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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2011

OR

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

For the transition period from                      to                     

Commission file number: 001-34659

Meru Networks, Inc.

(Exact name of registrant as specified in its charter)

894 Ross Drive

Sunnyvale, California 94089
(408) 215-5300
(Address, including zip code, and telephone number,
including area code, of registrant’s principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

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

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

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

The number of shares of the registrant’s common stock, par value $0.0005, outstanding as of October 28, 2011 was 17,568,367.

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Meru Networks, the Meru Networks logo, Meru Assure, patented System Director, Virtual Cell, Virtual Port and E(z)RF are trademarks of Meru Networks, Inc.

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MERU NETWORKS INC.

INDEX

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Item 1. Condensed Consolidated Financial Statements

MERU NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except for share and per share data)

See notes to condensed consolidated financial statements.

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MERU NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except for share and per share data)

* Includes stock-based compensation expense as follows:

See notes to condensed consolidated financial statements.

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MERU NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

See notes to condensed consolidated financial statements.

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MERU NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Business and Summary of Significant Accounting Policies

Business — Meru Networks, Inc. (“Meru”) was incorporated in Delaware in January 2002. Meru and its wholly-owned subsidiaries (collectively, the “Company”) develop and market a virtualized wireless Local Area Network (“LAN”) solution. The Company’s solution is built around its patented System Director ™ Operating System which runs on its controllers and access points. The Company offers additional products designed to deliver network management, diagnostics and security. The Company also offers support services related to its products, professional services, and training. Products and services are sold through value added resellers and distributors, as well as the Company’s sales force.

Basis of Presentation — These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting and include the accounts of Meru and its wholly-owned subsidiaries. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, filed on March 11, 2011. The condensed consolidated balance sheet as of December 31, 2010, included herein, was derived from the audited consolidated financial statements as of that date.

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the Company’s statement of financial position as of September 30, 2011 and December 31, 2010, the Company’s results of operations for the three months and nine months ended September 30, 2011 and 2010, and its cash flows for the nine months ended September 30, 2011 and 2010. The results for the three months and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the year ending December 31, 2011 or for any other future period. All references to September 30, 2011, or to the three months and nine months ended September 30, 2011 and 2010, in the notes to the condensed consolidated financial statements are unaudited.

Revenue Recognition — In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. Also in October 2009, the FASB amended the accounting standards for multiple-deliverable arrangements to (i) provide updated guidance on how the elements in a multiple-deliverable arrangement should be separated, and how the consideration should be allocated; (ii) require an entity to allocate revenue amongst the elements in an arrangement using estimated selling prices (“ESP”) if a vendor does not have vendor-specific objective evidence (“VSOE”) or third-party evidence (“TPE”) of the selling price; and (iii) eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

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MERU NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

The Company adopted this accounting guidance at the beginning of its first quarter of the year ending December 31, 2011 on a prospective basis for applicable arrangements originating or materially modified after December 31, 2010. The adoption of these two accounting standards resulted in $0.8 million and $1.4 million of additional revenue recognized during the three and nine months ended September 30, 2011, respectively, which would not have been recognized if the previous revenue recognition standards were in effect. The majority of this difference relates to revenue recognized on partial shipment transactions. Under previous accounting guidance, revenue from these orders was deferred in its entirety until the entire order was delivered. The Company cannot reasonably estimate the effect of the adoption on future financial periods as the impact may vary depending on the nature and volume of future sale contracts.

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

The Company’s revenues are derived primarily from two sources: (i) products revenues, including hardware and software products, and (ii) related support and service revenues. The majority of the Company’s products are networking communications hardware with embedded software components such that the software functions together with the hardware to provide the essential functionality of the product. Therefore, the Company’s hardware deliverables are considered to be non-software elements and are excluded from the scope of industry-specific software revenue recognition guidance. The Company’s products revenue also includes revenue from the sale of stand-alone software products. Stand-alone software products may operate on the Company’s networking communications hardware, but are not considered essential to the functionality of the hardware. Sales of stand-alone software generally include a perpetual license to the Company’s software. Sales of stand-alone software continue to be subject to the industry-specific software revenue recognition guidance. Product support typically includes software updates on a when and if available basis, telephone and internet access to the Company’s technical support personnel and hardware support. Software updates provide customers with rights to unspecified software product upgrades and to maintenance releases and patches released during the term of the support period.

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

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

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MERU NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

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

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

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

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

The Company recognizes revenue when all of the following have occurred: (1) the Company has entered into a legally binding arrangement with a customer; (2) delivery has occurred; (3) customer payment is deemed fixed or determinable and free of contingencies and significant uncertainties; and (4) collection is probable. The sales prices for the Company’s products are typically considered to be fixed or determinable at the inception of an arrangement. Delivery is considered to have occurred when product title has transferred to the customer, when the service or training has been provided, when software is delivered, or when the support period has lapsed. To the extent that agreements contain rights of return or acceptance provisions, revenues are deferred until the acceptance provisions or rights of return lapse.

The majority of the Company’s sales are generated through its distributors. Revenues from distributors with return rights are recognized when the distributor reports that the product has been sold through, provided that all other revenue recognition criteria have been met. The Company obtains sell-through information from these distributors. For transactions with all other distributors, the Company does not provide for rights of return and recognizes products revenues at the time of shipment, assuming all other revenue recognition criteria have been met.

Prior to April 1, 2008, the Company allowed some customers to receive support services outside of the contractual terms. Accordingly, the Company deferred and recognized revenues on all transactions, except for transactions with one customer, ratably over the economic life of the products sold as the Company determined that this was the best estimate of the period of time over which the Company provided these support services. The one exception relates to a customer for which the Company established VSOE of fair value for the related support contracts during the year ended December 31, 2007. Accordingly, the Company began to account for these support contracts as separate elements from the hardware sales.

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MERU NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

The Company estimated the economic life of the hardware to be three and a half years based on several factors such as: (1) the history of technology development of related products; (2) a Company-specific evaluation of product life cycles from both a sales and product development perspective; and (3) information on customer usage of the Company’s products.

On April 1, 2008, the Company ceased providing support services outside of the contractual terms. As a result, the Company began recognizing ratable revenues from sales in which VSOE of fair value for the related support services had not been established over the contractual support period and not the three and a half year economic life of the product. Also on April 1, 2008, the Company established VSOE of fair value for its support services to distributors. Accordingly, the Company recognized revenues from sales to distributors after this date and prior to January 1, 2011 using the residual method, assuming all revenue recognition criteria were met.

 On January 1, 2009, the Company established VSOE of fair value for all its remaining support services. Accordingly, the Company recognized revenues for other than support services for all sales made on and after January 1, 2009 and prior to January 1, 2011 using the residual method, assuming all revenue recognition criteria were met.

Revenues for support services are recognized on a straight-line basis over the support period, which typically ranges from one year to five years.

Shipping charges billed to customers are included in products revenues and the related shipping costs are included in costs of products revenues.

Initial Public Offering — On March 30, 2010, the Company sold 3,575,000 shares of common stock at a price of $15.00 per share in an initial public offering (“IPO”). The shares began trading on the NASDAQ Global Market on March 31, 2010. Also on March 31, 2010, the Company’s underwriters exercised their overallotment option to purchase 658,017 shares of common stock.  As part of the offering, 811,784 shares of common stock, as converted, were also sold by existing shareholders at $15.00 per share.  Included in the amounts sold by the existing shareholders were 795,836 shares of common stock which were converted from 8,770,054 shares of convertible preferred stock immediately prior to the IPO. The $59.1 million in proceeds, net of underwriting discount and commission, from the IPO were received on April 6, 2010, which was the closing date of the offering. Upon the closing of the offering, all outstanding shares of convertible preferred stock converted into common stock at each series of convertible preferred stock’s respective conversion rate as adjusted for a 13-for-1 reverse stock split and shares of convertible preferred stock are no longer authorized to be issued. The convertible preferred stock converted into 10,390,055 shares of common stock. Concurrently, the Company increased the number of authorized common stock to 150,000,000 shares and authorized 5,000,000 shares of preferred stock, both with a par value of $0.0005 per share.

Use of Estimates — The preparation of unaudited interim condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Such management estimates include implicit service periods for revenue recognition, litigation and settlement costs, other loss contingencies, sales returns and allowances, allowance for doubtful accounts, inventory valuation, valuation of goodwill and other intangible assets, reserve for warranty costs, valuation of deferred tax assets, fair value of common stock, stock-based compensation expense, and fair value of warrants. The Company bases its estimates on historical experience and also on assumptions that it believes are reasonable. The Company assesses these estimates on a regular basis; however, actual results could materially differ from those estimates.

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MERU NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

Certain Significant Risks and Uncertainties — The Company is subject to certain risks and uncertainties that could have a material and adverse effect on the Company’s future financial position or results of operations, which risks and uncertainties include, among others: it has a limited operating history, it may experience fluctuations in its revenues and operating results including as a result of seasonal factors, any inability of the Company to compete in a rapidly evolving market and to respond quickly and effectively to changing market requirements, any inability of the Company to increase market awareness of its brand and products and develop and expand its sales channels, the continued development of demand for wireless networks, its long and unpredictable sales cycle, declining average sales prices for its products, varying gross margins of its products and services, any inability of the Company to forecast customer demand accurately in making purchase decisions, its reliance on channel partners to generate a substantial majority of its revenues and the potential failure of these partners to perform, any inability of the Company to protect its intellectual property rights, claims by others that the Company infringes their proprietary technology, new or modified regulations related to its products, and any inability of the Company to raise additional funds in the future.

Concentration of Supply Risk — The Company relies on third parties to manufacture its products, and depends on them for the supply and quality of its products. Quality or performance failures of the Company’s products or changes in its manufacturers’ financial or business condition could disrupt the Company’s ability to supply quality products to its customers and thereby have a material and adverse effect on its business and operating results. Some of the components and technologies used in the Company’s products are purchased and licensed from a single source or a limited number of sources. The loss of any of these suppliers may cause the Company to incur additional transition costs, result in delays in the manufacturing and delivery of its products, or cause it to carry excess or obsolete inventory and could cause it to redesign its products. The Company relies on a third party for the fulfillment of its customer orders, and the failure of this third party to perform could have an adverse effect upon the Company’s reputation and its ability to distribute its products, which could adversely affect the Company’s business.

Concentration of Credit Risk — Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and accounts receivable. The Company maintains its cash, cash equivalents and short-term investments in fixed-income securities with financial institutions and invests in only high-quality credit instruments. Deposits held with banks may exceed the amount of insurance provided on such deposits. Credit risk with respect to accounts receivable in general is diversified due to the number of different entities comprising the Company’s customer base and their location throughout the world. The Company performs ongoing credit evaluations of its customers and generally works with both large and small channel partners. While balances outstanding with smaller partners have historically not been significant, three such parties represent 25% of accounts receivable as of September 30, 2011. The Company does not require collateral on accounts receivable and maintains reserves for estimated potential credit losses. As of September 30, 2011 and December 31, 2010, the allowance for doubtful accounts was $93,000 and $0.4 million, respectively.

Valuation of Long-lived Assets — The Company evaluates the recoverability of long-lived assets with finite lives whenever events or changes in circumstances occur that indicate that the carrying value of the asset or asset group may not be recoverable. Finite-lived intangible assets are being amortized on a straight-line basis over their estimated useful lives of two to three years. An impairment charge is recognized as the difference between the net book value of such assets and the fair value of such assets at the date of measurement. The measurement of impairment requires management to estimate future cash flows and the fair value of long-lived assets.

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MERU NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

Goodwill — The Company reviews goodwill for impairment on an annual basis or whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. The Company uses a two-step impairment test. In the first step, the Company compares the fair value of the reporting unit to its carrying value. The fair value of the reporting unit is determined using the market approach. If the fair value of the reporting unit exceeds the carrying value of net assets of the reporting unit, goodwill is not impaired, and the Company is not required to perform further testing. If the carrying value of the net assets of the reporting unit exceeds the fair value of the reporting unit, then the Company must perform the second step in order to determine the implied fair value of the reporting unit’s goodwill and compare it to the carrying value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then the Company we must record an impairment charge equal to the difference. The Company has determined that it has a single reporting unit for purposes of performing its goodwill impairment test. As of September 30, 2011, the Company had not identified any factors to indicate there was an impairment of its goodwill and determined that no additional impairment analysis was required.

2. Recently Issued Accounting Pronouncements

In September 2011, the Financial Accounting Standards Board (“FASB”) issued an update to existing guidance on the assessment of goodwill impairment. This amendment is intended to reduce the cost and complexity of the annual goodwill impairment test by providing entities an option to perform a qualitative assessment to determine whether further impairment testing is necessary. If an entity concludes that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, two-step goodwill impairment test is required. Otherwise, the two-step goodwill impairment test is not required. This standard is effective for reporting periods beginning on or after December 15, 2011 and early adoption is permitted if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company will adopt this standard in the first quarter of 2012 and does not expect the adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In June 2011, the FASB issued a new accounting standard to improve the comparability and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The new standard requires companies to present the components of net income and other comprehensive income either as one continuous statement or as two separate but consecutive statements. It eliminates the option to report other comprehensive income and its components as part of the statement of changes in shareholders’ equity. This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted, and full retrospective application is required. The Company will adopt this standard in the first quarter of 2012 and does not expect the adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In May 2011, the FASB issued a revised accounting standard. This amendment provides a consistent definition of fair value and ensures that the fair value measurement and disclosure requirements are similar between Generally Accepted Accounting Principles and International Financial Reporting Standards. The amendment clarifies the application of existing fair value measurements and disclosures, and changes certain principles or requirements for fair value measurements and disclosures. The amendment changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. The standard is effective for reporting periods beginning on or after December 15, 2011 and should be applied prospectively. The Company will adopt this standard in the first quarter of 2012 and does not expect the adoption to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

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MERU NETWORKS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

3. Acquisition of Identity Networks

On August 31, 2011, the Company acquired all of the outstanding stock of Identity Networks (“Identity”), a privately-owned provider of complete guest and device access management solutions located in the United Kingdom. Under the terms of the share purchase agreement, at closing, the Company paid approximately $2.0 million, net of cash acquired, to Identity shareholders. An additional $0.1 million was accrued as of September 30, 2011 due to a working capital adjustment and is to be paid to Identity shareholders. In addition, the Company agreed to pay up to $0.4 million to the former shareholders of Identity within six months of the acquisition date as earn-out consideration based on Identity meeting certain contractually agreed-upon development milestones. The Company assessed the probability of the earn-out milestones being met and included the estimated fair value of those milestones, as adjusted for the time-value of money, in the acquisition price.

The Company recorded the total acquisition price as follows (in thousands):

The allocation of the acquisition price for net tangible and intangible assets were as follows (in thousands):

The developed technology asset is attributable to products which have reached technological feasibility. The customer relationships asset is attributable to the Company’s ability and intent to sell existing in process and future versions of the acquired products to the existing customers of Identity. The value of the identified intangible assets was determined by discounting the estimated net future cash flows from the acquired products and customer agreements based on valuation technologies accepted in the technology industry. The Company is amortizing the developed technology and customer relationships assets on a straight-line basis over their estimated useful lives of three and two years, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets and is not deductible for tax purposes. Among the factors that contributed to a purchase price in excess of the fair value of the net tangible and identified intangible assets was the acquisition of an assembled workforce of experienced engineers, synergies in products, technologies, skill sets, operations, customer base and organizational cultures that can be leveraged to enable the Company to build an enterprise greater than the sum of its parts.

The Company has included the financial results of Identity Networks in the Company’s condensed consolidated financial statements commencing at the acquisition date. No pro forma information was presented based on the determination that the acquisition is not significant to the Company’s condensed consolidated financial statements.

4. Goodwill and Intangible Assets

The following table summarizes the activity related to the carrying value of goodwill (in thousands):

Intangible assets acquired are accounted for based on the fair value of assets purchased and are amortized over the period in which economic benefit is estimated to be received. Identifiable intangible assets were as follows (in thousands):

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

The Company recorded amortization expense related to these identified intangible assets in the condensed consolidated statements of operations as follows (in thousands):

As of September 30, 2011, the estimated aggregate future amortization expense in future years is as follows (in thousands):

5. Cost Method Investments

From time to time, Meru looks for opportunities to invest in other companies to further its business objectives. During the three months ended September 30, 2011, Meru invested $1.3 million in a company which is developing value-added applications that are designed to allow its customers to achieve greater benefit from wireless networks such as those offered by Meru. This company is co-founded by Dr. Vaduvur Bharghavan, a co-founder of Meru and a member of Meru’s board of directors.

Meru uses the cost method to account for this investment due to (i) Meru’s investment represents approximately 16% equity ownership of the company (ii) Dr. Bharghavan, who is the co-founder of the company, is transitioning from his day to day role as Meru’s Chief Technology Officer over the remainder of the 2011 calendar year, and (iii) Dr. Bharghavan, who remains the member of Meru’s board of directors, no longer receives any cash compensation for his role as an executive of Meru. Therefore, Meru does not control the company and does not have the ability to exercise significant influence over the company’s operating and financial policies.

Equity investments, especially equity investments in private companies are inherently risky. Many factors, including technical and product development challenges, market acceptance, competition, additional funding availability and the overall economy, could cause the investment to be impaired. Meru monitors the indicators of impairment. In the event that the fair value of the investment is below its carrying value and the impairment is other-than-temporary, Meru writes down the investment to its fair value. During the three months ended September 30, 2011, there were no indicators of impairment. The Company has not valued this investment at fair value due to the investment being a privately-held company.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

6. Inventory

Inventory as of September 30, 2011 and December 31, 2010 is as follows (in thousands):

7. Net Loss Per Share of Common Stock

The Company’s basic net loss per share of common stock is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period. The weighted-average number of shares of common stock used to calculate the Company’s basic net loss per share of common stock excludes stock awards prior to vesting and also those shares subject to repurchase related to stock options that were exercised prior to vesting as these shares are not deemed to be issued for accounting purposes until they vest. The diluted net loss per share of common stock is calculated by giving effect to all potential common stock equivalents outstanding for the period determined using the treasury-stock method. For purposes of the diluted shares outstanding calculation,  stock awards and options to purchase common stock, common stock subject to repurchase and warrants to purchase common stock are considered to be common stock equivalents. In periods in which the Company has reported a net loss, the common stock equivalents have been excluded from the calculation of diluted net loss per share of common stock as their effect is antidilutive.

The following outstanding shares of common stock and common stock equivalents were excluded from the computation of diluted net loss per share of common stock for the periods presented because including them would have been antidilutive:

8. Fair Value of Financial Instruments

As a basis for determining the fair value of certain of the Company’s assets and liabilities, the Company established a three-tier value hierarchy which prioritizes the inputs used in measuring fair value as follows: (Level I) observable inputs such as quoted prices in active markets; (Level II) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level III) unobservable inputs in which there is little or no market data that requires the Company to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. The Company’s financial assets that are measured at fair value on a recurring basis consist of cash equivalents and short-term investments. The Company’s liability that is measured at fair value on a recurring basis  consists of an earn-out consideration.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

The Company’s cash equivalents and short-term investments are valued using market prices on active markets (Level I) and less active markets (Level II). Level I instrument valuations are obtained from real-term quotes for transactions in active exchange markets involving identical assets. Level II instrument valuations are obtained from readily-available pricing sources for comparable instruments. The Company’s earn-out consideration liability is classified within Level III of the fair value hierarchy.

As of September 30, 2011, the Company’s fair value hierarchy for its financial assets and liabilities was as follows (in thousands):

The following table provides a summary of changes in fair value of the Company’s earn-out consideration liability measured at fair value using significant unobservable inputs (Level III) for the nine months ended September 30, 2011 (in thousands)

The valuation of the earn-out consideration is discussed in Note 3. At September 30, 2011, the Company had $5.0 million of U.S. government securities which mature in less than one year, of which less than $1,000 has been in a continuous unrealized loss position.

As of December 31, 2010, the Company’s fair value hierarchy for its financial assets was as follows (in thousands):

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

9. Commitments and Contingencies

Legal Matters

On June 13, 2011, the Company entered into a Patent Cross License Agreement (the “License Agreement”) with Motorola Solutions, Inc., a Delaware corporation, and its affiliates, including Symbol Technologies, Inc., Wireless Valley Communications, Inc., and AirDefense, Inc. (collectively “Motorola”). Pursuant to the License Agreement, the Company and Motorola each agreed to:

·   provide one another with limited licenses through November 3, 2016 to certain of each of their respective 802.11 Wireless LAN patent portfolios;

·   release one another of certain claims based on infringement or alleged infringement of certain patent rights; and

·   covenant not to assert patent claims against one another’s current products and certain commercially reasonable extensions thereof for three years.

As part of the License Agreement, the Company agreed to pay Motorola $7,250,000 on or before July 1, 2011.

In evaluating the accounting treatment for this transaction, the Company identified the following specific items the Company received from the License Agreement: (1) release of past infringement claims, (2) covenant by Motorola not to sue, and (3) limited license to certain Motorola technology. The Company does not believe this License Agreement will provide future value as the Company does not plan to utilize the underlying technology in any future product development or sales. The License Agreement released and avoided certain potential litigation for the Company, but provided no other future benefits to the Company. Therefore, the Company expensed the full $7.3 million in the second quarter of the Company’s fiscal year 2011.

Operating Leases — The Company leases office space for its headquarters in Sunnyvale, California under a noncancelable operating lease that expires in 2015. In addition, the Company leases space for a research and development facility in Bangalore, India pursuant to an operating lease that expires in October 2012. The Company also leases office space for sales offices in multiple locations around the world under noncancelable operating leases that expire at various dates through 2012.

Other commitments as of September 30, 2011 totaled approximately $9.8 million and consisted of inventory and other non-cancelable purchase obligations.

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Warranty — The Company provides a warranty on product sales and estimated warranty costs are recorded during the period of sale. The Company establishes warranty reserves based on estimates of product warranty return rates and expected costs to repair or to replace the products under warranty. The warranty provision is recorded as a component of costs of products revenues in the condensed consolidated statements of operations.

Accrued warranty, which is included in accrued liabilities on the condensed consolidated balance sheet, as of September 30, 2011 is as follows (in thousands):

Litigation  — The Company is subject to various claims arising in the ordinary course of business. Although no assurance may be given, the Company believes that it is not presently a party to any litigation of which the outcome, if determined adversely, would individually or in the aggregate be reasonably expected to have a material and adverse effect on the business, operating results, cash flows or financial position of the Company.

On May 11, 2010, Extricom Ltd., filed suit against the Company in the Federal District Court of Delaware asserting infringement of U.S. Patent No. 7,697,549.  Also on May 11, 2010, the Company filed a declaratory relief action against Extricom Ltd. in the Federal District Court for Northern California seeking a declaration that the Company is not infringing the Extricom Ltd. patent and that the patent is invalid. The Company’s declaratory relief action in the Northern District of California was dismissed by the Court on August 31, 2010 in favor of the Delaware action on the ground that Extricom Ltd. filed its suit in the Federal District Court of Delaware first.  On October 7, 2010, the Company filed a motion to transfer the Delaware action to the Northern District of California based upon the convenience of witnesses and in the interests of justice. The court denied our motion to transfer on October 12, 2011. Fact discovery was opened on March 2, 2011, and trial is scheduled to commence on November 12, 2012. The Extricom Ltd. complaint seeks unspecified monetary damages and injunctive relief.  At this time, the Company is unable to determine the outcome of this matter and, accordingly, cannot estimate the potential financial impact this action could have on its business, results of operations, cash flows and financial position.

On October 22, 2010, EON Corp. IP Holdings, LLC. (“EON”), filed suit against the Company and a number of other defendants, including Aruba Networks, Inc., Cisco Systems, Inc., Sonus Networks, Inc., and Sprint Nextel Corporation, in the United States District Court for the Eastern District of Texas asserting infringement of U.S. Patent No. 5,592,491.  EON has amended its complaint to add additional defendants and to add specificity to certain of its claims.  The Company’s response to the amended complaint was filed on March 7, 2011, denying the allegations of the amended complaint, and asserting that the EON patent is not infringed and is invalid. One of the co-defendants in the action has filed a motion to transfer the case to the Northern District of California, and the Company has joined in the motion to transfer.  The EON amended complaint seeks unspecified monetary damages and injunctive relief.  At this time, the Company is unable to determine the outcome of this matter and, accordingly, cannot estimate the potential financial impact this action could have on its business, results of operations, cash flows and financial position.

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On June 2, 2011, the U.S. International Trade Commission (“ITC”) instituted a Section 337 investigation regarding certain 802.11n products imported by the Company, as well as 802.11n products imported by Apple Inc., Aruba Networks, Inc., Hewlett-Packard Company and Ruckus Wireless, Inc. The complainant, Linex Technologies, Inc. (“Linex”), alleges that the respondents infringe certain U.S. patents owned by Linex.  The Company has denied that its products infringe the patents and has alleged that the patents are invalid.  Linex also filed a parallel action in the United States District Court for the District of Delaware. The Company has moved for the statutory automatic stay of the Delaware action. Discovery is ongoing  in the ITC action, and fact discovery will be completed by the end of November, 2011.  The parties’ first settlement conference was unsuccessful, and the parties are scheduling a mediation in January, 2012.  Trial is scheduled for April 12, 2012.  At this time, the Company is unable to determine the outcome of this matter and, accordingly, cannot estimate the potential financial impact this action could have on its business, operating results, cash flows or financial position.

Third parties have from time to time claimed, and others may claim in the future that the Company has infringed their past, current or future intellectual property rights. These claims, whether meritorious or not, could be time-consuming, result in costly litigation, require expensive changes in the Company’s methods of doing business or could require the Company to enter into costly royalty or licensing agreements, if available. As a result, these claims could harm the Company’s business, operating results, cash flows and financial position.

Indemnifications  — Under the indemnification provisions of the Company’s standard sales contracts, the Company agrees to defend its customers against third-party claims asserting infringement of certain intellectual property rights, which may include patents, copyrights, trademarks, or trade secrets, and to pay any judgments entered on such claims. The exposure to the Company under these indemnification provisions is generally limited to the total amount paid by the customer under the agreement. However, certain agreements include indemnification provisions that could potentially expose the Company to losses in excess of the amount received under the agreement. To date, there have been no material claims under such indemnification provisions.

10. Warrants for Convertible Preferred Stock and Common Stock

Series E

During 2008 and 2009, the Company issued warrants to purchase 4,510,843 shares of Series E convertible preferred stock. The Series E warrants were exercisable immediately and had an exercise price equal to $0.70 per share.

The relative fair value of the Series E warrants in the amount of $1.2 million was recorded in the consolidated balance sheets as a warrant liability upon issuance and, subsequently, the fair value of the warrant liability from the Series E warrants was remeasured at each period end. The change in fair value of the warrants resulted in a charge to other income (expense), net in the amount of $2.7 million during the nine months ended September 30, 2010.

The Company determined the fair value of the Series E warrants as of their respective exercise dates in April 2010 using the Black-Scholes option-pricing model with the following assumptions:

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Upon the closing of the IPO, these warrants were remeasured and the related fair value was reclassified to additional paid-in capital. During the year ended December 31, 2010, all of the Series E warrants were exercised and are no longer outstanding.

Series B

In 2005, the Company issued a warrant to purchase 541,346 shares of Series B convertible preferred stock. The Series B warrant was exercisable upon issuance and had an exercise price equal to $0.74 per share.

The relative fair value of the Series B warrant of $503,000 was recorded in the consolidated balance sheets as a warrant liability and debt discount. The fair value of the warrant liability for the Series B warrant was remeasured at each period end. As of April 6, 2010, all of the Company’s convertible preferred stock converted into shares of common stock upon the closing of the Company’s IPO. Following the conversion of the convertible preferred stock, the Series B warrant became a warrant to purchase 44,202 shares of common stock. Prior to the conversion of the convertible preferred stock, the change in fair value of the warrant resulted in a charge through other income (expense), net in the amount of $344,000 during the nine months ended September 30, 2010.

The Company determined the fair value of the Series B warrant as of April 6, 2010 using the Black-Scholes option-pricing model with the following assumptions:

Upon the closing of the IPO, the Series B warrant was remeasured and the related fair value was reclassified to additional paid-in capital. During the nine months ended September 30, 2011, this Series B warrant to purchase 44,202 shares of common stock (after giving effect to the stock split in connection with the IPO) was exercised, in full, utilizing a cashless exercise provision.  As a result, the Company issued 26,520 shares of common stock.

Common Stock

In 2009, the Company issued warrants to purchase 4,007,432 shares of common stock.  During 2010, the Company issued another warrant to purchase 36,582 shares of common stock as a result of the exercise of a Series E warrant.  These common stock warrants are exercisable immediately, have exercise prices ranging from $9.78 to $11.74 and expire in 2014. During the year ended 2010, warrants to purchase 54,764 shares were exercised utilizing a cashless exercise provision. As a result, the Company issued 19,072 shares of common stock. During the nine months ended September 30, 2011, warrants to purchase 1,265,293 shares were exercised utilizing a cashless exercise provision.  As a result, the Company issued 548,125 shares of common stock. The remaining warrants to purchase 2,723,957 shares of common stock have not been exercised and were still outstanding as of September 30, 2011.

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Because these common stock warrants were potentially redeemable for cash under certain change in control provisions and included certain variable terms outside of the control of the Company prior to the Company’s IPO, these common stock warrants were recorded as a warrant liability at fair value and were subject to remeasurement at each period end with any changes in fair value being recognized in other income (expense), net on the consolidated statements of operations. The Company determined the fair value of these common stock warrants as of April 6, 2010 using the Black-Scholes option-pricing model, with the following assumptions:

These common stock warrants were amended to remove the cash redemption feature and the other variable terms outside of the Company’s control effective upon the closing of the Company’s IPO which occurred on April 6, 2010. The change in fair value of the warrants resulted in a charge through other income (expense), net in the amount of approximately $30.6 million during the nine months ended September 30, 2010. Upon the closing of the Company’s IPO, these warrants were remeasured and the related fair value was reclassified to additional paid-in capital.

11. Equity Incentive Plans

The Company’s equity incentive plans are broad-based retention programs. The plans are intended to attract talented employees, directors and non-employee consultants. In March 2010, the Company’s board of directors and its stockholders approved the 2010 Stock Incentive Plan (the “2010 Plan”). A total of 1,846,154 shares of common stock plus any shares reserved and not issued or subject to outstanding grants under the 2002 Stock Incentive Plan were reserved for future issuance under the 2010 Plan, which became effective upon the completion of the Company’s IPO on April 6, 2010. The 2010 Plan provides for the granting of stock options, restricted stock, restricted stock units and stock appreciation rights. The number of shares reserved for issuance under the 2010 Plan will be increased on the first day of each of our fiscal years by the lesser of 4% of our outstanding common stock on the last day of the immediately preceding fiscal year or the number of shares determined by the board of directors. During the nine months ended September 30, 2011, shares equal to 4% of the outstanding shares of the Company on December 31, 2010, 653,512 shares, were registered and reserved for issuance under the 2010 Plan. In addition, an amendment to our 2010 Stock Incentive Plan to add an additional 700,000 shares to the number of shares of common stock authorized for issuance under our 2010 Stock Incentive Plan was approved at the Company’s 2011 shareholder meeting.

The Company’s stock-based compensation expense was $1.6 million and $1.1 million during the three months ended September 30, 2011 and 2010 and was $4.5 million and $2.6 million during the nine months ended September 30, 2011 and 2010, respectively. The total stock-based compensation expense consisted of stock-based compensation expense for stock options and awards granted to employees of $1.6 million and $1.1 million and nonemployees of $0 and $14,000 for the three months ended September 30, 2011 and 2010, respectively. The total stock-based compensation expense consisted of stock-based compensation expense for stock options and awards granted to employees of $4.5 million and $2.6 million and nonemployees of $0 and $45,000 for the nine months ended September 30, 2011 and 2010, respectively.

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Determining Fair Value of Stock Options

The fair value of stock options granted during the three and nine months ended September 30, 2011 and 2010 was determined by the Company using the methods and assumptions discussed below. Each of these inputs is subjective and generally requires significant judgment to determine.

Valuation Method — The Company estimates the fair value of stock options granted using the Black-Scholes option-pricing model.

Expected Term — The expected term represents the period that the Company’s stock-based awards are expected to be outstanding. The expected term is derived from historical data on employee exercises and post-vesting employment termination behavior taking into account the contractual life of the award.

Expected Volatility — The expected volatility was based on the historical stock volatilities of several of the Company’s publicly listed peers over a period equal to the expected terms of the options as the Company did not have a sufficient trading history to use the volatility of its own common stock.

Fair Value of Common Stock — Prior to the Company’s IPO, the fair value of the shares of common stock underlying the stock options was determined by the board of directors because there was no public market for the Company’s common stock. The board of directors therefore determined fair value of the common stock at the time of grant of the option by considering a number of objective and subjective factors including valuation of comparable companies, sales of convertible preferred stock to unrelated third parties, operating and financial performance, the lack of liquidity of capital stock and general and industry specific economic outlook, amongst other factors. Following the IPO, the fair value of the underlying common stock is based on the listing price for the Company’s common stock as noted on the NASDAQ on the grant date.

Risk-Free Interest Rate — The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to the option’s expected term.

Expected Dividend — The Company has never paid dividends and does not expect to pay dividends.

Forfeiture Rate — The Company estimates its forfeiture rate based on an analysis of its actual forfeitures and will continue to evaluate the adequacy of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover behavior, and other factors. The impact from a forfeiture rate adjustment will be recognized in full in the period of adjustment, and if the actual number of future forfeitures differs from that estimated by the Company, the Company may be required to record adjustments to stock-based compensation expense in future periods.

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Summary of Assumptions — The fair value of each employee stock option was estimated at the date of grant using a Black-Scholes option-pricing model, with the following weighted-average assumptions for grants of options during the three and nine months ended September 30, 2011 and 2010:

A summary of the Company’s stock option activity during the nine months ended September 30, 2011 is presented below:

The aggregate intrinsic value of options exercised was $0.1 million for each of the three months ended September 30, 2011 and 2010 and was $7.6 million and $0.5 million for the nine months ended September 30, 2011 and 2010, determined as of the date of option exercise.

Additional information regarding the Company’s stock options outstanding and vested as of September 30, 2011 is summarized below:

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As of September 30, 2011, total compensation cost related to unvested stock-based awards granted to employees, but not yet recognized, was $5.7 million, net of estimated forfeitures. This cost will be amortized on a straight-line basis over a weighted-average remaining period of 2.8 years and will be adjusted for subsequent changes in estimated forfeitures. Future option grants will increase the amount of compensation expense that will be recorded.

Restricted Stock — The Company issued 291,968 and 224,800 shares of restricted stock units (“RSUs”) to employees and members of the board of directors during the nine months ended September 30, 2011 and 2010, respectively. The Company recognized stock-based compensation in the amount of $0.8 million and $1.4 million for the restricted stock units during the three and nine months ended September 30, 2011. The Company recognized stock-based compensation in the amount of $72,000 for the restricted stock units during the three and nine months ended September 30, 2010. The Company did not issue restricted stock awards during the nine months ended September 30, 2011. The Company issued 30,572 shares of restricted stock awards to directors during the nine months ended September 30, 2010. These restricted shares will vest from one to four years from the date of issuance if the employees or directors, as applicable, remain with the Company for the duration of the vesting period. Some RSUs are performance based awards, therefore, the vesting of these RSUs is subject to the achievement of specific performance metrics in addition to continued service. The Company recognized stock-based compensation in the amount of $0.2 million for the restricted stock awards during the nine months ended September 30, 2011.The Company recognized stock-based compensation in the amount of $76,000 and $0.1 million for the restricted stock awards during the three and nine months ended September 30, 2010, respectively.

A summary of the Company’s restricted stock award activity during the nine months ended September 30, 2011 is presented below: