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TMCNet:  Part I. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

[November 07, 2012]

Part I. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements In addition to historical information, this Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the views of our management regarding current expectations and projections about future events and are based on currently available information. These forward-looking statements include, but are not limited to, statements concerning our possible or assumed future results of operations, business strategies, financing plans, technological leadership, market opportunity, expectations regarding product acceptance, ability to innovate new products and bring them to market in a timely manner, ability to successfully increase sales of our software offerings as part of our overall sales strategy, expectations concerning our technologies, products and solutions, including our ioMemory platform, our recently introduced ION Data Accelerator software, our ioTurbine virtualization caching software, our directCache data-tiering caching software, and our storage memory programming software, competitive position and the effects of competition, industry environment, potential growth opportunities, ability to expand internationally, the impact of quarterly fluctuations of revenue and operating results, changes to and expectations concerning gross margin, expectations concerning relationships with third parties, including channel partners, key customers and original equipment manufacturers, or OEMs, such as our recently announced OEM relationship with Cisco, levels of capital expenditures, future capital requirements and availability to fund operations and growth, the adequacy of facilities, impact of the acquisition of IO Turbine, Inc., the adequacy of our intellectual property rights, expectations concerning pending legal proceedings and related costs, the sufficiency of our issued patents and patent applications to protect our intellectual property rights, the effects of a natural disaster on us or our suppliers, our ability to resell inventory that we cannot use in our products due to obsolescence, our ability to grow our sales through OEMs and other channel partners and maintaining our relationships with those channel partners, including the timely qualification of our products for promotion and sale through those channels, particularly OEMs, OEM's continuing to design our products into their products, the importance of software innovation, and volatility regarding our provision for income taxes. Forward-looking statements include statements that are not historical facts and can be identified by terms such as "anticipates," "believes," "could," "seeks," "estimates," "expects," "intends," "may," "plans," "potential," "predicts, "projects," "should," "will," "would," or similar expressions and the negatives of those terms.


These forward-looking statements are inherently subject to uncertainties, risks, and changes in circumstances that are difficult to predict. Actual results could differ materially from those contained in these forward-looking statements for a variety of reasons, including, but not limited to, those discussed in the section entitled "Risk Factors" in Part II, Item 1A and elsewhere in this report. Other unknown or unpredictable factors also could have a material adverse effect on our business, financial condition, and results of operations.

Accordingly, readers should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management's beliefs and assumptions only as of the date of this Form 10-Q.

- 16 - -------------------------------------------------------------------------------- Table of Contents We are not under any obligation to, and do not intend to, publicly update or review any of these forward-looking statements, whether as a result of new information, future events, or otherwise, even if experience or future events make it clear that any expected results expressed or implied by those forward-looking statements will not be realized, except to the extent required by applicable securities laws. Please carefully review and consider the various disclosures made in this report and in our other reports filed with the Securities and Exchange Commission, or SEC, that attempt to advise interested parties of the risks and factors that may affect our business, prospects, and results of operations.

The information included in this management's discussion and analysis of financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the notes included in this report, and the audited consolidated financial statements and notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 30, 2012.

Overview We provide Enterprise datacenter, Hyperscale, and Workstation solutions that accelerate databases, virtualization, cloud computing, big data, information systems, and the applications that help drive business from the smallest e-tailers to some of the world's largest data centers, social media leaders, and Fortune Global 500 businesses. Our integrated hardware and software platform enables the acceleration of data away from legacy architectures and specialized hardware. This core technology leverages flash memory to significantly increase datacenter and computer-based information system efficiency, with enterprise grade performance, reliability, availability, and manageability.

We were incorporated in December 2005, and we initially focused on the engineering and development of our platform. We have experienced significant growth with revenue increasing from $74.4 million in the three months ended September 30, 2011 to $118.1 million in the three months ended September 30, 2012. Our headcount increased from 499 employees as of September 30, 2011 to 733 employees as of September 30, 2012.

We sell our products through our global direct sales force, OEMs, including Cisco, Dell, HP, and IBM, and other channel partners. Some of our OEMs and channel partners integrate our platform into their own proprietary product offerings. Our primary sales office is located in San Jose, California, and we also have additional sales presence in North America, Europe, and Asia.

Large purchases by a limited number of customers have accounted for a substantial majority of our revenue, and the composition of the group of our largest customers changes from period to period. Some of our customers make concentrated purchases to complete or upgrade specific large-scale data storage installations. These concentrated purchases are short-term in nature and are typically made on a purchase order basis rather than pursuant to long-term contracts. During the three months ended September 30, 2011 and 2012, sales to the 10 largest customers in each period, including the applicable OEMs, accounted for approximately 94% and 91% of revenue, respectively. Apple, through a reseller, our OEM customer HP, and our direct customer Facebook, each accounted for 46%, 22%, and less than 10% of our revenue, respectively, during the three months ended September 30, 2011, and 28%, 14%, and 28% of our revenue, respectively, during the three months ended September 30, 2012. We expect that sales to a limited number of customers will continue to contribute materially to our revenue for the foreseeable future.

We anticipate that sales through OEMs and other channel partners will continue to constitute a substantial portion of our future revenue. In some cases, our products must be designed or qualified into the OEM's products. If that fails to occur for a given product line of an OEM, we would likely be unable to sell our products to that OEM during the life cycle of that product, which would adversely affect our revenue. We expect that as we continue to expand our global presence and business overseas, we will increasingly depend on our OEM relationships in such markets.

We believe that extending our platform differentiation through software innovation will be critical to achieving broader market acceptance along with maintaining or increasing our gross margins. In this regard, our ioTurbine virtualization software, directCache data-tiering software, ION Data Accelerator software, ioSphere platform management software, and storage memory programming software allow Integrated Software Vendors to develop, integrate, and add significant value to applications using our platforms. We intend to continue adding software functionality to differentiate our products. The next generation VSL 3.0 virtualization software and hardware platform is in full production. We continue to devote the majority of our research and development resources to software development, and if we are unable to successfully develop or acquire, and then market and sell additional software functionality, our ability to increase our revenue and gross margins could be adversely affected.

Our ioMemory technology forms the basis of our hardware offering and is designed as a portfolio of upgradeable design modules, enabling faster time-to-market and increased extensibility, and it provides server-based storage memory, low access latency, field upgradeability, deep error correction, self-healing protection and native PCI Express connectivity. Our second generation ioMemory technology supports the latest NAND geometries, significantly increases performance and capacity, improves reliability while retaining the ability to build storage systems of varying capacity, performance, and form factors. At the heart of the ioMemory technology is our proprietary field programmable data-path controller.

It connects a large array of non-volatile memory chips natively - 17 - -------------------------------------------------------------------------------- Table of Contents to the server's PCI-Express 1.0 or 2.0 peripheral bus, and addresses the reliability issues of non-volatile memory with our Adaptive Flashback Protection advanced chip-level fault tolerance technology, which is capable of restoring, correcting, and resurrecting lost data in the Flash-based storage sub-system.

Our portfolio of storage memory products incorporates our ioMemory based hardware subsystems and related VSL and caching software into our family of ioDrive, ioDrive2, ioCache, and ioFX enterprise grade products. Our ioDrive, ioDrive2, ioCache, and ioFX products work in conjunction or are integrated with our ioTurbine virtualization caching software, directCache data-tiering software, and ION Data Accelerator software.

We outsource manufacturing of our hardware products using a limited number of contract manufacturers. We procure a majority of the components used in our products directly from third-party vendors and have them delivered to our contract manufacturers for manufacturing and assembly. Once our contract manufacturers perform sub-assembly and assembly quality tests, they are assembled to our specified configurations. We perform final manufacturing assurance tests, labeling, final configuration, including a final firmware installation and shipment to our customers.

As a consequence of the rapidly evolving nature of our business and our limited operating history, we believe that period-to-period comparisons of revenue and other operating results, including gross margin and operating expenses as a percentage of our revenue, are not necessarily meaningful and should not be relied upon as indications of future performance. Although we have experienced significant percentage growth in our revenue, we do not believe that our historical growth rates are likely to be sustainable or indicative of future growth.

Components of Condensed Consolidated Statements of Operations Revenue We derive revenue primarily from the sale of our storage memory products and support services. We sell our storage memory platforms and software through our global direct sales force, OEMs, and other channel partners. We provide our support services pursuant to support contracts, which involve hardware support, software support, and software upgrades on a when-and-if available basis for a period of one to five years. We recorded revenue from support services of $2.1 million and $7.5 million for the three months ended September 30, 2011 and 2012, respectively. For the periods presented, our software revenue was not significant to our condensed consolidated statements of operations.

Cost of Revenue Cost of revenue consists primarily of material costs including amounts paid to our suppliers and contract manufacturers for hardware components and assembly of those components into our products. The largest portion of our cost of revenue consists of the cost of non-volatile memory components. Given the commodity nature of memory components, neither we nor our contract manufacturers generally enter into long-term supply contracts for our product components, which can cause our cost of revenue to fluctuate. Cost of revenue is recorded when the related product revenue is recognized. Cost of revenue also includes costs related to allocated personnel expenses related to customer support, warranty costs, costs of shipping, manufacturing operations, and carrying value adjustments recorded for excess and obsolete inventory.

Operating Expenses The largest component of our operating expenses is personnel costs, consisting of salaries, benefits, and incentive compensation for our employees, which includes stock-based compensation.

Sales and Marketing Sales and marketing expenses consist primarily of personnel costs, incentive compensation, marketing programs, travel-related costs, consulting expenses associated with sales and marketing activities, and facilities-related costs.

Research and Development Research and development expenses consist primarily of personnel costs, prototype expenses, amortization of an intangible asset, consulting services, depreciation associated with research and development equipment, and facilities-related costs. We expense research and development costs as incurred.

General and Administrative General and administrative expenses consist primarily of personnel costs, legal expenses, consulting and professional services, audit costs, and facility-related expenses for our executive, finance, human resources, information technology, and legal organizations.

- 18 - -------------------------------------------------------------------------------- Table of Contents Other income (expense), net Other income (expense), net consists of changes in the fair value of a derivative related to a repurchase of our common stock, interest expense, interest income, realized gains and losses from investments, and transactional foreign currency gains and losses.

Trends in Our Business Gross Margin We anticipate our gross margin will slightly decrease due to product mix and balancing driving market adoption with gross margin.

Sales and Marketing We plan to continue to invest in sales by increasing our sales headcount. Our sales personnel are typically not immediately productive and therefore the increase in sales and marketing expense when we add new sales representatives is not immediately offset by increased revenue and may not result in increased revenue over the long-term. The timing of our hiring of new sales personnel and the rate at which they generate incremental revenue could therefore affect our future period-to-period financial performance. We expect sales and marketing expenses to increase in absolute dollars and increase as a percentage of revenue as we expect to continue hiring new sales representatives. We also expect to expand marketing activities to drive sales opportunities and brand awareness.

Research and Development We expect to continue to devote substantial resources to the development of our products including the development of new products. We believe that these investments are necessary to maintain and improve our competitive position. We expect research and development expenses to increase in absolute dollars and increase as a percentage of revenue as we expect to continue to invest in additional engineering personnel and infrastructure required to support the development of new products and to enhance existing products.

General and Administrative While we expect personnel costs, including stock-based compensation expense for employees and non-employees, to be the primary component of general and administrative expenses, we also expect to continue to incur significant legal and accounting costs related to compliance with rules and regulations implemented by the SEC. We expect that general and administrative expenses will continue to increase in absolute dollars and as a percentage of revenue primarily due to general growth of the business, infrastructure costs to support our international growth, and in legal costs related to intellectual property.

Results of Operations Revenue The following table presents our revenue for the periods indicated and related changes as compared to the prior periods (dollars in thousands): Three Months Ended September 30, Change in 2011 2012 $ % Revenue $ 74,385 $ 118,115 $ 43,730 59 % Revenue increased $43.7 million from the three months ended September 30, 2011 compared to the three months ended September 30, 2012 primarily due to the increase in the overall volume of our products shipped.

Revenue from the 10 largest customers, including the applicable OEMs, for the periods presented was 94% and 91% of revenue for the three months ended September 30, 2011 and 2012, respectively. Apple, through a reseller, our OEM customer HP, and our direct customer Facebook, each accounted for 46%, 22%, and less than 10% of our revenue, respectively, during the three months ended September 30, 2011, and 28%, 14%, and 28% of our revenue, respectively, during the three months ended September 30, 2012. No other customer accounted for 10% or more of revenue in the periods presented. Revenue from customers with a ship-to location in the United States accounted for 71% and 62% of revenue for the three months ended September 30, 2011 and 2012, respectively.

- 19 - -------------------------------------------------------------------------------- Table of Contents Cost of Revenue and Gross Margin The following table presents our cost of revenue, gross profit and gross margin for the periods indicated and related changes as compared to the prior periods (dollars in thousands): Three Months Ended September 30, Change in 2011 2012 $ % Cost of revenue $ 27,354 $ 47,994 $ 20,640 75 % Gross profit 47,031 70,121 23,090 49 % Gross margin 63 % 59 % Cost of revenue increased $20.6 million and gross profit increased $23.1 million from the three months ended September 30, 2011 compared to the three months ended September 30, 2012, primarily due to the increase in the volume of our products shipped. Additionally, headcount increased from September 30, 2011 to September 30, 2012. Gross margin decreased period over period due to higher raw material costs and product mix.

Operating Expenses Sales and Marketing The following table presents our sales and marketing expenses for the periods indicated and related changes as compared to the prior periods (dollars in thousands): Three Months Ended September 30, Change in 2011 2012 $ % Sales and marketing $ 17,477 $ 25,020 $ 7,543 43 % Sales and marketing expenses increased $7.5 million from the three months ended September 30, 2011 compared to the three months ended September 30, 2012, primarily due to an increase in sales and marketing personnel, as we hired additional employees to focus on acquiring new customers and expanding our business. This increase in headcount resulted in a $5.2 million increase in personnel-related costs, including a $1.1 million increase in sales commissions.

The largest portion of the remaining increase was due to a $0.6 million increase in tradeshow-related costs.

Research and Development The following table presents our research and development expenses for the periods indicated and related changes as compared to the prior periods (dollars in thousands): Three Months Ended September 30, Change in 2011 2012 $ % Research and development $ 11,152 $ 21,568 $ 10,416 93 % Research and development expenses increased $10.4 million from the three months ended September 30, 2011 compared to the three months ended September 30, 2012, primarily due to an increase in research and development personnel, resulting in an $8.3 million increase in personnel-related costs. The increase was also due to a $0.8 million increase in depreciation and amortization expense.

General and Administrative The following table presents our general and administrative expenses for the periods indicated and related changes as to the prior periods (dollars in thousands): Three Months Ended September 30, Change in 2011 2012 $ % General and administrative $ 13,737 $ 15,084 $ 1,347 10 % General and administrative expenses increased $1.3 million from the three months ended September 30, 2011 compared to the three months ended September 30, 2012, primarily due to an increase in general and administrative personnel, resulting in a $1.4 million increase in personnel-related costs.

- 20 - -------------------------------------------------------------------------------- Table of Contents Other Income (Expense), net The following table presents our other income (expense), net for the periods indicated and related changes as compared to the prior periods (dollars in thousands): Three Months Ended September 30, Change in 2011 2012 $ % Other income (expense), net $ 798 $ 55 $ (743 ) (93 )% Other income (expense), net changed by $0.7 million from the three months ended September 30, 2011 compared to the three months ended September 30, 2012, primarily due to $0.8 million in other income due to changes in the fair value of a common stock repurchase derivative liability for the three months ended September 30, 2011, which liability was paid in full in December 2012.

Income Tax Benefit (Expense) The following table presents our income tax benefit (expense) for the periods indicated and related changes as compared to the prior periods (dollars in thousands): Three Months Ended September 30, Change in 2011 2012 $ % Income tax benefit (expense) $ 1,726 $ (4,571 ) $ (6,297 ) (365 )% Income tax benefit (expense) changed by $6.3 million, primarily due to the income tax benefit recorded in the prior year as a result of a valuation allowance reversal related to deferred tax liabilities generated from the acquisition of IO Turbine. In addition, the prior year taxable income was substantially offset by net operating losses which are no longer available in the current year. The provision for income taxes for the three months ended September 30, 2012 was comprised of foreign income taxes as well as U.S. federal and state income taxes.

Financial Position, Liquidity, and Capital Resources Primary Sources of Liquidity As of September 30, 2012, our principal sources of liquidity consisted of cash and cash equivalents of $353.9 million, net accounts receivable of $65.7 million, and amounts available under our revolving line of credit of approximately $21.8 million. In June 2011, we completed an initial public offering of our common stock, or IPO, in which we issued and sold 12,600,607 shares and received net proceeds of approximately $218.9 million. In November 2011, we completed a follow-on public offering of our common stock in which we issued and sold 3,000,000 shares and received net proceeds of approximately $94.0 million. We had working capital of $414.5 million as of September 30, 2012.

In August 2011, we used approximately $17.6 million (net of cash acquired) of the net IPO proceeds as partial consideration to purchase IO Turbine. We anticipate using the remaining net proceeds from our public offerings for working capital and general corporate purposes, including expansion of our sales organization, further development and expansion of our product offerings and possible acquisitions of, or investments in, businesses, technologies, or other assets. We have no present material understandings, commitments, or agreements to enter into any acquisitions or investments. Our excess cash is primarily invested in money market funds.

Historically, our primary sources of liquidity have been from customer payments for our products and services, the issuance of common and convertible preferred stock and convertible notes, and proceeds from our revolving line of credit.

Cash Flow Analysis Three Months Ended September 30, 2011 2012 (In thousands) Net cash provided by (used in): Operating activities $ 3,094 $ 28,667 Investing activities (21,799 ) (5,175 ) Financing activities 1,042 9,068 - 21 - -------------------------------------------------------------------------------- Table of Contents Operating Activities Our operating cash flow primarily depends on the timing and amount of cash receipts from our customers, inventory purchases, and payments for operating expenses.

Our net cash provided by operating activities for the three months ended September 30, 2011 and 2012 was $3.1 million and $28.7 million, respectively.

During these periods, cash collected from our customers exceeded our operating cash outflows, which consisted primarily of purchases of inventory and personnel-related costs.

Investing Activities Cash flows from investing activities primarily relate to purchases of computer equipment, leasehold improvements, and property and equipment to support our growth. Investing activities also include cash used for business acquisitions.

During the three months ended September 30, 2011, our net cash used in investing activities was $21.8 million and was primarily due to cash paid for the acquisition of IO Turbine, net of cash acquired, of $17.6 million and purchases of property and equipment of $4.2 million.

During the three months ended September 30, 2012, our net cash used in investing activities was $5.2 million for purchases of property and equipment.

Financing Activities Cash flows from financing activities primarily include net proceeds from issuances of common and convertible preferred stock, proceeds and payments related to issuances of convertible notes, and loans from a financial institution.

We generated $1.0 million of net cash from financing activities for the three months ended September 30, 2011, primarily due to $1.1 million in net proceeds from our employee stock purchase plan and exercise of stock options.

We generated $9.1 million of net cash from financing activities for the three months ended September 30, 2012, primarily due to $5.7 million in net proceeds from the exercise of stock options and our employee stock purchase plan, and $4.4 million from a tax benefit from the exercise of stock options, all offset by the issuance of restricted stock awards and restricted stock units, net of repurchases of $1.1 million.

Revolving Line of Credit In September 2010, we amended and restated our loan and security agreement, or the revolving line of credit, with a financial institution. The revolving line of credit allows us to borrow up to a limit of $25.0 million. A sublimit of $6.0 million for letters of credit, certain cash management services, and foreign exchange forward contracts applied until May 2012. The total balance of letters of credit outstanding at September 30, 2012 was $3.2 million, which reduces the amount we have available to borrow under the revolving line of credit. Prior to May 2012, borrowings under the revolving line of credit would have accrued interest at a floating per annum rate equal to one-half of one percentage point (0.50%) above the prime rate as published in the Wall Street Journal. An unused commitment fee equal to 0.375% of the difference between the $25.0 million limit and the average daily balance of borrowings outstanding each quarter was due on the last day of such quarter. Prior to May 2012, the revolving line of credit was secured by substantially all of our assets. We can make advances against the revolving line of credit until its maturity date, at which time all unpaid principal and interest shall be due and payable.

In August 2011, we entered into an amendment to the revolving line of credit which provided for the consent of the financial institution with respect to the IO Turbine acquisition and certain amendments to provide us with further flexibility to consummate mergers and acquisitions permitted under the revolving line of credit.

In May 2012, we entered into a second amendment to the revolving line of credit.

Pursuant to this amendment, the pricing on revolving line of credit was amended such that borrowings under the revolving line of credit accrue interest at a per annum rate equal to, at our option, a floating per annum rate equal to the prime rate as published in the Wall Street Journal, or the LIBOR rate (based on 1, 2, 3 or 6-month interest periods) plus a margin equal to two percent (2.00%) per annum. This amendment further provides for, among other things, (i) the reduction of the quarterly unused commitment fee to an amount equal to one-quarter of one percent (0.25%) per annum of the difference between the $25.0 million loan commitment and the average daily balance of borrowings outstanding on the last day of each quarter, (ii) the removal of the borrowing base formula and the sublimit restricting the issuance of letters of credit, cash management services and foreign exchange forward contracts, and (iii) the release of the financial institution's security interest in all of our assets.

- 22 - -------------------------------------------------------------------------------- Table of Contents Under the terms of the revolving line of credit, we are required to maintain the following minimum financial covenants on a consolidated basis: • A ratio of current assets to current liabilities plus, without duplication, any of our obligations to the financial institution, of at least 1.25 to 1.00.

• A tangible net worth of at least $25.0 million, plus 25% of the net proceeds we received from the sale or issuance of our equity or subordinated debt, such increase to be measured as of the last day of the quarter in which we received such proceeds.

In September 2012, we entered into a third amendment to the revolving line of credit. Pursuant to this amendment, the maturity date of the revolving line of credit was extended to December 2012.

As of September 30, 2012, no borrowings were outstanding under the revolving line of credit and we were in compliance with all covenants.

Future Capital Requirements Our future capital requirements will depend on many factors, including our rate of revenue growth, possible acquisitions of, or investments in, businesses, technologies, or other assets, the expansion of our sales and marketing activities, the timing and extent of spending to support product development efforts, and the expansion into new territories, the timing of new product introductions, the building of infrastructure to support our growth, the continued market acceptance of our products, and strategic investments in businesses.

We believe that our cash and cash equivalents and available amounts under the revolving line of credit, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. Although we are not currently a party to any material agreement or letter of intent regarding potential investments in, or acquisitions of, complementary businesses, applications, or technologies, we may enter into these types of arrangements, which could require us to seek additional equity or debt financing. If required, additional financing may not be available on terms that are favorable to us, if at all. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and these securities might have rights, preferences, and privileges senior to those of our current stockholders. We cannot assure you that additional financing will be available or that, if available, such financing can be obtained on terms favorable to our stockholders and us.

Off Balance Sheet Arrangements During the periods presented, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purpose.

Contractual Obligations and Material Commitments In May 2012, we entered into a minimum purchase commitment for raw materials inventory that ends in June 2013 and provides for a termination fee based on a percentage of the amount of raw materials inventory not taken under the commitment. As of September 30, 2012, approximately $21.5 million remained outstanding under this commitment.

Indemnification We have agreed to indemnify our officers and directors for certain events or occurrences, while the officer or director is or was serving at our request in such capacity. The maximum amount of potential future indemnification is unlimited; however, we have a director and officer insurance policy that provides corporate reimbursement coverage that limits our exposure and enables us to recover a portion of any future amounts paid. We are 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, we had no liabilities recorded for these agreements as of June 30, 2012 and September 30, 2012.

Many of our agreements with customers and channel partners, including OEMs and resellers, generally include certain provisions for indemnifying the channel partners and customers against third-party claims of intellectual property infringement arising from the use of our products. To date, we have not incurred any material costs as a result of such indemnification provisions and have not accrued any liabilities related to such obligations in our condensed consolidated financial statements.

Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. These estimates and assumptions are often based on judgments that we believe to be reasonable under the circumstances at the time made, but all such estimates and assumptions are inherently uncertain and unpredictable. Actual results may differ from those estimates and assumptions, and it is possible that - 23 - -------------------------------------------------------------------------------- Table of Contents other professionals, applying their own judgment to the same facts and circumstances, could develop and support alternative estimates and assumptions that would result in material changes to our operating results and financial condition. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

Our critical accounting policies and estimates are detailed in Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for the year ended June 30, 2012. None of our critical accounting policies and estimates have been significantly changed since the filing of our most recent Form 10-K except for those noted below.

Income Taxes Significant judgment is required in determining our provision for income taxes and evaluating our uncertain tax positions. Historically, our effective tax rate has been volatile and difficult to forecast due to the valuation allowance against our deferred tax assets, stock based compensation, our ability to use tax credits and other adjustments. We expect this volatility to continue in our effective tax rate.

In evaluating our ability to recover our deferred tax assets, in full or in part, we consider all available positive and negative evidence, including reversal of taxable temporary differences, our past operating results, our forecast of future market growth, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies. To the extent that we continue to generate positive income and expect, with reasonable certainty, to continue to generate positive income we may release all or a portion of our valuation allowance during fiscal year 2013. This release would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period such release is recorded.

Recently Issued and Adopted Accounting Pronouncements For information with respect to recent accounting pronouncements and the impact of these pronouncements on our condensed consolidated financial statements, see Note 1 "Description of Business and Summary of Significant Accounting Policies - Recently Issued and Adopted Accounting Pronouncements" in the notes to condensed consolidated financial statements.

Segments Operating segments are defined in accounting standards as components of an enterprise about which separate financial information is available and is regularly evaluated by management, namely the chief operating decision maker of an organization, in order to make operating and resource allocation decisions.

We have concluded that we operate in one business segment, which is the development, marketing and sale of storage memory products. Substantially all of our revenue for all periods presented in the accompanying condensed consolidated statements of operations has been from sales of the ioDrive product lines and related customer support services.

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