would write down the recorded value of these intangible assets to their fair values. If and when these write-downs do occur, they could harm our business, financial condition, and results of operations.

 

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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. If we fail to effectively integrate new officers into our organization, our business could be harmed.
Our success is substantially dependent upon the performance of our senior management. All of our executive officers are at-will employees, and we do not maintain any key-man life insurance policies. The loss of the services of any members of our management team may significantly delay or prevent the achievement of our product development and other business objectives and could harm our business. Our success also is substantially dependent upon our ability to attract additional personnel for all areas of our organization, particularly in our sales, research and development, and customer service departments. 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.
Our future performance will depend in part on our ability to successfully integrate any new executive officers into our management team and develop an effective working relationship among senior management. We recently announced that we have initiated a search for a new Chief Financial Officer following the announcement by Steffan Tomlinson, our current Chief Financial Officer, that he is resigning effective March 2011 to take a position in venture capital. If we fail to identify, recruit and integrate a new Chief Financial Officer, or any other executive officer whom we may hire in the future, and create effective working relationships among them and other members of management, our business operating results and financial condition could be adversely affected.
If we fail to manage future growth effectively, our business would be harmed.
We have expanded our operations significantly since inception and anticipate that further significant expansion will be required. We intend to increase our market penetration and extend our geographic reach through our network of channel partners. We also plan to increase offshore operations by establishing additional offshore capabilities for certain engineering functions. This future growth, if it occurs, will place significant demands on our management, infrastructure and other resources. To manage any future growth, we will need to hire, integrate and retain highly skilled and motivated employees. If we do not effectively manage our growth, our business, operating results and financial condition could be adversely affected.
Our ability to sell our products is highly dependent on the quality of our support and services offerings, and our failure to offer high quality support and services would have a material adverse effect on our sales and results of operations.
Once our products are deployed within our end customers’ networks, they depend on our support organization to resolve any issues relating to our products. A high level of support is critical for the successful marketing and sale of our products. If we or our channel partners do not effectively assist our end customers in deploying our products, succeed in helping our end customers quickly resolve post-deployment issues, or provide effective ongoing support, it would adversely affect our ability to sell our products to existing customers and could harm our reputation with potential customers. In addition, as we expand our operations internationally, our support organization will face additional challenges including those associated with delivering support, training and documentation in languages other than English. As a result, our failure, or the failure of our channel partners, to maintain high quality support and services would have a material adverse effect on our business, operating results and financial condition.
Enterprises are increasingly concerned with the security of their data, and to the extent they elect to encrypt data between the end user and the server, our products will become less effective.
Our products depend on the ability to identify applications. Our products currently do not identify applications if the data is encrypted as it passes through our mobility controllers. Since most organizations currently encrypt most of their data transmissions only between sites and not on the LAN, the data is not encrypted when it passes through our mobility controllers. If more organizations elect to encrypt their data transmissions from the end user to the server, our products will offer limited benefits unless we have been successful in incorporating additional functionality into our products that address those encrypted transmissions. At the same time, if our products do not provide the level of network security expected by our customers, our reputation and brand would be damaged, and we would expect to experience decreased sales. Our failure to provide such additional functionality and expected level of network security could adversely affect our business, operating results and financial condition.

 

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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. 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, or breach of warranty, including claims relating to changes to our products made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.
Our use of open source software could impose limitations on our ability to commercialize our products.
We incorporate open source software into our products. Although we monitor our use of open source closely, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that such licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. In such event, we could be required to seek licenses from third parties in order to continue offering our products, to re-engineer our products or to discontinue the sale of our products in the event re-engineering cannot be accomplished on a timely basis, any of which could adversely affect our business, operating results and financial condition.
We rely on the availability of third-party licenses.
Many of our products are designed to include software or other intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various aspects of these products. There can be no assurance that the necessary licenses would be available on acceptable terms, if at all. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms, or the need to engage in litigation regarding these matters, could have a material adverse effect on our business, operating results, and financial condition. Moreover, the inclusion in our products of software or other intellectual property licensed from third parties on a nonexclusive basis could limit our ability to protect our proprietary rights in our products.
Enterprises may have slow WAN connections between some of their locations that may cause our products to become less effective.
Our mobility controllers and network management software were initially designed to function at LAN-like speeds in an office building or campus environment. In order to function appropriately, our mobility controllers synchronize with each other over network links. The ability of our products to synchronize may be limited by slow or congested data-links, including DSL and dial-up. Our failure to provide such additional functionality could adversely affect our business, operating results and financial condition.
New safety regulations or changes in existing safety regulations related to our products may result in unanticipated costs or liabilities, which could have a material adverse effect on our business, results of operations and future sales, and could place additional burdens on the operations of our business.
Radio emissions are subject to regulation in the United States and in other countries in which we do business. In the United States, various federal agencies including the Center for Devices and Radiological Health of the Food and Drug Administration, the Federal Communications Commission, the Occupational Safety and Health Administration and various state agencies have promulgated regulations that concern the use of radio/electromagnetic emissions standards. Member countries of the European Union (“EU”) have enacted similar standards concerning electrical safety and electromagnetic compatibility and emissions standards.
If any of our products becomes subject to new regulations or if any of our products becomes specifically regulated by additional government entities, compliance with such regulations could become more burdensome, and there could be a material adverse effect on our business and our results of operations.
In addition, our wireless communication products operate through the transmission of radio signals. Currently, operation of these products in specified frequency bands does not require licensing by regulatory authorities. Regulatory changes restricting the use of frequency bands or allocating available frequencies could become more burdensome and could have a material adverse effect on our business, results of operations and future sales.
Compliance with environmental matters and worker health and safety laws could be costly, and noncompliance with these laws could have a material adverse effect on our results of operations, expenses and financial condition.
Some of our operations use substances regulated under various federal, state, local and international laws governing the environment and worker health and safety, including those governing the discharge of pollutants into the ground, air and water, the management and disposal of hazardous substances and wastes, and the cleanup of contaminated sites. Some of our products are subject to various federal, state, local and international laws governing chemical substances in electronic products. We could be subject to increased costs, fines, civil or criminal sanctions, third-party property damage or personal injury claims if we violate or become liable under environmental and/or worker health and safety laws.

 

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We are subject to governmental export and import controls that could subject us to liability or impair our ability to compete in international markets.
Because we incorporate encryption technology into our products, our products are subject to U.S. export controls and may be exported outside the United States only with the required level of export license or through an export license exception. In addition, various countries regulate the import of certain encryption technology and radio frequency transmission equipment and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations.
Our business is subject to the risks of earthquakes, fire, floods and other natural catastrophic events, and to interruption by manmade problems such as computer viruses or terrorism.
Our corporate headquarters are located in the San Francisco Bay Area, a region known for seismic activity. A significant natural disaster, such as an earthquake, fire or a flood, occurring at our headquarters or in either China or Singapore, where our major contract manufacturers are located, could have a material adverse impact on our business, operating results and financial condition. In addition, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. In addition, acts of terrorism could cause disruptions in our or our customers’ businesses or the economy as a whole. To the extent that such disruptions result in delays or cancellations of customer orders, or the deployment of our products, our business, operating results and financial condition would be adversely affected.
Risks Related to Ownership of our Common Stock
Our stock price may be volatile.
The trading price of our common stock has been and may continue to be volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. Factors that could affect the trading price of our common stock could include:
  variations in our operating results;
 
  announcements of technological innovations, new products or product enhancements, strategic alliances or significant agreements by us or by our competitors;
 
  the gain or loss of significant customers;
 
  recruitment or departure of key personnel;
 
  the impact of unfavorable worldwide economic and market conditions;
 
  falling short of guidance on our financial results;
 
  changes in estimates of our operating results or changes in recommendations by any securities analysts who follow our common stock;
 
  significant sales, or announcement of significant sales, of our common stock by us or our stockholders; and
 
  adoption or modification of regulations, policies, procedures or programs applicable to our business.
In addition, the stock market in general, and the market for technology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may seriously affect the market price of our common stock, regardless of our actual operating performance. In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
If securities or industry analysts do not publish research or reports about our business, or if they issue an adverse or misleading opinion regarding our stock, our stock price and trading volume could decline.
The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If any of the analysts who cover us issue an adverse or misleading opinion regarding our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

 

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Insiders have substantial control over us and will be able to influence corporate matters.
As of January 31, 2011, our directors and executive officers and their affiliates beneficially owned, in the aggregate, approximately 10.5% 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 stockholders’ ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.
We may choose to raise additional capital. Such capital may not be available, or may be available on unfavorable terms, which would adversely affect our ability to operate our business.
We expect that our existing cash and cash equivalents balances will be sufficient to meet our working capital and capital expenditure needs for the foreseeable future. If we choose to raise additional funds, due to unforeseen circumstances or material expenditures, we cannot be certain that we will be able to obtain additional financing on favorable terms, if at all, and any additional financings could result in additional dilution to our existing stockholders.
Provisions in our charter documents, Delaware law, employment arrangements with certain of our executive officers, and our OEM supply agreement with Alcatel-Lucent could discourage a takeover that stockholders may consider favorable.
Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include but are not limited to the following:
  our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;
 
  our stockholders may not act by written consent or call special stockholders’ meetings; as a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions other than at annual stockholders’ meetings or special stockholders’ meetings called by the board of directors, the chairman of the board, the Chief Executive Officer or the president;
 
  our certificate of incorporation prohibits cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;
 
  stockholders must provide advance notice and additional disclosures in order to nominate individuals for election to the board of directors or to propose matters that can be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of our company; and
 
  our board of directors may issue, without stockholder approval, shares of undesignated preferred stock; the ability to issue undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us.
As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us.
Certain of our executive officers may be entitled to accelerated vesting of their stock options pursuant to the terms of their employment arrangements upon a change of control of Aruba. In addition to the arrangements currently in place with some of our executive officers, we may enter into similar arrangements in the future with other officers. Such arrangements could delay or discourage a potential acquisition of Aruba.
In addition, our OEM supply agreement with Alcatel-Lucent provides that, in the event of a change of control that would cause Alcatel-Lucent to purchase our products from an entity that is an Alcatel-Lucent competitor, we must, without additional consideration, (1) provide Alcatel-Lucent with any information required by Alcatel-Lucent to make, test and support the products that we distribute through our OEM relationship with Alcatel-Lucent, including all hardware designs and software source code, and (2) otherwise cooperate with Alcatel-Lucent to transition the manufacturing, testing and support of these products to Alcatel-Lucent. We are also obligated to promptly inform Alcatel-Lucent if and when we receive an inquiry concerning a bona fide proposal or offer to effect a change of control and will not enter into negotiations concerning a change of control without such prior notice to Alcatel-Lucent. Each of these provisions could delay or result in a discount to the proceeds our stockholders would otherwise receive upon a change of control or could discourage a third party from making a change of control offer.

 

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We have incurred and will continue to incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.
The Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act, as well as rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq Stock Market, have imposed various requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations have increased our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantial costs to maintain the same or similar coverage. These rules and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.
In addition, the Sarbanes-Oxley Act requires us to furnish a report by our management on our internal control over financial reporting. Such report contains, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. While we were able to assert in our Form 10-K for the year ended July 31, 2010, filed on September 24, 2010, that our internal control over financial reporting was effective as of July 31, 2010, we must continue to monitor and assess our internal control over financial reporting. If we are unable to assert in any future reporting period that our internal control over financial reporting is effective (or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal controls), we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our stock price.
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
(a) Sales of Unregistered Securities
On November 19, 2010, the Company entered into an agreement with an Australian-based company, pursuant to which Aruba acquired substantially all of the assets of the Australian-based company and its U.S. affiliate. The acquisition subsequently closed on December 3, 2010. Pursuant to the acquisition agreement, at the closing, the Company issued 86,852 shares of its common stock into an escrow fund for the benefit of four trusts of the founders of the Australian-based company (the “Founder Trusts”). The issuance of such common stock by the Company is exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), in reliance on Regulation D and/or Section 4(2) promulgated thereunder, on the basis that, among other factors: (1) there was no general solicitation or advertising in connection with the issuance of the shares; (2) the Company determined that each of the Founder Trusts had enough knowledge and experience to evaluate the risks and merits of the investment; (3) each of the Founder Trusts represented that it was acquiring the shares for its own account and not with a view towards distribution; and (4) the shares carry a legend stating that the shares are not registered under the Securities Act and therefore cannot be resold unless they are registered under the Securities Act or unless an exemption from registration is available.
(b) Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
Item 3.   Defaults Upon Senior Securities
None.
Item 4.   (Removed and Reserved)
Item 5.   Other Information
None.

 

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Item 6.   Exhibits
         
Exhibit No.   Description
       
 
  10.1  
Executive Officer Bonus Plan, as amended (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, Commission File No. 001-33347, filed on December 23, 2010)
       
 
  10.2 †   
Distribution Agreement, dated as of June 4, 2007, between the Registrant and ScanSource, Inc.
       
 
  10.3 †   
Distributor Agreement, dated as of June 15, 2007, between the Registrant and Avnet Logistics U.S., LP (the “Avnet Distributor Agreement”)
       
 
  10.4 †   
Amendment 1 to the Avnet Distributor Agreement, dated as of February 19, 2009, between the Registrant and Avnet Logistics U.S., LP
       
 
  10.5 †   
Amendment 2 to the Avnet Distributor Agreement, dated as of June 15, 2009, between the Registrant and Avnet Logistics U.S., LP
       
 
  10.6    
Amendment 3 to the Avnet Distributor Agreement, effective as of November 30, 2009, between the Registrant and Avnet Logistics, Inc.
       
 
  10.7 †   
Manufacturing Agreement, dated as of November 1, 2008, between the Registrant and SerComm Corporation
       
 
  10.8 †   
Amendment #4 to OEM Supply Agreement, dated as of December 31, 2010, between the Registrant and Alcatel-Lucent USA Inc. (fka Alcatel Internetworking, Inc.)
       
 
  31.1    
Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
       
 
  31.2    
Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32.1    
Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
101.INS    
XBRL Instance Document
       
 
101.SCH    
XBRL Taxonomy Extension Schema Document
       
 
101.DEF    
XBRL Taxonomy Extension Definition Linkbase Document
       
 
101.CAL    
XBRL Taxonomy Calculation Linkbase Document
       
 
101.LAB    
XBRL Taxonomy Label Linkbase Document
       
 
101.PRE    
XBRL Taxonomy Extension Presentation Linkbase Document
     
*   Denotes a management contract or compensatory plan or arrangement
 
  Confidential treatment has been requested for portions of this exhibit

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: March 11, 2011
         
ARUBA NETWORKS, INC.    
 
       
By:
  /s/ Dominic P. Orr
 
Dominic P. Orr
   
 
  President, Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer)    
 
       
Dated: March 11, 2011    
 
       
ARUBA NETWORKS, INC.    
 
       
By:
  /s/ Steffan Tomlinson
 
Steffan Tomlinson
   
 
  Chief Financial Officer (Principal Financial Officer)    

 

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EXHIBIT INDEX
         
Exhibit No.   Description
       
 
  10.1 *  
Executive Officer Bonus Plan, as amended (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, Commission File No. 001-33347, filed on December 23, 2010)
       
 
  10.2  
Distribution Agreement, dated as of June 4, 2007, between the Registrant and ScanSource, Inc.
       
 
  10.3  
Distributor Agreement, dated as of June 15, 2007, between the Registrant and Avnet Logistics U.S., LP (the “Avnet Distributor Agreement”)
       
 
  10.4  
Amendment 1 to the Avnet Distributor Agreement, dated as of February 19, 2009, between the Registrant and Avnet Logistics U.S., LP
       
 
  10.5  
Amendment 2 to the Avnet Distributor Agreement, dated as of June 15, 2009, between the Registrant and Avnet Logistics U.S., LP
       
 
  10.6    
Amendment 3 to the Avnet Distributor Agreement, effective as of November 30, 2009, between the Registrant and Avnet Logistics, Inc.
       
 
  10.7  
Manufacturing Agreement, dated as of November 1, 2008, between the Registrant and SerComm Corporation
       
 
  10.8  
Amendment #4 to OEM Supply Agreement, dated as of December 31, 2010, between the Registrant and Alcatel-Lucent USA Inc. (fka Alcatel Internetworking, Inc.)
       
 
  31.1    
Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes Oxley Act of 2002
       
 
  31.2    
Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32.1    
Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
101.INS    
XBRL Instance Document
       
 
101.SCH    
XBRL Taxonomy Extension Schema Document
       
 
101.DEF    
XBRL Taxonomy Extension Definition Linkbase Document
       
 
101.CAL    
XBRL Taxonomy Calculation Linkbase Document
       
 
101.LAB    
XBRL Taxonomy Label Linkbase Document
       
 
101.PRE    
XBRL Taxonomy Extension Presentation Linkbase Document
     
*   Denotes a management contract or compensatory plan or arrangement
 
  Confidential treatment has been requested for portions of this exhibit

 

46

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