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ARUN > SEC Filings for ARUN > Form 10-K on 24-Sep-2013All Recent SEC Filings

Show all filings for ARUBA NETWORKS, INC.

Form 10-K for ARUBA NETWORKS, INC.


24-Sep-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with our Consolidated Financial Statements and related notes included elsewhere in this report. Overview
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 BYOD initiatives.
We believe the market for mobility solutions in the enterprise is changing and that the explosion of mobile devices is forcing 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, including our mobility controllers and software modules, wireless access points, mobility access switches, remote access points, VPN software and AirWave management. The second component is our next-generation access management solution, including ClearPass software for network access control as well as device and application management. The third component consists of our mobility applications, including our WorkSpace mobile application, our APIs and our Meridian application for visitor engagement through indoor way-finding and targeted location-based messaging. Aruba conducts business in three geographic regions: Americas, EMEA, and 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 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 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. 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.


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The revenue growth that we have experienced has been driven primarily by an expansion of our customer base coupled with increased purchases from existing customers. We believe the growth we have experienced is the result of business enterprises 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 16.1% in fiscal 2013 as compared to in fiscal 2012. This performance was driven by solid execution, improvements across most of our geographical theatres and increased demand in our core verticals globally. Looking forward, we believe that we have strong growth drivers with our 802.11ac products, ClearPass, public facing enterprise solutions and Aruba Instant.
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
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 July 31, 2013, we had 1,473 employees worldwide compared to 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 year ended July 31, 2013. We expect to continue investing in our infrastructure and operations, including continuation of hiring of employees throughout the Company. Significant Events
Our consolidated financial statements during the year ended July 31, 2013 were affected by certain significant events that should be considered in comparing the periods presented.
Business Combinations
On May 13, 2013, we 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. The purchase price was $16.8 million, all of which was paid in cash. In addition, we are obligated to pay additional cash consideration of up to $10.2 million to certain former Meridian employees who became our employees, which will be made over a period of approximately three years from the closing date, subject to certain continued employment restrictions. For the year ended July 31, 2013, we recorded compensation costs of $0.8 million in general and administrative expenses associated with this additional cash compensation. Acquisition related costs, included in general and administrative expenses, were not material. As a result of the acquisition, we expect to offer new indoor location-based services by combining our unique, network-based contextual information about users, devices and applications with Meridian's Wi-Fi based visitor engagement solution for smart phones and tablets.
In connection with this acquisition, we retained the services of a third-party firm to complete a valuation of the assets acquired in order to allocate the purchase price consideration. The total purchase price consideration was allocated to the net tangible and identified intangible assets based upon the fair values as of May 13, 2013, in accordance with our review and oversight of the third-party valuation. The excess purchase price over the value of the net tangible and identifiable intangible assets was recorded as goodwill. The purchase price consideration of the acquisition was allocated as follows (in thousands, except years):


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Purchase price consideration:
Cash                                               $ 16,777

Tangible assets acquired and liabilities assumed     (1,218 )
                                                                 Estimated
                                                                Useful Lives
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 purchase price consideration                 $ 16,777

We expensed $0.1 million of acquisition-related costs incurred as general and administrative expenses in the Consolidated Statements of Operations and Comprehensive Income (Loss) in fiscal 2013. Stock Repurchase
On June 13, 2012, we announced a stock repurchase program for up to $100.0 million of our common stock, which was increased by an additional $100.0 million on July 15, 2013. We are authorized to make repurchases in the market until our Board of Directors' terminates the program or until expenditures 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 purchases are based on the price of our common stock, general business and market conditions and other investment considerations. Shares are retired upon repurchase and it is our policy to charge any excess of cost over par value entirely to additional paid-in capital. During the fiscal years ended July 31, 2013 and 2012, we repurchased a total of 5,311,332 shares and 1,408,504 shares, respectively for a total of purchase price of $86.2 million and $19.9 million, respectively. At July 31, 2013, $93.9 million remains authorized for repurchase under our stock repurchase program. Legal Settlement
During the fourth quarter of our fiscal 2013, we reached a settlement resolving the lawsuit filed against us by Nomadix, Inc. As part of the settlement, we agreed to pay Nomadix an amount in consideration for, among other things, a perpetual non-exclusive license to the patent asserted by Nomadix. The settlement amount was recorded in the fourth quarter of fiscal 2013. The terms of the settlement are confidential. Although the settlement did have a material impact to our Consolidated Statements of Operations and Comprehensive Income
(Loss), it did not have a material adverse effect on our consolidated financial position or cash flows for fiscal 2013. 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, 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 2014 compared to fiscal 2013. For more information about our international revenue, see Note 12, 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


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and 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, 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. 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.
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


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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 will increase as 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. 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 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 in connection with our acquisition of Azalea Networks ("Azalea") from September 2, 2010 to December 31, 2012, changes in the fair value or gains from the release of our contingent rights liability. See Note 2, Business Combinations of the Notes to Consolidated Financial Statements for more information on the Azalea acquisition and the 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 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.
Revenue Recognition
Total revenue is derived primarily from the sale of products and services, including professional services and support. The following revenue recognition policies define the manner in which we account for our sales transactions. We recognize revenue when all of the following have occurred: (1) we have entered into a legally binding arrangement with a customer; (2) delivery has occurred or the title and risk of loss has passed; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is reasonably assured.
Our fees are typically considered to be fixed or determinable at the inception of an arrangement, generally based on specific products and quantities to be delivered. Substantially all of our contracts do not include rights of return or acceptance provisions. To the extent that agreements contain such terms, we recognize revenue once the customer has accepted, or once the acceptance provisions or right of return lapses. Payment terms to customers generally range from net 30 to 90 days. In the event payment terms are provided that differ from our standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized when the payments are received, provided the remaining criteria for revenue recognition have been met. We assess the ability to collect from our customers based on a number of factors, including credit worthiness of the customer and past transaction history of the customer. If the customer is not deemed credit worthy, we defer revenue from the arrangement until payment is received and all other revenue recognition criteria have been met. We record estimated sales returns as a reduction to revenue upon shipment based on our contractual obligations and historical returns experience. In cases


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where we are aware of circumstances that will likely result in a specific customer's request to return purchased equipment, we record a specific sales returns reserve.
Our revenue recognition policies provide that, when a sales arrangement contains multiple elements, such as hardware and software products, licenses and/or services, we allocate revenue to each element based on a selling price hierarchy. The selling price for a deliverable is based on its vendor specific objective evidence ("VSOE") of selling price if available, third party evidence ("TPE") of selling price, if VSOE is not available, or best estimated selling price ("BESP"), if neither VSOE nor TPE is available. In multiple element arrangements where non-essential software deliverables are included, revenue for these multiple-element arrangements is allocated to the software deliverable and the non-software deliverables based on the relative selling prices of all of the deliverables in the arrangement using the hierarchy in the applicable accounting guidance. We limit the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges.
We establish VSOE of selling price using the price charged for a deliverable based upon the normal pricing and discounting practices when sold separately. VSOE for support services is measured by the stand-alone renewal rate offered to the customer. In determining VSOE, we require that a substantial majority of the selling prices for an element falls within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates. In addition, we consider major service groups, geographies, customer classifications, and other variables in determining VSOE. TPE of selling price is established by evaluating largely similar and interchangeable competitor products or services in standalone sales to similarly situated customers. We are typically not able to determine TPE for our products or services. Generally, our go-to-market strategy differs from that of our peers and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine selling prices of competitor products and services on a stand-alone basis.
When we are unable to establish the selling price of our non-software elements using VSOE or TPE, we use BESP in the allocation of arrangement consideration. The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine BESP for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies, customer classes and distribution channels.
We regularly review estimated selling price of the product offerings and maintain internal controls over the establishment and updates of these estimates. We currently do not expect a material impact in the near term from changes in estimated selling prices, including VSOE of selling price. Products
Product revenue consists of revenue from sales of our hardware appliances and perpetual software licenses. The majority of our products are hardware appliances containing software components that function together to provide the essential functionality of the product. Therefore, our hardware appliances are considered non-software elements and are not subject to the industry-specific . . .

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