UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-33347

Aruba Networks, Inc.

(Exact name of registrant as specified in its charter)

Delaware (State or Other Jurisdiction of Incorporation or Organization)		02-0579097 (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 þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The number of shares of the registrant’s common stock, par value $0.0001, outstanding as of November 30, 2010 was 98,330,472

 

 

ARUBA NETWORKS INC.
INDEX

		Page No.
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)			3
Consolidated Balance Sheets as of October 31, 2010 and July 31, 2010			3
Consolidated Statements of Operations for the three months ended October 31, 2010 and 2009			4
Consolidated Statements of Cash Flows for the three months ended October 31, 2010 and 2009			5
Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3. Quantitative and Qualitative Disclosures About Market Risk			30
Item 4. Controls and Procedures			31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			32
Item 1A. Risk Factors			32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			44
Item 3. Defaults Upon Senior Securities			44
Item 4. Submission of Matters to a Vote of Security Holders			44
Item 5. Other Information			44
Item 6. Exhibits			45
Exhibit 10.2
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

Item 1.		Consolidated Financial Statements

ARUBA NETWORKS, INC.

		October 31,				July 31,
		2010				2010
		(in thousands, except per share data)
ASSETS
Current assets
Cash and cash equivalents		$	54,384			$	31,254
Short-term investments			120,071				124,167
Accounts receivable, net			42,980				41,269
Inventory			18,072				15,159
Deferred costs			4,672				5,451
Prepaids and other			3,742				5,108
Total current assets			243,921				222,408
Property and equipment, net			10,617				9,919
Goodwill			32,498				7,656
Intangible assets, net			24,610				9,287
Other assets			1,673				1,437
Total assets		$	313,319			$	250,707
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	4,647			$	8,082
Accrued liabilities			49,048				36,458
Income taxes payable			575				519
Deferred revenue, current			43,247				43,422
Total current liabilities			97,517				88,481
Deferred revenue, long-term			13,730				10,976
Other long-term liabilities			596				595
Total liabilities			111,843				100,052
Commitments and contingencies (Note 13)
Stockholders’ equity
Common stock: $0.0001 par value; 350,000 shares authorized at October 31, 2010 and July 31, 2010, respectively; 97,592 and 93,606 shares issued shares issued and outstanding at October 31, 2010 and July 31, 2010, respectively			10				9
Additional paid-in capital			374,787				326,178
Accumulated other comprehensive income			174				98
Accumulated deficit			(173,495	)			(175,630	)
Total stockholders’ equity			201,476				150,655
Total liabilities and stockholders’ equity		$	313,319			$	250,707

See Notes to Consolidated Financial Statements.

ARUBA NETWORKS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

		Three months ended October 31,
		2010				2009
		(in thousands, except per share data)
Revenues
Product		$	69,204			$	47,198
Professional services and support			13,800				10,143
Ratable product and related professional services and support			143				255
Total revenues			83,147				57,596
Cost of revenues
Product			22,063				16,432
Professional services and support			2,905				2,079
Ratable product and related professional services and support			10				86
Total cost of revenues			24,978				18,597
Gross profit			58,169				38,999
Operating expenses
Research and development			17,113				11,796
Sales and marketing			33,415				24,740
General and administrative			7,188				7,132
Litigation reserves			—				19,750
Total operating expenses			57,716				63,418
Operating income (loss)			453				(24,419	)
Other income (expense), net
Interest income			233				211
Other income (expense), net			1,645				(96	)
Total other income (expense), net			1,878				115
Income (loss) before provision for income taxes			2,331				(24,304	)
Provision for income taxes			196				372
Net income (loss)		$	2,135			$	(24,676	)
Shares used in computing basic net income (loss) per common share			96,037				87,489
Net income (loss) per common share, basic		$	0.02			$	(0.28	)
Shares used in computing diluted net income (loss) per common share			113,271				87,489
Net income (loss) per common share, diluted		$	0.02			$	(0.28	)
Stock-based compensation expense included in above:
Cost of revenues		$	475			$	318
Research and development			3,901				2,131
Sales and marketing			5,102				3,021
General and administrative		$	2,090			$	2,349

See Notes to Consolidated Financial Statements.

ARUBA NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

		Three months ended October 31,
		2010				2009
		(in thousands)
Cash flows from operating activities
Net income (loss)		$	2,135			$	(24,676	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization			3,299				2,494
Provision for (benefit from) doubtful accounts			(8	)			21
Write downs for excess and obsolete inventory			661				446
Compensation related to stock options and share awards			11,568				7,819
Accretion of purchase discounts on short-term investments			334				81
Loss/ (gain) on disposal of fixed assets			(8	)			8
Change in carrying value of contingent rights liability			(1,777	)			—
Excess tax benefit associated with stock-based compensation			(55	)			(46	)
Changes in operating assets and liabilities:
Accounts receivable			822				467
Inventory			(1,996	)			(1,469	)
Prepaids and other			(304	)			(850	)
Deferred costs			780				(1,816	)
Other assets			(85	)			36
Accounts payable			(5,190	)			1,346
Deferred revenue			1,239				6,339
Other current and noncurrent liabilities			4,701				20,107
Income taxes payable			(82	)			179
Net cash provided by operating activities			16,034				10,486
Cash flows from investing activities
Purchases of short-term investments			(28,159	)			(15,730	)
Proceeds from sales of short-term investments			7,376				—
Proceeds from maturities of short-term investments			24,480				5,820
Purchases of property and equipment			(2,861	)			(497	)
Proceeds from sales of property and equipment			14				—
Cash paid in purchase acquisitions, net of cash acquired			(1,258	)			—
Net cash used in investing activities			(408	)			(10,407	)
Cash flows from financing activities
Proceeds from issuance of common stock			7,447				2,631
Excess tax benefit associated with stock-based compensation			55				46
Net cash provided by financing activities			7,502				2,677
Effect of exchange rate changes on cash and cash equivalents			2				2
Net increase in cash and cash equivalents			23,130				2,758
Cash and cash equivalents, beginning of period			31,254				41,298
Cash and cash equivalents, end of period		$	54,384			$	44,056
Supplemental disclosure of cash flow information
Income taxes paid		$	409			$	281
Supplemental disclosure of non-cash investing and financing activities
Common stock issued for purchase acquisition		$	28,691			$	—
Contingent rights issued for purchase acquisition			9,486				—
Advance on purchase price of acquisition		$	2,000			$	—

See Notes to Consolidated Financial Statements.

ARUBA NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. The Company and its Significant Accounting Policies

The Company

Aruba Networks, Inc. (the “Company”) was incorporated in the state of Delaware on February 11, 2002. The Company securely connects local and remote users to corporate IT resources via distributed enterprise networks. The Company’s portfolio of campus, branch office, teleworker, and mobile solutions simplifies operations and provides secure access to all corporate applications and services — regardless of a user’s device, location, or network. The products the Company licenses and sells include high-speed 802.11n wireless local area networks, Virtual Branching Networking solutions for branch offices and teleworkers, and network operations tools, including spectrum analyzers, wireless intrusion prevention systems, and the AirWave Wireless Management Suite for managing wired, wireless, and mobile device networks. The Company has offices in North America, Europe, the Middle East and the Asia Pacific region and employs staff around the world.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. The accompanying statements are unaudited and should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K filed on September 24, 2010. The July 31, 2010 consolidated balance sheet data were derived from audited financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States (“U.S.”).

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). They do not include all of the financial information and footnotes required by GAAP for complete financial statements. The Company believes the unaudited consolidated financial statements have been prepared on the same basis as its audited financial statements as of and for the year ended July 31, 2010 and include all adjustments necessary for the fair statement of the Company’s financial position as of October 31, 2010, its results of operations for the three months ended October 31, 2010 and 2009, and its cash flows for the three months ended October 31, 2010 and 2009. The results for the three months ended October 31, 2010 are not necessarily indicative of the results to be expected for any subsequent quarter or for the fiscal year ending July 31, 2011.

Other than the adoption of the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Accounting Standards Update (“ASU”) 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements, there have been no significant changes in the Company’s accounting policies during the three months ended October 31, 2010, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the year ended July 31, 2010.

Revenue Recognition

In October 2009, the FASB amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple-element revenue arrangements to:

	(i)		provide updated guidance on how the elements in a multiple-element arrangement should be separated, and how the consideration should be allocated;
	(ii)		require an entity to allocate revenue amongst the elements in an arrangement using estimated selling prices (“ESP”) if a vendor does not have vendor-specific objective evidence (“VSOE”) of the selling price or third-party evidence (“TPE”) of the selling price; and
	(iii)		eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

The Company adopted this accounting guidance at the beginning of its first quarter of fiscal 2011 on a prospective basis for applicable arrangements originating or materially modified after August 1, 2010. The impact of this adoption was not material to the Company’s financial position and results of operations in the three months ended October 31, 2010.

This guidance does not generally change the units of accounting for the Company’s revenue transactions. Most non-software products and services qualify as separate units of accounting because they have value to the customer on a stand-alone basis and the Company’s revenue arrangements generally do not include a general right of return relative to delivered products.

The majority of the Company’s products are hardware appliances containing software components that function together to provide the essential functionality of the product. Therefore, the Company’s hardware appliances are considered non-software elements and have been removed from the industry-specific software revenue recognition guidance.

The Company’s product revenue also includes revenue from the sale of stand-alone software products. Stand-alone software products may operate on the Company’s hardware appliance, but are not considered essential to the functionality of the hardware. Sales of stand-alone software generally include a perpetual license to the Company’s software. Sales of stand-alone software continue to be subject to the industry-specific software revenue recognition guidance.

For all arrangements originating or materially modified after July 31, 2010, the Company recognizes revenue in accordance with the amended accounting guidance. Certain arrangements with multiple-elements may continue to have stand-alone software elements that are subject to the existing software revenue recognition guidance along with non-software elements that are subject to the amended revenue accounting guidance. The revenue for these multiple deliverable arrangements is allocated to the stand-alone software elements as a group and the non-software elements based on the relative selling prices of all of the elements in the arrangement using the fair value hierarchy in the amended revenue accounting guidance.

For sales of stand-alone software after July 31, 2010 and for all transactions entered into prior to the first quarter of 2011, the Company recognizes revenue based on software revenue recognition guidance. Under the software revenue recognition guidance, the Company uses the residual method to recognize revenue when a product agreement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists. In the majority of the Company’s contracts, the only element that remains undelivered at the time of delivery of the product is support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the contract fee is recognized as product revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is generally deferred and recognized when delivery of those elements occurs or when fair value can be established. When the undelivered element for which the Company does not have VSOE of fair value is support, revenue for the entire arrangement is bundled and recognized ratably over the support period.

VSOE for elements of an arrangement is based upon the normal pricing and discounting practices for those services when sold separately, and VSOE for support services is measured by the stand-alone renewal rate offered to the customer. In determining VSOE, the Company requires that a substantial majority of the selling prices for an element falls within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates. In addition, the Company considers major service groups, geographies, customer classifications, and other variables in determining VSOE.

The Company is typically not able to determine TPE for the Company’s products or services. TPE is determined based on competitor prices for similar elements when sold separately. Generally, the Company’s go-to-market strategy differs from that of the Company’s peers and the Company’s offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, the Company is unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.

When the Company is unable to establish selling price of its non-software elements using VSOE or TPE, the Company uses ESP in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. The Company determines ESP for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies, customer classes and distribution channels.

The Company regularly reviews VSOE and ESP and maintains internal controls over the establishment and updates of these estimates. There was not a material impact during the quarter nor does the Company currently expect a material impact in the near term from changes in VSOE or ESP.

Product revenue consists of revenue from sales of the Company’s hardware appliances and perpetual software licenses. The Company recognizes product revenue when all of the following have occurred: (1) the Company has entered into a legally binding arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is reasonably assured.

For sales to direct end-users and channel partners, including value-added resellers, value-added distributors, and OEMs, the Company recognizes product revenue upon delivery, assuming all other revenue recognition criteria are met. For the Company’s hardware appliances, delivery occurs upon transfer of title and risk of loss, which is generally upon shipment. It is the Company’s practice to identify an end-user prior to shipment to a channel partner. For end-users and channel partners, the Company generally has no significant obligations for future performance such as rights of return or pricing credits. A portion of the Company’s sales are made through distributors under agreements allowing for stocking of the Company’s products in their inventory, pricing credits and limited rights of return for stock rotation. Product revenue on sales made through these distributors is initially deferred and revenue is recognized upon sell-through as reported by the distributors to the Company. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.

Support and services consist of support agreements, professional services, and training. Support services include repair and replacement of defective hardware appliances, software updates and access to technical support personnel. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period. Revenue for support services is recognized on a straight-line basis over the service contract term, which is typically one to three years. Professional services are recognized upon delivery or completion of performance. Professional service arrangements are typically short term in nature and are largely completed within 90 days from the start of service. Training services are recognized upon delivery of the training.

The Company’s fees are typically considered to be fixed or determinable at the inception of an arrangement, generally based on specific products and quantities to be delivered. Substantially all of the Company’s contracts do not include rights of return or acceptance provisions. To the extent that the Company’s agreements contain such terms, the Company recognizes revenue once the customer has accepted, or once the acceptance provisions or right of return lapses. Payment terms to customers generally range from net 30 to 60 days. In the event payment terms are provided that differ from the Company’s standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized when the payments become due, provided the remaining criteria for revenue recognition have been met.

The Company assesses the ability to collect from its customers based on a number of factors, including credit worthiness of the customer and past transaction history of the customer. If the customer is not deemed credit worthy, the Company defers revenue from the arrangement until payment is received and all other revenue recognition criteria have been met.

2. Acquisition

On September 2, 2010, the Company completed its acquisition of Azalea Networks (“Azalea”) for a total purchase price of $42.0 million. Azalea is a leading supplier of outdoor mesh networks and includes an operations center in Beijing, China which will complement the Company’s existing research and development centers. The results of Azalea’s operations have been included in the Consolidated Financial Statements since the acquisition date.

The Company accounted for this acquisition in accordance with ASC 805, Business Combinations; therefore, the tangible and intangible assets acquired and liabilities assumed were recorded at fair value on the acquisition date.

The purchase price consisted of the following (in thousands):

Stock (1,524,517 shares at $18.82)		$	28,691
Cash			1,808
Contingent rights			9,486
Advance on purchase price			2,000
Total consideration		$	41,985

The purchase price was allocated to the assets acquired and liabilities assumed based on management’s estimates of their fair values on the acquisition date. The excess of the purchase consideration over the fair value of the net assets acquired was allocated to goodwill. Goodwill is not being amortized but reviewed annually for impairment, or more frequently if impairment indicators arise. In part, goodwill reflected the competitive advantages the Company expected to realize from Azalea’s standing in the China service provider industry.

The following table summarizes the estimated purchase price allocation (in thousands, except estimated useful lives). Estimates of liabilities are subject to change, pending the Company’s final review of Azalea’s obligations.

Cash and cash equivalents		$	550
Accounts Receivable			2,525
Inventory			1,794
Prepaids and other assets			331
PP&E			265
Total tangible assets acquired			5,465

						Estimated
						Useful Lives
Amortizable intangible assets:
Existing Technology			11,800			5 years
Patents/Core Technology			2,300			6 years
Customer Contracts			1,800			6 years
Tradenames/Trademarks			100			1 year
Non-Compete Agreements			100			2 years
In-process research and development			900
Goodwill			24,842
Total assets acquired			47,307
Liabilities			(5,322	)
Total liabilities assumed			(5,322	)
Total		$	41,985

The purchased intangible assets have a weighted average useful life of 5.2 years from the date of the acquisition.

A portion of the purchase price was allocated to developed product technology and in-process research and development (“IPR&D”). They were identified and valued through an analysis of data provided by Azalea concerning developmental products, their stage of development, the time and resources needed to complete them, target markets, their expected income generating ability and associated risks. The Income Approach, which is based on the premise that the value of an asset is the present value of its future earning capacity, was the primary valuation technique employed. A discount rate of 16% was applied to developed product technology and IPR&D. The Company recognizes IPR&D at fair value as of the acquisition date, and subsequently accounts for it as an indefinite-lived intangible asset until completion or abandonment of the associated research and development efforts. IPR&D is tested for impairment during the period it is considered an indefinite lived asset.

Developed product technology, which includes products that are already technologically feasible, is primarily comprised of a portfolio of outdoor mesh routers. Developmental projects that had not reached technological feasibility are recognized as identifiable intangible assets. The principal project at the acquisition date relates to developing multi-radio outdoor mesh routers for the core network for even the largest enterprises. This technology would enable faster internet access for higher throughput performance, covering greater distances for both mesh and video networks. The Company expects to incur post-acquisition costs of approximately $0.3 million during fiscal 2011. The Company expects to complete all work by the end of the second quarter of fiscal 2011.

The Company expensed $0.7 million of acquisition-related costs incurred as general and administrative expenses in the Consolidated Statements of Operations in the period the expense was incurred.

Based on its evaluation of the materiality of Azalea’s stand-alone financial statements to the Consolidated Financial Statements of Aruba Networks taken as a whole, the Company determined that the acquisition does not meet the requirements needed to disclose pro forma financial statements for the acquisition.

Contingent Rights Liability

Contingent rights were issued to each Azalea shareholder as part of the purchase consideration. For each share received, the Azalea shareholder also received a right to receive an amount of cash equal to the shortfall generated if a share is sold below the target value within the payment period, as specified in the arrangement. For shares not held in escrow, the payment period begins August 1, 2011 and ends on December 31, 2011. For shares held in escrow the payment period begins April 2, 2012 and ends on May 1, 2012. The rights are subject to forfeiture in certain circumstances.

At the acquisition date, the Company recorded a liability for the estimated fair value of the contingent rights of $9.5 million. This liability was estimated using a lattice model and was based on significant inputs not observed in the market and thus represented a Level 3 instrument. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. The inputs included:

•

stock price as of the valuation date;

	•		strike price of the contingent right;
	•		maximum payoff per share;

•

number of shares held in and outside of escrow;

•

exercise period;

•

historical volatility of the Company’s stock price based on weekly stock price returns; and

•

risk-free rate interpolated from the Constant Maturity Treasury Rate.

The change in fair value from the acquisition date to October 31, 2010 was primarily driven by an increase in the Company’s stock price. Gains and losses on the remeasurement of the contingent rights liability are included in other income (expense), net. As the fair value of the contingent rights liability will largely be determined based on the Company’s closing stock price as of future fiscal periods, it is not possible to determine a probable range of possible outcomes of the valuation of the contingent rights liability. However, the maximum contingent rights liability will be no more than $13.5 million as defined in the acquisition agreement.

The following table represents the change in the contingent rights liability:

		Amount
		(in thousands)
Balance as of July 31, 2010		$	—
Acquisition date fair value measurement			9,486
Adjustments to fair value			(1,777	)
Balance as of October 31, 2010		$	7,709

3. Goodwill and Intangible Assets

The following table presents details of the Company’s goodwill:

		Amount
		(in thousands)
As of July 31, 2010		$	7,656
Goodwill acquired in acquisition			24,842
As of October 31, 2010		$	32,498

The following table presents details of the Company’s total purchased intangible assets:

		Estimated				Gross				Accumulated				Net
		Useful Lives				Value				Amortization				Value
						(in thousands)
As of October 31, 2010
Existing Technology			4 to 5 years			$	21,083			$	(6,887	)		$	14,196
In-process research and development		NA					900				—				900
Patents/Core Technology			4 to 6 years				5,346				(2,194	)			3,152
Customer Contracts			6 to 7 years				6,883				(2,279	)			4,604
Support Agreements			5 to 6 years				2,717				(1,420	)			1,297
Tradenames/Trademarks			1 to 5 years				700				(330	)			370
Non-Compete Agreements		2 years					812				(721	)			91
Total						$	38,441			$	(13,831	)		$	24,610

		Estimated		Gross				Accumulated				Net
		Useful Lives		Value				Amortization				Value
				(in thousands)
As of July 31, 2010
Existing Technology		4 years		$	9,283			$	(5,914	)		$	3,369
Patents/Core Technology		4 years			3,046				(1,940	)			1,106
Customer Contracts		6 to 7 years			5,083				(2,020	)			3,063
Support Agreements		5 to 6 years			2,717				(1,284	)			1,433
Tradenames/Trademarks		5 years			600				(284	)			316
Non-Compete Agreements		2 years			712				(712	)			—
Total				$	21,441			$	(12,154	)		$	9,287

The Company recorded approximately $1.7 million and $1.2 million of amortization expense related to its purchased intangible assets during each of the three months ended October 31, 2010 and 2009. Amortization expense is recorded in the Consolidated Statements of Operations under the following:

		Three months ended October 31,
		2010				2009
		(in thousands)
Cost of product revenues		$	1,228			$	771
Cost of professional services and support revenues			77				135
Sales and marketing			372				327
Total amortiztaion expense		$	1,677			$	1,233

The estimated future amortization expense of purchased intangible assets as of October 31, 2010 is as follows:

		Amount
		(in thousands)
Remaining nine months of fiscal 2011		$	5,805
Years ending July 31,
2012			6,023
2013			4,303
2014			3,599
2015			3,043
Thereafter			937
Total		$	23,710

4. Net Income (Loss) Per Common Share

Basic net income (loss) per common share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (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 income (loss) per share (in thousands, except per share data):

		Three months ended
		October 31, 2010
Net income		$	2,135
Weighted-average common shares outstanding- basic			96,037
Dilutive effect of employee stock plans			17,234
Weighted-average common shares outstanding- diluted		$	113,271
Net income per share, basic		$	0.02
Net income per share, diluted		$	0.02

		Three months ended
		October 31, 2009
Net loss		$	(24,676	)
Weighted-average common shares outstanding net of weighted-average common shares subject to repurchase			87,489
Basic and diluted net loss per common share		$	(0.28	)

The following outstanding stock options and restricted stock awards were excluded from the computation of diluted net loss per common share for the three months ended October 31, 2009 because including them would have had an anti-dilutive effect.

		Three months ended
		October 31, 2009
		(in thousands)
Options to purchase common stock			22,391
Restricted stock awards			2,784
Common stock subject to repurchase			111

5. Short-term Investments

Short-term investments consist of the following:

						Gross				Gross
		Cost				Unrealized				Unrealized				Fair
		Basis				Gains				Losses				Value
		(in thousands)
As of October 31, 2010
Corporate bonds and notes		$	23,722			$	103			$	(3	)		$	23,822
U.S. government agency securities			71,050				109				(6	)			71,153
U.S. treasury bills			18,327				64				—				18,391
Commercial paper			4,440				5				—				4,445
Certificates of deposit			2,255				5				—				2,260
Total short-term investments		$	119,794			$	286			$	(9	)		$	120,071

						Gross				Gross
		Cost				Unrealized				Unrealized				Fair
		Basis				Gains				Losses				Value
		(in thousands)
As of July 31, 2010
Corporate bonds and notes		$	23,802			$	69			$	(4	)		$	23,867
U.S. government agency securities			80,683				78				(9	)			80,752
U.S. treasury bills			12,816				57				—				12,873
Commercial paper			4,495				—				—				4,495
Certificates of deposit			2,179				1				—				2,180
Total short-term investments		$	123,975			$	205			$	(13	)		$	124,167

The cost basis and fair value of debt securities by contractual maturity, are presented below:

		Cost				Fair
		Basis				Value
		(in thousands)
As of October 31, 2010
One year or less		$	85,184			$	85,353
One to two years			34,610				34,718
Total short-term investments		$	119,794			$	120,071

The Company reviews the individual securities in its portfolio to determine whether a decline in a security’s fair value below the amortized cost basis is other than temporary. The Company determined that there were no investments in its portfolio, related to credit losses or otherwise, that were other-than temporarily impaired during the first quarter of fiscal 2011 or 2010.

The following table summarizes the fair value and gross unrealized losses of the Company’s investments with unrealized losses aggregated by type of investment instrument and length of time that individual securities have been in a continuous unrealized loss position:

		Less than 12 Months
		Fair				Unrealized
		Value				Loss
		(in thousands)
As of October 31, 2010
Corporate bonds and notes		$	2,178			$	(3	)
U.S. government agency securities			2,519				(6	)
		$	4,697			$	(9	)

Fair Value of Financial Instruments

Cash and cash equivalents consist primarily of bank deposits with third-party financial institutions and highly liquid money market securities with original maturities at date of purchase of 90 days or less and are stated at cost which approximates fair value.

Short-term investments are recorded at fair value, defined as the exit price in the principal market in which the Company would transact representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Level 1 instruments are valued based on quoted market prices in active markets for identical instruments and include the Company’s investments in money market funds. Level 2 securities are valued using quoted market prices for similar instruments, nonbinding market prices that are corroborated by observable market data, or discounted cash flow techniques and include the Company’s investments in corporate bonds and notes, U.S. government agency securities, treasury bills, and commercial paper. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value. The Company has no short-term investments classified as level 3 instruments.

As of October 31, 2010, the fair value measurements of the Company’s cash, cash equivalents and short-term investments consisted of the following:

		Total				Level 1				Level 2
		(in thousands)
Corporate bonds and notes		$	23,823			$	—			$	23,823
U.S. government agency securities			71,153				—				71,153
U.S. treasury bills			18,391				—				18,391
Commercial paper			4,444				—				4,444
Money market funds			17,276				17,276				—
Total cash equivalents and short-term investments			135,087			$	17,276			$	117,811
Certificates of deposit			2,260
Cash deposits with third-party financial institutions			37,108
Total cash, cash equivalents and short-term investments		$	174,455

6. Balance Sheet Components

The following tables provide details of selected balance sheet items:

		October 31,				July 31,
		2010				2010
		(in thousands)
Accounts Receivable, net
Trade accounts receivable		$	43,295			$	41,731
Less: Allowance for doubtful accounts			(315	)			(462	)
Total		$	42,980			$	41,269

		October 31,				July 31,
		2010				2010
		(in thousands)
Inventory
Raw materials		$	191			$	294
Finished goods			17,881				14,865
Total		$	18,072			$	15,159

		October 31,				July 31,
		2010				2010
		(in thousands)
Accrued Liabilities
Compensation and benefits		$	10,451			$	11,363
Inventory			12,223				9,381
Marketing			7,183				7,176
Contingent rights			7,709				—
Other			11,482				8,538
Total		$	49,048			$	36,458

7. Property and Equipment, Net

Property and equipment, net consists of the following:

		Estimated				October 31,				July 31,
		Useful Lives				2010				2010
						(in thousands)
Computer equipment		2 years				$	9,431			$	7,993
Computer software		2-5 years					4,654				4,558
Machinery and equipment		2 years					10,947				10,441
Furniture and fixtures		5 years					2,471				2,397
Leasehold improvements		2-6 years					2,316				2,174
Total property and equipment, gross							29,819				27,563
Less: Accumulated depreciation and amortization							(19,202	)			(17,644	)
Total property and equipment, net						$	10,617			$	9,919

8. Deferred Revenue

Deferred revenue consists of the following:

		October 31,				July 31,
		2010				2010
		(in thousands)
Product		$	13,191			$	16,087
Professional services and support			29,469				27,298
Ratable product and related services and support			587				37
Total deferred revenue, current			43,247				43,422
Professional services and support, long-term			13,083				10,976
Ratable product and related services and support, long-term			647				—
Total deferred revenue, long-term			13,730				10,976
Total deferred revenue		$	56,977			$	54,398

Deferred product revenue relates to arrangements where not all revenue recognition criteria have been met. Deferred professional services and support revenue primarily represents customer payments made in advance for support contracts. Support contracts are typically billed on an annual basis in advance and revenue is recognized ratably over the support period, typically one to five years.

Deferred ratable product and related services and support revenue consists of revenue on transactions where VSOE of fair value of support has not been established and the entire arrangement is being recognized ratably over the support period, which typically ranges from one year to three years. The increase in ratable product and related services and support is due to the acquisition of Azalea Networks.

9. Income Taxes

For the three months ended October 31, 2010, the Company generated operating income. The Company also generated consolidated book and taxable income in U.S. and foreign jurisdictions for the three months ended October 31, 2010. For the three months ended October 31, 2009, the Company generated consolidated book losses but generated taxable income in most U.S. and foreign jurisdictions.

The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Based on the available objective evidence, including the fact that the Company has historically generated losses, management believes it is more likely than not that the deferred tax assets will not be realized. Accordingly, management has applied a full valuation allowance against its deferred tax assets generated primarily in the U.S.

The Company files annual income tax returns in the U.S. federal jurisdiction, various U.S. state and local jurisdictions, and in various foreign jurisdictions. The Company remains subject to tax authority review for all jurisdictions for all years.

10. Equity Incentive Plans

Stock Option Activity

The following table summarizes the information about shares available for grant and outstanding stock option activity:

						Options Outstanding
										Weighted								Weighted
										Average				Weighted				Average
		Shares								Exercise				Average				Remaining				Aggregate
		Available for				Number of				Price				Fair Value				Contractual				Intrinsic
		Grant				Shares				per Share				per Share				Term (Years)				Value
As of July 31, 2010			635,877				23,640,524			$	5.00								5.9			$	283,285,534
Shares reserved for issuance			4,680,314				—
Restricted stock awards granted			(1,081,325	)			—
Restricted stock awards cancelled			79,899				—
Options granted			(973,760	)			973,760				20.51			$	10.92
Options exercised			—				(1,210,963	)			3.68												19,326,834
Options cancelled			151,651				(151,651	)			7.76
As of October 31, 2010			3,492,656				23,251,670			$	5.70								5.7			$	377,342,306

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the fair value of the Company’s common stock on the date of each option exercise. Stock-based compensation expense recognized for stock options was $4.4 million and $3.2 million for the three months ended October 31, 2010 and 2009, respectively.

Restricted Stock Award Activity

The following table summarizes the non-vested restricted stock awards activity:

						Weighted Average
						Grant Date
						Fair Value
		Shares				per Share
As of July 31, 2010			2,215,932			$	9.74
Awards granted			1,081,325				20.38
Awards vested			(259,782	)			12.03
Awards cancelled			(79,899	)			12.20
As of October 31, 2010			2,957,576			$	13.37

The estimated fair value of restricted stock awards is based on the market price of the Company’s stock on the grant date. Stock-based compensation expense recognized for restricted stock awards for the three months ended October 31, 2010 and 2009 was $5.6 million and $3.8 million, respectively.

Employee Stock Purchase Plan Activity

During the three months ended October 31, 2010, 990,512 shares were purchased at an average per share price of $3.02. Compensation expense recognized in connection with the ESPP for the three months ended October 31, 2010 and 2009 was $1.6 million and $0.8 million, respectively.

During the three months ended October 31, 2010, the Company modified the terms of certain existing awards under its ESPP as a result of employees who previously participated in ESPP and subsequently elected to increase their contribution. Consequently, the Company will recognize $1.2 million in incremental stock-based compensation expense over the vesting period. The Company recognized $0.3 million in incremental stock-based compensation expense arising from the award modification for the three months ended October 31, 2010.

Fair Value Disclosures

The fair value of each option grant is estimated on the date of grant using the Black-Scholes model with the following weighted average assumptions:

Employee Stock Options

		Three months ended October 31,
		2010				2009
Risk-free interest rate			1.7	%			1.9	%
Expected term (in years)			4				4.3
Dividend yield			0				0
Volatility			70	%			70	%

Employee Stock Purchase Plan

		Three months ended October 31,
		2010				2009
Risk-free interest rate		0.2% to 1.0%				0.2% to 1.0%
Expected term (in years)			0.5 to 2.0				0.5 to 2.0
Dividend yield			0				0
Volatility		41% to 101%				63% to 81%

The expected term of the stock-based awards represents the period of time that the Company expects such stock-based awards to be outstanding, giving consideration to the contractual term of the awards, vesting schedules and expectations of future employee behavior. The Company gave consideration to its historical exercises, the vesting term of its stock options, the post vesting cancellation history of its stock options and the stock options’ contractual terms. The contractual term of stock options granted from inception of the Company through August 16, 2007 was generally 10 years. On August 17, 2007, the Company’s Compensation Committee revised the 2007 Plan to provide for a contractual term of seven years on all option grants on or after such date. Given the Company’s limited operating history, the Company then compared this estimated term to those of comparable companies from a representative peer group, the selection of which was based on industry data to determine the expected term. Similarly, the Company computes expected volatility based on its historical volatility and the historical volatility of these comparable companies. The Company made an estimate of expected forfeitures, and is recognizing stock-based compensation only for those equity awards that it expects to vest. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury Constant Maturity rate as of the date of grant.

Stock-based Expenses

Total stock-based compensation for the three months ended October 31, 2010 and 2009 was $11.6 million and $7.8 million, respectively. The Company did not capitalize stock-based compensation during the three months ended October 31, 2010 and 2009, due to the amount qualifying for capitalization being immaterial.

11. Comprehensive Income (Loss)

Comprehensive income (loss) includes the following:

		Three months ended October 31,
		2010				2009
		(in thousands)
Net income (loss)		$	2,135			$	(24,676	)
Change in unrealized gain on short term investments, net of taxes			76				28
Total		$	2,211			$	(24,648	)

12. Segment Information and Significant Customers

The Company operates in one industry segment selling fixed and modular mobility controllers, wired and wireless access points, and related software and services.

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. The Company has one business activity, and there are no segment managers who are held accountable for operations, operating results and plans for products or components below the consolidated unit level. Accordingly, the Company reports as a single operating segment. The Company and its Chief Executive Officer evaluate performance based primarily on revenue in the geographic locations in which the Company operates. Revenue is attributed by geographic location based on the ship-to location of the Company’s customers. The Company’s assets are primarily located in the U.S. and not allocated to any specific region. Therefore, geographic information is presented only for total revenue.

The following presents total revenue by geographic region:

		Three months ended October 31,
		2010				2009
		(in thousands)
United States		$	51,752			$	33,616
Europe, Middle East and Africa			13,153				7,632
Asia Pacific			14,507				12,506
Rest of World			3,735				3,842
Total		$	83,147			$	57,596

The following table presents significant channel partners as a percentage of total revenues (* represents less than 10%):

		Three months ended October 31,
		2010				2009
Partner A			20.3	%			13.3	%
Partner B			14.4	%			11.8	%
Partner C			11.2	%			10.6	%
Partner D			*				11.2	%

13. Commitments and Contingencies

Legal Matters

The Company could become involved in litigation from time to time relating to claims arising out of its ordinary course of business. There were no claims as of October 31, 2010 that, in the opinion of management, might have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Lease Obligation

The Company leases office space under non-cancelable operating leases with various expiration dates through July 2016. The terms of certain operating leases provide for rental payments on a graduated scale. The Company recognizes rent expense on a straight-line basis over the respective lease periods and has accrued for rent expense incurred but not paid.

Future minimum lease payments under non-cancelable operating leases are as follows:

		Operating
		Leases
		(in thousands)
Nine months remaining in fiscal 2011		$	2,008
Year ending July 31,
2012			2,701
2013			2,775
2014			2,820
2015			2,809
2016			2,442
Total minimum payments		$	15,555

Non-cancelable purchase commitments

The Company outsources the production of its hardware to third-party contract manufacturers. In addition, the Company enters into various inventory related purchase commitments with its contract manufacturers and other suppliers. The Company had $20.7 million and $20.3 million in non-cancelable purchase commitments with these providers as of October 31, 2010 and July 31, 2010, respectively. The Company expects to sell all products that it has committed to purchase from these providers.

Warranties

The Company provides for future warranty costs upon product delivery. The specific terms and conditions of those warranties vary depending upon the product sold and country in which the Company does business. In the case of hardware, the warranties are generally for 12-15 months from the date of purchase. The Company also has a lifetime warranty program on certain access points purchased subsequent to the announcement of the program.

The Company warrants that any media on which its software products are recorded will be free from defects in materials and workmanship under normal use for a period of 90 days from the date the products are delivered to the end customer. In addition, the Company warrants that its hardware products will substantially conform to the Company’s published specifications. Historically, the Company has experienced minimal warranty costs. Factors that affect the Company’s warranty liability include the number of installed units, historical experience and management’s judgment regarding anticipated rates of warranty claims and cost per claim. The Company assesses the adequacy of its recorded warranty liabilities every period and makes adjustments to the liability as necessary.

The warranty liability is included as a component of accrued liabilities on the balance sheet. Changes in the warranty liability are as follows:

		Warranty
		Amount
		(in thousands)
As of July 31, 2010		$	210
Provision			63
Obligations fulfilled during period			(53	)
As of October 31, 2010		$	220

Indemnifications

In its sales agreements, the Company may agree to indemnify its indirect sales channels and end user customers for any expenses or liability resulting from claimed infringements of patents, trademarks or copyrights of third parties. The terms of these indemnification agreements are generally perpetual any time after execution of the agreement. The maximum amount of potential future indemnification is unlimited. To date the Company has not paid any amounts to settle claims or defend lawsuits pursuant to any indemnification obligation. The Company is unable to reasonably estimate the maximum amount that could be payable under these arrangements since these obligations are not capped but are conditional to the unique facts and circumstances involved. Accordingly, the Company has no liabilities recorded for these agreements as of October 31, 2010 and July 31, 2010.

14. Subsequent Event

On November 19, 2010, the Company entered into an agreement with an Australian-based company, pursuant to which Aruba acquired substantially all of the assets of the Australian-based company. The asset purchase was completed on December 3, 2010. The total consideration was $5.8 million and included $3.8 million in cash and 86,852 shares of common stock valued at $2.0 million.

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, among other things, statements concerning our expectations:

•		that revenues from our indirect channels will continue to constitute a significant majority of our future revenues;
•		that our product offerings, in particular our products that incorporate 802.11n wireless LAN standard technologies, will enable broader networking initiatives by both our current and potential customers;
•		that, within our indirect channel, sales through our VADs will grow, which will negatively impact our gross margins as VADs experience a larger net effective discount than our other channel partners;
•		that international revenues will remain consistent or increase in absolute dollars and remain consistent or decrease as a percentage of total revenues in fiscal 2011 compared to fiscal 2010;
•		that we will continue to hire employees throughout the company;
•		that we will continue to invest significantly in our research and development efforts;
•		that research and development expenses for fiscal 2011 will increase on an absolute dollar basis and remain consistent or increase as a percentage of revenue compared with fiscal 2010;
•		that we will continue to invest strategically in our sales and marketing efforts;
•		that sales and marketing expenses for fiscal 2011 will continue to be our most significant operating expense and will increase on an absolute dollar basis and decrease as a percentage of revenue compared with fiscal 2010;
•		that general and administrative expenses for fiscal 2011 will increase on an absolute dollar basis and decrease as a percentage of revenue compared with fiscal 2010;
•		that ratable product and related professional services and support revenues will decrease in absolute dollars and as a percentage of total revenues in future periods;
•		that, as we expand internationally, we may incur additional costs to conform our products to comply with local laws and product specifications and plan to continue to hire additional technical support personnel to support our growing international customer base;
•		regarding the sufficiency of our existing cash, cash equivalents, short-term investments and cash generated from operations, and
•		that we will increase our market penetration and extend our geographic reach through our network of channel partners,

as well as other statements regarding our future operations, financial condition and prospects and business strategies. These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report, and in particular, the risks discussed under the heading “Risk Factors” in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included elsewhere in this report.

Overview

We are a global leader in distributed enterprise networks that securely connect local and remote users to corporate IT resources. Our award-winning portfolio of campus, branch office, teleworker, and mobile solutions simplify operations and provide secure access to all corporate applications and services — regardless of a user’s device, location, or network. The result is improved productivity and lower capital and operating costs.

Our product portfolio encompasses: industry-leading high-speed 802.11a/b/g/n WLANs, Virtual Branching Networking solutions for branch offices and teleworkers, network operations tools, including spectrum analyzers, wireless intrusion prevention systems, and the AirWave Wireless Management Suite for managing wired, wireless, and mobile device networks. These products are key to our rightsizing initiative which allows companies to move toward a low-cost IT infrastructure solution by funding wireless projects rather than wired LANs.

Our products have been sold to nearly 12,000 end customers worldwide (not including customers of Alcatel-Lucent), including some of the largest and most complex global organizations. We have implemented a two-tier distribution model in most areas of the world, including the United States, with VADs selling our portfolio of products, including a variety of our support services, to a diverse number of VARs. Our focus continues to be management of our channel including selection and growth of high prospect partners, activation of our VARs and VADs through active training and field collaboration, and evolution of our channel programs in consultation with our partners.

Our ability to increase our product revenues will depend significantly on continued growth in the market for enterprise mobility and remote networking solutions, continued acceptance of our products in the marketplace, our ability to continue to attract new customers, our ability to compete, the willingness of customers to displace wired networks with wireless LANs, in particular, wireless LANs that utilize our 802.11n solution, and our ability to continue to sell into our installed base of existing customers. Our growth in support revenues is dependent upon increasing the number of products under support contracts, which is dependent on both growing our installed base of customers and renewing existing support contracts. Our future profitability and rate of growth, if any, will be directly affected by the continued acceptance of our products in the marketplace, as well as the timing and size of orders, product and channel mix, average selling prices, costs of our products and general economic conditions. Our future profitability will also be affected by our ability to effectively implement and generate incremental business from our two-tier distribution model, the extent to which we invest in our sales and marketing, research and development, and general and administrative resources to grow our business, and current economic conditions.

While we began to see improvements in the overall macroeconomic environment, and our revenues have increased over the last six quarters, economic conditions worldwide have negatively impacted our business since 2008. While we believe in the long-term growth prospects of the WLAN market, the deterioration in overall economic conditions and in particular, tightening in the credit markets and reduced spending by both enterprises and consumers have significantly impacted various industries on which we rely for purchasing our products. This has led to our customers deferring purchases in response to tighter credit, negative financial news and delayed budget approvals. These factors could create significant and increasing uncertainty for the future as they could continue to negatively impact technology spending for the products and services we offer and materially adversely affect our business, operating results and financial condition.

The revenue growth that we have experienced has been driven primarily by an expansion of our customer base coupled with increased purchases from existing customers. We believe the growth we have experienced is the result of business enterprises needing to provide secure mobility to their users in a manner that we believe is more cost effective than the traditional approach of using port-centric networks. While we have experienced both longer sales cycles and seasonality, both of which have slowed our revenue growth, we believe that our product offerings, in particular our products that incorporate 802.11n wireless LAN standard technologies, will enable broader networking initiatives by both our current and potential customers.

Each quarter, our ability to meet our product revenue expectations is dependent upon (1) new orders received, shipped, and recognized in a given quarter, (2) the amount of orders booked but not shipped in the prior quarter that are shipped in the current quarter, and (3) the amount of deferred revenue entering a given quarter. Our product deferred revenue is comprised of:

•		product orders that have shipped but where the terms of the agreement, typically with our large customers, contain acceptance terms and conditions or other terms that require that the revenue be deferred until all revenue recognition criteria are met;
•		product orders shipped to our VADs for which we have not yet received persuasive evidence from the VADs of a sale to an end customer; and
•		customer contracts that we entered into prior to our establishment of VSOE of fair value.

We typically ship products within a reasonable time period after the receipt of an order.

On September 2, 2010, we completed our acquisition of Azalea Networks for a total purchase price of $42.0 million which included common stock, cash, and contingent rights. Azalea is a leading supplier of outdoor mesh networks and includes an operations center in Beijing, China that will complement our existing research and development centers. As part of the acquisition, we recorded $5.5 million of tangible assets, $17.0 million of intangible assets and $24.8 million of goodwill. We recorded a liability for the estimated fair value of the contingent rights which was based on significant inputs not observed in the market and thus represents a Level 3 instrument. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect our own assumptions in measuring fair value. Gains and losses on the remeasurement of the liability are included in other income (expense), net.

Revenues, Cost of Revenues and Operating Expenses

Revenues

We derive our revenues from sales of our ArubaOS operating system, controllers, wired and wireless access points, application software modules, multi-vendor management solution software, and professional services and support. Professional services revenues consist of consulting and training services. Consulting services primarily consist of installation support services. Training services are instructor led courses on the use of our products. Support services typically consist of software updates, on a when-and-if available basis, telephone and internet access to technical support personnel and hardware support. We provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.

We sell our products directly through our sales force and indirectly through VADs, VARs, and OEMs. We expect revenues from indirect channels to continue to constitute a significant majority of our future revenues.

We sell our products to channel partners and end customers located in the Americas, Europe, the Middle East, Africa and Asia Pacific. Shipments to our channel partners that are located in the United States are classified as U.S. revenue regardless of the location of the end customer. We continue to expand into international locations and introduce our products in new markets, and we expect international revenues to remain consistent or increase in absolute dollars and remain consistent or decrease as a percentage of total revenues in fiscal 2011 compared to fiscal 2010. For more information about our international revenues, see Note 12 of the Notes to Consolidated Financial Statements.

Cost of Revenues

Cost of product revenues consists primarily of manufacturing costs for our products, shipping and logistics costs, and expenses for inventory obsolescence and warranty obligations. We utilize third parties to manufacture our products and perform shipping logistics. We have outsourced the substantial majority of our manufacturing, repair and supply chain operations. Accordingly, the substantial majority of our cost of revenues consists of payments to our contract manufacturers. Our contractor manufacturers produce our products in China and Singapore using quality assurance programs and standards that we jointly established. Manufacturing, engineering and documentation controls are conducted at our facilities in Sunnyvale, California, Bangalore, India and Beijing, China. Cost of product revenues also includes amortization expense from our purchased intangible assets.

Cost of professional services and support revenues is primarily comprised of personnel costs, including stock-based compensation, of providing technical support, including personnel costs associated with our internal support organization. In addition, we employ a third-party support vendor to complement our internal support resources, the costs of which are included within costs of professional services and support revenues.

Gross Margin

Our gross margin has been, and will continue to be, affected by a variety of factors, including:

•		the proportion of our products that are sold through direct versus indirect channels;
•		product mix and average selling prices;
•		new product introductions, such as our value-priced, high performance 802.11n access point, and product enhancements made by us as well as those made by our competitors;
•		pressure to discount our products in response to our competitor’s discounting practices;
•		demand for our products and services;
•		our ability to attain volume manufacturing pricing from our contract manufacturers and our component suppliers;
•		losses associated with excess and obsolete inventory;
•		growth in our headcount and other related costs incurred in our customer support organization;
•		costs associated with manufacturing overhead;
•		our ability to manage freight costs; and
•		amortization expense from our purchased intangible assets.

Due to higher net effective discounts for products sold through our indirect channel, our overall gross margins for indirect channel sales are typically lower than those associated with direct sales. We expect product revenues from our indirect channel to continue to constitute a significant majority of our total revenues, which, by itself, negatively impacts our gross margins. Further, we expect that within our indirect channel, sales through our VADs will grow which will negatively impact our gross margins as VADs experience a larger net effective discount than our other channel partners.

Operating Expenses

Operating expenses consist of research and development, sales and marketing, and general and administrative expenses. The largest component of our operating expenses is personnel costs. Personnel costs consist of salaries, benefits and incentive compensation for our employees, including commissions for sales personnel and stock-based compensation for all employees.

Our headcount increased to 868 (including 87 employees from the Azalea acquisition) at October 31, 2010 from 681 at July 31, 2010. Going forward, we expect to continue to hire employees throughout the company as well as invest in research and development.

Research and development expenses primarily consist of personnel costs and facilities costs. We expense research and development expenses as incurred. We are devoting substantial resources to the continued development of additional functionality for existing products and the development of new products. We intend to continue to invest significantly in our research and development efforts because we believe it is essential to maintaining our competitive position. For fiscal 2011, we expect research and development expenses to increase on an absolute dollar basis and remain consistent or increase as a percentage of revenue compared to fiscal 2010.

Sales and marketing expenses represent the largest component of our operating expenses and primarily consist of personnel costs, sales commissions, marketing programs and facilities costs. Marketing programs are intended to generate revenue from new and existing customers and are expensed as incurred.

We plan to continue to invest strategically in sales and marketing with the intent to add new customers and increase penetration within our existing customer base, expand our domestic and international sales and marketing activities, build brand awareness and sponsor additional marketing events. We expect future sales and marketing expenses to continue to be our most significant operating expense. Generally, sales personnel are not immediately productive, and thus, the increase in sales and marketing expenses that we experience as we hire additional sales personnel is not expected to immediately result in increased revenues and reduces our operating margins until such sales personnel become productive and generate revenue. Accordingly, the timing of sales personnel hiring and the rate at which they become productive will affect our future performance. For fiscal 2011, we expect sales and marketing expenses to increase on an absolute dollar basis and decrease as a percentage of revenue compared to fiscal 2010.

General and administrative expenses primarily consist of personnel and facilities costs related to our executive, finance, human resource, information technology and legal organizations, as well as insurance, investor relations, and IT infrastructure costs related to our ERP system. Further, our general and administrative expenses include professional services consisting of outside legal, audit, Sarbanes-Oxley and information technology consulting costs. We have incurred in the past, and 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, can have a significant impact on our financial statements. For fiscal 2011, we expect general and administrative expenses to increase on an absolute dollar basis and decrease as a percentage of revenue compared to fiscal 2010.

Other Income (Expense), net

Other income (expense), net includes interest income on cash balances, accretion of discount or amortization of premium on short-term investments, losses or gains on remeasurement of non-U.S. dollar transactions into U.S. dollars, and in connection with our acquisition of Azalea, changes in the fair value of our contingent rights liability. Cash has historically been invested in money market funds and marketable securities.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with U.S. GAAP. These accounting principles require us to make estimates and judgments that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based 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, stock-based compensation, inventory valuation, allowances for doubtful accounts, income taxes, and goodwill and purchased intangible assets.

Our critical accounting policies are disclosed in our Form 10-K for the year ended July 31, 2010. There were no material changes to our critical accounting policies during the first quarter of fiscal 2011 except for the adoption of ASU 2009-13 and ASU 2009-14. In October 2009, the FASB amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple-element revenue arrangements to:

	(i)		provide updated guidance on how the elements in a multiple-element arrangement should be separated, and how the consideration should be allocated;
	(ii)		require an entity to allocate revenue amongst the elements in an arrangement using estimated selling price (“ESP”) if a vendor does not have VSOE of the selling price or third-party evidence (“TPE”) of the selling price; and
	(iii)		eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

We adopted this accounting guidance at the beginning of our first quarter of fiscal 2011 on a prospective basis for applicable arrangements originating or materially modified after August 1, 2010. The impact of this adoption was not material to our financial position and results of operations for the first quarter of fiscal 2011.

This guidance does not generally change the units of accounting for our revenue transactions. Most non-software products and services qualify as separate units of accounting because they have value to the customer on a stand-alone basis and our revenue arrangements generally do not include a general right of return relative to delivered products.

The majority of our products are hardware appliances containing software components that function together to provide the essential functionality of the product. Therefore, our hardware appliances are considered non-software elements and have been removed from the industry-specific software revenue recognition guidance.

Our product revenue also includes revenue from the sale of stand-alone software products. Stand-alone software products may operate on our hardware appliance, but are not considered essential to the functionality of the hardware. Sales of stand-alone software generally include a perpetual license to our software. Sales of stand-alone software continue to be subject to the industry-specific software revenue recognition guidance.

For all arrangements originating or materially modified after July 31, 2010, we recognize revenue in accordance with the amended accounting guidance. Certain arrangements with multiple- elements may continue to have stand-alone software elements that are subject to the existing software revenue recognition guidance along with non-software elements that are subject to the amended revenue accounting guidance. The revenue for these multiple deliverable arrangements is allocated to the stand-alone software elements as a group and the non-software elements based on the relative selling prices of all of the elements in the arrangement using the fair value hierarchy in the amended revenue accounting guidance.

For sales of stand-alone software after July 31, 2010 and for all transactions entered into prior to the first quarter of 2011, we recognize revenue based on software revenue recognition guidance. Under the software revenue recognition guidance, we use the residual method to recognize revenue when a product agreement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists. In the majority of our contracts, the only element that remains undelivered at the time of delivery of the product is support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the contract fee is recognized as product revenue. If evidence of the fair value of one or more undelivered elements does not exist, all revenue is generally deferred and recognized when delivery of those elements occurs or when fair value can be established. When the undelivered element for which we do not have VSOE of fair value is support, revenue for the entire arrangement is bundled and recognized ratably over the support period.

VSOE for elements of an arrangement is based upon the normal pricing and discounting practices for those services when sold separately, and VSOE for support services is measured by the stand-alone renewal rate offered to the customer. In determining VSOE, we require that a substantial majority of the selling prices for an element falls within a reasonably narrow pricing range, generally evidenced by a substantial majority of such historical stand-alone transactions falling within a reasonably narrow range of the median rates. In addition, we consider major service groups, geographies, customer classifications, and other variables in determining VSOE.

We are typically not able to determine TPE for our products or services. TPE is determined based on competitor prices for similar elements when sold separately. Generally, our go-to-market strategy differs from that of our peers and our offerings contain a significant level of differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis.

When we are unable to establish selling price of our non-software elements using VSOE or TPE, we use ESP in our allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine ESP for a product or service by considering multiple factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies, customer classes and distribution channels.

We regularly review VSOE and ESP and maintain internal controls over the establishment and updates of these estimates. There was not a material impact during the quarter nor do we currently expect a material impact in the near term from changes in VSOE or ESP.

Product revenue consists of revenue from sales of our hardware appliances and perpetual software licenses. We recognize product revenue when all of the following have occurred: (1) we have entered into a legally binding arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is reasonably assured.

For sales to direct end-users and channel partners, including value-added resellers, value-added distributors, and OEMs, we recognize product revenue upon delivery, assuming all other revenue recognition criteria are met. For our hardware appliances, delivery occurs upon transfer of title and risk of loss, which is generally upon shipment. It is our practice to identify an end-user prior to shipment to a channel partner. For end-users and channel partners, we generally have no significant obligations for future performance such as rights of return or pricing credits. A portion of our sales are made through distributors under agreements allowing for stocking of our products in their inventory, pricing credits and limited rights of return for stock rotation. Product revenue on sales made through these distributors is initially deferred and revenue is recognized upon sell-through as reported by the distributors to us. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.

Support and services consist of support agreements, professional services, and training. Support services include repair and replacement of defective hardware appliances, software updates and access to technical support personnel. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period. Revenue for support services is recognized on a straight-line basis over the service contract term, which is typically one to three years. Professional services are recognized upon delivery or completion of performance. Professional service arrangements are typically short term in nature and are largely completed within 90 days from the start of service. Training services are recognized upon delivery of the training.

Our fees are typically considered to be fixed or determinable at the inception of an arrangement, generally based on specific products and quantities to be delivered. Substantially all of our contracts do not include rights of return or acceptance provisions. To the extent that our agreements contain such terms, we recognize revenue once the customer has accepted, or once the acceptance provisions or right of return lapses. Payment terms to customers generally range from net 30 to 60 days. In the event payment terms are provided that differ from our standard business practices, the fees are deemed to not be fixed or determinable and revenue is recognized when the payments become due, provided the remaining criteria for revenue recognition have been met.

We assess the ability to collect from our customers based on a number of factors, including credit worthiness of the customer and past transaction history of the customer. If the customer is not deemed credit worthy, we defer revenue from the arrangement until payment is received and all other revenue recognition criteria have been met.

Results of Operations

The following table presents our historical operating results as a percentage of revenues for the periods indicated:

		Three months ended October 31,
		2010				2009
Revenues:
Product			83.2	%			82.0	%
Professional services and support			16.6	%			17.6	%
Ratable product and related professional services and support			0.2	%			0.4	%
Total revenues			100.0	%			100.0	%
Cost of revenues:
Product			26.5	%			28.5	%
Professional services and support			3.5	%			3.6	%
Ratable product and related professional services and support			0.0	%			0.2	%
Gross margin			70.0	%			67.7	%
Operating expenses:
Research and development			20.6	%			20.5	%
Sales and marketing			40.2	%			42.9	%
General and administrative			8.7	%			12.4	%
Litigation reserves			0.0	%			34.3	%
Total operating expenses			69.5	%			110.1	%
Operating margin			0.5	%			(42.4	%)
Other income (expense), net
Interest income			0.3	%			0.4	%
Other income (expense), net			2.0	%			(0.2	%)
Income (loss) before income taxes			2.8	%			(42.2	%)
Provision for income taxes			0.2	%			0.6	%
Net income (loss)			2.6	%			(42.8	%)

Revenues

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

		Three months ended October 31,
		2010				2009
		(in thousands)
Total revenues		$	83,147			$	57,596
Type of revenues:
Product			69,204				47,198
Professional services and support			13,800				10,143
Ratable product and related professional services and support			143				255
Total revenues		$	83,147			$	57,596
Revenues by geography:
United States			51,752				33,616
Europe, the Middle East and Africa			13,153				7,632
Asia Pacific			14,507				12,506
Rest of World			3,735				3,842
Total revenues		$	83,147			$	57,596