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ARUN > SEC Filings for ARUN > Form 10-Q on 6-Jun-2013All Recent SEC Filings

Show all filings for ARUBA NETWORKS, INC. | Request a Trial to NEW EDGAR Online Pro



Quarterly Report

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 revenue from our indirect channels will continue to constitute a significant majority of our future revenue;

that mobile devices will surpass desktop connections;

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 associated with 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;

that, within our indirect channel, sales through our value-added distributors ("VADs") and original equipment manufacturers ("OEMs") will continue to be significant;

that our momentum in our MOVE architecture initiatives, including network rightsizing and adoption of our ClearPass access management system and Aruba Instant will continue;

that international revenue will increase in absolute dollars and increase as a percentage of total revenue in fiscal 2013 compared to fiscal 2012;

that research and development expenses for fiscal 2013 will increase on an absolute dollar basis and increase as a percentage of revenue compared to fiscal 2012;

that sales and marketing expenses for fiscal 2013 will continue to 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 consistent or decrease as a percentage of revenue compared to fiscal 2012;

that general and administrative expenses for fiscal 2013 will increase in absolute dollars and decrease as a percentage of revenue compared to fiscal 2012;

that our existing cash, cash equivalents, short-term investments and cash generated from operations will be sufficient to meet our needs;

that we will ensure the safety and preservation of our invested funds by limiting default risk, market risk and reinvestment risk; 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, 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 leading provider of next-generation network access solutions for the mobile enterprise. Our MOVE architecture leverages Aruba's diverse products (including our ArubaOS operating system, controllers, wireless access points, switches,

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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 our customers, enabling them to provide network access to traveling business professionals, remote workers and employees and guests of branch offices and corporate headquarters. With the Aruba MOVE architecture, access privileges are linked to a user's identity and context. That means an enterprise workforce has consistent, secure access to network resources based on who they are, where they are, what devices and applications they are using, and how they are connected. Demand for our products is driven by mobility and the proliferation of Wi-Fi-enabled mobile devices. These devices - which have no Ethernet port - are connecting to enterprise networks in unprecedented numbers and we expect they will surpass desktop connections. Aruba meets this challenge by designing and selling products intended to eliminate the cost and complexity of managing separate wired and wireless access policies. By implementing our solutions, our customers need fewer ports and consequently less equipment in the wiring closet
- effectively rightsizing our customers' access infrastructure. Aruba's MOVE architecture provides context-aware networking for the post-PC era. Mobility network services are delivered centrally from the data center across thin network access devices or on-ramps. At the heart of Aruba MOVE, a single set of mobility network services manages security, policy and network performance for every user and device on the network. This mobility and user-centric approach makes it possible to re-architect the access network to simultaneously provide workforce mobility and reduce costs. To connect users into the network, whether at work, home, or on the road, Aruba access on-ramps include wireless, wired, and VPN products. Device configuration, security policies, and reporting are centrally managed, effectively making installation a zero-touch experience. A key new addition to our MOVE architecture is our ClearPass Access Management System. ClearPass is designed to make it easy for IT-issued and personal mobile devices to securely connect to any network, which we believe makes ClearPass an attractive solution for "bring you own device," or BYOD, provisioning and onboarding. By centralizing access policies across the entire network, ClearPass automates differentiated user and device access, policy management and the provisioning of devices for secure network access and posture assessment. This ensures that each user has the right access privileges based on who they are and what device they are using. Given the increasing numbers of consumer devices - Windows, Mac OS X, iOS, Android and Linux - attempting to connect to enterprise networks and the increasing demand for access to those networks by a broader range of users - employees, visitors, customers and contractors - we believe ClearPass provides a compelling solution to these customer needs. Another addition to the MOVE architecture is Aruba Instant, a controller-less Wi-Fi solution that is designed to combine ease-of-use and cost-effectiveness with best-in-class security, resiliency and intelligence. In Aruba Instant mode, a single access point manages the other Aruba Instant APs in the WLAN, while the free Aruba Activate service offers zero-touch provisioning and cloud-based inventory management. This allows our customers to power-up one Aruba Instant AP, which will then automatically obtain its configuration and become operational. To grow the network, customers simply plug in additional access points. The deployment process is thereby substantially simplified, saving our customers' time and operational expenses. Our products have been sold to over 20,000 customers worldwide, 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 U.S., with value added distributors ("VADs") and original equipment manufacturers ("OEMs") selling our portfolio of products, including a variety of our support services, to a diverse number of value added resellers ("VARs") and managed service providers. We also sell our products and support services directly through our own sales force. In addition to direct sales, our sales force is engaged with our VARs and VADs to provide solutions for our end customers. 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.
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 it deteriorates further, 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 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 and growth rates.

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Our ability to increase our product revenue 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, our ability to retain existing distribution partners, and our ability to continue to sell into our installed base of existing 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. While our revenue growth rate was slower than that in the previous fiscal year, our revenue grew 11.6% and 18.4% in the three and nine months ended April 30, 2013, respectively, compared to our revenue for the same periods in fiscal 2012. We believe that our slower revenue growth was attributable to overall weakness in the global macroeconomic conditions, particularly in the Asia Pacific and Japan region, as well as increased competition during the third quarter of fiscal 2013. We believe that our product offerings associated with 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. 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 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. 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
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 April 30, 2013, we had 1,460 employees worldwide compared to 1,407 employees at January 31, 2013, 1,293 employees at October 31, 2012, and 1,223 employees at July 31, 2012. The increase in employees is the most significant driver behind the increase in costs and operating expenses in the three and nine months ended April 30, 2013. Despite the slowdown in our revenue growth, we expect to continue investing in our infrastructure and operations, including continuation of hiring of employees throughout the company. Stock Repurchase
On June 13, 2012, we announced a stock repurchase program for up to $100.0 million of our common stock. We are authorized to make repurchases in the open market until June 6, 2014, and any such repurchases will be funded from available working capital. The number of share repurchases 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 nine months ended April 30, 2013, we repurchased a total of 1,604,142 shares for a total purchase price of $30.5 million. As of April 30, 2013, we repurchased a cumulative total of 3,012,646 shares for a total purchase price of $50.4 million, with $49.6 million remaining authorized under the stock repurchase program. We made no stock repurchase during the three months ended April 30, 2013, and no repurchases during the three and nine months ended April 30, 2012.

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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 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, Europe, Middle East, Africa, Asia Pacific, Japan 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 increase as a percentage of total revenue in fiscal 2013 compared to fiscal 2012. For more information about our international revenue, see Note 12 of the Notes to Consolidated Financial Statements.
Professional services revenue consists of consulting and training services. Consulting services primarily consist of installation 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, 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.
Cost of Revenue
Cost of product revenue 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 product revenue consists of payments to our contract manufacturers. Our contract 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 revenue also includes amortization expense from our intangible assets.
Cost of professional services and support revenue is primarily comprised of personnel costs, including stock-based compensation, of 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:
the proportion of our products that are sold through direct versus indirect channels;

product mix and average selling prices;

new product introductions, such as ClearPass and Aruba Instant additions to our MOVE architecture, and product enhancements made by us as well as those made by our competitors;

pressure to discount our products in response to our competitors' discounting and/or product bundling practices;

mix of revenue attributed to our international regions and vertical markets;

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;

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our ability to manage freight costs; and

amortization expense from our intangible assets.

Due to higher net effective discounts for products sold through our indirect channel, our overall gross margins for indirect channel sales are typically lower than those associated with direct sales. We expect product revenue from our indirect channel to continue to constitute a significant majority of our total revenue, which, by itself, negatively impacts our gross margins. 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 except for costs associated with the development of internal-use software, which meet certain capitalization criteria. 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 2013, we expect research and development expenses to increase on an absolute dollar basis and increase as a percentage of revenue compared to fiscal 2012. 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 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 2013, we expect sales and marketing expenses to increase on an absolute dollar basis and remain consistent or decrease as a percentage of revenue compared to fiscal 2012.
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 information technology ("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. 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 2013, we expect general and administrative expenses to increase in absolute dollars and decrease as a percentage of revenue compared to fiscal 2012. However, fluctuations in third-party professional services can cause an increase in any particular quarter.
Other Income (Loss), Net
Other income (loss), net includes interest income on cash balances, accretion of discount or amortization of premium on short-term investments, losses or gains on foreign exchange rate changes, and in connection with our acquisition of Azalea Networks ("Azalea") in September 2010, changes in the fair value or gains from the release of our contingent rights liability. Critical Accounting Policies
Our Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). These accounting principles require us to make estimates and judgments that affect the reported amounts of assets and liabilities as of the date of the Consolidated Financial Statements, as well as the reported amounts of revenue and expenses during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based upon

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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. Our critical accounting policies are disclosed in our Form 10-K for the fiscal year ended July 31, 2012. There were no changes to our critical accounting policies during the three and nine months ended April 30, 2013.

Results of Operations
The following table presents our historical operating results as a percentage of
revenue for the periods indicated:
                                            Three months ended April 30,       Nine months ended April 30,
                                               2013              2012             2013              2012
Product                                         82.4  %            83.8  %        83.1  %           84.1  %
Professional services and support               17.6  %            16.2  %        16.9  %           15.9  %
Total revenue                                  100.0  %           100.0  %       100.0  %          100.0  %
Cost of revenue
Product                                         25.0  %            25.8  %        24.8  %           25.6  %
Professional services and support                4.9  %             4.2  %         4.5  %            4.0  %
Gross profit                                    70.1  %            70.0  %        70.7  %           70.4  %
Operating expenses
Research and development                        23.7  %            20.7  %        22.7  %           21.1  %
Sales and marketing                             38.9  %            37.9  %        37.7  %           38.5  %
General and administrative                       9.1  %             8.9  %         8.4  %            9.4  %
Total operating expenses                        71.7  %            67.5  %        68.8  %           69.0  %
Operating income (loss)                         (1.6 )%             2.5  %         1.9  %            1.4  %
Other income (loss), net
Interest income                                  0.2  %             0.2  %         0.2  %            0.2  %
Other income (loss), net                        (0.1 )%            (0.4 )%         0.2  %            0.8  %
Total other income (loss), net                   0.1  %            (0.2 )%         0.4  %            1.0  %
Income (loss) before income taxes               (1.5 )%             2.3  %         2.3  %            2.4  %
Provision for (benefit from) income taxes       12.2  %            (2.3 )%         5.9  %            3.9  %

Net income (loss) (13.7 )% 4.6 % (3.6 )% (1.5 )%

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The following table presents our revenue, by revenue source, for the periods

                                              Three months ended April 30,            Nine months ended April 30,
                                                2013                 2012               2013               2012

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