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Part I. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
[February 07, 2013]

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, expectations regarding future revenues from our customers, 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.


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 traditional enterprise, high-volume hyperscale datacenter, 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 $158.5 million in the six months ended December 31, 2011 to $238.7 million in the six months ended December 31, 2012.

Our headcount increased from 554 employees as of December 31, 2011 to 803 employees as of December 31, 2012.

-18--------------------------------------------------------------------------------- Table of Contents 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. Sales to our 10 largest customers, including the applicable OEMs, accounted for 95% and 89% of revenue during the three months ended December 31, 2011 and 2012, respectively, and 93% and 89% of revenue during the six months ended December 31, 2011 and 2012, respectively. Our direct customer Facebook, Apple, through a reseller, and our OEM customer HP each accounted for 43%, 14%, and 14% of our revenue, respectively, during the three months ended December 31, 2011, 34%, 16%, and 19% of our revenue, respectively, during the three months ended December 31, 2012, 27%, 29%, and 18% of our revenue, respectively, during the six months ended December 31, 2011, and 31%, 22%, and 17% of our revenue, respectively, during the six months ended December 31, 2012. We expect that revenue from sales to certain key customers will decline significantly for the three months ending March 31, 2013, and the six months ending June 30, 2013, as they complete their planned deployments. As a result of our revenue concentrations, our quarterly revenue and operating results are likely to fluctuate in the future and will be difficult to estimate. 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 and to 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 allowing Integrated Software Vendors to develop, integrate, and add significant value to applications using our platforms and 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 class 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 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 class memory products incorporates our ioMemory based hardware subsystems and related VSL and caching software into our family of ioDrive, ioDrive2, ioScale, ioCache, and ioFX enterprise grade products. Our ioDrive, ioDrive2, ioScale, 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. Our recently introduced ioScale product is derived from our ioMemory platform and is specifically designed for the unique needs of the high-volume hyperscale market.

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.

-19- -------------------------------------------------------------------------------- Table of Contents Components of Consolidated Statements of Operations Revenue We derive revenue primarily from the sale of our storage class memory products and support services. We sell our storage class 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 $3.0 million and $9.0 million for the three months ended December 31, 2011 and 2012, respectively, and $5.1 million and $16.5 million for the six months ended December 31, 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.

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, and transactional foreign currency gains and losses.

Trends in Our Business Gross Margin Our gross margin will vary due to product mix, customer demand, and opportunities to drive market adoption.

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.

-20- -------------------------------------------------------------------------------- Table of Contents 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, 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 applicable to public companies. 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 Six Months Ended December 31, Change in December 31, Change in 2011 2012 $ % 2011 2012 $ % Revenue $ 84,131 $ 120,569 $ 36,438 43 % $ 158,516 $ 238,684 $ 80,168 51 % Revenue increased $36.4 million from the three months ended December 31, 2011 to the three months ended December 31, 2012, and increased $80.2 million from the six months ended December 31, 2011 to the six months ended December 31, 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 95% and 89% of revenue during the three months ended December 31, 2011 and 2012, respectively, and 93% and 89% of revenue during the six months ended December 31, 2011 and 2012, respectively. Our direct customer Facebook, Apple, through a reseller, and our OEM customer HP each accounted for 43%, 14%, and 14% of our revenue, respectively, during the three months ended December 31, 2011, 34%, 16%, and 19% of our revenue, respectively, during the three months ended December 31, 2012, 27%, 29%, and 18% of our revenue, respectively, during the six months ended December 31, 2011, and 31%, 22%, and 17% of our revenue, respectively, during the six months ended December 31, 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 70% and 55% of revenue during the three months ended December 31, 2011 and 2012, respectively, and 70% and 59% of revenue during the six months ended December 31, 2011 and 2012, respectively.

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 Six Months Ended December 31, Change in December 31, Change in 2011 2012 $ % 2011 2012 $ % Cost of revenue $ 41,206 $ 46,010 $ 4,804 12 % $ 68,560 $ 94,004 $ 25,444 37 % Gross profit 42,925 74,559 31,634 74 % 89,956 144,680 54,724 61 % Gross margin 51 % 62 % 57 % 61 % Cost of revenue increased $4.8 million and gross profit increased $31.6 million from the three months ended December 31, 2011 compared to the three months ended December 31, 2012, and cost of revenue increased $25.4 million and gross profit increased $54.7 million from the six months ended December 31, 2011 compared to the six months ended December 31, 2012. These changes were primarily due to the increase in the volume of our products shipped. Additionally, headcount increased from December 31, 2011 to December 31, 2012. Gross margin increased period over period due to lower raw material costs and product mix.

-21--------------------------------------------------------------------------------- Table of Contents 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 Six Months Ended December 31, Change in December 31, Change in 2011 2012 $ % 2011 2012 $ % Sales and marketing $ 20,265 $ 28,676 $ 8,411 42 % $ 37,742 $ 53,696 $ 15,954 42 % Sales and marketing expenses increased $8.4 million from the three months ended December 31, 2011 compared to the three months ended December 31, 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 $6.2 million increase in personnel-related costs, including a $1.9 million increase in sales commissions.

The increase was also due to a $1.6 million increase in product demonstration expenses.

Sales and marketing expenses increased $16.0 million from the six months ended December 31, 2011 compared to the six months ended December 31, 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 an $11.4 million increase in personnel-related costs, including a $3.0 million increase in sales commissions. The increase was also due to a $2.3 million increase in product demonstration expenses.

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 Six Months Ended December 31, Change in December 31, Change in 2011 2012 $ % 2011 2012 $ % Research and development $ 13,479 $ 22,427 $ 8,948 66 % $ 24,631 $ 43,995 $ 19,364 79 % Research and development expenses increased $8.9 million from the three months ended December 31, 2011 compared to the three months ended December 31, 2012, primarily due to an increase in research and development personnel, resulting in an $8.4 million increase in personnel-related costs. The increase was also due to a $0.8 million increase in contract labor and consulting services.

Research and development expenses increased $19.4 million from the six months ended December 31, 2011 compared to the six months ended December 31, 2012, primarily due to an increase in research and development personnel, resulting in a $16.7 million increase in personnel-related costs. The increase was also due to a $1.4 million increase in contract labor and consulting services, and a $1.3 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 Six Months Ended December 31, Change in December 31, Change in 2011 2012 $ % 2011 2012 $ %General and administrative $ 13,228 $ 16,562 $ 3,334 25 % $ 26,965 $31,646 $ 4,681 17 % General and administrative expenses increased $3.3 million from the three months ended December 31, 2011 compared to the three months ended December 31, 2012, primarily due to a $1.0 million increase in legal expenses and a $0.8 million increase in depreciation and amortization expense.

General and administrative expenses increased $4.7 million from the six months ended December 31, 2011 compared to the three months ended December 31, 2012, primarily due to an increase in general and administrative personnel, resulting in a $1.6 million increase in personnel-related costs. The increase was also due to a $1.5 million increase in depreciation and amortization expense and a $0.9 million increase in legal expenses.

-22--------------------------------------------------------------------------------- Table of Contents Other (Expense) Income, net The following table presents our net other income (expense) for the periods indicated and related changes as compared to the prior periods (dollars in thousands): Three Months Ended Six Months Ended December 31, Change in December 31, Change in 2011 2012 $ % 2011 2012 $ % Other (expense) income, net $ (641 ) $ 96 $ 737 115 % $ 157 $ 151 $ (6 ) (4 )% Other (expense) income, net changed by $0.7 million from the three months ended December 31, 2011 compared to the three months ended December 31, 2012, primarily due to $0.7 million in other expense due to changes in the fair value of a common stock repurchase derivative liability for the three months ended December 31, 2011, which liability was paid in full in December 2012.

Other (expense) income, net changed by less than $0.1 million from the six months ended December 31, 2011 compared to the six months ended December 31, 2012, primarily due to the net change in the fair value of a common stock repurchase derivative liability for the six months ended December 31, 2011, which liability was paid in full in December 2012.

Income Tax (Expense) Benefit The following table presents our income tax (expense) benefit for the periods indicated and related changes as compared to the prior periods (dollars in thousands): Three Months Ended Six Months Ended December 31, Change in December 31, Change in 2011 2012 $ % 2011 2012 $ % Income tax (expense) benefit $ (1,021 ) $ (5,258 ) $ (4,237 ) (415 )% $ 705 $ (9,829 ) $ (10,534 ) (1,494 )% Income tax (expense) benefit changed by $4.2 million from the three months ended December 31, 2011 compared to the three months ended December 31, 2012, primarily due to the fact that 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 December 31, 2012 was comprised of U.S. federal and state income taxes as well as foreign income taxes.

Income tax (expense) benefit changed by $10.5 million from the six months ended December 31, 2011 compared to the six months ended December 31, 2012, 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 six months ended December 31, 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 December 31, 2012, our principal sources of liquidity consisted of cash and cash equivalents of $368.5 million and net accounts receivable of $56.0 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 $438.1 million as of December 31, 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 a revolving line of credit. The revolving line of credit matured on December 31, 2012.

-23--------------------------------------------------------------------------------- Table of Contents Cash Flow Analysis Six Months Ended December 31, 2011 2012 (In thousands) Net cash provided by (used in): Operating activities $ 16,619 $ 38,892 Investing activities (27,884 ) (8,712 ) Financing activities 99,115 17,025 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 six months ended December 31, 2011 and 2012 was $16.6 million and $38.9 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 six months ended December 31, 2011, our net cash used in investing activities was $27.9 million and was primarily due to $17.6 million of cash paid for the acquisition of IO Turbine, net of cash acquired, and $10.3 million of purchases of property and equipment.

During the six months ended December 31, 2012, our net cash used in investing activities was $8.7 million for purchases of property and equipment.

Financing Activities Cash flows from financing activities primarily include net proceeds from our employee stock purchase plan, issuance of common stock, and exercise of stock options.

We generated $99.1 million of net cash from financing activities for the six months ended December 31, 2011, primarily due to $94.0 million in net proceeds from the issuance of common stock through our follow-on offering, $4.4 million in net proceeds from our employee stock purchase plan and exercise of stock options, and $1.8 million from a tax benefit from the exercise of stock options, all offset by the payout of the common stock repurchase derivative liability of $1.1 million.

We generated $17.0 million of net cash from financing activities for the six months ended December 31, 2012, primarily due to net proceeds of $9.5 million from the exercise of stock options and our employee stock purchase plan, and a $9.4 million tax benefit from the exercise of stock options, all offset by $1.9 million in net issuance of restricted stock awards and restricted stock units, net of repurchases.

Revolving Line of Credit We maintained a loan and security agreement, or the revolving line of credit, with a financial institution prior to its maturity on December 31, 2012. The revolving line of credit allowed us to borrow up to a limit of $25,000,000, including the issuance of letters of credit. Borrowings under the revolving line of credit would have accrued 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. The quarterly unused commitment fee was equal to one-quarter of one percent (0.25%) per annum of the difference between the $25,000,000 loan commitment and the average daily balance of borrowings outstanding on the last day of each quarter. Under the terms of the revolving line of credit, we were 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 $25,000,000, 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.

-24- -------------------------------------------------------------------------------- Table of Contents During the three and six months ended December 31, 2012, there were no borrowings against 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 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. In November 2012, we amended the minimum purchase commitment to purchase additional raw material inventory. As of December 31, 2012, approximately $20.2 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 December 31, 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 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.

-25- -------------------------------------------------------------------------------- Table of Contents Income Taxes Significant judgment is required in determining our provision for income taxes and evaluating our uncertain tax positions. Historically, the 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 our past operating results, our forecast of future market growth, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies. Considering our recent positive evidence, we may release all or a portion of our valuation allowance during fiscal 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 made.

On January 2, 2013, the federal research and development tax credit was reinstated retroactive to January 1, 2012. As the legislation was enacted after December 31, 2012, we have not included the impact of the credit in the financial statements for the period ended December 31, 2012. We anticipate that the effective tax rate reported for the period ending March 31, 2013 will include the credit earned for the period January 1, 2012 through March 31, 2013.

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 class 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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