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ARUN > SEC Filings for ARUN > Form 10-Q on 5-Dec-2013All Recent SEC Filings

Show all filings for ARUBA NETWORKS, INC.

Form 10-Q for ARUBA NETWORKS, INC.


5-Dec-2013

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. 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.


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.


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.


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 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.


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 )%


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 . . .

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