The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included in Item 8, "Financial Statements and Supplementary Data" included in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this Annual Report on Form 10-K should be read as applying to all related forward-looking statements wherever they appear in this Annual Report on Form 10-K. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under Item 1A, "Risk factors" and elsewhere in this Annual Report on Form 10-K.

Business overview
We are a provider of mobile communication solutions focused on addressing critical communication challenges facing hospitals today. We help our customers improve patient safety and satisfaction, and increase hospital efficiency and productivity through our Voice Communication, Secure Messaging and Care Transition solutions. Our Voice Communication solution, which includes a lightweight, wearable, voice-controlled communication badge and a software platform, enables users to connect instantly with other hospital staff simply by saying the name, function or group name of the desired recipient. Our Secure Messaging solution securely delivers text messages and alerts directly to and from smartphones, replacing legacy pagers. Our Care Transition solution is a hosted voice and text based software application that captures, manages and monitors patient information when responsibility for the patient is transferred or "handed-off" from one caregiver to another, or when the patient is discharged from the hospital.
At the core of our Voice Communication solution is a patent-protected software platform that we introduced in 2002. We have significantly enhanced and added features and functionality to this solution through ongoing development based on frequent interactions with our customers. Our software platform is built upon a scalable architecture and recognizes more than 100 voice commands. Users can instantly communicate with others using the Vocera communication badge, or through Vocera Connect client applications available for iPhone and Android smartphones, as well as Cisco wireless IP phones and other mobile devices. Our Voice Communication solution can also be integrated with nurse call and other clinical systems to immediately and efficiently alert hospital workers to patient needs. We have shipped over 500,000 communication badges to our customers.
We outsource the manufacturing of our products. Our outsourced manufacturing model allows us to scale our business without the significant capital investment and on-going expenses required to establish and maintain manufacturing operations. We work closely with our contract manufacturer, SMTC Corporation, and key suppliers to manage the procurement, quality and cost of components. We seek to maintain an optimal level of finished goods inventory to meet our forecast sales and unanticipated shifts in sales volume and mix.
We primarily sell products and maintenance services directly to end users. To date, substantially all of our revenue has been derived from sales of our Voice Communication solution, including product maintenance and related services. Revenue grew 27.0% to $101.0 million in 2012 from $79.5 million in 2011, and our 2011 revenue grew 40.0% from $56.8 million in 2010. For the year ended December 31, 2012 we recorded net income of $2.9 million. For the year ended December 31, 2011, we recorded a net loss of $2.5 million, which included $1.0 million of additional outside service costs as we prepared to become a public company. Our diverse customer base ranges from large hospital systems to small local hospitals, as well as other healthcare facilities and customers in non-healthcare markets. We are not reliant on any one or group of customers. For 2012, our largest end customer represented only 2.7% of revenue. While we have international customers in other English speaking countries such as Canada, the United Kingdom and Australia, most of our customers are located in the United States. International customers represented 10.7% and 7.3% of our revenue in 2012 and in 2011, respectively. We are developing plans to expand our presence in other English speaking markets and enter non-English speaking markets.

Our growth in 2012 was primarily due to increased product sales of our Voice Communication solution, and, to a lesser extent, to an increase in services sales. We had balanced growth in product sales in 2012, with increases in sales to new customers and expanded deployments by existing customers, as well as sales of replacement badges due, in part, to favorable reception of our new B3000 badges. We believe that we have the ability to continue to grow in each of these areas in 2013. In addition, we are continuing to invest to accelerate the development of new products for our healthcare and targeted non-healthcare markets. In the fourth quarter of 2012 and continuing into the first quarter of 2013, we expanded and, we believe, upgraded our sales organization with the addition of new sales personnel and bifurcating sales roles between obtaining new customers and managing the installed customer base. In recent months, we also entered into sales contracts with four national health systems. A potential challenge in 2013 are sales to US government customers, which have experienced a slowdown and deferral of

orders due to the ongoing effects of and uncertainty around sequestration and debt ceiling issues. We believe that our business to US government customers will continue to be less visible and predictable in 2013 as we experienced in the third and fourth quarters of 2012.

Acquisitions
During the last four months of 2010, we completed four acquisitions, for total purchase consideration of $10.0 million. Assets acquired and liabilities assumed were recorded at their estimated fair values as of the respective acquisition date. We recorded $4.4 million as identifiable intangible assets and $5.6 million as goodwill. We also incurred $1.0 million in acquisition related expenses, which was recorded in general and administrative expense. These acquisitions did not contribute significantly to our revenue in 2010. The acquisitions of Integrated Voice Systems and of the OptiVox product line enhanced our product offerings by incorporating solutions designed to streamline patient hand-offs, enabling caregivers to capture and transfer important information in a secure, manageable, web-enabled manner. The acquisition of Wallace Wireless provided us with smartphone messaging solutions enabling the secure delivery of text messages, alerts and other information directly to and from smartphones, complementing our Voice Communication solution. The acquisition of DS Consulting Associates, d/b/a ExperiaHealth, enabled us to provide patient experience consulting services to help hospitals improve patient experience and safety.

Components of operating results
Revenue. We generate revenue from the sale of products and services. As discussed further in the section titled "Critical accounting policies and estimates-Revenue recognition and deferred revenue" below, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collection is reasonably assured. Revenue is comprised of the following:

• Product. Our solutions include both hardware and software. We refer to hardware revenue as device revenue, which includes revenue from sales of our communication badges, badge accessories, including batteries, battery chargers, lanyards, clips and other ancillary badge components, and our Vocera smartphone. Software revenue is derived primarily from the sale of perpetual licenses to our Voice Communication solution. We derive additional software revenue from the sale of term licenses, which can be renewed on a subscription basis. Product revenue is generally recognized upon shipment of hardware and perpetual licenses and, in the case of term licenses, ratably over the applicable term.

• Service. We receive service revenue from sales of software maintenance, extended warranties and professional services. Software maintenance is typically invoiced annually in advance, recorded as deferred revenue, and recognized as revenue ratably over the service period. Our professional services revenue is based on both time and materials, and fixed price contracts, and is recognized as the services are provided. Extended warranties are invoiced in advance, recorded as deferred revenue, and recognized ratably over the extended warranty period.

Cost of revenue. Cost of revenue is comprised of the following:

• Cost of product. Cost of product is comprised primarily of materials costs, software license costs, warranty, and manufacturing overhead for test engineering, material requirements planning and our shipping and receiving functions. Cost of product also includes facility costs and write-offs for excess and obsolete inventory, as well as depreciation and amortization expenses. As we introduce new products, we expect material costs will increase as a percent of revenue for a period of time.

• Cost of service. Cost of service is comprised primarily of employee wages, benefits and related personnel expenses of our technical support team, our professional consulting personnel and our training teams. Cost of service also includes facility and information technology costs. We expect our cost of service will increase as we continue to invest in support services to meet the needs of our customer base.

Operating expenses. Operating expenses are comprised of the following:

• Research and development. Research and development expenses consist primarily of employee wages, benefits and related personnel expenses, hardware materials, and consultant fees and expenses related to the design, development, testing and enhancements of our solutions. We intend to continue to invest in improving the functionality of our solutions and the development of new solutions. As a result, we expect research and development expense to increase for the foreseeable future.

• Sales and marketing. Sales and marketing expenses consist primarily of employee wages, benefits and related personnel expenses, as well as trade shows, marketing and public relations programs and advertising. Sales commissions are earned

when an order is received from a customer, and as a result, in some cases these commissions are expensed in an earlier period than the period in which the related revenue is recognized. Historically, our bookings have tended to peak in the fourth quarter of each year driving higher sales commissions, and to be lowest in the first quarter. We intend to continue to expand our direct sales force for the foreseeable future and, accordingly, expect sales and marketing expenses to increase.
• General and administrative. General and administrative expenses consist primarily of employee wages, benefits and related personnel expenses, consulting, audit fees, legal fees and other general corporate expenses. We expect general and administrative expense to increase for the foreseeable future due to the significant costs we expect to incur as we continue to build and maintain the infrastructure necessary to comply with the regulatory requirements of being a public company and as we add personnel to support our growth.

Interest income, interest expense and other income (expense), net.

• Interest income. Interest income consists primarily of interest income earned on our cash, cash equivalent and short-term investment balances. Our interest income will vary each reporting period depending on our average cash, cash equivalent and short-term investment balances during the period and market interest rates.

• Interest expense. Interest expense includes interest expense related to debt and financing obligations resulting from our credit facility and security agreement, which was paid off in full on April 3, 2012. We expect interest expense to fluctuate in the future with changes in our borrowings.

• Other income (expense), net. Other income (expense), net consists primarily of income from a stipend for market research regarding the industry in which our company operates that we provided to a market research firm, and the change in the fair value of our convertible preferred stock warrants. Our convertible preferred stock warrants were classified as liabilities and, as such, were marked-to-market at each balance sheet date with the corresponding gain or loss from the adjustment recorded as other income (expense), net. Upon the consummation of our initial public offering, on April 2, 2012, these warrants converted into warrants to purchase common stock and are no longer marked-to-market. Other income (expense), net also includes any foreign exchange gains and losses.

Provision for income taxes. We are subject to income taxes in the countries where we sell our solutions. We anticipate that in the future as we expand our sale of solutions to customers outside the United States, we will become subject to taxation based on the foreign statutory rates in the countries where these sales took place and our effective tax rate could fluctuate accordingly. Currently, each of our international subsidiaries is operating under cost plus agreements where the U.S. parent company reimburses the international subsidiary for its costs plus an arm's length profit.
Income taxes are computed using the asset and liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances have been established to reduce deferred tax assets to the amount reasonably expected to be realized. Changes in valuation allowances are reflected as component of provision for income taxes. At December 31, 2012, we had a valuation allowance against net deferred tax assets of $21.5 million. While we are encouraged by the pretax profit earned in 2012 and by the favorable trend of our financial results, management believes it is appropriate to obtain confirmatory evidence that the improvement in our results of operations is sustainable, and that realization of at least some of the deferred income tax assets is more likely than not, before reversing a portion of the valuation allowance to earnings.
We intend to review on a quarterly basis our conclusions about the appropriate amount of its deferred income tax asset valuation allowance. If we continue to generate profits in 2013 and beyond, it is likely that the US valuation allowance position will be reversed in the foreseeable future. We expect a significant benefit to be recorded in the period the valuation allowance reversal is recorded and a significantly higher effective tax rate in periods following the valuation allowance reversal.

Results of operations
The following table is a summary of our consolidated statements of operations for the years ended December 31, 2012, 2011 and 2010.

                                                    Years ended December 31,
                                          2012                      2011                      2010
(in thousands, except
percentages)                       Amount     % Revenue      Amount     % Revenue      Amount     % Revenue
Consolidated statements of
operations data:
Revenue
Product                          $ 65,028        64.4  %   $ 50,322        63.3  %   $ 35,516        62.5  %
Service                            35,929        35.6        29,181        36.7        21,287        37.5
Total revenue                     100,957       100.0        79,503       100.0        56,803       100.0
Cost of revenue
Product                            21,551        21.3        17,465        22.0        12,222        21.5
Service                            15,070        14.9        14,042        17.7         8,953        15.8
Total cost of revenue              36,621        36.3        31,507        39.6        21,175        37.3
Gross profit                       64,336        63.7        47,996        60.4        35,628        62.7
Operating expenses
Research and development           11,618        11.5         9,335        11.7         6,698        11.8
Sales and marketing                33,432        33.1        28,151        35.4        20,953        36.9
General and administrative         14,390        14.3        11,316        14.2         6,723        11.8
Total operating expenses           59,440        58.9        48,802        61.4        34,374        60.5
Income (loss) from operations       4,896         4.8          (806 )      (1.0 )       1,254         2.2
Interest income                       171         0.2            17           -            33         0.1
Interest expense                      (84 )      (0.1 )        (332 )      (0.4 )         (77 )      (0.1 )
Other expense, net                 (1,463 )      (1.4 )      (1,073 )      (1.3 )        (367 )      (0.6 )
Income (loss) before income
taxes                               3,520         3.5        (2,194 )      (2.8 )         843         1.5
(Provision for) benefit from
income taxes                         (627 )      (0.6 )        (285 )      (0.4 )         367         0.6
Net income (loss)                $  2,893         2.9  %   $ (2,479 )      (3.1 )%   $  1,210         2.1  %

Years ended December 31, 2012 compared to December 31, 2011

Revenue:
                                          Years ended December 31,
                                             2012              2011            Change
(in thousands, except percentages)          Amount            Amount      Amount       %
Revenue
Product                              $      65,028           $ 50,322    $ 14,706    29.2 %
Service                                     35,929             29,181       6,748    23.1
Total revenue                        $     100,957           $ 79,503    $ 21,454    27.0

Total revenue increased $21.5 million, or 27.0%, from 2011 to 2012. Product revenue increased $14.7 million, or 29.2% in 2012. Device revenue increased $10.6 million, or 28.7%, and software revenue increased $4.1 million, or 30.7%. The 2012 increase in device revenue, which related entirely to our Voice Communication solution, was driven by an increase in unit sales of badges and related accessories from new customers making initial purchases, existing customers expanding deployments within their facilities to new departments and users, and customers replacing badges. The list prices for our products did not change substantially in 2012. The 2012 increase in software revenue was comprised of $3.5 million from an increase in the sale of licenses of our Voice Communication solution to new and existing customers and $0.6 million from other software revenue.

Service revenue increased $6.7 million, or 23.1% in 2012. Software maintenance and support revenue increased $4.8 million, or 22.4%, and professional services and training revenue increased $2.0 million, or 25.2%. The 2012 increase in software maintenance and support revenue was primarily a result of a larger customer base but also included $1.0 million from extended warranty contracts and $0.3 million from other software services. The 2012 increase in professional services and training revenue included $0.9 million as a result of an increase in the number of new deployments and expansions of our Voice Communication solution. The remaining increase in professional services and training revenue of $0.9 million was from other service offerings.

Cost of revenue:
                                        Years ended December 31,
                                          2012             2011             Change
(in thousands, except percentages)       Amount           Amount       Amount       %
Cost of revenue
Product                              $     21,551       $  17,465     $ 4,086     23.4 %
Service                                    15,070          14,042       1,028      7.3
Total cost of revenue                $     36,621       $  31,507     $ 5,114     16.2
Gross margin
Product                                      66.9 %          65.3 %       1.6 %
Service                                      58.1            51.9         6.2
Total gross margin                           63.7            60.4         3.3

Cost of product revenue increased $4.1 million, or 23.4%, from 2011 to 2012. This increase was primarily due to the higher product revenue, offset by decreases due to lower per unit material and manufacturing costs as a result of increased unit volume and lower warranty expenses in 2012 due to lower return rates on our B3000 badge compared to the B2000 badge and to lower cost estimates for refurbishment and replacement alternatives. In 2011, we recorded a $0.6 million provision for excess inventory of the Vocera Wi-Fi smartphone due to quantities-on-hand exceeding forecast demand. Excluding the excess inventory charge, product gross margins in 2011 would have been only 0.4% lower than those realized in 2012.
Cost of service revenue increased $1.0 million, or 7.3%, from 2011 to 2012. This increase was primarily due to a $0.9 million increase in employee wages and other personnel costs in our technical support and professional services organizations to support growth in customer deployments and in our installed base. Headcount in our services organization increased from 71 employees at December 31, 2011 to 80 employees at December 31, 2012.

Operating expenses:
                                          Years ended December 31,
                                             2012              2011            Change
(in thousands, except percentages)          Amount            Amount      Amount       %
Operating expenses:
Research and development             $     11,618            $  9,335    $  2,283    24.5 %
Sales and marketing                        33,432              28,151       5,281    18.8
General and administrative                 14,390              11,316       3,074    27.2
Total operating expenses             $     59,440            $ 48,802    $ 10,638    21.8

Research and development expense. Research and development expense increased $2.3 million, or 24.5%, from 2011 to 2012. This increase was primarily due to an increase in employee wages and other personnel related costs of $1.6 million, a $0.3 million increase in stock compensation expenses and $0.4 million increase in other support costs. Headcount in our research and development organization increased from 50 employees at December 31, 2011 to 59 employees at December 31, 2012.
Sales and marketing expense. Sales and marketing expense increased $5.3 million, or 18.8%, from 2011 to 2012. This increase was primarily due to a $4.1 million increase in employee wages and other personnel costs to support corporate marketing and sales efforts, a $1.0 million increase in stock compensation expenses, $0.4 million increase in travel, $0.5 million increase in other support, offset by a $0.7 million decrease in brand and product launch expenses associated with the B3000 release in 2011. Headcount in our sales and marketing organization increased from 115 employees at December 31, 2011 to 136 employees at December 31, 2012. In particular, we expanded our sales force in the fourth quarter of 2012 and expect sales and marketing expense to increase as this expanded sales organization is in place for the full year.

General and administrative expense. General and administrative expense increased $3.1 million, or 27.2%, from 2011 to 2012. This increase was due to a $2.9 million increase in employee wages and other personnel costs, a $0.6 million increase in stock compensation expense, a $0.4 million increase in outside services costs as we prepared to become a public company, partially offset by a $0.8 million decrease in other support costs. Headcount in our general and administrative organization increased from 35 employees at December 31, 2011 to 44 employees at December 31, 2012.

                                              Years ended December  31,
(in thousands, except percentages)              2012               2011        Change
Non-operating income (expense) elements:
Interest income                            $       171         $      17      $  154
Interest expense                                   (84 )            (332 )       248
Other income (expense), net                     (1,463 )          (1,073 )      (390 )

Income taxes:
Provision for income taxes                        (627 )            (285 )      (342 )
Income (loss) before income taxes                3,520            (2,194 )     5,714
Effective tax rate %                              17.8 %           (13.0 )%     30.8 %

Interest income. Interest income increased $0.2 million from 2011 to 2012 due to higher cash balances from the proceeds of our initial public offering and follow-on offering completed in 2012.
Interest expense. Interest expense decreased $0.2 million from 2011 to 2012 as we paid all outstanding debt upon completion of our initial public offering. Other income (expense), net. The $0.4 million increase in other expense from 2011 to 2012 is due to a $0.7 million increase in fair market value of the convertible preferred stock warrants offset by a $0.2 million increase in other income and a $0.1 million decrease in foreign exchange losses.
Provision for income taxes. The $0.6 million provision on $3.5 million of pretax income in 2012 represented an effective tax rate of 17.8%. For 2011, the provision of $0.3 million on the consolidated pretax loss of $2.2 million represented a negative effective rate of 13.0%. The lower-than-normal 17.8% rate for 2012 was due primarily to the impact of the utilization of the valuation allowance on net deferred tax assets, together with permanent tax adjustments for stock options. The negative 13.0% rate for 2011 is due primarily to the increase in the valuation allowance on net deferred tax assets, together with tax liabilities in the foreign subsidiaries.
Years ended December 31, 2011 compared to December 31, 2010

Revenue:
                                          Years ended December 31,
                                             2011              2010            Change
(in thousands, except percentages)          Amount            Amount      Amount       %
Revenue
Product                              $     50,322            $ 35,516    $ 14,806    41.7 %
Service                                    29,181              21,287       7,894    37.1
Total revenue                        $     79,503            $ 56,803    $ 22,700    40.0

Total revenue increased $22.7 million, or 40.0%, from 2010 to 2011. Product revenue increased $14.8 million, or 41.7% in 2011. Device revenue increased $10.4 million, or 38.8%, and software revenue increased $4.4 million, or 50.6%. The 2011 increase in device revenue, which related entirely to our . . .