RUCKUS WIRELESS INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis of our financial condition and results of operations together with the consolidated financial statements and related notes that are included elsewhere in this report. This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Item 1A,"Risk Factors" and in other parts of this report.

Overview Ruckus is a leading provider of carrier-class Wi-Fi solutions. Our solutions, which we call Smart Wi-Fi, are used by service providers and enterprises to solve network capacity and coverage challenges associated with the rapidly increasing traffic and number of users on wireless networks. Our Smart Wi-Fi solutions offer carrier-class enhanced reliability, consistent performance, extended range and massive scalability. Our products include gateways, controllers and access points. These products incorporate our proprietary technologies, including Smart Radio, Smart QoS, Smart Mesh, SmartCell and Smart Scaling, to enable high performance in a variety of challenging operating conditions faced by service providers and enterprises.

Our products have been sold to over 21,700 end-customers worldwide. Our service provider end-customers include mobile operators, cable companies, wholesale operators and fixed-line carriers. Our enterprise end-customers span a wide range of industries, including hospitality, education, healthcare, warehousing and logistics, corporate enterprise, retail, state and local government and public venues, such as stadiums, convention centers, airports and major outdoor public areas.

Our revenue increased 79% to $214.7 million for the year ended December 31, 2012, from $120.0 million for the year ended December 31, 2011. Net income increased to $31.7 million for the year ended December 31, 2012, which included a $17.2 million income tax benefit, from net income of $4.2 million for the year ended December 31, 2011. The income tax benefit of $17.2 million for the year ended December 31, 2012, primarily relates to the release of our valuation allowance of $23.6 million, offset by tax expense associated with the use of net operating losses and minor amounts of state and foreign taxes.

We have focused since our inception in 2004 on developing products that combine industry standard Wi-Fi chip sets with our proprietary technology to deliver high performance Wi-Fi connectivity in challenging environments. We first commercialized our Wi-Fi technology in customer premise equipment, or CPE, that performed the highly demanding task of delivering live television over Wi-Fi. In 2005 we began selling our Smart Wi-Fi CPE products to broadband operators for Internet Protocol television, or IPTV, distribution within a home.

Following the launch of our CPE products, we began to apply the expertise that we gained in delivering a Wi-Fi solution for home use to address the capacity and coverage requirements of service providers and midsized enterprises. In late 2007, we first introduced our carrier-class ZoneFlex product line. ZoneFlex integrates our Smart Wi-Fi technologies into a set of access points and controllers that provide cost-effective, highly reliable and scalable solutions to service providers and enterprises.

In connection with the launch of our ZoneFlex product line we began to significantly increase our investments in our service provider and enterprise sales and marketing activities. At the same time we began to shift focus away from our CPE products. CPE revenue was less than 5% of total revenue for the year ended December 31, 2012, and we expect this revenue to decline as a percentage of total revenue in future periods.

As demand for our products from service providers increased, we recognized the need to enable service providers to integrate their Wi-Fi and cellular network infrastructures. We therefore significantly increased our research and development activities to address network integration requirements of service providers. Consistent with that focus, we acquired the business of IntelliNet Technologies, Inc., or IntelliNet, for total consideration of $15.6 million, which increased our ability to manage and control subscriber traffic across Wi-Fi and cellular networks.

We launched our SmartCell gateway in the first quarter of 2012 to enable service providers to support and manage our Smart Wi-Fi access points and to serve as a platform for integration of Wi-Fi and other services into the service provider network infrastructure. While this product was designed to address specific requirements of service providers, we generally develop and sell the same products for both our service provider and enterprise end-customers. This approach to our products provides us maximum leverage from our research and development and sales and marketing investments with respect to service providers and enterprises.

We target both service providers and enterprises that require carrier-class Wi-Fi solutions through our global force of sales personnel and systems engineers. They work with value-added resellers and distributors, which we collectively refer to as channel partners, to reach and service our end-customers. Our channel partners provide lead generation, pre-sales support, product fulfillment and, in certain circumstances, post-sales customer service and support. In some instances, service providers may also act as a channel partner for sales of our solutions to enterprises. Our sales personnel and systems engineers typically engage directly with selected large service providers and enterprises whether or not product fulfillment involves our channel partners. In contrast, the majority of our enterprise sales are originated and completed by our channel partners with little or no direct engagement with us.

Service providers typically require long sales cycles, which generally range between one and three years, but can be longer. The sale to a large service provider usually begins with an evaluation, followed by one or more network trials, followed by vendor selection and finally deployment and testing. A large service provider will frequently issue a request for proposals to shortlist competitive suppliers prior to the network trials. Completion of several of these steps is substantially outside of our control, which causes our revenue patterns from large service providers to vary widely from period to period.

After initial deployment, subsequent purchases of our products typically have a more compressed sales cycle. The service providers that we consider to be primarily end-customers produced approximately one third of our revenue for the year ended December 31, 2012, and approximately one quarter of our revenue for the year ended December 31, 2011. Sales cycles for enterprises are typically less than 90 days.

29-------------------------------------------------------------------------------- Table of Contents We are a global business and, for the year ended December 31, 2012, more than 57% of our annual revenue has been generated from customers outside of the United States. Due primarily to the size of large service provider orders, the amount of revenue from a region may vary significantly from period to period.

For example, for the year ended December 31, 2011, 37% of our revenue was generated from the Americas region, 35% was generated from the Asia Pacific, or APAC, region and 28% was generated from the Europe, Middle East and Africa, or EMEA, region. However, during the year ended December 31, 2012, 45% of our revenue was generated from the Americas, 32% was generated from the APAC region, and 23% was generated from the EMEA region. We derive revenue from sales of our products and from services, which are primarily maintenance and support. Over 94% of our revenue is from product sales.

We outsource the warehousing and delivery of our products to a third-party logistics provider for worldwide fulfillment. In 2012, the Company began warehousing and delivering some products in the United States from our headquarters in Sunnyvale, California. We perform quality assurance and testing at our Sunnyvale, California facilities.

We believe the market for our Smart Wi-Fi solutions is growing rapidly and our intention is to continue to invest for long-term growth. We expect to continue to invest heavily in research and development to expand the capabilities of our solutions with respect to services providers and enterprises. We also plan to continue to make significant investments in our field sales and marketing activities, both by increasing our service provider focused direct sales force and by expanding our network of channel partners.

Key Components of Our Results of Operations and Financial Condition Revenues We generate revenue from the sales of our products and services. As discussed further in "-Critical Accounting Policies and Estimates-Revenue Recognition" below, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is reasonably assured.

Our total revenue is comprised of the following: Product Revenue. The majority of our product revenue is generated from sales of our products, which predominately includes access points and controllers as well as corresponding controller licenses. We generally recognize product revenue on sales to distributors' customers and at the time of shipment for all other customers, provided that all other revenue recognition criteria have been met.

Service Revenue. Service revenue is generated primarily from post-contract support, or PCS, and includes software updates on a "if and when available" basis, telephone and internet access to technical support personnel and hardware support. PCS terms are typically one year to five years and we recognize service revenue ratably over the contractual service period.

Cost of Revenues Our total cost of revenues is comprised of the following: Cost of Product Revenue. Cost of product revenue primarily includes manufacturing costs of our products payable to third-party contract manufacturers. Our cost of product revenue also includes shipping costs, third-party logistics costs, provisions for excess and obsolete inventory, warranty and personnel costs, including stock-based compensation, certain allocated costs for facilities and other expenses associated with logistics and quality control.

Cost of Service Revenue. Cost of service revenue primarily includes personnel costs, including stock-based compensation, and certain allocated costs for facilities and other expenses associated with our global support organization.

Gross Margin Gross margin, or gross profit as a percentage of revenue, has been and will continue to be affected by a variety of factors, including the average sales price of our products, manufacturing costs, the mix of products sold, and the mix of revenue between products and services. For sales of our products, ZoneFlex products generally have higher gross margins than our CPE products. Our products currently have higher gross margins than our services, due to the continuing investment in our service operations to manage anticipated growth. We expect our gross margins to fluctuate over time depending on the factors described above.

Operating Expenses Research and Development. Research and development expense consists primarily of personnel costs, including stock-based compensation, for employees and contractors engaged in research, design and development activities, as well as costs for prototype-related expenses, product certification, travel, depreciation, recruiting and allocated costs for certain facilities and benefits costs allocated based on headcount. We believe that continued investment in research and development and our products is important to attaining our strategic objectives. We expect research and development expense to increase in absolute dollars as we continue to invest in our future products and services, although our research and development expense may fluctuate as a percentage of total revenue.

Sales and Marketing. Sales and marketing expense consists primarily of personnel costs, commission costs and stock-based compensation for employees and contractors engaged in sales and marketing activities. Commission costs are calculated on shipment and expensed in the same period. Sales and marketing expense also includes the costs of trade shows, marketing programs, promotional materials, demonstration equipment, travel, depreciation, recruiting and allocated costs for certain facilities and benefits costs allocated based on headcount. We expect sales and marketing expense to continue to increase in absolute dollars as we increase the size of our sales and marketing organizations in support of our investment in our growth opportunities, although our sales and marketing expense may fluctuate as a percentage of total revenue.

30-------------------------------------------------------------------------------- Table of Contents General and Administrative. General and administrative expense consists primarily of personnel costs and stock-based compensation for our executive, finance, legal, human resources and other administrative employees. In addition, general and administrative expenses include outside consulting, legal, audit and accounting services, depreciation and facilities and other supporting overhead costs not allocated to other departments. We expect that our general and administrative expenses will increase on an absolute basis in the near term as we continue to expand our business and incur additional expenses associated with being a publicly traded company. However, we expect general and administrative to decrease as a percentage of revenue.

Interest Expense Interest expense consists of interest on our outstanding debt and amortization of loan fees. All outstanding debt was repaid in full by the end of June 2012.

Other Expense, net Other expense, net consists primarily of the changes in the fair value of our convertible preferred stock warrant liability and the contingent liability arising from the acquisition of IntelliNet. Both were classified as a liability on our 2011 consolidated balance sheet and their estimated fair values were re-measured at each balance sheet date with the corresponding change recorded within other expense, net.

Concurrent with the closing of our IPO in November 2012, the convertible preferred stock issuable upon exercise of the warrants became exercisable for common stock and the related liability was reclassified to additional paid-in capital in stockholders' equity (deficit).

The contingent liability arising from the acquisition of IntelliNet was settled in the fourth quarter of 2012.

Income Tax Expense During the year ended December 31, 2012, we concluded that it was more likely than not that we would be able to realize our benefit of the U.S. federal and state deferred tax assets in the future. As a result, we reduced the valuation allowance on our net deferred tax assets by $23.6 million for the year ended December 31, 2012. The release of the valuation allowance contributed to the net income tax benefit of $17.2 million for the year ended December 31, 2012, after deducting tax expense associated with the use of net operating losses and minor amounts of state and foreign taxes.

Significant management judgment is required in determining the period in which the reversal of a valuation allowance should occur. We are required to consider all available evidence, both positive and negative, such as historical levels of income and future forecasts of taxable income amongst other items, in determining whether a full or partial release of our valuation allowance is required. We are also required to schedule future taxable income in accordance with accounting standards that address income taxes to assess the appropriateness of a valuation allowance, which further requires the exercise of significant management judgment. As a result, there can be no assurance that there will be a release in future periods of the remaining amount of our valuation allowance, or that an increase in such allowance may not be required in the future.

31-------------------------------------------------------------------------------- Table of Contents Results of Operations The following tables set forth our results of operations for the periods presented as a percentage of total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results.

Consolidated Statement of Operations.

Years Ended December 31, 2012 2011 2010 Revenues: Product 94.1 % 95.6 % 96.8 % Service 5.9 4.4 3.2 Total revenues 100.0 100.0 100.0 Cost of revenues: Product 32.8 37.2 45.1 Service 2.5 2.1 2.3 Total cost of revenues 35.3 39.3 47.4 Gross margin 64.7 60.7 52.6 Operating expenses: Research and development 20.4 20.7 25.5 Sales and marketing 26.2 27.2 25.4 General and administrative 9.4 7.1 5.6 Total operating expenses 56.0 55.0 56.5 Operating margin 8.7 5.7 (3.9 ) Interest expense (0.2 ) (0.9 ) (1.3 ) Other expense, net (1.7 ) (1.0 ) (0.4 ) Income (loss) before income taxes 6.8 3.8 (5.6 ) Income tax benefit (expense) 8.0 (0.3 ) (0.2 ) Net income (loss) 14.8 % 3.5 % (5.8 )% 32-------------------------------------------------------------------------------- Table of Contents Revenues Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 % of % of % of $ % $ % Amount Revenue Amount Revenue Amount Revenue Change Change Change Change (dollars inthousands) Revenues: Product $ 201,913 94.1 % $ 114,684 95.6 % $ 73,108 96.8 % $ 87,229 76.1 % $ 41,576 56.9 % Service 12,740 5.9 % 5,339 4.4 % 2,381 3.2 % 7,401 138.6 % 2,958 124.2 % Total revenue $ 214,653 100 % $ 120,023 100 % $ 75,489 100 % $ 94,630 78.8 % $ 44,534 59.0 % Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 % of % of % of $ $ Amount Revenue Amount Revenue Amount Revenue Change % Change Change % Change (dollars in thousands) Revenue by geographic region: Americas $ 96,732 45.0 % $ 45,154 37.6 % $ 24,038 31.8 % $ 51,578 114.2 % $ 21,116 87.8 % APAC 68,630 32.0 % 41,658 34.7 % 27,485 36.4 % 26,972 64.7 % 14,173 51.6 % EMEA 49,291 23.0 % 33,211 27.7 % 23,966 31.8 % 16,080 48.4 % 9,245 38.6 % Total revenue $ 214,653 100 % $ 120,023 100 % $ 75,489 100 % $ 94,630 78.8 % $ 44,534 59.0 % 2012 Compared to 2011 The increase in product revenue for the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily driven by an increase of $92.8 million in ZoneFlex product sales to new and existing customers, offset slightly by a decrease of $5.6 million in CPE product sales due to increased focus on our higher margin products and shift away from sales of our CPE products. The increase in ZoneFlex product sales was due to increased adoption by our end-customers of our ZoneFlex products. Our total number of end-customers increased to approximately 21,700 at December 31, 2012 from approximately 11,600 at December 31, 2011.

The increase in service revenue for the year ended December 31, 2012 compared to the year ended December 31, 2011 is primarily related to the increase in PCS sales in connection with the increased sales of our ZoneFlex products. Service revenues are amortized over the contractual service period.

The Americas and APAC contributed to the majority of the revenue increase between the periods. Revenue from all regions increased during the year ended December 31, 2012 primarily due to our investment in increasing the size of our sales force and the number of channel partners in each region focused on selling our ZoneFlex product and significant orders from service providers, which can be large enough to make our revenue trend appear nonlinear. APAC revenues were positively impacted by sales by one of our distributors to a large service provider. The growth in the EMEA region was offset in part by a decline of approximately $3.8 million in revenues from CPE products.

2011 Compared to 2010 The increase in product revenue for the year ended December 31, 2011 compared to the year ended December 31, 2010 was primarily driven by an increase of $52.9 million in ZoneFlex product sales to new and existing customers, offset in part by a decrease of $11.3 million in CPE product sales due to increased focus on our higher margin products and a shift away from sales of our CPE products. The increase in product sales was due to increased adoption by end-customers of our ZoneFlex products. Our total number of aggregate end-customers increased to approximately 11,600 at December 31, 2011 from approximately 5,600 at December 31, 2010.

The increase in service revenue for the year ended December 31, 2011 compared to the year ended December 31, 2010 is primarily related to the increase over time in PCS sales in connection with the sales of our ZoneFlex products, as service revenues are amortized over the contractual service period.

The Americas and APAC regions contributed the largest portion of the revenue increase between the periods because of their larger and more established sale force. Revenue from all regions increased during the year ended December 31, 2011 primarily due to our investment in increasing the size of our sales force and the number of channel partners in each region. The growth in the Americas, APAC and EMEA regions was slightly offset by a decline of approximately $2.3 million, $6.0 million and $3.0 million, respectively, in revenues from CPE products due to increased focus on our higher margin products and a shift away from sales of our CPE products.

33-------------------------------------------------------------------------------- Table of Contents Cost of Revenues and Gross Margin Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 % of Cost % of Cost % of Cost $ $ Amount of Revenue Amount of Revenue Amount of Revenue Change % Change Change % Change (dollars in thousands) Cost of revenues Product $ 70,478 93.0 % $ 44,705 94.7 % $ 34,039 95.2 % $ 25,773 57.7 % $ 10,666 31.3 % Service 5,306 7.0 % 2,502 5.3 % 1,705 4.8 % 2,804 112.1 % 797 46.7 % Total cost of revenues $ 75,784 100 % $ 47,207 100 % $ 35,744 100 % $ 28,577 60.5 % $ 11,463 32.1 % Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 $ Margin $ Margin Amount Gross Margin Amount Gross Margin Amount Gross Margin Change Change Change Change (dollars in thousands) Gross profit Product $ 131,435 65.1 % $ 69,979 61.0 % $ 39,069 53.4 % $ 61,456 4.1 $ 30,910 7.6 Service 7,434 58.4 % 2,837 53.1 % 676 28.4 % 4,597 5.3 2,161 24.7 Total gross profit $138,869 64.7 % $ 72,816 60.7 % $ 39,745 52.6 % $66,053 4.0 $ 33,071 8.1 2012 Compared to 2011 Gross margin for the year ended December 31, 2012 compared to the year ended December 31, 2011 increased 4.0 percentage points. The increase of 4.1 percentage points in product gross margin was primarily due to a shift in product mix. In 2011, higher margin ZoneFlex products accounted for approximately 87% of product revenue, while low margin CPE products accounted for approximately 13% of product revenues. In 2012, the ZoneFlex products represented over 95% of product revenues, while CPE products accounted for less than 5%. In addition to product mix, product margins increased due to improved operational efficiencies and reduced CPE inventory write downs due to product end of life in 2011, partially offset by increased amortization of purchased technology resulting from our purchase of IntelliNet. Our product gross margin can be impacted by sales of ZoneFlex products to service providers and enterprises, regional revenue mix and sales of low margin CPE products. The increase of 5.3 percentage points in service gross margin was primarily a result of a 138.6% growth in service revenue offset, in part, by an increase in the cost of 112.1% arising from our investment in increasing our service operations to manage anticipated growth.

2011 Compared to 2010 Gross margin for the year ended December 31, 2011 compared to the year ended December 31, 2010 increased 8.1 percentage points. The increase of 7.6 percentage points in product gross margin was primarily due to a shift in product mix, with an increase in our higher margin ZoneFlex products compared to our lower margin CPE products and improved operational efficiencies. The increase of 24.7 percentage points in service gross margin was primarily a result of a 124.2% growth in service revenue while cost of service revenue only increased by 46.7% due to increased operating efficiencies in our service and support group.

34-------------------------------------------------------------------------------- Table of Contents Research and Development Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 $ $ Amount Amount Amount Change % Change Change % Change (dollars in thousands) Research and development $ 43,821 $ 24,892 $ 19,256 $ 18,929 76.0 % $ 5,636 29.3 % % of revenue 20.4 % 20.7 % 25.5 % 2012 Compared to 2011 The increase in research and development expenses for the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily attributable to increases in personnel and related costs of $11.1 million, which included stock-based compensation of $1.4 million and bonuses of $1.2 million, as we continued to add headcount and increase our investments in enhancing existing products and the development of future product offerings. Research and development expenses also increased due to higher expensed materials and supplies of $2.0 million, increased depreciation of $0.9 million, increased product design and implementation of $2.1 million, increased allocated facilities of $1.5 million, and increased other engineering costs of $1.3 million. We expect our research and development costs to continue to increase in absolute dollars, as we continue to invest in developing new products and developing new versions of our existing products.

2011 Compared to 2010 The increase in research and development expenses for the year ended December 31, 2011 compared to the year ended December 31, 2010 was primarily attributable to increases in personnel and related costs of $4.7 million, which included increased stock-based compensation of $0.6 million, as we continued to add headcount and increase our investments in future product offerings and by an aggregate of $0.9 million due in part to increased depreciation and other allocations.

Sales and Marketing Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 $ $ Amount Amount Amount Change % Change Change % Change (dollars in thousands)Sales and marketing $ 56,209 $ 32,659 $ 19,185 $23,550 72.1 % $ 13,474 70.2 % % of revenue 26.2 % 27.2 % 25.4 % 2012 Compared to 2011 The increase in sales and marketing expenses for the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily attributable to increases in headcount and related expenses as we increase our sales organization as part of our strategy to expand our reach into new service providers and channel partners. Personnel and related expenses increased $14.5 million, including increased bonus and commission expenses of $3.0 million related to our increased sales, and stock-based compensation of $1.3 million.

Third-party commission expense increased by $1.3 million primarily related to our expansion in the Japanese market. Travel expenses increased $2.6 million and marketing programs increased $2.6 million due to an increase in tradeshows and public relations activities as we continue to focus our efforts on product marketing. Other sales and marketing expenses increased $2.6 million in consulting, general departmental expenses, including allocated facilities of $1.0 million, due to increased activity and headcount. We expect that sales and marketing expenses will continue to increase in absolute dollars as we continue our strategy of adding sales personnel to target service providers and enterprises.

2011 Compared to 2010 The increase in sales and marketing expenses for the year ended December 31, 2011 compared to the year ended December 31, 2010 was primarily attributable to increases in headcount and related expenses of $7.5 million, including commission expenses of $2.3 million related to increase in revenue and increased stock-based compensation expense of $0.2 million as we expand our sales organization to support our revenue growth. Third party commission expense increased by $1.8 million primarily due to expansion into the Japanese market.

Marketing expenses increased $1.0 million due to an increase in tradeshows and public relations activities. Travel expenses increased $1.2 million as a result of the increased marketing activities as well as our increased sales headcount.

Other sales and marketing costs, including consulting, depreciation and allocations, increased $2.0 million to support our continued growth and additional headcount.

35-------------------------------------------------------------------------------- Table of Contents General and Administrative Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 $ $ Amount Amount Amount Change % Change Change % Change (dollars in thousands)General and administrative $ 20,237 $ 8,524 $ 4,231 $11,713 137.4 % $ 4,293 101.5 % % of revenue 9.4 % 7.1 % 5.6 % 2012 Compared to 2011 The increase in general and administrative expenses for the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily attributable to an increase in personnel costs of $7.0 million which includes stock-based compensation of $3.4 million. General and administrative costs also increased due to higher external legal, audit and accounting services of $2.6 million and other general expenses of $2.1 million including depreciation, facilities and IT expense. The increases were attributable to our efforts to support the growth of our business, preparing and eventually becoming a publicly held company. We expect that general and administrative expenses will continue to increase in absolute dollars due primarily to costs associated with being a public company and to support the growth in our business.

2011 Compared to 2010 The increase in general and administrative expenses for the year ended December 31, 2011 compared to the year ended December 31, 2010 was primarily attributable to an increase in personnel related costs of $1.0 million which includes increased stock-based compensation of $0.2 million, and to increased professional services costs of $2.0 million, including increased legal expenses of $1.6 million due principally to defending several lawsuits. We also incurred an increase of $0.6 million in consulting expenses related to the growth in our business and an increase of $0.9 million in other general and administrative expenses including depreciation, travel, facilities, and other overhead costs to support the business.

Interest Expense Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 $ $ Amount Amount Amount Change % Change Change % Change (dollars in thousands) Interest expense $ 472 $ 1,025 $ 1,011 $ (553 ) (54.0 )% $ 14 1.4 % 2012 Compared to 2011 Interest expense decreased to $0.5 million in the year ended December 31, 2012 from $1.0 million in the year ended December 31, 2011 due to the Company repaying all outstanding loans by the end of June 2012. Interest expense relates to our loans payable that accrued interest at fixed rates between 7.0% and 9.5% per year.

2011 Compared to 2010 Interest expense primarily relates to our loans payable that accrue interest at fixed rates of between 7.0% and 9.5% per year. Loans outstanding during the two years did not substantially change.

36-------------------------------------------------------------------------------- Table of Contents Other Expense, net Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 $ $ Amount Amount Amount Change % Change Change % Change (dollars in thousands) Other expense, net $ 3,664 $ 1,215 $ 290 $ 2,449 201.6 % $ 925 319.0 % 2012 Compared to 2011 Other expense, net increased to $3.7 million in the year ended December 31, 2012 from $1.2 million in the year ended December 31, 2011 primarily due to an increase in the revaluation of our outstanding convertible preferred stock warrants of $2.0 million and an increase in fair value of the contingent consideration liability arising from the acquisition of IntelliNet of $0.4 million.

2011 Compared to 2010 Other expense, net primarily consists of charges related to the revaluation of our convertible preferred stock warrants to fair value each reporting period.

Income Tax (Benefit) Expense Years Ended December 31, 2012 2011 2010 2012 to 2011 2011 to 2010 $ $ Amount Amount Amount Change % Change Change % Change (dollars in thousands) Income tax (benefit) expense $ (17,238 ) $ 315 $ 176 $ (17,553 ) - $ 139 79.0 % 2012 Compared to 2011 The income tax benefit of $17.2 million for the year ended December 31, 2012 primarily relates to the release of our valuation allowance of $23.6 million, offset by tax expense associated with the use of net operating losses and minor amounts of state and foreign taxes.

The release of the valuation allowance is based on our determination during the year ended December 31, 2012 that it was more likely than not that we would be able to realize the benefit of the U.S. federal and state deferred tax assets in the future. We based this conclusion on our recent historical operations having generated taxable income, and our expectation that our future operations will continue to generate taxable income sufficient to realize the tax benefits associated with the deferred tax assets.

2011 Compared to 2010 The income tax expense primarily relates to amounts for state and foreign income taxes.

Selected Quarterly Financial Data The following tables set forth our unaudited quarterly consolidated statement of operations data for each of the eight quarters ended December 31, 2012. In management's opinion, the data has been prepared on the same basis as the audited Consolidated Financial Statements included in this report, and reflects all necessary adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of this data.

37-------------------------------------------------------------------------------- Table of Contents For the three months ended March 31, June 30, September 30, December 31, 2012 2012 2012 2012 (in thousands) Consolidated Statement of Operations Data: Revenues: Product $ 42,547 $ 46,150 $ 55,263 $ 57,953 Service 2,467 2,741 3,321 4,211 Total revenues 45,014 48,891 58,584 62,164 Cost of revenues: Product 15,636 16,280 19,034 19,528 Service 945 1,014 1,424 1,923 Total cost of revenues 16,581 17,294 20,458 21,451 Gross profit 28,433 31,597 38,126 40,713 Operating expenses: Research and development 8,749 9,438 12,291 13,343 Sales and marketing 12,203 12,707 14,872 16,427 General and administrative 2,981 5,456 5,356 6,444 Total operating expenses 23,933 27,601 32,519 36,214 Operating income 4,500 3,996 5,607 4,499 Interest expense (228 ) (244 ) - - Other expense, net (243 ) (724 ) (601 ) (2,096 ) Income before income taxes 4,029 3,028 5,006 2,403 Income tax benefit (expense) (284 ) 17,600 453 (531 ) Net income $ 3,745 $ 20,628 $ 5,459 $ 1,872 38-------------------------------------------------------------------------------- Table of Contents For the three months ended March 31, June 30, September 30, December 31, 2011 2011 2011 2011 (in thousands) Consolidated Statement of Operations Data: Revenues: Product $ 20,418 $ 24,900 $ 30,169 $ 39,197 Service 924 1,112 1,464 1,839 Total revenues 21,342 26,012 31,633 41,036 Cost of revenues: Product 9,011 9,971 11,401 14,322 Service 566 592 609 735 Total cost of revenues 9,577 10,563 12,010 15,057 Gross profit 11,765 15,449 19,623 25,979 Operating expenses: Research and development 4,927 5,833 6,434 7,698 Sales and marketing 6,245 7,054 8,199 11,161 General and administrative 1,518 1,552 2,801 2,653 Total operating expenses 12,690 14,439 17,434 21,512 Operating income (loss) (925 ) 1,010 2,189 4,467 Interest expense (224 ) (226 ) (203 ) (372 ) Other expense, net (50 ) (310 ) (67 ) (788 ) Income (loss) before income taxes (1,199 ) 474 1,919 3,307 Income tax expense (69 ) (68 ) (69 ) (109 ) Net income (loss) $ (1,268 ) $ 406 $ 1,850 $ 3,198 39-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources December 31, 2012 2011 2010 (dollars in thousands) Cash and cash equivalents $ 133,386 $ 11,200 $ 1,891 Years Ended December 31, 2012 2011 2010 (dollars in thousands) Net cash provided by (used in) operating activities $ 28,092 $ 14,951 $ (6,626 ) Net cash used in investing activities (10,122 ) (9,664 ) (1,555 ) Net cash provided by (used in) financing activities 104,216 4,022 (525 ) Net increase (decrease) in cash and cash equivalents $ 122,186 $ 9,309 $ (8,706 ) We had cash and cash equivalents of $133.4 million at December 31, 2012. Cash and cash equivalents consist of cash and money market funds. Cash held overseas was $1.2 million. We did not have any short-term or long-term investments.

Prior to our IPO, we financed our operations and capital expenditures through private sales of preferred stock, debt, and cash flows from our operations. On November 16, 2012, we closed our IPO, in which 8,400,000 shares of common stock were sold to the public (inclusive of 7,000,000 shares of common stock sold by us). The public offering price of the shares sold in the IPO was $15.00 per share. The total gross proceeds from the offering were $126.0 million. After deducting underwriting discounts and commissions, offering expenses payable by us, and net proceeds received by the selling stockholders, the aggregate net proceeds received by us totaled approximately $94.0 million, net of unpaid costs of $0.8 million as of December 31, 2012.

We also borrowed approximately $11.9 million under a loan and security agreement with a financial institution in 2007 and 2008 which was repaid in full in June 2012.

In October 2011, we acquired certain assets of IntelliNet for total cash consideration of $6.0 million and future consideration of up to $7.0 million.

During the year ended December 31, 2012, we paid $5.0 million of the future consideration. This acquisition was partially financed through a short-term credit facility for $5.0 million, which was repaid in full in January 2012.

We plan to continue to invest for long-term growth. We anticipate that these investments will continue to increase in absolute dollars. We believe that our existing cash and cash equivalents balance together with cash proceeds from operations will be sufficient to meet our working capital requirements for at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products and services offerings, the costs to ensure access to adequate manufacturing capacity, and the continuing market acceptance of our products. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition would be adversely affected.

Operating Activities We generated $28.1 million of cash from operating activities in the year ended December 31, 2012 resulting from our net income of $31.7 million, offset in part by changes in our operating assets and liabilities of $2.2 million and by non-cash net benefits of $1.4 million. The non-cash net benefit consisted primarily of the release of our valuation allowance for deferred income taxes of $18.3 million, partially offset by non-cash charges consisting mainly of depreciation and amortization of $4.9 million, stock-based compensation of $8.5 million, revaluation of our preferred stock warrants of $2.8 million, and revaluation of contingent liabilities of $0.4 million. The net change in our operating assets and liabilities was the result of a net increase in accounts payable, accrued compensation, and accrued liabilities of $9.0 million relating to the growth in our business, and an increase in deferred revenues of $23.3 million primarily due to increases in products held by our distributors, partially offset by increased inventories of $8.1 million, accounts receivable of $21.1 million, deferred costs of $3.7 million and prepaid and other current assets of $1.3 million, arising from the growth of our business.

40-------------------------------------------------------------------------------- Table of Contents We generated $15.0 million of cash from operating activities in the year ended December 31, 2011 resulting from our net income of $4.2 million, increased by non-cash charges primarily consisting of $5.4 million and changes in our operating assets and liabilities of $5.4 million. Non-cash charges consisted of stock-based compensation of $2.3 million, depreciation and amortization of $2.1 million and revaluation of preferred stock warrants of $0.9 million. The net changes in our operating assets and liabilities was the result of increased accounts payable and accrued expenses of $7.5 million relating to the growth in our business, increased accrued vacation due to our increased headcount and increased deferred rent for new facilities, increased deferred revenue of $6.9 million due to increased PCS sales, increase deferred product sales and increased stock at our distributors, and decreased inventories of $1.3 million as part of our effort to increase operational efficiency, offset in part by increased accounts receivable of $10.0 million due to increased sales.

We used $6.6 million of cash in operating activities in the year ended December 31, 2010 resulting from our net loss of $4.4 million and increased inventories of $9.5 million to satisfy growing demand partially offset in part by non-cash depreciation and amortization of $1.1 million, non-cash stock-based compensation of $1.2 million and increased accounts payable and accrued expenses of $5.3 million relating to the growth in the business.

Investing Activities Our primary investing activities have consisted of purchases of property and equipment related to leasehold improvements, technology hardware and tooling to support our growth in headcount and to support operations and our corporate infrastructure. Purchases of property and equipment may vary from period to period due to the timing of the expansion of our operations.

Cash used in investing activities in the year ended December 31, 2012 was $10.1 million, of which $7.5 million related to purchases of property and equipment, $2.0 million was a partial payment on future consideration for the purchase of IntelliNet and $0.6 million related to refundable deposits on new facility leases.

Cash used in investing activities in the year ended December 31, 2011 was $9.7 million, of which $6.0 million was for the acquisition of IntelliNet and $3.7 million was related to purchases of property and equipment.

Cash used in investing activities in the year ended December 31, 2010 was $1.6 million, all of which was for the purchase of property and equipment.

Financing Activities Our financing activities have primarily consisted of net proceeds from the sale of our common stock in our IPO, net proceeds from the issuance of convertible preferred stock and, to a much lesser extent, the issuance of common stock upon exercise of employee stock options.

We generated $104.2 million of cash from financing activities during the year ended December 31, 2012 primarily from proceeds, net of issuance costs paid, from our IPO of $94.8 million, net proceeds of $24.9 million from the sale of our Series G preferred stock financing and $0.6 million in proceeds from the exercises of stock options, offset in part by repayment of $13.6 million under our credit and loan facilities and settlement of the contingent consideration with IntelliNet of $2.6 million.

We generated $4.0 million of cash from financing activities in the year ended December 31, 2011, primarily due to a net increase of $3.4 million in borrowings under our credit facilities and $0.6 million in proceeds from the exercises of stock options.

We used $0.5 million of cash in financing activities in the year ended December 31, 2010 due to a net repayment of $0.8 million under our credit facilities, offset in part by $0.3 million in proceeds from the exercises of stock options.

Contractual Obligations & Commitments We lease our headquarters in Sunnyvale, California and other locations worldwide under non-cancelable operating leases that expire at various dates through 2022.

The following table summarizes our contractual obligations at December 31, 2012, including leases: Payment Due by Period Less than More than 5 Total 1 Year 1-3 Years 3-5 Years Years Operating leases $ 27,607 $ 4,111 $ 6,727 $ 4,503 $ 12,266 Purchase commitments(1) 4,262 4,262 - - - Acquisition liabilities 2,000 2,000 - - - Total $ 33,869 $ 10,373 $ 6,727 $ 4,503 $ 12,266 (1) Consists of minimum purchase commitments with our contract manufacturers.

The table above excludes liabilities for deferred revenue of $40.5 million and uncertain tax positions and related interest and penalties accrual of $0.1 million. We have not provided a detailed estimate of the payment timing of uncertain tax positions due to the uncertainty of when the related tax settlements will become due.

41-------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements Through December 31, 2012, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. 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.

We believe that the assumptions and estimates associated with revenue recognition, inventory, valuation of goodwill, intangible assets, income taxes, stock-based compensation, and warranties have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, please see Note 1 of the accompanying notes to our consolidated financial statements.

In connection with the audits of our consolidated financial statements for the years ended December 31, 2011 and 2010, our independent registered public accountants identified a material weakness in our internal control over financial reporting. As of December 31, 2012, we have remediated the previously identified material weakness.

Revenue Recognition We generate revenue from the sales of hardware with embedded software and related PCS through a direct sales force and indirect relationships with our channel partners.

Revenue is recognized when all of the following criteria are met: • Persuasive evidence of an arrangement exists. We rely upon sales contracts and purchase orders to determine the existence of an arrangement.• Delivery has occurred. Delivery is deemed to have occurred when title has transferred. We use shipping documents to verify transfer of title.

• The fee is fixed or determinable. We assess whether the fee is fixed or determinable based on the terms associated with the transaction.

• Collectability is reasonably assured. We assess collectability based on credit analysis and payment history.

We recognize product revenue at the time title transfers provided that all other revenue recognition criteria have been met.

Certain of our distributors that stock our product are granted stock rotation rights as well as rebates for sales of our products. Therefore, the arrangement fee for this group of distributors is not fixed and determinable when products are shipped and revenue is therefore deferred until our products are shipped to the distributors' customer.

Certain of our arrangements are multiple-element arrangements which consist of hardware products with embedded software and PCS. Our hardware with the embedded software, which is a proprietary operating system that together with the hardware delivers the functionality desired by our customers, is considered a separate unit of accounting from PCS as our customers often buy our hardware products without PCS. For multiple-element arrangements, we allocate revenue to each unit of accounting based on an estimated selling price at the inception of the arrangement. The total arrangement consideration is allocated to each separate unit of accounting using the relative estimated selling prices of each unit. We limit the amount of revenue recognized for delivered elements to an amount that is not contingent upon future delivery of additional products or service.

To determine the estimated selling price in multiple-element arrangements, we first look to establish vendor specific objective evidence, or VSOE, of the selling price using the prices charged for a deliverable when sold separately.

If VSOE of the selling price cannot be established for a deliverable, we look to establish third-party evidence, or TPE, of the selling price by evaluating the pricing of similar and interchangeable competitor products or services in standalone arrangements. However, as our products contain a significant element of proprietary technology and offer substantially different features and functionality from our competitors, we have been unable to obtain comparable pricing information with respect to our competitors' products. Therefore, we have not been able to obtain reliable evidence of TPE of the selling price. If neither VSOE nor TPE of the selling price can be established for a deliverable, we establish best estimate selling price, or BESP, by reviewing historical transaction information and considering several other internal factors including discounting and margin objectives. We have established VSOE of the selling price of PCS through an analysis of the historical separate sales of PCS, noting that such sales have occurred at consistent prices and with a high level of concentration with respect to such pricing. Furthermore, we have established BESP of the selling price of our hardware products with embedded software based on an analysis of our historical separate sales of hardware products with embedded software. The concentration of such pricing was not sufficient to assert VSOE of the selling price, and accordingly we have determined that we can only demonstrate BESP of the selling price.

We make certain estimates and maintain allowances for sales returns, stock rotation, and other programs based on our historical experience. To date, these estimates have not been significant.

We recognize services revenue from PCS ratably over the contractual service period, which is typically one to five years. Other services revenue is recognized as the services are rendered and has not been significant to date.

42-------------------------------------------------------------------------------- Table of Contents Revenue is reported net of sales taxes. Shipping charges billed to channel partners are included in revenue and related costs are included in cost of revenue. To date, shipping charges have not been significant. After receipt of a channel partner order, any amounts billed in excess of revenue recognized are recorded as deferred revenue.

Inventories Inventories are carried at the lower of standard cost, which approximates actual cost on a first-in, first-out basis, or market or estimated net realizable value. We evaluate inventory for excess and obsolete products based on management's assessment of future demand and market conditions. We subcontract manufacturing on substantially all of our products. At December 31, 2012 and 2011, inventories were predominately comprised of finished goods.

Goodwill We evaluate goodwill for impairment annually in the fourth quarter of our fiscal year or whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Triggering events that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate that could affect the value of goodwill or a significant decrease in expected cash flows. As of December 31, 2012, no impairment of goodwill has been identified.

Intangible Assets, Net Acquired intangible assets consist of existing technology resulting from acquisitions. Acquired intangible assets are recorded at fair value, net of accumulated amortization. Intangible assets are amortized on a straight-line basis over their estimated useful lives.

Income Taxes We utilize the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between financial reporting and tax reporting bases of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized.

We record uncertain tax positions in accordance with accounting standards on the basis of a two-step process whereby (1) a determination is made as to whether it is more likely than not that the tax positions will be sustained based on the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold we recognize the largest amount of tax benefit that is more likely than not to be realized upon ultimate settlement with the related tax authority.

Stock-Based Compensation Stock-based compensation is measured at the grant date based on the fair value of the award and is recognized as expense, net of estimated forfeitures, over the requisite service period, which is generally the vesting period of the award.

Determining the fair value of stock-based awards at the grant date represent management's best estimates, but the estimates involve inherent uncertainties and the application of management's judgment. We use the Black-Scholes option pricing model to determine the fair value of stock options and purchases under our 2012 Employee Stock Purchase Plan ("ESPP"). The determination of the grant date fair value of options using an option pricing model is affected by our estimated common stock fair value, prior to our IPO, as well as assumptions regarding a number of other complex and subjective variables. These variables include the fair value of our common stock, our expected stock price volatility over the expected term of the options, stock option exercise and cancellation behaviors, risk-free interest rates and expected dividends, which are estimated as follows: • Fair Value of Our Common Stock. Prior to the IPO our stock was not publicly traded, therefore we estimated the fair value of our common stock, as discussed in "Pre-IPO Common Stock Valuations" below. Following our IPO, we established a policy of using the closing sale price per share of our common stock as quoted on the New York Stock Exchange on the date of grant for purposes of determining the exercise price per share of our options to purchase common stock.

• Expected Term. The expected term for stock options was estimated using the simplified method allowed under SEC guidance. The expected term for the ESPP is based on the term of the purchase period.

• Volatility. Given the limited trading history for our common stock, the expected stock price volatility for our common stock was estimated by taking the average historic price volatility for industry peers, which we have designated, based on daily price observations over a period equivalent to the expected term of the stock option grants. Industry peers, which we have designated, consist of several public companies in the industry similar in size, stage of life cycle and financial leverage.

We did not rely on implied volatilities of traded options in these industry peers' common stock because the volume of activity was relatively low. We intend to continue to consistently apply this process using the same or similar public companies until a sufficient amount of historical information regarding the volatility of our own common stock share price becomes available, or unless circumstances change such that the identified companies are no longer similar to us, in which case more suitable companies whose share prices are publicly available would be utilized in the calculation.

• Risk-free Rate. The risk-free interest rate is based on the yields of U.S.

Treasury securities with maturities similar to the expected term of the options for each option group.

• Dividend Yield. We have never declared or paid any cash dividends and do not presently plan to pay cash dividends in the foreseeable future.

Consequently, we used an expected dividend yield of zero.

43-------------------------------------------------------------------------------- Table of Contents In addition to assumptions used in the Black-Scholes option-pricing model, we must also estimate a forfeiture rate to calculate the share-based compensation for our awards. Our forfeiture rate is based on an analysis of our actual historical forfeitures. Quarterly changes in the estimated forfeiture rate can have a significant impact on our share-based compensation expense as the cumulative effect of adjusting the rate is recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the share-based compensation expense recognized in the financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the share-based compensation expense recognized in the financial statements.

We will continue to use judgment and estimates in evaluating the assumptions related to our share-based compensation on a prospective basis. As we continue to accumulate additional data, we may have refinements to our estimates, which could materially impact our future share-based compensation expense.

Pre-IPO Common Stock Valuations Prior to the IPO, the fair value of the common stock underlying stock options was approved by our board of directors, which intended all options granted to have an exercise price per share equal to the per-share fair value of the common stock underlying those options on the date of grant. The valuations of our common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. In the absence of a public trading market, the board of directors, with input from management, exercised significant judgment and considered numerous objective and subjective factors to determine the fair value of our common stock as of the date of each option grant, including the following factors: • sales by the company of preferred stock and common stock to outside investors in arm's-length transactions; • the market performance of comparable publicly traded technology companies; • the introduction by us of new products or services; • the likelihood of achieving a liquidity event for the shares of common stock underlying these stock options, such as an initial public offering or sale of our company, given prevailing market conditions; • adjustments necessary to recognize a lack of marketability for our common stock; • the U.S. and global capital market conditions; and • other changes in the company since the last time the board of directors had approved option grants and made a determination of fair value.

In order to determine the fair value of our common stock underlying option grants issued prior to our initial public offering, the board of directors considered recent sales of common stock to outside investors in arm's-length transactions and used the income approach to estimate the business enterprise value, or BEV, and then allocated the BEV to each element of our capital structure (preferred stock, common stock, warrants and options). In application of the income approach, a discounted cash flow method, or DCF, is utilized. The DCF method estimates enterprise value based on the estimated present value of future net cash flows the business is expected to generate over a forecasted period and an estimate of the present value of cash flows beyond that period, which is referred to as terminal value. In estimating the terminal value, a market comparable method was utilized. A market comparable method considers guideline public company trading multiples of certain financial metrics that can be applied to a subject company as an indication of value. A multiple of enterprise value to revenue was utilized as an exit multiple to estimate the undiscounted terminal value. The present value of the terminal value and the discrete cash flows were estimated using a discount rate, which accounts for the time value of money and the appropriate degree of risks inherent in the business. In allocating the total equity value between preferred and common stock, we assumed that the preferred stock would convert to common stock. Our indicated BEV at each valuation date was allocated to the shares of preferred stock, common stock, warrants and options, using an option pricing method, or OPM. Estimates of the volatility of our common stock were based on available information on the volatility of common stock of comparable, publicly traded companies.

For each valuation, we prepared financial projections to be used in the income approach. The financial projections took into account our historical financial operating results, our business experiences and our future expectations. We factored the risk associated with achieving our forecast into selecting the appropriate exit multiple and discount rate. There is inherent uncertainty in these estimates, as the assumptions we used were highly subjective and subject to change as a result of new operating data and economic and other conditions that impact our business.

Warranties We offer a limited lifetime hardware warranty on our indoor wireless LAN products and a limited warranty for all other products for a period of up to one year for hardware and 90 days for software. We accrue for potential warranty claims as a component of cost of product revenues based on historical experience and other data. Accrued warranty is recorded in accrued liabilities on the consolidated balance sheets and is reviewed periodically for adequacy. If we experience an increase in warranty claims compared with our historical experience, or if the cost of servicing warranty claims is greater than expected, our gross margin could be adversely affected. To date, we have not accrued any significant costs associated with our warranty.

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