Attached files
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 24, 2011
or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period to
Commission File Number 000-51333
SILICON GRAPHICS INTERNATIONAL CORP.
(Exact name of registrant as specified in its charter)
Delaware | 32-0047154 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
46600 Landing Parkway
Fremont, California 94538
(Address of principal executive offices, including zip code)
(510) 933-8300
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, $0.001 par value per share | The NASDAQ Stock Market, Inc. | |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 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 definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer x | Non-accelerated filer o | Smaller reporting company o |
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
As of December 24, 2010, the aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the last sale price of such stock as of such date on the NASDAQ Global Select Market, was approximately $268,627,475.
As of August 22, 2011, there were 31,382,497 shares of the registrant’s common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the registrant’s definitive proxy statement for its 2011 Annual Meeting of Stockholders which will be filed with the Commission within 120 days after the close of the registrant’s fiscal year are incorporated by reference into Part III of this Annual Report on Form 10-K.
SILICON GRAPHICS INTERNATIONAL CORP.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED JUNE 24, 2011
TABLE OF CONTENTS
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements included or incorporated by reference in this Form 10-K other than statements of historical fact, are forward-looking statements. Investors can identify these and other forward-looking statements by the use of words such as “estimate,” “may,” “will,” “could,” “anticipate,” “expect,” “intend,” “believe,” “continue” or the negative of such terms, or other similar expressions. Forward-looking statements also include the assumptions underlying or relating to such statements.
Our actual results could differ materially from those projected in the forward-looking statements included herein as a result of a number of factors, risks and uncertainties, including, among others, the risk factors set forth in “Item 1A—Risk Factors ,”and Item 7—“Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-K and elsewhere in this Form 10-K and the risks detailed from time to time in Silicon Graphics International Corp.’s future U.S. Securities and Exchange Commission reports. The information included in this Form 10-K is as of the filing date with the Securities and Exchange Commission and future events or circumstances could differ materially from the forward-looking statements included herein. We disclaim any intent to update any of the forward-looking statements after the date of this report or to conform these statements to actual results except as required by law. Accordingly, we caution readers not to place undue reliance on such statements.
“Silicon Graphics,” “SGI,” “Eco-Logical,” “RapidScale,” “Roamer,” “CloudRack,” “ICE Cube,” “MobiRack,” “Rackable,” “Altix,” “CXFS,” “NUMAlink,” “Octane,” “Origin,” “REACT,” “SGI FullCare,” “SGI FullExpress,” “SGI Global Developer Program,” "SGI Tempo," "OpenFOAM," "SGI ArcFiniti," "SGI Accelerate," “COPAN” and the “Silicon Graphics” logo are trademarks or registered trademarks of Silicon Graphics International Corp. or its subsidiaries in the U.S. and/or other countries. Other trademarks or service marks appearing in this report may be trademarks or service marks of other owners.
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PART I
Item 1. Business
Overview
We are a global leader in technical computing. We are focused on helping customers solve their most demanding business and technology challenges by delivering large-scale computing and storage, high-performance compute and storage, and data center solutions. We develop, market, and sell a broad line of low cost, mid-range and high-end computing servers and data storage as well as differentiating software. We sell data center infrastructure products purpose-built for large-scale data center deployments. In addition, we provide global customer support and professional services related to our products. We enable enterprises to meet their computing and storage requirements at a lower total cost of ownership and provide them greater flexibility and scalability. We are also a leading developer of enterprise class, high-performance features for the Linux operating system that provide our customers with a standard Linux operating environment combined with our differentiated yet un-intrusive Linux capabilities that are designed to improve performance, simplify system management, and provide a more robust development environment.
Our products and services are used by the scientific, technical, and business communities to solve challenging data-intensive computing, data storage and management problems. These problems typically require large amounts of computing power, along with fast and efficient data movement both within the computing system and to and from large-scale data storage installations. Enterprises have also begun to deploy large-scale computing and storage installations by aggregating large numbers of relatively inexpensive, open-standard modular computing and storage systems. Our end-users employ our systems to access, analyze, transform, manage, visualize and store very large amounts of data in real time or near real time by running low-cost operating systems such as Linux® and Microsoft® Windows® and, we believe, enable enterprises to meet their computing and storage requirements at a lower total cost of ownership and provide enterprises with greater flexibility and scalability. The vertical industry markets we serve include defense and strategic systems, weather and climate, physical sciences, life sciences, energy (including oil and gas), aerospace and automotive, media and entertainment, semiconductor design, manufacturing, financial services, data centers, business intelligence and data analytics.
Applications for our systems within these vertical markets include simulating global climate changes, accelerating engineering of new automotive designs, supporting homeland security initiatives, providing real-time fraud detection, streaming media from Internet-video to film and gaining business intelligence through data-mining. Our global services organization facilitates rapid installation and implementation of our products, assists in optimizing the use of our products, maintains their availability to serve our customers and educates customers to increase productivity.
We pioneered Eco-Logical™ data center design with innovative technologies in the areas of chassis and cabinet design, power distribution techniques, cooling techniques, and hardware-based remote management capabilities. We refer to these advantages as “Eco-Logical,” a term we trademarked to best describe our environmentally-friendly, efficient products. The term “eco” refers to the fact that our products are environmentally-friendly and efficient, while the term “logical” describes the ability of these products to enable smart, practical solutions for our end-users. We offer compute servers using our Rackable™ half-depth rackmount design, enabling back-to-back mounting for higher server density and improved thermal management. We also offer compute servers using our CloudRack® tray-based design that deliver similar advantages in a front-to-back cooling model. Data center products include ICE Cube®, a modular data center which augments or replaces traditional brick-and-mortar facilities, and MobiRack™, a mobile, all-in-one data center capabilities for field deployments.
From developing custom semiconductors to data center solutions, we differentiate by scaling for compute and data intensive workloads of our customers’ most demanding applications. We have over 1,500 employees worldwide. We sell and market our systems, technologies, software, and services to enterprises in over 25 countries through our direct and indirect sales force including original equipment manufacturers, system integrators and value added resellers. In the years ended June 24, 2011, June 25, 2010 and January 3, 2009, and for the six months ended June 26, 2009, international revenue was approximately 38%, 25%, 8% and 25%, respectively, of our total revenue.
Acquisitions
SGI Japan, Ltd.
On March 9, 2011 (the “Closing Date”), pursuant to a Stock Purchase Agreement dated March 8, 2011, our wholly-owned subsidiary, Silicon Graphics World Trade BV ("SGI BV") acquired the remaining outstanding shares of SGI Japan, Ltd., a Japanese corporation (“SGI Japan”). Prior to the Closing Date, we owned approximately 10% of the outstanding shares of SGI Japan and accounted for such investment as a cost method investment. SGI Japan operates primarily as a seller and servicer of high-performance computing ("HPC"), visualization, data center, and media and archive systems in Japan.
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Pursuant to the terms of the Stock Purchase Agreement, the total purchase price was approximately $17.9 million in cash, $1.8 million of which was placed in escrow to secure our indemnification rights under the Stock Purchase Agreement. The acquisition is expected to serve as a strategic entry into the large technical computing market of Japan and to enable us to extend our global reach, accelerate growth opportunities, and strengthen the relationships with our partners and customers in Japan. Furthermore, the acquisition is expected to enable us to more fully participate in the Japanese HPC market and benefit from SGI Japan's extensive service business.
Silicon Graphics, Inc.
On May 8, 2009, we completed the acquisition of substantially all of the assets of Silicon Graphics, Inc. (“Legacy SGI”), excluding certain assets unrelated to the ongoing business, including certain of Legacy SGI’s non-U.S. subsidiaries and operations and assumed certain liabilities (together, the “Net Assets”). The acquisition was consummated pursuant to the terms of an Asset Purchase Agreement dated as of March 31, 2009 and as amended on April 30, 2009. As Legacy SGI and certain of its affiliates had filed bankruptcy petitions and motions for voluntary Chapter 11 reorganization, the Asset Purchase Agreement was subject to the approval of the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). On April 30, 2009, the Asset Purchase Agreement and the transactions contemplated thereby were approved by the Bankruptcy Court, allowing us to complete the acquisition under Section 363 of the U.S. Bankruptcy Code. Under the terms of the Asset Purchase Agreement, we acquired the Net Assets for a purchase price of approximately $42.5 million in cash.
Copan Systems, Inc.
On February 23, 2010, we completed the acquisition of substantially all the assets of Copan Systems, Inc. (“Copan”) and assumed certain liabilities for $2.0 million in cash.
Change in Corporate Name and Trading Symbol
We were originally incorporated as Rackable Corporation and later changed to Rackable Systems, Inc. On May 18, 2009, in connection with our purchase of the Legacy SGI assets, we changed our name to Silicon Graphics International Corp. (“SGI”) and changed our NASDAQ stock ticker symbol from “RACK” to “SGI.”
Change in fiscal year
On June 19, 2009, the Board of Directors approved a change in our fiscal year end from the Saturday closest to December 31st of each year to the last Friday in June of each year. As a result of this change, we had a six-month transition period beginning on January 4, 2009 and ending on June 26, 2009, consisting of 25 weeks. Accordingly, our fiscal year 2010 began on June 27, 2009 and ended on June 25, 2010.
Included in this report are our consolidated balance sheets as of June 24, 2011 and June 25, 2010, the consolidated statements of operations, the consolidated statements of stockholders’ equity, and the consolidated statements of cash flows for the 52-week fiscal years ended June 24, 2011 ("2011") and June 25, 2010 (“2010”), 53-week fiscal year ended January 3, 2009 (“2008”), and the 25-week, six-month transition period ended June 26, 2009.
Segment Information
Our operating segments are determined based upon several criteria including: our internal organizational structure; the manner in which our operations are managed; the criteria used by our Chief Executive Officer, who functions as our Chief Operating Decision Maker (“CODM”), to evaluate segment performance; and the availability of separate financial information. Our business is organized as two operating segments, products and services. Due to their similar economic characteristics, production processes, and distribution methods, we group the product lines as the product operating segment and service offerings as the service operating segment. Our CODM reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by product and service for purposes of allocating resources and evaluating financial performance. The products and services metrics are derived on a contractual basis.
Our product revenue is comprised of sales of our broad line of low-cost, mid-range and high-end scale-out and scale-up servers and data storage solutions, as well as sales of a variety of software products that increase the efficiency, performance, and manageability of the systems or software applications for server and storage management. Our servers and data storage solutions are based on the Intel® Xeon® processors, industry standard graphics processors, and the Linux or Microsoft® Windows® operating systems. Our servers include products sold under the Altix® Supercomputer, Altix ICE Clusters, CloudRack, and Rackable Rackmount server brand names. Our data storage solutions are sold under the SGI® InfiniteStorage and COPAN™ brand names. We also sell third-party products if these products are needed to complete customer installations as part of our service offerings.
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Our service revenue is comprised of sales from two types of services: customer support services and professional services. Our customer support organization provides ongoing maintenance and technical support for our products and some third party products, as well as contracted maintenance services, hardware deployment services (install and de-install), time and materials-based services and spare parts. Our professional services organization provides technology consulting, project management, managed services, and customer education, all of which help our customers realize the full value of their information technology investments.
During the years ended June 24, 2011 and June 25, 2010 and the six months ended June 26, 2009, product revenue represented approximately 74%, 63% and 76% of total revenue, respectively, and service revenue represented approximately 26%, 37% and 24% of total revenue, respectively, on a contractual basis. Prior to the acquisition of Legacy SGI, service revenue was not material; therefore, year ended January 3, 2009 has not been presented to reflect service revenue as a separate operating segment. Further information regarding our operating segments is presented in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this Annual Report on Form 10-K and in Note 20 "Segment Information" to the consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K.
Customers
For the years ended June 24, 2011 and June 25, 2010, Amazon accounted for approximately 12% and 20% of our revenue, respectively. For the year ended January 3, 2009, Amazon and Microsoft accounted for approximately 35% and 14% of our revenue, respectively. For the six months ended June 26, 2009, Amazon and Microsoft accounted for 30% and 13% of our revenue, respectively. No other customers accounted for more than 10% of our revenue for the years ended June 24, 2011, June 25, 2010, and January 3, 2009 and the six months ended June 26, 2009. Our sales to the U.S. government, which have been historically less than 10% of our revenues, are made to and through numerous government agencies.
Information regarding revenue and gross profit by reportable segments and revenue from our customers and long-lived assets by geographic region is presented in Note 20 "Segment Information" to the consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of this Annual Report on Form 10-K.
Products
We provide a broad line of products designed to address the demands of technical computing and data management and storage applications. These products allow our customers to run data-intensive applications rapidly and to store their data. Our core products are computing systems and storage products based on Intel, AMD, and VIA processors, NVIDIA and AMD graphics processing units (GPU), and the Linux or Windows® operating system. Our storage product lines integrate disk systems, ranging from entry-level disk arrays to complex storage systems.
Our products predominantly utilize a software environment that is based on the industry-standard Linux operating system and comprehensive data management tools, as well as open source software and our own execution, development and administrative tools and utilities. We believe that our integrated software stack and the features of our architecture and hardware differentiate our product offerings in performance and ease of use. Our products can be customized to meet end-user requirements and were developed to permit easy hardware and software installation, both to add capacity and to take advantage of future technology advances.
We design our products for performance, quick deployment, efficient operation, high system availability and efficient serviceability. Our servers incorporate premium quality components, selected for superior functionality and reliability. In addition, we design our systems to minimize the number and complexity of interconnects for power and data transfer in order to improve reliability, speed of implementation and serviceability. We also integrate third party hardware and software products into solutions we sell and implement for our customers and system integrators. Our third party integration capabilities provide our customers with a single source for high performance, technical computing solutions.
We group our products into six categories: Scale Up Servers, Scale Out Servers, Workgroup Servers, Data Storage Systems, Software, and Data Center Infrastructure:
Scale Up Servers:
• | Altix® UV: SGI Altix UV targets high-end supercomputing, large-scale databases and data analytic environments. SGI Altix UV leverages next generation Intel® Xeon® x86 processors to deliver the fastest and most scalable shared memory supercomputer in the world. Altix UV enables scaling from 32 to 2,560 processing cores with architectural provisioning for up to 262,144 cores, while supporting up to 16 terabytes of global shared memory in a single system image (SSI). Altix UV can support Novell® SLES® Linux, Red Hat® Enterprise Linux®, or Microsoft Windows server. With Windows® Server 2008 R2 certification, we believe that Altix UV represents the largest and most powerful |
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certified instance of Windows Server to date, and takes technical and data-intensive workloads to new levels of speed and scalability. Superior performance is built into every SGI Altix UV system, leveraging our high speed 15 gigabytes per second interconnect NUMAlink® 5 and MPI Offload Engine (MOE) acceleration. Based on open standards, the system’s x86 architecture leverages the quad-, six- or eight-core Intel® Xeon® E7 series processor family. This allows for the use of completely unmodified Novell® SLES® or Red Hat® Enterprise Linux® or Microsoft Windows server operating systems. Altix UV is ideal for open source, custom and commercial applications, ranging from technical computing applications like ANSYS FLUENT and OpenFOAM®, to enterprise applications like Oracle business applications.
• | Altix® 450/4700: Altix 450 and 4700 are our prior-generation dual-core Intel® Itanium processor based scale-up supercomputing systems. Altix 450 scales from 2 to 38 processors (4 to 76 cores) and up to 864 gigabytes of globally addressable memory. Altix 4700 scales from 2 to 512 sockets (4 to 1024 cores) and up to 128 terabytes of globally addressable memory. Both models are supported by a complete technical computing solution stack running on industry-standard Linux® operating systems with the choice of Novell® SUSE® LINUX Enterprise Server or Red Hat® Enterprise Linux® Advanced Server operating systems. |
Scale Out Servers:
• | Rackable™: Rackable servers are comprised of industry-standard rackmount compatible form factors and along with the CloudRack® C2 family offer pre-configured data intensive solutions that support Hadoop as the overlying application layer, and can be designed and built with a customer's choice of processors. Rackable servers are available in both half-depth and standard-depth form factors. Our half-depth servers are high-density, rack-mounted systems designed specifically for large-scale data center environments. This line of servers utilizes our back-to-back cabinet design to facilitate increased physical server density, reducing floor space requirements. We are generally able to offer approximately twice the server or processor density of traditional rack-mount solutions, or we can provide similar densities but with larger server sizes, yielding better air flow characteristics, and lower cooling requirements. We offer both AC and DC powered servers, with DC power servers offering the advantage of rack-level uninterruptible power supply (UPS) versus individual server-level real private server (RPS) power supplies. These servers also provide configurable components, front-facing cable connections for enhanced serviceability and remote management functionality either based on our proprietary Roamer® or industry-standard IPMI-based technologies. Our standard-depth servers consist of several models marketed under the Rackable brand (previously under the Altix® XE brands). Standard-depth servers are generally deployed in situations requiring front-to-back cooling (also known as "hot-aisle/cold-aisle" deployments) such as installation into existing third-party racks. The standard-depth servers offer a broader range of add-in card or disk drive expansion options than what can be accommodated in our half-depth offerings. They are also used in conjunction with our other scale-up and scale-out computing systems as management nodes. |
• | CloudRack®: Sold as a rack-level solution, CloudRack C2 cabinets support up to 38 trays—a proprietary, coverless form factor that yields a high degree of flexibility and server density while conforming to industry-standard hot-aisle/cold-aisle data center environments. In addition to improved serviceability due to easy access to server components, the tray form factor enables CloudRack to be optimized for use of open-standard components at the motherboard, processor, dynamic random access memory (DRAM) and disk drive level. CloudRack’s advanced thermal design eliminates all cooling fans and power supplies at the server level, relying instead on larger cabinet-level cooling and DC rectification technology. This increases reliability while reducing power consumption. This design offers advantages for many data center environments, especially those focused on cloud computing. We also offer CloudRack X2 which supports up to nine trays in an industry-standard rack mount enclosure. We recently deployed AC powered CloudRack for some of our large customers, versus the traditional DC power. |
• | Altix® ICE: Altix ICE 8400, with its innovative blade design and quad data rate InfiniBand® interconnect, is our primary scale-out solution for large technical computing clusters. Altix ICE makes it easy to affordably scale up to 65,536 compute nodes. Its open x86 architecture makes it equally simple to deploy commercial, open source or custom applications on completely unmodified Novell® SLES® or Red Hat® Enterprise Linux® operating systems. In addition to support for Intel® Xeon® 5500 and 5600 series processors, Altix ICE supports AMD® Opteron™ 6100 series processors. |
• | Origin® 400: Origin 400 is an integrated workgroup blade system that features compute and storage area network (SAN) storage functionality, making it ideal for remote offices and small- to medium-sized enterprises. Origin 400 delivers highly differentiated enterprise features, such as virtualization capabilities that provide maximum flexibility and eliminate the need to over-invest in hardware. Extensive software certifications, including VMware®, Linux®, SAP®, Microsoft® Windows®, Microsoft® Exchange and Microsoft® SQL Server®, ensure suitability for a large number of applications. Origin 400 is a single platform that functions seamlessly as a web server, applications server, email server and back-end database server. It addresses a variety of enterprise verticals, including regional health care, education, local government, retail, software development, call centers, community banking, accounting and legal. |
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Workgroup Servers:
• | Octane® III: Octane III is marketed as a personal supercomputer, taking high-performance computing to a new level by combining the immense power and performance capabilities of a high-performance desk-side cluster with the portability and usability of a workstation. Octane III is uniquely suited for workplace environments and supports a vast range of distributed technical computing applications. Octane III is office-ready with a pedestal, one-by-two foot form factor, easy-to-use features, low maintenance requirements and support for standard office power outlets in some configurations. While a typical workstation has only eight cores and moderate memory capacity, the superior design of the Octane III permits up to 120 high-performance cores and nearly two terabytes of memory. |
Data Storage Systems:
Our storage product line, which includes the ArcFiniti™ integrated data archive solution and the SGI® InfiniteStorage, is comprised of direct attached storage (DAS), SAN, and network-attached storage (NAS), solutions designed to meet the needs of technical and cloud computing and persistent data.
• | ArcFinity: Introduced in March 2011, ArcFinity brings together for the first time the best of SGI's powerful data management hardware and software tools in a fully-integrated archive solution aimed specifically at providing a scalable, easily accessible solution to the problem of unparalleled growth of unstructured file-based data. Leveraging patented SGI technology to significantly reduce power consumption and ensure data integrity, ArcFiniti can be ordered in five different factory-integrated configurations, ranging from 154 terabytes to 1.4 petabytes of usable storage in a single rack before compression. This results in significant infrastructure savings over conventional archive systems, while also enabling easy immediate access to archived data to users. |
• | EBOD: Our expansion bunch of disk (EBOD) products leverage the capabilities of the Rackable and CloudRack server lines to maximize density, performance and capacity while reducing power consumption to a minimum. EBOD products are available in both half-depth and full-depth configurations. |
• | Storage Servers: Leveraging our unique server expertise and adding high performance input/output (I/O) capabilities, the Storage Server line-up is composed of both half-depth and full-depth servers. Scaling from 8 to 36 drives per server, and with a wide variety of network interfaces, this product line is the foundation for many of our storage solutions, which combines hardware and software to offer differentiated solutions that address core customer needs. |
• | Entry Level RAID: Our entry level redundant array of independent disk (RAID) products are focused on delivering a high price/performance ratio. Easily deployable, this line of products works equally well for small work groups, small to medium size enterprises and small data centers. With a wide range of host interfaces and feature functionality, this product line offers customers the flexibility to tune their storage array to their exact requirements. |
• | Enterprise RAID: Our InfiniteStorage 4000 series of RAID systems meets the reliability, availability and serviceability requirements for enterprise data storage needs. Scalable up to 480 disk drives, this family of products features both robust hardware and copy feature services such as Snap Shot and Remote Mirroring, enabling data protection and disaster recovery strategies. |
• | InfiniteStorage SP Line: The InfiniteStorage Select Product (“SP”) line was specifically introduced to meet the need of heterogeneous environments and the need to integrate tightly with common enterprise applications. With plug-ins for applications such as Oracle, VMware and Microsoft Exchange, the InfiniteStorage SP line seamlessly integrates into a wide variety of environments. |
• | HPC RAID: Our InfiniteStorage 6120, 15000 and 16000 are designed to meet the high performance and capacity requirements found in typical high performance compute (HPC) workloads. Offering scalability to 1,200 disk drives, guaranteed latency and extremely high bandwidth, our HPC RAID systems are suitable for the requirements of digital media, supercomputing, life sciences and remote sensor acquisition. |
• | NAS products: High performance network attached storage and file-serving solutions are available as a core part of the SGI storage ecosystem. These enable multiple node file-based NAS access to serial attached small computer system interface (SAS), InfinityBand and Fibre Channel SAN infrastructures. Whether as a Cluster NAS configuration or as a high performance file server, these solutions serve as gateways in front of the SGI InfiniteStorage RAID systems mentioned above, and can provide extremely high performance access for NAS-type workflows. |
• | MAID Systems: Our COPAN product family is based on the massive array of idle disks (MAID) storage platform. Intended to address the needs of long-term data storage in organizations, the COPAN platform is purpose built to meet persistent data handling requirements. Key to this is the ability to take disk drives completely off-line, thereby providing significant cost savings on power and cooling. In addition, COPAN’s unique packaging enables density levels unseen in typical RAID systems. The COPAN systems are available in both VTL (virtual tape library) and native MAID (disk target) configurations. |
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Software:
Our software stack for technical computing runs on standard, unmodified distributions of Novell® SLES® or Red Hat® Enterprise Linux® server operating systems. We also sell and support Novell® SLED®, Red Hat Enterprise Linux Desktop, and Microsoft Windows Server 2008 and 2008 R2 on selected systems. We also certify selected servers for use with VMware ESX.
• | SGI Management Suite: SGI Management Suite was introduced to combine a number of existing tools and capabilities into a single integrated software product, allowing the customer choice of various features. SGI Management Suite contains SGI Management Center, the current generation of our system management software drawing on our expertise in providing the highest performance and ease of use on cluster and single system image systems. It provides a consistent management interface and workflow for all SGI systems including Altix® ICE which used to have its own management software called SGI® Tempo, but which is now managed by SGI Management Center. SGI Management Center is a full remote system management console with an advanced graphical user interface (GUI) which monitors essential system metrics and initiates management actions from a single point of control. SGI Management Center is designed to reduce the time and resources spent by customers administering their systems by streamlining software maintenance procedures and automating repetitive tasks while new power monitoring features allow fine-grain monitoring of some systems based upon the hardware features. The comprehensive features of SGI Management Center are designed to lower customer’s cost of operation, increase productivity and provide for optimal use of our systems. |
• | SGI Performance Suite: SGI Performance Suite software improves performance and provides key additional capabilities for developers of technical computing applications on all of our systems supported on standard Linux distributions. SGI Performance Suite software contains the following components: SGI® Accelerate™, SGI MPT, SGI REACT™ and SGI UPC. SGI Accelerate provides features that accelerate applications, enable development of parallel and real-time applications, and manage system resources for SGI’s large scalable servers, clusters and storage. SGI Message Passing Interface (MPI) contains SGI Message Passing Toolkit (MPT) for very high levels of scalability and performance of MPI applications on our systems and software library. SGI REACT software provides features that enable real-time, guaranteed response time applications to run on SGI systems. SGI UPC is the SGI Unified Parallel Compiler which has optimization for the Altix UV server features. |
• | SGI Foundation Software: SGI Foundation Software is our suite of support tools and utilities that enable our servers to run more reliably, with improved support, and enable new server capabilities. SGI Foundation software includes key capabilities to monitor memory component failures in our servers, which minimizes or eliminates impact of these failures on system users. SGI Foundation Software also includes customized simple network management protocol (SNMP) interfaces for many of our systems, allowing them to interface easily to enterprise management systems. |
• | DMF: Our Data Migration Facility (DMF) creates and automatically manages a tiered virtual storage environment that significantly reduces customer equipment and operating costs, improves service levels and lowers customer data risks. DMF incorporates industry leading features such as automatic data migration, automatic data recall, file and volume level migration policies, custom migration policies through user-defined plug-ins, accelerated data access, partial file migration and recall, active backup, GUI-based administration and tape library management. Currently, DMF is deployed at customer sites managing multiple petabytes of data, nearly one billion files, and runs storage devices at their maximum rated speed. DMF operates in the background so there is no interruption or degradation of service to end-users and applications. DMF is one of the core components of the ArcFiniti™ solution, providing the top capabilities of DMF in an easy-to-administer and use package. |
• | CXFS™: Our CXFS software provides no-compromise data sharing, enhanced workflow, and reduced costs in data-intensive environments. It eliminates file duplication and the time it takes to move large files over networks. CXFS significantly boosts productivity where large files are shared by multiple processes in a workflow. Because it uses a SAN infrastructure, CXFS delivers much greater I/O performance and bandwidth than any network data-sharing mechanism, such as network file system (NFS) or common internet file system (CIFS). |
Data Center Infrastructure:
• | ICE Cube®: Designed to augment or replace traditional brick-and-mortar data centers of any size, ICE Cube features density levels of up to 46,080 processing cores in a standard forty feet-by-eight feet ISO container, or up to 29.8 petabytes of storage and is ideal for data centers facing power and space limitations. Our introduction marked the first-ever known deployment of a modular data center, and we are seeing strong interest in this model given the growing challenges many large-scale data centers face today around power, cooling and space. ICE Cube currently has eight designs, including universal models that support all of our server and storage products in addition to wide support for rackmount systems from other vendors. |
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• | ICE Cube® Air: The ICE Cube Air expandable line of Modular Data Centers (MDCs) creates one of the most cost efficient solutions on the market for the ever-expanding need for more data center space. As an alternative to brick-and-mortar or co-location sites, ICE Cube Air brings the latest data center technology to a location of the customer's choosing. Designed to reduce data center costs, deployment times and maintenance, ICE Cube Air is ideal for supplementing or replacing traditional data center facilities, and are also compelling as disaster recovery sites, field deployed compute and storage assets, or even to address temporary spikes in IT demand. ICE Cube Air MDCs can be deployed to nearly any location in any environment. The entry level ICE Cube Air consists of a single unit which houses up to four racks, and can become a "head unit" expanding out to as many as three additional units for a total of 16 racks. The largest ICE Cube Air consists of three 20-foot paired units with 20 racks under cover, expandable to four pairs and a total of 60 racks. Highly efficient fans, along with an innovative three-stage evaporative cooling system, allow the ICE Cube Air to run with outside air and evaporative cooling in most climates, achieving a Power Usage Effectiveness (PUE) ratio of 1.06 or less. |
• | MobiRack: MobiRack is a line of mobile, all-in-one data center cabinets designed for field deployments and is available in compact (5 rack units and 11 rack units) and midrange (14 rack units and 16 rack units) MDC configurations. |
In addition to selling these products to customers, we also make select products available through Cyclone™, our cloud computing offering. A customer using Cyclone pays for access over the Internet to our high performance computing servers and attached storage systems on a per core hour basis.
Global Services
Our global services organization is comprised of customer support services and professional services which function as a single business unit. As of June 24, 2011, the global services organization employed more than 500 employees in over 25 countries. Both customer support services and professional services develop and implement services solutions for our customers, as well as provide a complete suite of support and maintenance offerings to address the requirements and business strategies of our customers, distributors and resellers.
Our global services organization offers market competitive warranties, generally from one (1) to three (3) years and warranty upgrade options for products sold by our direct sales team and approved distributors and resellers. We are committed to meeting our customer's maintenance and support needs by providing a broad range of support programs from cost effective SGI® FullCare™ plans to the SGI® FullExpress™ 7X24 for mission critical environments. Our services may include hardware and software maintenance, system installation, configuration and management services, spares management, site preparation, technical training, as well as software upgrades and updates. We provide service to our customers directly and through approved distributors, resellers and third-party provider partners.
Customer Support. Our customers may purchase a variety of support services plans. We offer several levels of support that vary depending on specific services, response times, coverage hours and duration. In addition to our standard support plans and installation services offerings, our customer support services provide potential competitive advantages in the form of long-standing relationships with our customer base, as well as the expertise of our systems engineers. Our high quality service personnel and strong customer relationships also enable us to provide multi-vendor support services.
Professional Services. Our professional services group provides fee-based consultative services to our customers and system integrators. We architect, design, implement, and manage complex and complete solutions for our customers’ technical computing infrastructures. Our engagements are designed to ensure our customers' success with our products and technologies. Our professional services portfolio is designed to meet a variety of consulting needs, including custom time and materials, fixed price contract consulting services, standard assessments and implementation offerings, or long-term onsite staff augmentation services. Our onsite staff augmentation services in particular enable us to develop and maintain long-term relationships with our customers whereby we gain a deeper understanding of industry-specific information technology needs.
Sales and Distribution
We sell our systems and services primarily through our direct sales force and distributors, system integrators, value-added resellers, OEMs and channel partners. Our sales teams consist of sales representatives and sales engineers, who are supported by channel, inside sales, sales support and professional services personnel. Our professional services and engineering personnel collaborate with our sales teams in all stages of the sales and integration process, including developing proposals that address the technical requirements of our customers, performing proofs of concept and benchmarking system performance.
By selling our products through our direct sales team, we are able to maintain close client contact and feedback throughout the entire sales process. Our sales process begins with leads generated through targeted marketing programs and by our inside sales team, which are then logged, qualified and assigned to an account executive. After an initial lead qualification,
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our sales executives and sales engineers collect information regarding the customer’s data center environment and application requirements. We then collaborate with the customer’s technical point of contact and our own internal technical resources to agree upon a particular system configuration for the customer. For larger customers, we allow evaluation of one or more hardware configurations to enable the customer to conduct their own benchmarking analyses.
We currently have direct sales personnel in various countries, including the United States, United Kingdom, Germany, Australia, France, China, India, Japan, Czech Republic, Canada, Spain, Netherlands, Brazil, and Singapore. We augment our sales coverage with indirect coverage via distributor and channel partner arrangements in countries in which we have a presence. In markets where we have no direct sales personnel, we provide our products through our distributors and channel partners. We are engaged in a multi-year program to further develop additional channel partner relationships in order to improve our indirect sales efforts, expand our customer base and enter new markets. Our direct sales personnel are responsible for managing all direct or indirect sales with specific named accounts and our channel sales personnel are responsible for managing all sales that are not with specific named accounts.
In our largest markets, our sales representatives have a vertical industry market focus to more effectively leverage their domain expertise. We establish direct sales groups focused on different industry markets. One group concentrates on the defense and intelligence, scientific research and higher education markets while the second focuses on the commercial business intelligence and data analytics markets. We have developed expertise in a number of vertical industry markets, including weather and climate; physical sciences; life sciences; energy, aerospace and automotive; financial services; internet and media and entertainment. As part of our emphasis on increased sales within these vertical industry markets, we have a program to identify and develop customer workflows in each of the vertical industry markets. The customer workflows allow us to offer our customers standard solutions that include our hardware, software, storage and professional services.
We have increased our sales and marketing efforts recently in the commercial business intelligence and data analytics markets in an effort to expand our penetration of these markets. We continue to expand our targeted customer base to include all organizations with technical computing requirements, the largest firms through our direct selling force and other firms through our channel partners. Our channel program is designed to work with those partners who provide additional geographic and vertical market coverage for SGI-based solutions. We have created a channel council to increase communication between channel partners and our executive team in order to guide this program.
Marketing
Our marketing organization is active in all markets in which we sell products and services and continuously executes on programs that encompass sales tools, brand awareness, and demand generation. The marketing team consists of product marketing, field marketing, corporate marketing, and channel marketing. In order to drive market demand, we create and deliver a number of marketing vehicles, including industry and customer events, webinars, case studies, advertisements and white papers to showcase and demonstrate the capabilities of our systems. Our marketing channels include a mix of product-based activities which leverage our hardware and software expertise and our industry-based activities which leverage our understanding of customer challenges and applications. Our marketing team also works with industry experts, analysts and members of the press to generate awareness about our products and services. Using our history and experience in
the technical computing community, we issue white papers on technology trends such as performance ratings, benchmark results, power, cooling and system management. We participate in worldwide business and industry events throughout the year as both exhibitors and speakers, thereby maintaining a constant presence with our customers, prospects, and industry influencers.
We maintain active programs to encourage independent software development on our differentiated platforms. Through our Solution Network Program™, we provide software, marketing support and access to hardware to attract and enable software developers to leverage the differentiations in our hardware and software products in their applications and hence add value to our customers. This program includes the key independent software vendor’s (“ISV”) covering all our target market segments and provides technical information to ISVs for developing, porting, tuning and differentiating their applications and opportunities for promoting their SGI-based solutions. We also engage in co-marketing activities with many of our ISVs.
We also develop co-marketing partnerships with our major customers and suppliers. We provide and maintain a comprehensive channel portal and marketing program, which provides significant marketing support to an active and established base of worldwide channel partners.
Research and Development
Our research and development organization includes hardware design engineers, software architects and developers, and storage engineers. We focus our research and development efforts where we believe differentiation from a standard component, product or technology holds the highest potential for increasing our market share. These include shared memory computing
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system architecture; integrated system implementation optimized for space, power, performance, reliability and usability; the Linux development and operating environment; software to exploit the differentiated features of our computing platforms; and storage software to enable better performance, scalability and ease of management of large amounts of data. We have developed cooperative working relationships with many of the world’s most advanced technology companies, such as AMD and Intel, to leverage their research and development capabilities. Additionally, we work closely with our customers to develop product innovations and incorporate these into subsequent product design. This cooperative approach allows us to develop products that meet our customers’ needs in a cost-effective manner. We monitor new technology developments, new component availability, and the impact of evolving standards through customer and supplier collaboration. From time to time, we accept third-party funding, provided the work being funded is consistent with and contributes to our strategic roadmap.
UV System development. We have invested significantly in the development of application-specific integrated circuits (ASICs) and interconnect technology in order to create next-generation shared-memory systems. We have recently completed the introduction of the Altix UV shared-memory system based on the fifth-generation of our NUMAlink interconnect and NUMAflex architecture. This architecture is intended to increase substantially the performance and scalability of our single system image shared-memory products, as well as to incorporate hybrid processing elements and provide optimized features to enhance application performance on a cluster computing system.
System architecture and hardware design. We also recently introduced the Altix ICE 8400, which offers superior system configuration flexibility and is based on InfiniBand interconnect. We continue to emphasize scalability, extremely dense packaging, dramatic power and thermal efficiency, enterprise-class reliability, availability and serviceability features, impressive configurability, and strong interoperability in our designs. We expect these design efforts to enable us to introduce products that reach broader market segments.
Storage. We develop software for file serving, data management and energy efficient data archival for petascale environments. We select “best-in-class” storage hardware, including disk arrays and controllers from OEM suppliers that meet the particular needs of our customers’ applications and environments. Our engineers design software for efficient data access and management of these storage systems and we qualify storage systems ranging from small appliances to enterprise-class storage systems. We strive to tightly integrate the storage software and the hardware systems. We optimize the software that we include in our storage solutions for capacity-driven and performance-driven applications and environments.
Software. Our research and development efforts include the development of software tools and utilities that facilitate more efficient management and operation of our systems as well as enable software applications to run faster on our systems. In addition, we continue to enhance our software development and operating environments. Our experience in creating and implementing complex systems benefits our development of new tools. Leveraging this experience, we have developed the SGI Management Center as a means for accelerating results. SGI Management Center is a premier software environment for high performance technical computing. It is a complete, integrated environment from desk side to supercomputer. It consists of extensible SGI software based on open standards and services that improve the productivity of users, developers and system administrators.
Modular Data Center. We have revolutionized data center design principles through the development of ICE Cube. ICE Cube meets the need for data center facility capacity with a just-in-time approach, minimizing up-front costs. Our engineers have designed multiple container models to provide the configurability to address varying IT and site requirements—all while delivering extraordinary density levels of up to 46,080 computational cores or 29.8 petabytes of data storage per container. We have designed ICE Cube models to accommodate varying types of IT equipment with ease, including third-party equipment as well as SGI server and storage systems. These many advantages make ICE Cube the ideal data center solution for a wide range of deployment scenarios, augmenting or replacing traditional data centers of any size.
Through our global benchmarking and solutions centers, we provide access to a full range of our server and storage hardware and software, integrated in a wide variety of configurations, for application testing, benchmarking and performance tuning by end-users. At these centers, our personnel, including our application benchmarking team and domain, algorithm, technical computing and facility experts, work with end-users to build and optimize large-scale cluster computing systems, conduct proof-of-concept testing and simulate end-user environments. Through these centers, we also provide demonstrations of the standardized SGI workflow solutions that we have developed and are developing for their vertical markets. In addition, the SGI® Global Developer Program provides ISVs, systems integrators and consultants technical information for developing and porting their applications, as well as access to our online systems to streamline the implementation.
During the years ended June 24, 2011, June 25, 2010 and January 3, 2009, and the six months ended June 26, 2009, our research and development expenses were $54.1 million, $56.9 million, $14.9 million and $10.7 million, respectively, representing 9%, 14%, 6% and 10% of total revenue in each respective period. During the years ended June 24, 2011 and June 25, 2010 and the six months ended June 26, 2009, we received $1.3 million, $2.0 million and $0.9 million, respectively, in
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third-party funding which offset a portion of our research and development expenses. During the year ended January 3, 2009, we did not receive any third-party funding.
We believe that focused investments in research and development are critical to our future performance and competitiveness in the marketplace. Our investments in this area will directly relate to enhancement of our current product line, development of new products that achieve market acceptance, and our ability to meet an expanding range of customer requirements. As such, we expect to continue to spend on current and future product development efforts.
Manufacturing and Operations
Our sole manufacturing facility, located in Chippewa Falls, Wisconsin, is responsible for worldwide production, supply-chain management and order fulfillment. Our manufacturing operations involve the onsite assembly and testing of high-level subassemblies, subsystems and complete systems, configured to customer specifications. We subject complete systems to environmental and functional testing prior to shipment. Our consolidated worldwide manufacturing operations increase our control over our supply chain and our inventories. Our manufacturing facility is ISO 9001:2008 certified.
Our supply base is composed of suppliers that meet our rigorous quality and technology standards. We maximize the use of industry-standard components in our products to reduce cost, and we custom design components where we believe that doing so adds value to the customer. We have established close relationships with key suppliers and work closely with them on new product introduction plans, strategic inventories, quality and delivery commitments. We depend on a limited number of key sub-contractors for the production of certain assemblies and multi-source standard components to minimize supply chain risk. Consistent with industry practice, we acquire components through a combination of formal purchase orders, supplier contracts and open orders based on projected demand information. These purchase commitments typically cover our requirements for periods ranging from 30 to 120 days.
Competition
The server and storage markets are highly competitive, with rapid technological advances and constantly improving price/performance ratios. These advances and pricing pressures result in frequent product introductions and short product life cycles. We believe that purchasers make buying decisions based on many factors, including: product quality and reliability, ease of system management, application availability, price/performance ratios, software functionality, product features, total cost of ownership, and quality customer service and support. We believe we compete effectively in each of these areas by providing differentiated products, services and support that address the needs of our customers.
The market for our products is highly competitive, rapidly evolving and subject to changing technology, customer needs and new product introductions. In the server market, we compete primarily with large and build-to-order vendors of x86 servers based in the United States, such as Dell Inc. (“Dell”), Hewlett-Packard Company (“HP”), International Business Machines Corporation (“IBM”), Oracle Corporation (“Oracle”) and Cray, Inc. In the storage market, we compete primarily with EMC Corporation (“EMC”), NetApp Inc. (“NetApp”) and Hitachi Data Systems, Inc. (“HDS”). In all of our markets we compete principally on the basis of product features and performance, design-to-order capabilities, total cost of ownership, customer service, configurability and manageability and the ability to deliver environmentally friendly solutions. The ability of competitors to leverage multiple business lines, which we historically have not offered, allows them to target customers with benefits and deeper discounted pricing. Also, as we continue to enter international markets, we anticipate facing additional competition from foreign vendors.
Our largest competitors have far greater resources, greater name recognition, larger customer bases and greater financial, technical, sales and marketing resources. For the largest systems in the supercomputing category, our principal competitor is IBM. We also compete with other systems manufacturers and resellers of systems based on x86 class processors with our CloudRack, Rackable and Altix ICE product lines. Because a computing system is a substantial investment that can require extensive service and support commitments, our smaller size can have a significant competitive impact. In some instances, the diversified business of our competitors can support deep discounting to gain market share in the technical computing market. In addition, particularly in the storage market, there are many new companies that are competing with us and rapidly introducing new products and technology.
Proprietary Rights and Licenses
We rely on a combination of patent, trademark, copyright and trade secret laws and disclosure restrictions to protect our intellectual property rights. We also enter into confidentiality and proprietary rights agreements with our employees, consultants and other third parties. We currently have issued and have pending approximately 600 U.S. patents in the United States and abroad, and we intend to continue to protect our intellectual property with patents. We also hold various U.S. and foreign trademarks as well as copyrights in our original software. Although we believe the ownership of patents, copyrights,
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trademarks and service marks, and trade secrets is an important factor in our business and that our success depends in part on ownership rights, we rely primarily on the innovative skills, technical competence and marketing abilities of our personnel to differentiate our products and services within the marketplace.
As is customary in our industry, we license from third parties a wide range of software, including the Linux, Microsoft CCS and UNIX operating systems, for internal use and use by our customers. We also license various patents and trade secrets of third parties through agreements such as patent or technology licenses or cross-licenses. We expect the extent of such IP license and cross-license activities may increase as the scope of our product line increases. In some cases, our intellectual property is licensed to third parties.
Our success will depend in part on our ability to protect our intellectual property portfolio and proprietary information. From time to time, we may need to enforce our intellectual property rights through litigation. If a claim is asserted that we have infringed the intellectual property rights of a third party, we may be required to seek licenses under those intellectual property rights, if available, pay damages and/or redesign our products. If we were to litigate, we would incur significant costs, litigation may be a significant distraction for our management team, and we might not ultimately prevail. Litigation or changes in the interpretation of intellectual property laws could expand or reduce the extent to which we or our competitors are able to protect intellectual property and could require significant changes in product design. Because of technological changes and the extent of issued patents in our industry, it is possible certain components of our products and business methods may unknowingly infringe existing patents of others. Our industry has seen a substantial increase in litigation with respect to intellectual property matters, and we have been engaged in intellectual property disputes as a defendant as well as in an effort to protect our rights. We expect that we will engage in patent infringement litigation from time to time. See Part I, Item 1A. “Risk Factors” in this Annual Report on Form 10-K.
Backlog
We manufacture products based on a combination of specific order requirements and forecasts of our customers’ demand. Orders are generally placed by customers on an as-needed basis. An accepted order can be canceled only with our written consent, and only on terms that will indemnify us against resulting losses, including, but not limited to, any costs already incurred in performing the order. In certain circumstances, purchase orders are subject to change with respect to quantity of product or timing of delivery resulting from changes in customer requirements. We experience some quarterly variability in our product and service revenues in any given period. Factors impacting the amount of product and service revenue in any given period includes deployment time of our larger systems, manufacturing and delivery schedules, changes in delivery schedules requested by our customers and the timing of our product development. Our business is also characterized by intra-quarter variability in demand and varying customer delivery and acceptance schedule. Accordingly, the timing for recognition of our backlog as revenue may be difficult to predict and current levels of backlog may not be a meaningful indicator of future revenue in any given quarter.
Environmental Laws
Our products and certain aspects of our operations are regulated under various environmental laws in the U.S., Europe and other parts of the world. These environmental laws are broad in scope and regulate numerous activities including the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites, the content of our products and the recycling and treatment and disposal of our products. Certain of these laws also pertain to tracking and labeling potentially harmful substances that have been incorporated into our products. These product labeling laws require us to know whether certain substances are present in our products, and to what degree. Environmental laws may limit the use of certain substances in our products, or may require us to provide product safety information to our customers if certain substances are present in our products in sufficient quantities. Additionally, we may be required to recycle certain of our products when they become waste. Compliance with environmental laws and regulations across multiple jurisdictions is complex and will require further capital expenditures in future periods, including expenditures for the implementation of new processes in supply chain management and order fulfillment. We believe that these expenditures are necessary to maintain our presence and competitive position in certain markets, including in particular the European Union. No material capital expenditures for environmental control facilities were made in fiscal year 2011 and none are planned for fiscal year 2012. See Part I, Item 1A. “Risk Factors” in this Annual Report on Form 10-K.
Employees
As of June 24, 2011, we had over 1,500 employees worldwide. Our future success will require that we continue to retain and motivate highly qualified technical, sales, marketing, finance and management personnel. We have never had a work stoppage, and no employees are represented by a labor union. We have workers’ councils where required by the European Union or other applicable laws.
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Corporate Data
We were originally incorporated as Rackable Corporation and later changed our name to Rackable Systems, Inc. (“Rackable Systems”). Rackable Systems® was incorporated in the state of Delaware in December 2002 in connection with the acquisition of substantially all of the assets and liabilities of Rackable Systems’ predecessor company. On May 8, 2009, we completed the acquisition of substantially all of the assets, excluding certain assets unrelated to the ongoing business, and assumed certain liabilities of Silicon Graphics, Inc. Effective May 18, 2009, Rackable Systems changed its name to Silicon Graphics International Corp.
Our website address is www.sgi.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and 10-QT, current reports on Form 8-K, and amendments to those reports are available, without charge, on the investor relations section of our website, www.sgi.com, as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Our Corporate Governance Guidelines, Code of Business Conduct and Ethics and the charters of the Audit Committee, Compensation Committee, Strategic Planning Committee and Nominating and Corporate Governance Committee of our Board of Directors are also posted on our website at http://investors.sgi.com/. Copies are also available, without charge, from the Corporate Secretary, Silicon Graphics International Corp., 46600 Landing Parkway, Fremont, CA 94538. The information contained in, or that can be accessed through, our website is not incorporated by reference herein.
Executive Officers of the Registrant
Our executive officers, their ages and positions as of August 29, 2011, are as follows:
Name | Age | Position | ||
Mark J. Barrenechea | 46 | Chief Executive Officer, President and Director | ||
James Wheat | 53 | Senior Vice President and Chief Financial Officer | ||
Anthony Carrozza | 56 | Senior Vice President of Worldwide Sales | ||
Timothy Pebworth | 45 | Vice President and Chief Accounting Officer | ||
Jennifer Pratt | 50 | Senior Vice President of Human Resources | ||
Rick Rinehart | 52 | Senior Vice President of Services | ||
Mark Barrenechea joined SGI in November 2006 as a member of our board of directors, and in April 2007 became our President and Chief Executive Officer. Previously, Mr. Barrenechea served as Executive Vice President and CTO for CA, Inc. (“CA”), (formerly Computer Associates International, Inc.), a software company, from 2003 to 2006 and was a member of the executive management team. Prior to CA, Mr. Barrenechea served as Senior Vice President of Applications Development at Oracle Corporation, an enterprise software company, from 1997 to 2003, managing a multi-thousand person global team while serving as a member of the executive management team. From 1994 to 1997, Mr. Barrenechea served as Vice President of Development at Scopus, an applications company. Prior to Scopus, Mr. Barrenechea was with Tesseract, an applications company, where he was responsible for reshaping the company’s line of human capital management software as Vice President of Development. Mr. Barrenechea holds a Bachelor of Science degree in computer science from Saint Michael’s College.
James Wheat joined SGI in April 2008 and in May 2008 was named as our Senior Vice President and Chief Financial Officer. From 2006 to 2008, Mr. Wheat served as the Vice President and Corporate Controller at Lam Research, a publicly traded company engaged in designing, manufacturing, marketing and servicing semiconductor processing equipment. Mr. Wheat served as Corporate Controller at Asyst Technologies, Inc. from 2005 to 2006, a publicly traded company that develops, manufactures, sells and supports integrated hardware and software automation systems and he also served as acting principal financial officer in 2006. From 2003 to 2004, Mr. Wheat served as Senior Director of Finance for Sybase, Inc., an enterprise software company. Prior to 2003, Mr. Wheat held senior financial management positions at various public and private companies including Tele-Video, Sunterra Corporation, Raychem, Core-Mark International, Spectra Physics and Honeywell. Mr. Wheat holds a B.B.A. in Accounting and Business from the University of Michigan and a Masters of Business Administration from the Wharton School of the University of Pennsylvania and is a Certified Public Accountant in California.
Anthony Carrozza joined SGI in March 2008. In his role as Senior Vice President of Worldwide Sales, Mr. Carrozza is responsible for SGI’s product sales for both direct and indirect customers on a worldwide basis. Mr. Carrozza brings more than twenty five years of worldwide sales experience in the technology sector. Prior to joining SGI, Mr. Carrozza was with Neterion, Inc. from 2006 to 2008, a company that designed and manufactured 10 gigabyte Ethernet ASICs, where he was vice president, sales. Mr. Carrozza was with Quantum Corporation, a manufacturer of storage systems, from 1987 to 2006. When Mr. Carrozza left Quantum, he held the title of senior vice president, worldwide sales and was a member of the executive management team. Mr. Carrozza holds a Bachelor of Arts degree in political science from Iona College.
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Timothy Pebworth became the Vice President, Corporate Controller and Chief Accounting Officer of SGI in May 2008. Prior to joining the Company, Mr. Pebworth served as the Chief Financial Officer of 24/7 Customer, Inc. from April 2007 to April 2008 and as the Corporate Controller from April 2005 to March 2007. From December 2002 to March 2005, Mr. Pebworth was a Senior Finance Manager at Intel Corporation serving in the Technology Manufacturing Group overseeing microprocessor, chipset and flash costing and inventory. Prior to leaving Intel in April 2005, and while still serving in his capacity in the Technology Manufacturing Group, Mr. Pebworth was promoted to a Controller position. Mr. Pebworth holds a M.B.A. from the Peter F. Drucker Graduate School of Management and a B.A. from Ambassador College in Pasadena, California. He is a Certified Public Accountant and Certified Management Accountant.
Jennifer Pratt joined SGI in March 2005 and moved into her current role as Senior Vice President of Human Resources in May 2009. Ms Pratt brings more than twenty five years of human resources experience. Prior to joining SGI, Ms. Pratt was the senior director of human resources at New Wave Research, a manufacturer of laser based systems, from 2003 to 2005. Ms. Pratt served as the vice president of human resources of Appiant Technologies, Inc., a unified communications, software applications company, from 2000 to 2003. Prior to 2000, Ms Pratt held senior human resource positions in a variety of industries including technology, manufacturing and healthcare. Ms. Pratt holds a Bachelor of Science degree in Business Administration from Morningside College, Sioux City, Iowa.
Rick Rinehart joined SGI in May 2010 as the Senior Vice President of Services and is responsible for SGI’s services on a worldwide basis. Mr. Rinehart has over 20 years of experience in the service business, and most recently came from Oracle (Sun Microsystems), where he held the position of Vice President, Global Customer Services for North America. Prior to that he held positions as Senior Director, Sun Federal Services with Sun Microsystems from 2006 to 2007, and from 2005 to 2006, he served as Director of Services for Storagetek for the federal business, which was acquired by Sun Microsystems. Prior to that, Mr. Rinehart worked as General Manager for NCR Corporation from 2001 to 2005. He holds a BS in Information Systems Management from the University of Maryland, and Master of Science degree in Business Administration through Central Michigan University.
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Item 1A. Risk Factors
Risks Related To Our Business and Industry
Our periodic operating results have fluctuated significantly in the past and will continue to fluctuate in the future, which could cause our stock price to decline.
Our quarterly and annual periodic operating results have fluctuated significantly in the past, and we believe that they will continue to fluctuate in the future, due to a number of factors, many of which are beyond our control. We expect that our revenue, gross margin, and earnings per share will fluctuate on a periodic basis in future periods. If in future periods our operating results do not meet the expectations of investors or analysts who choose to follow our company, our stock price may fall. Factors that may affect our periodic operating results include the following:
• | fluctuations in the buying patterns and sizes of customer orders from one quarter to the next; |
• | increased competition causing us to sell our products or services at decreasing margins; |
• | location and timing requirements for the delivery of our products and services; |
• | longer acceptance cycles of our products by certain customers; |
• | addition of new customers or loss of existing customers, especially involving our largest customers; |
• | gross margin obtained on the sales of products and services, especially to our largest customers; |
• | write-off of excess and obsolete inventory; |
• | impairment and shortening of the useful life of components from our suppliers; |
• | unexpected changes in the price for, and the availability of, components from our suppliers; |
• | our ability to enhance our products with new and better designs and functionality; |
• | costs associated with obtaining components to satisfy customer demand; |
• | productivity and growth of our sales force; |
• | actions taken by our competitors, such as new product announcements or introductions or changes in pricing; |
• | revenue and gross margin disparity among our lines of server product and storage product lines; |
• | market acceptance of our newer products, such as Arcfinity and ICE Cube AIR; |
• | technology regulatory compliance, certification and intellectual property issues associated with our products; |
• | the payment of unexpected legal fees and potential damages or settlements resulting from protecting or defending our intellectual property or other matters; |
• | the payment of significant damages or settlements resulting from faulty or malfunctioning products or the provision of services unsatisfactory to our customers; |
• | the market downturn and delay in orders of our products; |
• | compliance costs associated with new laws, rules and regulations, including environmental regulations; |
• | the payment of unexpected IP licensing royalties to third-parties who successfully assert that our product(s) infringe their intellectual property rights; |
• | the departure and acquisition of key management and other personnel; and |
• | general economic trends, including changes in information technology spending or geopolitical events such as war or incidents of terrorism. |
We face intense competition from the leading enterprise computing companies in the world as well as from emerging companies. If we are unable to compete effectively, we might not be able to achieve sufficient market penetration, revenue growth or profitability.
The markets for compute server products and storage products are highly competitive. In addition to intensely competitive smaller companies, we face challenges from some of the most established companies in the computer industry, such as Dell Inc., Hewlett-Packard Company (“HP”), International Business Machines Corporation, Cray, Inc. and Oracle Corporation in the computer server market. In the storage market, we compete primarily with EMC Corporation, HP, Hitachi Data Systems, Inc, and NetApp, Inc. Our largest competitors have at least the following advantages over us:
• | substantially greater market presence and greater name recognition; |
• | substantially greater financial, technical, research and development, sales and marketing, manufacturing, distribution and other resources; |
• | longer operating histories; |
• | a broader offering of products and services; |
• | more established relationships with customers, suppliers and other technology companies; and |
• | the ability to acquire technologies or consolidate with other companies in the industry to compete more effectively. |
Because these competitors may have greater financial strength than we do and are able to offer a more diversified bundle of products and services, they may have the ability to severely undercut the pricing of our products or provide additional
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products or servicing at little or no cost, which would make us less competitive or force us to reduce our selling prices, negatively impacting our margins. We have had transactions where one or more competitors undercut our prices causing us to reduce our price, which negatively impacted our gross margin on that transaction and our overall gross margin. In addition, we have, on occasion, lost sales opportunities due to a competitor undercutting the pricing of our products or maintaining superior brand recognition. These competitors may be able to develop products that are superior to the commercially available components that we incorporate into our products, or may be able to offer products that provide significant price advantages over those we offer. For instance, a competitor could use its resources to develop proprietary motherboards with specifications and performance that are superior in comparison with the platforms that are currently available to the marketplace, which could give that competitor a distinct technological advantage. In addition, if our competitors’ products become more widely accepted than our products, our competitive position will be impaired.
The intense competition we face in the sales of our products and services and general economic and business conditions can put pressure on us to change our prices. If our competitors offer deep discounts on certain products or services or develop products that the marketplace considers more valuable, we may need to lower prices or offer other favorable terms in order to compete successfully. Any such changes may reduce margins and could adversely affect operating results.
As the enterprise computing industry evolves, we expect to encounter additional competitors, including companies in adjacent technology businesses such as storage and networking infrastructure and management, companies providing technology that is complementary to ours in functionality, such as data center management software, contract manufacturers, and other emerging companies that may announce server product offerings. Moreover, our current and potential competitors, including companies with whom we currently have strategic alliances, may establish cooperative relationships among themselves or with other third parties. If this occurs, new competitors or alliances may emerge that could negatively impact our competitive position.
We intend to continue to expand our operations and increase our expenditures in an effort to grow our business. If we are not able to manage this growth and expansion, or if our business does not grow as we expect, our operating results may suffer.
We intend to continue to grow our business by entering new markets, acquisitions, developing new product and service offerings and pursuing new customers. In connection with this growth, we expect that our annual operating expenses may increase over the next several years to the extent we expand our sales and marketing, research and development, manufacturing and production infrastructure, and our customer service and support efforts. Our failure to timely or efficiently expand operational and financial systems and to implement or maintain effective internal controls and procedures could result in additional operating inefficiencies that could increase our costs and expenses more than we had planned and might cause us to lose the ability to take advantage of market opportunities, enhance existing products, develop new products, satisfy customer requirements, respond to competitive pressures or otherwise execute our business plan. Additionally, if we do increase our operating expenses in anticipation of the growth of our business and this growth does not meet our expectations, our financial results could be negatively impacted.
If we acquire or invest in other companies, assets or technologies and we are not able to integrate them with our business, or we do not realize the anticipated financial and strategic goals for any of these existing or future transactions, our financial performance may be impaired.
If appropriate opportunities present themselves, as they have in the past, we may consider acquiring or making investments in companies, assets or technologies that we believe are strategic. We only have limited experience in doing so, and for any such company, asset or technology which we successfully acquire or invest in, we will be exposed to a number of risks, including:
• | we may find that the acquired company, asset or technology does not further our business strategy, that we overpaid for the company, asset or technology or that the economic conditions underlying our acquisition decision have changed; |
• | we may have difficulty integrating the assets, technologies, operations or personnel of an acquired company, or retaining the key personnel of the acquired company; |
• | our ongoing business and management’s attention may be disrupted or diverted by transition or integration issues and the complexity of managing geographically or culturally diverse enterprises; |
• | we may encounter difficulty entering and competing in new product or geographic markets or increased competition, including price competition or intellectual property litigation; and |
• | we may experience significant problems or liabilities associated with product quality, technology and legal contingencies relating to the acquired business or technology, such as intellectual property or employment matters. |
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For example, in connection with our acquisition of Terrascale Technologies, Inc., we expended a great deal of effort and resources, but were unable to generate revenue, increase gross profit or contribute positive cash flow into our business, sufficient to realize our investment, causing us to exit this product line. This resulted in an impairment charge of $17.5 million during the year ended January 3, 2009. We have presented the results of this product line as discontinued operations in our consolidated financial statements.
If we were to proceed with one or more significant acquisitions or investments in which the consideration included cash, we could be required to use a substantial portion of our available cash. To the extent we issue shares of capital stock or other rights to purchase capital stock, including options and warrants, existing stockholders might be diluted and earnings per share might decrease. In addition, acquisitions and investments may result in the incurrence of debt, large one-time write-offs, such as acquired in-process research and development costs and restructuring charges.
We rely on sales to U.S. government entities. A loss of contracts, a failure to obtain new contracts or a reduction of sales under existing contracts with the U.S. government could adversely affect our operating performance.
We expect to derive a significant portion of our revenue directly from U.S. government entities, research institutions funded by the U.S. government and third-parties that sell directly to the U.S. government. In addition, many of our scientific and research customers depend on U.S. government funding for their information technology budgets. As a result, a significant portion of our revenue depends on sales to or funded by the U.S. government such that a loss of a U.S. government contract or the failure to obtain new contracts could adversely affect our operating performance. Sales to or funded by the U.S. government present risks in addition to those involved in sales to commercial customers, including potential disruptions and delays due to changes in appropriation and spending patterns. Our U.S. government business is also highly sensitive to changes in the U.S. government’s national and international priorities and budgeting. Changes in the continuing war on terrorism may affect funding for our programs or result in changes in government programs or spending priorities that may harm our business. In addition, the U.S. government can typically terminate or modify its contracts with us at any time for its convenience. Our U.S. government business is also subject to specific procurement regulations and a variety of other requirements. Failure to comply with these or other applicable regulations and requirements could lead to suspension or debarment from U.S. government contracting or subcontracting for a period of time. Any disruption or limitation in our ability to do business with the U.S. government or entities funded by the U.S. government would materially and adversely affect our revenue and operating results.
In addition, we have not historically required government security clearances which are necessary in some cases to do business with the U.S. government, and have limited experience in obtaining or maintaining these security clearances for us or our employees. Failure to retain necessary security clearances could negatively impact our business with the U.S. Government.
We have extensive international operations, which subject us to additional business risks.
A significant portion of our sales occur and are expected to occur in international jurisdictions, including countries outside of Europe, and Asia where we have limited operating experience. International operations involve inherent risks that we may not be able to control, and risks of which we may not be aware, including:
• | supporting multiple languages; |
• | recruiting sales and technical support personnel internationally with the skills to design, manufacture, sell and support our products; |
• | complying with governmental regulation of encryption technology and regulation of imports and exports, including obtaining required import or export approval for our products; |
• | increased complexity and costs of managing international operations; |
• | increased exposure to foreign currency exchange rate fluctuations; |
• | commercial laws and business practices that favor local competition; |
• | multiple, potentially conflicting, and changing governmental laws, regulations and practices, including differing export, import, tax, labor, anti-bribery and employment laws, including potential changes to the tax laws in Japan; |
• | longer sales cycles and manufacturing lead times; |
• | difficulties in collecting accounts receivable; |
• | difficulties associated with repatriating cash generated or held abroad in a tax-efficient manner; |
• | reduced or limited protection of intellectual property rights; |
• | more complicated logistics and distribution arrangements; and |
• | political and economic instability, as well as foreign currency exchange risk. |
International political instability may halt or hinder our ability to do business and may increase our costs. Various events, including the occurrence or threat of terrorist attacks, increased national security measures in the United States and other countries, and military action and armed conflicts, may suddenly increase international tensions. In addition, other international crises or concerns about these crises, such as potential pandemics or natural disasters, may have an adverse effect on our operations as well as the world economy generally and could adversely affect our business operations or the operations of our
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contract manufacturers and suppliers. Additionally, the ongoing international credit crisis could adversely affect our operations, including our international operations in particular.
We may experience foreign currency gains and losses.
We conduct a significant number of transactions in currencies other than the U.S. Dollar. Changes in the value of major foreign currencies, particularly the Euro, British Pound, and Japanese Yen relative to the U.S. Dollar can significantly affect revenues and our operating results. Our revenues and operating results are adversely affected when the dollar strengthens relative to other currencies and are positively affected when the dollar weakens. For example, our revenues and operating results in fiscal year 2010 were unfavorably affected by the strengthening of the U.S. Dollar relative to other major foreign currencies.
For the year ended June 24, 2011, our international revenue was $240.2 million and as of June 24, 2011, the balance in our foreign currency cash accounts is $70.2 million. At June 24, 2011, we had no foreign currency forward contracts or option contracts. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and, thus, not competitively priced in foreign markets. Additionally, a decrease in the value of the U.S. dollar relative to foreign currencies could increase our operating costs in foreign locations. In the future, a larger portion of our international revenue may be denominated in foreign currencies, which will subject us to additional risks associated with fluctuations in those foreign currencies. In addition, we may be unable to successfully hedge against any such fluctuations.
Our international sales may require export licenses and expose us to additional risks.
Our sales to customers outside the United States are subject to U.S. export regulations. Under these regulations, sales of many of our high-end products require clearance and export licenses from the U.S. Department of Commerce. Our international sales would be adversely affected if these regulations were tightened, or if they are not modified over time to reflect the increasing performance of our products. Delay or denial in the granting of any required licenses could make it more difficult to make sales to non-U.S. customers. In addition, we could be subject to regulations, fines and penalties for violations of import and export regulations if we were found in violation of these regulations. End-users could circumvent end-user documentation requirements that are intended to aid in our compliance with export regulations, potentially causing us to violate these regulations. These violations could result in penalties, including prohibitions on us from exporting our products to one or more countries, and could materially harm our business, including our sales to the U.S. government.
Our sales cycle requires us to expend a significant amount of resources, and could have an adverse effect on the amount, timing and predictability of future revenue.
The sales cycle of our products, beginning from our first customer contact to closing of the sale, often ranges from three to six months. We may expend significant resources during the sales cycle and ultimately fail to close the sale. The success of our product sales process is subject to factors, over which we have little or no control, including:
• | the timing of our customers’ budget cycles and approval processes; |
• | our customers’ existing use of, or willingness to adopt, open standard server products, or to replace their existing servers or expand their processing capacity with our products; |
• | the announcement or introduction of competing products; and |
• | established relationships between our competitors and our potential customers. |
We expend substantial time, effort and money educating our current and prospective customers as to the value of our products. Even if we are successful in persuading lower-level decision makers within our customers’ organizations of the benefits of our products, senior management might nonetheless elect not to buy our products after months of sales efforts by our employees or resellers. If we are unsuccessful in closing sales, after expending significant resources, our revenue and operating expenses will be adversely affected.
We rely primarily on our direct sales force to generate revenue, and may be unable to hire additional qualified sales personnel in a timely manner or retain our existing sales representatives.
To date, we have relied primarily on our direct sales force to sell our products in the United States. Because we are looking to expand our customer base and grow our sales to existing customers, we will need to continue to hire qualified sales personnel, both in the United States and abroad, if we are to achieve our business objectives. The competition for qualified sales personnel in our industry is very intense. If we are unable to hire, train, deploy and manage qualified sales personnel in a timely manner, our ability to grow our business will be impaired. For example, in the past it has taken us up to six months to hire a qualified sales executive and it may take a newly-hired sales executive up to nine months after hiring to become productive, resulting in aggregate lag time between the commencement of the search to productivity, in excess of one year. In addition, if we are unable to retain our existing sales personnel, or if our sales personal are ineffective, our ability to maintain or grow our revenue will be adversely affected. In addition, a large percentage of our revenue has been historically generated from
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a small number of customers. If we are unable to retain the sales personnel who are responsible for those customer accounts, our business could be negatively impacted.
We are continuing to develop and execute upon a channel strategy to generate additional sales and revenue, and the failure to successfully expand channel sales might affect our ability to sustain revenue growth and may harm our business and operations.
An increasing portion of our sales strategy is to develop our sales efforts through the use of resellers and other third parties to sell our systems. We may not be successful in building or expanding relationships with these third parties. Further, even if we do develop and expand these relationships, they may conflict with our direct sales efforts in some territories. Ineffective marketing of our products by our resellers or disruptions in our distribution channels could lead to decreased sales or slower than expected growth in revenue and might harm our business and operations.
We have been substantially dependent on a concentrated number of customers that purchase in large quantities. If we are unable to maintain or replace our relationships with concentrated customers and/or diversify our customer base, our revenue may fluctuate and our growth may be limited.
Historically, a significant portion of our revenue has come from a limited number of customers. There can be no guarantee that we will be able to sustain our revenue levels from this type of customer. For the year ended June 24, 2011, our top five customers accounted for approximately 39% of our total revenues, with Amazon accounting for 12% of our total revenues. We expect a limited number of customers to continue to account for a significant portion of our revenues for the foreseeable future. This customer concentration increases the risk of quarterly fluctuations in our revenues and operating results. The loss or reduction of business from one or a combination of our significant customers could materially adversely affect our revenues, financial condition and results of operations.
Our customers require a high degree of reliability in our products and services, and if we cannot meet their expectations our relationships with our customers could be damaged and demand for our products and services will decline.
Because our customers rely on our products and services for their enterprise or mission critical applications, any failure to provide high quality products and reliable services, whether caused by our own failure or failures by our suppliers or contract manufacturers, could damage our reputation and reduce demand for our products and services. Some of our products, such as our ICE cube line, are particularly complex and carry a higher per unit price. A failure of products in our ICE cube line would therefore potentially be more costly to us, with the risk and potential cost to us increasing proportionately with the number of products we sell in this line. Most of our customers use our systems for applications that are critical to their organization; as a result system reliability is critical to the success of our products. In addition, delays in our ability to fill product orders as a result of quality control issues, such as an increase in failure rates or the rate of product returns, may negatively impact our relationships with our customers and harm our revenue and growth.
Our business depends on decisions by potential customers to adopt our modular, open standard-based products and to replace their legacy server systems with our products, and they may be reluctant to do so, which would limit our growth.
Our business depends on companies moving away from large proprietary RISC/UNIX servers to standardized servers that utilize commercially available x86 processor architectures and can deploy a variety of operating systems, including Linux and Microsoft Windows. Excluding sales to Microsoft Corporation, we believe that a majority of the server systems that we sold in 2011, 2010, and 2009 ran on the Linux® operating system. Products based on the Linux operating system and sold by other software vendors have been the subject of intellectual property infringement litigation.
Legal actions taken by The SCO Group, Inc. (“SCO”) against several companies, including in particular IBM in 2003 and Novell, Inc. (“Novell”) in 2004, alleging intellectual property infringement and disputing the ownership of core UNIX® copyrights in code that allegedly is used in Linux are ongoing. The litigation involving SCO’s claim against IBM that Linux is an unauthorized derivative work of the UNIX operating system has been stayed due to SCO’s bankruptcy filing. On March 30, 2010 in the Novell litigation, a jury returned a verdict in favor of Novell finding that Novell owns the UNIX copyrights. SCO has appealed the verdict to the U.S. Court of Appeals for the Tenth Circuit. If SCO’s appeal is ultimately successful, SCO could obtain a ruling that users or distributors of Linux must pay royalties to SCO or others, which could impede broader Linux adoption and could materially harm our ability to sell our products based on the Linux operating system.
In addition, several companies, including Microsoft Corporation and Bedrock Computing Technologies, LLC, have asserted patents which purportedly may be infringed by various versions and portions of Linux. Microsoft has publicly claimed that Linux infringes 235 or more of Microsoft’s patents and has entered into transactions with Novell, Inc. and other Linux distributors under which the parties reportedly agree, among other things, not to sue each other’s customers for potential patent infringements related to Linux. In 2009, Bedrock Computing Technologies filed litigation against ten defendants, including
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Google, claiming that certain methods used in certain versions of Linux infringed one of Bedrock's patents. On April 15, 2011, a jury found that Google's use of Linux did infringe Bedrock's patent and ordered Google to pay a $5 million fine for past damages, although that verdict was later vacated and the case against Google was closed by stipulation of the parties. The Bedrock case is continuing against other defendants. It is possible that a party could prove a claim for proprietary rights in the Linux operating system or other programs developed and distributed under the GNU General Public License or other open source software licenses. In addition, the GNU General Public License has itself been, and may be in the future, a subject of litigation, and it is possible that a court could hold these licenses to be unenforceable in that litigation. Any ruling by a court that the Linux operating system or significant portions of it may not be copied, modified or distributed subject only to the minimal restrictions contained in these licenses, that users or distributors of Linux must pay royalties to Microsoft or others or that these licenses are not enforceable could also impede broader Linux adoption and materially harm our ability to sell our products based on the Linux operating system. Further, because potential customers have often invested significant capital and other resources in existing systems, many of which run mission-critical applications, customers may be hesitant to make dramatic changes to their data center systems. The failure of our customers and potential customers to replace their legacy server systems and adopt open standard-based modular technologies could have a material adverse impact on our ability to maintain or generate additional revenue.
Our products have incorporated or have been dependent upon, open standards, commoditized components and materials that we obtain in spot markets, and, as a result, our cost structure and our ability to respond in a timely manner to customer demand are sensitive to volatility of the market prices for these components and materials.
A significant portion of our cost of revenue is directly related to the pricing of commoditized materials and components utilized in the manufacture of our products, such as memory, hard drives, central processing units (“CPUs”), or power supplies. As part of our procurement model, we generally do not enter into long-term supply contracts for these materials and components, but instead, purchase these materials and components in a competitive bid purchase order environment with suppliers or on the open market at spot prices. As a result, our cost structure is affected by the availability and price volatility in the marketplace for these components and materials, including new versions of hard drives and CPUs that are introduced by our suppliers. This volatility makes it difficult to predict expense levels and operating results and may cause them to fluctuate significantly. Further, if we are successful in growing our business, we may not be able to continue to procure components solely on the spot market, which would require us to enter into contracts with component suppliers to obtain these components.
In addition, because our procurement model involves our ability to maintain low inventory and to acquire materials and components as needed, and because we do not enter into long-term supply contracts for these materials and components, our ability to effectively and efficiently respond to customer orders may be constrained by the then-current availability or the terms and pricing of these materials and components. Our industry has experienced component shortages and delivery delays in the past, and in the future we may experience shortages or delays of critical components as a result of strong demand in the industry or other factors. For example, occasionally we may experience a shortage of, or a delay in receiving, certain components as a result of strong demand, capacity constraints, supplier financial weaknesses, inability of suppliers to borrow funds in the credit markets, disputes with suppliers (some of whom are also customers), disruptions in the operations of component suppliers, other problems experienced by suppliers or problems faced during the transition to new suppliers.
If shortages or delays occur, the price of these components may increase, we may be exposed to quality issues or the components may not be available at all. We may therefore not be able to secure enough components at reasonable prices or of acceptable quality to build products or provide services in a timely manner in the quantities or according to the specifications needed. Accordingly, our revenue and gross margin could suffer as we could lose time-sensitive sales, incur additional freight costs or be unable to pass on price increases to our customers. If we cannot adequately address supply issues, we might have to reengineer some products or service offerings, resulting in further costs and delays.
In order to secure components for the provision of products or services, at times we may enter into non-cancelable commitments with vendors. In addition, we may purchase components strategically in advance of demand to take advantage of favorable pricing or to address concerns about the availability of future components. If we fail to anticipate customer demand properly, a temporary oversupply could result in excess or obsolete components, which could adversely affect our gross margin. This could increase our costs and decrease our gross margin. Further, we compete in an industry that is characterized by rapid technological advances in hardware with frequent introduction of new products. New product introductions provide risks in predicting customer demand for the future products as well as the transition from existing products. If we do not make an effective transition from existing products to future products, an oversupply could result in excess components. For example, DRAM can represent a significant portion of our cost of revenue, and both the price and availability of various kinds of DRAM are subject to substantial volatility in the spot market. Additionally, if any of our suppliers of CPUs, such as Intel or AMD, were to increase the costs to us for components we use, we would either pass these price increases on to our customers, which could cause us to lose business from these customers, or we would need to absorb these price increases, which would cause our margins to decrease, either of which could adversely affect our business and financial results.
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If we fail to maintain or expand our relationships with our suppliers, in some cases single-source suppliers, we may not have adequate access to new or key technology necessary for our products, and, as a result, our ability to deliver leading-edge products may be impaired.
In addition to the technologies we develop, our suppliers develop product innovations at our direction that are requested by our customers. In many cases, we retain the ownership of the intellectual property developed by these suppliers. Further, we rely heavily on our component suppliers, such as Intel and AMD, to provide us with leading-edge components on time and in accordance with a product roadmap. If we are not able to maintain or expand our relationships with our suppliers or continue to leverage their research and development capabilities to develop new technologies desired by our customers, our ability to deliver leading-edge products in a timely manner may be impaired and we could be required to incur additional research and development expenses.
Unforeseen environmental costs could impact our future net earnings.
We are subject to various federal, state, local and foreign laws and regulations concerning environmental protection, including laws addressing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites, the content of our products and the recycling, treatment and disposal of our products. In particular, we face increasing complexity in our product design and procurement operations as we adjust to new and future requirements relating to the chemical and materials composition of our products, their safe use, the energy consumption associated with those products, and climate change laws and regulations. We could incur substantial costs, our products could be restricted from entering certain jurisdictions, and we could face other sanctions, if we were to violate or become liable under environmental laws or if our products become non-compliant with environmental laws. Our potential exposure includes fines and civil or criminal sanctions, third-party property damage, personal injury claims and clean up costs. Further, liability under some environmental laws relating to contaminated sites can be imposed retroactively, on a joint and several basis, and without any finding of noncompliance or fault. The amount and timing of costs under environmental laws are difficult to predict and such costs could have a negative effect on our profitability. If we are found to be in violation of any environmental laws, costs associated with such liability may have an adverse affect on our financial results.
We have historically relied on contract manufacturers to manufacture our products, and our failure to successfully manage our relationships with these contract manufacturers could impair our ability to deliver our systems in a manner consistent with required volumes or delivery schedules, which could damage our relationships with our customers and decrease our revenue.
We have historically relied on a very small number of contract manufacturers to assemble and test our products. None of these third-party contract manufacturers are obligated to perform services or supply products to us for any specific period, or in any specific quantities, except as may be provided in a particular purchase order. For example, we design custom silicon chips for application specific integrated circuits (ASIC), but rely on a third party to manufacture the ASICs for us. None of our contract manufacturers has provided contractual assurances to us that adequate capacity will be available to us to meet future demand for our products. If our contract manufacturers are not able to maintain our high standards of quality, are not able to increase capacity as needed, or are forced to shut down a factory, our ability to deliver quality products to our customers on a timely basis may decline, which would damage our relationships with customers, decrease our revenue and negatively impact our growth.
If our cost control measures are not successful, we may become less competitive.
A variety of factors could prevent us from achieving our goal of better aligning our product and service offerings and cost structure with customer needs in the current business environment. We are currently focused on reducing and maintaining our operating expenses, total costs in procurement, product design, transformation, and simplifying our structure. For example, we may experience delays in the anticipated timing of activities related to our cost savings plans and higher than expected or unanticipated costs to implement the plans. As a result, we may not achieve our expected cost savings in the time anticipated, or at all. In such case, our results of operations and profitability may be negatively impacted, making us less competitive and potentially causing us to lose industry unit share.
We may fail to achieve our financial forecasts.
Our revenues are difficult to forecast and our quarterly and annual operating results can fluctuate substantially. We use a “pipeline” system, a common industry practice, to forecast sales and trends in our business. Our sales personnel monitor the status of all proposals and estimate when a customer will make a purchase decision and the dollar amount of the sale. These estimates are aggregated periodically to generate a sales pipeline. Our pipeline estimates can prove to be unreliable both in a particular quarter and over a longer period of time, in part because the “conversion rate” or “closure rate” of the pipeline into contracts can be very difficult to estimate. A contraction in the conversion rate, or in the pipeline itself, could cause us to plan or budget incorrectly and adversely affect our business or results of operations.
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In particular, a slowdown in IT spending or economic conditions generally can unexpectedly reduce the conversion rate in particular periods as purchasing decisions are delayed, reduced in amount or canceled. The conversion rate can also be affected by the tendency of some of our customers to wait until the end of a fiscal period in the hope of obtaining more favorable terms, which can also impede our ability to negotiate and execute these contracts in a timely manner. In addition, for newly acquired companies, we have limited ability to predict how their pipelines will convert into sales or revenues for one or two quarters following the acquisition and their conversion rate post-acquisition may be quite different from their historical conversion rate.
If we are unable to retain and attract adequate qualified personnel, including key executive, managerial, technical, finance, marketing and sales personnel, we may not be able to execute on our business strategy.
Our future success depends in large part upon the continued service and enhancement of our executive, managerial, technical, finance, marketing and sales employees. Changes in management can be disruptive within a company, which could negatively affect our operations, our culture and our strategic direction. Our employees may terminate their employment with us at any time. Our U.S. employees are “at will,” while outside of the U.S., notice or severance may be required if we wish to terminate an employee. The failure of our management team to seamlessly manage employee transitions, or the loss of services of any of these executives or of one or more other members of our executive management or sales team or other key employees could seriously harm our business. Competition for qualified executives is intense and if we are unable to continue expanding our management team, or successfully integrate new additions to our management team in a manner that enables us to scale our business and operations effectively, our ability to operate effectively and efficiently could be limited or negatively impacted.
Additionally, to help attract, retain, and motivate qualified employees, we use share-based incentive awards such as employee stock options and non-vested share units (restricted stock units). If the value of such stock awards does not appreciate as measured by the performance of the price of our common stock, or if our share-based compensation otherwise ceases to be viewed as a valuable benefit, our ability to attract, retain, and motivate employees could be weakened, which could harm our results of operations.
We make estimates and assumptions in connection with the preparation of our consolidated financial statements, and any changes to those estimates and assumptions could have a material adverse effect on our results of operations.
In connection with the preparation of our consolidated financial statements, we use certain estimates and assumptions based on historical experience and other factors. Our most critical accounting estimates are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of this Annual Report on Form 10-K. While we believe that these estimates and assumptions are reasonable under the circumstances, they are subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, it could have a material adverse effect on our results of operations, and we may be required to restate our financial results for prior periods which could cause our stock price to decline.
If we are unable to implement and maintain effective internal control over financial reporting in the future, the accuracy and timeliness of our financial reporting may be adversely affected.
Effective internal controls over financial reporting are necessary for us to provide reliable financial reports and effectively prevent fraud. As a publicly traded company we must maintain effective disclosure controls and procedures and internal control over financial reporting, which can be difficult to do. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that:
• | pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; |
• | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and |
• | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. |
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Even after corrective actions are implemented, the effectiveness of our controls and procedures may be limited by a variety of risks including:
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• | faulty human judgment and simple errors, omissions or mistakes; |
• | collusion of two or more people; |
• | inappropriate management override of procedures; and |
• | the risk that enhanced controls and procedures may still not be adequate to assure timely and reliable financial information |
A failure to have effective internal controls and procedures for financial reporting in place could result in a restatement of our financial statements, as it did in our Form 10-Q for the quarterly period ended March 29, 2008, or impact our ability to accurately report financial information on a timely basis, which could adversely affect our stock price.
Maintaining and improving our financial controls, particularly in light of the requirements of being a public company, may strain our resources and divert management’s attention.
We are subject to the reporting requirements of the Securities Exchange Act of 1934 and the rules and regulations promulgated thereunder (the “Exchange Act”) and the NASDAQ Stock Market Rules. The requirements of these rules and regulations have increased our legal and financial compliance costs, make some activities more difficult, time-consuming or costly and may also place undue strain on our personnel, systems and resources.
The Sarbanes-Oxley Act of 2002 requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. This can be difficult to do. For example, when we acquired substantially all the assets of Legacy SGI, we went through the process of integrating and harmonizing Legacy SGI financial reporting and information technology systems, including internal control over financial reporting, with our own. As a result of this and similar activities, management’s attention may be diverted from other business concerns, which could have a material adverse effect on our business, financial condition and results of operations. We may not be able to meet the requirements needed to prevent material weaknesses in internal controls over financial reporting. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on the NASDAQ Global Select Market.
Unanticipated changes in our tax provisions or exposure to additional income tax liabilities could affect our profitability.
We are subject to income taxes in the United States and numerous foreign jurisdictions. Our tax liabilities are affected by the amounts we charge for inventory, services, funding and other items in intercompany transactions. We are subject to ongoing tax audits in various jurisdictions. Tax authorities may disagree with our intercompany charges, cross-jurisdictional transfer pricing or other matters and assess additional taxes. For example, we have been assessed tax and interest by the Canada Revenue Agency (CRA) in connection with excess research credits claimed by our Canadian subsidiaries in prior periods. The assessment has not been paid because the CRA has not yet accepted our claim that the assessment should be reduced due to overstatement of taxable income of our Canadian subsidiaries during these periods. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the amounts ultimately paid upon resolution of audits could be materially different from the amounts previously included in our income tax expense and therefore could have a material impact on our tax provision, net income and cash flows.
In addition, our effective tax rate in the future could be adversely affected by changes to our operating structure, changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws and the discovery of new information in the course of our tax return preparation process.
Unsuccessful deployment of new transaction processing applications and other systems integration issues could disrupt our internal operations and any such disruption could reduce our expected revenue, increase our expenses, and damage our reputation.
Portions of our IT infrastructure may experience interruptions, delays or cessations of service or produce errors in connection with systems integration and implementation of new transaction processing applications, including accounting, manufacturing and sales system. We may not be successful in implementing new systems and transitioning data, which could cause business disruptions and be more expensive, time consuming, disruptive and resource-intensive to remediate. Such disruptions could adversely impact our ability to fulfill orders and negatively impact our business or interrupt other processes. Delayed sales, lower margins or lost customers resulting from these disruptions have adversely affected us in the past, and in the future could adversely affect our financial results, public disclosures and reputation.
We maintain confidential and proprietary information on our computer networks and employ security measures designed to protect this information from unauthorized access. If our security measures are breached and unauthorized access is obtained, we may lose proprietary data and may suffer economic losses.
We maintain confidential information on our computer networks, including information and data that are proprietary to our customers and third parties, as well as to our company. Although we have designed and employed security measures to
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protect this information from unauthorized access, our security measures may be breached as a result of third-party action, including computer hackers, employee error, malfeasance or otherwise, and result in someone obtaining unauthorized access to our customers' data or our data, including our intellectual property and other confidential business information. Because the techniques employed by hackers to obtain unauthorized access or to sabotage systems change frequently, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any security breach could result in disclosure of our trade secrets or disclosure of confidential customer, supplier or employee data. If this should happen, we could be exposed to potentially significant legal liability, harm to our reputation and other harm to our business.
Business disruptions could affect our operating results.
A significant portion of our manufacturing, research and development activities and certain other critical business operations is concentrated in a few geographic areas. We are a highly automated business and a disruption or failure of our systems could cause delays in completing sales and providing services. A major earthquake, fire or other catastrophic event that results in the destruction or disruption of any of our critical business or information technology systems could severely affect our ability to conduct normal business operations and, as a result, our future operating results could be materially and adversely affected. For example, our operations in Japan may be negatively affected by earthquakes and other natural disasters, as well as ongoing power supply disruptions following the March 2011 earthquake and tsunami.
Further, we maintain a program of insurance coverage for various types of property, casualty, and other risks. We place our insurance coverage with various carriers in numerous jurisdictions. However, there is a risk that one or more of our insurance providers may be unable to pay a claim. The types and amounts of insurance that we obtain vary from time to time and from location to location, depending on availability, cost, and our decisions with respect to risk retention. The policies are subject to deductibles and exclusions that result in our retention of a level of risk on a self-insurance basis. Losses not covered by insurance may be substantial and may increase our expenses, which could harm our results of operations and financial condition.
Unstable market and economic conditions may have serious adverse consequences on our business.
Our general business strategy may be adversely affected by the current economic downturn and volatile business environment and continued unpredictable and unstable market conditions. If the current equity and credit markets deteriorate further, or do not continue to improve, it may make any necessary debt or equity financing more difficult, more costly, and more dilutive. We believe we are well positioned with significant capital resources to meet our current working capital and capital expenditure requirements. However, a further prolonged or profound economic downturn may result in adverse changes to demand for our products, or our customers’ ability to pay for our products, which would harm our operating results. There is also a risk that one or more of our current service providers, manufacturers and other partners may not survive these difficult economic times, which would directly affect our ability to attain our operating goals on schedule and on budget. Failure to secure any necessary financing in a timely manner and on favorable terms could have a material adverse effect on our financial performance and stock price and could require us to change our business plans.
If we are unable to protect our intellectual property adequately, we may not be able to compete effectively.
Our intellectual property is critical to our success and our ability to compete. If we fail to protect our intellectual property rights adequately, our competitors might gain access to our technology. Unauthorized parties may attempt to copy or otherwise obtain and use our proprietary technology despite our efforts to protect our intellectual property. In addition, we license our technology and intellectual property to third parties, including in some cases, our competitors, which could under some circumstances make our patent rights more difficult to enforce. Third parties could also obtain licenses to some of our intellectual property as a consequence of a merger or acquisition. Also, our participation in standard setting organizations or industry initiatives may require us to license our patents to other companies that adopt certain standards or specifications. As a result of such licensing, our patents might not be enforceable against others who might otherwise be infringing those patents and the value of our intellectual property may be impaired.
However, litigation is inherently uncertain, and there is no assurance that any litigation we initiate will have a successful outcome. Monitoring unauthorized use of our technology is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as the laws of the United States. Any claims or litigation that we have initiated or that we may initiate in the future to protect our proprietary technology could be time consuming and expensive and divert the attention of our technical and management resources whether or not the claims or litigation are decided in our favor. Enforcing our rights could subject us to claims that the intellectual property right is invalid, is otherwise not enforceable, or is licensed to the party against whom we are asserting a claim. Also, assertion of our intellectual property rights could result in the other party seeking to assert alleged intellectual property rights of its own or assert other claims against us, which could harm our business.
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We currently have numerous patents issued and a number of patent applications pending in the United States and other countries. These patents may be limited in value in asserting our intellectual property rights against more established companies in the computer technology sector that have sizable patent portfolios and greater capital resources. In addition, patents may not be issued from these patent applications, and even if patents are issued, they may not benefit us or give us adequate protection from competing products. For example, issued patents might be circumvented or challenged, and could be declared invalid or unenforceable. Moreover, if other companies develop unpatented proprietary technology similar to ours or competing technologies, our competitive position will be weakened.
If we are found to have violated the intellectual property rights of others, we could be required to indemnify our customers, resellers or suppliers, redesign our products, pay significant royalties and enter into license agreements with third parties.
Our industry is characterized by a large number of patents, copyrights, trade secrets and trademarks and by frequent litigation based on allegations of infringement or other violation of intellectual property rights. As we continue our business, expand our product lines and our product functionality, and expand into new jurisdictions around the world, third parties may assert that our technology or products violate their intellectual property rights. Because of technological changes and the extent of issued patents in our industry, it is possible certain components of our products and business methods may unknowingly infringe existing patents of others. Any claim, regardless of its merits, could be expensive and time consuming to defend against. It would also divert the attention of our technical and management resources. Successful intellectual property claims against us could result in significant financial liability, impair our ability to compete effectively, or prevent us from operating our business or portions of our business. In addition, resolution of claims may require us to redesign our technology, to obtain licenses to use intellectual property belonging to third parties, which we may not be able to obtain on reasonable terms, to cease using the technology covered by those rights, and to indemnify our customers, resellers or suppliers. Any of these events could result in unexpected expenses, negatively affect our competitive position and materially harm our business, financial condition and results of operations.
Our use of open source and third-party software could impose unanticipated conditions or restrictions on our ability to commercialize our products.
We incorporate open source software into our products. Open source software is made available to us and to the public by its authors or other third parties under licenses that impose certain obligations on licensees in the event those licensees re-distribute or make derivative works of the open source software. The terms of many open source licenses have not been interpreted by United States or other courts, and these licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to commercialize our products. In this event, we could be required to seek licenses from third parties in order to continue offering our products, to make generally available, in source code form, proprietary code that links to certain open source modules, to re-engineer our products, or to discontinue the sale of our products if re-engineering could not be accomplished on a timely basis, any of which might harm our business, operating results and financial condition.
Adverse litigation results could affect our business.
We are subject to various legal proceedings. Litigation can be lengthy, expensive and disruptive to our operations, and results cannot be predicted with certainty. An adverse decision could result in monetary damages or injunctive relief that could affect our business, operating results or financial condition. Additional information regarding certain of the lawsuits we are involved in is discussed under "Legal Proceedings" in Part I, Item 3 of this Annual Report on Form 10-K.
Risks Related to Owning Our Stock
Our stock price in the past has been volatile, and may continue to be volatile or may decline regardless of our operating performance, and investors may not be able to resell shares at or above the price at which they purchased the shares.
Our stock has been publicly traded for a relatively short period of time, having first begun trading in June 2005. During that time our stock price has fluctuated significantly, from a high of approximately $56.00 per share to a low of approximately $3.42 per share. At times the stock price has changed very quickly. During the year ended June 24, 2011, our stock price has fluctuated from a high of approximately $22.95 to a low of approximately $5.84. If investors purchase shares of our common stock, they may not be able to resell those shares at or above the price at which they purchase them. The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, and which may not relate to our performance or results of operations, including:
• | price and volume fluctuations in the overall stock market; |
• | purchases of shares of our common stock pursuant to our share repurchase program; |
• | the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections; |
• | actual or anticipated fluctuations in our operating results; |
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• | changes in operating performance and stock market valuations of other technology companies generally, or those that sell enterprise computing products in particular; |
• | changes in financial estimates by any securities analysts who follow our company, our failure to meet these estimates or failure of those analysts to initiate or maintain coverage of our stock; |
• | ratings downgrades by any securities analysts who follow our company; |
• | the public’s response to our press releases or other public announcements, including our filings with the SEC; |
• | announcements by us or our competitors of significant technical innovations, customer wins or losses, acquisitions, strategic partnerships, joint ventures or capital commitments; |
• | introduction of technologies or product enhancements that reduce the need for our products; |
• | market conditions or trends in our industry or the economy as a whole; |
• | the loss of one or more key customers; |
• | the loss of key personnel; |
• | the development and sustainability of an active trading market for our common stock; |
• | lawsuits threatened or filed against us; |
• | future sales of our common stock by our officers, directors and significant stockholders; and |
• | other events or factors, including those resulting from war, incidents of terrorism or responses to these events. |
In addition, the stock markets, and in particular the NASDAQ Stock Market, have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. We could become involved in additional securities litigation in the future, which could have substantial costs and divert resources and the attention of management from our business. For additional information regarding our securities litigation, please see “Legal Proceedings” in Part I, Item 3 of this Annual Report on Form 10-K.
Due to these factors, sales of a substantial number of shares of our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock.
Some provisions in our certificate of incorporation and bylaws may deter third parties from acquiring us.
Our certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult without the approval of our board of directors, including the following:
• | limitations on persons authorized to call a special meeting of stockholders; |
• | our stockholders may take action only at a meeting of stockholders and not by written consent; |
• | our certificate of incorporation authorizes undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval; and |
• | advance notice procedures required for stockholders to nominate candidates for election as directors or to bring matters before an annual meeting of stockholders. |
These anti-takeover defenses could discourage, delay or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors of their choosing and cause us to take other corporate actions they desire.
We do not expect to pay any cash dividends for the foreseeable future.
We do not anticipate that we will pay any cash dividends to holders of our common stock in the foreseeable future. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends in the foreseeable future should not purchase our common stock.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
Our properties consist of leased and owned facilities used for manufacturing, warehouse, sales and marketing, research and development, services and support, and administrative purposes worldwide. As of June 24, 2011, we owned or leased approximately 739,000 square feet of space in our domestic and international locations. We owned 36% of this space and leased the remaining 64%. Included in these amounts are approximately 11,000 square feet of vacated space, which we sublease to a third party.
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Approximately 80% of our owned and leased properties are located in the United States. These domestic locations are primarily located in Fremont, California, which is our corporate headquarters, and in Chippewa Falls, Wisconsin, which is where our manufacturing and warehouse facilities are located. Our international locations, which comprise approximately 20% of all our properties, are mainly located in Tokyo, Japan, Shanghai, China, and Reading, United Kingdom. Our international properties are primarily used for sales, services, research and development and administrative offices.
Because of the relationship between our segments, products and service, substantially all of our properties are used, at least in part, by both of these segments, and we have the flexibility to use each of the properties, in whole or in part, for each of the segments. We believe that our existing properties are in good condition, are suitable for the conduct of our business, and appropriately support our current business needs.
Item 3. Legal Proceedings
We are involved in various legal proceedings and disputes that arise in the normal course of business. These matters include product liability actions, patent infringement actions, contract disputes, and other matters. We do not know whether we will prevail in these matters nor can we assure that any remedy could be reached on commercially viable terms, if at all. Based on currently available information, we believe that we have meritorious defenses to these actions and that the resolution of these cases is not likely to have a material adverse effect on our business, financial position or future results of operations. We record a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case.
On May 1, 2007, Legacy SGI received a legal notice from counsel to Bharat Heavy Electricals Ltd. (“BHEL”), located in India, alleging delay in and failure to deliver products and technical problems with its hardware and software in relation to the establishment of a facility in Hyderabad. We assumed this claim in connection with our acquisition of Legacy SGI assets, and are currently engaged in arbitration. On January 21, 2008, BHEL filed its statement of claim against Silicon Graphics Systems (India) Pvt. Ltd. for a sum of Indian Rupee (“INR”) 78,478,200 ($1.7 million based on the conversion rate on June 24, 2011) plus interest and costs. On February 29, 2008, we filed our reply as well as a counter claim for a sum of INR 27,453,007 ($0.6 million based on the conversion rate on June 24, 2011) plus interest and costs. The proceeding has commenced but the hearing, scheduled for August 28, 2011, could not take place and the next rescheduled hearing date is awaited from the Arbitor. We cannot currently predict the outcome of this dispute nor determine the amount or a reasonable range of potential loss, if any.
Item 4. Removed and Reserved
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities
Market Information
Our common stock started trading on the NASDAQ National Market under the symbol “RACK” on June 10, 2005 and, commencing in 2006, on the NASDAQ Global Select Market. On May 18, 2009, we changed our name to Silicon Graphics International Corp. and changed our NASDAQ stock ticker symbol to “SGI”. Prior to June 10, 2005, there was no public market for our common stock. The following table sets forth for the periods indicated the high and low sale prices of our common stock, as reported by the NASDAQ Markets.
Year Ending June 24, 2011 | High | Low | ||||||
Fourth Quarter | $ | 22.95 | $ | 14.56 | ||||
Third Quarter | $ | 19.92 | $ | 8.77 | ||||
Second Quarter | $ | 9.72 | $ | 6.83 | ||||
First Quarter | $ | 8.20 | $ | 5.84 | ||||
Year Ending June 25, 2010 | High | Low | ||||||
Fourth Quarter | $ | 11.34 | $ | 6.82 | ||||
Third Quarter | $ | 12.74 | $ | 6.80 | ||||
Second Quarter | $ | 7.28 | $ | 5.77 | ||||
First Quarter | $ | 7.16 | $ | 4.16 | ||||
Holders
As of August 22, 2011, there were 31,382,497 shares of our common stock outstanding held by nine registered holders of record. A substantially greater number of holders of our outstanding common stock are “street name” or beneficial holders, whose shares are held of record by banks, brokers, and other financial institutions.
Dividends
We have never declared or paid any dividends on our capital stock. We currently intend to retain any future earnings to fund the development and expansion of our business, and therefore we do not anticipate paying cash dividends on our common stock in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors.
Recent Sale of Unregistered Securities
None
Issuer Purchases of Equity Securities
None
Performance Graph (2)
The following graph shows the cumulative total stockholder return of an investment of $100 in cash on December 31, 2005 through June 24, 2011, for (i) our common stock, (ii) the NASDAQ Composite Index and (iii) the RDG Technology Composite Index. Pursuant to applicable SEC rules, all values assume reinvestment of the full amount of all dividends; however, no dividends have been declared on our common stock to date. The stockholder return shown on the graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future stockholder returns.
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12/31/2005 | 12/30/2006 | 12/29/2007 | 1/3/2009 | 6/26/2009 | 6/25/2010 | 6/24/2011 | |||||||||||||||
Silicon Graphics International Corp. | 100.00 | 108.74 | 34.13 | 14.43 | 16.08 | 28.48 | 54.04 | ||||||||||||||
NASDAQ Composite | 100.00 | 112.29 | 124.12 | 73.89 | 86.17 | 99.75 | 131.86 | ||||||||||||||
RDG Technology Composite | 100.00 | 367.22 | 435.83 | 228.99 | 311.91 | 405.59 | 498.96 | ||||||||||||||
(2) | This graph and data are not “soliciting material,” are not deemed “filed” with the SEC and are not to be incorporated by reference in any filing of Silicon Graphics International Corp. under the 1933 Act or the 1934 Act whether made before or after the date hereof and irrespective of any general incorporation language in any such filing. |
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Item 6. Selected Financial Data
The following selected summary consolidated financial data should be read in conjunction with Part II, Item 8. “Financial Statements and Supplementary Data,” and with Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.
On June 19, 2009, our Board of Directors approved a change in our fiscal year end from the Saturday closest to December 31st of each year to the last Friday in June of each year. As a result of this change, we had a six-month transition period, which began on January 4, 2009 and ended on June 26, 2009. Accordingly, our fiscal year 2010 began on June 27, 2009 following a transition period that ended June 26, 2009. Additionally, this change in year end resulted in the quarter ended June 26, 2009 containing 83 days versus a standard 91 day quarter. The change in fiscal year end was made to facilitate the integration and consolidated reporting of the businesses and other related assets acquired and liabilities assumed from the acquisition of Legacy SGI.
Year Ended | Six Months Ended June 26, 2009 | |||||||||||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 (3) | December 29, 2007 (3) | December 30, 2006 (3) | ||||||||||||||||||||
(in thousands, except per share amounts) | ||||||||||||||||||||||||
Revenue | $ | 629,568 | $ | 403,717 | $ | 247,430 | $ | 350,684 | $ | 359,569 | $ | 102,777 | ||||||||||||
Gross profit (1) | 169,812 | 89,589 | 29,438 | 47,244 | 76,446 | 7,777 | ||||||||||||||||||
Income (loss) from continuing operations before income taxes (2) | (19,991 | ) | (93,302 | ) | (30,911 | ) | (29,049 | ) | 24,506 | (16,433 | ) | |||||||||||||
Income tax provision (benefit) from continuing operations | 1,242 | (4,441 | ) | 376 | 12,531 | 10,589 | (2,242 | ) | ||||||||||||||||
Net income (loss) from continuing operations | (21,233 | ) | (88,861 | ) | (31,287 | ) | (41,580 | ) | 13,917 | (14,191 | ) | |||||||||||||
Income (loss) from discontinued operations | — | 409 | (25,896 | ) | (33,941 | ) | (4,662 | ) | (20 | ) | ||||||||||||||
Income tax benefit from discontinued operations | — | — | (2,955 | ) | (5,964 | ) | (2,217 | ) | — | |||||||||||||||
Income (loss) from discontinued operations, net of tax | — | 409 | (22,941 | ) | (27,977 | ) | (2,445 | ) | (20 | ) | ||||||||||||||
Net income (loss) | $ | (21,233 | ) | $ | (88,452 | ) | $ | (54,228 | ) | $ | (69,557 | ) | $ | 11,472 | $ | (14,211 | ) | |||||||
Net income (loss) per share: | ||||||||||||||||||||||||
Net income (loss) per share, basic | ||||||||||||||||||||||||
Continuing operations | $ | (0.69 | ) | $ | (2.95 | ) | $ | (1.06 | ) | $ | (1.45 | ) | $ | 0.52 | $ | (0.48 | ) | |||||||
Discontinued operations | — | 0.01 | (0.77 | ) | (0.97 | ) | (0.09 | ) | — | |||||||||||||||
Net income (loss) per share, basic | $ | (0.69 | ) | $ | (2.94 | ) | $ | (1.83 | ) | $ | (2.42 | ) | $ | 0.43 | $ | (0.48 | ) | |||||||
Net income (loss) per share, diluted | ||||||||||||||||||||||||
Continuing operations | $ | (0.69 | ) | $ | (2.95 | ) | $ | (1.06 | ) | $ | (1.45 | ) | $ | 0.49 | $ | (0.48 | ) | |||||||
Discontinued operations | — | 0.01 | (0.77 | ) | (0.97 | ) | (0.09 | ) | — | |||||||||||||||
Net income (loss) per share, diluted | $ | (0.69 | ) | $ | (2.94 | ) | $ | (1.83 | ) | $ | (2.42 | ) | $ | 0.40 | $ | (0.48 | ) | |||||||
Shares used in computing net income (loss) per share: | ||||||||||||||||||||||||
Basic | 30,608 | 30,130 | 29,583 | 28,786 | 26,948 | 29,798 | ||||||||||||||||||
Diluted | 30,608 | 30,130 | 29,583 | 28,786 | 28,618 | 29,798 | ||||||||||||||||||
June 24, 2011 | June 25, 2010 | June 26, 2009 | January 3, 2009 | December 29, 2007 | December 30, 2006 | |||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Consolidated Balance Sheet Data: | ||||||||||||||||||||||||
Cash and cash equivalents | $ | 139,868 | $ | 129,343 | $ | 128,714 | $ | 171,954 | $ | 49,897 | $ | 30,446 | ||||||||||||
Working capital | $ | 133,970 | $ | 124,495 | $ | 168,687 | $ | 216,315 | $ | 249,929 | $ | 268,180 | ||||||||||||
Total assets | $ | 538,009 | $ | 497,212 | $ | 441,636 | $ | 285,493 | $ | 352,458 | $ | 406,770 | ||||||||||||
Total liabilities | $ | 414,723 | $ | 362,283 | $ | 223,537 | $ | 54,004 | $ | 76,340 | $ | 91,081 | ||||||||||||
Total stockholders’ equity | $ | 123,286 | $ | 134,929 | $ | 218,099 | $ | 231,489 | $ | 276,118 | $ | 315,689 | ||||||||||||
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(1) | Gross profit includes the following items: |
Year Ended | Six Months Ended June 26, 2009 | |||||||||||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | December 29, 2007 | December 30, 2006 | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Share-based compensation | $ | 685 | $ | 691 | $ | 1,120 | $ | 2,152 | $ | 3,583 | $ | 423 | ||||||||||||
(2) | Income (loss) from continuing operations before income taxes includes the following items: |
Year Ended | Six Months Ended June 26, 2009 | |||||||||||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | December 29, 2007 | December 30, 2006 | ||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||
Share-based compensation | $ | 5,898 | $ | 4,827 | $ | 9,152 | $ | 21,083 | $ | 20,008 | $ | 3,215 | ||||||||||||
Restructuring charges | 5,072 | 5,213 | 685 | — | — | 1,270 | ||||||||||||||||||
Acquisition-related | 1,271 | (3,264 | ) | — | — | — | 6,070 | |||||||||||||||||
Impairment of long-lived assets | — | — | — | 2,820 | — | — | ||||||||||||||||||
Gain from settlement agreement | — | — | — | — | — | (5,000 | ) | |||||||||||||||||
Gain from acquisition | — | — | — | — | — | (19,831 | ) | |||||||||||||||||
Total charges | $ | 12,241 | $ | 6,776 | $ | 9,837 | $ | 23,903 | $ | 20,008 | $ | (14,276 | ) | |||||||||||
(3) | Information has been restated to present the results of our Rapidscale™ product line as discontinued operations. See Note 19 "Discontinued Operations" to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K. The Rapidscale product line was purchased in 2006. |
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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. The discussions in this section contain forward-looking statements that involve risks and uncertainties, and actual results could differ materially from those discussed below. See “Item 1A—Risk Factors” and “Cautionary Statement Regarding Forward-Looking Information” at the beginning of this Annual Report on Form 10-K for a discussion of these risks and uncertainties.
Overview
We are a global leader in technical computing. We are focused on helping customers solve their most demanding business and technology challenges by delivering large-scale computing and storage, high-performance compute and storage, and data center solutions. We develop, market, and sell a broad line of low cost, mid-range and high-end computing servers and data storage as well as differentiating software. We sell data center infrastructure products purpose-built for large-scale data center deployments. In addition, we provide global customer support and professional services related to our products. We enable enterprises to meet their computing and storage requirements at a lower total cost of ownership and provide them greater flexibility and scalability. We are also a leading developer of enterprise class, high-performance features for the Linux operating system that provide our customers with a standard Linux operating environment combined with our differentiated yet un-intrusive Linux capabilities that are designed to improve performance, simplify system management, and provide a more robust development environment.
Our compute and storage products are comprised of:
• | solutions ranging from scalable entry-level solutions to hyper-scale and cloud solutions, including CloudRack®X2, Origin® 400 and Octane® III. We also build large-scale data center solutions with products such as CloudRack and Rackable™. Our design-to-order processes ensure the solutions are tailored to the customer's computing environment, are optimized to support their specific applications, and are ready for immediate integration. |
• | SGI's Altix® UV, which we believe is the world's fastest and most scalable shared memory supercomputer family, scaling from 32 to 2,560 cores and supports up to 16 terabytes of global shared memory in a single system image. |
• | a comprehensive range of platforms optimized for requirements including cost, scalability and performance; and |
• | software meeting diverse customer needs. These storage products include cloud storage based on CloudRack and Rackable servers, SGI® InfiniteStorage RAID systems, and Integrated Storage servers, and Active Archive systems, including ArcFinity™ based on our SGI COPAN™ technology. |
We have two business segments for financial reporting purpose - products and services. The products segment generated 74% of our total revenue and the services segment generated 26% of our total revenue for the year ended June 24, 2011 on a contractual basis.
Our current business strategy includes diversifying our business by customer, by industry, and by geography while focusing on technical computing. We believe that these multiple paths to growth will create a strong foundation for our business results in the long term.
Technical computing
We remain focused on expanding our opportunities within the technical computing market. We are focused on scientific and commercial HPC, public and private clouds, persistent and real time data storage, and emerging big data opportunities. The barriers to enter the technical computing market are high and the technical computing marketplace requires the ability to translate complex customer requirements into architected, ready-to-deploy solutions with an expert sales force. Customer trust and proven relationships, deep technical and scientific domain expertise, strategic industry partnerships, expertise across many vertical industry markets, global delivery capabilities, and products designed at extremes of scale and speed are all key criteria for competing in the technical computing market. We have a strong track record of driving innovation in this market.
During the year ended June 24, 2011, we introduced new product offerings, including ArcFinity™ and ICE Cube® AIR products. We continue to sell our Altix UV and COPAN products. These higher margin, high performance compute server and storage products contributed to our revenue and gross margin increases during the year ended June 24, 2011.
Diversifying our business
During the year ended June 24, 2011, we generated new business with large enterprises in the U.S., European and Asian regions and with U.S. Government agencies. On March 9, 2011, we acquired the remaining outstanding shares of SGI Japan
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and SGI Japan became our wholly-owned subsidiary. We acquired SGI Japan to serve as a strategic entry into the large technical computing market of Japan and to enable us to extend our global reach, accelerate growth opportunities, and strengthen the relationships with our partners and customers in Japan. Our revenue mix by geography shows that we are expanding our international presence. In fiscal year 2011, 38% of our total revenue was generated from our international locations compared to 25% in fiscal year 2010. Our customer base is also expanding. For fiscal year 2011, we only have one customer contributing to at least 10% of our total revenue. Our customers come from various industries, including the public, cloud, and manufacturing sectors.
Significant events
Our financial results during the year ended June 24, 2011 were affected by certain significant events that should be considered in comparing the periods presented.
Acquisition of SGI Japan, Ltd.
On March 9, 2011, we acquired the remaining outstanding shares of SGI Japan. Prior to the Closing Date, we owned approximately 10% of the outstanding shares of SGI Japan and accounted for such investment as a cost method investment. SGI Japan operates primarily as a seller and servicer of high-performance computing, visualization, data center, and media and archive systems in Japan. The total purchase price was approximately $17.9 million in cash, $1.8 million of which was placed in escrow to secure our indemnification rights under the Stock Purchase Agreement. The acquisition is expected to serve as a strategic entry into the large technical computing market of Japan and to enable us to extend our global reach, accelerate growth opportunities, and strengthen the relationships with our partners and customers in Japan. Furthermore, the acquisition is expected to enable us to more fully participate in the Japanese HPC market and benefit from SGI Japan's extensive service business.
Acquisition of Silicon Graphics, Inc.
On May 8, 2009, we acquired substantially all of the assets, excluding certain assets unrelated to the ongoing business and assumed certain liabilities of Silicon Graphics, Inc. (an entity in Chapter 11 of the U.S. Bankruptcy code) (“Legacy SGI”) for approximately $42.5 million in cash.
Copan Systems, Inc.
On February 23, 2010, we completed the acquisition of substantially all the assets of Copan Systems, Inc. (“Copan”) and assumed certain liabilities for $2.0 million in cash.
Change in Corporate Name and Trading Symbol
On May 18, 2009, we changed our name to Silicon Graphics International Corp. (“SGI”) and changed our NASDAQ stock ticker symbol from “RACK” to “SGI.”
Change in fiscal year
On June 19, 2009, our Board of Directors approved a change in our fiscal year-end from the Saturday closest to December 31st of each year to the last Friday in June of each year. As a result of this change, we had a six-month transition period, which began on January 4, 2009, ended on June 26, 2009. Accordingly, our fiscal year 2010 began on June 27, 2009 following a transition period that ended June 26, 2009. The change in fiscal year-end was made to facilitate the integration and consolidated reporting of the businesses and other related assets acquired and liabilities assumed from Legacy SGI.
The financial periods presented and discussed will be as follows: (i) the year ended June 24, 2011 represents the 52-week fiscal year ended June 24, 2011 ("fiscal year 2011"); (ii) the year ended June 25, 2010 represents the 52-week fiscal year ended June 25, 2010 ("fiscal year 2010"); (iii) the six months ended June 26, 2009 represents the 25-week, six-month transition period ended June 26, 2009; and (iv) the year ended January 3, 2009 represents the 53-week fiscal year ended January 3, 2009. In addition, the six months ended June 28, 2008 (unaudited) is presented to compare to the six months ended June 26, 2009.
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Results of Operations
We have included the operating results associated with the acquisition of SGI Japan, Legacy SGI and Copan in our consolidated financial statements only for the periods since the date of the acquisition in March 2011, May 2009 and February 2010, respectively. This inclusion has significantly affected our revenues, results of operations and financial position.
Comparison of the Years Ended June 24, 2011 and June 25, 2010
Financial Highlights
• | Our total revenue significantly increased in fiscal year 2011 compared to fiscal year 2010. Our higher total revenue resulted partially from the required adoption of new accounting standards for revenue recognition which resulted in us recognizing more revenue upon delivery or acceptance and from an increase in sales of high performance compute server and storage products. The required adoption of these new accounting standards for revenue recognition resulted in $166.2 million and $104.1 million increases in total revenue and total cost of revenue in the year ended June 24, 2011, respectively. In addition, our acquisition of SGI Japan increased our total revenue by $51.6 million during the year ended June 24, 2011. |
• | We increased our overall gross margin by 478 basis points from 22.2% in the year ended June 25, 2010 to 27.0% in the year ended June 24, 2011. Approximately 370 basis point increase in our overall gross margin percentage is attributable to the adoption of the new revenue recognition standards. |
• | As a result of increased total revenue and overall gross margin, our total gross profit increased $80.2 million or 90% to $169.8 million in the year ended June 24, 2011 from $89.6 million in the year ended June 25, 2010. Of the $80.2 million increase in total gross profit, $62.0 million is attributable to the adoption of the new accounting standards for revenue recognition required for the year ended June 24, 2011. |
• | We incurred acquisition related costs of $1.3 million resulting from our purchase of all the remaining shares of SGI Japan. Prior to this acquisition, we owned approximately 10% of the outstanding shares of SGI Japan. |
Revenue, cost of revenue, gross profit and gross margin
The following table presents revenue, cost of revenue, gross profit, and gross margin for the years ended June 24, 2011 and June 25, 2010 (presented on a contractual basis):
Year ended | Change | |||||||||||||||
June 24, 2011 | June 25, 2010 | $ | % | |||||||||||||
(in thousands, except percentages) | ||||||||||||||||
Product revenue | $ | 465,177 | $ | 256,007 | $ | 209,170 | 82 | % | ||||||||
Service revenue | 164,391 | 147,710 | 16,681 | 11 | % | |||||||||||
Total revenue | $ | 629,568 | $ | 403,717 | $ | 225,851 | 56 | % | ||||||||
Cost of product revenue | $ | 367,393 | $ | 229,913 | $ | 137,480 | 60 | % | ||||||||
Cost of service revenue | 92,363 | 84,215 | 8,148 | 10 | % | |||||||||||
Total cost of revenue | $ | 459,756 | $ | 314,128 | $ | 145,628 | 46 | % | ||||||||
Product gross profit | $ | 97,784 | $ | 26,094 | $ | 71,690 | 275 | % | ||||||||
Service gross profit | 72,028 | 63,495 | 8,533 | 13 | % | |||||||||||
Total gross profit | $ | 169,812 | $ | 89,589 | $ | 80,223 | 90 | % | ||||||||
Product gross margin | 21.0 | % | 10.2 | % | ||||||||||||
Service gross margin | 43.8 | % | 43.0 | % | ||||||||||||
Overall gross margin | 27.0 | % | 22.2 | % | ||||||||||||
Revenue. We derive revenue from the sale of products and services directly to end-users as well as through resellers and system integrators. Product revenue is derived from the sale of mid-range to high-end computing servers and data storage systems as well as software. We enter into sales contracts to deliver multiple products and/or services. In accordance with our revenue recognition policy, certain sales contracts are deferred and recognized over the service period. Service revenue is generated from the sale of standard maintenance contracts as well as custom maintenance contracts that are tailored to individual customers' needs. We recognize service revenue ratably over the service periods. Maintenance contracts are typically
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between one to three years in length and we actively pursue renewals of these contracts. We also generate professional services revenue related to implementation of and training on our products.
Our products are highly configurable for customer requirements. Price changes, unit volumes, customer mix and product configuration can impact our revenues, cost of revenues and gross profit. Effective June 26, 2010, we adopted the provisions of Accounting Standards Update ("ASU") No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements for new and materially modified arrangements originating after June 25, 2010. The new revenue recognition standards allows for deliverables for which revenue would have been previously deferred to be separated and recognized as delivered, rather than over the longest service delivery period as a single unit of accounting with other elements in the arrangement. The new revenue recognition standards were required to be adopted for fiscal years beginning on or after June 15, 2010. For fiscal year 2011 and future periods, pursuant to the guidance of ASU 2009-13, when a sales arrangement contains multiple elements, such as products, software, customer support services, and or professional services, we will allocate revenue to each element based on a selling price hierarchy as described in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the Critical Accounting Policies and Estimates - Revenue Recognition below. In multiple element arrangements where software is essential to the functionality, revenue is allocated to each separate unit of accounting for each of the non-software deliverables and to the software deliverables as a group using the relative selling prices of each of the deliverables in the arrangement based on the aforementioned selling price hierarchy. If the arrangement contains more than one software deliverable, the arrangement consideration allocated to the software deliverables as a group is then recognized as one unit of accounting using the guidance for recognizing software revenue, as amended. The new revenue recognition standards permit prospective or retrospective adoption, and we elected prospective adoption.
Prior to the adoption of the new revenue recognition standards, we did not have a reasonable basis for separating product and service revenue as we had not been able to establish vendor-specific objective evidence of fair value of both the delivered and undelivered elements for our multiple-element arrangements. These multiple-element arrangements may include software products integrated with our hardware or include post-contract customer support. As a result of the adoption of the new revenue recognition standards, we now have a reasonable basis for separately presenting product and service for new and materially modified arrangements originating after June 25, 2010 as we are able to allocate revenue to each element within a multiple-element arrangement based on the aforementioned selling price hierarchy. However, as we did not have a reasonable basis for separating product and service revenue prior to the adoption of the new revenue recognition standards, revenue and related cost of revenue are presented in the table above on a contractual basis, which is the same metrics used by management for segment reporting, for the year ended June 24, 2011 and year ended June 25, 2010.
Product revenue increased $209.2 million or 82% to $465.2 million in the year ended June 24, 2011 from $256.0 million in the year ended June 25, 2010. Of the $209.2 million increase in product revenue, $166.2 million is attributable to the adoption of the new revenue recognition standards which allows for us to generally recognize more product revenue upon shipment or acceptance. Excluding the impact from the adoption of the new revenue recognition standards, product revenue increased $43.0 million or 17% in the year ended June 24, 2011. During the year ended June 24, 2011, our product mix continued to shift to higher margin high performance compute server and storage products, driven by the strength in sales of our new Altix® UV and COPAN™ products. Both Altix® UV and COPAN™ products are new product offerings introduced in fiscal year 2011. Altix® UV is our next generation shared-memory computer and continues to be well received in the marketplace. Consistent with the shift in product mix, our Amazon customer concentration moved from 20% of total revenue during the year ended June 25, 2010 to 12% during the year ended June 24, 2011. In addition, we recorded $29.1 million of product revenue from SGI Japan since its acquisition in the third quarter of fiscal year 2011. If SGI Japan had not been acquired, we would have recorded $9.6 million of product revenue related to products sold to SGI Japan.
Service revenue increased $16.7 million or 11% to $164.4 million in the year ended June 24, 2011 from $147.7 million in the year ended June 25, 2010. This increase was primarily due to the service revenue of $22.5 million from SGI Japan that we recorded since its acquisition in the third quarter of fiscal year 2011. If SGI Japan had not been acquired, we would not have recognized any service revenue from SGI Japan as prior to the acquisition, we did not sell service to SGI Japan.
Consistent with our strategy to extend our global reach and accelerate our growth opportunities, our international revenues grew to 38% of our total revenue during the year ended June 24, 2011 compared to 25% during the year ended June 25, 2010. The increase in international revenue as a percentage of total revenue is attributable to the acquisition of SGI Japan and to the increase in total revenue in European region for the year ended June 24, 2011.
Our continuous introduction of new products and improvements of our product's performance and data storage capacity means that we are unable to directly compare our products from period to period, and therefore, we are unable to quantify the changes in pricing of our products from period to period. We believe that our on-going introduction of new products and product features help mitigate competitive pricing pressures by forcing our competitors to compete on the basis of product
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features, rather than on pricing.
Cost of revenue and gross profit. Cost of revenue consists of costs associated with direct material, labor, manufacturing overhead, shipment of products, inventory write downs and share-based compensation. Cost of revenue also includes personnel costs for providing maintenance and professional services. Our manufacturing overhead and professional services personnel costs are fixed or semi-variable. Our gross margins are impacted by changes in customer and product mix, pricing actions by our competitors and commodity prices that comprise a significant portion of cost of revenue from period to period. Further when certain sales contracts are deferred in accordance with our revenue recognition policy, the related cost of revenue is deferred and recognized upon recognition of revenue.
Our cost of revenue and gross profit are impacted by price changes, product configuration, revenue mix and product material costs. Our service cost of revenue and gross margin are impacted by timing of support service initiations and renewals, and incremental investments in our customer support infrastructure.
Our headcount in the manufacturing and services organization increased from 576 employees at June 25, 2010 to 680 employees at June 24, 2011. This includes 133 employees working in SGI Japan.
Overall gross profit increased $80.2 million or 90% to $169.8 million in the year ended June 24, 2011 from $89.6 million in the year ended June 25, 2010. Overall gross margin percentage increased to 27.0% in the year ended June 24, 2011 from 22.2% in the year ended June 25, 2010. Approximately 370 basis point increase in our overall gross margin percentage is attributable to the adoption of the new revenue recognition standards. Historically, our high performance compute server and storage products were deferred and amortized under the previous revenue recognition standards. With the adoption of the new revenue recognition standards, we are able to recognize revenue and gross profit on these products at the time of delivery or acceptance.
Product gross profit increased $71.7 million or 275% to $97.8 million in the year ended June 24, 2011 from $26.1 million in the year ended June 25, 2010. Product gross margin percentage increased to 21.0% in the year ended June 24, 2011 from 10.2% in the year ended June 25, 2010. Of the $71.7 million increase in product gross profit, $62.0 million is attributable to the adoption of the new revenue recognition standards. The adoption of the new revenue recognition standards impacted cost of product revenue by $104.2 million during the year ended June 24, 2011. In addition to the adoption of the new accounting standards for revenue recognition, our product gross profit and product gross margin percentage increased due to a change in mix shift to higher margin high performance compute server and storage products, including the increase in sales of our new Altix UV and COPAN products. Our increase in product gross profit and product gross margin during year ended June 24, 2011 is also attributable to a decrease in inventory obsolescence to $3.0 million from $10.6 million in year ended June 25, 2010. In addition, we recorded product gross profit of $4.8 million from SGI Japan since its acquisition in the third quarter of fiscal year 2011. If SGI Japan had not been acquired, we would have recorded $3.0 million of product gross profit related to products sold to them.
Service gross profit increased $8.5 million or 13% to $72.0 million in the year ended June 24, 2011 from $63.5 million in the year ended June 25, 2010. Service gross margin slightly increased to 43.8% in the year ended June 24, 2011 from 43.0% in the year ended June 25, 2010. Of the $8.5 million increase in service gross profit, $7.2 million is attributable to service gross profit from the acquisition of SGI Japan.
Operating expenses
Operating expenses for the years ended June 24, 2011 and June 25, 2010 were as follows:
Year Ended | Change | |||||||||||||||
June 24, 2011 | June 25, 2010 | $ | % | |||||||||||||
(in thousands, except percentages) | ||||||||||||||||
Research and development | $ | 54,067 | $ | 56,865 | $ | (2,798 | ) | (5 | )% | |||||||
Sales and marketing | 75,813 | 64,831 | 10,982 | 17 | % | |||||||||||
General and administrative | 52,578 | 52,594 | (16 | ) | — | % | ||||||||||
Restructuring | 5,072 | 5,213 | (141 | ) | (3 | )% | ||||||||||
Acquisition-related | 1,271 | (3,264 | ) | 4,535 | (139 | )% | ||||||||||
Total operating expense | $ | 188,801 | $ | 176,239 | $ | 12,562 | 7 | % | ||||||||
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Research and development. Research and development expense consists primarily of personnel and related costs, contractor fees, new component testing and evaluation, test equipment, new product design and testing, other product development activities, share-based compensation, and facilities and information technology costs.
Research and development expense decreased $2.8 million or 5% to $54.1 million in the year ended June 24, 2011 from $56.9 million in the year ended June 25, 2010. The decrease in research and development expense was due to a decrease in facilities related expenses of $1.9 million, of which $1.5 million is due to a decrease in depreciation expense as some of our fixed assets were fully depreciated as of June 25, 2010. In addition, the decrease in research and development expense is due to a decrease in purchases of materials and test equipment used for research and development activities of $1.3 million, a decrease in third party consulting fees of $0.5 million, and a decrease in losses on disposal of property and equipment of $0.3 million. This decrease in research and development expenses was partially offset by an increase in compensation and related expenses of $0.6 million. Compensation and related expenses increased in fiscal year 2011 compared with fiscal year 2010 due to an increase in headcount from 270 employees at June 25, 2010 to 293 employees at June 24, 2011, including five employees from SGI Japan. In addition, during the year ended June 24, 2011, research and development reimbursements from our business partners decreased by $0.7 million to $1.3 million from $2.0 million in year ended June 25, 2010.
We believe that focused investments in research and development are critical to our future performance and competitiveness in the marketplace. Our investments in this area will directly relate to enhancement of our current product line, development of new products that achieve market acceptance, and our ability to meet an expanding range of customer requirements. As such, we expect to continue to spend on current and future product development efforts.
Sales and marketing. Sales and marketing expense consists primarily of salaries, bonuses and commissions paid to our sales and marketing employees, amortization of intangible assets, share-based compensation, and facilities and information technology costs. We also incur marketing expenses for activities such as trade shows, direct mail and advertising.
Sales and marketing expense increased $11.0 million or 17% to $75.8 million in the year ended June 24, 2011 from $64.8 million in the year ended June 25, 2010. This increase was primarily due to an increase in compensation and related expenses of $8.7 million in fiscal year 2011 compared to fiscal year 2010. Headcount increased from 291 employees at June 25, 2010 to 344 employees at June 24, 2011. This includes 106 employees from SGI Japan. The increase in headcount together with higher commission expense paid during fiscal year 2011 compared to fiscal year 2010 resulted to an overall increase in compensation and related expenses. In addition to compensation and related expenses, the increase in sales and marketing expense was also due to an increase in intangible amortization of $1.5 million, third party sales and marketing services of $0.5 million, share-based compensation expense of $0.5 million, travel expenses of $0.6 million, and marketing supplies and equipment of $0.4 million. The increase in sales and marketing expense was partially offset by a decrease in facility related expenses of $1.2 million, of which $0.5 million is due to a decrease in depreciation expense as some of our fixed assets were fully depreciated as of June 25, 2010.
We will continue to deploy our sales and support organizations to focus on key vertical markets such as defense and strategic systems, weather and climate, physical sciences, life sciences, energy (including oil and gas), aerospace and automotive, media and entertainment, semiconductor design, manufacturing, financial services, data centers, and business intelligence and data analytics.
General and administrative. General and administrative expense consists primarily of personnel costs, legal and professional service costs, depreciation, share-based compensation, and facilities and information technology costs.
The change in our general and administrative expense is not material in the year ended June 24, 2011 compared with the year ended June 25, 2010. Our compensation related expenses, hiring expenses, and share-based compensation expenses increased by $3.1 million, $0.8 million, and $0.7 million, respectively. This increase in general and administrative expenses is offset by decreases in professional and consulting fees of $1.4 million, decrease in bad debt expense of $1.0 million, decrease in insurance of $0.9 million, decrease in facility related expenses of $0.4 million, and decrease in supplies and small equipment expenses of $0.8 million. Compensation and related expenses increased due to increase in headcount from 188 employees at June 25, 2010 to 246 employees, which includes 34 employees in SGI Japan, at June 24, 2011.
Restructuring. On February 18, 2011, management approved the 2011 restructuring action as part of a worldwide workforce reduction to streamline operations and reduce operating expenses. Prior to this action, on July 27, 2009, management approved the 2010 restructuring action to reduce our European workforce and vacate certain facilities.
Restructuring expense for the year ended June 24, 2011 related to these actions was $5.1 million. For the year ended June 25, 2010, restructuring expense was $5.2 million. As a result of the restructuring actions undertaken, we anticipate future cash outflow of $1.5 million, primarily during fiscal year 2012.
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Acquisition-related. On March 9, 2011, pursuant to a Stock Purchase Agreement dated March 8, 2011, we acquired the remaining outstanding shares of SGI Japan. In connection with the acquisition, during the year ended June 24, 2011, we incurred acquisition-related costs of $1.3 million, which consisted primarily of costs related to due diligence, legal and other professional fees.
In the year ended June 25, 2010, we recorded a net gain of $3.3 million, related to our acquisition of Legacy SGI. During the year ended June 25, 2010, we received a $1.0 million payment from Legacy SGI related to potential liabilities of Legacy SGI, which pursuant to the Asset Purchase Agreement were to be remitted to the Company if not paid to a third party. In addition, we received $2.3 million from a Legacy SGI customer, resulting from a settlement of dispute with this customer which existed prior to the acquisition of Legacy SGI. Accordingly, we have recorded the $3.3 million payments received as a gain in our statement of operations in the year ended June 25, 2010.
Total other income (expense)
Total other income (expense) for the years ended June 24, 2011 and June 25, 2010 was as follows:
Year Ended | Change | ||||||||||||||
June 24, 2011 | June 25, 2010 | $ | % | ||||||||||||
(in thousands, except percentages) | |||||||||||||||
Interest income, net | $ | 95 | $ | 436 | $ | (341 | ) | (78 | )% | ||||||
Other income (expenses), net | (1,097 | ) | (7,088 | ) | 5,991 | (85 | )% | ||||||||
Total other income (expense) | $ | (1,002 | ) | $ | (6,652 | ) | $ | 5,650 | (85 | )% | |||||
Interest income, net. Interest income, net primarily consists of interest earned on our interest-bearing investment accounts which include money market funds, U.S. treasury bills, and auction rate securities ("ARS"). The decrease in interest income, net for the year ended June 24, 2011 compared to the year ended June 25, 2010 was due to lower interest rates on our investment portfolio, as we sold our ARS during the second quarter of fiscal year 2011.
Other income (expense), net. Other expense, net in the year ended June 24, 2011 consists primarily of impairment of our investment in SGI Japan of $2.9 million and $0.8 million in recognized losses on our investments in auction rate securities. These losses were partially offset by foreign exchange gains of $2.6 million that resulted from the favorable exchange rate effect due to the strengthening of the Euro against the U.S. Dollar.
During the year ended June 25, 2010, other expense, net consisted of foreign exchange losses of $7.2 million that resulted from the unfavorable exchange rate effect due to the strengthening of the U.S. dollar against the Euro.
Income tax provision from continuing operations
Income tax provision from continuing operations for the years ended June 24, 2011 and June 25, 2010 was as follows:
Year Ended | Change | ||||||||||||||
June 24, 2011 | June 25, 2010 | $ | % | ||||||||||||
(in thousands, except percentages) | |||||||||||||||
Income tax provision (benefit) from continuing operations | $ | 1,242 | $ | (4,441 | ) | $ | 5,683 | (128 | )% | ||||||
We recorded a tax expense of $1.2 million for the year ended June 24, 2011. Our tax expense for the year ended June 24, 2011 primarily related to our foreign operations, and included $1.2 million of unrecognized tax benefits and related interest. Additional amounts recorded include a discrete tax benefit of $1.6 million attributable to release of valuation allowance. The effective tax rate used to record the tax expense differed from the combined federal and net state statutory income tax rate for the year ending June 24, 2011 primarily due to domestic operating losses generated during the period from which the Company does not benefit, tax expense incurred by the Company's foreign subsidiaries with operating income, tax benefit attributable to release of valuation allowance, and tax expense associated with our unrecognized tax benefits and related interest.
We recorded a net tax benefit of $4.4 million for the year ended June 25, 2010. The net income tax benefit includes a discrete tax benefit of $4.9 million resulting from the November 6, 2009 enactment of the Worker, Homeownership, and Business Assistance Act of 2009 (the Act). The Act provides an election for federal taxpayers to increase the carry back period for an applicable net operating loss to three to five years from two years. Additional amounts recorded include a discrete tax benefit of $1.0 million attributable to release of valuation allowance and tax expense of $1.1 million for unrecognized tax benefits and related interest. The effective tax rate used to record the tax expense differed from the combined federal and net
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state statutory income tax rate for the year ended June 25, 2010 primarily due to the discrete items noted above and the fact that we do not record a benefit for operating losses generated during the period due to uncertainties regarding the realizability of the resulting loss carryforwards.
As of June 24, 2011, we have provided a full valuation allowance against the majority of our net deferred tax assets. Based on all available evidence, on a jurisdictional basis, including our historical operating results, and the uncertainty of predicting our future income, the valuation allowance reduces the majority of our deferred tax assets to an amount that is more likely than not to be realized. The amount of the valuation allowance is attributable to U.S. federal, state and certain foreign deferred tax assets primarily consisting of net operating loss carryovers, tax credit carryovers, accrued expenses, and other temporary differences. As of June 24, 2011, we have determined that it is more likely than not that certain foreign deferred tax assets will be realized and as a result, we released the valuation allowance related to the deferred tax assets of certain foreign subsidiaries. We continue to evaluate the realizability of deferred tax assets and related valuation allowance. If our assessment of the deferred tax assets or the corresponding valuation allowance were to change, we would record the related adjustment to income during the period in which management makes the determination.
Income from discontinued operations, net of tax
Income from discontinued operations, net of tax, for the years ended June 24, 2011 and June 25, 2010 was as follows:
Year Ended | Change | |||||||||||||||
June 24, 2011 | June 25, 2010 | $ | % | |||||||||||||
(in thousands, except percentages) | ||||||||||||||||
Income from discontinued operations, net of tax | $ | — | $ | 409 | $ | (409 | ) | (100 | )% | |||||||
During the year ended January 3, 2009, we classified our RapidScale™ product line as a discontinued operation as a result of discontinuing this product line. Our decision was a result of a change in strategic direction, as well as an inability to license certain third party software on reasonable commercial terms.
The revenue contribution from this product line was not significant for the year ended June 24, 2011 and $0.4 million for the year ended June 25, 2010.
Comparison of the years ended June 25, 2010 and January 3, 2009
Financial Highlights
• | Our higher revenue and gross margin in the year ended June 25, 2010 was a result of including higher margin high performance compute server and storage products and the related service revenue associated with our acquisition of Legacy SGI. |
• | We experienced a significant increase in our operating expenses due to including the results of operations of the Legacy SGI acquisition in the year ended June 25, 2010. |
• | As a result of the acquisition, our headcount significantly increased from 318 employees at January 3, 2009 to 1,325 employees at June 25, 2010. Our properties also increased significantly from approximately 177,000 square feet of floor space as of January 3, 2009 to approximately 436,000 square feet of leased floor space as of June 25, 2010. As of June 25, 2010, we also owned land and buildings with aggregate floor space of approximately 268,000 square feet. |
• | During the year ended June 25, 2010, we experienced a significant decrease in total share-based compensation expense due to a declining stock price and employee turnover compared to the year ended January 3, 2009. |
Revenue, cost of revenue, gross profit and gross margin
The following table presents revenue, cost of revenue, gross profit, and gross margin for the years ended June 25, 2010 and January 3, 2009 (presented on a contractual basis):
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Year Ended | Change | ||||||||||||||
June 25, 2010 | January 3, 2009 | $ | % | ||||||||||||
(in thousands, except percentages) | |||||||||||||||
Product revenue | $ | 256,007 | $ | 247,430 | $ | 8,577 | 3 | % | |||||||
Service revenue | 147,710 | — | 147,710 | n/a | |||||||||||
Total revenue | $ | 403,717 | $ | 247,430 | $ | 156,287 | 63 | % | |||||||
Cost of product revenue | $ | 229,913 | $ | 217,992 | $ | 11,921 | 5 | % | |||||||
Cost of service revenue | 84,215 | — | 84,215 | n/a | |||||||||||
Total cost of revenue | $ | 314,128 | $ | 217,992 | $ | 96,136 | 44 | % | |||||||
Product gross profit | $ | 26,094 | $ | 29,438 | $ | (3,344 | ) | (11 | )% | ||||||
Service gross profit | 63,495 | — | 63,495 | n/a | |||||||||||
Total gross profit | $ | 89,589 | $ | 29,438 | $ | 60,151 | 204 | % | |||||||
Product gross margin | 10.2 | % | 11.9 | % | |||||||||||
Service gross margin | 43.0 | % | — | ||||||||||||
Overall gross margin | 22.2 | % | 11.9 | % | |||||||||||
Revenue. Revenue increased $156.3 million or 63% to $403.7 million in the year ended June 25, 2010 from $247.4 million in the year ended January 3, 2009. The increase in revenue was primarily due to the addition of revenue from high performance compute server and storage products and related service revenue associated with our acquisition of Legacy SGI. The acquisition of Legacy SGI contributed $235.0 million of revenue in the year ended June 25, 2010. Revenue from the sale of data center products and services of $168.7 million decreased $78.7 million or 32% in the year ended June 25, 2010 as compared with $247.4 million in the year ended January 3, 2009. The decline was primarily due to a 31% decrease in the number of units shipped, reflecting the economic downturn which we believe impacted the timing of our customer’s buying decisions, and a slight decrease in average selling price compared to prior year.
Cost of revenue and gross profit. With the acquisition of Legacy SGI, we added facilities and personnel that contribute to an increase in our cost of revenue. Our headcount increased by 448 employees from 128 employees at January 3, 2009 to 576 employees at June 25, 2010. Cost of revenue increased by a lower percentage than revenue due to a shift in mix towards a greater percentage of higher margin service offerings and high performance compute server and storage products.
Gross profit increased $60.2 million to $89.6 million in the year ended June 25, 2010 from $29.4 million in the year ended January 3, 2009. Gross margin percentage increased to 22.2% in the year ended June 25, 2010 from 11.9% in the year ended January 3, 2009. Our increase in gross profit and gross margin was primarily attributable to higher margin, high performance compute server and storage product revenue and related service revenue associated with our acquisition of Legacy SGI, which had gross margin of 31.7% and contributed $74.5 million in gross profit in the year ended June 25, 2010. Gross profit from the sale of data center products and services decreased $14.4 million or 48.8% to $15.1 million in the year ended June 25, 2010 from $29.4 million in the year ended January 3, 2009.
Operating Expenses
Operating expenses for the years ending June 25, 2010 and January 3, 2009 were as follows:
Year Ended | Change | ||||||||||||||
June 25, 2010 | January 3, 2009 | $ | % | ||||||||||||
(in thousands, except percentages) | |||||||||||||||
Research and development | $ | 56,865 | $ | 14,864 | $ | 42,001 | 283 | % | |||||||
Sales and marketing | 64,831 | 23,412 | 41,419 | 177 | % | ||||||||||
General and administrative | 52,594 | 24,526 | 28,068 | 114 | % | ||||||||||
Restructuring | 5,213 | 685 | 4,528 | 661 | % | ||||||||||
Acquisition-related | (3,264 | ) | — | (3,264 | ) | n/a | |||||||||
Total operating expense | $ | 176,239 | $ | 63,487 | $ | 112,752 | 178 | % | |||||||
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Research and development. Research and development expense increased $42.0 million or 283% to $56.9 million in the year ended June 25, 2010 from $14.9 million in the year ended January 3, 2009. The overall increase in research and development expenses was primarily due to the expansion of our business and research and development activities which resulted from our acquisition of Legacy SGI. In the year ended June 25, 2010, our compensation and related expenses increased by $26.6 million due to an increase in research and development headcount from 60 employees at January 3, 2009 to 270 employees at June 25, 2010. Additionally, materials and supplies increased $2.8 million and third-party research and development services increased $5.5 million, primarily driven by expenses incurred for development of our UV system and other new products. Further, facilities costs increased $3.0 million and depreciation expense increased $4.2 million. These increases were partially offset by lower share-based compensation related expenses of $1.1 million due to declining stock price and employee turnover.
Sales and marketing. Sales and marketing expense increased $41.4 million or 177% to $64.8 million in the year ended June 25, 2010 from $23.4 million in the year ended January 3, 2009. The overall increase in sales and marketing expense was primarily due to the expansion of our business which resulted from our acquisition of Legacy SGI. In the year ended June 25, 2010, our compensation and related expenses increased by $29.5 million due to an increase in sales and marketing headcount from 70 employees at January 3, 2009 to 291 employees at June 25, 2010. Our facilities costs, rent expenses, and depreciation expenses are higher in the year ended June 25, 2010 by $6.3 million compared to the year ended January 3, 2009. We also experienced an increase in marketing costs of $1.4 million and higher travel and entertainment expenses of $1.4 million. In addition, we recorded intangible asset amortization expense of $5.0 million during the year ended June 25, 2010 related to the amortization of customer backlog intangible asset acquired as part of our acquisition of Legacy SGI. There was no intangible asset amortization for the year ended January 3, 2009. This increase in sales and marketing expense was reduced by lower share-based compensation costs of $1.1 million due to declining stock price and employee turnover, and write-off of loaner and demo equipments of $2.2 million recorded in the year ended January 3, 2009.
General and administrative. General and administrative expense increased $28.1 million or 114% to $52.6 million in the year ended June 25, 2010 from $24.5 million in the year ended January 3, 2009. The overall increase in general and administrative expense was primarily due to the expansion of our business which resulted from our acquisition of Legacy SGI. In the year ended June 25, 2010, our compensation and related expenses increased by $16.0 million due to increase in general and administrative headcount from 60 employees at January 3, 2009 to 188 employees at June 25, 2010. Due to the increased complexity of our business post-acquisition, our financial audit and SOX compliance fees increased by $1.3 million. Our outside tax consulting fees also increased by $2.1 million primarily due to an increase in consulting services regarding foreign tax issues, as we are now currently operating in over 25 countries. Our legal expenses also increased by $1.6 million. Our third-party contractors and temporary employees increased by $3.0 million primarily driven by outsourcing of finance and IT related functions in the year ended June 25, 2010 as we integrated Legacy SGI. Facilities related expenses increased by $2.2 million. Our property taxes also increased by $0.9 million, insurance by $1.0 million, and bad debt expense by $0.8 million. This increase in expenses was offset by lower share based compensation cost of $1.7 million due to a decline in stock price and employee turnover.
Restructuring. On July 27, 2009, management approved restructuring actions to reduce the Company’s European workforce and vacate certain facilities. The expense for the year ended June 25, 2010 related to these actions was $4.6 million for severance and $0.6 million for vacating facilities.
Acquisition-related. In the year ended June 25, 2010, we recorded a net gain of $3.3 million, related to our acquisition of Legacy SGI. During the year ended June 25, 2010, we received a $1.0 million payment from Legacy SGI related to potential liabilities of Legacy SGI, which pursuant to the Agreement were to be remitted to the Company if not paid to a third party. In addition, we received $2.3 million from a Legacy SGI customer, resulting from a settlement of dispute with this customer which existed prior to the acquisition of Legacy SGI. At the Closing Date, we assessed whether it was more likely than not that contingent assets existed and based on all available information concluded that no contingent assets existed. Accordingly, we have recorded the $3.3 million payments received as a gain in our statement of operations in the year ended June 25, 2010.
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Total other income (expense)
Total other income (expense) for the years ended June 25, 2010 and January 3, 2009 was as follows:
Year Ended | Change | ||||||||||||||
June 25, 2010 | January 3, 2009 | ||||||||||||||
$ | % | ||||||||||||||
(in thousands, except percentages) | |||||||||||||||
Interest income, net | $ | 436 | $ | 4,106 | $ | (3,670 | ) | (89 | )% | ||||||
Other income (expense), net | (7,088 | ) | (968 | ) | (6,120 | ) | 632 | % | |||||||
Total other income (expense) | $ | (6,652 | ) | $ | 3,138 | $ | (9,790 | ) | (312 | )% | |||||
Interest income, net. Interest income, net primarily consists of interest earned on our investment portfolio. Interest income, net decreased $3.7 million or 89% primarily due to lower interest rates earned on our investment portfolio in the year ended June 25, 2010 as compared to the year ended January 3, 2009. Our cash and cash equivalents, including restricted cash and cash equivalents, and long-term investments in ARS was $140.8 million as of June 25, 2010 and $180.6 million as of January 3, 2009.
Other income (expense), net. Other income (expense), net primarily consists of foreign exchange loss. The foreign exchange loss was $7.2 million in year ended June 25, 2010 and $0.7 million in year ended January 3, 2009. In the year ended June 25, 2010, we experienced an unfavorable exchange rate effect resulting from the strengthening of the U.S dollar against the Euro.
Income tax provision (benefit) from continuing operations
Income tax provision (benefit) from continuing operations for the years ended June 25, 2010 and January 3, 2009 was as follows:
Year Ended | Change | ||||||||||||||
June 25, 2010 | January 3, 2009 | ||||||||||||||
$ | % | ||||||||||||||
(in thousands, except percentages) | |||||||||||||||
Income tax provision (benefit) from continuing operations | $ | (4,441 | ) | $ | 376 | $ | (4,817 | ) | (1,281 | )% | |||||
We recorded a net tax benefit of $4.4 million for the year ended June 25, 2010. The net income tax benefit includes a discrete tax benefit of $4.9 million resulting from the November 6, 2009 enactment of the Worker, Homeownership, and Business Assistance Act of 2009 (the Act). The Act provides an election for federal taxpayers to increase the carry back period for an applicable net operating loss to three to five years from two years. Additional amounts recorded include a discrete tax benefit of $1.0 million attributable to release of valuation allowance and tax expense of $1.1 million for unrecognized tax benefits and related interest. The effective tax rate used to record the tax expense differed from the combined federal and net state statutory income tax rate for the year ended June 25, 2010 primarily due to the discrete items noted above and the fact that we do not record a benefit for operating losses generated during the period due to uncertainties regarding the realizability of the resulting loss carryforwards.
Our income tax provision recorded for the year ended January 3, 2009 consisted primarily of refunds of prior taxes paid offset by the recording of a valuation allowance for deferred tax asset balances due to the Company’s loss position. Our effective tax rate for the year ended January 3, 2009 differed from the combined federal and state statutory rate primarily due to the recording of the valuation allowance.
Income (loss) from discontinued operations, net of tax
Income (loss) from discontinued operations, net of tax, for the years ended June 25, 2010 and January 3, 2009 was as follows:
Year Ended | Change | ||||||||||||||
June 25, 2010 | January 3, 2009 | $ | % | ||||||||||||
(in thousands, except percentages) | |||||||||||||||
Income (loss) from discontinued operations, net of tax | $ | 409 | $ | (22,941 | ) | $ | 23,350 | (102 | )% | ||||||
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During the year ended January 3, 2009, we classified our Rapidscale product line as a discontinued operation as a result of discontinuing this product line. Our decision was a result of a change in strategic direction, as well as an inability to license certain third party software on reasonable commercial terms.
Comparison of the six-month transition period ended June 26, 2009 and the six months ended June 28, 2008 (unaudited)
Financial Highlights
• | Our lower revenue and gross margin was primarily attributed to a decrease in the number of units shipped as well as a decrease in the average selling price partially offset by six weeks of revenue from our acquisition of Legacy SGI. |
• | We experienced a significant increase in our operating expenses due to the acquisition of Legacy SGI in May 2009 during the six-month transition period ended June 26, 2009. |
• | We experienced a significant decrease in total share-based compensation expense due to a declining stock price and employee turnover. Total share-based compensation expense decreased by approximately $4.1 million from $7.2 million in the six months ended June 28, 2008 to $3.1 million for the six months ended June 26, 2009. |
Revenue, cost of revenue, gross profit and gross margin
The following table presents revenue, cost of revenue, gross profit, and gross margin for the six months ended June 26, 2009 and June 28, 2008 (presented on a contractual basis):
Six months ended | Change | ||||||||||||||
June 26, 2009 | June 28, 2008 | $ | % | ||||||||||||
(unaudited) | |||||||||||||||
(in thousands, except percentages) | |||||||||||||||
Product revenue | $ | 77,987 | $ | 143,569 | $ | (65,582 | ) | (46 | )% | ||||||
Service revenue | 24,790 | — | 24,790 | n/a | |||||||||||
Total revenue | $ | 102,777 | $ | 143,569 | $ | (40,792 | ) | (28 | )% | ||||||
Cost of product revenue | $ | 78,132 | $ | 119,159 | $ | (41,027 | ) | (34 | )% | ||||||
Cost of service revenue | 16,868 | — | 16,868 | n/a | |||||||||||
Total cost of revenue | $ | 95,000 | $ | 119,159 | $ | (24,159 | ) | (20 | )% | ||||||
Product gross profit | $ | (145 | ) | $ | 24,410 | $ | (24,555 | ) | (101 | )% | |||||
Service gross profit | 7,922 | — | 7,922 | n/a | |||||||||||
Total gross profit | $ | 7,777 | $ | 24,410 | $ | (16,633 | ) | (68 | )% | ||||||
Product gross margin | (0.2 | )% | 17.0 | % | |||||||||||
Service gross margin | 32.0 | % | — | ||||||||||||
Overall gross margin | 7.6 | % | 17.0 | % | |||||||||||
Revenue. Revenue decreased $40.8 million or 28% in the six months ended June 26, 2009 from $143.6 million in the six months ended June 28, 2008. The decline was primarily due to a 53% decrease in the number of units shipped over the prior year period. The decline was offset by a 6% increase in average selling price reflecting customer and product configuration mix changes. The decline was partially offset by six weeks of revenue from our acquisition of Legacy SGI assets during the six months ended June 26, 2009 which contributed $30.7 million of revenue to our results for the period.
Cost of revenue and gross profit. The decline in cost of revenue is less than the decline in revenue due to the fixed nature of our manufacturing overhead and personnel costs. Additionally, with the acquisition of Legacy SGI, we added facilities and personnel that contributed to our cost of revenue.
The lower gross margin for the six months ended June 26, 2009 compared to the six months ended June 28, 2008 is primarily attributed to a decrease in average selling price and number of units shipped. In the six months ended June 26, 2009, we experienced a 53% decrease in the number of units shipped which was offset by a 6% increase in average selling price. The decrease in units shipped resulted in $13.0 million decrease in gross margin and an $11.6 million decrease related to lower gross margin on those shipments. Lower gross margin was also a result of excess and obsolete charges being a higher percentage of revenue in the six months ended June 26, 2009 compared to the six months ended June 28, 2008. This was offset
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by higher margin revenue earned from the Legacy SGI business. Legacy SGI contributed $7.6 million in gross profit in the six months ended June 26, 2009.
Operating Expenses
Operating expenses for the six months ended June 26, 2009 and June 28, 2008 were as follows:
Six months ended | Change | ||||||||||||||
June 26, 2009 | June 28, 2008 | $ | % | ||||||||||||
(unaudited) | |||||||||||||||
(in thousands, except percentages) | |||||||||||||||
Research and development | $ | 10,729 | $ | 7,239 | $ | 3,490 | 48 | % | |||||||
Sales and marketing | 18,236 | 12,196 | 6,040 | 50 | % | ||||||||||
General and administrative | 14,013 | 13,790 | 223 | 2 | % | ||||||||||
Restructuring | 1,270 | 685 | 585 | 85 | % | ||||||||||
Acquisition-related | 6,070 | — | 6,070 | n/a | |||||||||||
Gain from settlement agreement | (5,000 | ) | — | (5,000 | ) | n/a | |||||||||
Gain from acquisition | (19,831 | ) | — | (19,831 | ) | n/a | |||||||||
Total operating expense | $ | 25,487 | $ | 33,910 | $ | (8,423 | ) | (25 | )% | ||||||
Research and development. Research and development expenses increased $3.5 million or 48% in the six months ended June 26, 2009 from $7.2 million in the six months ended June 28, 2008. The increase was primarily due to a $3.4 million increase in compensation and related expenses resulting from an increase in headcount primarily from our acquisition of Legacy SGI. Headcount in research and development increased from 63 employees to 275 employees due to the addition of 212 employees as a result of the Legacy SGI acquisition. The increase is also attributed to an increase in our facilities costs of $0.5 million as we now have facilities in more locations and an increase in depreciation expense of $0.6 million. Materials and supplies usage increased by $0.4 million due to our acquisition of Legacy SGI. These increases were offset by a decrease in our share-based compensation expense of $0.8 million and Legacy SGI research and development reimbursement arrangements with business partners of $0.9 million.
Sales and marketing. Sales and marketing expense increased $6.0 million or 50% in the six months ended June 26, 2009 from $12.2 million in the six months ended June 28, 2008. The increase was primarily due to $3.8 million increase in compensation and related expenses due to an increase in headcount from our acquisition of Legacy SGI. Headcount in sales and marketing increased from 52 employees to 308 employees due to the addition of 256 employees as a result of the Legacy SGI acquisition. We also recorded an impairment charge of $2.5 million related to the write down of the Rackable trade name. In addition, we experienced an increase in facilities expense of $0.6 million, information technology costs of $0.5 million, depreciation expense of $0.3 million and amortization of intangibles of $0.3 million as a result of our acquisition of Legacy SGI. The increase was offset by a decrease in share-based compensation of $0.7 million, decrease of $0.5 million in commissions and bonuses due to a decline in sales, decrease in use of evaluation systems of $0.3 million, and decrease in our recruiting costs of $0.3 million.
General and administrative. General and administrative expense increased $0.2 million or 2% in the six months ended June 26, 2009 from $13.8 million in the six months ended June 28, 2008. The increase was primarily due to $2.0 million increase in compensation and related expenses due to an increase in headcount from our acquisition of Legacy SGI. Headcount in general and administrative increased from 47 employees to 197 employees due to the addition of 150 employees as a result of the Legacy SGI acquisition. The increase is also due to an increase in tax settlement expense of $0.4 million. The increase was offset by a decrease in share-based compensation expense of $1.8 million.
Restructuring. Restructuring expense consist primarily of severance costs and costs to exit facilities. Restructuring expenses increased $0.6 million or 85% for the six months ended June 26, 2009 from $0.7 million in the six months ended June 28, 2008. Restructuring expenses in the current quarter consist of severance costs for employees that were terminated as a result of the Legacy SGI acquisition. We incurred restructuring charges of $0.7 million related to future lease commitments for excess facilities vacated during the six months ended June 28, 2008.
Acquisition-related. Acquisition-related cost for the six months ended June 26, 2009, were $6.1 million related to the acquisition of Legacy SGI consisting primarily of costs related to due diligence, legal and other professional fees.
44
Gain from settlement agreement. During the six months ended June 26, 2009, we reached a settlement with a customer over a dispute on the terms of a statement of work under which this customer agreed to pay us $5.0 million. No such benefit was recorded in any other period presented.
Gain from acquisition. During the six months ended June 26, 2009, we acquired substantially all of the assets of Legacy SGI. The estimated fair value of the acquired net assets of $62.3 million exceeds the $42.5 million cash consideration paid resulting in a bargain purchase gain of $19.8 million. No such gain was recorded in the six months ended June 28, 2008.
Total other income (expense)
Total other income (expense) for the six months ended June 26, 2009 and June 28, 2008 was as follows:
Six months ended | Change | ||||||||||||||
June 26, 2009 | June 28, 2008 | $ | % | ||||||||||||
(unaudited) | |||||||||||||||
(in thousands, except percentages) | |||||||||||||||
Interest income, net | $ | 176 | $ | 2,879 | $ | (2,703 | ) | (94 | )% | ||||||
Other income (expense), net | 1,101 | (3 | ) | 1,104 | * | ||||||||||
Total other income (expense) | $ | 1,277 | $ | 2,876 | $ | (1,599 | ) | (56 | )% | ||||||
* | not meaningful |
Total other income (expense) decreased for the six months ended June 26, 2009 by $1.6 million from $2.9 million in the six months ended June 28, 2008 to $1.3 million due to a decline in interest income, net of $2.7 million. Interest income, net decreased primarily due to lower interest rates earned on our investment portfolio in the six months ended June 26, 2009 as compared to the six months ended June 28, 2008. This decline was partially offset by an increase in other income by $1.1 million, primarily due to an increase in foreign currency gains.
Income tax provision (benefit) from continuing operations
Income tax provision (benefit) from continuing operations for the six months ended June 26, 2009 and June 28, 2008 was as follows:
Six months ended | Change | ||||||||||||||
June 26, 2009 | June 28, 2008 | $ | % | ||||||||||||
(unaudited) | |||||||||||||||
(in thousands, except percentages) | |||||||||||||||
Income tax provision (benefit) from continuing operations | $ | (2,242 | ) | $ | 1,526 | $ | (3,768 | ) | (247 | )% | |||||
We recorded a tax benefit of $2.2 million and a tax provision of $1.5 million for the six months ended June 26, 2009 and June 28, 2008, respectively. The tax benefit was computed based on the year to date financial statements reflecting our new fiscal year end of June 26, 2009. The income tax benefit for the six months ended June 26, 2009 includes a tax benefit of $1.8 million resulting from the release of Legacy Rackable’s valuation allowance to offset the deferred tax liabilities recorded through the business combination of Legacy SGI. In addition, Legacy Rackable released valuation allowance in the amount of $0.8 million resulting from changing the classification of indefinite to definite lived intangible assets. The effective tax rate used to record the tax benefit differed from the combined federal and net state statutory income tax rate for the six months ended June 26, 2009 was primarily due to the release of Legacy Rackable’s valuation allowance and operating losses generated during the six months ended June 26, 2009 from which we do not benefit.
Loss from discontinued operations, net of tax
Loss from discontinued operations, net of tax, for the six months ended June 26, 2009 and June 28, 2008 was as follows:
Six months ended | Change | ||||||||||||||
June 26, 2009 | June 28, 2008 | $ | % | ||||||||||||
(unaudited) | |||||||||||||||
(in thousands, except percentages) | |||||||||||||||
Loss from discontinued operations, net of tax | $ | (20 | ) | $ | (20,546 | ) | $ | 20,526 | (100 | )% | |||||
45
During the six months ended June 28, 2008, we classified our Rapidscale product line as a discontinued operation as a result of discontinuing this product line. Our decision was a result of a change in strategic direction, as well as an inability to license certain third party software on reasonable commercial terms.
The revenue contribution from this product line was not significant at $0.1 million and $0.3 million for the six months ended June 26, 2009 and June 28, 2008, respectively.
Liquidity and Capital Resources
We had $139.9 million of cash and cash equivalents at June 24, 2011 and $129.3 million of cash and cash equivalents at June 25, 2010. Historically, we have required capital principally to support business operations and capital expenditures. We have also required capital to allow discretionary share repurchases and acquisition of businesses. During the year ended June 24, 2011, we used $17.9 million of cash to acquire the remaining outstanding shares of SGI Japan, $9.6 million to repay the notes payable we assumed as part of the acquisition, and $3.9 million for our discretionary share repurchases.
At June 24, 2011, we had short-term and long-term restricted cash and cash equivalents of $3.3 million that are pledged as collateral for various guarantees issued to cover rent on leased facilities and equipment, to government authorities for value-added tax (“VAT”) and other taxes, and certain vendors to support payments in advance of delivery of goods and services.
The adequacy of these resources to meet our liquidity needs beyond the next twelve months will depend on our growth, operating results and capital expenditures required to meet our business needs. If we fail to generate sufficient cash from operations on a timely basis, we may need to seek additional sources of funds to meet our business needs. Cash flows from our discontinued operations have been included in our consolidated statement of cash flows with continuing operations within each cash flow category. The absence of cash flows from discontinued operations is not expected to affect our future liquidity or capital resources.
At June 24, 2011, we believe our current cash and cash equivalents will be sufficient to fund working capital requirements, capital expenditures, and operations for at least the next twelve months. We intend to retain any future earnings to support operations and to finance the growth and development of our business, and we do not anticipate paying any dividends in the foreseeable future. At the present time, we have no material commitments for capital expenditures.
If we require additional capital resources to expand our business internally or to acquire complementary technologies and businesses at any time in the future, we may seek to sell additional equity or debt securities or obtain other debt financing. The sale of additional equity or debt securities could result in more dilution to our stockholders. Financing arrangements may not be available to us, or may not be available in amounts or on terms acceptable to us.
The following is a summary of cash activity (in thousands):
Year Ended | Six Months Ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Consolidated statements of cash flows data: | ||||||||||||||||
Net cash provided by (used in) operating activities | $ | 11,533 | $ | 8,197 | $ | (15,699 | ) | $ | (27,014 | ) | ||||||
Net cash provided by (used in) investing activities and acquisitions | 6,312 | (8,500 | ) | 137,433 | (15,097 | ) | ||||||||||
Net cash (used in) provided by financing activities | (8,364 | ) | 932 | 148 | (1,014 | ) | ||||||||||
Effect of exchange rate changes on cash and cash equivalents | 1,044 | — | 175 | (115 | ) | |||||||||||
Net increase (decrease) in cash and cash equivalents | $ | 10,525 | $ | 629 | $ | 122,057 | $ | (43,240 | ) | |||||||
Operating Activities
Cash provided by operating activities was $11.5 million for the year ended June 24, 2011. Our net loss was $21.2 million for the year ended June 24, 2011. Non-cash items included in net loss consisted primarily of depreciation and amortization expense of $17.8 million, share-based compensation expense of $5.9 million, impairment of investment in SGI Japan of $2.9 million, impairment on investments of $0.8 million, changes in deferred income taxes of $8.2 million, and recovery of doubtful accounts receivable of $0.1 million. Net change in operating assets and liabilities was $13.5 million. The primary operating activity source of cash was a decrease in inventory. The primary uses of cash in operating activities were an increase in accounts receivable and decrease in deferred revenue.
For the year ended June 24, 2011, deferred revenue decreased $12.4 million and deferred cost of revenue increased $1.9 million, respectively, primarily due to the timing of revenue recognition on sales transactions which were required to be
46
deferred in accordance with our revenue recognition policy. Inventory decreased $17.2 million due to timing of inventory purchases and shipments to customers. Additionally, accounts payable increased $7.6 million, primarily due to the increase in inventory purchases and the timing of payments. Accrued compensation increased $1.8 million primarily due to timing of compensation and related payments.
Cash provided by operating activities of $8.2 million for the year ended June 25, 2010 reflected cash provided by changes in working capital of $44.2 million, offset by our net loss of $64.6 million, net of adjustments for non-cash items. The primary working capital sources of cash were an increase in deferred revenue and decreases in inventories and prepaid and other current assets. The primary working capital uses of cash were increases in deferred cost of revenue and accounts receivable and a decrease in accounts payable and other liabilities. Non-cash items consisted primarily of depreciation and amortization of $18.4 million and share-based compensation of $4.7 million.
During the six months ended June 26, 2009, cash used in operating activities was $27.0 million. Our net loss included non-cash items for a gain on acquisition of $19.8 million, gain on settlement of $5.0 million, depreciation and amortization of $3.3 million, share-based compensation of $3.1 million, and impairment charge of $2.5 million due to the write down of the Legacy Rackable trade name. Cash used for working capital was approximately $3.2 million, primarily due to increases in accounts receivable, prepaid expenses and other current assets, and a decrease in deferred revenue, offset by an increase in accounts payable.
During the year ended January 3, 2009, cash used in operating activities totaled $15.7 million due to our net loss exceeding both our non-cash items and changes in operating assets and liabilities. Our net loss included substantial non-cash items in the form of stock compensation of $9.6 million, impairment of long-lived assets of $17.5 million and depreciation and amortization of long-lived assets of $5.6 million, partially offset by the decrease in deferred tax liabilities of $1.5 million. These non-cash items totaled $31.9 million. Changes in operating assets and liabilities offset our net loss by approximately $6.6 million, primarily in accounts receivable, prepaid and other assets, accounts payable, deferred revenue and deferred cost of revenue.
Investing Activities and Acquisition
Cash provided by investing activities and acquisition was $6.3 million in the year ended June 24, 2011, primarily due to proceeds from sales and maturities of investments of $7.9 million. In addition, we purchased the remaining outstanding shares of SGI Japan that we did not already own for $17.9 million in cash. In connection with the acquisition, we acquired $24.0 million of cash, resulting in net cash acquired of $6.0 million. Our restricted cash and cash equivalents also increased our cash by $0.6 million during fiscal year 2011. Cash provided by investing activities was partially offset by purchases of property and equipment of $8.2 million.
Cash used in investing activities and acquisition was $8.5 million in the year ended June 25, 2010, primarily due to the purchases of property and equipment of $6.3 million and the acquisition of Copan Systems, Inc. for $2.0 million.
During the six months ended June 26, 2009, net cash used in investing activities and acquisition was $15.1 million, primarily used in the acquisition of substantially all of the assets and certain liabilities of Legacy SGI for which we paid $42.5 million and acquired cash of $29.0 million for a net cash use of $13.5 million. During the period we also purchased property and equipment of $2.4 million. The cash outflows were offset by $0.7 million of proceeds from the sale and maturities of restricted cash and cash equivalents.
During the year ended January 3, 2009, net cash provided by investing activities was $137.4 million and consisted primarily of proceeds from sales and maturities of marketable securities of $165.4 million, offset by purchases of marketable securities of $26.3 million and purchases of property and equipment of $1.6 million. Our purchases of property and equipment in 2008 related mainly to tenant improvements and asset additions to our new Shanghai office. We reduced our investment in ARS from $64.6 million at December 29, 2007 to $8.7 million at January 3, 2009.
Financing Activities
Cash used in financing activities was $8.4 million in the year ended June 24, 2011, primarily for repayment of notes payable assumed in the acquisition of SGI Japan of $9.6 million, repurchases of restricted stock of $1.4 million, and purchase of treasury stock of $3.9 million. This decrease in cash was partially offset by proceeds of $6.5 million from the issuance of stock and stock options under the employee stock purchase plan and stock options .
Cash provided by financing activities was $0.9 million in the year ended June 25, 2010, primarily due to proceeds from the issuance of stock under the employee stock purchase plan and stock options of $1.8 million, partially offset by restricted stock retired to cover taxes of $0.9 million.
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Cash used in financing activities during the six months ended June 26, 2009 was $1.0 million, primarily for the purchase of the our stock under our share repurchase program. The purchase of restricted stock of $0.4 million was offset by $0.4 million of cash generated from issuance of stock under the employee stock purchase plan.
Cash provided by financing activities during the year ended January 3, 2009 was $0.1 million. Cash generated from financing activities included $1.8 million from stock option exercises and employee stock purchases, largely offset by $1.7 million of restricted stock repurchases.
In February 2009, the Board of Directors authorized a share repurchase program of up to $40.0 million of our common stock. Under the program, we are able to purchase shares of common stock through open market transactions and privately negotiated purchases at prices deemed appropriate by management. During the year ended June 24, 2011, we repurchased 505,100 shares of outstanding common stock for a total of $3.9 million which was paid in cash.
We expect to continue to invest in the business including working capital, capital expenditures and operating expenses. We intend to fund these activities with our cash reserves and cash generated from operations, if any. Increases in operating expenses may not result in an increase in our revenue and our anticipated revenue may not be sufficient to support these increased expenditures. We anticipate that operating expenses and working capital will constitute a material use of our cash resources.
Contractual Obligations and Commitments
The following are contractual obligations and commitments at June 24, 2011, associated with lease obligations and contractual commitments (in thousands):
Payments due by period | ||||||||||||||||||||
Total | Less than 1 year | 1 - 3 years | 3 - 5 years | More than 5 years | ||||||||||||||||
Operating leases | $ | 22,115 | $ | 10,577 | $ | 10,995 | $ | 543 | $ | — | ||||||||||
Purchase obligations | 14,639 | 14,639 | — | — | — | |||||||||||||||
Total | $ | 36,754 | $ | 25,216 | $ | 10,995 | $ | 543 | $ | — | ||||||||||
Operating Leases—We lease certain real and personal property under non-cancelable operating leases. Certain leases require us to pay property taxes, insurance and routine maintenance and include renewal options and escalation clauses.
As of June 24, 2011, we had total outstanding commitments on non-cancelable operating leases of our real property of $20.6 million, of which $10.1 million relate to our domestic leases. Our domestic leases are generally for terms of five to seven years and generally provide renewal options for terms of three to five additional years. These leases include our headquarters in Fremont, California and our warehouse facility in Chippewa Falls, Wisconsin. A significant portion of our domestic leases will expire in fiscal year 2013. We have total outstanding commitments of $10.5 million in non-cancelable international operating leases. The total outstanding commitments included $4.8 million relating to our leased facility in Japan, which was assumed as part of the SGI Japan acquisition. Our major facility leases in our international locations are generally for terms of two to nine years, and generally do not provide renewal options, except for our Japan leases, which generally provide for a two-year renewal option.
As of June 24, 2011, personal property under operating lease is comprised primarily of automobiles and office equipments. Total outstanding commitments under these leases is approximately $1.5 million at June 24, 2011.
Purchase Obligations—From time to time, we issue blanket purchase orders to our contract manufacturers for the procurement of materials to be used for upcoming orders, particularly for those components that have long lead times. Blanket purchase orders vary in size depending on our projected requirements. If we do not consume these materials on a timely basis or if our relationship with one of our contract manufacturers was to terminate, we could experience an abnormal increase to our inventory carrying amount and related accounts payable.
In connection with supplier agreements, we agreed to purchase certain units of inventory and non-inventory through fiscal year 2012. As of June 24, 2011, there was a remaining commitment of approximately $14.6 million, due within the next 12 months.
Other than the contractual obligations and commitments described above, we have no significant unconditional purchase obligations or similar instruments. We are not a guarantor of any other entities’ debt or other financial obligations.
Uncertain Tax Positions—As of June 24, 2011 the liability for uncertain tax positions, net of offsetting tax benefits associated with the correlative effects of state income taxes and interest deductions, was $22.9 million. As of June 24, 2011, the
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Company has accrued $15.2 million of interest and penalty associated with its uncertain tax positions. The Company cannot conclude on the range of cash payments that will be made within the next twelve months associated with its uncertain tax positions.
Off Balance Sheet Arrangements—We have issued financial guarantees to cover rent on leased facilities and equipment, to government authorities for VAT and other taxes, and to various other parties to support payments in advance of future delivery on goods and services. The majority of our financial guarantees have terms of one year or more. The maximum potential obligation under financial guarantees at June 24, 2011 was $3.7 million for which we have $3.3 million of assets held as collateral. The full amount of the assets held as collateral are included in short-term and long-term restricted cash and cash equivalents in the consolidated balance sheets.
Additionally, we enter into standard indemnification agreements with our customers and certain other business partners in the ordinary course of business. These agreements include provisions for indemnifying the customer against any claim brought by a third-party to the extent any such claim alleges that our product infringes a patent, copyright or trademark, or misappropriates a trade secret, of that third-party. The agreements generally limit the scope of the available remedies in a variety of industry-standard methods, including, but not limited to, product usage and geography-based limitations, a right to control the defense or settlement of any claim, and a right to replace or modify the infringing products to make them non-infringing. We have not incurred significant expenses related to these indemnification agreements and no material claims for such indemnifications were outstanding as of June 24, 2011. As a result, we believe the estimated fair value of these indemnification agreements, if any, to be immaterial; accordingly, no liability has been recorded with respect to such indemnifications as of June 24, 2011.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of revenues and expenses during the reporting period and the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements. We periodically evaluate our material estimates and judgments based on the terms of underlying agreements, the expected course of development, historical experience and other factors that we believe are reasonable under the circumstances. However, actual future results may vary from our estimates.
We believe that the following accounting policies are significantly affected by critical accounting estimates and that they are both highly important to the portrayal of our financial condition and results and require difficult management judgments and assumptions about matters that are inherently uncertain. Note 2 of the consolidated financial statements in Part II Item 8 of this Annual Report on Form 10-K describes the significant accounting policies used in the preparation of the consolidated financial statements. Certain of these significant accounting policies are considered to be critical accounting policies.
Our critical accounting policies and estimates are as follows:
• | Revenue recognition; |
• | Share-based compensation; |
• | Restructuring reserve; |
• | Allowance for doubtful accounts; |
• | Inventory valuation; |
• | Fair value of financial instruments; |
• | Impairment of intangibles and long-lived assets; |
• | Warranty reserve; |
• | Retirement benefit obligations; and |
• | Accounting for income taxes; |
Revenue Recognition. We enter into sales contracts to deliver multiple products and/or services. A typical multiple-element arrangement includes product, third-party product, customer support services and professional services. We also sell software products as part of certain multiple-element arrangements. In addition to selling multiple-element arrangements, we also sell certain products and services on a stand-alone basis.
Product revenue. We recognize revenue from sales of products, primarily hardware, when persuasive evidence of an arrangement exists, shipment has occurred and title has transferred, the sales price is fixed or determinable, and collection of the resulting receivable is reasonably assured. In arrangements where a formal acceptance of products or services is required by the customer, revenue is recognized upon meeting such acceptance criteria.
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Service revenue. Service revenue includes customer support services, primarily hardware maintenance services, and professional services, which include consulting services and product integration services. Revenue from service contracts, that is not subject to deferral under our revenue recognition policy applicable to sales contracts entered into prior to fiscal year 2011 (discussed below) and are expressly priced separately from the hardware, is recognized ratably over the contract term, generally one to three years. Professional services are offered under time and material or fixed fee-based contracts or as part of multiple-element arrangements. Professional services revenue is recognized as services are performed.
Multiple-element arrangements. Our multiple-element arrangements include products, customer support services and/or professional services. Certain multiple-element arrangements include software products integrated with the hardware (“Hardware Appliance”) and we provide unspecified software updates and enhancements to the software through its service contracts. For arrangements which do not include Hardware Appliances, we recognize revenue from the sale of products prior to the completion of services as product sales are not dependent on services to be functional.
In October 2009, the Financial Accounting Standards Board ("FASB") amended the Accounting Standards Codification (“ASC”) as summarized in Accounting Standards Update ("ASU") No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. ASU 2009-14 amends industry specific revenue accounting guidance for software and software related transactions to exclude from its scope tangible products containing software components and non-software components that function together to deliver the product's essential functionality. ASU 2009-13 amends the accounting for multiple-element arrangements to provide guidance on how the deliverables in an arrangement should be separated and eliminates the use of the residual method. ASU 2009-13 also requires an entity to allocate revenue using the relative selling price method. The standard establishes a hierarchy of evidence to determine the stand-alone selling price of a deliverable based on vendor-specific objective evidence ("VSOE"), third-party evidence ("TPE"), and the best estimate of selling price ("BESP"). If VSOE is available, it would be used to determine the selling price of a deliverable. If VSOE is not available, the entity would determine whether TPE is available. If so, TPE must be used to determine the selling price. If TPE is not available, then the BESP would be used.
Effective June 26, 2010, we adopted the provisions of ASU 2009-13 and ASU 2009-14 on a prospective basis for new and materially modified arrangements originating after June 25, 2010. The adoption of ASU 2009-13 and ASU 2009-14 was material to the Company's financial results, increasing revenues by $166.2 million for the year ended June 24, 2011, and increasing gross profit by $62.0 million for the year ended June 24, 2011. The impact was due to the recognition of revenue that would have been previously deferred for multiple-element arrangements which include Hardware Appliances or arrangements where the undelivered element is post contract customer support ("PCS") for which we were unable to establish VSOE of fair value of the element. The new standard allows for deliverables for which revenue would have been previously deferred to be separated and recognized as delivered, rather than over the longest service delivery period as a single unit with other elements in the arrangement.
For fiscal year 2011 and future periods, pursuant to the guidance of ASU 2009-13, when a sales arrangement contains multiple elements, such as products, software, customer support services, and/or professional services, we allocate revenue to each element based on the aforementioned selling price hierarchy. In multiple element arrangements where software is essential to the functionality of the products, revenue is allocated to each separate unit of accounting for each of the non-software deliverables and to the software deliverables as a group using the relative selling prices of each of the deliverables in the arrangement based on the aforementioned selling price hierarchy. If the arrangement contains more than one software deliverable, the arrangement consideration allocated to the software deliverables as a group is then recognized as one unit of accounting using the guidance for recognizing software revenue, as amended.
We limit the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges.
We evaluate each deliverable in an arrangement to determine whether they represent separate units of accounting. The delivered item constitutes a separate unit of accounting when it has standalone value and there are no customer-negotiated refunds or return rights for the delivered elements. If the arrangement includes a customer-negotiated refund or return right relative to the delivered item and the delivery and performance of the undelivered item is considered probable and substantially in our control, the delivered element constitutes a separate unit of accounting. In instances when the aforementioned criteria are not met, the deliverable is combined with the undelivered elements and revenue recognition is determined for the combined unit as a single unit. Allocation of the consideration is determined at arrangement inception on the basis of each unit's relative selling price.
We have not consistently established VSOE of fair value of any of our products or services. In addition, we have not established TPE as there are no similar or interchangeable competitor products or services in standalone sales to similarly
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situated customers. Therefore, revenue from our multiple-element arrangements is allocated based on the BESP. The objective of BESP is to determine the price at which we would transact a sale if a product or service were sold on a stand-alone basis. We determine BESP for product or service by considering multiple factors including, but not limited to, overall market conditions, including geographic or regional specific market factors, competitive positioning, competitor actions, profit objectives and pricing practices. The determination of BESP is a formal process that includes review and approval by our management. In addition, we regularly review VSOE and TPE for our products and services, in addition to BESP.
For fiscal year 2010 and sales contracts entered into prior to fiscal year 2011, we recognize revenue pursuant to the previous guidance for multiple-element arrangements. For arrangements which do not include Hardware Appliances and where services are included, we recognize revenue from the sale of products prior to the completion of services as the services are not essential to the functionality of the products. For certain multiple-element arrangements, we deliver software products integrated with the Hardware Appliance and provide unspecified software updates and enhancements to the software through PCS. For arrangements which include Hardware Appliances or arrangements where the undelivered element is PCS, we have not established VSOE of fair value of the element. Therefore, revenue and related cost of revenue from these arrangements are deferred and recognized ratably over the PCS period as combined product and service revenue in the consolidated statements of operations.
Share-Based Compensation. We use the fair value method of accounting for share-based compensation arrangements, including grants of employee stock awards and purchases under an employee stock purchase plan. The fair values of our unvested stock awards are calculated based on the fair value of our common stock at the dates of grant, using the Black-Scholes option-pricing model, which requires the input of subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock awards before exercising them, the estimated volatility of our common stock over the expected term and the number of awards that will ultimately not vest (i.e. forfeitures). Our assumptions on the estimated length of time employees will retain their vested stock awards before exercising them is based on examining our historical pattern of option exercises to determine if there were any discernible activity patterns based on certain employee populations. From this analysis, we identified two employee populations to which to apply the Black-Scholes model. We determined that implied volatility calculated based on the average of historical volatility and volatility calculated based on actively traded options on SGI common stock is a good indicator of the overall stock volatility. We analyzed SGI's historical forfeiture rate and calculated forfeiture rate using a weighted average of the actual forfeitures as a percentage of average unvested options. The estimated fair value of stock awards is expensed on a straight-line basis over the expected term of the grant. Compensation expense for purchases under the employee stock purchase plan is recognized based on the estimated fair value of the common stock during each offering period and the percentage of the purchase discount.
The assumptions used in calculating the fair value of share-based payment awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. Changes to any of these assumptions could have a material impact on our reported share-based compensation expense.
Restructuring Reserve. In recent years, we have recorded accruals in connection with our restructuring programs. These accruals include estimates of employee separation costs, fixed asset write-offs and the settlements of contractual obligations, including lease terminations resulting from our actions. Accruals associated with employee termination costs are accrued when it is determined that a liability has been incurred, which is generally when individuals have been notified of their termination dates and expected severance payments. Fixed asset write-offs primarily consist of equipment, leasehold improvements, and furnitures and fixtures associated with lease terminations, and are based on an estimate of the amounts and timing of future cash flows related to the expected future remaining use and ultimate sale or disposal of the equipment and furniture. Accruals associated with vacated facilities are accrued when we have vacated the premises. Our estimates may need to be adjusted upon the occurrence of future events, which include, but are not limited to, changes in the estimated time to enter into a sublease, the sublease terms and the sublease rates. Due to the extended contractual obligations of certain of these leases and the inherent volatility of the commercial real estate markets, future adjustments to these vacated facilities accruals could have a material impact on our results of operations and financial position.
Allowance for Doubtful Accounts. We provide an allowance for uncollectible accounts receivable based on our assessment of the collectability of specific customer accounts and an analysis of the remaining accounts receivable. We also analyze historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment terms, when evaluating the adequacy of the allowance for doubtful accounts. Credit evaluations are undertaken for all major sale transactions before shipment is authorized. Provisions are made based upon a specific review of all significant outstanding invoices. For those invoices not specifically reviewed, provisions are provided at differing rates, based upon the factors discussed above. In the future, if our actual collections differ significantly from our estimates it may result in additional provisions for doubtful accounts and our results of operations and financial position could be materially affected.
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Inventory Valuation. We value our inventories at the lower of cost or market with cost determined on a first-in, first-out basis. We write down obsolete inventory or inventory in excess of our estimated usage to its estimated market value less cost to sell, if less than its cost. Inherent in our estimates of market value in determining inventory valuation are estimates related to future demand and technological obsolescence of our products. Any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventories and our results of operations and financial position could be materially affected.
Fair Value of Financial Instruments. We measure our financial assets and liabilities in our consolidated financial statements at fair value or amounts that approximate fair value. We maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. When available, we use quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that use primarily market-based or independently-sourced market parameters. If market observable inputs for model-based valuation techniques are not available, we make judgments about assumptions market participants would use in estimating the fair value of the financial instrument. Carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate their fair values due to the short-term nature and liquidity of these financial instruments.
Impairment of Intangibles and Long-Lived Assets. We assess the carrying values of long-lived assets, including our intangible assets with finite lives, for possible impairment when we identify events or when we believe that circumstances may have changed to indicate that the carrying amount of a long-lived asset may not be recoverable. Such events or changes in circumstances may include the significant under-performance relative to historical or projected future operating results, significant changes in the strategy for our overall business, discontinuation of a product or product line, a sudden or consistent decline in the forecast for a product, changes in technology or in the way an asset is being used, or an adverse change in legal factors or in the business climate. An impairment loss would be recognized when the sum of the estimated future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Such impairment loss would be measured as the difference between the carrying amount of the asset and its fair value. Cash flow assumptions used in calculating the fair value are based on historical and forecasted revenue, operating costs, and other relevant factors. This analysis requires judgment with respect to many factors, including future cash flows, changes in technology, the continued success of product lines and future volume and revenue and expense growth rates. If our estimate of future operating results changes, or if there are changes to other assumptions, the estimate of the fair value of our long-lived assets could change significantly. Such change could result in impairment charges in future periods, which could have a material impact on our results of operations and financial position.
Warranty Reserve. We provide for estimated cost to warrant our products against defects in materials and workmanship at the time revenue is recognized. We net any cost recoveries from warranties offered to us by our suppliers against the warranty expense. Warranty costs include labor to repair faulty systems and replacement parts for defective items, as well as other costs incidental to warranty repairs. We estimate our warranty obligation based on factors such as product life cycle analysis and historical experience, and our estimate is affected by data such as product failure rates, material usage and service delivery costs incurred in correcting a product failure. Our standard warranty ranges from one to three years. Should actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required which could have a material impact on our results of operations and financial position.
Retirement Benefit Obligations. Our defined benefit obligations and plan assets are dependent on various assumptions. Our major assumptions relate primarily to discount rates, rates of compensation growth, and expected long-term rates of return on plan assets. Our discount rate assumption is based on current investment yields of a portfolio of high quality, fixed-income debt instruments that would produce cash flows sufficient in timing and amount to settle projected future benefits. Expected long-term rate of return on assets is determined using the projected long-term rate of return estimated by the insurance company for its general fund for the defined benefit plan in Germany and based on historical portfolio results and target asset allocations, as well as the projected long-term rate of return based on the Japanese market for the defined benefit plan in Japan. The weighted-average rates used are set forth in Note 17 to the consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K. For fiscal year 2011, the effect of rate changes in these assumptions does not result in a material change in the net periodic benefit cost.
Accounting for Income Taxes. The determination of our tax provision is subject to judgments and estimates. The carrying value of our net deferred tax assets, which is comprised primarily of future tax deductions, net operating loss carryovers and tax credit carryovers, is subject to significant judgment as to whether it is more likely than not our deferred tax assets will be realized. In determining whether the realization of these deferred tax assets may be impaired, we evaluate both positive and negative evidence. As of June 24, 2011, we have recorded a valuation allowance against the majority of our net deferred tax assets. Based on all available evidence, on a jurisdictional basis, including our historical operating results, and the uncertainty of predicting our future income, the valuation allowance reduces our deferred tax assets to an amount that is more likely than not to be realized. The valuation allowance is attributable to U.S. federal, state and certain foreign deferred tax
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assets primarily consisting of net operating loss carryovers, tax credit carryovers, accrued expenses, and other temporary differences. We have determined that certain foreign deferred tax assets will more likely than not be realized, and as a result, released valuation allowance on the deferred tax assets of certain foreign subsidiaries.
We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement with the taxing authorities. We evaluate these uncertain tax positions on a quarterly basis, based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, new audit activity and lapses in the statutes of limitations on assessment. A change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period that such event occurs and could have a material impact on our results of operations and financial position.
Recent Accounting Pronouncements
See Note 2 to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for a description of recent accounting pronouncements, including our expected adoption dates and estimated effects on our results of operations, financial condition, and cash flows.
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ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
In the normal course of business, our financial position is routinely subject to a variety of risks, including market risk for investments associated with interest rate movements, liquidity risks, credit risks, and foreign exchange market risk associated with currency rate movements on non-U.S. dollar denominated assets and liabilities. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures.
Investment Risk
The primary objective of our investment activities is to preserve principal while maximizing the income we receive from our investments without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash, cash equivalents, and investments in high credit quality, readily liquid securities, primarily U.S. treasuries and money market funds. Our portfolio of investments have original maturities of less than three months from date of purchase.
There has been significant deterioration and instability in the financial markets since 2008. The extraordinary disruption and readjustment in the financial markets exposes us to additional investment risk. The value and liquidity of the securities in which we invest could deteriorate rapidly and the issuers of such securities could be subject to credit rating downgrades. In light of the current market conditions and these additional risks, we actively monitor market conditions and developments specific to the securities and security classes in which we invest. We believe that we take a conservative approach to investing our funds in that we invest only in highly-rated securities with relatively short maturities and do not invest in securities we believe involve a higher degree of risk. While we believe we take prudent measures to mitigate investment related risks, such risks cannot be fully eliminated as there are circumstances outside of our control. We currently believe that the current credit market difficulties do not have a material impact on our investment portfolio. However, future degradation in credit market conditions could have a material adverse affect on our financial position.
Interest Rate Risk
Our exposure to market risks for changes in interest rates relates primarily to our investment portfolio. As of June 24, 2011, our cash and cash equivalents of $139.9 million consisted primarily of cash, money market funds, and U.S. Treasury notes. We believe that the exposure of our principal to interest rate risk is minimal, although our future interest income is subject to reinvestment risk.
Given the short term nature of our cash and cash equivalents, the risk of loss in fair value resulting from interest rate changes is minimal.
Foreign Exchange Risk
As of June 24, 2011 and June 25, 2010, foreign currency cash accounts totaled $70.2 million and $28.6 million, respectively, primarily in Japanese Yen, Euros, and British Pounds.
Foreign currency risks are associated with our cash and cash equivalents, investments, receivables, and payables denominated in foreign currencies. Fluctuations in exchange rates will result in foreign exchange gains and losses on these foreign currency assets and liabilities, which are included in other income, net in our consolidated statements of operations. Our exposure to foreign currency exchange rate risk relates to sales commitments, anticipated sales, purchases and other expenses, and assets and liabilities denominated in foreign currencies. For most currencies, we are a net receiver of the foreign currency and are adversely affected by a stronger U.S. dollar relative to the foreign currency. At June 24, 2011, we had no foreign currency forward contracts or option contracts.
We assessed the risk of loss in fair values from the impact of hypothetical changes in foreign currency exchange rates. For foreign currency exchange rate risk, a 10% increase or decrease of foreign currency exchange rates against the U.S. dollar with all other variables held constant would have resulted in a $7.0 million change in the value of our foreign currency cash accounts.
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Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
Page | ||
Financial Statements: | ||
Financial Statement Schedule: | ||
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Silicon Graphics International Corp.
Fremont, California
We have audited the accompanying consolidated balance sheets of Silicon Graphics International Corp. and subsidiaries (the “Company”) as of June 24, 2011 and June 25, 2010, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years ended June 24, 2011, June 25, 2010, and January 3, 2009 and the six-month period ended June 26, 2009. Our audits also included the consolidated financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Silicon Graphics International Corp. and subsidiaries at June 24, 2011 and June 25, 2010, and the results of their operations and their cash flows for the years ended June 24, 2011, June 25, 2010, and January 3, 2009 and the six-month period ended June 26, 2009, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in the year ended June 24, 2011, the Company changed its method of recognizing revenue for multiple element arrangements in accordance with the Financial Accounting Standards Board's Accounting Standards Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements and ASU 2009-14, Certain Revenue Arrangements that include Software Elements.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of June 24, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 29, 2011 expressed an unqualified opinion on the Company's internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
August 29, 2011
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SILICON GRAPHICS INTERNATIONAL CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Year Ended | Six Months Ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Revenue | ||||||||||||||||
Product | $ | 392,661 | $ | — | $ | — | $ | — | ||||||||
Service | 147,951 | — | — | — | ||||||||||||
Combined product and service | 88,956 | 403,717 | 247,430 | 102,777 | ||||||||||||
Total revenue (Note 2) | 629,568 | 403,717 | 247,430 | 102,777 | ||||||||||||
Cost of revenue | ||||||||||||||||
Product | 307,264 | — | — | — | ||||||||||||
Service | 91,103 | — | — | — | ||||||||||||
Combined product and service | 61,389 | 314,128 | 217,992 | 95,000 | ||||||||||||
Total cost of revenue | 459,756 | 314,128 | 217,992 | 95,000 | ||||||||||||
Gross profit | 169,812 | 89,589 | 29,438 | 7,777 | ||||||||||||
Operating expenses: | ||||||||||||||||
Research and development | 54,067 | 56,865 | 14,864 | 10,729 | ||||||||||||
Sales and marketing | 75,813 | 64,831 | 23,412 | 18,236 | ||||||||||||
General and administrative | 52,578 | 52,594 | 24,526 | 14,013 | ||||||||||||
Restructuring | 5,072 | 5,213 | 685 | 1,270 | ||||||||||||
Acquisition-related | 1,271 | (3,264 | ) | — | 6,070 | |||||||||||
Gain from settlement agreement | — | — | — | (5,000 | ) | |||||||||||
Gain from acquisition | — | — | — | (19,831 | ) | |||||||||||
Total operating expenses | 188,801 | 176,239 | 63,487 | 25,487 | ||||||||||||
Loss from operations | (18,989 | ) | (86,650 | ) | (34,049 | ) | (17,710 | ) | ||||||||
Total other income (expense): | ||||||||||||||||
Interest income, net | 95 | 436 | 4,106 | 176 | ||||||||||||
Other income (expense), net | (1,097 | ) | (7,088 | ) | (968 | ) | 1,101 | |||||||||
Total other income (expense) | (1,002 | ) | (6,652 | ) | 3,138 | 1,277 | ||||||||||
Loss from continuing operations before income taxes | (19,991 | ) | (93,302 | ) | (30,911 | ) | (16,433 | ) | ||||||||
Income tax provision (benefit) from continuing operations | 1,242 | (4,441 | ) | 376 | (2,242 | ) | ||||||||||
Net loss from continuing operations | (21,233 | ) | (88,861 | ) | (31,287 | ) | (14,191 | ) | ||||||||
Discontinued operations (Note 19): | ||||||||||||||||
Income (loss) from discontinued operations | — | 409 | (25,896 | ) | (20 | ) | ||||||||||
Income tax benefit | — | — | (2,955 | ) | — | |||||||||||
Income (loss) from discontinued operations, net of tax | — | 409 | (22,941 | ) | (20 | ) | ||||||||||
Net loss | $ | (21,233 | ) | $ | (88,452 | ) | $ | (54,228 | ) | $ | (14,211 | ) | ||||
Net income (loss) per share, basic and diluted: | ||||||||||||||||
Continuing operations | $ | (0.69 | ) | $ | (2.95 | ) | $ | (1.06 | ) | $ | (0.48 | ) | ||||
Discontinued operations | — | 0.01 | (0.77 | ) | — | |||||||||||
Basic and diluted net loss per share | $ | (0.69 | ) | $ | (2.94 | ) | $ | (1.83 | ) | $ | (0.48 | ) | ||||
Shares used in computing basic and diluted net loss per share | 30,608 | 30,130 | 29,583 | 29,798 | ||||||||||||
See accompanying notes.
57
SILICON GRAPHICS INTERNATIONAL CORP.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
June 24, 2011 | June 25, 2010 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 139,868 | $ | 129,343 | ||||
Current portion of restricted cash and cash equivalents | 948 | 830 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $1,335 and $1,646 as of June 24, 2011 and June 25, 2010, respectively | 108,675 | 79,464 | ||||||
Inventories | 80,965 | 89,929 | ||||||
Deferred cost of revenue | 59,306 | 45,255 | ||||||
Prepaid expenses and other current assets | 17,937 | 15,967 | ||||||
Total current assets | 407,699 | 360,788 | ||||||
Non-current portion of restricted cash and cash equivalents | 2,390 | 3,102 | ||||||
Long-term investments | — | 7,475 | ||||||
Property and equipment, net | 29,573 | 28,172 | ||||||
Intangible assets, net | 13,289 | 16,223 | ||||||
Non-current portion of deferred cost of revenue | 45,219 | 49,109 | ||||||
Other assets | 39,839 | 32,343 | ||||||
Total assets | $ | 538,009 | $ | 497,212 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 71,299 | $ | 49,204 | ||||
Accrued compensation | 29,477 | 21,885 | ||||||
Other current liabilities | 39,967 | 27,608 | ||||||
Current portion of deferred revenue | 132,986 | 137,596 | ||||||
Total current liabilities | 273,729 | 236,293 | ||||||
Non-current portion of deferred revenue | 93,146 | 91,989 | ||||||
Long-term income taxes payable | 24,104 | 21,715 | ||||||
Retirement benefit obligations | 15,569 | 7,012 | ||||||
Other non-current liabilities | 8,175 | 5,274 | ||||||
Total liabilities | 414,723 | 362,283 | ||||||
Commitments and contingencies (Note 23) | ||||||||
Stockholders’ equity: | ||||||||
Preferred stock, par value $0.001 per share; 12,000 shares authorized; none outstanding | — | — | ||||||
Common stock, par value $0.001 per share; 120,000 shares authorized; 31,850 shares and 30,709 shares issued at June 24, 2011 and June 25, 2010, respectively | 31 | 31 | ||||||
Additional paid-in capital | 470,343 | 459,339 | ||||||
Treasury stock, at cost (749 shares and 244 shares at June 24, 2011 and June 25, 2010, respectively) | (4,912 | ) | (1,022 | ) | ||||
Accumulated other comprehensive income (loss) | 573 | (1,903 | ) | |||||
Accumulated deficit | (342,749 | ) | (321,516 | ) | ||||
Total stockholders’ equity | 123,286 | 134,929 | ||||||
Total liabilities and stockholders’ equity | $ | 538,009 | $ | 497,212 | ||||
See accompanying notes.
58
SILICON GRAPHICS INTERNATIONAL CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share amounts)
Common Stock | Treasury Stock | Additional Paid-in Capital | Accumulated Other Comprehensive Income (Loss) | Accumulated Deficit | Total Stockholders’ Equity | |||||||||||||||||||||||||
Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||
Balance at December 29, 2007 | 29,525,561 | $ | 29 | — | $ | — | $ | 440,725 | $ | (11 | ) | $ | (164,625 | ) | $ | 276,118 | ||||||||||||||
Net loss | — | — | — | — | — | — | (54,228 | ) | (54,228 | ) | ||||||||||||||||||||
Unrealized loss on short-term investments | — | — | — | — | — | (442 | ) | — | (442 | ) | ||||||||||||||||||||
Cumulative translation adjustment | — | — | — | — | — | 176 | — | 176 | ||||||||||||||||||||||
Total comprehensive loss | (54,494 | ) | ||||||||||||||||||||||||||||
Issuance of common stock under employee stock options and employee stock purchase plan, net of taxes | 225,100 | 1 | — | — | 146 | — | — | 147 | ||||||||||||||||||||||
Restricted common stock | 204,683 | — | — | — | — | — | — | — | ||||||||||||||||||||||
Share-based compensation in connection with employee stock option plans and other | — | — | — | — | 9,718 | — | — | 9,718 | ||||||||||||||||||||||
Balance at January 03, 2009 | 29,955,344 | $ | 30 | — | $ | — | $ | 450,589 | $ | (277 | ) | $ | (218,853 | ) | $ | 231,489 | ||||||||||||||
Net loss | — | — | — | — | — | — | (14,211 | ) | (14,211 | ) | ||||||||||||||||||||
Unrealized loss on short-term investments | — | — | — | — | — | (1,193 | ) | — | (1,193 | ) | ||||||||||||||||||||
Unrecognized gain on defined benefit plans | — | — | — | — | — | 10 | — | 10 | ||||||||||||||||||||||
Cumulative translation adjustment | — | — | — | — | — | (115 | ) | — | (115 | ) | ||||||||||||||||||||
Total comprehensive loss | (15,509 | ) | ||||||||||||||||||||||||||||
Issuance of common stock under employee stock options and employee stock purchase plan, net of taxes | 5,049 | — | — | — | 37 | — | — | 37 | ||||||||||||||||||||||
Repurchase of treasury stock | — | — | (243,695 | ) | (1,022 | ) | — | — | — | (1,022 | ) | |||||||||||||||||||
Restricted common stock | 210,164 | — | — | — | — | — | ||||||||||||||||||||||||
Share-based compensation in connection with employee stock option plans and other | — | — | — | — | 3,104 | — | — | 3,104 | ||||||||||||||||||||||
Balance at June 26, 2009 | 30,170,557 | $ | 30 | (243,695 | ) | $ | (1,022 | ) | $ | 453,730 | $ | (1,575 | ) | $ | (233,064 | ) | $ | 218,099 | ||||||||||||
Net loss | — | — | — | — | — | — | (88,452 | ) | (88,452 | ) | ||||||||||||||||||||
Unrealized gain on short-term investments | — | — | — | — | — | 230 | — | 230 | ||||||||||||||||||||||
Unrecognized loss on defined benefit plans | — | — | — | — | — | (558 | ) | — | (558 | ) | ||||||||||||||||||||
Total comprehensive loss | — | — | — | — | — | — | — | (88,780 | ) | |||||||||||||||||||||
Issuance of common stock under employee stock options and employee stock purchase plan, net of taxes | 391,676 | 1 | — | — | 931 | — | — | 932 | ||||||||||||||||||||||
Restricted common stock | 146,835 | — | — | — | — | — | — | — | ||||||||||||||||||||||
Share-based compensation in connection with employee stock option plans and other | — | — | — | — | 4,678 | — | — | 4,678 | ||||||||||||||||||||||
Balance at June 25, 2010 | 30,709,068 | $ | 31 | (243,695 | ) | $ | (1,022 | ) | $ | 459,339 | $ | (1,903 | ) | $ | (321,516 | ) | $ | 134,929 | ||||||||||||
Net loss | — | — | — | — | — | — | (21,233 | ) | (21,233 | ) | ||||||||||||||||||||
Unrealized gain on short-term investments | — | — | — | — | — | 1,355 | — | 1,355 | ||||||||||||||||||||||
Unrecognized gain on defined benefit plans | — | — | — | — | — | 380 | — | 380 | ||||||||||||||||||||||
Cumulative translation adjustment | 741 | 741 | ||||||||||||||||||||||||||||
Total comprehensive loss | — | — | — | — | — | — | — | (18,757 | ) | |||||||||||||||||||||
Issuance of common stock under employee stock options and employee stock purchase plan, net of taxes | 501,567 | — | — | — | 5,118 | — | — | 5,118 | ||||||||||||||||||||||
Repurchase of treasury stock | (505,100 | ) | (3,890 | ) | (3,890 | ) | ||||||||||||||||||||||||
Restricted common stock | 165,906 | — | — | — | — | — | — | — | ||||||||||||||||||||||
Share-based compensation in connection with employee stock option plans and other | 473,698 | — | — | — | 5,886 | — | — | 5,886 | ||||||||||||||||||||||
Balance at June 24, 2011 | 31,850,239 | $ | 31 | (748,795 | ) | $ | (4,912 | ) | $ | 470,343 | $ | 573 | $ | (342,749 | ) | $ | 123,286 | |||||||||||||
See accompanying notes.
59
SILICON GRAPHICS INTERNATIONAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended | Six Months Ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||||||
Net loss | $ | (21,233 | ) | $ | (88,452 | ) | $ | (54,228 | ) | $ | (14,211 | ) | ||||
Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | ||||||||||||||||
Depreciation and amortization | 17,799 | 18,358 | 5,647 | 3,251 | ||||||||||||
Gain on acquisition | — | — | — | (19,831 | ) | |||||||||||
Share-based compensation | 5,898 | 4,721 | 9,587 | 3,104 | ||||||||||||
Impairment of long-lived assets | — | — | 17,519 | 2,520 | ||||||||||||
Non-cash restructuring expense | — | — | — | 1,695 | ||||||||||||
Impairment on investments | 790 | — | — | — | ||||||||||||
(Recovery) provision for doubtful accounts | (77 | ) | 852 | 36 | 389 | |||||||||||
Deferred income taxes | (8,177 | ) | (1,039 | ) | (1,503 | ) | (2,175 | ) | ||||||||
Gain from settlement agreement | — | — | — | (5,000 | ) | |||||||||||
Loss on disposal of property and equipment | 86 | 915 | 280 | — | ||||||||||||
Impairment of cost method investment | 2,904 | — | 350 | — | ||||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||
Accounts receivable | (6,379 | ) | (15,506 | ) | 22,139 | (9,935 | ) | |||||||||
Inventories | 17,219 | 28,268 | 168 | 2,778 | ||||||||||||
Deferred cost of revenue | (1,925 | ) | (88,520 | ) | (10,529 | ) | 7,268 | |||||||||
Prepaid expenses and other assets | 1,248 | 7,742 | 14,128 | (6,896 | ) | |||||||||||
Other assets | 3,016 | 1,176 | 837 | (74 | ) | |||||||||||
Accounts payable | 7,558 | (4,202 | ) | (26,153 | ) | 15,554 | ||||||||||
Accrued compensation | 1,783 | 1,030 | — | 773 | ||||||||||||
Other current liabilities | (7,458 | ) | (3,575 | ) | (5,240 | ) | 4,716 | |||||||||
Deferred revenue | (12,424 | ) | 145,295 | 11,149 | (11,402 | ) | ||||||||||
Income taxes payable | 6,703 | (1,039 | ) | 114 | 313 | |||||||||||
Other liabilities | 4,202 | 2,173 | — | 149 | ||||||||||||
Net cash provided by (used in) operating activities | 11,533 | 8,197 | (15,699 | ) | (27,014 | ) | ||||||||||
CASH FLOWS FROM INVESTING ACTIVITIES AND ACQUISITION: | ||||||||||||||||
Purchases of property and equipment | (8,245 | ) | (6,273 | ) | (1,593 | ) | (2,364 | ) | ||||||||
Decrease (increase) in restricted cash and cash equivalents | 594 | (519 | ) | — | 674 | |||||||||||
Purchases of marketable securities | — | — | (26,278 | ) | — | |||||||||||
Proceeds from sales and maturities of investments | 7,917 | 275 | 165,387 | 55 | ||||||||||||
Cash acquired (used) in acquisition, net of cash acquired | 6,046 | (1,983 | ) | — | (13,462 | ) | ||||||||||
Expenditures for intangibles | — | — | (83 | ) | — | |||||||||||
Net cash provided by (used in) investing activities and acquisition | 6,312 | (8,500 | ) | 137,433 | (15,097 | ) | ||||||||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||||||
Repurchase of restricted stock | (1,433 | ) | (857 | ) | (1,681 | ) | (376 | ) | ||||||||
Purchase of treasury stock | (3,890 | ) | — | — | (1,022 | ) | ||||||||||
Repayment of notes payable | (9,592 | ) | — | — | — | |||||||||||
Proceeds from issuance of common stock upon exercise of stock options | 4,428 | 887 | 536 | 8 | ||||||||||||
Proceeds from issuance of common stock under employee stock purchase plan | 2,123 | 902 | 1,293 | 376 | ||||||||||||
Net cash (used in) provided by financing activities | (8,364 | ) | 932 | 148 | (1,014 | ) | ||||||||||
Effect of exchange rate changes on cash and cash equivalents | 1,044 | — | 175 | (115 | ) | |||||||||||
Net increase (decrease) in cash and cash equivalents | 10,525 | 629 | 122,057 | (43,240 | ) | |||||||||||
Cash and cash equivalents—beginning of period | 129,343 | 128,714 | 49,897 | 171,954 | ||||||||||||
Cash and cash equivalents—end of period | $ | 139,868 | $ | 129,343 | $ | 171,954 | $ | 128,714 | ||||||||
SUPPLEMENTAL DISCLOSURE OF OTHER CASH FLOW INFORMATION | ||||||||||||||||
Income taxes paid (refunded) | $ | 1,511 | $ | (4,206 | ) | $ | 178 | $ | (386 | ) | ||||||
NON-CASH INVESTING AND FINANCING ACTIVITIES | ||||||||||||||||
Property and equipment purchases in accounts payable | $ | 250 | $ | 788 | $ | — | $ | (41 | ) | |||||||
Unrealized gain (loss) on investments | $ | — | $ | 230 | $ | (442 | ) | $ | (1,193 | ) | ||||||
See accompanying notes.
60
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Silicon Graphics International Corp. (“SGI” or the “Company”) was originally incorporated as Rackable Corporation which later changed its name to Rackable Systems, Inc. (“Rackable Systems” or “Legacy Rackable”) prior to changing its name to SGI. Rackable Systems was incorporated in the state of Delaware in December 2002. On May 8, 2009, Rackable Systems completed the acquisition of substantially all of the assets, excluding certain assets unrelated to the ongoing business, and assumed certain liabilities of Silicon Graphics, Inc. (“Legacy SGI”) (see Note 3). This acquisition was consummated pursuant to the terms of an Asset Purchase Agreement dated March 31, 2009, as amended on April 30, 2009, which was approved by the United States Bankruptcy Court for the Southern District of New York for Silicon Graphics, Inc. Effective May 18, 2009, Rackable Systems changed its name to Silicon Graphics International Corp.
The Company's headquarters is located in Fremont, California. The Company has significant global presence with the ability to provide products and services either directly or through its distributors and channel partners. The principal business of the Company is the design, manufacture and implementation of highly scalable compute servers, high-capacity storage systems and high-end computing and data management systems. The Company has its primary manufacturing facility located in Chippewa Falls, Wisconsin. In addition to the broad line of mid-range to high-end computing servers, data storage and data center technologies, the Company provides global customer support and professional services related to these products. The Company's products are used by the scientific, technical and business communities to solve challenging data intensive computing, data management and visualization problems. The vertical industry markets the Company serves include the federal government, defense and strategic systems, weather and climate, physical sciences, life sciences, energy (including oil and gas), aerospace and automotive, Internet, financial services, media and entertainment, and business intelligence and data analytics.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation. The consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the periods presented.
Fiscal Year-End. On June 19, 2009, the Company’s Board of Directors approved a change in the Company’s fiscal year end from the Saturday closest to December 31st of each year to the last Friday in June of each year. As a result of this change, the Company had a six-month transition period beginning on January 4, 2009 and ending on June 26, 2009, consisting of 25 weeks. Accordingly, the Company’s fiscal year 2010 began on June 27, 2009 and ended on June 25, 2010.
Included in this report are the Company’s consolidated balance sheets as of June 24, 2011 and June 25, 2010, the consolidated statements of operations, statements of stockholders’ equity, and cash flows for the 52-week fiscal years ended June 24, 2011 ("2011") and June 25, 2010 (“2010”), 53-week fiscal year ended January 3, 2009 (“2008”), and the 25-week six-month transition period ended June 26, 2009.
Principles of Consolidation. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All inter-company balances and transactions have been eliminated.
Estimates and Assumptions. The preparation of consolidated financial statements in accordance with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses as presented in the consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management’s best knowledge of current events and actions that may impact the Company in the future, actual results may be different from the estimates. The Company’s critical accounting policies are those that affect the Company’s financial statements materially and involve difficult, subjective or complex judgments by management and include revenue recognition, share-based compensation, restructuring reserve, allowance for doubtful accounts, inventory valuation, impairment of long-lived assets, fair value measurements and impairments, warranty reserve, and accounting for income taxes.
Discontinued Operations. In October 2008, the Company committed to a formal plan to abandon the Rapidscale product line (“Rapidscale”). The Company has accounted for the Rapidscale product line as a discontinued operation. The results of operations of the Rapidscale product line have been reclassified and presented as discontinued operations, net of tax, for all periods presented. The cash flows of the Rapidscale product line have not been reported separately within the accompanying consolidated statement of cash flows based upon materiality (see Note 19).
61
Rapidscale was accounted for as discontinued operations and therefore, the results of operations and cash flows have been removed from the company’s results of continuing operations for the year ended January 3, 2009.
Revenue Recognition. The Company enters into sales contracts to deliver multiple products and/or services. A typical multiple-element arrangement includes product, customer support services and professional services. The Company also sells software products as part of certain multiple-element arrangements. In addition to selling multiple-element arrangements, the Company also sells certain products and services on a stand-alone basis.
Product revenue. The Company recognizes revenue from sales of products, primarily hardware, when persuasive evidence of an arrangement exists, shipment has occurred and title has transferred, the sales price is fixed or determinable, and collection of the resulting receivable is reasonably assured. In arrangements where a formal acceptance of products or services is required by the customer, revenue is recognized upon meeting such acceptance criteria.
Service revenue. Service revenue includes customer support services, primarily hardware maintenance services, and professional services, which include consulting services and product integration services. Revenue from service contracts, that is not subject to deferral under the Company's revenue recognition policy applicable to sales contracts entered into prior to fiscal year 2011 (discussed below) and are expressly priced separately from the hardware, is recognized ratably over the contract term, generally one to three years. Professional services are offered under time and material or fixed fee-based contracts or as part of multiple-element arrangements. Professional services revenue is recognized as services are performed.
Multiple-element arrangements. The Company's multiple-element arrangements include products, customer support services and/or professional services. Certain multiple-element arrangements include software products integrated with the hardware (“Hardware Appliance”) and the Company provides unspecified software updates and enhancements to the software through its service contracts. For arrangements which do not include Hardware Appliances, the Company recognizes revenue from the sale of products prior to the completion of services as product sales are not dependent on services to be functional.
In October 2009, the Financial Accounting Standards Board ("FASB") amended the Accounting Standards Codification (“ASC”) as summarized in Accounting Standards Update ("ASU") No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. ASU 2009-14 amends industry specific revenue accounting guidance for software and software related transactions to exclude from its scope tangible products containing software components and non-software components that function together to deliver the product's essential functionality. ASU 2009-13 amends the accounting for multiple-element arrangements to provide guidance on how the deliverables in an arrangement should be separated and eliminates the use of the residual method. ASU 2009-13 also requires an entity to allocate revenue using the relative selling price method. The standard establishes a hierarchy of evidence to determine the stand-alone selling price of a deliverable based on vendor-specific objective evidence ("VSOE"), third-party evidence ("TPE"), and the best estimate of selling price ("BESP"). If VSOE is available, it would be used to determine the selling price of a deliverable. If VSOE is not available, the entity would determine whether TPE is available. If so, TPE must be used to determine the selling price. If TPE is not available, then the BESP would be used.
Effective June 26, 2010, the Company adopted the provisions of ASU 2009-13 and ASU 2009-14 on a prospective basis for new and materially modified arrangements originating after June 25, 2010. The adoption of ASU 2009-13 and ASU 2009-14 was material to the Company's financial results, increasing revenues by $166.2 million for the year ended June 24, 2011, and increasing gross profit by $62.0 million for the year ended June 24, 2011. The impact was due to the recognition of revenue that would have been previously deferred for multiple-element arrangements which include Hardware Appliances or arrangements where the undelivered element is post contract customer support ("PCS") for which the Company was unable to establish VSOE of fair value of the element. The new standard allows for deliverables for which revenue would have been previously deferred to be separated and recognized as delivered, rather than over the longest service delivery period as a single unit with other elements in the arrangement.
For fiscal year 2011 and future periods, pursuant to the guidance of ASU 2009-13, when a sales arrangement contains multiple elements, such as products, software, customer support services, and/or professional services, the Company allocates revenue to each element based on the aforementioned selling price hierarchy. In multiple element arrangements where software is essential to the functionality of the products, revenue is allocated to each separate unit of accounting for each of the non-software deliverables and to the software deliverables as a group using the relative selling prices of each of the deliverables in the arrangement based on the aforementioned selling price hierarchy. If the arrangement contains more than one software deliverable, the arrangement consideration allocated to the software deliverables as a group is then recognized as one unit of accounting using the guidance for recognizing software revenue, as amended.
62
The Company limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges.
The Company evaluates each deliverable in an arrangement to determine whether they represent separate units of accounting. The delivered item constitutes a separate unit of accounting when it has standalone value and there are no customer-negotiated refunds or return rights for the delivered elements. If the arrangement includes a customer-negotiated refund or return right relative to the delivered item and the delivery and performance of the undelivered item is considered probable and substantially in the Company's control, the delivered element constitutes a separate unit of accounting. In instances when the aforementioned criteria are not met, the deliverable is combined with the undelivered elements and revenue recognition is determined for the combined unit as a single unit. Allocation of the consideration is determined at arrangement inception on the basis of each unit's relative selling price.
The Company has not consistently established VSOE of fair value of any of its products or services. In addition, the Company has not established TPE as there are no similar or interchangeable competitor products or services in standalone sales to similarly situated customers. Therefore, revenue from these multiple-element arrangements is allocated based on the BESP. The objective of BESP is to determine the price at which the Company would transact a sale if a product or service were sold on a stand-alone basis. The Company determines BESP for product or service by considering multiple factors including, but not limited to, overall market conditions, including geographic or regional specific market factors, competitive positioning, competitor actions, profit objectives and pricing practices. The determination of BESP is a formal process within the Company that includes review and approval by the Company's management. In addition, the Company regularly reviews VSOE and TPE for its products and services, in addition to BESP.
For fiscal year 2010 and sales contracts entered into prior to fiscal year 2011, the Company recognizes revenue pursuant to the previous guidance for multiple-element arrangements. For arrangements which do not include Hardware Appliances and where services are included, the Company recognizes revenue from the sale of products prior to the completion of services as the services are not essential to the functionality of the products. For certain multiple-element arrangements, the Company delivers software products integrated with the Hardware Appliance and provides unspecified software updates and enhancements to the software through PCS. For arrangements which include Hardware Appliances or arrangements where the undelivered element is PCS, the Company had not established VSOE of fair value of the element. Therefore, revenue and related cost of revenue from these arrangements are deferred and recognized ratably over the PCS period as combined product and service revenue in the accompanying consolidated statements of operations.
Shipping and Handling Costs. Shipping and handling costs are classified as a component of cost of revenue. Customer payments of shipping and handling costs are recorded as revenue.
Research and Development. Costs related to research, design and development of Company products are charged to research and development expense as incurred. Software development costs are required to be capitalized when a product’s technological feasibility has been established through the date the product is available for general release to customers. The Company has not capitalized any software development costs, as technological feasibility is generally not established until a working model is completed, at which time substantially all development is complete.
Share-Based Compensation. The Company uses the fair value method of accounting for share-based compensation arrangements. Share-based compensation arrangements currently include stock options granted, restricted shares issued (“RSAs”), restricted stock unit awards granted (“RSUs”) and purchases of common stock by the Company’s employees under the employee stock purchase plan. The fair values of stock options, RSAs, RSUs and employee stock purchase plan awards are estimated using the Black-Scholes option-pricing model. The estimated fair value of stock options, RSAs and RSUs is expensed on a straight-line basis over the expected term of the grant. Compensation expense for purchases under the employee stock purchase plan is recognized based on the estimated fair value of the common stock during each offering period and the percentage of the purchase discount.
Share-based compensation expense for stock options and RSUs has been reduced for estimated forfeitures so that compensation expense is based on options and RSUs ultimately expected to vest. The Company’s estimated annual forfeiture rates for stock options and RSUs are based on its historical forfeiture experience.
Restructuring Expense. The Company recognizes restructuring expense resulting from reduction in headcount, excess manufacturing or administrative facilities that the Company chooses to close, or consolidate, and from other exit activities. In connection with exit activities, the Company records restructuring charges for employee termination costs, long-lived asset
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impairments, costs related to leased facilities abandoned or subleased, and other exit-related costs. These charges are incurred pursuant to formal plans developed and approved by management. The recognition of restructuring expense requires management to make judgments and estimates regarding the nature, timing, and amount of costs associated with the planned exit activity, including estimating sublease income and the fair value, less selling costs, of property and equipment to be disposed of. Estimates of future liabilities may change, requiring the Company to record additional restructuring expense or to reduce the amount of liabilities previously recorded. At the end of each reporting period, the Company evaluates the remaining accrued balances to ensure their adequacy, that no excess accruals are retained and that the utilization of the provisions is for the intended purpose in accordance with developed exit plans. In the event circumstances change and the provision is no longer required, the provision is reversed.
Foreign Currency Transactions. The functional currency of the Company's foreign subsidiaries is the U.S. dollar, except for its Japanese subsidiary. Accordingly, all monetary assets and liabilities of the foreign subsidiaries, except for the Japanese subsidiary, are re-measured into U.S. dollars at the exchange rates in effect at the reporting date, nonmonetary assets and liabilities are translated at historical rates, and revenue and expenses are translated at average exchange rates in effect during each reporting period. The transaction gains and losses are included as a component of other income (expense), net in the accompanying consolidated statements of operations.
The Company uses the Japanese yen as the functional currency for its Japanese subsidiary. Assets and liabilities of the Japanese subsidiary with Japanese yen are translated to U.S. dollars using exchange rates in effect at the balance sheet dates. Revenues and expenses are translated at average exchange rates in effect during the period. Translation adjustments are included in stockholders' equity in the accompanying consolidated balance sheet as a component of accumulated other comprehensive income (loss).
Comprehensive Income (Loss). Comprehensive income (loss) consists of two components, net loss and other comprehensive income (loss). Other comprehensive income (loss) refers to revenue, expenses, gains and losses that under generally accepted accounting principles are recorded as an element of shareholders’ equity but are excluded from net loss. The Company’s other comprehensive income (loss) consists of unrealized gains and losses on investments categorized as available-for-sale, unrecognized loss related to defined benefit pension plans, and foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as the functional currency.
Fair Value of Financial Instruments. The Company measures its financial instruments in its financial statements at fair value or amounts that approximate fair value. The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when developing fair value measurements. When available, the Company uses quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that use primarily market-based or independently-sourced market parameters. If market observable inputs for model-based valuation techniques are not available, the Company makes judgments about assumptions market participants would use in estimating the fair value of the financial instrument. Carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate their fair values due to the short-term nature and liquidity of these financial instruments.
Cash and Cash Equivalents. The Company classifies highly liquid investments with remaining contractual maturity at date of purchase of three months or less as cash equivalents. Cash equivalents consist primarily of money market funds and U.S. treasuries. Due to the short-term nature and liquidity of these financial instruments, the carrying values of these assets approximate fair value.
Restricted Cash and Cash Equivalents. Short-term and long-term restricted cash and cash equivalents consist primarily of cash deposits with banks. The cash deposits are pledged as collateral for various guarantees issued to cover rent on leased facilities and equipment, to government authorities for value-added tax (“VAT”) and other taxes, and certain vendors to support payments in advance of delivery of goods and services. The deposits are classified as short-term or long-term depending on the nature of the period of guarantee.
Accounts Receivable. Accounts receivable are recorded at the invoiced amount and do not bear interest. Accounts receivable have been reduced by an estimated allowance for doubtful accounts, which is management’s best estimate of the amount of probable credit losses in existing accounts receivable. Among other factors, management determines the allowance based on customer specific experience and the aging of the receivables.
Concentration of Credit Risk. Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash and cash equivalents, long-term investments, and accounts receivable. The Company maintains cash and cash equivalents with high credit quality financial institutions. The Company
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derives a significant portion of its revenue from a large number of individual customers spread globally. The Company also derives revenue from several large customers in different industries and geographies. If the financial condition or results of operations of any one of the large customers deteriorates substantially, the Company’s operating results could be adversely affected. To reduce credit risk, management performs ongoing credit evaluations of the financial condition of significant customers. The Company generally does not require collateral and maintains reserves for probable credit losses on customer accounts when considered necessary.
Inventories. Inventories are stated at the lower of cost or market, which approximates actual cost on a first-in, first-out basis. The Company assesses the value of inventory on a quarterly basis based upon estimates about future demand and actual usage. To the extent that the Company determines that it is holding excess or obsolete inventory, it writes down the value of its inventory to its net realizable value. Such write-downs are reflected in cost of revenue. If the inventory value is written down to its net realizable value and subsequently there is an increased demand for the inventory at a higher value, the increased value of the inventory is not realized until the inventory is sold either as a component of a system or as separate inventory.
In addition, the Company records a liability for firm, noncancelable, and unconditional purchase commitments with contract manufacturers and suppliers for quantities in excess of future demand forecasts consistent with the Company's valuation of excess and obsolete inventory.
The Company maintains a long-term service inventory of parts to support maintenance arrangements. The long-term service inventory is valued based on assumptions about product life cycles, historical usage, current production status and installed base, and is periodically tested for impairment. The long-term service inventory is included in other assets in the accompanying consolidated balance sheets.
Sales and Value Added Taxes. The Company collects various types of taxes from its customers that are assessed by governmental authorities, which are imposed on and concurrent with revenue-producing transactions. Such taxes are recorded on a net basis and are not included in revenue on the accompanying consolidated statements of operations.
Property and Equipment. Property and equipment is stated at cost, net of accumulated depreciation and amortization. Equipment and capitalized software are depreciated on a straight-line basis over their estimated useful lives, generally two to seven years. Buildings are depreciated on a straight-line basis over their estimated useful life, generally 30 to 32 years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the respective assets, or the original lease term. When assets are retired or disposed of, the cost and related accumulated depreciation and amortization are removed from the Company’s accounts and the resulting gain or loss is reflected in the accompanying consolidated statements of operations.
Repairs and maintenance are charged to expense as incurred and significant improvements and betterments that substantially enhance the life of an asset are capitalized.
Impairment of Long-lived Assets. The Company reviews the carrying values of long-lived assets for indicators of impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets is measured by a comparison of the carrying amount of the assets to the estimated undiscounted future cash flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds their fair value, which is typically calculated using discounted expected future cash flows utilizing a discount rate.
Intangible Assets. Intangible assets with finite lives consist of customer relationships, customer backlog, purchased technology, trademarks and trade names, and in-process research and development costs, acquired in business combinations. Intangible assets with finite lives are carried at cost, less accumulated amortization. Amortization is computed using the straight-line method over the estimated useful lives of the respective assets, generally one to five years, except for the customer backlog intangible asset, which is amortized as acceptance is received for a particular customer order, reflecting the use of the asset.
Warranty Reserve. The warranty period for the Company’s products is generally one to three years. Estimated future warranty costs are expensed as a cost of revenues when revenue is recognized. The warranty accrual is based upon historical experience and product life and is affected by actual product failure rates, material usage, and service delivery costs incurred in correcting the product failure. The Company periodically assesses the adequacy of the warranty reserve and adjusts the amount as considered necessary. The short-term portion of the warranty reserve is included in other current liabilities and the long-term portion of the warranty reserve is recorded in non-current liabilities on the accompanying consolidated balance sheets.
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Deferred Revenue and Deferred Cost of Revenue. Deferred revenue is primarily comprised of revenue deferred for arrangements which include hardware appliances or arrangements where the undelivered element is PCS. Deferred revenue is recorded when products or services provided are invoiced prior to completion of the related performance obligations and is recognized as revenue ratably over the PCS period. Deferred cost of revenue primarily consists of product costs related to revenue deferred in accordance with the Company’s revenue recognition policy. Deferred revenue and associated deferred cost of revenue, expected to be realized within one year are classified as current liabilities and current assets, respectively, on the accompanying consolidated balance sheets.
Retirement Benefit Obligations. The Company recognizes the underfunded or overfunded status of a defined benefit pension or postretirement plan as an asset or liability in the accompanying consolidated balance sheets. Changes in the funded status are recognized through accumulated other comprehensive income, a component of stockholder’s equity, in the year in which the changes occur.
Income Taxes. The Company computes income taxes using the asset and liability method, under which deferred income taxes are provided for temporary differences between financial reporting basis and tax basis of assets and liabilities and operating loss and tax credit carry forwards. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. Deferred tax assets and liabilities and operating loss and tax credit carryforwards are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and operating loss and tax credit carryforwards are expected to be recovered or settled.
The Company is subject to audits and examinations of tax returns by tax authorities in various jurisdictions, including the Internal Revenue Service. The Company regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of the provision for income taxes.
Recently Issued Accounting Standards.
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income ("ASU 2011-05"), which requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. This requirement under ASU 2011-05 should be applied retrospectively and is effective for the Company beginning June 30, 2012 (first quarter of fiscal year 2013). Other than requiring additional disclosures, the adoption will not have a material impact on the Company's consolidated financial statements.
3. ACQUISITION
Acquisition of SGI Japan, Ltd.
On March 9, 2011 (the “Closing Date”), pursuant to a Stock Purchase Agreement (the "Agreement") dated March 8, 2011, the Company's wholly-owned subsidiary, Silicon Graphics World Trade BV ("SGI BV") acquired the remaining outstanding shares of SGI Japan, Ltd., a Japanese corporation (“SGI Japan”). Prior to the Closing Date, the Company owned approximately 10% of the outstanding shares of SGI Japan and accounted for such investment as a cost method investment. SGI Japan operates primarily as a seller and servicer of high-performance computing ("HPC"), visualization, data center, and media and archive systems in Japan.
Pursuant to the terms of the Agreement, the total purchase price was approximately $17.9 million in cash, $1.8 million of which was placed in escrow to secure the Company's indemnification rights under the Agreement. The acquisition is expected to serve as a strategic entry into the large technical computing market of Japan and to enable the Company to extend its global reach, accelerate growth opportunities, and strengthen the relationships with its partners and customers in Japan. Furthermore, the acquisition is expected to enable the Company to more fully participate in the Japanese HPC market and benefit from SGI Japan's extensive service business.
The Company retained independent appraisers to assist management in the determination of the fair value of the various assets acquired and liabilities assumed. The fair value of the acquired assets, net of assumed liabilities and the fair value of the Company's previous investment, equals the $17.9 million cash consideration paid by the Company. The acquisition-date fair value of the equity interest in SGI Japan held by the Company immediately before the Closing Date was $2.1 million and was equal to its carrying value of $2.1 million. No gain or loss was recorded as the fair value approximated the carrying value of the investment.
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The following are the estimated fair value of assets acquired and liabilities assumed as of the Closing Date (in thousands):
Cash and cash equivalents | $ | 23,950 | ||
Prepaid maintenance contracts | 8,211 | |||
Other tangible assets | 41,190 | |||
Deferred revenue | (8,801 | ) | ||
Notes payable | (9,408 | ) | ||
Other liabilities assumed | (41,834 | ) | ||
Net tangible assets | 13,308 | |||
Customer backlog | 5,222 | |||
Goodwill | 1,470 | |||
Total net assets acquired | 20,000 | |||
Less: acquisition-date fair value of investment in SGI Japan previously held | 2,096 | |||
Cash paid | $ | 17,904 | ||
The fair value of the major components of the intangibles assets acquired and their estimated useful lives is as follows (in thousands):
Intangible Asset Class | Fair Value | Weighted Average Useful Life (in Years) | ||||
Customer Backlog | $ | 5,222 | (a) | |||
Goodwill | $ | 1,470 | (b) | |||
(a) The customer backlog intangible asset is amortized as all revenue recognition criteria is accomplished for a particular customer order, reflecting the use of the asset.
(b) Goodwill is not amortized but is tested for impairment at least annually. The goodwill resulted from expected synergies from combining the operations of the Company and SGI Japan and from the value of SGI Japan's workforce. None of this goodwill is deductible for tax purposes. The goodwill is not material to the Company and is recorded as other assets in the accompanying consolidated balance sheet.
The revenue and net loss of SGI Japan from the Closing Date to June 24, 2011 included in the accompanying consolidated statement of operations were $51.6 million and $0.2 million, respectively.
The Company incurred acquisition-related costs (i.e., advisory, legal, accounting, valuation, and other costs) of $1.3 million during the year ended June 24, 2011. The acquisition-related costs were expensed in the periods in which the costs were incurred and are recorded in the accompanying consolidated statements of operations.
The following unaudited pro forma condensed financial information presents the combined results of operations of the Company and SGI Japan as if the acquisition had occurred at the beginning of fiscal year 2010 (in thousands except per share amounts):
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Year Ended | ||||||||
June 24, 2011 | June 25, 2010 | |||||||
Revenue | $ | 671,163 | $ | 510,854 | ||||
Net loss from continuing operations | $ | (27,472 | ) | $ | (93,854 | ) | ||
Income from discontinued operations, net of tax | — | 409 | ||||||
Net loss | $ | (27,472 | ) | $ | (93,445 | ) | ||
Net loss per share, basic and diluted: | ||||||||
Continuing operations | $ | (0.90 | ) | $ | (3.11 | ) | ||
Discontinued operations | — | 0.01 | ||||||
Basic and diluted net loss per share | $ | (0.90 | ) | $ | (3.10 | ) | ||
Shares used in computing basic and diluted net loss per share | 30,608 | 30,130 | ||||||
The unaudited pro forma condensed financial information is not intended to represent or be indicative of the condensed results of operations of the Company that would have been reported had the acquisition been completed as of the beginning of the period presented, and should not be taken as representative of the future consolidated results of operations of the Company. The acquisition-related costs of $1.3 million during the year ended June 24, 2011 are not presented in the pro forma condensed financial information because they will not have a continuing impact on the combined results.
In connection with the acquisition of SGI Japan, the Company assumed the outstanding borrowings under SGI Japan's notes payable to various Japanese financial institutions. In June 2011, the Company repaid all of the notes payable for a sum of $9.6 million, included in this amount is the foreign currency exchange rate impact of approximately $0.2 million.
Acquisition of Silicon Graphics, Inc.
On May 8, 2009 (the “Legacy SGI Closing Date”), the Company completed the acquisition of substantially all of the assets of Legacy SGI, excluding certain assets unrelated to the ongoing business, including certain of Legacy SGI’s non-U.S. subsidiaries and operations and assumed certain liabilities. The acquisition was consummated pursuant to the terms of an Asset Purchase Agreement dated as of March 31, 2009 and as amended on April 30, 2009 (as amended, the “Legacy SGI Agreement”). As Legacy SGI and certain of its affiliates had filed bankruptcy petitions and motions for voluntary Chapter 11 reorganization, the Legacy SGI Agreement was subject to the approval of the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). On April 30, 2009, the Legacy SGI Agreement and the transactions contemplated thereby were approved by the Bankruptcy Court, allowing the Company to complete the Acquisition under Section 363 of the U.S. Bankruptcy Code. Under the terms of the Legacy SGI Agreement, the Company acquired the net assets for a purchase price of approximately $42.5 million in cash.
The Company retained independent appraisers to assist management in the determination of the fair value of the various assets acquired and liabilities assumed. The fair value of the acquired net assets of $62.3 million, including assumed liabilities, exceeded the $42.5 million cash consideration paid by the Company, resulting in a gain of $19.8 million for the six months ended June 26, 2009.
The Company conducted a review to reassess whether it identified all the assets acquired and all the liabilities assumed, and followed the required measurement procedures for Closing Date recognition of the fair value of net assets acquired. The review confirmed the calculation of the gain on acquisition, which is consistent with a distressed sale of assets in bankruptcy, as well as the depressed market capitalization of Legacy SGI.
The following are the estimated fair value of assets acquired and liabilities assumed as of the Legacy SGI Closing Date (in thousands):
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Cash and short-term investments | $ | 33,018 | |
Deferred cost of revenue | 1,821 | ||
Other tangible assets | 163,150 | ||
Deferred revenue | (76,265 | ) | |
Deferred income tax liabilities | (1,818 | ) | |
Other liabilities assumed | (79,275 | ) | |
Net tangible assets | 40,631 | ||
Intangible assets | 21,700 | ||
Net assets acquired | 62,331 | ||
Gain on acquisition | 19,831 | ||
Cash paid | $ | 42,500 | |
The fair value of the major components of the intangibles assets acquired and their estimated useful lives is as follows (dollars in thousands):
Fair Value | Weighted Average Useful Life (in Years) | ||||||
Customer relationships | $ | 6,900 | 5 | ||||
Customer backlog | 5,100 | (a) | |||||
Purchased technology | 5,000 | 4 | |||||
Trademark/ trade name portfolio | 2,600 | 5 | |||||
In-process research and development costs | 2,100 | (b) | |||||
Total | $ | 21,700 | |||||
(a) | The customer backlog intangible asset is amortized as all revenue recognition criteria is accomplished for a particular customer order, reflecting the use of the asset. |
(b) | In-process research and development is accounted for as an indefinite-lived intangible asset until completion or abandonment of the associated research and development efforts. |
The following unaudited pro forma condensed financial information presents the combined results of operations of the Company and Legacy SGI as if the acquisition had occurred in the six months ended June 26, 2009 and in the year ended January 3, 2009 (in thousands except per share amounts):
Pro forma combined Six Months Ended June 26, 2009 | Pro forma combined Year Ended January 3, 2009 | |||||||
Revenue | $ | 232,909 | $ | 595,912 | ||||
Net loss from continuing operations | $ | (73,462 | ) | $ | (192,719 | ) | ||
Net loss from discontinued operations, net of tax | (20 | ) | (22,941 | ) | ||||
Net loss | $ | (73,482 | ) | $ | (215,660 | ) | ||
Net loss per share, basic and diluted | ||||||||
Continuing operations | $ | (2.47 | ) | $ | (6.45 | ) | ||
Discontinued operations | — | (0.77 | ) | |||||
Basic and diluted net loss per share | $ | (2.47 | ) | $ | (7.22 | ) | ||
Shares used in computing basic and diluted net loss per share | 29,798 | 29,853 | ||||||
The unaudited pro forma condensed financial information is not intended to represent or be indicative of the condensed results of operations of the Company that would have been reported had the acquisition been completed as of the beginning of the periods presented, and should not be taken as representative of the future consolidated results of operations of the Company.
During the year ended June 25, 2010, the Company received a $1.0 million payment from Legacy SGI related to potential
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liabilities of Legacy SGI, which pursuant to the Agreement were to be remitted to the Company if not paid to a third party. In addition, the Company settled a lawsuit filed by Legacy SGI with its customer and received a $2.3 million settlement payment during the year ended June 25, 2010. At the Closing Date, the Company assessed whether it was more likely than not that contingent assets existed and based on all available information concluded that no assets existed. Accordingly, the Company has recorded the total $3.3 million payment as an acquisition-related gain in the accompanying consolidated statement of operations in the year ended June 25, 2010.
During the six months ended June 26, 2009, the Company incurred acquisition-related costs (i.e., advisory, legal, valuation and other professional fees) of $6.1 million which was expensed in the periods in which the costs were incurred.
Acquisition of Copan Systems, Inc.
On February 23, 2010, the Company completed the acquisition of substantially all the assets of Copan Systems, Inc. (“Copan”) and assumed certain liabilities. The purchase price of $2.0 million was allocated to Copan’s tangible and identifiable intangible assets acquired and liabilities assumed based on their fair market values as of the acquisition date. The purchase price allocation resulted in purchased net tangible assets of $1.0 million, consisting primarily of inventories and fixed assets, and purchased identifiable intangible assets of $1.0 million.
The Company retained independent appraisers to assist management in the determination of the fair value of the various assets acquired and liabilities assumed.
The fair value of the intangible assets acquired and their estimated useful lives are as follows (dollars in thousands):
Fair Value | Useful Life (in Years) | ||||||
Purchased technology | $ | 300 | 2 | ||||
Patents and core technology | 200 | 2 | |||||
Trademark / trade name portfolio | 100 | 2 | |||||
In-process research and development costs | 400 | (a) | |||||
Total | $ | 1,000 | |||||
(a) | In-process research and development is accounted for as an indefinite-lived intangible asset until completion or abandonment of the associated research and development efforts. |
The financial results of this acquisition are not considered significant for purposes of pro forma financial disclosures.
4. FINANCIAL INSTRUMENTS AND FAIR VALUE
The Company measures its assets and liabilities at fair value based upon the expected exit price, representing the amount that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value reflects the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model.
The Company uses a three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
• | Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities; |
• | Level 2 - Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and |
• | Level 3 - Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. |
The Company’s assessment of the hierarchy level of the assets or liabilities measured at fair value is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company considers an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing
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information on an ongoing basis, and views an inactive market as one in which there are a few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate, the Company or the counterparty’s non-performance risk is considered in determining the fair values of liabilities and assets, respectively.
Long-term Investments
Long-term investments consisted of ARS, which are investments with contractual maturities generally between zero and 50 years. The Company’s ARS consisted of investments that were backed by pools of student loans, the majority of which are ultimately guaranteed by the U.S. Department of Education. Beginning in February 2008, certain ARS failed auction due to sell orders exceeding buy orders. Given the recent disruptions in the credit markets and the fact that the liquidity for these types of securities remains uncertain, the Company classified all of the ARS as long-term investments in the accompanying consolidated balance sheets as the Company’s ability to liquidate such securities in the next 12 months was considered uncertain.
During the three months ended September 24, 2010, the Company entered into an 'offer to sell' with a secondary market broker for all of its ARS securities. As such, the Company determined that an other-than-temporary impairment had occurred with respect to its entire ARS portfolio. The Company recognized the total unrealized loss of $1.2 million as realized loss in the accompanying consolidated statement of operations during the three months ended September 24, 2010. During the three months ended December 24, 2010, the Company sold one of its ARS and received approximately $1.2 million in cash proceeds. The fair value of the ARS was approximately $1.1 million at the time of the sale.
On February 4, 2011, the Company and its former investment advisor, Thomas Weisel Partners LLC ("TWP"), entered into a settlement agreement whereby the Company sold all of its ARS through TWP and received proceeds of approximately $6.5 million (see Note 23). At the time of the sale, the fair value of the remaining securities was approximately $6.2 million and the Company recorded a realized gain of $0.3 million. During the year ended June 24, 2011, the Company recognized a net realized loss of $0.8 million, which is classified as other income in the accompanying consolidated statement of operations. The Company no longer has any ARS in its investment portfolio as of June 24, 2011.
As of June 25, 2010, long-term investments consist of the following (in thousands):
Amortized Cost | Gross Unrealized Gain | Gross Unrealized Loss | Estimated Fair Value | |||||||||||||
June 25, 2010 | ||||||||||||||||
Auction rate securities | $ | 8,775 | $ | — | $ | (1,300 | ) | $ | 7,475 | |||||||
As of June 25, 2010, the Company recorded a temporary impairment loss within accumulated other comprehensive loss of $1.3 million. The unrealized losses on the investments in ARS were caused by market declines as a result of the recent disruption in the credit markets. Because the decline in market value was attributable to changes in market conditions and not credit quality, and the Company did not intend to sell nor likely be required to sell these investments prior to the recovery of the entire amortized cost basis, the Company did not consider the investments in ARS to be other-than-temporarily impaired at June 25, 2010. There were no realized losses in the investments in ARS as of year ended June 25, 2010.
Fair Value of Financial Instruments
The following is a summary of investments at June 24, 2011 and June 25, 2010 (in thousands):
June 24, 2011 | June 25, 2010 | |||||||||||||||||||||||||
Gross Unrealized | Estimated | Gross Unrealized | Estimated | |||||||||||||||||||||||
Cost | Gains | Losses | Fair Vale | Cost | Gains | Losses | Fair Vale | |||||||||||||||||||
Cash equivalents | ||||||||||||||||||||||||||
Money market funds | $ | 1,495 | $ | — | $ | — | $ | 1,495 | $ | 1,493 | $ | — | $ | — | $ | 1,493 | ||||||||||
U.S. treasuries | 15,534 | — | — | 15,534 | 50,592 | — | — | 50,592 | ||||||||||||||||||
Total cash equivalents | $ | 17,029 | $ | — | $ | — | $ | 17,029 | $ | 52,085 | $ | — | $ | — | $ | 52,085 | ||||||||||
Total long-term investments | ||||||||||||||||||||||||||
Auction rate securities | $ | — | $ | — | $ | — | $ | — | $ | 8,775 | $ | — | $ | (1,300 | ) | $ | 7,475 | |||||||||
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As of June 24, 2011, all of the Company's cash equivalents have remaining contractual maturity at date of purchase of three months or less.
The following table presents the Company's assets and liabilities that are measured at fair value on a recurring basis (in thousands):
June 24, 2011 | June 25, 2010 | |||||||||||||||||||||||||
Fair Value Measured Using | Total | Fair Value Measured Using | Total | |||||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Balance | Level 1 | Level 2 | Level 3 | Balance | |||||||||||||||||||
Cash equivalents | ||||||||||||||||||||||||||
Money market funds | $ | 1,495 | $ | — | $ | — | $ | 1,495 | $ | 1,493 | $ | — | $ | — | $ | 1,493 | ||||||||||
U.S. treasuries | 15,534 | — | — | 15,534 | 50,592 | — | — | 50,592 | ||||||||||||||||||
Total cash equivalents | $ | 17,029 | $ | — | $ | — | $ | 17,029 | $ | 52,085 | $ | — | $ | — | $ | 52,085 | ||||||||||
Total long-term investments | ||||||||||||||||||||||||||
Auction rate securities | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 7,475 | $ | 7,475 | ||||||||||
There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the year ended June 24, 2011. The Company’s cash equivalents, consisting of money market funds and U.S. treasuries, are classified within Level 1 of the fair value hierarchy as they are valued using quoted market prices of the identical underlying securities in active markets.
During year ended June 24, 2011, the Company sold all of its investments in ARS. The Company's ARS was classified within Level 3 of the fair value hierarchy as the fair value of ARS was estimated using an income (discounted cash flow) approach that incorporates both observable and unobservable inputs to discount the expected future cash flows. The material factors used in preparing the discounted cash flow model were 1) the discount rate utilized to present value the cash flows, 2) the time period until redemption and 3) the estimated rate of return. The Company derived the estimates by obtaining input from market data on the applicable discount rate, estimated time to maturity and estimated rate of return. The changes in fair value had been primarily due to changes in the estimated rate of return.
The Company’s ARS were classified within Level 3 of the fair value hierarchy as the fair value of ARS was estimated using an income (discounted cash flow) approach that incorporates both observable and unobservable inputs to discount the expected future cash flows. The material factors used in preparing the discounted cash flow model were 1) the discount rate utilized to present value the cash flows, 2) the time period until redemption and 3) the estimated rate of return. The Company derived the estimates by obtaining input from market data on the applicable discount rate, estimated time to maturity and estimated rate of return. The changes in fair value had been primarily due to changes in the estimated rate of return.
The changes in Level 3 assets measured at fair value on a recurring basis for the year ended June 24, 2011 were as follows (in thousands):
ARS | |||
Balance at January 3, 2009 | $ | 8,664 | |
Total unrealized loss included in other comprehensive income | (1,248 | ) | |
Balance at June 26, 2009 | 7,416 | ||
Total unrealized gains included in other comprehensive income | 334 | ||
Redemption at par value | (275 | ) | |
Balance at June 25, 2010 | 7,475 | ||
Redemption at par value | (225 | ) | |
Total realized gains included in net income | 442 | ||
Sale of securities | (7,692 | ) | |
Balance at June 24, 2011 | $ | — | |
There were no transfers in and out of Level 3 of the fair value hierarchy during the year ended 2011.
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The Company may also be required to measure certain assets or liabilities at fair value on a nonrecurring basis. The fair values of accounts receivable, accounts payable, and accrued liabilities due within one-year approximates their carrying values because of the short-term nature of these instruments. The fair value of the Company's retirement benefit plans are disclosed in Note 17 of the consolidated financial statements. Prior to its acquisition, the Company's investment in SGI Japan was accounted for under the cost method and fair value of the investment was measured using comparisons to companies in Japan, analysis of the financial condition of SGI Japan, and conditions reflected in the capital markets. During the three months ended December 24, 2010, the Company determined that there had been an other-than-temporary impairment of its investment in SGI Japan. As a result, the Company wrote down the investment by $2.9 million, which represented the difference between the investment's carrying value and the estimated fair value of the investment of $2.1 million. The Company included the impairment loss in other expense, net, for year ended June 24, 2011. As of June 25, 2010, the fair value of the investment in SGI Japan was $5.0 million.
5. INVENTORIES
Inventories consist of the following (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Finished goods | $ | 15,788 | $ | 37,525 | ||||
Work in process | 16,891 | 13,875 | ||||||
Raw materials | 48,286 | 38,529 | ||||||
Total inventories | $ | 80,965 | $ | 89,929 | ||||
6. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of the following (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Other receivable | $ | 3,867 | $ | 4,794 | ||||
Prepaid income taxes | 1,542 | 2,128 | ||||||
Value-added tax receivable | 7,433 | 5,272 | ||||||
Deferred income taxes | 1,815 | 463 | ||||||
Other prepaid and current assets | 3,280 | 3,310 | ||||||
Total prepaid expenses and other current assets | $ | 17,937 | $ | 15,967 | ||||
7. PROPERTY AND EQUIPMENT, NET
Property and equipment, net consist of the following (dollars in thousands):
Estimated Useful Life | June 24, 2011 | June 25, 2010 | ||||||||
Land | N/A | $ | 799 | $ | 799 | |||||
Building | 30-32 | 11,562 | 11,062 | |||||||
Computer equipment and software | 2-6 | 25,076 | 17,830 | |||||||
Manufacturing equipment | 2-7 | 6,280 | 5,451 | |||||||
Leasehold improvements | 2-7 | 8,214 | 7,501 | |||||||
Furniture and fixtures | 2-7 | 3,307 | 1,532 | |||||||
Vehicles | 5 | 30 | 104 | |||||||
Construction in progress | N/A | 518 | 428 | |||||||
55,786 | 44,707 | |||||||||
Less accumulated depreciation and amortization | (26,213 | ) | (16,535 | ) | ||||||
Total property and equipment, net | $ | 29,573 | $ | 28,172 | ||||||
Depreciation and amortization expense for the years ended June 24, 2011, June 25, 2010 January 3, 2009, and for the six months ended June 26, 2009 was $9.5 million, $12.1 million, $3.2 million and $2.1 million, respectively.
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8. INTANGIBLE ASSETS, NET
Intangible assets by major asset class consist of the following (dollars in thousands):
Intangible Asset Class | Weighted Average Useful Life (in Years) | At June 24, 2011 | ||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net | ||||||||||||
Customer relationships | 5 | $ | 6,900 | $ | (2,990 | ) | $ | 3,910 | ||||||
Purchased technology | 5 | 7,800 | (3,271 | ) | 4,529 | |||||||||
Customer backlog | (a) | 10,497 | (7,768 | ) | 2,729 | |||||||||
Trademark/trade name portfolio | 5 | 3,667 | (1,612 | ) | 2,055 | |||||||||
Patents and other | 2 | 200 | (134 | ) | 66 | |||||||||
Total | $ | 29,064 | $ | (15,775 | ) | $ | 13,289 | |||||||
Intangible Asset Class | Weighted Average Useful Life (in Years) | At June 25, 2010 | |||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net | |||||||||||||
Customer relationships | 5 | $ | 6,900 | $ | (1,610 | ) | $ | 5,290 | |||||||
Purchased technology | 4 | 5,300 | (1,434 | ) | 3,866 | ||||||||||
Customer backlog | (a) | 5,100 | (3,517 | ) | 1,583 | ||||||||||
Trademark/ trade name portfolio | 5 | 3,667 | (849 | ) | 2,818 | ||||||||||
Patents and other | 2 | 200 | (34 | ) | 166 | ||||||||||
Subtotal | 21,167 | (7,444 | ) | 13,723 | |||||||||||
In-process research & development costs not subject to amortization | (b) | 2,500 | — | 2,500 | |||||||||||
Total | $ | 23,667 | $ | (7,444 | ) | $ | 16,223 | ||||||||
(a) | The customer backlog intangible asset is amortized as all revenue recognition criteria is accomplished for a particular customer order, reflecting the use of the asset. |
(b) | In-process research and development is accounted for as an indefinite-lived intangible asset until completion or abandonment of the associated research and development efforts. During the year ended June 24, 2011, the Company completed the associated research and development efforts and transferred the $2.5 million in-process research and development costs to the purchased technology category. |
Intangible assets amortization expense was $8.3 million, $6.3 million, $2.4 million and $1.2 million in the years ended June 24, 2011, June 25, 2010 and January 3, 2009, and in the six months ended June 26, 2009, respectively.
In the year ended January 3, 2009, the Company performed an impairment analysis of the goodwill related to the Terrascale acquisition as events and circumstances indicated that its carrying amount may not be recoverable. As a result of the analysis, the Company recognized and charged to discontinued operations an impairment charge of $17.5 million as described in Note 19.
In the six months ended June 26, 2009, the Company recognized an impairment charge of $2.5 million related to its tradename intangible asset. Upon the acquisition of Legacy SGI and the change in the Company’s name to Silicon Graphics International Corp., the Company determined that the tradename intangible asset of $3.5 million was impaired, primarily as it will be used for a product line only. The impairment charge was recorded as sales and marketing expense in the accompanying consolidated statement of operations. Additionally, the Company determined that the remaining capitalized tradename intangible asset of $1.0 million, which was historically classified as an indefinite life asset, has a finite life of five years.
No impairment of intangible assets was recorded in the years ended June 24, 2011 and June 25, 2010.
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As of June 24, 2011, expected amortization expense for all intangible assets is as follows (in thousands):
Fiscal Year | Amortization Expense | ||
2012 | $ | 6,630 | |
2013 | 3,114 | ||
2014 | 2,645 | ||
2015 | 300 | ||
2016 | 300 | ||
2017 and thereafter | 300 | ||
Total amortization | $ | 13,289 | |
9. OTHER ASSETS
Other assets consist of the following (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Long-term service inventory | $ | 15,520 | $ | 16,135 | ||||
Restricted pension plan assets | 8,211 | 6,945 | ||||||
Deferred tax assets | 8,673 | 376 | ||||||
Investment in SGI Japan | — | 5,000 | ||||||
Long-term refundable deposits | 4,117 | 1,154 | ||||||
Other assets | 3,318 | 3,109 | ||||||
Total other assets | $ | 39,839 | $ | 32,343 | ||||
10. OTHER CURRENT LIABILITIES
Other current liabilities consist of the following (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Accrued sales and use tax payable | $ | 12,342 | $ | 8,083 | ||||
Accrued warranty, current portion | 4,805 | 2,859 | ||||||
Income taxes payable | 7,917 | 1,214 | ||||||
Accrued professional services fees | 3,959 | 4,772 | ||||||
Accrued restructuring | 1,286 | 1,311 | ||||||
Other | 9,658 | 9,369 | ||||||
Total other current liabilities | $ | 39,967 | $ | 27,608 | ||||
11. OTHER NON-CURRENT LIABILITIES
Other non-current liabilities consist of the following (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Accrued warranty, non-current portion | $ | 2,773 | $ | 1,527 | ||||
Deferred income taxes | 1,814 | 342 | ||||||
Other | 3,588 | 3,405 | ||||||
Total other non-current liabilities | $ | 8,175 | $ | 5,274 | ||||
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12. WARRANTY RESERVE
Activity in the warranty reserve, which is included in other current and non-current liabilities, is as follows (in thousands):
Year Ended | ||||||||
June 24, 2011 | June 25, 2010 | |||||||
Balance at beginning of period | $ | 4,386 | $ | 8,572 | ||||
Warranty accrual assumed in acquisition of SGI Japan | 1,690 | — | ||||||
Current period accrual | 4,595 | 1,548 | ||||||
Warranty expenditures charged to accrual | (4,359 | ) | (4,021 | ) | ||||
Changes in accrual for pre-existing warranties | 1,266 | (1,713 | ) | |||||
Balance at end of period | $ | 7,578 | $ | 4,386 | ||||
13. RESTRUCTURING ACTIVITY
Fiscal 2011 Restructuring Action
On February 18, 2011, management approved restructuring actions to reduce the Company's worldwide workforce to streamline operations and reduce operating expenses. The Company expects to incur up to $6.6 million for severance pay and related cash expenditures, with the remaining costs to be incurred in fiscal year 2012. As of June 24, 2011, the total severance cost incurred in connection with the fiscal 2011 restructuring action was $4.3 million.
The total expense for the fiscal 2011 restructuring action is as follows (in thousands):
Year Ended | ||||
June 24, 2011 | ||||
Employee terminations | $ | 4,296 | ||
Activity in accrued restructuring for the fiscal 2011 restructuring action during the year ended June 24, 2011 is as follows (in thousands):
Employee Terminations | ||||
Balance at June 25, 2010 | $ | — | ||
Costs incurred | 4,296 | |||
Cash payments | (3,166 | ) | ||
Balance at June 24, 2011 | $ | 1,130 | ||
There was no activity in accrued restructuring for the fiscal 2011 restructuring action prior to the year ended June 24, 2011.
Other Restructuring Actions
2010 Restructuring
On July 27, 2009, management approved restructuring actions to reduce the Company's European workforce and vacate certain facilities in Europe. The total amount expected to be incurred in connection with the restructuring activity is $6.0 million. The Company expects remaining contractual obligations and employee severance to be substantially paid by fiscal year 2012. As of June 24, 2011, the total cost incurred in connection with the fiscal year 2010 restructuring action was $6.0 million, including the liabilities assumed in the acquisition of Legacy SGI.
Other Restructuring
During the year ended January 3, 2009, the Company relocated certain engineering activities that were being performed at the Milmont, California facility, which was under lease through June 30, 2009. The Company negotiated and completed a lease termination agreement with the lessor, releasing the Company from any further responsibilities in exchange for a payment of
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$0.7 million, which was recorded as a restructuring expense in the accompanying consolidated statement of operations.
During the six months ended June 26, 2009, In addition, to effect the desired synergies of the acquisition of Legacy SGI, the Company incurred restructuring expenses to consolidate functions and facilities and resize the workforce. The Company recorded restructuring expense of $1.3 million, primarily for cash charges for employee terminations, during the six months ended June 26, 2009.
The total restructuring expense for other restructuring actions is as follows (in thousands):
Year Ended | Six months ended | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | June 26, 2009 | |||||||||||||
Employee terminations | $ | 736 | $ | 4,590 | $ | — | $ | 1,253 | ||||||||
Facilities exits costs | 78 | 630 | 685 | 17 | ||||||||||||
Total restructuring expense | $ | 814 | $ | 5,220 | $ | 685 | $ | 1,270 | ||||||||
Activity in accrued restructuring for other restructuring actions is as follows (in thousands):
Employee Terminations | Facilities Exit Costs | Total | ||||||||||
Balance at December 29, 2007 | $ | — | $ | — | $ | — | ||||||
Costs incurred | — | 685 | 685 | |||||||||
Cash payments | — | (685 | ) | (685 | ) | |||||||
Balance at January 3, 2009 | $ | — | $ | — | $ | — | ||||||
Liabilities assumed in the acquisition of Legacy SGI | 869 | 345 | 1,214 | |||||||||
Costs incurred | 1,253 | 17 | 1,270 | |||||||||
Cash payments | (626 | ) | (163 | ) | (789 | ) | ||||||
Balance at June 26, 2009 | $ | 1,496 | $ | 199 | $ | 1,695 | ||||||
Costs incurred | 4,590 | 630 | 5,220 | |||||||||
Cash payments | (4,818 | ) | (492 | ) | (5,310 | ) | ||||||
Balance at June 25, 2010 | $ | 1,268 | $ | 337 | $ | 1,605 | ||||||
Costs incurred | 736 | 78 | 814 | |||||||||
Cash payments | (1,752 | ) | (269 | ) | (2,021 | ) | ||||||
Balance at June 24, 2011 | $ | 252 | $ | 146 | $ | 398 | ||||||
All Restructuring Actions
Total expense for all restructuring actions was $5.1 million, $5.2 million, $0.7 million and $1.3 million for the years ended June 24, 2011, June 25, 2010 and January 3, 2009, and the six months ended June 26, 2009, respectively. The restructuring expense is included in operating expenses in the accompanying consolidated statement of operations. The accrued restructuring for all restructuring actions was $1.5 million as of June 24, 2011, of which $1.2 million is included in other current liabilities and $0.3 million is included in other non-current liabilities in the accompanying consolidated balance sheet.
14. SHARE-BASED COMPENSATION
Share-Based Benefit Plans
In 2005, the Company’s Board of Directors adopted and its stockholders approved the Company’s 2005 Equity Incentive Plan (“2005 Plan”), 2005 Non-Employee Directors’ Stock Option Plan and 2005 Employee Stock Purchase Plan (“2005 ESPP Plan”). As of June 24, 2011, the aggregate number of shares of common stock available for grant under each plan is 1,645,911, 70,333 and 585,858 shares, respectively. Each plan contains a provision that automatically increases the number of shares of common stock reserved for issuance on January 1 of each year. During the year ended January 3, 2009, the number of stock options authorized for issuance under each Plan was increased by 1,180,516 shares, 16,581 shares and 282,796 shares, respectively. During the year ended June 25, 2010, the number of stock options authorized for issuance under each Plan was increased by 1,583,135 shares, 68,703 shares and 364,923 shares, respectively. During the year ended June 24, 2011, the number of stock options authorized for issuance under each Plan was increased by 153,515, 0 and 310,561 shares, respectively.
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The Company’s Board of Directors adopted the 2006 New Recruit Equity Incentive Plan (“New Recruit Plan”) in January 2006 which allows the Company to grant non-statutory stock awards for up to 1,000,000 shares of common stock to newly hired employees as an inducement to join the Company. No grants may be made under the New Recruit Plan to persons who are continuing employees or directors. The New Recruit Plan provides for the grant of the following stock awards: (i) non-statutory stock options, (ii) stock purchase awards, (iii) stock bonus awards, (iv) stock appreciation rights, (v) stock unit awards and (vi) other stock awards. As of June 24, 2011, the number of shares of common stock available for grant under the 2006 Plan is 819,127 shares. The total shares of common stock reserved for the New Recruit Plan was increased by 500,000 shares in August 2006 and by another 500,000 shares in January 2007. The exercise price of each non-statutory stock option shall be not less than 100% of the fair market value of the common stock subject to the option on the date the option is granted.
Stock awards expire ten years from the date of grant, or such shorter period specified in the option agreement. The options generally vest at a rate of 25% per year over four years from the date the option is granted. The Company issues new shares of its common stock upon exercise of stock options, issuance of restricted stock awards (“RSA”), restricted stock units (“RSU”) and issuance of shares purchased under its 2005 ESPP. RSAs differ from RSUs in that RSAs result in issuance of common stock with all rights, including rights to vote and to receive dividends, upon grant, with the exception of the ability to sell the common stock. Common stock to be issued for grants of RSUs are not issued until the RSU vests and do not have rights of voting or to receive dividends.
Determining Fair Value
The fair value of share-based awards was estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions for the following periods:
Year Ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Option Plans Shares | ||||||||||||||||
Risk-free interest rate | 1.4 | % | 2.6 | % | 2.9 | % | 1.9 | % | ||||||||
Volatility | 61.5 | % | 61.6 | % | 59.0 | % | 63.7 | % | ||||||||
Weighted average expected life (in years) | 4.29 | 4.98 | 5.20 | 5.00 | ||||||||||||
Expected dividend yield | — | % | — | % | — | % | — | % | ||||||||
Weighted average fair value | $ | 6.04 | $ | 3.09 | $ | 5.30 | $ | 2.20 | ||||||||
ESPP Plan shares | ||||||||||||||||
Risk-free interest rate | 0.4 | % | 0.6 | % | 2.2 | % | 0.7 | % | ||||||||
Volatility | 56.0 | % | 58.0 | % | 50.0 | % | 68.0 | % | ||||||||
Weighted average expected life (in years) | 1.25 | 1.25 | 1.25 | 1.25 | ||||||||||||
Expected dividend yield | — | % | — | % | — | % | — | % | ||||||||
Weighted average fair value | $ | 3.91 | $ | 2.55 | $ | 3.82 | $ | 1.66 | ||||||||
The computation of expected life is based on an analysis of the Company's historical exercise and post-vesting forfeiture experience. In the year ended June 24, 2011, expected volatility is based on the implied and historical volatility for the Company. The interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term. Where the expected term of the Company’s share-based awards do not correspond with the terms for which interest rates are quoted, the Company performs a straight-line interpolation to determine the rate from the available term maturities. As share-based compensation expense recognized in the accompanying consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimated.
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Share-Based Compensation Expense
Total share-based compensation expense is as follows (in thousands):
Year Ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Cost of revenue | $ | 685 | $ | 691 | $ | 1,120 | $ | 423 | ||||||||
Research and development | 641 | 767 | 1,811 | 524 | ||||||||||||
Sales and marketing | 990 | 445 | 1,568 | 579 | ||||||||||||
General and administrative | 3,582 | 2,924 | 4,653 | 1,689 | ||||||||||||
Continuing operations | 5,898 | 4,827 | 9,152 | 3,215 | ||||||||||||
Discontinued operations | — | (106 | ) | 435 | (111 | ) | ||||||||||
Total share-based compensation expense | $ | 5,898 | $ | 4,721 | $ | 9,587 | $ | 3,104 | ||||||||
Stock Option Activity
Summary of stock option activity is as follows:
Options Outstanding | ||||||||||||||
Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual term in years | Aggregate Intrinsic Value | |||||||||||
(in thousands) | ||||||||||||||
Balance at December 29, 2007 | 2,892,480 | $ | 13.13 | |||||||||||
Options granted | 1,158,873 | 9.83 | ||||||||||||
Options exercised | (75,884 | ) | 7.06 | |||||||||||
Options cancelled | (770,096 | ) | 12.45 | |||||||||||
Balance at January 3, 2009 | 3,205,373 | 12.24 | ||||||||||||
Options granted | 210,164 | 4.03 | ||||||||||||
Options exercised | (5,890 | ) | 1.36 | |||||||||||
Options cancelled | (523,487 | ) | 10.51 | |||||||||||
Balance at June 26, 2009 | 2,886,160 | 11.98 | ||||||||||||
Options granted | 1,656,500 | 5.80 | ||||||||||||
Options exercised | (152,787 | ) | 5.81 | |||||||||||
Options cancelled | (636,953 | ) | 9.96 | |||||||||||
Balance at June 25, 2010 | 3,752,920 | 9.85 | ||||||||||||
Options granted | 228,000 | 12.18 | ||||||||||||
Options exercised | (501,567 | ) | 8.83 | |||||||||||
Options cancelled | (358,271 | ) | 7.99 | |||||||||||
Balance at June 24, 2011 | 3,121,082 | $ | 10.40 | 6.70 | $ | 17,257 | ||||||||
Vested and expected to vest at June 24, 2011 | 2,892,147 | $ | 10.60 | 6.54 | $ | 15,468 | ||||||||
Exercisable at June 24, 2011 | 2,024,591 | $ | 11.84 | 5.90 | $ | 8,653 | ||||||||
The total intrinsic value of options exercised in the years ended June 24, 2011, June 25, 2010 and January 3, 2009 was $3.7 million, $0.5 million and $0.4 million, respectively. The total intrinsic value of options exercised in the six months ended June 26, 2009 was not material. The total fair value of shares vested during the years ended June 24, 2011, June 25, 2010, January 3, 2009 and the six months ended June 26, 2009 was $4.4 million, $5.8 million, $6.9 million and 3.0 million, respectively.
As of June 24, 2011, there was $1.6 million of total unrecognized compensation cost related to non-vested stock options, which is expected to be recognized over a weighted average period of 1.25 years.
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The following table summarizes information about stock options outstanding under all option plans as of June 24, 2011 (in thousands, except for per share information and life):
Options Outstanding | Options Exercisable | ||||||||||||||||
Exercise Price Range | Number of Outstanding Options | Weighted Average Remaining Contractual Life (In Years) | Weighted Average Exercise Price | Number of Options Exercisable | Weighted Average Exercise Price | ||||||||||||
$ 3.65-$ 5.07 | 66,986 | 7.05 | $ | 4.30 | 14,923 | $ | 4.26 | ||||||||||
$ 5.34-$ 5.34 | 912,064 | 7.94 | 5.34 | 345,480 | 5.34 | ||||||||||||
$ 6.00-$ 8.35 | 320,250 | 6.15 | 7.41 | 158,598 | 7.21 | ||||||||||||
$ 8.98-$10.66 | 320,981 | 7.65 | 9.64 | 170,408 | 9.66 | ||||||||||||
$10.88-$13.15 | 310,189 | 5.92 | 11.86 | 271,362 | 11.87 | ||||||||||||
$13.23-$13.23 | 700,000 | 5.96 | 13.23 | 700,000 | 13.23 | ||||||||||||
$13.44-$16.85 | 312,780 | 4.23 | 14.70 | 278,988 | 14.84 | ||||||||||||
$17.34-$33.07 | 136,000 | 8.21 | 20.28 | 43,000 | 26.06 | ||||||||||||
$35.94-$35.94 | 30,000 | 5.40 | 35.94 | 30,000 | 35.94 | ||||||||||||
$37.91-$37.91 | 11,832 | 4.93 | 37.91 | 11,832 | 37.91 | ||||||||||||
$ 3.65-$37.91 | 3,121,082 | 6.70 | $ | 10.40 | 2,024,591 | $ | 11.84 | ||||||||||
Performance-based option grant
On August 11, 2009, the Company’s CEO was granted a non-qualified stock option, with performance-based metrics, to purchase 40,000 shares of the Company’s common stock. The stock option, which has a grant date fair value of approximately $0.1 million, was valued using the Black-Scholes option-pricing model. The stock option has an exercise price of $5.34 per share, a contractual term of ten years and a maximum of 10,000 shares vesting per annum depending on the attainment of performance-based metrics. Compensation expense for this award is recognized when it is determined that it is probable that the performance metrics will be achieved. Compensation expense related to this award was not material in the years ended June 24, 2011 and June 25, 2010.
Restricted Stock Activity
The following table summarizes the Company’s RSA activity for the years ended June 24, 2011 and June 25, 2010, the six months ended June 26, 2009 and the year ended January 3, 2009.
Number of Shares | Weighted Average Grant Date Fair Value | ||||||
Balance at December 29, 2007 | 239,534 | $ | 16.03 | ||||
Released | (59,531 | ) | 15.28 | ||||
Forfeited | (51,877 | ) | 20.03 | ||||
Balance at January 3, 2009 | 128,126 | 14.75 | |||||
Released | (27,186 | ) | 14.95 | ||||
Balance at June 26, 2009 | 100,940 | 14.69 | |||||
Released | (54,375 | ) | 14.95 | ||||
Forfeited | (5,313 | ) | 18.07 | ||||
Balance at June 25, 2010 | 41,252 | 13.91 | |||||
Released | (41,252 | ) | 13.91 | ||||
Balance at June 24, 2011 | — | $ | — | ||||
As of June 24, 2011, the total unrecognized compensation cost related to RSA was not material.
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The following table summarizes the Company’s RSU activity for the year ended June 24, 2011.
Number of Shares | Weighted Average Grant Date Fair Value | Weighted Average Remaining Contractual Life | Aggregate Intrinsic Value | |||||||||||
(in thousands) | ||||||||||||||
Balance at December 29, 2007 | 801,164 | $ | 12.30 | |||||||||||
Awarded | 1,137,600 | 8.86 | ||||||||||||
Released | (430,953 | ) | 10.84 | |||||||||||
Forfeited | (464,026 | ) | 10.90 | |||||||||||
Balance at January 3, 2009 | 1,043,785 | 9.80 | ||||||||||||
Released | (195,066 | ) | 10.37 | |||||||||||
Forfeited | (146,069 | ) | 9.65 | |||||||||||
Balance at June 26, 2009 | 702,650 | 9.67 | ||||||||||||
Awarded | 10,000 | 7.73 | ||||||||||||
Released | (270,550 | ) | 10.09 | |||||||||||
Forfeited | (127,752 | ) | 9.37 | |||||||||||
Balance at June 25, 2010 | 314,348 | 9.37 | ||||||||||||
Awarded | 558,043 | 6.96 | ||||||||||||
Released | (279,369 | ) | 8.65 | |||||||||||
Forfeited | (48,404 | ) | 7.51 | |||||||||||
Balance at June 24, 2011 | 544,618 | $ | 7.43 | 1.47 | $ | 8,382 | ||||||||
Vested and expected to vest at June 24, 2011 | 422,597 | $ | 7.54 | 1.40 | $ | 6,504 | ||||||||
As of June 24, 2011, there was $2.8 million of total unrecognized compensation cost related to RSU, which is expected to be recognized over a weighted average period of 2.73 years.
RSUs and RSAs are converted into common stock upon the release to the employees or directors upon vesting. Upon the vesting of restricted stock, the Company primarily uses the net share settlement approach, which withholds a portion of the shares to cover the applicable taxes and decreases the shares issued to the employee by a corresponding value. The withholding tax obligations were based upon the fair market value of the Company’s common stock on the vesting date. The number and the value of the shares netted for employee taxes are summarized in the table below (in thousands except share amounts):
Year Ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
RSUs and RSAs shares withheld for taxes | 113,463 | 118,486 | 174,225 | 85,262 | ||||||||||||
RSUs and RSAs amounts withheld for taxes | $ | 1,433 | $ | 857 | $ | 1,681 | $ | 376 | ||||||||
Employee Stock Purchase Plan
At June 24, 2011, the total compensation cost related to options to purchase the Company’s common stock under the 2005 ESPP Plan not yet recognized was approximately $0.9 million. This cost will be amortized on a straight-line basis over approximately 1.6 years. The following table shows the shares issued and their respective weighted-average purchase price per share during the years ended June 24, 2011, June 25, 2010, January 3, 2009 and the six months ended June 26, 2009.
Year Ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Shares issued | 473,698 | 238,889 | 162,823 | 99,603 | ||||||||||||
Weighted-average purchase price per share | $ | 4.51 | $ | 3.78 | $ | 7.94 | $ | 3.77 | ||||||||
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15. STOCKHOLDERS’ EQUITY
Stock Repurchase
In February 2009, the Company's Board of Directors authorized a share repurchase program of up to $40.0 million of its common stock. Under the program, the Company was able to purchase shares of common stock through open market transactions and privately negotiated purchases at prices deemed appropriate by management. The timing and amount of repurchase transactions under this program will depend on market conditions, corporate and regulatory considerations, and other relevant considerations. The shares the Company repurchases will be held in treasury for general corporate purposes, including issuance under employee equity incentive plans. The program was suspended in April 2009, and on August 31, 2010, the Company's Board of Directors authorized the Company to resume its stock repurchase program. The program may be discontinued at any time by the Board of Directors.
During the year ended June 24, 2011, the Company repurchased and held in treasury 505,100 shares of outstanding common stock for a total of $3.9 million. Such repurchases were accounted for at cost and reflected as treasury stock in the accompanying consolidated balance sheets. During the six months ended June 26, 2009, the Company repurchased 243,695 shares of outstanding common stock which are being held in treasury at an average price of $4.19 per share, for a total of $1.0 million. No shares of outstanding common stock were repurchased during the years ended June 25, 2010 and January 3, 2009.
As of June 24, 2011, the Company held in treasury 748,795 shares for a total of $4.9 million. The Company has $35.1 million in remaining authorization for the stock repurchase program as of June 24, 2011.
Accumulated Other Comprehensive Income (Loss)
The following table summarized the components of accumulated other comprehensive income (loss) as of June 24, 2011, June 25, 2010, January 3, 2009 and as of June 26, 2009 (in thousands):
June 24, 2011 | June 25, 2010 | January 3, 2009 | June 26, 2009 | |||||||||||||
Net unrealized gains/(losses) on investments | $ | — | $ | (1,355 | ) | $ | (394 | ) | $ | (1,585 | ) | |||||
Cumulative translation adjustment | 741 | — | 117 | — | ||||||||||||
Gain/(loss) on pension assets | (168 | ) | (548 | ) | — | 10 | ||||||||||
Accumulated other comprehensive income (loss) | $ | 573 | $ | (1,903 | ) | $ | (277 | ) | $ | (1,575 | ) | |||||
The related tax effects of these components of accumulated other comprehensive income (loss) is not material to the Company.
16. EARNINGS PER SHARE
Basic and diluted net loss per common share is computed by dividing consolidated net loss by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing consolidated net income by the weighted average number of common shares outstanding and dilutive common stock equivalent shares outstanding during the period. For the years ended June 24, 2011, June 25, 2010 and January 3, 2009, and the six months ended June 26, 2009, potentially dilutive shares, which include outstanding common stock options and restricted stock units, were not included in the computation of diluted net loss per common share as the result would be anti-dilutive. Such potentially dilutive shares are excluded when the effect would be to reduce a net loss per share. As the Company had a net loss in each of the periods presented, basic and diluted net loss per share are the same for each period presented.
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The following table sets forth the computation of basic and diluted net loss per share for the years ended June 24, 2011, June 25, 2010 and January 3, 2009, and the six months ended June 26, 2009 (in thousands, except per share amount):
Year ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Numerators: | ||||||||||||||||
Loss from continuing operations, net of tax | $ | (21,233 | ) | $ | (88,861 | ) | $ | (31,287 | ) | $ | (14,191 | ) | ||||
Income (loss) from discontinued operations, net of tax | — | 409 | (22,941 | ) | (20 | ) | ||||||||||
Net loss | $ | (21,233 | ) | $ | (88,452 | ) | $ | (54,228 | ) | $ | (14,211 | ) | ||||
Denominator: | ||||||||||||||||
Weighted-average common shares used in computing basic and diluted net loss per share | 30,608 | 30,130 | 29,583 | 29,798 | ||||||||||||
Net loss per share, basic and diluted: | ||||||||||||||||
Continuing operations | $ | (0.69 | ) | $ | (2.95 | ) | $ | (1.06 | ) | $ | (0.48 | ) | ||||
Discontinued operations | — | 0.01 | (0.77 | ) | — | |||||||||||
Basic and diluted net loss per share | $ | (0.69 | ) | $ | (2.94 | ) | $ | (1.83 | ) | $ | (0.48 | ) | ||||
The following table sets forth potential shares of common stock, which are excluded from the calculation of diluted net loss per share, as the result would be anti-dilutive (in thousands):
Year ended | Six months ended June 26, 2009 | |||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||
Potentially dilutive securities | 3,666 | 4,067 | 3,205 | 2,886 | ||||||||
17. RETIREMENT BENEFIT PLAN
Defined Benefit Plans
The Company sponsors defined benefit plans covering certain of its international employees in the United Kingdom and Germany. No additional employees are eligible to join these plans. Pension benefits associated with these plans generally are based on each participant's years of service, compensation, and age at retirement or termination. The Company funds these pension plans in amounts sufficient to meet the minimum requirements of the local laws and regulations. Additional funding may be provided as deemed appropriate.
In addition, in connection with the acquisition of SGI Japan (See Note 3), the Company acquired a defined benefit plan ("Japan plan") covering substantially all of its employees in Japan. All employees of SGI Japan are eligible to participate in the Japan plan. Pension benefits associated with the Japan plan are based on a point-based plan under which a point is added every year reflecting the individual employee's years of service and their job classification. The amount of pension benefit payment is determined based on the sum of cumulative points from past services. The pension benefits are payable, depending on the employee's eligibility, in either in a lump-sum amount or monthly pension payments. The Company funds the SGI Japan pension plan in amounts sufficient to meet the minimum requirements of the local laws and regulations. Additional funding may be provided as deemed appropriate.
United Kingdom Plan
The projected benefit obligation ("PBO") and the assets of the United Kingdom plan have been transferred to an insurance company and the Company is not responsible for any additional contributions to the plan to fund the benefit payments to the employees. However, the Company continues to pay the annual administrative costs of the plan.
German Plan
The German plan is managed by an insurance company and the insurance company makes investment decisions with the guidelines set by the German regulation. The plan assets are invested as part of the insurance company’s general fund and the Company does not have control over the target allocation or visibility of the investment strategies of these investments.
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Following is a reconciliation of the beginning and ending balances of the projected benefit obligation and the fair value of plan assets as of June 24, 2011 and June 25, 2010 (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Projected Benefit Obligation | ||||||||
Benefit obligation, beginning | $ | 9,548 | $ | 10,223 | ||||
Service cost | 119 | 126 | ||||||
Interest cost | 558 | 589 | ||||||
Actuarial gains and losses | (191) | 436 | ||||||
Benefits paid | (349) | (316 | ) | |||||
Foreign exchange rate changes | 1,650 | (1,311 | ) | |||||
Benefit obligation, ending | $ | 11,334 | $ | 9,547 | ||||
June 24, 2011 | June 25, 2010 | |||||||
Fair Value of Plan Assets | ||||||||
Fair value of plan assets, beginning | $ | 2,587 | $ | 2,614 | ||||
Expected return on plan assets | 102 | 105 | ||||||
Participant contributions | 30 | 37 | ||||||
Actuarial gains and losses | 9 | (123 | ) | |||||
Benefit payments | (53) | (31 | ) | |||||
Foreign exchange rate changes | 46 | (343 | ) | |||||
Fair value of plan assets, ending | $ | 2,721 | $ | 2,259 | ||||
June 24, 2011 | June 25, 2010 | |||||||
Underfunded Status | ||||||||
Projected benefit obligation | $ | 11,334 | $ | 9,547 | ||||
Fair value of plan assets | 2,721 | 2,259 | ||||||
Underfunded status of plan | $ | 8,613 | $ | 7,288 | ||||
The Company has life insurance policies with cash surrender values that have been earmarked by the Company to partly cover the underfunded status of the plan. As of June 24, 2011, the cash surrender values of the life insurance plans of $0.3 million and $8.3 million are included in other current assets and other assets, respectively, in the accompanying consolidated balance sheets. As of June 25, 2010, the cash surrender values of the life insurance plans of $0.3 million and $7.0 million are included in other current assets and other assets, respectively, in the accompanying consolidated balance sheets.
The following table summarizes the amounts recognized on the consolidated balance sheets as of June 24, 2011 and June 25, 2010 (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Amounts recognized in the consolidated balance sheets | ||||||||
Accrued benefit cost | ||||||||
Current liabilities | $ | 339 | $ | 276 | ||||
Non-current liabilities | $ | 8,274 | $ | 7,012 | ||||
Amounts recognized in the accumulated other comprehensive loss (income) | ||||||||
Net actuarial loss (gain) | $ | 366 | $ | 548 | ||||
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The following table summarizes the amounts recorded to other comprehensive income loss (income) before taxes during the years ended June 24, 2011 and June 25, 2010 (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Amounts recognized in other comprehensive loss (income) | ||||||||
Net actuarial loss (gain) | $ | (182 | ) | $ | 558 | |||
Total recognized in other comprehensive loss (income) | $ | (182 | ) | $ | 558 | |||
The Company does not expect any amortization from accumulated other comprehensive loss (income) into net periodic benefit cost during fiscal year 2012.
The following table summarizes the amounts related to the pension plan with accumulated benefit obligation in excess of plan assets at June 24, 2011 and June 25, 2010 (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Projected benefit obligation | $ | 11,334 | $ | 9,547 | ||||
Accumulated benefit obligation | $ | 10,973 | $ | 8,479 | ||||
Fair value of plan assets | $ | 2,721 | $ | 2,259 | ||||
The Company carries the interest and service cost of the plan. Actuarial gains and losses are amortized over the life of the plan.
Weighted average assumptions used to determine benefit obligations for the German plan were as follows:
June 24, 2011 | June 25, 2010 | |||||
Discount rate | 5.4 | % | 5.4 | % | ||
Rate of compensation increase | 2.0 | % | 2.0 | % | ||
Weighted average assumptions used to determine net periodic benefit cost for the German plan were as follows:
June 24, 2011 | June 25, 2010 | |||||
Discount rate | 5.4 | % | 5.4 | % | ||
Expected long-term rate of return on plan assets | 4.1 | % | 4.1 | % | ||
Rate of compensation increase | 2.0 | % | 2.0 | % | ||
The discount rate reflects the current rate at which the associated liabilities could be effectively settled at the end of the year. The Company sets its rate to reflect the yield of a portfolio of high quality, fixed-income debt instruments that would produce cash flows sufficient in timing and amount to settle projected future benefits. Using this methodology, the Company determined a discount rate of 5.4% for the German plan as of June 24, 2011, which is consistent rate used as of June 25, 2010.
Expected long-term rate of return on assets assumptions for the German plan is determined using the projected long-term rate of return estimated by the insurance company for its general fund.
The net periodic benefit cost of the German plan was comprised of the following components (in thousands):
Year Ended | Six Months Ended | |||||||||||
June 24, 2011 | June 25, 2010 | June 26, 2009 | ||||||||||
Net periodic benefit cost | ||||||||||||
Service cost | $ | 119 | $ | 126 | $ | 20 | ||||||
Interest expense | 558 | 589 | 84 | |||||||||
Expected return on plan assets | (102) | (105) | (15 | ) | ||||||||
Net periodic benefit cost | $ | 575 | $ | 610 | $ | 89 | ||||||
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The Company does not expect to make any contributions to the German plan during the next fiscal year as contributions are not required by funding regulations or laws and the cash surrender value of the life insurance plan earmarked by the Company substantially covers the under-funded status of the German plan.
Fair Value of Plan Assets
The plan assets measured at fair value consisted of the following as of June 24, 2011 (in thousands):
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Investments held by an insurance company | $ | — | $ | 2,721 | $ | — | $ | 2,721 | ||||||||
Total assets measured at fair value | $ | — | $ | 2,721 | $ | — | $ | 2,721 | ||||||||
The plan assets measured at fair value consisted of the following as of June 25, 2010 (in thousands):
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Investments held by an insurance company | $ | — | $ | 2,259 | $ | — | $ | 2,259 | ||||||||
Total assets measured at fair value | $ | — | $ | 2,259 | $ | — | $ | 2,259 | ||||||||
Level 2 assets include investments that are pooled with other investments held by the insurance company within its general fund. The investments held by the insurance company are valued by taking the percentage owned by the plan in the underlying net asset value of the insurance company’s general fund.
Future Employee Benefit Payments
The following table provides the estimated pension payments that are payable from the German plan to participants (in thousands):
Fiscal Year | Future Payments | |||
2012 | $ | 439 | ||
2013 | 455 | |||
2014 | 628 | |||
2015 | 532 | |||
2016 | 546 | |||
Following five years | 3,984 | |||
Total | $ | 6,583 | ||
Japan Plan
The Japan plan is managed by a financial institution and the financial institution makes investment decisions with the guidelines set by the Company’s investment policy. The investment objectives of the SGI Japan plan assets are designed to generate returns that will enable the plan to meet its future obligations. The plan assets are invested in domestic and international equity and fixed-income securities.
Following is a reconciliation of the beginning and ending balances of the projected benefit obligation and the fair value of plan assets as of June 24, 2011 (in thousands):
June 24, 2011 | ||||
Projected Benefit Obligation | ||||
Benefit obligation, beginning | $ | — | ||
Business combinations | 9,861 | |||
Service cost | 350 | |||
Interest cost | 50 | |||
Actuarial gains and losses | (186) | |||
Benefits paid | (37) | |||
Foreign exchange rate changes | 436 | |||
Benefit obligation, ending | $ | 10,474 | ||
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June 24, 2011 | ||||
Fair Value of Plan Assets | ||||
Fair value of plan assets, beginning | $ | — | ||
Business combinations | 2,585 | |||
Expected return on plan assets | 23 | |||
Participant contributions | 529 | |||
Actuarial gains and losses | 11 | |||
Benefit payments | (36) | |||
Foreign exchange rate changes | 124 | |||
Fair value of plan assets, ending | $ | 3,236 | ||
June 24, 2011 | ||||
Underfunded Status | ||||
Projected benefit obligation | $ | 10,474 | ||
Fair value of plan assets | (3,236) | |||
Underfunded status of plan | $ | 7,238 | ||
The following table summarizes the amounts recognized on the consolidated balance sheets as of June 24, 2011 (in thousands):
June 24, 2011 | ||||
Amounts recognized in the consolidated balance sheets | ||||
Accrued benefit cost | ||||
Non-current liabilities | $ | 7,238 | ||
Amounts recognized in the accumulated other comprehensive loss (income) | ||||
Net actuarial loss (gain) | $ | (198 | ) | |
The following table summarizes the amounts recorded to other comprehensive income loss (income) before taxes during the year ended June 24, 2011 (in thousands):
June 24, 2011 | ||||
Amounts recognized in other comprehensive loss (income) | ||||
Net actuarial gain | $ | (198 | ) | |
Total recognized in other comprehensive loss (income) | $ | (198 | ) | |
The Company does not expect any amortization from accumulated other comprehensive loss (income) into net periodic benefit cost during fiscal year 2012.
The following table summarizes the amounts related to the pension plan with accumulated benefit obligation in excess of plan assets at June 24, 2011 (in thousands):
June 24, 2011 | ||||
Projected benefit obligation | $ | 10,474 | ||
Accumulated benefit obligation | $ | 9,206 | ||
Fair value of plan assets | $ | 3,236 | ||
The Company carries the interest and service cost of the plan. Actuarial gains and losses are amortized over the life of the plan.
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Weighted average assumptions used to determine benefit obligations for the Japan plan were as follows:
June 24, 2011 | |||
Discount rate | 1.8 | % | |
Rate of compensation increase | 6.2 | % | |
Weighted average assumptions used to determine net periodic benefit cost for the Japan plan were as follows:
June 24, 2011 | |||
Discount rate | 1.8 | % | |
Expected long-term rate of return on plan assets | 3.0 | % | |
Rate of compensation increase | 6.2 | % | |
The discount rate reflects the current rate at which the associated liabilities could be effectively settled at the end of the year. The Company sets its rate to reflect the yield of a portfolio of high quality, fixed-income debt instruments that would produce cash flows sufficient in timing and amount to settle projected future benefits. Using this methodology, the Company determined a discount rate of 1.8% for the Japan plan as of June 24, 2011.
Expected long-term rate of return on assets assumptions for the Japan plan is determined by SGI Japan in consideration of the portfolio of SGI Japan's pension plan and projected long-term rate of return based on the Japanese market.
The net periodic benefit cost of the Japan plan was comprised of the following components (in thousands):
Year Ended June 24, 2011 | ||||
Net periodic benefit cost | ||||
Service cost | $ | 350 | ||
Interest expense | 50 | |||
Expected return on plan assets | (23) | |||
Net periodic benefit cost | $ | 377 | ||
The Company expects to make contributions to the Japan plan of approximately $3.4 million during the next fiscal year.
Fair Value of Plan Assets
The objective of the SGI Japan's investment policy is to ensure a stable return from the plan's investments over the long term, which allows the SGI Japan's pension funds to meet their future obligations. In order to achieve the above objective, a target rate of return is established, taking into consideration the composition of participants, level of funded status, SGI Japan's capacity to absorb risks and the current economic environment. Also, a target asset allocation is established to achieve a target rate of return, based on the expected rate of return by each asset class, the standard deviation of the rate of return and the correlation coefficient among the assets. The investments are diversified primarily into domestic and foreign equity and debt securities according to the target asset allocation. Under the current target asset allocation, approximately 44% of plan assets are invested in equity securities and approximately 50% are invested in domestic and foreign government bonds and corporate bonds. The remaining 6% of plan assets are invested in other assets, such as money in trust, and other funds. SGI Japan reviews actual returns on assets, economic environments and its capacity to absorb risk and realigns the target allocation if necessary.
SGI Japan prioritizes the use of observable inputs in markets over the use of unobservable inputs when measuring fair value as follows:
• | Level 1 - Quoted prices for identical assets in active markets. |
• | Level 2 - Quoted prices for similar assets in active markets; quoted prices associated with transactions that are not distressed for identical or similar assets in markets that are not active; or, valuations whose significant inputs are derived from or corroborated by observable market data. |
• | Level 3 - Valuations using inputs that are not observable. |
88
The plan assets measured at fair value consisted of the following as of June 24, 2011 (in thousands):
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Equity securities | ||||||||||||||||
Japanese | $ | 696 | $ | 17 | $ | — | $ | 713 | ||||||||
Non-Japanese | 677 | 15 | — | 692 | ||||||||||||
Debt securities | ||||||||||||||||
Japanese | 939 | 413 | — | 1,352 | ||||||||||||
Non-Japanese | 164 | 111 | — | 275 | ||||||||||||
Cash and cash equivalents | 204 | — | — | 204 | ||||||||||||
Total assets measured at fair value | $ | 2,680 | $ | 556 | $ | — | $ | 3,236 | ||||||||
Future Employee Benefit Payments
The following table provides the estimated pension payments that are payable from the Japan plan to participants (in thousands):
Fiscal Year | Future Payments | |||
2012 | $ | 593 | ||
2013 | 654 | |||
2014 | 481 | |||
2015 | 648 | |||
2016 | 699 | |||
Following five years | 4,488 | |||
Total | $ | 7,563 | ||
Defined Contribution Plan
The Company's U.S. employees are eligible to participate in the Company's qualified defined contribution plan under section 401(k) of the Internal Revenue Code. The plan provides for voluntary salary reduction contributions up to the maximum allowed under Internal Revenue Service rules. Under the terms of the plan, the Company may provide a discretionary matching contribution at the discretion of its management or the Company can make annual contributions to the plan at the discretion of the Board of Directors. There were no contributions for the years ended June 24, 2011 and June 25, 2010. The Company contributed $0.1 million and $0.2 million during the six months ended June 26, 2009 and the year ended January 3, 2009.
18. INCOME TAXES
The provision (benefit) for income taxes for the years ended June 24, 2011, June 25, 2010, and January 3, 2009 and the six months ended June 26, 2009 consisted of the following (in thousands):
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Year ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Federal: | ||||||||||||||||
Current | $ | (417 | ) | $ | (4,923 | ) | $ | (1,222 | ) | $ | 27 | |||||
Deferred | — | (482 | ) | 1,539 | (2,289 | ) | ||||||||||
(417 | ) | (5,405 | ) | 317 | (2,262 | ) | ||||||||||
State: | ||||||||||||||||
Current | (47 | ) | (395 | ) | (4 | ) | 75 | |||||||||
Deferred | — | (59 | ) | (11 | ) | (279 | ) | |||||||||
(47 | ) | (454 | ) | (15 | ) | (204 | ) | |||||||||
Foreign: | ||||||||||||||||
Current | 3,280 | 1,915 | 74 | 224 | ||||||||||||
Deferred | (1,574 | ) | (497 | ) | — | — | ||||||||||
1,706 | 1,418 | 74 | 224 | |||||||||||||
Provision (benefit) for income taxes | $ | 1,242 | $ | (4,441 | ) | $ | 376 | $ | (2,242 | ) | ||||||
The components of income (loss) before income taxes consisted of the following (in thousands):
Year ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Domestic sources | $ | (14,874 | ) | $ | (50,733 | ) | $ | (30,522 | ) | (31,210 | ) | |||||
Foreign sources | (5,117 | ) | (42,569 | ) | (389 | ) | 14,777 | |||||||||
Total | $ | (19,991 | ) | $ | (93,302 | ) | $ | (30,911 | ) | $ | (16,433 | ) | ||||
Deferred tax assets and liabilities reflect the effects of tax losses, credits, and the future income tax effects of temporary differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and are measured using enacted tax rates that apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
As of June 24, 2011 and June 25, 2010, the significant components of the Company’s deferred tax assets and liabilities were (in thousands):
June 24, 2011 | June 25, 2010 | |||||||
Deferred tax assets: | ||||||||
Net operating losses and tax credit carry forwards | $ | 128,494 | $ | 78,887 | ||||
Accrued liabilities and other reserves | 14,708 | 458 | ||||||
Stock based compensation | 13,109 | 13,170 | ||||||
Intangible and fixed assets | 9,248 | 13,170 | ||||||
Accounts receivable and inventory reserves | 10,505 | 19,017 | ||||||
Other | 3,978 | 2,354 | ||||||
Total deferred tax assets | 180,042 | 127,056 | ||||||
Less valuation allowance | (177,970 | ) | (126,559 | ) | ||||
Deferred tax assets, net of valuation allowance | $ | 2,072 | $ | 497 | ||||
Net deferred tax assets | $ | 2,072 | $ | 497 | ||||
The valuation allowance against the Company's deferred tax assets increased from $126.6 million as of June 25, 2010 to $178.0 million as of June 24, 2011 and increased from $98.4 million as of June 26, 2009 to $126.6 million as of June 25, 2010. The net deferred tax asset as of June 24, 2011 is attributable to deferred tax assets of certain foreign subsidiaries which the Company believes are more likely than not of being realized.
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As of June 24, 2011, the Company has federal, state, and foreign tax net operating loss carry forwards of $126.2 million, $101.4 million, and $289.1 million, respectively. If not utilized, the net operating loss carry forwards will begin to expire in fiscal years 2028, 2012, and 2012, respectively. The Company's ability to utilize federal and state net operating loss carryforwards is subject to limitation as a result of a change in ownership as defined by section 382 of the Internal Revenue Code.
As of June 24, 2011, the Company has federal and state Research and Development tax credits of $2.3 million and $1.3 million, respectively, and $5.3 million of foreign investment tax credits. If not utilized, the federal and foreign tax credits will begin to expire in 2027 and 2019, respectively. The state tax credits do not expire.
The Company's policy with respect to its undistributed foreign subsidiaries' earnings is to consider those earnings to be indefinitely reinvested or repatriated tax-free and, accordingly, no related provision of income taxes has been provided. Upon distribution of those earnings in the form of dividends or otherwise, we may be subject to both income taxes and withholding taxes in the U.S. and various foreign countries. At June 24, 2011, we have not recorded deferred tax liabilities on approximately $27.0 million of foreign earnings that are deemed to be permanently reinvested overseas or repatriated tax free.
A reconciliation of the statutory federal income tax rate for the years ended June 24, 2011, June 25, 2010 and January 3, 2009 and for the six months ended June 26, 2009 is as follows:
Year ended | Six months ended | |||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | June 26, 2009 | |||||||||
Federal statutory rate provision | 35.0 | % | 35.0 | % | 35.0 | % | 35.0 | % | ||||
State taxes, net of federal tax benefit | (0.4 | ) | 0.8 | 2.0 | (0.2 | ) | ||||||
Foreign taxes | (7.8 | ) | (2.0 | ) | — | (8.4 | ) | |||||
Stock based compensation | 0.1 | 0.1 | — | (0.3 | ) | |||||||
Valuation allowance | (23.2 | ) | (30.6 | ) | (35.0 | ) | (21.0 | ) | ||||
Losses carried back | — | 5.3 | — | — | ||||||||
Unrecognized tax benefits | (6.0 | ) | (1.2 | ) | — | — | ||||||
Other | (3.9 | ) | (2.6 | ) | (3.0 | ) | 1.1 | |||||
Effective tax rate | (6.2 | )% | 4.8 | % | (1.0 | )% | 6.2 | % | ||||
A reconciliation of the unrecognized tax benefits (excluding interest and penalties) from January 3, 2009 through June 24, 2011 are as follows (in thousands):
Balance at January 3, 2009 | $ | 95 | |
Increase (decrease) to current year position | 8,162 | ||
Balance at June 26, 2009 | $ | 8,257 | |
Increase (decrease) to current year positions | 310 | ||
Increase (decrease) to prior year positions | 982 | ||
Decrease due to lapse of statute of limitations | (17 | ) | |
Increase (decrease) due to settlements | (197 | ) | |
Balance at June 25, 2010 | $ | 9,335 | |
Increase (decrease) to current year positions | 12,777 | ||
Increase (decrease) to prior year positions | 1,570 | ||
Decrease due to lapse of statute of limitations | (819 | ) | |
Balance at June 24, 2011 | $ | 22,863 | |
At June 24, 2011, the Company had approximately $22.9 million of gross unrecognized tax benefit of which $8.9 million, if recognized, will impact the effective tax rate. The Company does not expect that the total unrecognized tax benefits will significantly increase or decrease in the next 12 months.
The Company classifies interest expense and penalties related to unrecognized tax benefits as components of income tax expense. As of June 24, 2011, the Company has accrued interest and penalties of approximately $14.9 million and $0.3 million,
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respectively, on the Company’s consolidated balance sheet.
The Company’s U.S. federal tax returns for 2006 and prior years are no longer subject to examination. The Company’s state tax returns for years prior to 2005 are not subject to examination.
The Company’s foreign subsidiaries file income tax returns in the countries in which they have operations. Generally, these countries have statutes of limitations ranging from 4 to 6 years. Tax years still open to examination by foreign tax authorities in the Company’s larger subsidiaries located in Canada, France, Germany, and the United Kingdom are tax years ending June 2006 through June 2010. The Company is under examination by the taxing authorities in Canada, France, Israel, and the United States. The financial statement impact of these examinations cannot be estimated as of June 24, 2011.
19. DISCONTINUED OPERATIONS
In October 2008, the Company committed to a formal plan to abandon the Rapidscale product line, which was reviewed and approved by management with appropriate authority, and was communicated to the affected employees. The Company continues to honor service contracts with existing Rapidscale customers, but had no other significant continuing involvement in the operations of the Rapidscale product line subsequent to the abandonment.
The results of operations of the Rapidscale product line were reclassified and included in “discontinued operations, net of tax”, within the accompanying consolidated statements of operations for the years ended June 25, 2010 and January 3, 2009, and for the six months ended June 26, 2009. Results of operations of the RapidScale product line for the year ended June 24, 2011 were not material to the Company's operations and, therefore, were not reclassified.
The following summarizes the results of discontinued operations (in thousands):
Year ended | Six months ended June 26, 2009 | |||||||||||
June 25, 2010 | January 3, 2009 | |||||||||||
Revenue | $ | 366 | $ | 730 | $ | 307 | ||||||
Cost of revenue | 72 | 133 | 132 | |||||||||
Gross profit | 294 | 597 | 175 | |||||||||
Operating expenses: | ||||||||||||
Research and development | (106 | ) | 8,436 | (48 | ) | |||||||
Sales and marketing | (14 | ) | 60 | — | ||||||||
General and administrative | 10 | 251 | 32 | |||||||||
Impairment of long-lived assets | — | 17,519 | — | |||||||||
Total operating expenses | (110 | ) | 26,266 | (16 | ) | |||||||
Income (loss) from discontinued operations | 404 | (25,669 | ) | 191 | ||||||||
Total other income (expense) | 5 | (227 | ) | (211 | ) | |||||||
Income (loss) from discontinued operations before income tax benefit | 409 | (25,896 | ) | (20 | ) | |||||||
Income tax benefit | — | (2,955 | ) | — | ||||||||
Income (loss) from discontinued operations | $ | 409 | $ | (22,941 | ) | $ | (20 | ) | ||||
In the year ended January 3, 2009, the Company performed an impairment analysis of its intangible assets as events and circumstances indicated that their carrying amounts may not be recoverable. As a result of the analysis, the Company recognized and charged to discontinued operations an impairment charge of $17.5 million.
20. SEGMENT INFORMATION
As a result of the acquisition of the Legacy SGI assets, the Company reassessed its segment reporting based on the operating and reporting structure of the combined company. Historically, the Company concluded that it operated in a single operating segment. In connection with the acquisition of Legacy SGI, the Company changed its operating and reporting structure to operate in two operating segments, products and services. The year ended January 3, 2009 has not been presented to reflect the new operating segments as service revenue was immaterial in these periods.
The Company’s operating segments are determined based upon several criteria including: the Company’s internal organizational structure; the manner in which the Company’s operations are managed; the criteria used by the Company’s Chief
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Executive Officer, the Chief Operating Decision Maker (“CODM”), to evaluate segment performance; and the availability of separate financial information. The Company’s business is organized as two operating segments, products and services. Due to their similar economic characteristics, production processes, and distribution methods, the Company groups the product lines as the product operating segment and service offerings as the service operating segment. The Company’s CODM reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by product and service for purposes of allocating resources and evaluating financial performance.
Segment Results
The following table presents revenues and gross margin for the Company’s products and services segments for the years ended June 24, 2011, June 25, 2010, and January 3, 2009, and the six months ended June 26, 2009 (dollars in thousands):
Year ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Revenue | ||||||||||||||||
Products | $ | 465,177 | $ | 256,007 | $ | 247,430 | $ | 77,987 | ||||||||
Services | 164,391 | 147,710 | — | 24,790 | ||||||||||||
Total | $ | 629,568 | $ | 403,717 | $ | 247,430 | $ | 102,777 | ||||||||
Cost of revenue | ||||||||||||||||
Products | $ | 367,393 | $ | 229,913 | $ | 217,992 | $ | 78,132 | ||||||||
Services | 92,363 | 84,215 | — | 16,868 | ||||||||||||
Total | $ | 459,756 | $ | 314,128 | $ | 217,992 | $ | 95,000 | ||||||||
Gross profit: | ||||||||||||||||
Products | $ | 97,784 | $ | 26,094 | $ | 29,438 | $ | (145 | ) | |||||||
Services | 72,028 | 63,495 | — | 7,922 | ||||||||||||
Total | $ | 169,812 | $ | 89,589 | $ | 29,438 | $ | 7,777 | ||||||||
Gross margin: | ||||||||||||||||
Products | 21.0 | % | 10.2 | % | 11.9 | % | (0.2 | )% | ||||||||
Services | 43.8 | % | 43.0 | % | — | 32.0 | % | |||||||||
Total | 27.0 | % | 22.2 | % | 11.9 | % | 7.6 | % | ||||||||
The Company derives the results of the business segments directly from its internal management reporting system. The products and services metrics are derived on a contractual basis. Management measures the performance of each business segment based on two metrics, revenue and cost of revenue. These are the only discrete financial information that the Company has available for its segments. For this reason, the Company is not able to provide other financial results or assets by segment.
Operating segments do not sell products to each other, and accordingly, there is no inter-segment revenue to be reported.
The Company does not assess the performance of its geographic regions on other measures of income or expense, such as depreciation and amortization, operating income or net income. In addition, the Company’s assets are located primarily in the United States and are not allocated to any specific region. The Company does not produce reports for, or measure the performance of, its geographic regions on any asset-based metrics. Therefore, geographic information is presented only for revenues.
Customer information
For the years ended June 24, 2011 and June 25, 2010, Amazon accounted for approximately 12% and 20% of the Company's product revenues. For the year ended January 3, 2009, Amazon and Microsoft accounted for approximately 35% and 14% of the Company's product revenues, respectively. For the six months ended June 26, 2009, Amazon and Microsoft accounted for 30% and 13% of our product revenues, respectively. No other customers accounted for more than 10% of the Company's revenue for years ended June 24, 2011, June 25, 2010, and January 3, 2009, and the six months ended June 26, 2009.
At June 24, 2011, Amazon, Raytheon, and the U.S. Government accounted for approximately 13%, 12% and 11% of the Company's accounts receivable, respectively. No other single customer accounted for 10% or more of the Company's trade accounts receivable at June 24, 2011. No single customer accounted for 10% or more of the Company's trade accounts
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receivable at June 25, 2010.
Geographic Information
Summarized revenues by geographic region, based on the Company's internal management system and as utilized by the Company's CODM, is as follows (in thousands):
Year ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Domestic revenue | $ | 389,328 | $ | 301,837 | $ | 227,141 | $ | 76,880 | ||||||||
International revenue | 240,240 | 101,880 | 20,289 | 25,897 | ||||||||||||
Total revenue | $ | 629,568 | $ | 403,717 | $ | 247,430 | $ | 102,777 | ||||||||
International sales to single foreign countries which accounted for ten percent or more of revenues were $67.5 million or 11% of revenues for the year ended June 24, 2011 in Japan. No individual foreign country’s revenue accounted for ten percent or more of revenues in the years ended June 25, 2010 and January 3, 2009, and the six months ended June 26, 2009.
Approximately 81% and 91% of the Company’s property and equipment was located in the United States as of June 24, 2011 and June 25, 2010, respectively. No individual foreign country’s property and equipment was material for disclosure purposes.
21. RELATED PARTY TRANSACTIONS
Investment in SGI Japan
The Company acquired approximately 90% of the outstanding stock of SGI Japan for $17.9 million on March 9, 2011. Prior to that date, the Company owned approximately 10% of the outstanding stock of SGI Japan, which was acquired in connection with the acquisition of Legacy SGI. As a result, effective March 10, 2011, SGI Japan became a wholly-owned subsidiary of the Company (See Note 3).
Prior to March 10, 2011, the Company's investment in SGI Japan of $2.1 million was accounted for under the cost method and was included in other assets in the accompanying consolidated balance sheet at June 25, 2010. During the three months ended December 24, 2010, the Company determined that there had been an other-than-temporary impairment of its investment in SGI Japan. As a result, the Company wrote down the investment from $5.0 million to $2.1 million, which represented the estimated fair value of the investment at December 24, 2010. On March 9, 2011, the carrying value of $2.1 million was equal to the acquisition-date fair value of the equity interest in SGI Japan held by the Company immediately before the acquisition, no gain or loss was recorded.
The Company's consolidated statements of operations and consolidated statement of cash flows for the year ended June 24, 2011 include SGI Japan's statement of operations and statement of cash flows for the period from March 10, 2011 to June 24, 2011. The Company's consolidated balance sheet at June 24, 2011 includes the accounts of SGI Japan. All significant intercompany transactions between the Company and SGI Japan for the period from March 10, 2011 to June 24, 2011 have been eliminated in consolidation. All significant intercompany balances between the Company and SGI Japan at June 24, 2011 have also been eliminated in consolidation.
Sales to Related Party
Prior to March 10, 2011, the Company recognized product revenue and cost of product revenue from sales to SGI Japan. The Company ceased recognizing product revenue and cost of product revenue from sales to SGI Japan effective March 10, 2011. Product revenue and cost of product revenue from sales to SGI Japan prior to March 10, 2011 were as follows (in thousands):
Period from June 26, 2010 to March 9, 2011 | Year ended June 25, 2010 | Six months ended June 26, 2009 | ||||||||||
Product revenue | $ | 15,718 | $ | 18,890 | $ | 145 | ||||||
Cost of product revenue | $ | 10,027 | $ | 13,829 | $ | 95 | ||||||
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Amounts Receivable From and Payable to Related Party
As of June 25, 2010, amounts receivable from and payable to SGI Japan were as follows (in thousands):
June 25, 2010 | ||||
Amounts receivable from SGI Japan | $ | 8,845 | ||
Amounts due to SGI Japan | $ | 127 | ||
Amounts receivable from SGI Japan at June 25, 2010 were included in accounts receivable in the accompanying consolidated balance sheets. Amounts payable to SGI Japan at June 25, 2010 were included in accounts payable in the accompanying consolidated balance sheets. Amounts receivable from and payable to SGI Japan as of June 24, 2011 have been reclassified to intercompany accounts. All significant intercompany balances have been eliminated in consolidation.
There were no transactions with SGI Japan during the year ended January 3, 2009 as the acquisition of Legacy SGI was finalized on May 8, 2009 (Note 3).
22. FINANCIAL GUARANTEES
The Company has issued financial guarantees to cover rent on leased facilities and equipment, to government authorities for VAT and other taxes, and to various other parties to support payments in advance of future delivery on goods and services. The majority of the Company’s financial guarantees have terms of one year or more. The maximum potential obligation under financial guarantees at June 24, 2011 was $3.7 million for which the Company has $3.3 million of assets held as collateral. The full amount of the assets held as collateral are included in short-term and long-term restricted cash and cash equivalents in the consolidated balance sheets.
23. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases certain real and personal property under non-cancelable operating leases. The Company leases its facilities and office buildings under operating leases that expire at various dates through March 2017. Certain leases also contain escalation and renewal option clauses calling for increased rents. Where a lease contains an escalation clause or a concession such as a rent holiday, rent expense is recognized using the straight line method over the term of the lease. In addition to the minimum future lease commitments presented below, the leases generally require that the Company pay property taxes, insurance, maintenance and repair costs. Also, under certain leases, the Company is granted an option to early terminate the lease by providing an advance notice and paying an early termination fee. The Company does not intend early termination of the leases and hence the future minimum operating lease commitments disclosed herein consist of the total lease payments through the end of the initial lease terms. Personal property under operating leases is comprised primarily of automobiles and office equipment.
Future minimum lease payments under operating leases are as follows (in thousands):
Fiscal Year | ||||
2012 | $ | 10,577 | ||
2013 | 6,784 | |||
2014 | 3,216 | |||
2015 | 995 | |||
2016 | 543 | |||
2017 and thereafter | — | |||
Total | $ | 22,115 | ||
Rent expense for the years ended June 24, 2011, June 25, 2010, and January 3, 2009, and the six months ended June 26, 2009 was approximately $6.4 million, $6.8 million, $2.5 million, and $2.0 million, respectively.
Purchase Commitments
In connection with supplier agreements, the Company has unconditional purchase obligations that include agreements to purchase certain units of inventory and non-inventory items through 2012. These purchase obligations that are enforceable and
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legally binding on the Company specify all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable price provisions and the approximate timing of the transaction.
As of June 24, 2011, these remaining non-cancelable commitments were approximately $14.6 million and are due in the next 12 months.
Indemnification Agreements
The Company enters into standard indemnification agreements with its customers and certain other business partners in the ordinary course of business. These agreements include provisions for indemnifying the customer against any claim brought by a third party to the extent any such claim alleges that the Company’s product infringes a patent, copyright or trademark, or misappropriates a trade secret, of that third-party. The agreements generally limit the scope of the available remedies in a variety of industry-standard methods, including, but not limited to, product usage and geography-based limitations, a right to control the defense or settlement of any claim, and a right to replace or modify the infringing products to make them non-infringing. The Company has not incurred significant expenses related to these indemnification agreements and no material claims for such indemnifications were outstanding as of June 24, 2011. As a result, the Company believes the estimated fair value of these indemnification agreements, if any, to be immaterial; accordingly, no liability has been recorded with respect to such indemnifications as of June 24, 2011.
Contingencies
The Company may, from time to time, be involved in lawsuits, claims, investigations and proceedings that arise in the ordinary course of business. The Company records a provision for a liability when management believes that it is both probable that a liability has been incurred and it can reasonably estimate the amount of the loss. The Company believes it has adequate provisions for any such matters. The Company reviews these provisions at least quarterly and adjusts these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case.
On May 1, 2007, Legacy SGI received a legal notice from counsel to Bharat Heavy Electricals Ltd. (“BHEL”), located in India, alleging delay in and failure to deliver products and technical problems with its hardware and software in relation to the establishment of a facility in Hyderabad. The Company assumed this claim in connection with its acquisition of Legacy SGI assets, and is currently engaged in arbitration. On January 21, 2008, BHEL filed its statement of claim against Silicon Graphics Systems (India) Pvt. Ltd. for a sum of Indian Rupee (“INR”) 78,478,200 ($1.7 million based on the conversion rate on June 24, 2011) plus interest and costs. On February 29, 2008, the Company filed its reply as well as a counter claim for a sum of INR 27,453,007 ($0.6 million based on the conversion rate on June 24, 2011) plus interest and costs. The proceeding has commenced but the hearing, scheduled for August 28, 2011, could not take place and the next rescheduled hearing date is awaited from the Arbitor. The Company cannot currently predict the outcome of this dispute nor determine the amount or a reasonable range of potential loss, if any.
On January 16, 2009, the Company and certain of its former officers were sued in the United States District Court for the Northern District of California, in a matter captioned In Re Rackable Systems, Inc. Securities Litigation, Case No. C-09-0222-CW. On April 16, 2009, the Court appointed Elroy Whittaker as Lead Plaintiff and the Law Firm of Glancy Binkow & Goldberg LLP as Lead Plaintiff's Counsel. Lead Plaintiff filed a consolidated amended complaint (the “Amended Complaint”) on June 15, 2009. The Amended Complaint asserts claims for violations of (i) Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and (ii) Section 20(a) of the Exchange Act. The allegations relate to the drops in the Company's share price in early 2007 relating to its earnings reports for 2006 and Q4 2006. On April 9, 2010, the Company and its former officers filed a Motion to Dismiss the Supplemental Second Amended Complaint. The Court granted the Motion to Dismiss and entered judgment dismissing the action with prejudice on August 31, 2010. Because Lead Plaintiffs did not appeal the dismissal, the Court's judgment is now final and the action is terminated.
On March 10, 2009, the Company and certain of its present and former directors and officers were sued in the Superior Court of the State of California for Alameda County, in a shareholder derivative lawsuit captioned Milo v. Barton, et al, Case No. R30944-0474. The complaint alleges that the defendants engaged in various acts and omissions that resulted in the drops of the Company's share price in early 2007, and asserts claims for alleged breaches of defendants' fiduciary duties, waste of corporate assets, and unjust enrichment. The complaint seeks compensatory damages in an unspecified amount, unspecified equitable or injunctive relief, disgorgement of unspecified compensation earned by the defendants, and an award of an unspecified amount for plaintiff's costs and attorney's fees. On January 18, 2011, defendants filed a demurrer to the complaint on the grounds that plaintiff failed to plead that a pre-suit demand on the Company's Board of Directors was excused under controlling state law. On February 15, 2011, plaintiff stipulated to a voluntary dismissal of the action. The Court entered
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judgment dismissing the action with prejudice and the action is terminated.
On December 3, 2009, the Company initiated an arbitration proceeding captioned Silicon Graphics Intl. Corp., f/k/a Rackable Systems, Inc. v. Thomas Weisel Partners Group, Inc., et al., FINRA Arb. No. 09-06849, against its former investment advisor Thomas Weisel Partners LLC (“TWP”), as well as TWP's parent company Thomas Wiesel Partners Group, Inc., to remedy TWP's alleged mismanagement and wrongful advice pertaining to the Company's investments in allegedly unsuitable and illiquid investments called “auction rate securities” (“ARS”). On February 4, 2011, the Company settled with TWP. As part of the settlement, the Company sold all of its remaining ARS through TWP and received proceeds of approximately $6.5 million. Each of the parties agreed to bear their own attorneys' fees and costs. The Company's carrying value of the ARS was $6.2 million; therefore, the Company recorded a $0.3 million gain as a result of the settlement.
Third parties in the past have asserted, and may in the future assert, intellectual property infringement claims against the Company, and such future claims, if proved, could require the Company to pay substantial damages or to redesign its existing products or pay fees to obtain cross-license agreements. Litigation may be necessary in the future to enforce or defend the Company's intellectual property rights, to protect the Company's trade secrets or to determine the validity and scope of its proprietary rights or the proprietary rights of others. Any such litigation could result in substantial costs and diversion of management resources, either of which could harm the Company's business, operating results and financial condition. Further, many of the Company's current and potential competitors have the ability to dedicate substantially greater resources to enforcing and defending their intellectual property rights than the Company.
Additionally, from time to time, the Company receives inquiries from regulatory agencies informally requesting information or documentation. There can be no assurance in any given case that such informal review will not lead to further proceedings involving the Company in the future.
The Company is not aware of any pending disputes, including those disputes and settlements described above, that would be likely to have a material adverse effect on its consolidated financial condition, results of operations or liquidity. However, litigation is subject to inherent uncertainties and costs and unfavorable outcomes could occur. An unfavorable outcome could include the payment of monetary damages, cash or other settlement, or an injunction prohibiting it from selling one or more products. If an unfavorable resolution were to occur, there exists the possibility of a material adverse impact on the Company's consolidated financial condition, results of operations or cash flows of the period in which the resolution occurs or on future periods.
24. TRANSITION PERIOD FINANCIAL INFORMATION
The following table presents certain Consolidated Statement of Operations data for the six months ended June 26, 2009 and for the six months ended June 28, 2008 (unaudited) (in thousands except per share data):
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Six months ended | ||||||||
June 26, 2009 | June 28, 2008 | |||||||
(unaudited) | ||||||||
Revenue | $ | 102,777 | $ | 143,569 | ||||
Gross profit | $ | 7,777 | $ | 24,410 | ||||
Loss from operations | $ | (17,710 | ) | $ | (9,500 | ) | ||
Loss from continuing operations before income taxes | $ | (16,433 | ) | $ | (6,624 | ) | ||
Income tax provision (benefit) from continuing operations | (2,242 | ) | 1,526 | |||||
Net loss from continuing operations | (14,191 | ) | (8,150 | ) | ||||
Loss from discontinued operations | (20 | ) | (23,487 | ) | ||||
Income tax benefit | — | (2,941 | ) | |||||
Loss from discontinued operations, net of tax | (20 | ) | (20,546 | ) | ||||
Net loss | $ | (14,211 | ) | $ | (28,696 | ) | ||
Net loss per share, basic and diluted: | ||||||||
Continuing operations | $ | (0.48 | ) | $ | (0.28 | ) | ||
Discontinued operations | — | (0.70 | ) | |||||
Basic and diluted net loss per share | $ | (0.48 | ) | $ | (0.98 | ) | ||
Shares used in computing basic and diluted net loss per share | 29,798 | 29,429 | ||||||
25. SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
On June 19, 2009, the Company’s Board of Directors approved a change in the Company’s fiscal year end from the Saturday closest to December 31st of each year to the last Friday in June of each year. Accordingly, the financial periods presented are defined as follows: (i) the year ended June 24, 2011; and (ii) year ended June 25, 2010 (in thousands, except per share amounts).
Fiscal Quarter Ended | ||||||||||||||||
June 24, 2011 (1) | March 25, 2011 (1) | December 24, 2010 | September 24, 2010 | |||||||||||||
Revenue | $ | 195,486 | $ | 143,664 | $ | 177,524 | $ | 112,894 | ||||||||
Gross profit | $ | 45,984 | $ | 40,502 | $ | 52,329 | $ | 30,997 | ||||||||
Net income (loss) | $ | (12,098 | ) | $ | (1,672 | ) | $ | 3,724 | $ | (11,187 | ) | |||||
Basic and diluted net income (loss) per share: | ||||||||||||||||
Basic | $ | (0.39 | ) | $ | (0.05 | ) | $ | 0.12 | $ | (0.37 | ) | |||||
Diluted | $ | (0.39 | ) | $ | (0.05 | ) | $ | 0.12 | $ | (0.37 | ) | |||||
Shares used in the calculation of net loss per share: | ||||||||||||||||
Basic | 31,029 | 30,577 | 30,321 | 30,536 | ||||||||||||
Diluted | 31,029 | 30,577 | 30,836 | 30,536 | ||||||||||||
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Fiscal Quarter Ended | ||||||||||||||||
June 25, 2010 | March 26, 2010 | December 25, 2009 | September 25, 2009 | |||||||||||||
Revenue | $ | 101,637 | $ | 107,820 | $ | 94,137 | $ | 100,123 | ||||||||
Gross profit | $ | 19,615 | $ | 28,920 | $ | 18,686 | $ | 22,368 | ||||||||
Net loss from continuing operations | $ | (27,670 | ) | $ | (20,262 | ) | $ | (23,127 | ) | $ | (17,802 | ) | ||||
Income from discontinued operations, net of tax | $ | 63 | $ | 82 | $ | 84 | $ | 180 | ||||||||
Net loss | $ | (27,607 | ) | $ | (20,180 | ) | $ | (23,043 | ) | $ | (17,622 | ) | ||||
Basic and diluted net income (loss) per share: | ||||||||||||||||
Continued operations | $ | (0.91 | ) | $ | (0.67 | ) | $ | (0.77 | ) | $ | (0.60 | ) | ||||
Discontinued operations | — | — | — | 0.01 | ||||||||||||
Net loss per share—basic and diluted | $ | (0.91 | ) | $ | (0.67 | ) | $ | (0.77 | ) | $ | (0.59 | ) | ||||
Shares used in the calculation of net loss per share: | ||||||||||||||||
Basic and diluted | 30,121 | 30,097 | 29,952 | 29,893 | ||||||||||||
(1) | On March 9, 2011 Silicon Graphics World Trade BV ("SGI BV") acquired the remaining outstanding shares of SGI Japan, Ltd., a Japanese corporation (“SGI Japan”). Prior to the Closing Date, the Company owned approximately 10% of the outstanding shares of SGI Japan and accounted for such investment as a cost method investment. |
SCHEDULE II.
SILICON GRAPHICS INTERNATIONAL CORP.
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Year ended | Six months ended June 26, 2009 | |||||||||||||||
June 24, 2011 | June 25, 2010 | January 3, 2009 | ||||||||||||||
Allowance for doubtful accounts: | ||||||||||||||||
Beginning Balance | $ | 1,646 | $ | 859 | $ | 434 | $ | 470 | ||||||||
(Recovery) Charges | (77 | ) | 844 | 66 | 389 | |||||||||||
Reduction and Write-offs | (234 | ) | (57 | ) | (30 | ) | — | |||||||||
Ending Balance | $ | 1,335 | $ | 1,646 | $ | 470 | $ | 859 | ||||||||
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended (the "Exchange Act"). The evaluation considered the procedures designed to ensure that the information included in reports we file under the Exchange Act, is recorded, processed, summarized and reported within the appropriate time periods and that information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosures. Based on that evaluation, our management, including our chief executive officer and chief financial officer, has concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of June 24, 2011.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our internal control over financial reporting based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that the Company’s internal control over financial reporting was effective as of June 24, 2011.
Management's assessment of the effectiveness of internal control over financial reporting as of June 24, 2011 excluded the internal control over financial reporting at SGI Japan, Ltd., which constituted 16% of total assets, 11% of revenue, and 1% of net loss of the consolidated financial statements as of and for the year ended June 24, 2011. On March 9, 2011, we acquired SGI Japan which operated under its own set of systems and internal controls. We have not completed incorporating SGI Japan's processes into our systems and control environment as of June 24, 2011. We believe that we have taken the necessary steps to monitor and maintain appropriate internal control over financial reporting during this change. This exclusion was in accordance with Securities and Exchange Commission guidance that an assessment of a recently acquired business may be omitted in management's report on internal controls over financial reporting in the year of acquisition.
The effectiveness of our internal control over financial reporting as of June 24, 2011 has been audited by Deloitte & Touche LLP, independent registered public accounting firm, as stated in its report which appears below.
Changes in Internal Control over Financial Reporting
The Company also evaluated changes to its internal control over financial reporting. There were no changes in the Company's internal control over financial reporting during the quarter ended June 24, 2011 that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Silicon Graphics International Corp.
Fremont, California
We have audited the internal control over financial reporting of Silicon Graphics International Corp. and subsidiaries (the “Company”) as of June 24, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. As described in the accompanying Management's Report on Internal Control over Financial Reporting, management excluded from its assessment, the internal control over financial reporting at SGI Japan, Ltd. (“SGI Japan”) which was acquired on March 9, 2011 and whose financial statements constitute 16% of total assets, 11% of revenue, and 1% of net loss of the consolidated financial statement amounts as of and for the year ended June 24, 2011. Accordingly, our audit did not include the internal control over financial reporting at SGI Japan. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 24, 2011, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and consolidated financial statement schedule as of and for the year ended June 24, 2011 of the Company and our report dated August 29, 2011 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
August 29, 2011
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Item 9B. Other Information
None
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item is incorporated herein by reference from the sections tentatively entitled “Proposal 1—Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Code of Business Conduct & Ethics” and “Information Regarding the Board of Directors and Corporate Governance” contained in our proxy statement for our 2011 Annual Meeting of Stockholders (the “Proxy Statement”) provided however, that the information required by this Item with respect to our executive officers is contained in Item 1 of Part I of this Annual Report on Form 10-K under the heading “Executive Officers.”
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference from the sections tentatively entitled “Compensation Committee” in “Proposal 1—Election of Directors,” and “Executive Compensation and Related Information,” in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item is incorporated herein by reference from the section tentatively entitled “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” of the Proxy Statement.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated herein by reference from the section tentatively entitled “Certain Relationships and Related Transactions” and “Proposal 1—Election of Directors” in the Proxy Statement.
Item 14. Principal Accounting Fees and Services
The information required by this Item is incorporated herein by reference from the section tentatively entitled “Principal Accountant Fees and Services” in the Proxy Statement.
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PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) 1. Financial Statements
See Index to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference.
2. Financial Statement Schedules
All other financial statement schedules have been omitted because they are either not applicable or the required information is shown in the consolidated financial statements or notes thereto.
3. Exhibits
See the Exhibit Index which follows the signature page of this Annual Report on Form 10-K, which is incorporated herein by reference.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SILICON GRAPHICS INTERNATIONAL CORP. | |||
By: | /s/ JAMES D. WHEAT | ||
James D. Wheat Chief Financial Officer | |||
Dated: August 29, 2011
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears below constitutes and appoints Mark J. Barrenechea and James D. Wheat, and each of them, acting individually, as his or her attorney-in-fact, each with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||
/s/ MARK J. BARRENECHEA | Chief Executive Officer and Director | August 29, 2011 | ||
Mark J. Barrenechea | (Principal Executive Officer) | |||
/s/ JAMES D WHEAT | Chief Financial Officer | August 29, 2011 | ||
James D. Wheat | (Principal Financial Officer) | |||
/s/ TIMOTHY L. PEBWORTH | Vice President and Principal Accounting Officer | August 29, 2011 | ||
Timothy L. Pebworth | (Principal Accounting Officer) | |||
/s/ CHARLES M. BOESENBERG | Director | August 29, 2011 | ||
Charles M. Boesenberg | ||||
/s/ GARY A. GRIFFITHS | Director | August 29, 2011 | ||
Gary A. Griffiths | ||||
/s/ MICHAEL W. HAGEE | Director | August 29, 2011 | ||
Michael W. Hagee | ||||
/s/ DOUGLAS R. KING | Director | August 29, 2011 | ||
Douglas R. King | ||||
/s/ HAGI SCHWARTZ | Director | August 29, 2011 | ||
Hagi Schwartz | ||||
/s/ RONALD D. VERDOORN | Director | August 29, 2011 | ||
Ronald D. Verdoorn | ||||
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EXHIBIT INDEX
Exhibit Number | Exhibit Description | Incorporated by Reference | Filing Date | Filed Herewith | ||||||||||
Form | Ex. No. | File No. | ||||||||||||
2.1 | Asset Acquisition Agreement, dated December 23, 2002, by and between GNJ, Inc. (f.k.a. Rackable Systems, Inc.) and Registrant. | S-1 | 2.1 | 333-122576 | 2/4/2005 | |||||||||
2.2 | Share Purchase Agreement dated as of August 29, 2006, by and among Rackable Systems, Inc., Rackable Systems Canada Acquisition ULC, Terrascale Technologies Inc. and the other parties identified on Schedule A thereto. | 8-K | 2.1 | 000-51333 | 8/30/2006 | |||||||||
2.3 | Asset Purchase Agreement dated as of March 31, 2009, by and among Silicon Graphics, Inc., the subsidiaries of Silicon Graphics, Inc. listed on Schedule I thereto, and Rackable Systems, Inc. | 8-K | 2.1 | 000-51333 | 4/1/2009 | |||||||||
2.4 | Amendment to Asset Purchase Agreement dated as of March 31, 2009, by and among Silicon Graphics, Inc., the subsidiaries of Silicon Graphics, Inc. listed on Schedule I thereto, and Rackable Systems, Inc., dated as of April 30, 2009. | 8-K | 2.1 | 000-51333 | 5/5/2009 | |||||||||
2.5 | Secured Creditor Asset Purchase Agreement dated as of February 23, 2010, by and between Silicon Valley Bank and Silicon Graphics International Corp. | 8-K | 2.5 | 000-51333 | 3/1/2010 | |||||||||
2.6 | Stock Purchase Agreement dated as of March 8, 2011, by and among SGI Japan, Ltd., Silicon Graphics World Trade B.V., NEC SOFT, LTD., SONY CORPORATION, Morgan Stanley MUFG Securities Co., Ltd., Nomura Securities Co., Ltd., JAFCO V2 Venture Capital Investment Limited Partnership, JAFCO V2-R Venture Capital Investment Limited Partnership, SOFTBANK Media Marketing Holdings Corp., NIHON SGI TRUST EIGHT and NEC CORPORATION as the Stockholders' Representative. | 8-K | 2.1 | 000-51333 | 3/9/2011 | |||||||||
3.1 | Amended and Restated Certificate of Incorporation. | 10-Q | 3.1 | 000-51333 | 8/12/2005 | |||||||||
3.2 | Amended and Restated Bylaws. | 8-K | 3.2 | 000-51333 | 3/7/2008 | |||||||||
3.3 | Certificate of Ownership and Merger. | 8-K | 3.3 | 000-51333 | 5/21/2009 | |||||||||
4.1 | Reference is made to Exhibits 3.1, 3.2 and 3.3. | |||||||||||||
4.2 | Form of Specimen Stock Certificate. | 8-K | 4.2 | 000-51333 | 5/21/2009 | |||||||||
10.1 | Amendment to Registration Agreement and Founder Repurchase and Rights Agreement, dated November 16, 2005, by and among Registrant, Rackable Investment LLC, Parthenon Investors II, L.P. and the founders named therein. | S-1A/1 | 10.7 | 333-129573 | 11/17/2005 | |||||||||
10.2 | Form of Indemnity Agreement entered into by Registrant with each of its directors and certain executive officers. | S-1 | 10.7 | 333-122576 | 2/4/2005 | |||||||||
10.3 | 2002 Stock Option Plan and form of related agreements. | S-1 | 10.8 | 333-122576 | 3/30/2005 | |||||||||
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Exhibit Number | Exhibit Description | Incorporated by Reference | Filing Date | Filed Herewith | ||||||||||
Form | Ex. No. | File No. | ||||||||||||
10.4 | * | 2005 Equity Incentive Plan. | S-1 | 10.9 | 333-122576 | 2/4/2005 | ||||||||
10.5 | * | 2005 Non-Employee Directors’ Stock Option Plan. | S-1 | 10.10 | 333-122576 | 2/4/2005 | ||||||||
10.6 | * | 2005 Employee Stock Purchase Plan. | S-1 | 10.11 | 333-122576 | 2/4/2005 | ||||||||
10.7 | * | Executive Compensation Summary. | 10-K | 10.18 | 000-51333 | 3/19/2009 | ||||||||
10.8 | Director Compensation Arrangements. | 10-K | 10.31 | 000-51333 | 2/28/2007 | |||||||||
10.9 | * | Offer letter, dated August 18, 2004, from the Registrant to Hagi Schwartz. | S-1 | 10.35 | 333-122576 | 2/4/2005 | ||||||||
10.10 | * | Offer letter, dated November 4, 2004, from the Registrant to Gary Griffiths. | S-1 | 10.37 | 333-122576 | 2/4/2005 | ||||||||
10.11 | * | Offer letter dated March 18, 2005, from the Registrant to Ronald D. Verdoorn. | S-1A/2 | 10.42 | 333-122576 | 5/2/2005 | ||||||||
10.12 | * | Form of Stock Option Agreement under the 2006 New Recruit Equity Incentive Plan. | 8-K | 10.2 | 000-51333 | 1/30/2006 | ||||||||
10.13 | Net Lease Agreement dated June 26, 2006 by and among Rackable Systems, Inc. and Fremont Landing Investors, LLC. | 8-K | 10.6 | 000-51333 | 8/25/2006 | |||||||||
10.14 | * | Amended and Restated 2006 New Recruit Equity Inventive Plan. | 10-K | 10.5 | 000-51333 | 2/28/2007 | ||||||||
10.15 | * | Executive Change in Control Benefit Plan and Form of Participation Notices. | 8-K | 10.1 | 000-51333 | 9/5/2006 | ||||||||
10.16 | * | Form of Option Agreement and Grant Notices under the 2005 Equity Incentive Plan. | 8-K | 10.2 | 000-51333 | 9/5/2006 | ||||||||
10.17 | * | Form of Stock Bonus Award Agreement and Grant Notice under the 2005 Equity Incentive Plan. | 8-K | 10.3 | 000-51333 | 9/5/2006 | ||||||||
10.18 | * | Form of Stock Option Agreement and Grant Notice with Outside Directors under the 2002 Stock Option Plan. | 10-Q | 10.1 | 000-51333 | 11/14/2006 | ||||||||
10.19 | * | Form of Non-statutory Stock Option Agreement under the 2005 Non-Employee Directors’ Stock Option Plan. | 10-Q | 10.1 | 000-51333 | 11/14/2006 | ||||||||
10.20 | * | Offer Letter, dated August 21, 2006, by and between the Registrant and Charles Boesenberg. | 10-K | 10.6 | 000-51333 | 2/28/2007 | ||||||||
10.21 | * | Offer Letter, dated November 17, 2006, by and between the Registrant and Mark Barrenechea. | 10-K | 10.6 | 000-51333 | 2/28/2007 | ||||||||
10.22 | * | Change in Control Severance Benefit Plan. | 8-K | 10.1 | 000-51333 | 10/6/2006 | ||||||||
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Exhibit Number | Exhibit Description | Incorporated by Reference | Filing Date | Filed Herewith | ||||||||||
Form | Ex. No. | File No. | ||||||||||||
10.23 | * | Employment Agreement, dated May 24, 2007, by and between Rackable Systems, Inc. and Mark J. Barrenechea. | 8-K | 10.1 | 000-51333 | 5/30/2007 | ||||||||
10.24 | * | Form of 2005 Equity Incentive Plan Restricted Stock Unit Grant Notice and Restricted Stock Unit Award Agreement. | 8-K | 10.1 | 000-51333 | 6/8/2007 | ||||||||
10.25 | * | Offer Letter, dated January 29, 2008, by and between the Registrant and Douglas R. King. | 10-K | 10.45 | 000-51333 | 9/8/2010 | ||||||||
10.26 | * | Offer Letter, dated January 29, 2008, by and between the Registrant and Michael W. Hagee. | 10-K | 10.46 | 000-51333 | 9/8/2010 | ||||||||
10.27 | * | Amendment to Employment Agreement, dated December 31, 2008, between Rackable Systems, Inc. and Mark J. Barrenechea. | 8-K | 10.3 | 000-51333 | 1/6/2009 | ||||||||
10.28 | * | Employment Agreement, dated March 31, 2008, between Rackable Systems, Inc. and James Wheat. | 10-K | 10.69 | 000-51333 | 3/19/2009 | ||||||||
10.29 | * | Amendment #1 to Employment Agreement, dated December 31, 2008, between Rackable Systems, Inc. and James Wheat. | 10-K | 10.70 | 000-51333 | 3/19/2009 | ||||||||
10.30 | * | First Amendment to Employment Agreement, dated December 31, 2008, between Rackable Systems, Inc. and James Wheat. | 8-K | 10.20 | 000-51333 | 1/6/2009 | ||||||||
10.31 | * | Amended and Restated Employment Agreement, dated December 30, 2008, between Rackable Systems, Inc. and Giovanni Coglitore. | 8-K | 10.10 | 000-51333 | 1/6/2009 | ||||||||
10.32 | * | Offer Letter made by Rackable Systems, Inc. to Anthony Carrozza, dated January 24, 2008. | 10-K | 10.73 | 000-51333 | 3/19/2009 | ||||||||
10.33 | * | First Amendment to Employment Agreement, dated December 23, 2008, between Rackable Systems, Inc. and Anthony Carrozza. | 10-K | 10.74 | 000-51333 | 3/19/2009 | ||||||||
10.34 | * | Corporate Bonus Plan. | 8-K | 5.02 | 000-51333 | 2/12/2009 | ||||||||
10.35 | * | Offer Letter made by Rackable Systems, Inc. to Tim Pebworth, dated May 1, 2009. | 8-K | 10.20 | 000-51333 | 5/14/2009 | ||||||||
10.36 | * | 2010 Corporate Bonus Plan. | 8-K | — | 000-51333 | 8/14/2009 | ||||||||
10.37 | * | Director Compensation Arrangement. | 10-Q | 10.86 | 000-51333 | 11/4/2009 | ||||||||
10.38 | * | Separation Agreement dated June 23, 2010, between Silicon Graphics International Corp. and Giovanni Coglitore. | 10-K | 10.62 | 000-51333 | 9/8/2010 | ||||||||
10.39 | * | 2011 Short Term Incentive Plan. | 10-K | 10.63 | 000-51333 | 9/8/2010 | ||||||||
10.40 | * | Compensation arrangement with named executive officers. | 8-K | — | 000-51333 | 2/4/2010 | ||||||||
10.41 | * | 2012 Short Term Incentive Plan. | 8-K | — | 000-51333 | 8/18/2011 | ||||||||
10.42 | * | First Amendment to Employment Agreement, dated June 13, 2011 between Silicon Graphics International Corp. and Tim Pebworth. | X | |||||||||||
10.43 | * | Separation Agreement dated June 22, 2011, between Silicon Graphics International Corp. and Maurice Leibenstern. | X | |||||||||||
10.44 | * | 2005 Equity Incentive Plan Amendment. | X | |||||||||||
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Exhibit Number | Exhibit Description | Incorporated by Reference | Filing Date | Filed Herewith | ||||||||
Form | Ex. No. | File No. | ||||||||||
10.45 | * | Offer Letter made by Rackable Systems, Inc. to Jennifer Pratt, dated March 1, 2005. | X | |||||||||
10.46 | * | Employment Agreement Restatement and Amendment #1, dated January 23, 2008 between Rackable Systems, Inc. and Jennifer Pratt. | X | |||||||||
10.47 | * | Second Amendment to Employment Agreement, dated December 23, 2008 between Rackable Systems, Inc. and Jennifer Pratt. | X | |||||||||
10.48 | * | Third Amendment to Employment Agreement, dated May 14, 2009 between Silicon Graphics International Corp. and Jennifer Pratt. | X | |||||||||
10.49 | * | Fourth Amendment to Employment Agreement, dated January 10, 2011 between Silicon Graphics International Corp. and Jennifer Pratt. | X | |||||||||
10.50 | * | Offer Letter made by Silicon Graphics International Corp. to Rick Rinehart, dated April 1, 2010. | X | |||||||||
21.1 | Subsidiaries of the Company. | X | ||||||||||
23.1 | Consent of Independent Registered Public Accounting Firm. | X | ||||||||||
24.1 | Power of Attorney. (Included on the signature page hereto). | |||||||||||
31.1 | Certification required by Rule 13a-14(a) or Rule 15d-14(a). | X | ||||||||||
31.2 | Certification required by Rule 13a-14(a) or Rule 15d-14(a). | X | ||||||||||
32.1 | ** | Certifications required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350). | X | |||||||||
* | Indicates a management contract or compensatory plan or arrangement. |
** | The certification attached as Exhibit 32.1 accompanies the Annual Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by Silicon Graphics International Corp. for purposes of Section 18 of the Securities Exchange Act of 1934, as amended. |
109