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Aruba Networks 10-Q 2013
ARUN-2014.10.31-10Q



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________ 
FORM 10-Q
 _________________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number: 001-33347
_________________________________________________ 
Aruba Networks, Inc.
(Exact name of registrant as specified in its charter)
 _________________________________________________
Delaware
 
02-0579097
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)
1344 Crossman Ave.
Sunnyvale, California 94089-1113
(408) 227-4500
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
_________________________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
x
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
The number of outstanding shares of the registrant's common stock was 109,138,262 as of December 2, 2013.
 




ARUBA NETWORKS, INC.
FORM 10-Q
QUARTER ENDED OCTOBER 31, 2013

INDEX
 
 
 
Page
No.
 
 
 
 
 
 
 
 
 
 
 
Consolidated Statements of Comprehensive Loss for the three months ended October 31, 2013 and 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Signatures
 
 
 
 


2




 PART I. FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements

ARUBA NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
 
 
October 31,
2013
 
July 31,
2013
 
(in thousands, except per share data)
ASSETS
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
81,913

 
$
144,919

Short-term investments
243,028

 
269,882

Accounts receivable, net of allowance for doubtful accounts of $337 and $805 as of October 31, 2013 and July 31, 2013, respectively
68,258

 
93,191

Inventory, net
34,364

 
28,895

Deferred cost of revenue
13,778

 
12,657

Prepaids and other current assets
22,005

 
20,090

Deferred income tax assets, current
28,208

 
29,076

Total current assets
491,554

 
598,710

Property and equipment, net
28,545

 
27,536

Goodwill
67,242

 
67,242

Intangible assets, net
24,573

 
26,937

Deferred income tax assets, non-current
20,310

 
19,788

Other non-current assets
6,881

 
6,530

Total assets
$
639,105

 
$
746,743

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities
 
 
 
Accounts payable
$
19,636

 
$
24,891

Accrued liabilities
62,609

 
94,632

Income taxes payable, current
479

 
662

Deferred revenue, current
117,200

 
109,765

Total current liabilities
199,924

 
229,950

Deferred revenue, non-current
39,576

 
31,578

Other non-current liabilities
9,537

 
8,990

Total liabilities
249,037

 
270,518

Commitments and contingencies (Note 12)

 

Stockholders’ equity
 
 
 
Common stock: $0.0001 par value; 350,000 shares authorized at October 31, 2013 and July 31, 2013; 109,113 and 113,409 shares issued and outstanding at October 31, 2013 and July 31, 2013, respectively
11

 
11

Additional paid-in capital
544,707

 
623,155

Accumulated other comprehensive loss
(1,422
)
 
(1,540
)
Accumulated deficit
(153,228
)
 
(145,401
)
Total stockholders’ equity
390,068

 
476,225

Total liabilities and stockholders’ equity
$
639,105

 
$
746,743

See Notes to Consolidated Financial Statements.

3



ARUBA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
 
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands, except per share data)
Revenue
 
 
 
Product
$
130,831

 
$
119,222

Professional services and support
30,096

 
25,260

Total revenue
160,927

 
144,482

Cost of revenue
 
 
 
Product
40,118

 
36,161

Professional services and support
8,433

 
5,957

Total cost of revenue
48,551

 
42,118

Gross profit
112,376

 
102,364

Operating expenses
 
 
 
Research and development
40,445

 
31,963

Sales and marketing
63,044

 
53,919

General and administrative
14,515

 
11,951

Total operating expenses
118,004

 
97,833

Operating income (loss)
(5,628
)
 
4,531

Other income, net
 
 
 
Interest income
261

 
316

Other income, net
270

 
276

Total other income, net
531

 
592

Income (loss) before income taxes
(5,097
)
 
5,123

Provision for income taxes
2,730

 
5,949

Net loss
$
(7,827
)
 
$
(826
)
 
 
 
 
Shares used in computing net loss per common share, basic
112,011

 
111,976

Net loss per common share, basic
$
(0.07
)
 
$
(0.01
)
Shares used in computing net loss per common share, diluted
112,011

 
111,976

Net loss per common share, diluted
$
(0.07
)
 
$
(0.01
)
See Notes to Consolidated Financial Statements.

4


ARUBA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(unaudited)
 
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
 
 
 
 
Net loss
$
(7,827
)
 
$
(826
)
 
 
 
 
Other comprehensive loss, net of tax:
 
 
 
Available-for-sale investments:
 
 
 
Unrealized gains (losses), net
(88
)
 
(28
)
Realized gains reclassified into earnings
(30
)
 

Net change of unrealized losses on available-for-sale investments
(118
)
 
(28
)
Net change in cumulative translation adjustments

 
19

Other comprehensive loss
(118
)
 
(9
)
 
 
 
 
Comprehensive loss
$
(7,945
)
 
$
(835
)
 
 
 
 
See Notes to Consolidated Financial Statements.


5



ARUBA NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Cash flows from operating activities
 
 
 
Net loss
$
(7,827
)
 
$
(826
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
7,032

 
5,051

Change in provision for doubtful accounts
(85
)
 
117

Write-downs for excess and obsolete inventory
1,853

 
1,868

Stock-based compensation expense
27,419

 
22,562

Accretion of purchase discounts on short-term investments
609

 
263

Loss (gain) on disposal of fixed assets
109

 

Change in carrying value of contingent rights liability

 
(401
)
Deferred income taxes
(351
)
 
126

Excess tax benefit associated with stock-based compensation

 
(925
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
25,018

 
7,057

Inventory
(7,322
)
 
(8,602
)
Prepaids and other current assets
(763
)
 
208

Deferred cost of revenue
(1,121
)
 
65

Other non-current assets
(351
)
 
1,459

Accounts payable and other current and non-current liabilities
(37,643
)
 
(5,198
)
Deferred revenue
15,433

 
10,923

Income taxes payable
(762
)
 
3,163

Net cash provided by operating activities
21,248

 
36,910

Cash flows from investing activities
 
 
 
Purchases of short-term investments
(62,362
)
 
(67,037
)
Proceeds from sales of short-term investments
48,080

 
20,252

Proceeds from maturities of short-term investments
40,645

 
38,166

Purchases of property and equipment
(4,604
)
 
(5,357
)
Net cash provided by (used in) investing activities
21,759

 
(13,976
)
Cash flows from financing activities
 
 
 
Proceeds from issuance of common stock
7,449

 
11,336

Repurchases of common stock under stock repurchase program
(113,462
)
 
(11,524
)
Excess tax benefit associated with stock-based compensation

 
925

Net cash provided by (used in) financing activities
(106,013
)
 
737

Effect of exchange rate changes on cash and cash equivalents

 
19

Net increase (decrease) in cash and cash equivalents
(63,006
)
 
23,690

Cash and cash equivalents, beginning of period
144,919

 
133,629

Cash and cash equivalents, end of period
$
81,913

 
$
157,319

 
 
 
 
Supplemental disclosure of cash flow information
 
 
 
Income taxes paid
$
2,099

 
$
1,180

Non-cash investing and financing activities:
 
 
 
Unpaid purchases of property and equipment
$
1,182

 
$
212

See Notes to Consolidated Financial Statements.

6

ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


1.
The Company and its Significant Accounting Policies
The Company
Aruba Networks, Inc. (the “Company”), incorporated in the state of Delaware on February 11, 2002, is a leading global provider of enterprise mobility solutions. The Company's Mobile Virtual Enterprise (“MOVE”) architecture leverages its diverse products (including its ArubaOS operating system, controllers, wireless access points, switches, application software modules, access management solution, and multi-vendor management solution software) to unify wired and wireless network infrastructures into one seamless access solution for its customers, enabling them to provide network access to traveling business professionals, remote workers and employees and guests of branch offices and corporate headquarters. The Company derives its revenue from sales of its ArubaOS operating system, controllers, wireless access points, switches, application software modules, access management solution, multi-vendor management solution software, and professional services and support. The Company has offices in the Americas, Europe, the Middle East and Africa ("EMEA"), and the Asia Pacific and Japan ("APJ") regions and employs staff around the world.
Basis of Presentation
The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with United States of America ("U.S.") generally accepted accounting principles (“GAAP”) for interim financial information, pursuant to the rules and regulations of the United States Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the financial information and footnotes required by GAAP for complete financial statements. The accompanying Consolidated Financial Statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances, transactions and cash flows have been eliminated.
The unaudited Consolidated Financial Statements have been prepared on the same basis as the Company's audited financial statements as of and for the year ended July 31, 2013 and include all adjustments necessary for the fair statement of the Company’s financial position as of October 31, 2013, its results of operations and its cash flows for the three months ended October 31, 2013 and 2012. The results for the three months ended October 31, 2013 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending July 31, 2014. The July 31, 2013 Consolidated Balance Sheet data were derived from audited financial statements but do not include all disclosures required by U.S. GAAP.
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 with the SEC on September 24, 2013.
Significant Accounting Policies
There have been no significant changes in the Company’s accounting policies for the three months ended October 31, 2013, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended July 31, 2013.
Recent Accounting Pronouncements
In July 2012, the Financial Accounting Standards Board ("FASB") issued revised guidance on how an entity tests indefinite-lived intangible assets for impairment. Under the new guidance, an entity is no longer required to calculate the fair value of the indefinite-lived intangible assets and perform the quantitative impairment test unless the entity determines, based on a qualitative assessment, that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. The Company adopted this guidance during the first quarter of fiscal 2014, which did not have a material impact on the Company’s consolidated financial statements.
In February 2013, the FASB issued guidance on disclosure requirements for items reclassified out of Accumulated Other Comprehensive Income (“AOCI”). This new guidance requires entities to present (either on the face of the income statement or in the notes) the effects on the line items of the income statement for amounts reclassified out of AOCI. The Company adopted this guidance during the first quarter of fiscal 2014 and presented the effects within the Consolidated Statements of Comprehensive Loss.
In June 2013, the FASB issued guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists, with the purpose of reducing diversity in

7


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

practice. This new standard requires the netting of unrecognized tax benefits ("UTBs") against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. Accounting Standard Update 2013-11 ("ASU 2013-11") is required for our fiscal year beginning August 1, 2014. Early adoption is permitted. The Company will adopt ASU 2013-11 for its fiscal year beginning August 1, 2014. The Company expects that the impact of ASU 2013-11 will be to reduce its long-term tax liability for UTBs and reduce its deferred tax assets and/or increase its additional paid-in capital shown in the consolidated balance sheets.
2.
Business Combinations
On May 13, 2013, the Company acquired Meridian Apps, Inc. (“Meridian”), a privately-held mobile-software company providing software for visitor engagement through indoor way-finding and targeted location-based messaging. As a result of the acquisition, Meridian became a wholly owned subsidiary of the Company. The Company is offering new indoor location-based services by combining its unique, network-based contextual information about users, devices and applications with Meridian's Wi-Fi based visitor engagement solution for smart phones and tablets.
The results of operations of Meridian are included in the Company's consolidated Statement of Operations from the date of acquisition. The Company does not consider the acquisition of Meridian to be material to its results of operations or financial position, and therefore, the Company is not presenting pro-forma financial information of combined operations.
The purchase price consideration was $16.8 million, consisting of cash consideration. In addition, the Company is obligated to pay additional cash compensation of up to $10.2 million to certain former Meridian employees who became employees of the Company, which will be made over a period of approximately three years from the closing date, subject to certain continued employment restrictions. For the first quarter of fiscal 2014, the Company recorded $0.9 million in general and administrative expenses associated with this additional cash compensation.
In connection with this acquisition, the Company allocated the total purchase price consideration to the net assets and liabilities acquired, including identifiable intangible assets, based on their respective fair values at the acquisition date. The excess purchase price over the value of the net tangible and identifiable intangible assets was recorded as goodwill, which is not expected to be deductible for income tax purposes. There are a number of factors contributing to the amount of goodwill, including Meridian workforce and the expectation that the acquisition of Meridian will create synergies, which will provide future value to the Company.
The following table summarizes the allocation of the purchase price consideration:
 
 
Amount
 
Estimated
Useful Lives
 
 
(in thousands)
 
 
Purchase price consideration:
 
 
 
 
Cash
 
$
16,777

 
 
 
 

 
 
Tangible assets acquired and liabilities assumed
 
$
(1,218
)
 
 
 
 
 
 
 
Identifiable intangible assets:
 
 
 
 
Existing technology
 
5,000

 
3 years
Patent
 
2,000

 
11 years
Customer contracts and related relationships
 
300

 
4 years
Trade name and trademarks
 
400

 
4 years
Goodwill
 
10,295

 
 
Total net assets acquired
 
$
16,777

 
 
 
 


 
 

3.
Contingent Rights Liability Arising from Business Combinations
On September 2, 2010, the Company completed its acquisition of Azalea Networks (“Azalea”) for a total purchase price of $42.0 million. As part of the purchase consideration for each share of the Company received by the Azalea shareholders, each Azalea shareholder also received a right ("Contingent Rights") to receive an amount of cash equal to the shortfall generated if a share was sold below the target value within the payment period, as specified in the arrangement. For shares not

8


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

held in escrow, the payment period began on August 1, 2011 and ended on December 31, 2011. The Contingent Rights related to these shares were settled in cash of $1.9 million in January 2012. For shares held in escrow, the payment period began on the later of January 2, 2012 or the date such shares are released from escrow to the Azalea shareholders, if at all, and ending on the earlier of thirty calendar days following such release date or December 31, 2012. The rights related to the escrow shares are subject to forfeiture in certain circumstances. For shares held in escrow, the Company made claims against all of the escrow shares prior to the claim period expiration, which was April 1, 2012. Currently the escrow shares remain in escrow pending the resolution of the Company’s claims.
At the acquisition date, the Company recorded a liability for the estimated fair value of the contingent rights of $9.5 million. The change in fair value of this contingent right was primarily driven by changes in the Company's common stock price. Gains and losses as a result of the revaluation of the contingent rights liability are included in other income, net in the Consolidated Statements of Operations. For the three months ended October 31, 2013 and 2012, the Company recorded zero and $0.4 million due to the revaluation of the contingent rights liability, respectively. In December 2012, the Company released the contingent rights liability as a result of the payment period expiring on December 31, 2012, resulting in a $1.3 million gain recorded in other income, net.
4.
Goodwill and Intangible Assets
The following table presents details of the Company’s goodwill:
 
Amount
 
(in thousands)
Balance at July 31, 2012
$
56,947

Goodwill acquired in acquisition of Meridian
10,295

Balance at July 31, 2013
$
67,242

Changes in goodwill

Balance at October 31, 2013
$
67,242

The following table presents details of the Company’s intangible assets:
 
Estimated
Useful Lives
 
Gross
Value
 
Accumulated
Amortization
 
Net
Value
 
(in thousands, except estimated useful lives)
Balance at October 31, 2013
 
 
 
 
 
 
 
Existing technology
3 to 7 years
 
$
41,383

 
$
(23,000
)
 
$
18,383

Patents/core technology
4 to 11 years
 
9,046

 
(5,057
)
 
3,989

Customer contracts
4 to 7 years
 
7,533

 
(5,857
)
 
1,676

Support agreements
5 to 6 years
 
2,917

 
(2,814
)
 
103

Tradenames/trademarks
1 to 5 years
 
1,150

 
(792
)
 
358

Non-compete agreements
 2 to 4 years
 
912

 
(848
)
 
64

Total
 
 
$
62,941

 
$
(38,368
)
 
$
24,573


 
Estimated
Useful Lives
 
Gross
Value
 
Accumulated
Amortization
 
Net
Value
 
(in thousands, except estimated useful lives)
Balance at July 31, 2013
 
 
 
 
 
 
 
Existing technology
3 to 7 years
 
$
41,383

 
$
(21,269
)
 
$
20,114

Patents/core technology
4 to 11 years
 
9,046

 
(4,784
)
 
4,262

Customer contracts
4 to 7 years
 
7,533

 
(5,537
)
 
1,996

Support agreements
5 to 6 years
 
2,917

 
(2,805
)
 
112

Tradenames/trademarks
1 to 5 years
 
1,150

 
(767
)
 
383

Non-compete agreements
 2 to 4 years
 
912

 
(842
)
 
70

Total
 
 
$
62,941

 
$
(36,004
)
 
$
26,937


9


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

Amortization expense related to intangible assets was recorded as follows in the Consolidated Statements of Operations:
 
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Cost of product revenue
$
2,005

 
$
1,436

Cost of professional services and support revenue

 
135

Sales and marketing
353

 
344

Research and development
6

 
6

Total amortization expense
$
2,364

 
$
1,921

The following table presents the estimated future amortization expense of intangible assets as of October 31, 2013:
 
Amount
 
(in thousands)
Fiscal Year
 
2014 (remaining nine months)
$
6,873

2015
8,485

2016
4,646

2017
1,835

2018
1,307

Thereafter
1,427

Total
$
24,573

5.
Net Loss Per Common Share
Basic net loss per common share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is calculated by giving effect to all potentially dilutive common shares, including stock options and awards, unless the result is anti-dilutive. The following tables set forth the computation of net loss per share: 
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands, except per share data)
Net loss
$
(7,827
)
 
$
(826
)
Weighted-average common shares outstanding, basic
112,011

 
111,976

Dilutive effect of potential common shares

 

Weighted-average common shares outstanding, diluted
112,011

 
111,976

Net loss per share, basic
$
(0.07
)
 
$
(0.01
)
Net loss per share, diluted
$
(0.07
)
 
$
(0.01
)

The following outstanding stock options and awards were excluded from the computation of diluted net loss per common share for the periods presented because including them would have had an anti-dilutive effect.
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Options to purchase common stock
1,250

 
1,748

Restricted stock awards
2,787

 
2,454

Contingently issuable shares
632

 
530

Employee stock purchase plan
40

 
74


10


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

6.
Short-Term Investments
Short-term investments consist of the following:
 
Cost Basis
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(in thousands)
Balance at October 31, 2013
 
 
 
 
 
 
 
Corporate bonds
$
84,042

 
$
72

 
$
(20
)
 
$
84,094

U.S. government agency securities
102,702

 
37

 
(4
)
 
102,735

U.S. treasury bills
44,188

 
42

 

 
44,230

Commercial paper
5,390

 
3

 

 
5,393

Certificates of deposit
5,000

 
5

 

 
5,005

Municipal notes and bonds
1,572

 

 
(1
)
 
1,571

Total short-term investments
$
242,894

 
$
159

 
$
(25
)
 
$
243,028

 
Cost Basis
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(in thousands)
Balance at July 31, 2013
 
 
 
 
 
 
 
Corporate bonds
$
79,493

 
$
29

 
$
(97
)
 
$
79,425

U.S. government agency securities
133,794

 
43

 
(11
)
 
133,826

U.S. treasury bills
36,317

 
39

 

 
36,356

Commercial paper
13,672

 
3

 

 
13,675

Certificates of deposit
5,000

 
10

 

 
5,010

Municipal notes and bonds
1,590

 

 

 
1,590

Total short-term investments
$
269,866

 
$
124

 
$
(108
)
 
$
269,882


The cost basis and fair value of the short-term investments by contractual maturity are presented below:
 
Cost
Basis
 
Fair
Value
 
(in thousands)
Balance at October 31, 2013
 
 
 
One year or less
$
142,834

 
$
142,889

Over one year and less than two years
100,060

 
100,139

Total short-term investments
$
242,894

 
$
243,028

 
Cost
Basis
 
Fair
Value
 
(in thousands)
Balance at July 31, 2013
 
 
 
One year or less
$
165,614

 
$
165,682

Over one year and less than two years
104,252

 
104,200

Total short-term investments
$
269,866

 
$
269,882

The Company reviews the individual securities in its portfolio to determine whether a decline in a security’s fair value below the amortized cost basis is other-than-temporary. The Company determined that as of October 31, 2013 and July 31, 2013 there were no investments in its portfolio that were other-than-temporarily impaired.

11


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

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 the length of time that individual securities have been in a continuous unrealized loss position:
 
Less than 12 Months
 
Fair
Value
 
Unrealized
Loss
 
(in thousands)
Balance at October 31, 2013
 
 
 
Corporate bonds
$
27,677

 
$
(20
)
U.S. government agency securities
15,086

 
(4
)
Municipal notes and bonds
1,571

 
(1
)
 
$
44,334

 
$
(25
)
 
Less than 12 Months
 
Fair
Value
 
Unrealized
Loss
 
(in thousands)
Balance at July 31, 2013
 
 
 
Corporate bonds
$
51,850

 
$
(97
)
U.S. government agency securities
26,611

 
(11
)
 
$
78,461

 
$
(108
)
As of October 31, 2013 and July 31, 2013, no securities were in a continuous unrealized loss position for more than twelve months.
7.
Fair Value of Financial Instruments
Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be either recorded or disclosed at fair value, the Company considers the principal or most advantageous market in which it would transact, and it also considers assumptions that market participants would use when pricing the asset or liability.
The Company determines the fair values of its financial instruments based on a three-level fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The classification of a financial asset or liability within the hierarchy is based upon the lowest level input that is significant to the fair value measurement. The fair value hierarchy prioritizes the inputs into three levels that may be used to measure fair value:
Level 1 — Quoted prices in active markets for identical assets or liabilities.
Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level 3 — Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Such unobservable inputs include an estimated discount rate used in the Company's discounted present value analysis of future cash flows, which reflects the Company's estimate of debt with similar terms in the current credit markets. As there is currently minimal activity in such markets, the actual rate could be materially different.
Level 1 instruments are valued based on quoted market prices in active markets for identical instruments. Level 1 instruments 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.
Level 2 securities are valued using quoted market prices for similar instruments, non-binding market prices that are corroborated by observable market data, or discounted cash flow techniques and include the Company’s investments in certain corporate bonds, U.S. government agency securities, U.S. treasury bills, commercial paper, municipal notes and bonds.

12


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

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.
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.
There were no transfers between levels during the three months ended October 31, 2013.
The fair value measurements of the Company’s cash, cash equivalents and short-term investments consisted of the following:
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Balance at October 31, 2013
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash deposits with third-party financial institutions
$
78,872

 
$

 
$

 
$
78,872

Money market funds
2,341

 

 

 
2,341

Commercial paper
700

 

 

 
700

Short-term investments:
 
 
 
 
 
 
 
Certificates of deposit
5,005

 

 

 
5,005

Corporate bonds

 
84,094

 

 
84,094

U.S. government agency securities

 
102,735

 

 
102,735

U.S. treasury bills

 
44,230

 

 
44,230

Commercial paper

 
5,393

 

 
5,393

Municipal notes and bonds

 
1,571

 

 
1,571

Total assets measured and recorded at fair value
$
86,918

 
$
238,023

 
$

 
$
324,941


 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Balance at July 31, 2013
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash deposits with third-party financial institutions
$
129,290

 
$

 
$

 
$
129,290

Money market funds
8,612

 

 

 
8,612

U.S. government agency securities
3,017

 

 

 
3,017

Commercial paper
4,000

 

 

 
4,000

Short-term investments:
 
 
 
 
 
 
 
Certificates of deposit
5,010

 

 

 
5,010

Corporate bonds

 
79,425

 

 
79,425

U.S. government agency securities

 
133,826

 

 
133,826

U.S. treasury bills

 
36,356

 

 
36,356

Commercial paper

 
13,675

 

 
13,675

Municipal notes and bonds

 
1,590

 

 
1,590

Total assets measured and recorded at fair value
$
149,929

 
$
264,872

 
$

 
$
414,801



13


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

Other Investments
As of October 31, 2013 and July 31, 2013, the Company has investments in privately-held companies of $1.8 million and included in other non-current assets in the accompanying Consolidated Balance Sheets. These investments are recorded at cost and are adjusted to fair value only in the event that they become other-than-temporarily impaired.
8.
Consolidated Balance Sheet Components
The following tables provide details of selected consolidated balance sheet items:
 
October 31,
2013
 
July 31,
2013
 
(in thousands)
Inventory, net:
 
 
 
Raw materials
$
319

 
$
288

Finished goods
34,045

 
28,607

Total
$
34,364

 
$
28,895


 
October 31,
2013
 
July 31,
2013
 
(in thousands)
Accrued Liabilities:
 
 
 
Compensation and benefits
$
22,912

 
$
25,214

Marketing
21,336

 
41,014

Litigation reserves
85

 
14,125

Other
18,276

 
14,279

Total
$
62,609

 
$
94,632


 
Estimated
Useful Lives
 
October 31,
2013
 
July 31,
2013
 Property and Equipment, net
(in thousands, except estimated useful lives)
Computer equipment
2 to 3 years
 
$
24,035

 
$
23,109

Computer software
2 to 5 years
 
14,826

 
13,525

Machinery and equipment
2 years
 
31,317

 
29,009

Furniture and fixtures
5 years
 
4,411

 
4,304

Leasehold improvements
1 to 6 years
 
6,829

 
5,892

Total property and equipment, gross
 
 
81,418

 
75,839

Less: accumulated depreciation and amortization
 
 
(52,873
)
 
(48,303
)
Total property and equipment, net
 
 
$
28,545

 
$
27,536

Depreciation and amortization expense of property and equipment for the three months ended October 31, 2013 and October 31, 2012 was $4.7 million and $3.1 million, respectively.
 
October 31,
2013
 
July 31,
2013
 Deferred Revenue:
(in thousands)
Product
$
42,849

 
$
38,974

Professional services and support
74,351

 
70,791

Total deferred revenue, current
117,200

 
109,765

Professional services and support, non-current
39,576

 
31,578

Total deferred revenue
$
156,776

 
$
141,343

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.

14


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

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.
9.
Income Taxes
The effective tax rate in all periods is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. For the three month period ended October 31, 2013, tax expense was $2.7 million and the effective tax rate was 53.6%. For the three month period ended October 31, 2012, tax expense was $5.9 million and the effective tax rate was 116.1%.
For the three month period ended October 31, 2013, the Company computed its provision for income taxes based upon the actual tax rate for that period as the Company determined that small changes in the estimated income or loss between tax jurisdictions would result in significant changes in the estimated annual effective tax rate. For the three month period ending October 31, 2013, the effective tax rate differs from a tax benefit computed at the 35% U.S. federal statutory income tax rate due primarily to non-deductible stock based compensation and fixed amortization of deferred tax charges related to the fiscal 2012 intercompany sale of intellectual property rights. Future effective tax rates could be adversely affected if earnings are lower than anticipated in countries where the Company has lower statutory tax rates or by unfavorable changes in tax laws and regulations or their interpretation.
For the three month period ending October 31, 2012, the Company computed its provision for income taxes based on the estimated annual rate. For the three month period ending October 31, 2012, the effective tax rate differed from the federal statutory rate due to state taxes and significant permanent differences primarily from taxes in foreign jurisdictions with a tax rate different than the 35% U.S. federal statutory rate, non-deductible stock-based compensation expense, R&D credits, certain acquisition related items and the amortization of deferred tax charges related to the to the fiscal 2012 intercompany sale of intellectual property rights, and a $1.8 million adjustment recorded for prior period tax expense.
The decrease in the tax expense between the three month period ending October 31, 2013 and the three month period ending October 31, 2012 is primarily due to the $1.8 million adjustment recorded for prior period tax expense in the three month period ending October 31, 2012 and a pre-tax loss incurred in the three month period ending October 31, 2013 compared to a pre-tax profit earned in the three month period ending October 31, 2012.
In fiscal 2012, the Company implemented a new corporate organization structure to more closely align its corporate organization with the international nature of its business activities and to reduce its overall effective tax rate through changes in how it develops and uses its intellectual property and the structure of its international procurement and sales, including transfer-price arrangements for intercompany transactions. Therefore, the Company incurred and recorded IP structure charges starting in fiscal 2012. IP structure charges consist primarily of non-recurring items of gain recognized in the U.S. related to the international restructuring, including the transfer of certain intellectual property and inventory overseas. The tax associated with the IP structure charges are deferred and amortized for financial reporting purposes under Accounting Standards Codification (“ASC”) 740-10-25-3(e) (Income Taxes) and ASC 810-10-45-8 (Consolidation). For fiscal 2014 and fiscal 2013, the international restructuring resulted in an increase to the effective tax rate due to the non- recurring items of gain triggered in the U.S. The deferred charge resulted in a 37.8 point increase to the effective tax rate for the three month period ended October 31, 2013, from 15.8% to 53.6%. While the Company has yet to realize any tax savings to date, the Company expects to realize a reduction in the effective tax rate as a result of the international restructuring after the deferred charges have been fully amortized.
Each quarter the Company assesses the likelihood that it will be able to recover its deferred tax assets. The Company considers available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance. The Company believes that its realization of certain California tax research credit carryforwards is not more likely than not to be realized. Therefore the Company has recorded a valuation allowance on certain California tax research credit carryforward generated in fiscal years before 2013 and a full valuation on credits earned after fiscal year 2012. For the three months ended of October 31, 2013, the Company recorded an increase in the valuation allowance by $0.5 million relating to California tax research credits earned during the three months ended October 31, 2013. It is reasonably possible that a material increase in the valuation allowance could occur within one year depending on changes, if any, in the mix of earnings in the jurisdictions in which the Company operates, the percentage of revenue from California customers, the Company's evaluation of prudent and feasible tax planning strategies, the Company's expectation of exercising elections available under the applicable tax laws, and the Company's projections of its future growth and forecasted earnings. An increase to the valuation

15


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

allowance would have the effect of increasing the income tax provision in the Consolidated Statements of Operations in the period that the valuation allowance is increased.
The Company believes that it is reasonably possible that unrecognized tax benefits will not increase or decrease significantly over the next 12 months. The Company files income tax returns in the U.S. federal jurisdiction, various U.S. state and local jurisdictions, and in various foreign jurisdictions. Due to the Company's net operating loss and credit carryforwards, substantially all years are subject to examination. There are no material income tax audits currently in progress as of October 31, 2013.
A reserve for uncertain tax benefits relating to tax positions claimed in tax returns is included in other non-current liabilities in the Company’s Consolidated Balance Sheets. In June 2013, the FASB issued guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists, with the purpose of reducing diversity in practice. This new standard requires the netting of unrecognized tax benefits ("UTBs") against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. ASU 2013-11 is required for the Company's fiscal year beginning August 1, 2014. Early adoption is permitted. The Company will adopt ASU 2013-11 for its fiscal year beginning August 1, 2014. The Company expects that the impact of ASU 2013-11 will be to reduce its long-term tax liability for UTBs and reduce its deferred tax assets and/or increase its additional paid-in capital shown in the consolidated balance sheets.
Prior Period Adjustment
In the three months ended October 31, 2012, the Company recorded an out-of-period adjustment to correct an error that increased the provision for income taxes by $1.8 million which related to the three months ended July 31, 2012. The impact of this correction would have resulted in an increase in net loss of $1.8 million for the three months and fiscal year ended July 31, 2012. The Company assessed the impact of this adjustment on previously reported financial statements and for the year ended July 31, 2013 and concluded that the adjustment was not material, either individually or in the aggregate to previously reported consolidated financial statements. On that basis, the Company recorded the adjustment in the three months ended October 31, 2012.
10.
Equity Incentive Plans and Benefit Plans
Stock Option Activity
The following table summarizes the information about shares available for grant and outstanding stock option activity (in thousands, except for share and share data): 
 
 
 
Options Outstanding
 
 
 
 
 
Shares
Available for
Grant
 
Number of
Shares
 
Weighted
Average
Exercise
Price
per Share
 
Weighted
Average
Fair Value
per Share
 
Weighted
Average
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic
Value
Balance at July 31, 2012
532,596

 
13,264,031

 
$
6.63

 
 
 
3.9
 
$
112,868

Shares reserved for issuance
5,576,433

 

 
 
 
 
 
 
 
 
Restricted stock awards granted
(7,252,248
)
 

 
 
 
 
 
 
 
 
Restricted stock awards forfeited
1,393,834

 

 
 
 
 
 
 
 
 
Options exercised

 
(2,860,592
)
 
6.71

 
 
 
 
 
$
38,697

Options cancelled
306,970

 
(355,870
)
 
14.94

 
 
 
 
 
 
Balance at July 31, 2013
557,585

 
10,047,569

 
6.29

 
 
 
2.9
 
$
121,227

Shares reserved for issuance
5,670,469

 

 
 
 
 
 
 
 
 
Restricted stock awards granted
(2,225,410
)
 

 
 
 
 
 
 
 
 
Restricted stock awards forfeited
435,545

 

 
 
 
 
 
 
 
 
Options exercised

 
(229,099
)
 
5.84

 
 
 
 
 
$
2,815

Options cancelled
80,985

 
(80,985
)
 
19.38

 
 
 
 
 
 
Balance at October 31, 2013
4,519,174

 
9,737,485

 
$
6.19

 
 
 
2.7
 
$
126,836


16


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

Restricted Stock Award Activity
The following table summarizes the information about non-vested restricted stock awards and units: 
 
Shares
 
Weighted Average
Grant Date
Fair Value
per Share
Balance at July 31, 2012
8,422,681

 
$
19.49

Awards granted
7,252,248

 
18.76

Awards vested
(3,493,341
)
 
19.51

Awards forfeited
(1,393,834
)
 
20.44

Balance at July 31, 2013
10,787,754

 
18.87

Awards granted
2,225,410

 
18.21

Awards vested
(1,406,014
)
 
18.88

Awards forfeited
(435,545
)
 
20.01

Balance at October 31, 2013
11,171,605

 
$
18.69

Fair Value Disclosures
The fair value of each option is estimated on the date of grant using the Black-Scholes model with the below assumptions.
Employee Stock Options
There were no stock option grants during the three months ended October 31, 2013 and October 31, 2012.
Employee Stock Purchase Plan
The fair value of the purchase right for the Employee Stock Purchase Plan is estimated on the date of grant using the Black-Scholes model with the following weighted average assumptions:
 
Three Months Ended October 31,
 
2013
 
2012
Risk-free interest rates
0.1% to 0.4%
 
0.1% to 0.2%
Expected term (in years)
0.5 to 2.0
 
0.5 to 2.0
Dividend yield
—%
 
—%
Volatility
57% to 64%
 
54% to 63%
The following table shows for each purchase date during the three months ended October 31, 2013 and 2012, the shares issued and the weighted average purchase price per share:
 
September 1,
2013
 
September 1,
2012
Shares issued
432,749

 
348,520

Weighted average purchase price per share
$
14.12

 
$
16.65


17


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

Stock-based Compensation Expense
Stock-based compensation expense consists primarily of expenses for stock options, restricted stock awards, and employee stock purchase rights granted to employees. The following table summarizes stock-based compensation expense:
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Cost of revenue
$
2,158

 
$
1,501

Research and development
10,808

 
8,427

Sales and marketing
10,311

 
8,745

General and administrative
4,142

 
3,889

Total
$
27,419

 
$
22,562

The following table presents stock-based compensation expense by award-type:
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Stock options
$
1,699

 
$
2,723

Stock awards
23,834

 
17,300

Employee stock purchase plan
1,886

 
2,539

Total
$
27,419

 
$
22,562

Included in the stock-based compensation expense is $5.7 million and $3.5 million for the three months ended October 31, 2013 and 2012, respectively, associated with the Company's Executive Officer Bonus Plan and Corporate Bonus Plan.
Stock Repurchase Program
As of October 31, 2013, the Company's Board of Directors had authorized a stock repurchase program for an aggregate amount of up to $300.0 million (consisting of an original $100.0 million authorization on June 13, 2012, plus subsequent authorizations of an additional $100.0 million on July 15, 2013 and $100.0 million on October 9, 2013). The Company is authorized to make repurchases in the market until the Board of Directors terminates the program or until such repurchases reach the authorized amount, whichever occurs first. Any repurchases under the program will be funded either from available working capital or external financing. The number of shares repurchased and the timing of repurchases are based on the price of the Company's common stock, general business and market conditions, and other investment considerations. Shares are retired upon repurchase. The Company's policy related to repurchases of its common stock is to charge any excess of cost over par value entirely to additional paid-in capital.
During the three months ended October 31, 2013, the Company repurchased a total of 6,363,780 shares for a total purchase price of $113.5 million. As of October 31, 2013, the Company repurchased a cumulative total of 13,083,616 shares for a total purchase price of $219.6 million, with $80.4 million remaining authorized under the stock repurchase program.
11.
Segment Information and Significant Customers
The Company operates as one reportable and operating segment, selling its ArubaOS operating system, controllers, wireless access points, switches, application software modules, access management solution, multi-vendor management solution software, and professional services and support.
A reportable segment is defined as a component of an enterprise for which separate financial information is available and is evaluated regularly by the chief operating decision maker, or decision making group, for resource allocation and for assessing performance. The Company’s chief operating decision maker is its chief executive officer (“CEO”), who reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. The Company operates as a single reportable and operating segment. Revenue is attributed by geographic location based on the ship-to location of the Company’s customers.

18


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

The following presents total revenue by geographic region:
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
United States
$
108,315

 
$
92,752

Europe, Middle East and Africa
25,996

 
21,550

Asia Pacific and Japan
22,994

 
24,653

Rest of World
3,622

 
5,527

Total
$
160,927

 
$
144,482

The Company’s product revenue was $130.8 million and $119.2 million for the three months ended October 31, 2013 and 2012, respectively. Professional services and support revenue was $30.1 million and $25.3 million for the same periods.
The following table presents significant channel partners contributing 10% or more of total revenue:
 
Three Months Ended October 31,
 
2013
 
2012
ScanSource, Inc.
21.3
%
 
20.2
%
Synnex Corp.
13.6
%
 
*

(*) Indicates less than 10%.
The following table presents significant channel partners accounting for 10% or more of total net accounts receivable: 
 
October 31,
2013
 
October 31,
2012
ScanSource, Inc.
24.4
%
 
24.1
%
Synnex Corp.
19.1
%
 
13.1
%

The following table sets forth the Company's long-lived assets (property, plant, and equipment) by geographic region based on the location of the asset:
 
October 31,
2013
 
July 31,
2013
 
(in thousands)
United States
$
19,590

 
$
19,291

All other countries
8,955

 
8,245

Total
$
28,545

 
$
27,536

12.
Commitments and Contingencies
Legal Matters
The Company is involved in disputes, claims, litigation, investigations, proceedings and other legal actions, consisting of intellectual property, commercial, securities, and employment matters from time to time that arise in the ordinary course of business, including the legal matters identified below.
U.S. Federal Court Class Action Litigation. On May 23, 2013, a purported stockholder class action lawsuit captioned Mazzafero v. Aruba Networks, Inc., et al., was filed in the United States District Court for the Northern District of California against the Company and certain of its officers. The purported class action alleges claims for violations of the federal securities laws, and seeks unspecified compensatory damages and other relief. The Company believes that it has meritorious defenses to these claims and intends to defend the litigation vigorously. Based on information currently available, the Company has determined that the amount of any possible loss or range of possible loss is not reasonably estimable.
Nomadix, Inc v. Hewlett Packard Company et al. In November 2009, Nomadix, Inc. filed a lawsuit against multiple defendants including Aruba Networks. The plaintiff claimed that the defendants infringed several of their patents; however, only one patent was asserted against Aruba, U.S. Patent No. 6,636,894. On July 30, 2013, the Company and Nomadix reached a

19


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

settlement. As part of the settlement, the Company agreed to pay Nomadix an amount in consideration for a perpetual non-exclusive license for Nomadix' alleged patent, among other things. The Company determined there would be no material benefit from the acquired patent, thus the settlement was recorded as an operating expense in the fourth quarter of fiscal 2013. The settlement amount was fully paid during the first quarter of fiscal 2014. The terms of the settlement are confidential.
The Company reviews all legal matters at least quarterly and assesses whether an accrual for loss contingencies needs to be recorded. The assessment reflects the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. The Company records an accrual for loss contingencies when management believes that it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Legal matters are subject to uncertainties and are inherently unpredictable; however, the Company believes that it has valid defenses with respect to its pending legal matters. Actual liability in any such matters may be materially different from the Company's estimates, which could result in the need to adjust the liability and record additional expenses. If an unfavorable resolution were to occur, there exists the possibility of a material adverse impact on the Company's consolidated financial condition, results of operations or cash flows for the period in which the resolution occurs or on future periods.
In addition, these actions or other third-party claims against the Company may cause the Company to incur costly litigation and/or substantial settlement charges. Furthermore, the resolution of any patent related litigation may require the Company to make royalty payments, which could adversely affect gross margins in future periods. If any of those events were to occur, the Company's business, financial condition, results of operations, and cash flows could be adversely affected in any particular period by an unfavorable resolution of one or more of these contingencies.
Lease Obligations
The Company leases office spaces under non-cancelable operating leases with various expiration dates through June 2018. Future minimum lease payments under non-cancelable operating leases are as follows:
Fiscal Year
Amount
 
(in thousands)
2014 (remaining nine months)
$
5,402

2015
6,872

2016
6,926

2017
2,636

2018
1,341

Total minimum payments
$
23,177

Employee Agreements
The Company has signed various employment agreements with certain executives pursuant to which if their employment is terminated without cause, the executives are entitled to receive certain benefits, including, but not limited to, accelerated stock option vesting.
Non-cancelable Purchase Commitments
The Company outsources the production of its hardware to third-party contract manufacturers, and enters into various inventory-related purchase commitments with these contract manufacturers and other suppliers. In addition, from time to time, the Company also enters into significant information technology and marketing agreements with its vendors, which are non-cancelable. The Company had $41.8 million and $40.0 million in non-cancelable purchase commitments as of October 31, 2013 and July 31, 2013, respectively. The Company expects to sell the products that it has committed to purchase from its third-party contract manufacturers and other suppliers.

20


ARUBA NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited) - Continued

Product Warranties
The Company’s accrued liability for estimated future product warranty costs is included as a component of accrued liabilities in the accompanying Consolidated Balance Sheets. The following table summarizes the activity related to the Company’s accrued liability for estimated future warranty costs:
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Beginning balance
$
777

 
$
818

Provision
170

 
182

Obligations fulfilled during period
(148
)
 
(184
)
Ending balance
$
799

 
$
816

Indemnification
In its sales agreements, the Company may agree to indemnify its indirect sales channels and end user customers for certain expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. The terms of these indemnification provisions are generally perpetual any time after execution of the agreement. The agreements generally limit the scope of the available remedies in a variety of industry-standard methods, including, but not limited to, product usage and geography-based limitations, a right to control the defense or settlement of any claim, and a right to replace or modify the infringing products to make them non-infringing. In certain circumstances, the Company may be subject to uncapped indemnity obligations. To date the Company has not paid any amounts to settle claims or defend lawsuits pursuant to such indemnification provisions. The Company believes the likelihood of such claims is remote. Accordingly, the Company has no liabilities recorded for these agreements as of October 31, 2013 and July 31, 2013. In addition, the Company indemnifies its officers, directors, and certain key employees while they are serving in good faith in their company capacities.

21



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. You can identify these forward-looking statements by words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “potential,” “should,” “will,” “would” and other similar expressions. These statements include, among other things, statements concerning our expectations:
that revenue from our indirect channels will continue to constitute a significant majority of our future revenue;
that competition will intensify in the future as other companies introduce new products in the same markets we serve or intend to enter;
that our product offerings, in particular our Mobile Virtual Enterprise ("MOVE") architecture, including our new ClearPass and Aruba Instant products, will enable broader networking initiatives by both our current and potential customers;
that we will increase offshore operations by establishing additional offshore capabilities for certain engineering and general and administrative functions in China, India and Ireland;
that within our indirect channel, sales through our value-added distributors, ("VADs"), and original equipment manufacturers ("OEMs"), will continue to be significant;
that international revenue will increase in absolute dollars and remain in the approximate percentage range of prior years;
that research and development expenses for fiscal 2014 will increase on an absolute dollar basis and increase as a percentage of revenue compared to fiscal 2013;
that we intend to continue to invest significantly in our research and development efforts;
that sales and marketing expenses for fiscal 2014 will continue be our most significant operating expense and will increase on an absolute dollar basis as we continue to invest strategically in this area and remain approximately flat as a percentage of revenue compared to fiscal 2013;
that general and administrative expenses for fiscal 2014 will increase in absolute dollars and decrease as a percentage of revenue compared to fiscal 2013;
that we have incurred in the past, and may continue to incur, significant legal costs defending ourselves against claims made by third parties and depending on the timing and outcome of lawsuits and the legal process, legal costs and any resulting damages could have a significant impact on our financial statements;
that our existing cash, cash equivalents, short-term investments and cash generated from operations will be sufficient to meet anticipated cash requirements for at least the next 12 months;
that we anticipate achieving cash tax savings and a reduction in our overall tax rate as a result of the corporate organization structure implemented in fiscal 2012;
that we will attempt to ensure the safety and preservation of our invested funds by limiting default risk, market risk and reinvestment risk; and
that we will continue our international expansion and increase our market penetration both domestically and internationally through our network of channel partners and by increasing our direct sales force.
These forward-looking statements are based on information available to us as of the date of this report and current expectations, forecasts and assumptions 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, or SEC. Our forward-looking statements should not be relied upon as representing our views as of any subsequent date, and we are under no obligation to, and expressly disclaim any responsibility to, update or alter our forward-looking statements, whether as a result of new information, future events or otherwise. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
The following information should be read in conjunction with the Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included in this report.

22



Overview
Aruba Networks, Inc. is a leading global provider of enterprise mobility solutions. We develop, market and sell products and services designed to solve our customers' secure mobility requirements though our MOVE architecture, which unifies the network infrastructure, access management and mobility applications into one integrated system that offers strong security and a simplified approach to bring-your-own-device ("BYOD") initiatives.
We believe the market for mobility solutions in the enterprise is changing and that the explosion of mobile devices is forcing information technology ("IT") departments to radically revise the way they approach provisioning and supporting these devices in the workplace. Our goal is to provide simplified, dependable solutions that permit IT departments to quickly, securely and cost-effectively meet their mobility and BYOD needs. We address these needs with our flexible MOVE architecture, a fundamentally new network architecture, designed for an increasingly mobile universe of end-users. Our MOVE architecture is comprised of three major components. The first component consists of our mobility-centric network infrastructure, the second component consists of our next-generation access management solution, and the third component consists of our mobility applications.
We primarily conduct business in three geographic regions: Americas, Europe, the Middle East and Africa ("EMEA"), and Asia Pacific and Japan ("APJ"). Our products and services have been sold to more than 30,000 customers worldwide, including some of the largest and most complex global organizations. Our customer base spans major industries and verticals, including general enterprise, high tech enterprise, industrial enterprise, higher education, K-12 education, health care, retail, federal/state/local government, financial services and hospitality. We typically sell to and support these customers through a two-tier distribution model in most areas of the world, including the United States. Our VADs and OEMs sell our portfolio of products, including a variety of our support services, to a diverse number of VARs, system integrators and service providers. Also, certain of our OEMs sell directly to end customers.
Major Trends Affecting Our Financial Results
Worldwide Economic Conditions
Our business depends on the overall demand for IT initiatives and on the economic health and general willingness of our current and prospective customers to make capital commitments. If the conditions in the global economic environment remain uncertain or continue to be volatile, or if these conditions deteriorate, our business, operating results, and financial condition may be adversely affected in a material way. Economic weakness, customer financial difficulties and constrained spending on IT initiatives have resulted, and may in the future result, in challenging and delayed sales cycles and could negatively impact our ability to forecast future periods. Sequestration, the U.S. government’s failure to raise the debt limit beyond the current February 7, 2014 deadline or other significant cuts in U.S. government spending could adversely affect our future results. 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.
Revenue
Our ability to increase our revenue will depend significantly on, among other things, 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 and distribution partners, our ability to compete, the willingness of customers to displace wired networks with wireless LANs, our ability to retain existing distribution partners, and our ability to continue to sell into our installed base of existing customers. We believe that our MOVE architecture, including our ClearPass and Aruba Instant offerings, will enable broader networking initiatives by both our current and potential customers. Our growth in support revenue is dependent upon increasing the number of products under support contracts, which is dependent on both growing our installed base of customers and renewing existing support contracts. Our future profitability and rate of growth, if any, will also be directly affected by the timing and size of orders, product and channel mix, average selling prices, costs of our products, our ability to effectively manage our two-tier distribution model, general economic conditions, and the extent to which we invest in our sales and marketing, research and development, and general and administrative resources.
The revenue growth that we have experienced has been driven primarily by an expansion of our customer base coupled with increased purchases from existing customers. We believe the growth we have experienced is the result of business enterprises and other organizations needing to provide secure mobility to their users in a manner that we believe is more cost effective than the traditional approach of using port-centric networks. Our revenue grew 11.4% in the first quarter of fiscal 2014 as compared with the same period in fiscal 2013.
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 prior quarters that are shipped in the current quarter, and (3) the amount of deferred revenue entering a given quarter that is recognized as revenue in the quarter.

23



Our product deferred revenue is comprised of:
product orders that have shipped but where the terms of the agreement, typically with our large customers, contain acceptance terms and conditions or other terms that require that the revenue be deferred until all revenue recognition criteria are met; and
product orders shipped to our VADs and OEMs for which we have not yet received persuasive evidence of sell-through from the VADs or OEMs.
We typically ship products within 10 days after the receipt of an order.
Costs and Expenses
The substantial majority of our cost of product revenue consisted of payments to third parties to manufacture our products, including Wistron NeWeb Corp. ("WNC"), Sercomm, and Accton Technology Corporation ("Accton'), who were our largest contract manufacturers during our first quarter of fiscal 2014.
Our operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The largest component of our operating expenses in each of these categories is personnel costs. Personnel costs consist of salaries, benefits and incentive compensation for our employees, including commissions for sales personnel and stock-based compensation for employees. As of October 31, 2013, we had 1,567 employees worldwide compared to 1,473 employees at July 31, 2013. The increase in employees is the most significant driver behind the increase in costs and operating expenses in the three months ended October 31, 2013. We expect to continue hiring additional employees as we continue to invest in our infrastructure and operations.
Stock Repurchase
As of October 31, 2013, our Board of Directors had authorized a stock repurchase program for an aggregate amount of up to $300.0 million (consisting of an original $100.0 million authorization on June 13, 2012, plus subsequent authorizations of an additional $100.0 million on July 15, 2013 and $100.0 million on October 9, 2013). We are authorized to make repurchases in the market until our Board of Directors terminates the program or until our repurchases reach the authorized amount, whichever occurs first. Any repurchases under the program will be funded from available working capital. The number of shares repurchased and the timing of repurchases are based on the price of our common stock, general business and market conditions, and other investment considerations. Shares are retired upon repurchase.
Our policy related to repurchases of our common stock is to charge any excess of cost over par value entirely to additional paid-in capital. During the first quarter of fiscal 2014 and 2013, we repurchased a total of 6,363,780 shares and 590,141 shares, respectively, for a total purchase price of $113.5 million and $11.5 million, respectively. As of October 31, 2013, we repurchased a cumulative total of 13,083,616 shares for a total purchase price of $219.6 million, with $80.4 million remaining authorized under the stock repurchase program.
Revenue, Cost of Revenue and Operating Expenses
Revenue
We derive our revenue from sales of our ArubaOS operating system, controllers, wired and wireless access points, switches, application software modules, access-management solution, multi-vendor management solution software, and professional services and support.
We sell our products and services directly through our sales force and indirectly through partners including VADs, VARs, service providers and OEMs. We expect revenue from indirect channels to continue to constitute a significant majority of our future revenue.
We sell our products to channel partners and end customers located in the United States, EMEA, APJ, and other parts of the world. We continue to expand into international locations and introduce our products in new markets, and we expect international revenue to increase in absolute dollars and remain in the approximate percentage range of prior years. For more information about our international revenue, see Note 11, Segment Information and Significant Customers, of the Notes to Consolidated Financial Statements.
Professional services revenue consists of consulting and training services. Consulting services primarily consist of design as well as onsite and remote support services. Training services are typically instructor-led courses on the use of our products. Support services typically consist of software updates, on a when-and-if available basis, and 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.

24



Cost of Revenue
Cost of product revenue consists primarily of manufacturing costs for our products, shipping and logistics costs, charges for inventory obsolescence, amortization of existing technology and warranty obligations. We utilize third parties to manufacture our products and perform shipping logistics. We have outsourced the substantial majority of our manufacturing, repair and supply chain operations. Accordingly, the substantial majority of our cost of product revenue consists of payments to our contract manufacturers. Our contract manufacturers produce our products in Asia using quality assurance programs and standards that we jointly established. Manufacturing, engineering and documentation controls are conducted at our facilities in Sunnyvale, California, Bangalore, India and Beijing, China. Cost of product revenue also includes amortization expense from our purchased intangible assets.
Cost of professional services and support revenue is primarily comprised of personnel costs, including stock-based compensation, for providing technical support. In addition, we engage third-party support vendors to complement our internal support resources, the costs of which are included within costs of professional services and support revenue.
Gross Margin
Our gross margin has been, and will continue to be, affected by a variety of factors, including:
changes in the mix of products sold or manner in which products are sold in our channel;
the percentage of revenue from international regions;
increased price competition and discounting pressures;
increases in material, labor or other manufacturing-related costs;
excess product component or obsolescence charges from our contract manufacturers;
write-downs for obsolete or excess inventory;
increased costs due to changes in component pricing or charges incurred due to component holding periods if our forecasts do not accurately anticipate product demand;
timing of revenue recognition and revenue deferrals;
warranty-related issues;
freight charges;
our introduction of new products or new product platforms or entry into new markets with different pricing and cost structures;
amortization expense from our intangible assets which is mainly existing technology; and
amortization of capitalized software development costs.
Due to higher net effective discounts for products sold through our indirect channel, our overall gross margins for indirect channel sales are typically lower than those associated with direct sales. We expect product revenue from our indirect channel to continue to constitute a significant majority of our total revenue, which we expect will continue to negatively impact our gross margin. Further, we expect that within our indirect channel, sales through our VADs and OEMs will continue to be significant, which will negatively impact our gross margins as VADs and OEMs generally experience a larger net effective discount than our other channel partners.
Research and Development Expenses
Research and development expenses primarily consist of personnel costs and facilities costs. We expense research and development expenses as incurred. We are devoting substantial resources to the continued development of additional functionality for existing products and the development of new products. We intend to continue to invest significantly in our research and development efforts because we believe it is essential to maintaining our competitive position. For fiscal 2014, we expect research and development expenses to increase on an absolute dollar basis and as a percentage of revenue compared to fiscal 2013.

25



Sales and Marketing Expenses
Sales and marketing expenses represent the largest component of our operating expenses and primarily consist of personnel costs, sales commissions, marketing programs and facilities costs. A portion of the amortization expense related to our intangible assets is also included in sales and marketing expenses. Marketing programs are intended to generate revenue from new and existing customers and are expensed as incurred. We plan to continue to invest strategically in sales and marketing with the intent to add new customers and increase penetration within our existing customer base, expand our domestic and international sales and marketing activities, build brand awareness and sponsor additional marketing events. We expect future sales and marketing expenses to continue to be our most significant operating expense. Generally, sales personnel are not immediately productive, and thus, the increase in sales and marketing expenses that we experience as we hire additional sales personnel is not expected to immediately result in increased revenue. As a result, these expenses will reduce our operating margin until the new 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 2014, we expect sales and marketing expenses to increase on an absolute dollar basis as we continue to invest strategically in this area and remain approximately flat as a percentage of revenue compared to fiscal 2013.
General and Administrative Expenses
General and administrative expenses primarily consist of personnel and facilities costs related to our executive, finance, human resource, information technology and legal organizations, as well as insurance, investor relations, and IT infrastructure costs related to our enterprise resource planning (“ERP”) system. Further, our general and administrative expenses include professional services consisting of outside legal, audit, Sarbanes-Oxley and IT consulting costs, and non-income tax reserves. 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, legal costs and any resulting damages could have a significant impact on our financial statements. For fiscal 2014, we expect general and administrative expenses to increase in absolute dollars and decrease as a percentage of revenue compared to fiscal 2013. However, third-party professional services are subject to material fluctuations given the needs of the business, which may cause our expected expenditures in absolute dollars and as a percentage of revenue to differ from our forecasted expectations.
Other Income, net
Other income, net includes interest income on cash balances, accretion of discount or amortization of premium on short-term investments, losses or gains from foreign exchange rate changes, and changes in the valuation of our contingent rights liability related to the acquisition of Azalea Networks ("Azalea") from September 2, 2010 to December 31, 2012 (expiration of our contingent rights liability). See Note 3, Contingent Rights Liability Arising from Business Combinations, of the Notes to Consolidated Financial Statements for further information on the Azalea acquisition and our related contingent rights liability.
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 revenue and expenses during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based upon information available to us at the time that these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, our Consolidated Financial Statements will be affected. The accounting policies that reflect our more significant estimates and judgments and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include revenue recognition, share-based compensation, inventory valuation, allowance for doubtful accounts, impairment of goodwill and intangible assets, and accounting for income taxes.
There have been no material changes in the matters for which we make critical accounting estimates in the preparation of our condensed consolidated financial statements during the three months ended October 31, 2013, as compared to those disclosed in our Annual Report on Form 10-K for the fiscal year ended July 31, 2013 filed on September 24, 2013.
Recent Accounting Pronouncements
Refer to Recent Accounting Pronouncements under Note 1, The Company and its Significant Accounting Policies, of the Notes to Consolidated Financial Statements for recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, that could have on us.

26



Results of Operations
The following table presents our historical operating results as a percentage of total revenue for the periods indicated:
 
 
Three Months Ended October 31,
 
2013
 
2012
Revenue:
 
 
 
Product
81.3
 %
 
82.5
 %
Professional services and support
18.7
 %
 
17.5
 %
Total revenue
100.0
 %
 
100.0
 %
Cost of revenue:
 
 
 
Product
25.0
 %
 
25.0
 %
Professional services and support
5.2
 %
 
4.2
 %
Total cost of revenue
30.2
 %
 
29.2
 %
Gross margin
69.8
 %
 
70.8
 %
Operating expenses:
 
 
 
Research and development
25.1
 %
 
22.1
 %
Sales and marketing
39.2
 %
 
37.3
 %
General and administrative
9.0
 %
 
8.3
 %
Total operating expenses
73.3
 %
 
67.7
 %
Operating income (loss)
(3.5
)%
 
3.1
 %
Other income, net
 
 
 
Interest income
0.1
 %
 
0.2
 %
Other income, net
0.2
 %
 
0.2
 %
Income (loss) before income taxes
(3.2
)%
 
3.5
 %
Provision for income taxes
1.7
 %
 
4.1
 %
Net loss
(4.9
)%
 
(0.6
)%


27



Revenue
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Total revenue
$
160,927

 
$
144,482

Type of revenue:
 
 
 
Product
$
130,831

 
$
119,222

Professional services and support
30,096

 
25,260

Total revenue
$
160,927

 
$
144,482

% revenue by type:
 
 
 
Product
81.3
%
 
82.5
%
Professional services and support
18.7
%
 
17.5
%
Revenue by geography:
 
 
 
United States
$
108,315

 
$
92,752

Europe, the Middle East and Africa
25,996

 
21,550

Asia Pacific and Japan
22,994

 
24,653

Rest of World
3,622

 
5,527

Total revenue
$
160,927

 
$
144,482

% revenue by geography:
 
 
 
United States
67.2
%
 
64.2
%
Europe, the Middle East and Africa
16.2
%
 
14.9
%
Asia Pacific and Japan
14.3
%
 
17.1
%
Rest of World
2.3
%
 
3.8
%
Total revenue by sales channel:
 
 
 
Indirect
$
149,201

 
$
133,652

Direct
11,726

 
10,830

Total revenue
$
160,927

 
$
144,482

% revenue by sales channel:
 
 
 
Indirect
92.7
%
 
92.5
%
Direct
7.3
%
 
7.5
%
For the first quarter of fiscal 2014, total revenue increased $16.4 million, or 11.4%, over the first quarter of fiscal 2013, primarily driven by higher demand for our products and services from existing and new customers as a result of improved product solutions and by our go-to-market sales strategy.
Product revenue increased $11.6 million, or 9.7% during the first quarter of fiscal 2014 compared to the first quarter of fiscal 2013. The increase in product revenue was primarily driven by a combination of solid demand for our Controllers and Access Points, including technology leadership in our 802.11ac products, and increasing demand for our ClearPass solution.
Professional services and support revenue increased $4.8 million, or 19.1%, during the first quarter of fiscal 2014 compared to the first quarter of fiscal 2013. The increase in support revenue was primarily a result of increased initial sales and renewals of post-contract support agreements boosted by higher product sales and a larger customer install base. We also experienced higher professional service revenue in the first quarter of fiscal 2014, compared to the first quarter of fiscal 2013 as a result of increasing demand for our ClearPass and AirWave solutions, leveraged by an expansion of our internal professional services team as well as by our installation services partners.
Revenue from shipments to locations outside the U.S. increased $0.9 million, or 1.7%, during the first quarter of fiscal 2014 compared to the first quarter of fiscal 2013 due to increasing demand internationally. However, as a percentage of total revenue, U.S. revenue increased during the first quarter of fiscal 2014 compared to the first quarter of fiscal 2013 from 64.2% to 67.3%.
Revenue from our indirect sales channel increased $15.5 million during the first quarter of fiscal 2014 compared to the first quarter of fiscal 2013 and increased slightly as a percentage of revenue from 92.5% to 92.7%. Going forward, we expect to continue to derive a significant majority of our total revenue from indirect channels as we continue to focus on expanding our channels and improving the efficiency of marketing and selling our products through these channels.

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Cost of Revenue and Gross Margin
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Total revenue
$
160,927

 
$
144,482

 
 
 
 
Cost of product revenue
40,118

 
36,161

Cost of professional services and support revenue
8,433

 
5,957

Total cost of revenue
48,551

 
42,118

Gross profit
$
112,376

 
$
102,364

 
 
 
 
Gross margin
69.8
%
 
70.8
%
For the first quarter of fiscal 2014, our total cost of revenue increased $6.4 million, or 15.3%, as compared to the first quarter of fiscal 2013. This increase was primarily due to the corresponding increase in our product revenue. The substantial majority of our cost of product revenue consisted of payments to WNC, Sercomm, and Accton, our largest contract manufacturers during our first quarter of fiscal 2014. For the first quarter of fiscal 2014, payments to WNC, Sercomm, and Accton constituted approximately 38%, 25% and 24%, respectively, of our cost of product revenue. Additionally, cost of product revenue was impacted by an increase of $0.7 million in stock-based compensation and amortization of intangible assets during the first quarter of fiscal 2014 compared to the first quarter of fiscal 2013.
Our cost of professional services and support revenue increased $2.5 million, or 41.6%, during the first quarter of fiscal 2014 as compared to the first quarter of fiscal 2013. This increase was primarily due to the corresponding increase in our service revenue, as well as increased outside services as we expanded our customer support call centers and increased costs associated with our initiative to increase professional services delivery capabilities to accelerate the expansion of our solutions. Additionally, cost of professional services and support revenue was impacted by an increase of $0.6 million in stock-based compensation during the first quarter of fiscal 2014 compared to the first quarter of fiscal 2013 primarily as a result of increase in headcount and compensation during the first quarter of fiscal 2014 compare to the first quarter of fiscal 2013.
Our total gross margin decreased 100 basis points to 69.8% for the first quarter of fiscal 2014 as compared to 70.8% for the first quarter of fiscal 2013, primarily due to changes in our product and geographical mix, as well as decreased gross margins on services revenue. As we expand internationally, we will likely incur additional costs to conform our products to comply with local laws or local product specifications. In addition, we plan to continue hiring additional professional services personnel to support our growing ClearPass deployments and our international customer base, which would increase our cost of professional services and support.

Research and Development Expenses
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Research and development expenses
$
40,445

 
$
31,963

Percent of total revenue
25.1
%
 
22.1
%

For the first quarter of fiscal 2014, our research and development expenses increased $8.5 million, or 26.5%, compared to the first quarter of fiscal 2013. As a result of the increase in headcount, personnel and related costs increased $4.4 million, including an increase in stock-based compensation of $2.4 million, as we continued to enhance our technology solutions. Depreciation expenses increased $1.2 million as we invested in additional lab equipment to support our product development efforts. Facilities and IT-related expenses related to our worldwide research and development efforts also increased $1.8 million as a result of the increase in personnel during the first quarter of fiscal 2014.


29



Sales and Marketing Expenses
 
Three Months Ended October 31,
 
2013
 
2012
 
(in thousands)
Sales and marketing expenses
$
63,044

 
$
53,919

Percent of total revenue
39.2
%
 
37.3
%
For the first quarter of fiscal 2014, our sales and marketing expenses increased $9.1 million, or 16.9%, compared to the first quarter of fiscal 2013. As a result of expanding our headcount and of higher sales commission expense due to our go-to-market strategy, personnel and related costs increased $5.6 million, including an increase in stock-based compensation of $1.6 million. Overall marketing expenses increased $1.6 million primarily due to field marketing efforts and increased participation in marketing programs to introduce and promote our new and existing products. Facilities and IT-related expenses related to our sales and marketing efforts also increased $1.1 million, due to increased spending to support business growth.

General and Administrative Expenses
 
Three Months Ended October 31,