10Q 2012 Q3
Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 30, 2012
Or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from                 to
Commission File Number 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)
 
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 x  No  o 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the 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
 
 
(Do not check if a smaller reporting company)
 

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 May 3, 2012, there were 31,935,542 shares of the registrant's common stock outstanding.


Table of Contents


SILICON GRAPHICS INTERNATIONAL CORP.
TABLE OF CONTENTS
 
 
 
Page
PART I
 2
Item 1.
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
PART II
 39
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 


Table of Contents


PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements

SILICON GRAPHICS INTERNATIONAL CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
 
 
 
 
 
 
 
 
Revenue
 
 
 
 
 
 
 
Product
$
131,290

 
$
88,205

 
$
364,297

 
$
265,281

Service
47,910

 
34,143

 
147,354

 
100,821

Combined product and service
20,190

 
21,316

 
61,848

 
67,980

Total revenue
199,390

 
143,664

 
573,499

 
434,082

Cost of revenue
 
 
 
 
 
 
 
Product
109,396

 
68,482

 
296,029

 
203,653

Service
25,620

 
19,883

 
80,990

 
57,454

Combined product and service
12,864

 
14,797

 
40,149

 
49,147

Total cost of revenue
147,880

 
103,162

 
417,168

 
310,254

Gross profit
51,510

 
40,502

 
156,331

 
123,828

Operating expenses:
 

 
 
 
 
 
 
Research and development
14,982

 
13,305

 
47,427

 
40,473

Sales and marketing
21,824

 
16,607

 
66,722

 
49,566

General and administrative
16,176

 
12,428

 
47,860

 
36,952

Restructuring
19

 
915

 
129

 
1,716

Acquisition-related
—

 
1,094

 
—

 
1,094

Total operating expenses
53,001

 
44,349

 
162,138

 
129,801

Loss from operations
(1,491
)
 
(3,847
)
 
(5,807
)
 
(5,973
)
Total other income (expense), net:
 

 
 
 
 
 
 
Interest income (expense), net
(126
)
 
10

 
(150
)
 
236

Other income (expense), net
913

 
2,880

 
(230
)
 
(1,300
)
Total other income (expense), net
787

 
2,890

 
(380
)
 
(1,064
)
Loss before income taxes
(704
)
 
(957
)
 
(6,187
)
 
(7,037
)
Income tax provision (benefit)
458

 
715

 
(112
)
 
2,098

Net loss
$
(1,162
)
 
$
(1,672
)
 
$
(6,075
)
 
$
(9,135
)
 
 
 
 
 
 
 
 
Basic and diluted net loss per share
$
(0.04
)
 
$
(0.05
)
 
$
(0.19
)
 
$
(0.30
)
 
 
 
 
 
 
 
 
Shares used in computing basic and diluted net loss per share
31,783

 
30,577

 
31,557

 
30,468

 
 
 
 
 
 
 
 
See accompanying notes.

2
Table of Contents


SILICON GRAPHICS INTERNATIONAL CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)
 
March 30,
2012
 
June 24,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
88,872

 
$
139,868

Current portion of restricted cash and cash equivalents
1,247

 
948

Accounts receivable, net of allowance for doubtful accounts of $1,892 and $1,335 as of March 30, 2012 and June 24, 2011, respectively
138,179

 
108,675

Inventories
107,517

 
80,965

Deferred cost of revenue
51,651

 
59,306

Prepaid expenses and other current assets
21,236

 
17,937

Total current assets
408,702

 
407,699

Non-current portion of restricted cash and cash equivalents
3,032

 
2,390

Property and equipment, net
28,713

 
29,573

Intangible assets, net
9,675

 
13,289

Non-current portion of deferred cost of revenue
24,190

 
45,219

Other assets
41,205

 
39,839

Total assets
$
515,517

 
$
538,009

LIABILITIES AND STOCKHOLDERS' EQUITY
 

 
 
Current liabilities:
 

 
 
Credit facility
$
15,199

 
$
—

Accounts payable
65,407

 
71,299

Accrued compensation
24,995

 
29,477

Current portion of deferred revenue
123,822

 
132,986

Other current liabilities
41,436

 
39,967

Total current liabilities
270,859

 
273,729

Non-current portion of deferred revenue
73,811

 
93,146

Long-term income taxes payable
22,567

 
24,104

Retirement benefit obligations
9,965

 
15,569

Other non-current liabilities
10,239

 
8,175

Total liabilities
387,441

 
414,723

Commitments and contingencies (Note 24)


 

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; 32,684 shares and 31,850 shares issued at March 30, 2012 and June 24, 2011, respectively
31

 
31

Additional paid-in capital
482,334

 
470,343

Treasury stock, at cost (749 shares at March 30, 2012 and June 24, 2011)
(4,912
)
 
(4,912
)
Accumulated other comprehensive income (loss)
(553
)
 
573

Accumulated deficit
(348,824
)
 
(342,749
)
Total stockholders' equity
128,076

 
123,286

Total liabilities and stockholders' equity
$
515,517

 
$
538,009

 
 
 
 

See accompanying notes.

3
Table of Contents


SILICON GRAPHICS INTERNATIONAL CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine Months Ended
 
March 30,
2012
 
March 25,
2011
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(6,075
)
 
$
(9,135
)
Adjustments to reconcile net loss to net cash used in operating activities:
 

 
 
Depreciation and amortization
11,220

 
12,254

Share-based compensation
7,925

 
3,948

Impairment of investment in SGI Japan, Ltd.
—

 
2,904

Impairment on investments
—

 
858

Other
664

 
(219
)
Changes in operating assets and liabilities:
 

 
 
Accounts receivable
(29,856
)
 
1,011

Inventories
(26,575
)
 
15,456

Deferred cost of revenue
28,389

 
(7,689
)
Prepaid expenses and other assets
(3,585
)
 
1,745

Accounts payable
(6,705
)
 
(19,846
)
Accrued compensation
(4,436
)
 
(2,838
)
Income taxes payable
(1,821
)
 
2,594

Deferred revenue
(28,577
)
 
(3,352
)
Other liabilities
(1,978
)
 
(7,371
)
Net cash used in operating activities
(61,410
)
 
(9,680
)
CASH FLOWS FROM INVESTING ACTIVITIES AND ACQUISITIONS:
 

 
 
Purchases of property and equipment
(5,609
)
 
(5,383
)
Proceeds from sales of long-term investments
—

 
7,692

Proceeds from maturities of long-term investments
—

 
225

Cash acquired, net of cash used in acquisition
—

 
6,046

Other
(2,450
)
 
(1,149
)
Net cash provided by (used in) investing activities and acquisitions
(8,059
)
 
7,431

CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 
Proceeds from draw-down on credit facility
15,000

 
—

Repurchase of restricted stock
(1,037
)
 
(894
)
Purchase of treasury stock
—

 
(3,890
)
Proceeds from issuance of common stock upon exercise of stock options
1,841

 
3,725

Proceeds from issuance of common stock under employee stock purchase plan
3,262

 
2,123

Net cash provided by financing activities
19,066

 
1,064

Effect of exchange rate changes on cash and cash equivalents
(593
)
 
569

Net decrease in cash and cash equivalents
(50,996
)
 
(616
)
Cash and cash equivalents-beginning of period
139,868

 
129,343

Cash and cash equivalents-end of period
$
88,872

 
$
128,727

 
 
 
 
SUPPLEMENTAL DISCLOSURE OF OTHER CASH FLOW INFORMATION:
 

 
 
Income taxes paid
$
1,012

 
$
4


See accompanying notes.

4
Table of Contents


SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. DESCRIPTION OF BUSINESS
The principal business of Silicon Graphics International Corp. ("SGI" or 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 significant global presence providing products and services either directly or through its distributors and channel partners. 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 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. The Company's headquarters is located in Fremont, California and its primary manufacturing facility is located in Chippewa Falls, Wisconsin.

2. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Basis of Presentation. The accompanying unaudited condensed 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. These unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) applicable to interim financial information. The results for the interim periods are not necessarily indicative of results for the entire year or any future periods. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements for the fiscal year ended June 24, 2011, which are included in the Company's Annual Report on Form 10-K filed with the SEC on August 29, 2011.
The preparation of unaudited condensed consolidated financial statements in accordance with generally accepted accounting principles in the United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses as presented in the accompanying unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.
Fiscal Year. The Company has a 52 or 53-week fiscal year ending on the last Friday in June. The current fiscal year 2012 will be comprised of 53 weeks and will end on June 29, 2012. Fiscal year 2011 was comprised of 52 weeks and ended on June 24, 2011. The Company's fiscal quarters generally have 13 weeks ending on the last Friday of the respective period. When a 53-week year occurs, the Company includes the additional week in the first fiscal quarter. Accordingly, the first quarter of fiscal year 2012 ended September 30, 2011 was comprised of 14 weeks.
In fiscal year 2011, the Company's fiscal quarters ended on September 24, 2010 (first quarter), December 24, 2010 (second quarter), March 25, 2011 (third quarter) and June 24, 2011 (fourth quarter).
In fiscal year 2012, the Company's fiscal quarters end on September 30, 2011 (first quarter), December 30, 2011 (second quarter), March 30, 2012 (third quarter) and June 29, 2012 (fourth quarter).
Principles of Consolidation. The unaudited condensed consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
There have been no changes in the Company's significant accounting policies for the nine months ended March 30, 2012 as compared to those disclosed in the Company's Annual Report on Form 10-K for the year ended June 24, 2011.
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,

5
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

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 in fiscal year 2013. The Company does not believe that the adoption of this guidance will have a material impact on the Company's consolidated financial statements.

4. 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 escrow funds were released in full in March 2012. The acquisition was 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 was 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.
The following were 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)

6
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

(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 earnings of SGI Japan from the Closing Date to March 25, 2011 included in the Company's unaudited condensed consolidated statement of operations was $5.4 million and net loss of $0.5 million for the three and nine months ended March 25, 2011 (see Note 22).
The Company incurred acquisition-related costs (i.e., advisory, legal, accounting, valuation, and other costs) of $1.1 million during the three months ended March 25, 2011. The acquisition-related costs were expensed in the periods in which the costs were incurred and are recorded in the unaudited condensed 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 2011 (in thousands except per share amounts):
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 25,
2011
 
March 25,
2011
Revenue
 
$
159,297

 
$
475,677

 
 
 
 
 
Net loss
 
$
(3,760
)
 
$
(14,697
)
 
 
 
 
 
Basic and diluted net loss per share
 
$
(0.12
)
 
$
(0.48
)
 
 
 
 
 
Shares used in computing basic and diluted net loss per share
 
30,577

 
30,468

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 $1.1 million during the three months ended March 25, 2011 were not presented in the pro forma condensed financial information because this would not have a continuing impact on the combined results.

5. FINANCIAL INSTRUMENTS AND FAIR VALUE
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).
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table presents the Company's assets and liabilities that are measured at fair value on a recurring basis (in thousands):
 
 
March 30, 2012
 
 
Carrying
 
Fair Value Measured Using
Total
 
 
Value
 
Level 1
Level 2
Level 3
Balance
Cash equivalents
 
 
 
 
 
 
 
U.S. treasuries
 
$
5,529

 
$
5,529

—

—

$
5,529

 
 
 
 
 
 
 
 

7
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

 
 
June 24, 2011
 
 
Carrying
 
Fair Value Measured Using
Total
 
 
Value
 
Level 1
Level 2
Level 3
Balance
Cash equivalents
 
 
 
 
 
 
 
Money market funds
 
$
1,495

 
$
1,495

$
—

$
—

$
1,495

U.S. treasuries
 
15,534

 
15,534

—

—

15,534

Total cash equivalents
 
$
17,029

 
$
17,029

$
—

$
—

$
17,029

 
 
 
 
 
 
 
 
There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the three and nine months ended March 30, 2012. The Company’s cash equivalents, consisting of U.S. treasuries as of March 30, 2012, 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.
As of March 25, 2011, the Company had sold all of its investments in auction rate securities ("ARS"). The Company's ARS were classified within Level 3 of the fair value hierarchy. During the three months ended March 25, 2011, the Company sold its remaining ARS and received approximately $6.5 million in cash proceeds. The fair value of the ARS was approximately $6.2 million at the time of the sale. As a result, the Company recognized a gain of approximately $0.3 million in its unaudited condensed consolidated statements of operations. For the nine month period ended March 25, 2011, the Company recognized a net loss of $0.8 million with respect to its entire ARS portfolio in its unaudited condensed consolidated statements of operations. As of March 30, 2012 and June 24, 2011, the Company had no investments in ARS as all of these securities have been sold during the year ended June 24, 2011.
The fair values of accounts receivable, accounts payable, accrued liabilities, and credit facility due within one year approximates their carrying values because of their short-term nature.
Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
As of March 30, 2012 and June 24, 2011, the Company had no assets or liabilities measured at fair value on a nonrecurring basis.

6. INVENTORIES
Inventories consist of the following (in thousands):
 
March 30,
2012
 
June 24,
2011
Finished goods
$
26,159

 
$
15,788

Work in process
28,196

 
16,891

Raw materials
53,162

 
48,286

Total inventories
$
107,517

 
$
80,965


7. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of the following (in thousands):
 
March 30,
2012
 
June 24,
2011
Value-added tax receivable
$
9,934

 
$
7,433

Deferred tax assets
1,683

 
1,815

Prepaid taxes
832

 
1,542

Other prepaid and current assets
8,787

 
7,147

Total prepaid expenses and other current assets
$
21,236

 
$
17,937


8
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)


8. PROPERTY AND EQUIPMENT, NET
Property and equipment, net consist of the following (in thousands):
 
 
March 30,
2012
 
June 24,
2011
Land
 
$
799

 
$
799

Building
 
12,797

 
11,562

Computer equipment and software
 
27,462

 
25,076

Manufacturing equipment
 
6,814

 
6,280

Leasehold improvements
 
8,230

 
8,214

Furniture and fixtures
 
3,261

 
3,307

Vehicles
 
33

 
30

Construction in progress
 
1,912

 
518

 
 
61,308

 
55,786

Less accumulated depreciation and amortization
 
(32,595
)
 
(26,213
)
Total property and equipment, net
 
$
28,713

 
$
29,573

Depreciation and amortization expense for property and equipment, net was $2.3 million for the three months ended March 30, 2012 and March 25, 2011. Depreciation and amortization expense for property and equipment, net was $7.1 million and $7.3 million for the nine months ended March 30, 2012 and March 25, 2011, respectively.

9. INTANGIBLE ASSETS, NET
Intangible assets by major asset class consist of the following (in thousands):
Intangible Asset Class
 
At March 30, 2012
Gross
Carrying
Amount 
 
Accumulated
Amortization 
 
Net
Customer relationships
 
$
7,245

 
$
(4,052
)
 
$
3,193

Purchased technology
 
7,800

 
(4,636
)
 
3,164

Customer backlog
 
10,320

 
(8,634
)
 
1,686

Trademark/trade name portfolio
 
3,738

 
(2,185
)
 
1,553

Patents & other
 
314

 
(235
)
 
79

Total
 
$
29,417

 
$
(19,742
)
 
$
9,675

Intangible Asset Class
 
At June 24, 2011
 
Gross
Carrying
Amount 
 
Accumulated
Amortization
 
Net
Customer relationships
 
$
6,900

 
$
(2,990
)
 
$
3,910

Purchased technology
 
7,800

 
(3,271
)
 
4,529

Customer backlog
 
10,497

 
(7,768
)
 
2,729

Trademark/trade name portfolio
 
3,667

 
(1,612
)
 
2,055

Patents & other
 
200

 
(134
)
 
66

Total
 
$
29,064

 
$
(15,775
)
 
$
13,289

Intangible assets amortization expense was $1.2 million and $1.4 million in the three months ended March 30, 2012 and March 25, 2011, respectively. Intangible assets amortization expense was $4.1 million and $5.0 million in the nine months ended March 30, 2012 and March 25, 2011, respectively.

9
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

As of March 30, 2012, expected amortization expense for all intangible assets was as follows (in thousands):
Fiscal Year 
 
Amortization
Expense
2012 (remaining three months)
 
$
1,073

2013
 
3,800

2014
 
3,342

2015
 
532

2016
 
442

2017 and thereafter
 
486

Total amortization
 
$
9,675


10. OTHER ASSETS
Other assets consist of the following (in thousands):
 
March 30,
2012
 
June 24,
2011
Long-term service inventory
$
16,023

 
$
15,520

Deferred tax assets
8,574

 
8,673

Restricted pension plan assets
7,921

 
8,211

Long-term refundable deposits
3,876

 
4,117

Other assets
4,811

 
3,318

Total other assets
$
41,205

 
$
39,839


11. OTHER CURRENT LIABILITIES
Other current liabilities consist of the following (in thousands):
 
March 30,
2012
 
June 24,
2011
Accrued sales and use tax payable
$
14,569

 
$
12,342

Deferred tax liabilities
6,602

 
6,602

Accrued warranty, current portion
4,161

 
4,805

Accrued professional services fees
4,064

 
3,959

Income taxes payable
1,031

 
1,315

Accrued restructuring
287

 
1,286

Other
10,722

 
9,658

Total other current liabilities
$
41,436

 
$
39,967


12. OTHER NON-CURRENT LIABILITIES
Other non-current liabilities consist of the following (in thousands):
 
March 30,
2012
 
June 24,
2011
Accrued warranty, non-current portion
$
3,403

 
$
2,773

Deferred tax liabilities
1,814

 
1,814

Other
5,022

 
3,588

Total other non-current liabilities
$
10,239

 
$
8,175


10
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)


13. WARRANTY RESERVE
Activity in the warranty reserve, which is included in other current and non-current liabilities, was as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
Balance at beginning of period
 
$
8,036

 
$
3,726

 
$
7,578

 
$
4,386

Accrual assumed in acquisition of SGI Japan
 
—

 
1,690

 
—

 
1,690

Current period accrual
 
1,308

 
958

 
4,627

 
2,239

Warranty expenditures charged to accrual
 
(1,341
)
 
(1,053
)
 
(3,751
)
 
(2,914
)
Changes in accrual for pre-existing warranties
 
(439
)
 
248

 
(890
)
 
168

Balance at end of period
 
$
7,564

 
$
5,569

 
$
7,564

 
$
5,569


14. RESTRUCTURING ACTIVITY
Fiscal 2012 Restructuring Action
On March 16, 2012, the Company's Board of Directors approved a restructuring action to reduce approximately 25% of the Company's European workforce and close certain legal entities and offices in Europe. The Company adopted the restructuring action to streamline operations and reduce operating expenses in Europe.
In connection with the restructuring action, the Company expects to incur pre-tax cash charges between $14.0 million and $17.0 million, which consist of pre-tax cash charges between $13.0 million and $16.0 million for employee termination benefits, and up to $1.0 million for the planned office and legal entity closures, which expenses include contract termination costs and other associated costs. The Company expects to recognize the majority of the expense associated with the employee termination benefits prior to the third quarter of fiscal 2013. There were no expenses incurred in connection with this restructuring during the three months ended March 30, 2012.
Fiscal 2011 Restructuring Action
On February 18, 2011, the Company's Board of Directors approved restructuring actions to reduce the Company's worldwide workforce to streamline operations and reduce operating expenses. The total amount expected to be incurred in connection with the restructuring activity was $4.4 million, all of which was incurred as of March 30, 2012. There were no expenses incurred related to the fiscal 2011 restructuring action during the three months ended March 30, 2012. The total fiscal 2011 restructuring expense for the nine months ended March 30, 2012 was $0.1 million. The total fiscal 2011 restructuring expense for the three and nine months ended March 25, 2011 was $0.9 million. The Company expects the remaining contractual obligations and employee severance of $0.3 million to be paid by the end of fiscal year 2013.
Activity in accrued restructuring for the fiscal 2011 restructuring action during the nine months ended March 30, 2012 was as follows (in thousands):

11
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

 
Employee
Terminations
Balance at June 25, 2010
$
—

Costs incurred
4,296

Cash payments
(3,166
)
Balance at June 24, 2011
1,130

Costs incurred
133

Cash payments
(388
)
Balance at September 30, 2011
875

Costs incurred
(4
)
Cash payments
(572
)
Balance at December 30, 2011
$
299

Costs incurred
—

Cash payments
(37
)
Balance at March 30, 2012
$
262

Fiscal 2010 Restructuring Action
On July 27, 2009, the Company's Board of Directors 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 was $6.0 million, all of which was incurred as of March 30, 2012. The Company expects the remaining employee termination costs to be paid by the end of fiscal year 2012. The total expense for the fiscal 2010 restructuring action was not significant during the three months ended March 25, 2011. The total expense for the fiscal 2010 restructuring action was $0.8 million associated with employee related terminations for the nine months ended March 25, 2011. The Company did not incur significant expenses related to the fiscal 2010 restructuring for the three and nine months ended March 30, 2012.
Activity in accrued restructuring for the fiscal 2010 restructuring action during the nine months ended March 30, 2012 was as follows (in thousands):
 
Employee
Terminations
 
Facilities
Exit Costs 
 
Total
Balance at June 26, 2009
$
—

 
$
—

 
$
—

Costs incurred
4,590

 
630

 
5,220

Cash payments
(3,322
)
 
(293
)
 
(3,615
)
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

Costs incurred
—

 
—

 
—

Cash payments
(41
)
 
(68
)
 
(109
)
Balance at September 30, 2011
211

 
78

 
289

Costs incurred
(19
)
 
—

 
(19
)
Cash payments
(39
)
 
(53
)
 
(92
)
Balance at December 30, 2011
$
153

 
$
25

 
$
178

Costs incurred
—

 
(19
)
 
(19
)
Cash payments
(128
)
 
(6
)
 
(134
)
Balance at March 30, 2012
$
25

 
$
—

 
$
25


12
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

All Restructuring Actions
The aggregate restructuring liability for all of these restructuring actions was $0.3 million as of March 30, 2012, all of which is included in other current liabilities in the accompanying unaudited condensed consolidated balance sheet.

15. CREDIT FACILITY
On December 5, 2011, the Company entered into a five-year senior secured credit facility in the aggregate principal amount of $35.0 million. The availability under the credit facility is limited to a borrowing base, subject to meeting certain conditions set forth in the credit facility. The credit facility includes a feature that allows the Company to increase the revolver amount in the first 18 months of the credit facility up to $15.0 million to an aggregate principal amount of $50.0 million, subject to meeting certain conditions set forth in the credit facility. The credit facility includes a $10.0 million letter of credit subfacility. See Note 24 "Commitments and Contingencies" for more information regarding the letter of credit.
The availability of the aggregate principal amount under the credit facility will fluctuate, generally monthly, based on eligible domestic accounts receivable and inventory due to a variety of factors including the Company's overall mix of sales and resulting accounts receivable with international and domestic customers, United States governmental agencies and a few individual customer accounts which may result in high concentrations of accounts receivable as compared to the overall level of the Company's accounts receivable. The credit facility contains financial covenants including, under certain conditions, maintaining a minimum fixed charge coverage ratio, as well as other non-financial covenants, including restrictions on declaring and paying dividends, and is secured by substantially all of the Company's assets. The credit facility terminates on December 5, 2016. Borrowings under the credit facility bear interest based on a rate of the Company's choice equal to either: 1) the LIBOR plus a margin of 2.50 percent per annum or 2) the base rate plus a margin of 1.75 percent per annum. The base rate is the greater of (a) the Federal Funds rate plus 0.50 percent, (b) the LIBOR rate plus 1.00 percent or (c) the prime rate of the financial institution. The LIBOR rate and the base rate are determined at the specified date preceding or at the time of the borrowing in accordance with the terms of the credit facility. In addition, unused line fees are payable on the credit facility at rates of 0.40 percent per annum.
As of March 30, 2012, the Company had $15.2 million outstanding borrowings under this credit facility, including $0.2 million of accrued interest. The amount borrowed bears interest at 2.7% based on LIBOR as of March 30, 2012. As of March 30, 2012, the remaining amount available to be borrowed under the credit facility was approximately $17.8 million and the Company was in compliance with all covenants.

16. SHARE-BASED COMPENSATION
During the three and nine month periods ended March 30, 2012 and March 25, 2011, the Company granted stock options and restricted stock units to employees and non-employee directors under its 2005 Equity Incentive Plan and issued shares of the Company's common stock to participating employees under its 2005 Employee Stock Purchase Plan. Total share-based compensation expense was as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
Cost of revenue
 
$
368

 
$
188

 
$
1,035

 
$
499

Research and development
 
526

 
82

 
1,548

 
361

Sales and marketing
 
458

 
262

 
1,258

 
707

General and administrative
 
2,264

 
963

 
4,084

 
2,381

Total share-based compensation expense
 
$
3,616

 
$
1,495

 
$
7,925

 
$
3,948

Total share-based compensation expense for the three-month period ended March 30, 2012 includes $1.3 million of share-based expense recognized by the Company due to the modification of certain terms of the vested options held by the Company's former Chief Executive Officer. No additional share-based compensation expense is expected related to the modification of such stock options.

13
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

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:
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
Option Plans Shares
 
 
 
 
 
 
 
 
Risk-free interest rate
 
0.8
%
 
1.6
%
 
1.0
%
 
1.5
%
Volatility
 
63.8
%
 
60.3
%
 
70.0
%
 
57.9
%
Weighted average expected life (in years)
 
4.76

 
4.06

 
4.73

 
4.31

Expected dividend yield
 
—

 
—

 
—

 
—

Weighted average fair value
 
$
5.36

 
$
4.37

 
$
7.17

 
$
3.92

 
 
 
 
 
 
 
 
 
ESPP Plan shares
 
 
 
 
 
 
 
 
Risk-free interest rate
 
0.2
%
 
0.4
%
 
0.2
%
 
0.3
%
Volatility
 
76.1
%
 
60.6
%
 
78.4
%
 
55.5
%
Weighted average expected life (in years)
 
1.25

 
1.25

 
1.25

 
1.25

Expected dividend yield
 
—

 
—

 
—

 
—

Weighted average fair value
 
$
4.37

 
$
4.81

 
$
5.38

 
$
4.11

Stock Option Activity
A summary of stock option activity for the nine months ended March 30, 2012 follows:
 
Options Outstanding
 
Shares
 
Weighted
Average
Exercise
Price 
 
Weighted
Average
Remaining
Contractual term
in years 
 
Aggregate
Intrinsic
Value
 
 
 
 
 
 
 
(in thousands)
Balance at June 24, 2011
3,121,082

 
$
10.40

 
 
 
 
Options granted
1,070,500

 
12.72

 
 
 
 
Options exercised
(186,055
)
 
9.90

 
 
 
 
Options cancelled
(321,102
)
 
11.17

 
 
 
 
Balance at March 30, 2012
3,684,425

 
$
11.03

 
6.18

 
$
4,341

Vested and expected to vest at March 30, 2012
3,414,337

 
$
11.04

 
5.94

 
$
4,090

Exercisable at March 30, 2012
2,201,527

 
$
11.30

 
4.33

 
$
2,643

The total intrinsic value of options exercised in the nine months ended March 30, 2012 and March 25, 2011 was $1.0 million and $2.9 million, respectively. The total fair value of shares vested during the nine months ended March 30, 2012 and March 25, 2011 was $2.2 million and $3.4 million, respectively.
As of March 30, 2012, there was $4.8 million of total unrecognized compensation cost related to non-vested stock options, which is expected to be recognized over a weighted average period of 1.4 years.
Restricted Stock Unit Activity
The following table summarizes the Company's activity with respect to restricted stock units (“RSUs”) for the nine months ended March 30, 2012:

14
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

 
Number of
Shares 
Balance at June 24, 2011
544,618

Awarded
725,650

Released
(219,182
)
Forfeited
(103,637
)
Balance at March 30, 2012
947,449

Vested and expected to vest at March 30, 2012
718,692

As of March 30, 2012, there was $6.5 million of total unrecognized compensation cost related to RSUs, which is expected to be recognized over a weighted average period of 3.3 years.
RSUs are converted into common stock upon vesting. Upon the vesting of RSUs, the Company generally withholds a portion of the shares to cover applicable taxes and decreases the shares issued to the employee by a corresponding value. The withholding tax obligations are based upon the fair market value of the Company’s common stock on the vesting date. The number and the value of the shares withheld for tax purposes are summarized in the table below (in thousands except share amounts):
 
Three Months Ended
 
Nine Months Ended
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
RSUs shares withheld for taxes
22,673

 
31,712

 
79,730

 
84,809

RSUs amounts withheld for taxes
$
222

 
$
519

 
$
1,040

 
$
908

Employee Stock Purchase Plan
At March 30, 2012, the total unrecognized compensation cost related to rights to purchase the Company's common stock under the employee stock purchase plan ("ESPP") was approximately $2.1 million. This cost will be amortized on a straight-line basis over approximately 1.9 years. The following table shows the shares issued and their respective weighted-average purchase price per share, pursuant to the ESPP, during the three and nine months ended March 30, 2012 and March 25, 2011.
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
Shares issued
 
248,785

 
221,823

 
508,132

 
473,698

Weighted-average purchase price per share
 
$
6.87

 
$
4.42

 
$
6.42

 
$
4.51


17. STOCKHOLDERS' EQUITY
Stock Repurchase Program
In February 2009, the Company's Board of Directors approved a stock repurchase program of up to $40.0 million of the Company's common stock. Under the program, the Company is authorized to purchase shares of common stock through open market transactions until such authority is revoked by the Board of Directors. As of March 30, 2012, the Company held in treasury 748,795 shares for a total of $4.9 million. No shares of outstanding common stock were repurchased during the three and nine months ended March 30, 2012. As of March 30, 2012, $35.1 million remained available for future repurchases under the stock repurchase program.
During the three months ended March 25, 2011, the Company did not repurchase any shares of outstanding common stock. During the nine months ended March 25, 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 unaudited condensed consolidated balance sheets.
Accumulated Other Comprehensive Income (Loss)
The following table summarizes the components of accumulated other comprehensive income as of March 30, 2012 and

15
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

June 24, 2011 (in thousands):
 
March 30,
2012
 
June 24,
2011
Cumulative translation adjustment
$
(228
)
 
$
741

Losses on pension assets
(325
)
 
(168
)
Accumulated other comprehensive income (loss)
$
(553
)
 
$
573

Comprehensive Loss
Comprehensive loss for the three and nine months ended March 30, 2012 and March 25, 2011 were as follows (the related tax effects of these components of comprehensive loss were not material):
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
Net loss
 
$
(1,162
)
 
$
(1,672
)
 
$
(6,075
)
 
$
(9,135
)
Change in cumulative translation adjustment
 
(1,591
)
 
492

 
(969
)
 
492

Change in unrealized loss on pension assets
 
(1
)
 
—

 
(157
)
 
—

Change in unrealized loss on investments
 
—

 
—

 
—

 
1,355

Comprehensive loss
 
$
(2,754
)
 
$
(1,180
)
 
$
(7,201
)
 
$
(7,288
)

18. EARNINGS PER SHARE
Basic and diluted net loss per common share is computed by dividing unaudited consolidated net loss by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing unaudited consolidated net income by the weighted average number of common shares outstanding and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares are determined by applying the treasury stock method to the assumed exercise of outstanding stock options, the assumed vesting of outstanding RSUs, and the assumed issuance of common stock under the ESPP. Potentially dilutive common shares are excluded when the effect would be to reduce a net loss per share. As the Company had a net loss in the three and nine months ended March 30, 2012 and March 25, 2011, basic and diluted net loss per share are the same for these periods.
The following table sets forth the computation of basic and diluted net loss per share for the three and nine months ended March 30, 2012 and March 25, 2011 (in thousands, except per share amount):
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
Numerator:
 
 
 
 
 
 
 
 
Net loss
 
$
(1,162
)
 
$
(1,672
)
 
$
(6,075
)
 
$
(9,135
)
 
 
 
 
 
 
 
 
 
Denominator:
 
 

 
 

 
 
 
 
Weighted-average common shares used in computing basic and diluted net loss per share
 
31,783

 
30,577

 
31,557

 
30,468

 
 
 
 
 
 
 
 
 
Basic and diluted net loss per share
 
$
(0.04
)
 
$
(0.05
)
 
$
(0.19
)
 
$
(0.30
)
The following potential common shares have been excluded from the basic net loss per share calculations, as their effect would have been anti-dilutive (in thousands):

16
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

 
 
At period end
 
 
 
March 30,
2012
 
March 25,
2011
 
Options, RSUs, and ESPP
 
4,761

 
3,791

 

19. RETIREMENT BENEFIT PLAN
Defined Benefit Plans
The Company sponsors defined benefit plans covering certain of its employees in Germany ("German plan") and Japan ("Japan plan").
German Plan
The net periodic benefit cost of the German plan was comprised of the following components (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
Net periodic benefit cost
 
 
 
 
 
 
 
 
Interest expense
 
$
129

 
$
131

 
$
405

 
$
387

Service cost
 
29

 
29

 
90

 
87

Expected return on plan assets
 
(20
)
 
(21
)
 
(63
)
 
(64
)
Net periodic benefit cost
 
$
138

 
$
139

 
$
432

 
$
410

Japan Plan
In October 2011, SGI Japan, Ltd ("SGI Japan"), its employees, and the Japanese Ministry of Health, Labor and Welfare approved an action to change SGI Japan's retirement benefit plan effective October 1, 2011 in accordance with the Defined Benefit Corporate Pension Law and Defined Contribution Corporate Pension Law of 2001 (the "Acts"). SGI Japan shifted a portion of its defined benefit plan to a defined contribution plan and modified the terms of its defined benefit plan in accordance with the Acts. The change in the retirement benefit plan reduced SGI Japan's retirement benefit obligation and resulted in a gain from curtailment of $1.3 million and a loss from settlement of $1.0 million. In addition, SGI Japan will increase its employer contribution to the defined benefit plan and defined contribution plan to fund the underfunded portion of the retirement benefit obligation as required under the Acts.
The net periodic benefit cost of the Japan plan was comprised of the following components (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
March 30,
2012
 
March 30,
2012
Net periodic benefit cost
 
 
 
 
Service cost
 
$
149

 
$
604

Interest expense
 
26

 
103

Expected return on plan assets
 
(24
)
 
(74
)
Loss on settlement
 
—

 
992

Gain from curtailment
 
—

 
(1,265
)
Net periodic benefit cost
 
$
151

 
$
360


20. INCOME TAXES
The Company recorded a tax expense of $0.5 million and a tax benefit of $0.1 million for the three and nine months ended March 30, 2012, respectively. The net tax benefit was primarily comprised of tax liability computed based on the Company’s foreign projected financial results for the year ending June 29, 2012 offset by the reversals of unrecognized tax

17
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

benefits including related interest. The effective tax rate differed from the combined federal and net state statutory income tax rate for the three and nine months ended March 30, 2012 primarily due to tax expense incurred by the Company's foreign subsidiaries with operating income, offset by the release of the unrecognized tax benefits due to lapse of statute of limitations, benefits from reversals of previously accrued taxes in foreign jurisdictions and benefit from utilization of net operating losses not previously recognized.
The Company recorded a tax expense of $0.7 million and $2.1 million for the three and nine months ended March 25, 2011, respectively. The tax expense was computed based on the Company's projected financial results for the year ending June 24, 2011 and amounts related to unrecognized tax benefits and 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 three months and nine months ended March 25, 2011 primarily due to domestic operating losses generated from which the Company does not benefit, tax expense incurred by the Company's foreign subsidiaries with operating income, and the Company's unrecognized tax benefits and related interest recorded during the period.
As of March 30, 2012, the Company has provided a partial valuation allowance against its net deferred tax assets. Management continues to evaluate the realizability of deferred tax assets and related valuation allowance. If management's assessment of the deferred tax assets or the corresponding valuation allowance were to change, the Company would record the related adjustment to income during the period in which management makes the determination.
The Company had approximately $20.3 million of gross unrecognized tax benefit as of March 30, 2012, of which $8.0 million will impact the effective tax rate when recognized. The Company recognizes interest expense and penalties related to the unrecognized tax benefits within income tax expense. As of March 30, 2012, the Company also had approximately $14.6 million of interest, penalties and foreign currency differences attributable to the gross unrecognized tax benefits.
The Company is going through an audit in Canada and expects that the audit will be concluded in the next twelve months.  It is reasonably possible that over the next twelve-month period the Company may experience an increase or decrease in its unrecognized tax benefits.  However, it is not possible to estimate either the magnitude or the range of any increase or decrease at this time.

21. SEGMENT INFORMATION
Commencing in the quarter ended September 30, 2011, the Company started managing its business primarily on a geographical basis. Accordingly, the Company determined its operating and reporting segments, which are generally based on the location of its sales and service employees generating revenue, to be the Americas, Europe, and Asia-Pacific operations. The Americas segment includes both North and South America. The Europe segment ("EMEA") includes European countries, as well as the Middle East and Africa. The Asia-Pacific segment ("APJ") includes Australia, Japan, and all other Asian countries. The segment information for the three and nine months ended March 25, 2011 has been retrospectively presented to reflect the new reporting segments.
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 Executive Officer, the Chief Operating Decision Maker (“CODM”), to evaluate segment performance; and the availability of separate financial information. The accounting policies of the various segments are the same as those described in Note 3. Summary of Significant Accounting Policies of this Form 10-Q and in Note 2 of the Consolidated Financial Statements in the Company's fiscal year 2011 Annual Report on Form 10-K.
The Company's CODM evaluates the performance of its operating segments based on revenue and operating profit (loss). Revenues are generally based on the location of its sales and service employees generating revenues. Operating profit (loss) for each segment includes related cost of sales and operating expenses directly attributable to the segment. A significant portion of the segments’ expenses arise from shared services and infrastructure that the Company has historically provided to the segments in order to realize economies of scale and to efficiently use resources. These expenses, collectively called corporate charges, include costs of centralized research and development, legal, accounting, information technology services, treasury and other corporate infrastructure expenses. These corporate charges are allocated to the segments and are reassessed on an annual basis. The allocations have been determined on a basis that the Company considers to be a reasonable reflection of the utilization of services provided to or benefits received by the segments. The Company does not include intercompany transfers between segments for management reporting purposes.

18
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

Segment Results
Summary information by operating segment for the three and nine months ended March 30, 2012 and March 25, 2011 is as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
March 30,
2012
 
March 25,
2011
 
March 30,
2012
 
March 25,
2011
 
Total revenue
 
 
 
 
 
 
 
 
 
Americas
 
$
128,321

 
$
99,355

 
$
350,434

 
$
297,071

 
APJ
 
44,660

 
17,120

 
141,639

 
47,448

 
EMEA
 
26,409

 
27,189

 
81,426

 
89,563

 
Total revenue
 
$
199,390

 
$
143,664

 
$
573,499

 
$
434,082

 
 
 
 
 
 
 
 
 
 
 
Product revenue
 
 
 
 
 
 
 
 
 
Americas
 
$
107,580

 
$
74,516

 
$
285,065

 
$
220,007

 
APJ
 
25,253

 
11,434

 
81,144

 
36,335

 
EMEA
 
17,406

 
18,954

 
56,025

 
65,515

 
Total product revenue
 
$
150,239

 
$
104,904

 
$
422,234

 
$
321,857

 
 
 
 
 
 
 
 
 
 
 
Service revenue
 
 
 
 
 
 
 
 
 
Americas
 
$
20,741

 
$
24,839

 
$
65,369

 
$
77,064

 
APJ
 
19,407

 
5,686

 
60,495

 
11,113

 
EMEA
 
9,003

 
8,235

 
25,401

 
24,048

 
Total service revenue
 
$
49,151

 
$
38,760

 
$
151,265

 
$
112,225

 
 
 
 
 
 
 
 
 
 
 
Operating loss
 
 
 
 
 
 
 
 
 
Americas
 
$
(2,083
)
 
$
402

 
$
(348
)
 
$
8,039

 
APJ
 
1,749

 
(2,024
)
 
3,710

 
(1,547
)
 
EMEA
 
(1,157
)
 
(2,225
)
 
(9,169
)
 
(12,465
)
 
Total operating loss
 
$
(1,491
)
 
$
(3,847
)
 
$
(5,807
)
 
$
(5,973
)
 
The Company derives the results of the business segments directly from its internal management reporting system. The presentation of our revenue for segment information purpose differs from the accompanying unaudited condensed consolidated statement of operations. The segment information is presented on the basis which the Company's CODM evaluates the performance of its operating segments. The combined product and service revenue is allocated to product and service revenue on a contractual basis for segment information purposes.
The Company's assets are located primarily in the United States and are not allocated to any specific region. The Company does not measure the performance of its geographic regions on any asset-based metrics. Therefore, geographic information is presented only for revenue and operating profit (loss).
Customer information
For the three months ended March 30, 2012, two customers from the Americas segment each accounted for approximately 13% of the Company's revenue. For the nine months ended March 30, 2012, only one customer located in the Americas segment accounted for approximately 14% of the Company's revenue. For the three months ended March 25, 2011, a customer from the Americas segment and various agencies of the United States Government (collectively, U.S. Government) accounted for approximately 12% and 10% of the Company's revenue, respectively. For the nine months ended March 25, 2011, only one customer located in the Americas segment accounted for approximately 12% of the Company's revenue. No other customers accounted for 10% or more of the Company's revenue for the three and nine months ended March 30, 2012 and March 25, 2011.

19
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

At March 30, 2012, a customer from the Americas segment accounted for approximately 21% of the Company's accounts receivable. At June 24, 2011, two customers from the Americas segment accounted for approximately 13% and 12% of the Company's accounts receivable while the U.S. Government accounted for 11% of the Company's accounts receivable. No other single customer accounted for 10% or more of the Company's trade accounts receivable at March 30, 2012 and June 24, 2011.
Geographic Information
International sales to Japan, the only single foreign country which accounted for 10% or more of revenues, were $35.7 million or 18% and $111.0 million or 19% of revenues for the three and nine months ended March 30, 2012, respectively. No other individual foreign country’s revenue accounted for 10% or more of revenues in the three and nine months ended March 30, 2012 and March 25, 2011.

22. RELATED PARTY TRANSACTIONS
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 and accounted for the investment in SGI Japan under the cost method investment. As a result, effective March 10, 2011, SGI Japan became a wholly-owned subsidiary of the Company and consolidated in the operating results of the Company.
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
December 25, 2010 to
March 9, 2011
 
Period From
June 26, 2010
to
March 9, 2011
Product revenue
 
$
3,029

 
$
15,718

Cost of product revenue
 
$
1,922

 
$
10,027


23. FINANCIAL GUARANTEES
The Company has issued financial guarantees to cover rent on leased facilities and equipment to government authorities for value-added tax 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 March 30, 2012 was $4.5 million for which the Company has $4.3 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 accompanying unaudited condensed consolidated balance sheets.

24. 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 terminate the lease early by providing an advance notice and paying an early termination fee. The Company does not intend to terminate the leases early 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 non-cancelable operating leases are as follows (in thousands):

20
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

Fiscal Year
 
2012 (remaining three months)
$
2,783

2013
7,889

2014
3,855

2015
1,489

2016
953

2017 and thereafter
168

Total
$
17,137

Rent expense for the three months ended March 30, 2012 and March 25, 2011 was $2.1 million and $1.6 million, respectively. Rent expense for the nine months ended March 30, 2012 and March 25, 2011 was $6.2 million and $4.3 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 fiscal year 2014. These purchase obligations are generally enforceable and legally binding on the Company and 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 March 30, 2012, the outstanding non-cancelable purchase commitments totaled $20.4 million, of which $17.2 million are due in the next twelve months.
Letter of Credit
The Company's credit facility includes a $10.0 million letter of credit subfacility. As of March 30, 2012, the Company has $2.0 million of outstanding letter of credit to back the Company's obligation to pay or perform when required to do so pursuant to the requirements of an underlying agreement or the provision of goods or services to a supplier. See Note 15 "Credit facility" for more information regarding the credit facility.
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 March 30, 2012. 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 March 30, 2012.
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, Silicon Graphics, Inc., the predecessor company that the Company acquired in May 2009 (“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

21
Table of Contents
SILICON GRAPHICS INTERNATIONAL CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(UNAUDITED)

sum of Indian Rupee (“INR”) 78,478,200 ($1.5 million based on the conversion rate on March 30, 2012) 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 ($0.5 million based on the conversion rate on March 30, 2012) plus interest and costs. The proceeding has commenced, witness testimony is now complete and the parties have been instructed to submit final arguments by the next scheduled hearing date (to be determined by the arbitrator).  The Company cannot currently predict the outcome of this dispute nor determine the amount or a reasonable range of potential loss, if any.
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.

25. SUBSEQUENT EVENTS
Credit Facility
On May 1, 2012, the revolver amount of the Company's credit facility was increased by $5.0 million to an aggregate principal amount of $40.0 million. As of May 9, 2012, the remaining amount available to be borrowed under the credit facility was approximately $22.7 million. See Note 15 "Credit Facility" for more information regarding the credit facility.





22
Table of Contents


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q 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-Q 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. . In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. 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, changes in the anticipated amounts and timing of restructuring charges to be incurred and cost savings expected to be realized from our restructuring actions in Europe, our ability to successfully execute our strategies, the sufficiency of our cash, cash equivalents and short-term investments and cash generated from operations, and our future liquidity requirements, the risks discussed in this Part I, Item 2 -"Management's Discussion and Analysis of Financial Condition and Results of Operations,” the risk factors set forth in Part II, Item 1A- "Risk Factors” and elsewhere in this Form 10-Q, the risk factors set forth in our Annual Report on Form 10-K for the year ended June 24, 2011 filed with the Securities and Exchange Commission (the “SEC”) on August 29, 2011 (our “Annual Report”), and the risks detailed from time to time in our future reports filed with the SEC. The information included herein is as of the filing date of this Form 10-Q with the SEC and future events or circumstances could differ materially from the forward-looking statements included herein. Accordingly, we caution readers not to place undue reliance on these forward-looking statements. Unless required by law, we expressly disclaim any obligation to update or alter our forward-looking statements, whether as a result of new information, future events or otherwise. All subsequent written or oral forward-looking statements attributable to SGI or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Readers are urged to carefully review and consider the various disclosures made in this report and other documents we file from time to time with the SEC to advise interested parties of the risks and factors that may affect our business.
The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto in Item 1 in this Form 10-Q and with our financial statements and notes thereto for the year ended June 24, 2011 contained in our Annual Report.
“Silicon Graphics,” “SGI,” "Altix," "ArcFiniti," "COPAN," “ICE Cube,” “SGI UV,” "SGI ICE X," "SGI Modular InfiniteStorage," 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.
Overview
SGI is the 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 products, 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 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:
•
compute solutions ranging from scalable entry-level solutions to hyper-scale, cloud, and large-scale data center solutions that include scale up, scale out and workgroup servers. 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 use;
•
SGI® UV™ (formerly known as SGI® Altix® UV), which we believe is the world's fastest and most scalable shared memory supercomputer family, scales from 32 to 2,560 cores and supports up to 16 terabytes of global shared memory in a single system image;
•
SGI® ICE X™ platform (formerly known as SGI® Altix® ICE) is the next generation of the world's fastest distributed memory platform for over three years running, delivering up to 2,304 processor cores - over 22 teraflops of compute power - per rack, easily scaling from 36 to tens of thousands of nodes to address the most challenging compute

23
Table of Contents


problems;
•
storage solutions ranging from cloud, high performance, and high density storage solutions which include integrated storage servers and active archive systems; and
•
a comprehensive range of software suites optimized to increase efficiency, performance, and manageability of our compute and storage solutions or software applications.
Our current strategy involves profitably growing our business in the compute, storage and service areas of technical computing, and broadening our customer penetration by industry and geography. We believe that these multiple paths to growth will create a strong foundation for our business 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 high-performance computing, or 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.
In fiscal 2011, we introduced new product offerings, including ArcFiniti™ and ICE Cube® AIR products. During the second quarter of fiscal year 2012, we introduced our innovative new SGI® ICE X™ HPC platform. SGI ICE X is the fifth-generation of our SGI ICE platform, and we believe that it is the most flexible supercomputer in the industry for addressing a wide range of applications and customer needs. We also continue to sell our SGI® UV™ and other storage products.
Diversifying our business
On March 9, 2011, we acquired the remaining outstanding shares of SGI Japan, Ltd. ("SGI Japan") that we did not previously own 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 resulting in a 40% of total international revenue in the three months ended March 30, 2012 compared to 35% of total revenue in the three months ended March 25, 2011. In addition, our customer base continues to expand in various sectors, including the public, cloud and manufacturing sectors.
Change in Segment Reporting
In the quarter ended September 30, 2011, we started managing our business primarily on a geographic basis. Our operating and reporting segments consist of the Americas, Europe, and Asia-Pacific operations. The Americas segment includes both North and South America. The Europe segment ("EMEA") includes European countries, as well as the Middle East and Africa. The Asia-Pacific segment ("APJ") includes Australia, Japan, and other Asian countries. Each operating segment provides similar hardware and software products and similar services. We do not aggregate any of the operating segments in determining our reporting segments. Prior to this change, we reported our operating segments as product and service segments.
Credit facility
In December 2011, we entered into a five-year credit facility in the aggregate principal amount of $35.0 million. The credit facility includes a feature that allows us to increase the revolver amount in the first 18 months of the credit facility up to $15.0 million to an aggregate principal amount of $50.0 million, subject to meeting certain conditions set forth in the credit facility. We intend to use the credit facility to primarily fund our working capital requirements, capital expenditures and operations to the extent that cash provided by operating activities is not sufficient to fund our cash needs. As of March 30, 2012, our total outstanding balance was $15.2 million, including $0.2 million of accrued interest. Further, the credit facility includes a $10.0 million letter of credit subfacility and we had $2.0 million outstanding letters of credit as of March 30, 2012.
On May 1, 2012, the revolver amount of our credit facility was increased by $5.0 million to an aggregate principal amount of $40.0 million. On May 9, 2012, the remaining amount available to be borrowed under the credit facility was approximately $22.7 million and we were in compliance with all covenants.
Restructuring action in Europe

24
Table of Contents


On March 16, 2012, our Board of Directors approved a restructuring action (the "Fiscal 2012 Restructuring Action") to reduce approximately 25% of our European workforce and close certain legal entities and offices in Europe. We adopted the Fiscal 2012 Restructuring Action to streamline operations and reduce operating expenses in Europe.
In connection with the Fiscal 2012 Restructuring Action, we expect to incur pre-tax cash charges between $14.0 million and $17.0 million, which consist of pre-tax cash charges between $13.0 million and $16.0 million for employee termination benefits, and up to $1.0 million for the planned office and legal entity closures, which expenses include contract termination costs and other associated costs. We expect to recognize the majority of the expense associated with the employee termination benefits prior to the third quarter of fiscal 2013. The closure of offices and legal entities are expected to take up to 18 months and the related expenses are expected to be recognized over that period of time. Upon completion of the Fiscal 2012 Restructuring Action, we expect to realize annualized savings of approximately $7.5 million in the aggregate.


Results of Operations
Summarized below are the results of our operations for the three and nine months ended March 30, 2012 as compared to the three and nine months ended March 25, 2011.
Financial Summary
•
Revenue increased $55.7 million or 39% in the three months ended March 30, 2012 compared to the three months ended March 25, 2011. In addition, revenue increased $139.4 million or 32% in the nine months ended March 30, 2012 to $573.5 million from $434.1 million in the nine months ended March 25, 2011. Our higher revenue in both periods resulted primarily from the increase in our product revenue in our Americas and APJ segment and increase in the service revenue of our APJ segment.
•
Our overall gross margin decreased by 236 basis points from 28.2% in the three months ended March 25, 2011 to 25.8% in the three months ended March 30, 2012. Also, our overall gross margin decreased by 127 basis points from 28.5% in the nine months ended March 25, 2011 to 27.3% in the nine months ended March 30, 2012. This change in overall gross margin is due to decreased in both product and service gross margin. The decline in our product gross margin was due to product mix shift to lower margin products, as well as a result of competitive pricing pressures in our EMEA region. The decline in our service gross margins was largely as a result of lower support services revenue as our new products replace our installed base of older generation products with higher margin support contracts.
•
Total operating expense increased for the three months and the nine months ended March 30, 2012 as compared to the three months and nine months ended March 25, 2011, due to the acquisition of SGI Japan in March 2011. In fiscal year 2011, SGI Japan did not significantly impact our total expense as there were only 15 days in the three and nine months ended March 25, 2011 in which the two companies were combined, compared to a full quarter's expense from SGI Japan in the three and nine months ended March 30, 2012.
Revenue, cost of revenue, gross profit and gross margin
As a result of the change in our operating segments commencing in the quarter ended September 30, 2011, we presented information for the three and nine months ended March 25, 2011 on the basis of the new reportable segments. For additional information relating to our segment information, see Note 21 to our unaudited condensed financial statements in this Form 10-Q.
The following table presents revenue by operating segment for the three and nine months ended March 30, 2012 and March 25, 2011 (in thousands except percentages):

25
Table of Contents


 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
March 30, 2012
 
March 25, 2011
 
$
 
%
 
March 30, 2012
 
March 25, 2011
 
$
 
%
Total revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Americas
$
128,321

 
$
99,355

 
$
28,966

 
29%
 
$
350,434

 
$
297,071

 
$
53,363

 
18%
APJ
44,660

 
17,120

 
27,540

 
161%
 
141,639

 
47,448

 
94,191

 
199%
EMEA
26,409

 
27,189

 
(780
)
 
(3)%
 
81,426

 
89,563

 
(8,137
)
 
(9)%
Total revenue
$
199,390

 
$
143,664

 
$
55,726

 
39%
 
$
573,499

 
$
434,082

 
$
139,417

 
32%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Americas
$
107,580

 
$
74,516

 
$
33,064

 
44%
 
$
285,065

 
$
220,007

 
$
65,058

 
30%
APJ
25,253

 
11,434

 
13,819

 
121%
 
81,144

 
36,335

 
44,809

 
123%
EMEA
17,406

 
18,954

 
(1,548
)
 
(8)%
 
56,025

 
65,515

 
(9,490
)
 
(14)%
Total product revenue
$
150,239

 
$
104,904

 
$
45,335

 
43%
 
$
422,234

 
$
321,857

 
$
100,377

 
31%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Service revenue
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Americas
$
20,741

 
$
24,839

 
$
(4,098
)
 
(16)%
 
$
65,369

 
$
77,064

 
$
(11,695
)
 
(15)%
APJ
19,407

 
5,686

 
13,721

 
241%
 
60,495

 
11,113

 
49,382

 
444%
EMEA
9,003

 
8,235

 
768

 
9%
 
25,401

 
24,048

 
1,353

 
6%
Total service revenue
$
49,151

 
$
38,760

 
$
10,391

 
27%
 
$
151,265

 
$
112,225

 
$
39,040

 
35%
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 includes revenue generated from the sale of maintenance contracts as well as professional service projects that are tailored to individual customer's needs. We recognize service revenue from maintenance contracts ratably over the service periods. Maintenance contracts are typically between one to three years in length and we actively pursue renewals of these contracts. We also recognize professional services revenue related to implementation of and training on our products upon completion of these projects.
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 shifting the competitive landscape to differentiated value rather than price.
Segment Operating Performance
Americas
Revenue increased $29.0 million or 29% to $128.3 million in the three months ended March 30, 2012 from $99.4 million in the three months ended March 25, 2011. The increase in Americas revenue was driven by higher product revenue partially offset by a decrease in service revenue. Product revenue increased by $33.1 million due primarily to the strength in sales of our scale out servers. This increase in product revenue was partially offset by a decrease in service revenue of $4.1 million as our new products replace our installed base of older generation products with higher margin support contracts. In addition, our service revenue was impacted by competitive pricing and economic challenges. The Americas segment represented 64% and 69% of the total revenue in the three months ended March 30, 2012 and March 25, 2011, respectively.
Revenue increased $53.4 million or 18% to $350.4 million in the nine months ended March 30, 2012 from $297.1 million in the nine months ended March 25, 2011. The increase in Americas revenue was driven by higher product revenue partially offset by a decline in service revenue. Product revenue increased by $65.1 million driven by the strength in sales of our scale out servers and storage products. Service revenue decreased $11.7 million despite having one additional week in the nine months ended March 30, 2012 compared to the nine months ended March 25, 2011. The decrease is primarily attributable to lower support revenue as our new products replace our installed base of older generation products with higher margin support contracts. The Americas segment represented 61% and 68% of the total revenue in the nine months ended March 30, 2012 and March 25, 2011, respectively.

26
Table of Contents


APJ
Revenue increased $27.5 million or 161% to $44.7 million in the three months ended March 30, 2012 from $17.1 million in the three months ended March 25, 2011. Our higher revenue in APJ is primarily due to the acquisition of SGI Japan in March 2011, which contributed $35.7 million of revenue in the three months ended March 30, 2012 compared to $8.4 million in the three months ended March 25, 2011. Of the $8.4 million of revenue, $3.0 million is the revenue we recognized during the period SGI Japan was a customer and $5.4 million is revenue recognized by the Company after the acquisition of SGI Japan.  Our revenue for the three months ended March 30, 2012 is comprised of $25.3 million from product sales and $19.4 million from services compared to product and service revenue of $11.4 million and $5.7 million, respectively, for the three months ended March 25, 2011. The APJ segment represented 22% and 12% of the total revenue in the three months ended March 30, 2012 and March 25, 2011, respectively.
Revenue increased $94.2 million or 199% to $141.6 million in the nine months ended March 30, 2012 from $47.4 million in the nine months ended March 25, 2011. Our higher revenue in APJ is primarily due to the acquisition of SGI Japan in March 2011, which contributed $111.0 million of revenue in the nine months ended March 30, 2012 compared to $21.1 million in the nine months ended March 25, 2011. Of the $21.1 million of revenue, $15.7 million is the revenue we recognized during the period SGI Japan was a customer and $5.4 million is revenue recognized by the Company after the acquisition of SGI Japan.  Our revenue for the nine months ended March 30, 2012 is comprised of $81.1 million from product sales and $60.5 million from services compared to product and service revenue of $36.3 million and $11.1 million, respectively, for the nine months ended March 25, 2011. The APJ segment represented 25% and 11% of the total revenue in the nine months ended March 30, 2012 and March 25, 2011, respectively.
EMEA
Revenue decreased $0.8 million or 3% to $26.4 million in the three months ended March 30, 2012 from $27.2 million in the three months ended March 25, 2011. The decrease in revenue is primarily attributable to a decrease in product revenue of $1.5 million as a result of lower server sales, as well as lower pricing due to competitive pressures in the region. This decrease was partially offset by an increase in service revenue of $0.8 million. The EMEA segment represented 14% and 19% of the total revenue in the three months ended March 30, 2012 and March 25, 2011, respectively.
Revenue decreased $8.1 million or 9% to $81.4 million in the nine months ended March 30, 2012 from $89.6 million in the nine months ended March 25, 2011. The decrease in revenue is primarily attributable to a decrease in product revenue of $9.5 million as a result of lower server and storage sales. This decrease was partially offset by an increase in service revenue of $1.4 million due to one additional week in the nine months ended March 30, 2012 compared to the nine months ended March 25, 2011. The EMEA segment represented 14% and 21% of the total revenue in the nine months ended March 30, 2012 and March 25, 2011, respectively.
Cost of revenue and gross profit
Cost of revenue and gross profit for the three and nine months ended March 30, 2012 and March 25, 2011 were as follows (in thousands except percentages):
 
 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
 
March 30,
2012
 
March 25,
2011
 
$
 
%
 
March 30,
2012
 
March 25,
2011
 
$
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of product revenue
 
$
121,263

 
$
83,279

 
$
37,984

 
46%
 
$
333,347

 
$
251,542

 
$
81,805

 
33%
Cost of service revenue
 
26,617

 
19,883

 
6,734

 
34%
 
83,821

 
58,712

 
25,109

 
43%
Total cost of revenue
 
$
147,880

 
$
103,162

 
$
44,718

 
43%
 
$
417,168

 
$
310,254

 
$
106,914

 
34%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product gross profit
 
28,976

 
21,625

 
7,351

 
34%
 
88,887

 
70,315

 
18,572

 
26%
Service gross profit
 
22,534

 
18,877

 
3,657

 
19%
 
67,444

 
53,513

 
13,931

 
26%
Total gross profit
 
$
51,510

 
$
40,502

 
$
11,008

 
27%
 
$
156,331

 
$
123,828

 
$
32,503

 
26%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product gross margin
 
19.3
%
 
20.6
%
 
 
 
 
 
21.1
%
 
21.8
%
 
 
 
 
Service gross margin
 
45.8
%
 
48.7
%
 
 
 
 
 
44.6
%
 
47.7
%
 
 
 
 
Total gross margin
 
25.8
%
 
28.2
%
 
 
 
 
 
27.3
%
 
28.5
%
 
 
 
 
Cost of revenue consists of costs associated with direct material, labor, manufacturing overhead, freight, inventory write

27
Table of Contents


downs, warranty 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 over the service period.
Our cost of product revenue and gross profit are impacted by price changes, product configuration, revenue mix and product material costs. Our cost of service revenue and gross margin are impacted by timing of support service initiations and renewals as well as incremental investments in our customer support infrastructure. Our headcount in the manufacturing and services organization decreased by 98 employees from 744 employees at March 25, 2011 to 646 employees at March 30, 2012, primarily due to the decrease in service support employees as a result of the restructuring action in fiscal year 2011.
Overall gross profit increased by $11.0 million to $51.5 million in the three months ended March 30, 2012 from $40.5 million in the three months ended March 25, 2011. Overall gross margin decreased to 25.8% in the three months ended March 30, 2012 from 28.2% in the three months ended March 25, 2011. Our gross margin decreased due to unfavorable product mix shifts and competitive product pricing pressures in EMEA, as well as lower service margins.
Overall gross profit increased $32.5 million or 26% to $156.3 million in the nine months ended March 30, 2012 from $123.8 million in the nine months ended March 25, 2011 due to increased revenue. Gross margin decreased to 27.3% in the nine months ended March 30, 2012 from 28.5% in the nine months ended March 25, 2011 due to unfavorable product mix shifts and competitive product pricing pressures in EMEA, as well as lower service margins.
Product gross profit increased $7.4 million or 34% to $29.0 million in the three months ended March 30, 2012 from $21.6 million in the three months ended March 25, 2011. Product gross margin decreased to 19.3% in the three months ended March 30, 2012 from 20.6% in the three months ended March 25, 2011. Product gross profit increased $18.6 million or 26% in the nine months ended March 30, 2012. Product gross margin slightly decreased to 21.1% in the nine months ended March 30, 2012 from 21.8% in the nine months ended March 25, 2011. In both the three and nine month period ended March 30, 2012, our product gross margin decreased as a result of unfavorable product mix shifts to lower margin products and competitive pricing pressures in EMEA compared to the three and nine month period ended March 25, 2011.
Service gross profit increased $3.7 million or 19% and $13.9 million or 26% in the three and nine months ended March 30, 2012, respectively, compared with the same periods in the last fiscal year. Service gross margin decreased by 286 basis points and 310 basis points in the three and nine months ended March 30, 2012, respectively, compared with the same periods last fiscal year. The decrease is primarily attributable to lower support revenue as our new products replace our installed base of older generation products with higher margin support contracts.
Operating Expenses
Operating expenses for the three and nine months ended March 30, 2012 and March 25, 2011 were as follows (in thousands except percentages):
 
 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
 
March 30, 2012
 
March 25, 2011
 
$
 
%
 
March 30, 2012
 
March 25, 2011
 
$
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research and development
 
$
14,982

 
$
13,305

 
$
1,677

 
13%
 
$
47,427

 
$
40,473

 
$
6,954

 
17%
Sales and marketing
 
21,824

 
16,607

 
5,217

 
31%
 
66,722

 
49,566

 
17,156

 
35%
General and administrative
 
16,176

 
12,428

 
3,748

 
30%
 
47,860

 
36,952

 
10,908

 
30%
Restructuring
 
19

 
915

 
(896
)
 
(98)%
 
129

 
1,716

 
(1,587
)
 
(92)%
Acquisition-related
 
—

 
1,094

 
(1,094
)
 
(100)%
 
—

 
1,094

 
(1,094
)
 
(100)%
Total operating expense
 
$
53,001

 
$
44,349

 
$
8,652

 
20%
 
$
162,138

 
$
129,801

 
$
32,337

 
25%
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. Consistent with our strategy of growing the Company by introducing new products, the overall increase in research and development expense is driven by innovation-focused spending in our compute servers, storage and software offerings.
Research and development expense increased $1.7 million or 13% to $15.0 million in the three months ended March 30, 2012 from $13.3 million in the three months ended March 25, 2011. The increase in research and development expense is

28
Table of Contents


primarily due to additional expense as a result of the acquisition of SGI Japan in March 2011. In addition, our headcount in research and development increased by 27 employees from 290 employees as of March 25, 2011 to 317 employees as of March 30, 2012 as we continue to invest in research and development activities. As a result of increased headcount, compensation and related expenses increased by $1.0 million and share-based compensation increased by $0.4 million during the three months ended March 30, 2012. Other research and development expenses increased as a result of an increase of $0.4 million in materials and supplies used and an increase of $0.2 million in facility related expenditures. The increase in expenses was partially offset by a decrease in third party consulting fees of $0.6 million.
Research and development expense increased $7.0 million or 17% to $47.4 million in the nine months ended March 30, 2012 from $40.5 million in the nine months ended March 25, 2011. The increase is primarily due to our acquisition of SGI Japan, as well as additional headcount as we continue to invest in research and development activities. As a result of increased headcount, compensation and related expenses increased $4.0 million and share-based compensation expense increased by $1.2 million during the nine months ended March 30, 2012. Other research and development expenses increased in connection with an increase of $1.7 million in materials and supplies and an increase of $0.6 million in facility related expenditures. The increase in expenses was partially offset by a decrease in third party consulting fees of $0.6 million.
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 $5.2 million or 31% to $21.8 million in the three months ended March 30, 2012 from $16.6 million in the three months ended March 25, 2011. This increase was primarily due to an increase in our compensation and related expenses of $4.4 million during the three months ended March 30, 2012. Compensation and related expenses increased due mainly to increase in commissions expense as a result of achievement of sales commission targets, as well as additional expense as a result of the acquisition of SGI Japan in March 2011. Our headcount in sales and marketing increased by 71 employees from 293 employees as of March 25, 2011 to 364 employees as of March 30, 2012. Other expenses increased as a result of an increase in travel and marketing related expenses of $0.6 million, facility related expenses of $0.4 million, and share-based compensation expense of $0.2 million. The increase in these expenses is partially offset by a decrease in intangible amortization expense of $0.2 million and outside consulting fees of $0.1 million.
Sales and marketing expense increased $17.2 million or 35% to $66.7 million in the nine months ended March 30, 2012 from $49.6 million in the nine months ended March 25, 2011. This increase was primarily due to an increase in compensation and related expenses of $14.6 million during the nine months ended March 30, 2012, as a result of increase in commissions expense, as well as the acquisition of SGI Japan in March 2011. In addition, travel and marketing related expenses increased our expense by $1.8 million, facility related expenses increased by $1.2 million, and share-based compensation expense increased by $0.6 million. The increase in these expenses is partially offset by a decrease in intangible amortization expense of $0.9 million.
General and administrative. General and administrative expense consists primarily of personnel costs, legal and professional service costs, depreciation, bad debt expense, share-based compensation, and facilities and information technology costs.
General and administrative expense increased $3.7 million or 30% to $16.2 million in the three months ended March 30, 2012 from $12.4 million in the three months ended March 25, 2011 due to the acquisition of SGI Japan in March 2011. Total headcount in general and administrative increased by 11 employees from 224 employees as of March 25, 2011 to 235 employees as of March 30, 2012. Compensation and related expenses increased by $0.8 million. Further, facility related expenses, including property and other taxes, increased by $0.9 million, share-based compensation expense increased by $1.3 million, and materials and supplies used increased by $0.3 million.
General and administrative expense increased $10.9 million or 30% to $47.9 million in the nine months ended March 30, 2012 from $37.0 million in the nine months ended March 25, 2011 due to our acquisition of SGI Japan in March 2011. Compensation related expenses increased by $3.3 million, professional fees, including legal related expenses, increased by $1.3 million, facility related expenses, including property and other taxes, increased by $1.8 million, recruiting costs increased by $0.8 million, purchases of small equipment and supplies increased by $1.0 million, and share-based compensation expense increased by $1.7 million, and other expenses increased by $1.0 million.
Restructuring. Total restructuring expense related to the Fiscal 2012 Restructuring Action and the restructuring actions we undertook in prior years was immaterial for three months ended March 30, 2012 and was $0.1 million for the nine months ended March 30, 2012. For the three and nine months ended March 25, 2011, restructuring expense was $0.9 million and $1.7 million, respectively. As a result of the Fiscal 2012 Restructuring Action, we anticipate future cash outflow of between $14.0 million to $17.0 million, which we expect to recognize a substantial portion of this expense in fiscal year 2013. In addition, we

29
Table of Contents


anticipate future cash outflow of $0.3 million for the restructuring actions in prior years, which we expect to be fully paid in fiscal year 2013.
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 three months ended March 25, 2011, we incurred acquisition-related costs of $1.1 million, which consisted primarily of costs related to due diligence, legal and other professional fees. There were no significant acquisition costs during the three and nine months ended March 30, 2012.
Total other income (expense), net
Total other income (expense), net for the three months ended March 30, 2012 and March 25, 2011 were as follows (in thousands except percentages):
 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
 
 
March 30, 2012
 
March 25, 2011
 
$
 
%
 
March 30,
2012
 
March 25,
2011
 
$
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income (expense), net
$
(126
)
 
$
10

 
$
(136
)
 
(1,360)%
 
$
(150
)
 
$
236

 
$
(386
)
 
(164)%
Other income (expense), net
913

 
2,880

 
(1,967
)
 
(68)%
 
(230
)
 
(1,300
)
 
1,070

 
(82)%
Total other income (expense), net
$
787

 
$
2,890

 
$
(2,103
)
 
(73)%
 
$
(380
)
 
$
(1,064
)
 
$
684

 
(64)%
Interest income (expense), 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"), as well as interest expense relating to our credit facility and to certain tax payments. The increase in interest expense in the three months ended March 30, 2012 compared to the three months ended March 25, 2011 was primarily due to the interest expense from our credit facility of $0.2 million, which was partially offset by interest income of $0.1 million from our interest-bearing investment accounts. Interest income (expense), net decreased in the nine months ended March 30, 2012 compared to the nine months ended March 25, 2011 primarily due to the interest expense from our credit facility of $0.2 million, as well as a decrease in our interest income of $0.1 million, as a result of lower investment account balances, as well as the sale of our remaining ARS in March 2011.
Other income (expense), net. Other income (expense), net during the three months ended March 30, 2012 consisted primarily of foreign exchange gain of $0.9 million primarily as a result of the strengthening of the Euro and British Pound against the U.S. Dollar compared to foreign exchange gains of $2.6 million during the three months ended March 25, 2011 as a result of favorable exchange rates in effect during this period. In addition, during the three months ended March 25, 2011, we realized a gain of $0.3 million related to the sale of our remaining investments in auction rate securities.
Other income (expense), net in the nine months ended March 30, 2012 consists primarily of foreign exchange losses of $0.4 million, which was partially offset by $0.2 million of miscellaneous income. Other income (expense), net in the nine months ended March 25, 2011 consists primarily of impairment of our investment in SGI Japan of $2.9 million and $0.8 million in recognized unrealized losses on our ARS investments, partially offset by foreign exchange gains of $2.4 million.
Income tax provision (benefit)
Income tax provision (benefit) for the three and nine months ended March 30, 2012 and March 25, 2011 were as follows (in thousands except percentages):
 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
March 30, 2012
 
March 25, 2011
 
$
 
%
 
March 30,
2012
 
March 25,
2011
 
$
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income tax provision (benefit)
$
458

 
$
715

 
$
(257
)
 
(36)%
 
$
(112
)
 
$
2,098

 
$
(2,210
)
 
(105)%
We recorded a tax expense of $0.5 million and a tax benefit of $0.1 million for the three and nine months ended March 30, 2012, respectively. The net tax benefit was primarily comprised of tax liability computed based on the Company’s foreign projected financial results for the year ending June 29, 2012 offset by the reversals of unrecognized tax benefits including related interest. The effective tax rate differed from the combined federal and net state statutory income tax rate for the three and nine months ended March 30, 2012 primarily due to tax expense incurred by the Company's foreign subsidiaries with operating income, offset by the release of the unrecognized tax benefits due to lapse of statute of limitations, benefits from

30
Table of Contents


reversals of previously accrued taxes in foreign jurisdictions and benefit from utilization of net operating losses not previously recognized.
We recorded a tax expense of $ 0.7 million and $2.1 million for the three and nine months ended March 25, 2011, respectively. Our tax expense for the three and nine months ended March 25, 2011 included $0.3 million and $1.6 million of 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 fiscal 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, and tax expense associated with our unrecognized tax benefits and related interest.
As of March 30, 2012, we have provided a partial valuation allowance against 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. 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.

31
Table of Contents


Liquidity and Capital Resources
We had $88.9 million of cash and cash equivalents at March 30, 2012 and $139.9 million at June 24, 2011. As of March 30, 2012, we had $52.3 million of cash and cash equivalents that are held outside the United States. Historically, we have required capital principally to fund our working capital needs. It is our investment policy to invest in a manner that preserves capital, provides liquidity and maintains appropriate diversification and optimizes after-tax yield and return within our policy's framework and stipulated benchmarks. Adherence with our policy requires the assets to be liquid on and before their maturity dates. This liquidity requirement means that the holder of the assets must be able to pay us, upon our demand, the cash value of the assets invested.
At March 30, 2012, we had short-term and long-term restricted cash and cash equivalents of $4.3 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.
As described further below under the section titled "Contractual Obligations and Other Commitments", in December 2011, we entered into a five-year senior secured credit facility in the aggregate principal amount of $35.0 million, which was increased to $40.0 million on May 1, 2012. The credit facility is intended to be used primarily to fund working capital requirements, capital expenditures and operations to the extent that cash provided by operating activities is not sufficient to fund our cash needs. As of March 30, 2012, we had an outstanding balance of $15.2 million from our credit facility, which included $0.2 million of accrued interest. We also had $2.0 million outstanding letters of credit under this credit facility.
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 cash from operations, or generate additional cash from our operations on a timely basis, we may not have the cash resources required to run our business and we may need to seek additional sources of funds to meet our needs.
At May 9, 2012, we believe our current cash and cash equivalents, in conjunction with the funds that may be drawn down under our credit facility, will be sufficient to fund working capital requirements, capital expenditures and operations for at least the next twelve months. During the nine months ended March 30, 2012, we signed several large sales contracts resulting in cash being invested to fund working capital for some of these sales contracts in excess of nine months before the related revenues are collected. As a result of such cash investments, we have further intensified our cash processes related to monitoring, projections and control procedures to operate our business. The remaining principal that is available for withdrawal on the credit facility will provide us with additional capital resources to the extent that cash provided by operating activities is not sufficient to fund our cash needs. 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.
If we require additional capital resources to expand our business internally or to acquire complementary products, 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):
 
Nine Months Ended
 
March 30, 2012
 
March 25, 2011
Consolidated statements of cash flows data:
 
 
 
Net cash used in operating activities
$
(61,410
)
 
$
(9,680
)
Net cash provided by (used in) investing activities and acquisitions
(8,059
)
 
7,431

Net cash provided by financing activities
19,066

 
1,064

Effect of exchange rate changes on cash and cash equivalents
(593
)
 
$
569

Net decrease in cash and cash equivalents
$
(50,996
)
 
$
(616
)
 
 
 
 
Operating Activities
Cash used in operating activities was $61.4 million for the nine months ended March 30, 2012. Our net loss was $6.1 million for the nine months ended March 30, 2012. Non-cash items included in net loss consisted primarily of depreciation and amortization expense of $11.2 million and share-based compensation expense of $7.9 million. Net change in operating assets and liabilities contributed to the decrease in cash from operating activities of $75.1 million. The primary operating activity use of cash was from purchases of inventory, increase in accounts receivable and prepayments, and payment of accrued

32
Table of Contents


compensation and accounts payable.
For the nine months ended March 30, 2012, inventory increased $26.6 million to meet the demands of the large sales contracts that we entered during the second quarter of fiscal year 2012, as well as due to timing of shipments to customers. Additionally, accounts receivable increased $29.9 million due to the timing of collections of the trade receivables, and prepaids and other current assets increased $3.6 million due mainly to timing of value-added tax remittances, as well as increase in prepayments. Accounts payable decreased $6.7 million, primarily due to the timing of payments, and accrued compensation decreased $4.4 million primarily due to timing of compensation related payments. The decrease in deferred revenue during the nine months ended March 30, 2012 was offset by a corresponding decrease in deferred cost of goods sold.
Cash used in operating activities was $9.7 million for the nine months ended March 25, 2011. Our net loss was $9.1 million for the nine months ended March 25, 2011. Non-cash items included in net loss consisted primarily of depreciation and amortization expense of $12.3 million, share-based compensation expense of $3.9 million, impairment of equity investment of $2.9 million, realized loss on investments of $0.9 million, and recovery of doubtful accounts receivable of $0.2 million. Net change in operating assets and liabilities was $20.3 million. The primary operating activity source of cash was a decrease in inventory. The primary operating activities uses of cash were increases in deferred cost of revenue, decreases in accounts payable and other liabilities.
For the nine months ended March 25, 2011, deferred revenue decreased $3.4 million and deferred cost of revenue increased $7.7 million, respectively, primarily due to the timing of revenue recognition on sales transactions which were required to be deferred in accordance with our revenue recognition policy. Inventory decreased $15.5 million due to timing of inventory purchases and shipments to customers. Additionally, accounts payable decreased $19.8 million, primarily due to the decrease in inventory purchases and the timing of payments. Accrued compensation decreased $2.8 million primarily due to timing of compensation and related payments.

Investing Activities and Acquisitions
Cash used by investing activities was $8.1 million in the nine months ended March 30, 2012, primarily due to purchases of property and equipment and other individually immaterial investing activities of $5.6 million and $2.5 million, respectively.
Cash provided by investing activities and acquisitions was $7.4 million in the nine months ended March 25, 2011, primarily due to proceeds from sales and maturities of investments of $7.9 million. In addition, we purchased approximately 90% of the outstanding shares of SGI Japan for $17.9 million in cash. In connection with the acquisition, we acquired $24.0 million of cash, for a net cash acquired of $6.0 million. Cash provided by investing activities was partially offset by purchases property and equipment of $5.4 million and an increase in our restricted cash and cash equivalents of $1.1 million.

Financing Activities
Cash provided by financing activities was $19.1 million in the nine months ended March 30, 2012, primarily due to proceeds from draw-down on our credit facility of $15.0 million, the issuance of stock under our employee stock purchase plan and stock option exercises of $5.1 million, which was partially offset by repurchases of restricted stock units of $1.0 million for tax withholding purposes.
Cash provided by financing activities was $1.1 million in the nine months ended March 25, 2011, primarily due to proceeds from the issuance of stock under the employee stock purchase plan and stock options of $5.8 million, partially offset by repurchases of restricted stock of $0.9 million and the purchase of treasury stock of $3.9 million.
In February 2009, the Board of Directors approved a stock repurchase program of up to $40.0 million of our common stock. Under the program, we are authorized to purchase shares of common stock through open market transactions and privately negotiated purchases at prices deemed appropriate by management. During the nine months ended March 25, 2011, we repurchased 505,100 shares of outstanding common stock for a total of $3.9 million which was paid in cash. There were no repurchases in the nine months ended March 30, 2012. As of March 30, 2012, $35.1 million remained available for future repurchases under the stock repurchase program.
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, cash generated from operations, if any, and with the remaining principal that is available for withdrawal on the credit facility to the extent that cash provided by operating activities is not sufficient to fund our cash needs. 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

33
Table of Contents


working capital will constitute a material use of our cash resources.

Contractual Obligations and Commitments
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 March 30, 2012, we had total outstanding commitments on non-cancelable operating leases of our real properties of $16.3 million, $7.1 million of which relate to our domestic leases. 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 2014. As of March 30, 2012, we had total outstanding commitments of $9.2 million in non-cancelable international real property operating leases. The total outstanding commitments included $3.1 million relating to our leased facility in Japan, which we 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 March 30, 2012, personal property under operating lease was comprised primarily of automobiles and office equipment. Total outstanding commitments under such leases totaled approximately $0.8 million at March 30, 2012.
Purchase Commitments
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 2014. As of March 30, 2012, there was a remaining commitment of approximately $20.4 million, of which $17.2 million is expected to be paid in 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.
Credit Facility
On December 5, 2011, we entered into a five-year senior secured credit facility in the aggregate principal amount of $35.0 million. The credit facility includes a feature that allows us to increase the revolver amount in the first 18 months of the credit facility by up to $15.0 million to an aggregate principal amount of $50.0 million, subject to meeting certain conditions set forth in the credit facility. As of March 30, 2012, the outstanding balance under the credit facility was $15.2 million, including $0.2 million of accrued interest. On May 1, 2012, the revolver amount of our credit facility was increased by $5.0 million to an aggregate principal amount of $40.0 million. On May 9, 2012, the remaining amount available to be borrowed under the credit facility was approximately $22.7 million. This availability will fluctuate over time, and generally monthly, due to a variety of factors including our overall mix of sales and resulting accounts receivable with international and domestic customers, U.S. governmental agencies and a few individual customer accounts which may result in high concentrations of accounts receivable as compared to the overall level of the our accounts receivable. See Note 15 "Credit Facility" to our unaudited condensed consolidated financial statements in this Form 10-Q for further information on the credit facility.
Uncertain Tax Positions
As of March 30, 2012, the net recorded tax liability for uncertain tax positions was $22.6 million, including interest and penalty. We cannot conclude on the range of cash payments that will be made within the next twelve months associated with our uncertain tax positions.
Guarantees and Indemnifications
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

34
Table of Contents


guarantees at March 30, 2012 was $4.5 million for which we have $4.3 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 unaudited condensed 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 March 30, 2012. As a result, we believe the estimated fair value of these indemnification agreements, if any, to be immaterial and, accordingly, no liability has been recorded with respect to such indemnifications as of March 30, 2012.
Off-Balance Sheet Arrangements
Our credit facility includes a $10.0 million letter of credit subfacility. As of March 30, 2012, we have $2.0 million of outstanding letter of credit to back our obligation to pay or perform when required to do so pursuant to the requirements of an underlying agreement or the provision of goods or services to a supplier.
We had no other off-balance sheet arrangements as of March 30, 2012.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed 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 accounting policies discussed under Part I, Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended June 24, 2011 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. 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;
•
Impairment of intangibles and long-lived assets;
•
Warranty reserve;
•
Retirement benefit obligations; and
•
Accounting for income taxes.

There have been no significant changes in the Company's significant accounting policies for the nine months ended March 30, 2012 as compared to those discussed under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended June 24, 2011.
 

35
Table of Contents



Recent Accounting Pronouncements
See Note 3 to our unaudited condensed consolidated financial statements in this Form 10-Q 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.


36
Table of Contents


ITEM 3. 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 has 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 generally invest 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.
Interest Rate Risk
Our exposure to market risks for changes in interest rates relates primarily to our investment portfolio and our credit facility. We currently do not hedge our interest rate exposure.
As of March 30, 2012, our cash and cash equivalents of $88.9 million consisted primarily of cash 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, we believe that the current risk of loss in fair value resulting from interest rate changes is minimal. At March 30, 2012, we had no interest rate forward contracts or option contracts.
The interest expense on outstanding cash borrowings under our credit facility is based on variable interest rates and is therefore affected by changes in market interest rates. If interest rates rise significantly, our results from operations and cash flows may be materially affected. As of March 30, 2012, we had $15.2 million of outstanding borrowings under our credit facility, of which $0.2 million was accrued interest. A 1% increase or decrease in interest rate, with all other variables held constant, would have resulted in a $0.2 million increase in interest expense.
Foreign Exchange Risk
As of March 30, 2012, foreign currency cash accounts totaled $48.6 million, 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 March 30, 2012, 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 $4.9 million change in the value of our foreign currency cash accounts.


37
Table of Contents


ITEM 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our interim chief executive officer (principal executive officer) and chief financial officer (principal 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 required to be disclosed 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 interim 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 March 30, 2012.
Changes in Internal Control over Financial Reporting
Except for the continuing modification of the processes, systems and controls relating to SGI Japan, which was acquired on March 9, 2011, there were no changes in the Company's internal control over financial reporting during the quarter ended March 30, 2012, which were identified in connection with management's evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.
Inherent Limitation on the Effectiveness of Internal Controls
The effectiveness of any system of internal control over financial reporting, including ours, is subject to inherent limitations, including the exercise of judgment in designing, implementing, operating, and evaluating the controls and procedures, and the inability to eliminate misconduct completely. Accordingly, any system of internal control over financial reporting, including ours, no matter how well designed and operated, can only provide reasonable, not absolute assurances. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We intend to continue to monitor and upgrade our internal controls as necessary or appropriate for our business, but we cannot assure that such improvements will be sufficient to provide us with effective internal control over financial reporting.


38
Table of Contents


PART II - OTHER INFORMATION

ITEM 1. 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, Silicon Graphics, Inc., the predecessor company that we acquired in May 2009 ("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 ($1.5 million based on the conversion rate on March 30, 2012) 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 ($0.5 million based on the conversion rate on March 30, 2012) plus interest and costs. The proceeding has commenced, witness testimony is now complete and the parties have been instructed to submit final arguments by the next scheduled hearing date (to be determined by the arbitrator). We cannot currently predict the outcome of this dispute nor determine the amount or a reasonable range of potential loss, if any.


ITEM 1A. Risk Factors
The risk factors presented below update the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended June 24, 2011 (the “Annual Report”). The following factors, along with those in the Annual Report and those described above under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” should be reviewed carefully, in conjunction with the other information contained in this Form 10-Q and our financial statements. These factors, among others, could cause actual results to differ materially from those currently anticipated and contained in forward-looking statements made in this Form 10-Q and presented elsewhere by our management from time to time. See the discussion of forward-looking statements in "Part I, Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
 
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 low margins;
•
location and timing requirements for the delivery of our products and services;
•
lengthy acceptance cycles of our products by certain customers;
•
addition of new customers or loss of existing customers
•
gross margin pressures from the sales of products and services due to discounted pricing, especially to our largest customers;
•
changes in the mix of products sold due to differences in profitability among our products;
•
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;

39
Table of Contents


•
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;
•
market acceptance of newer products, such as ICE X™ and SGI® Modular InfiniteStorage™;
•
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 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, Japanese Yen, and British Pound relative to the U.S. Dollar can significantly affect revenues and our operating results. Our revenues and operating results are adversely affected when the U.S. Dollar strengthens relative to other currencies and are positively affected when the U.S. Dollar weakens. Our revenues and operating results in fiscal 2011 have been unfavorably affected by the recent strengthening of the U.S. Dollar relative to other major foreign currencies.
For the three months ended March 30, 2012, our combined revenue from our EMEA and APJ segments was $71.1 million. As of March 30, 2012, the balance in our foreign currency cash accounts was $48.6 million. As of March 30, 2012, 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. On the other hand, 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.
A concentrated number of customers that purchase our products in large quantities have historically accounted for a significant portion of our revenues. If we are unable to maintain or replace our relationships with concentrated customers and/or diversify our customer base, our revenue may fluctuate or decline 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 these large customers. For the three months ended March 30, 2012, our top five customers accounted for approximately 46% of our total revenues. For the three months ended March 30, 2012, two customers in the Americas segment each accounted for 13% of our total revenues. 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, for example as a result of a customer's capital expenditure budget reductions or U.S. Government spending reductions, could materially adversely affect our revenues, financial condition and results of operations.

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

40
Table of Contents


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 is currently experiencing such a shortage for hard drives as a result of recent flooding in Southeast Asia, which has affected hard drive manufacturing facilities. In the future, we may experience other 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, natural disasters, other problems experienced by suppliers or problems faced during the transition to new suppliers.
The price of components may increase due to potential shortages or delays, such as the current hard drive shortage related to the flooding in Thailand in 2011 through early this calendar year, and 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 may 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. 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, we could have an oversupply of 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.
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.
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.
Moreover, we may experience delays in recognizing revenue from the sales of products or services due to lengthy acceptance cycles of our products by certain customers, development or product delivery delays, delays in obtaining necessary components from our suppliers, contractual provisions or other reasons. Such factors could adversely affect our operating results in any specific quarter or year, and could cause our revenue, gross profit and cash receipts to be delayed to later periods.

41
Table of Contents


Lengthy cash collection cycles in the sales of our products to certain customers may adversely affect our liquidity and ability to fund our operations.
Several large transactions that we have entered into require us to invest cash upfront to fund working capital without collecting cash for several periods. If we are unable to negotiate for more favorable cash collection terms in the future, our liquidity and ability to fund our operations could be adversely affected.
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. In December 2011, Mark Barrenechea resigned from the positions of chief executive officer and president effective January 1, 2012 and Ron Verdoorn, the Chairman of our Board of Directors, was appointed Interim Chief Executive officer in accordance with the succession plan in place by the Nominating and Corporate Governance Committee of the Board of Directors. The Board of Directors appointed Jorge L. Titinger as Chief Executive Officer and President, effective February 27, 2012. In addition, Timothy Pebworth resigned as Vice President and Chief Accounting Officer effective April 20, 2012, and James Wheat resigned as Senior Vice President, Chief Financial Officer and Chief Accounting Officer effective May 14, 2012, each for personal reasons. On April 30, 2012, Robert Nikl was appointed as Executive Vice President, Chief Financial Officer and Chief Accounting Officer effective May 15, 2012. If there were further changes in management, such changes could be disruptive and could negatively affect our operations, our culture and our strategic direction.
Further, 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 are subject to restrictions under our credit facility that may result in our inability to engage in favorable business activities or finance future operations or capital needs.
On December 5, 2011, we entered into a five-year senior secured credit facility in the aggregate principal amount of $35.0 million. The credit facility contains various financial and other covenants that, among other things:
•
Require us to maintain a fixed charge coverage ratio (applicable during certain periods),
•
Limit our ability to incur indebtedness, grant liens, or consign inventory, and
•
Require us to obtain the bank's consent prior to selling the company via a consolidation, merger or transfer of substantially all of our assets. 
As a result of these covenants and the increased indebtedness and higher debt-to-equity ratio of the Company in comparison to that of the Company on a historical basis, we are, among other things, limited in the manner in which we can conduct our business, including our flexibility to respond to changing business and economic conditions and increasing borrowing costs. In addition, we may be unable to engage in favorable business activities or finance future operations or capital needs, including without limitation, funding acquisitions or repurchasing our stock. This indebtedness may also adversely affect our ability to access sources of capital or incur certain liens. Accordingly, these restrictions may limit our ability to successfully operate our business. A failure to comply with these restrictions could lead to an event of default, which could result in an acceleration of the indebtedness and could adversely affect our cash flow and operating results. If any of the Company's indebtedness is accelerated, the Company may not have sufficient funds available to repay such indebtedness.


42
Table of Contents


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 (for example, we alone have 584 issue patents worldwide, 491 of which were issued in the United States), it is possible that 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. Such claims 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 or at all, 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.
In addition, we are also subject to risks related to ownership of our patentable inventions as a result of recent changes in U.S. patent law under the America Invents Act, pursuant to which the United States is transitioning from a “first-to-invent” system to a “first-to-file” system for patent applications filed on or after March 16, 2013. Accordingly, with respect to patent applications filed on or after March 16, 2013, even if we are the first to invent, we will not obtain ownership of an invention unless we are the first to file a patent application or can establish that such an earlier filing is derived from a previous public disclosure of our inventive work. If we are the first to invent but not the first to file a patent application, we will not be able to fully protect our intellectual property rights and may be found to have violated the intellectual property rights of others if we continue to operate in the absence of a patent issued to us. This is a departure from the current regime under which we have been operating, whereby we are currently able to obtain ownership of an invention even if we are not the first party to file a patent application. If we are not the first to file one or more patent applications to protect our intellectual property rights when the new patent regime becomes effective, we may be required to redesign our technology, cease using the related technology or attempt to license rights from another party, any of which could materially harm our business, financial condition and results of operations.
Our investment portfolio may be impaired by deterioration of the capital markets.
Our cash equivalent and short-term investment portfolio as of March 30, 2012 consists of U.S. treasuries. Our investment portfolio carries both interest rate risk and credit risk. Fixed rate debt securities may have their market value adversely impacted due to a credit downgrade or a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall or a credit downgrade occurs. As a result of current adverse financial market conditions, including the recent downgrade by Standard and Poor's (S&P) of the U.S. long-term sovereign credit rating, capital pressures on certain banks, especially in Europe, and the continuing low interest rate environment, some of our financial instruments may become impaired. Our future investment income may fall short of expectations due to changes in interest rates or if the decline in fair value of our publicly traded debt or equity investments is judged to be other-than-temporary. In addition, we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in the issuer's credit quality or changes in interest rates.


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 $56.00 per share to a low of $3.42 per share. At times the stock price has changed very quickly. During the three months ended March 30, 2012, our stock price has fluctuated from a high of $14.93 to a low of $8.36. Investors may not be able to sell the 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 without limitation:

43
Table of Contents


•
price and volume fluctuations in the overall stock market;
•
purchases of shares of our common stock pursuant to our stock 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;
•
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 securities litigation in the future, which could have substantial costs and divert resources and the attention of management from our business.
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.


44
Table of Contents


ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.

ITEM 3. Defaults Upon Senior Securities
None.

ITEM 4. Mine Safety Disclosures
Not applicable.

ITEM 5. Other Information
None.
 
ITEM 6. Exhibits


45
Table of Contents



 EXHIBIT INDEX
Exhibit
Number 
 
Exhibit Description
 
Incorporated by Reference 
 
Filing Date
 
Filed
Herewith
 
Form
 
Ex. No.  
 
File No.
 
  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*
 
Employment Agreement Letter dated February 21, 2012 between the Company and Jorge L. Titinger

 
8-K
 
10.1

 
 
000-51333
 
2/23/2012
 
 
31.1
 
Certification of Principal Executive Officer furnished pursuant to Rule 13a-14(a) or Rule
15d-14(a).
 
 
 
 
 
 
 
 
 
X
31.2
 
Certification of Principal Financial Officer furnished pursuant to Rule 13a-14(a) or Rule
15d-14(a).
 
 
 
 
 
 
 
 
 
X
32.1
 
Certifications of Principal Executive Officer and Principal Financial Officer furnished pursuant to 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
101.INS**
 
XBRL Instance Document
 
 
 
 
 
 
 
 
 
 
X
101.SCH**
 
XBRL Taxonomy Extension Schema Document
 
 
 
 
 
 
 
 
 
 
X
101.CAL**
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
 
 
 
 
 
 
 
X
101.DEF**
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
 
 
 
 
 
 
 
X
101.LAB**
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
 
 
 
 
 
 
 
X
101.PRE**
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
 
 
 
 
 
 
 
X

* Indicates a management contract or compensatory plan or arrangement
** XBRL (eXtensible Business Reporting Language) information is furnished and not filed herewith, is not a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.



46
Table of Contents


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: May 9, 2012