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SUPER MICRO COMPUTER, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report on Form 10-K, particularly under the heading "Risk Factors." Overview We are a global leader in server technology and green computing innovation. We develop and provide high performance server solutions based on an innovative, modular and open-standard architecture. Our solutions include a range of complete rackmount, workstation, storage, graphic processing unit and blade server systems, as well as subsystems and accessories which can be used by distributors, OEMs and end customers to assemble server systems. To date, we have generated the majority of our net sales from subsystems. In recent years our growth in net sales has been driven by the growth in the market for application optimized server systems. For fiscal years 2011, 2010 and 2009, net sales of optimized servers were $351.3 million, $245.2 million and $196.7 million, respectively, and net sales of subsystems and accessories were $591.3 million, $476.2 million and $309.0 million, respectively. The increase in our net sales in fiscal year 2011 compared with fiscal year 2010 was primarily attributable to the server refresh cycle and increased sales across our product lines. The growth on a percentage basis was primarily in our SuperBlade®, GPU and storage solutions. We commenced operations in 1993 and have been profitable every year since inception. For fiscal years 2011, 2010 and 2009, our net sales were $942.6 million, $721.4 million and $505.6 million, respectively, and our net income was $40.2 million, $26.9 million and $16.1 million, respectively. Our increase in profitability in fiscal year 2011 was primarily attributable to the increase in our gross profit resulting from our increased net sales and to a lesser extent to the lower effective tax rate resulting from the reinstatement of the Federal research and development tax credit in fiscal year 2011. We sell our server systems and subsystems and accessories primarily through distributors and to a lesser extent to OEMs as well as through our direct sales force. For fiscal years 2011, 2010 and 2009, we derived 56.1%, 66.7% and 64.9%, respectively, of our net sales from products sold to distributors, and we derived 43.9%, 33.3% and 35.1%, respectively, from sales to OEMs and to end customers. None of our customers accounted for 10% or more of our net sales in fiscal years 2011, 2010 or 2009. For fiscal years 2011, 2010 and 2009, we derived 58.3%, 60.1% and 64.4%, respectively, of our net sales from customers in the United States. For fiscal years 2011, 2010, and 2009, we derived 41.7%, 39.9% and 35.6%, respectively, of our net sales from customers outside the United States. We perform the majority of our research and development efforts in-house. For fiscal years 2011, 2010 and 2009, research and development expenses represented 5.1%, 5.2% and 6.8% of our net sales, respectively. We use several suppliers and contract manufacturers to design and manufacture components in accordance with our specifications, with most final assembly and testing performed at our manufacturing facility in San Jose, California. During fiscal year 2011, we continued to invest in expanding our operations both in San Jose, California and our subsidiaries in the Netherlands and Taiwan in order to support our growth. We have increased manufacturing and service operations in the Netherlands and Taiwan to support our European and Asian customers and we plan to continue expanding our overseas manufacturing capacity through fiscal year 2012. One of our key suppliers is Ablecom, a related party, which supplies us with contract design and manufacturing support. For fiscal years 2011, 2010 and 2009, our purchases from Ablecom represented 19.6%, 20.5% and 22.1% of our cost of sales, respectively. The decrease in percentage of cost of sales in fiscal year 2011 and 2010 was primarily related to server systems sales composing a higher percentage of our net sales and a change in product mix which resulted in a higher percentage of server subsystems and accessories being purchased from other suppliers. Ablecom's sales to us constitute a substantial majority of Ablecom's net sales. We continue to 37-------------------------------------------------------------------------------- Table of Contents maintain our manufacturing relationship with Ablecom in Asia in an effort to reduce our product costs and do not have any current plans to reduce our reliance on Ablecom product purchases. In addition to providing a larger volume of contract manufacturing services for us, Ablecom continues to warehouse for us a number of components and subassemblies manufactured by multiple suppliers prior to shipment to our facilities in the U.S. and Europe. We typically negotiate the price of products that we purchase from Ablecom on a quarterly basis; however, either party may re-negotiate the price of products with each order. As a result of our relationship with Ablecom, it is possible that Ablecom may in the future sell products to us at a price higher or lower than we could obtain from an unrelated third party supplier. This may result in our future reporting of gross profit as a percentage of net sales that is less than or in excess of what we might have obtained absent our relationship with Ablecom. In order to continue to increase our net sales and profits, we believe that we must continue to develop flexible and customizable server solutions and be among the first to market with new features and products. We measure our financial success based on various indicators, including growth in net sales, gross profit as a percentage of net sales, operating income as a percentage of net sales, levels of inventory, and days sales outstanding, or DSOs. In connection with these efforts, we monitor daily and weekly sales and shipment reports. Among the key non-financial indicators of our success is our ability to rapidly introduce new products and deliver the latest application optimized server solutions. In this regard, we work closely with microprocessor and other component vendors to take advantage of new technologies as they are introduced. Historically, our ability to introduce new products rapidly has allowed us to benefit from the introduction of new microprocessors and as a result we monitor the introduction cycles of Intel, AMD and Nvidia carefully. This also impacts our research and development expenditures. For example, our results for the quarter ended March 31, 2009 were in part adversely impacted by customer order delays in anticipation of the introduction of the Nehalem line of microprocessors and research and development expenditures necessary for us to prepare for the introduction. Other Financial Highlights The following is a summary of other financial highlights of fiscal year 2011: • Net cash generated (used) in operating activities was $8.5 million, ($2.2) million and $21.8 million in fiscal year 2011, 2010 and 2009, respectively. Our cash and cash equivalents, together with our investments, were $75.2 million at the end of fiscal year 2011, compare with $79.4 million at the end of fiscal year 2010. The decrease in our cash and cash equivalents, together with our investments at the end of fiscal year 2011 was primarily due to an increase in our inventory balance to support our growth and the investments in property for our expansion overseas. • Days sales outstanding in accounts receivable ("DSO") at the end of fiscal year 2011 was 30 days, consistent with the end of fiscal year 2010. • Our inventory balance was $192.7 million at the end of fiscal year 2011, compared with $135.6 million at the end of fiscal year 2010. Days sales of inventory ("DSI") at the end of fiscal year 2011 was 75 days, compared with 67 days at the end of fiscal year 2010. The increase in our inventory balance at the end of fiscal year 2011 was in part due to an increase in demand for our products resulting from a recovering economy, in part to support our growth and in part due to our increasing manufacturing activities in the Netherlands and Taiwan. Our purchase commitments with contract manufacturers and suppliers were $91.8 million at the end of fiscal year 2011 and $92.1 million at the end of fiscal year 2010. • In August 2010, we purchased land in Taiwan, consisting of approximately 4.7 acres for a total purchase price of $6.1 million. In March 2011, we drew an additional $9.9 million from our revolving line of credit and paid $9.2 million as a deposit to purchase land in Taiwan that is adjacent to the land that was purchased in August 2010. Title to this land is expected to transfer in the first half of fiscal year 2012. We are developing the land through fiscal year 2012 for manufacturing and service operations. 38 -------------------------------------------------------------------------------- Table of Contents Fiscal Year Our fiscal year ends on June 30. References to fiscal year 2011, for example, refer to the fiscal year ended June 30, 2011. Revenues and Expenses Net sales. Net sales consist of sales of our server solutions, including server systems, subsystems and accessories. The main factors which impact our net sales are unit volumes shipped and average selling prices. The prices for server systems range widely depending upon the configuration, and the prices for our subsystems and accessories vary based on the type. As with most electronics-based products, average selling prices typically are highest at the time of introduction of new products which utilize the latest technology and tend to decrease over time as such products mature in the market and are replaced by next generation products. Cost of sales. Cost of sales primarily consists of the costs to manufacture our products, including the costs of materials, contract manufacturing, shipping, personnel and related expenses, equipment and facility expenses, warranty costs and inventory excess and obsolete provisions. The primary factors that impact our cost of sales are the mix of products sold and cost of materials, which include raw material costs, shipping costs and salary and benefits related to production. Cost of sales as a percentage of net sales may increase over time if decreases in average selling prices are not offset by corresponding decreases in our costs. Our cost of sales, as a percentage of net sales, is generally lower on server systems than on subsystems and accessories. Because we do not have long-term fixed supply agreements, our cost of sales is subject to change based on market conditions. Research and development expenses. Research and development expenses consist of the personnel and related expenses of our research and development teams, and materials and supplies, consulting services, third party testing services and equipment and facility expenses related to our research and development activities. All research and development costs are expensed as incurred. We occasionally receive non-recurring engineering, or NRE funding from certain suppliers and customers. Under these programs, we are reimbursed for certain research and development costs that we incur as part of the joint development of our products and those of our suppliers and customers. These amounts offset a portion of the related research and development expenses and have the effect of reducing our reported research and development expenses. Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries and commissions for our sales and marketing personnel, costs for tradeshows, independent sales representative fees and marketing programs. From time to time, we receive cooperative marketing funding from certain suppliers. Under these programs, we are reimbursed for certain marketing costs that we incur as part of the joint promotion of our products and those of our suppliers. These amounts offset a portion of the related expenses and have the effect of reducing our reported sales and marketing expenses. Similarly, we from time to time offer our distributors cooperative marketing funding which has the effect of increasing our expenses. The timing, magnitude and estimated usage of our programs and those of our suppliers can result in significant variations in reported sales and marketing expenses from period to period. Spending on cooperative marketing, either by us or our suppliers, typically increases in connection with significant product releases by us or our suppliers. General and administrative expenses. General and administrative expenses consist primarily of general corporate costs, including personnel expenses, financial reporting, corporate governance and compliance and outside legal, audit and tax fees. Provision for litigation loss. Loss from litigation relates to an action filed in France by Digitechnic, S.A., a former customer. The Company entered into a settlement agreement with Digitechnic, pursuant to which the Company made a payment of $1.1 million in December 2009. Interest and other income, net. Interest and other income, net represents the net of our interest income on investments or interest expense on the building loans or letters of credit for our owned facilities offset by interest earned on our cash balances. 39 -------------------------------------------------------------------------------- Table of Contents Income tax provision. Our income tax provision is based on our taxable income generated in the jurisdictions in which we operate, currently primarily the United States and the Netherlands and to a lesser extent, Taiwan. Our effective tax rate differs from the statutory rate primarily due to research and development tax credits and the domestic production activities deduction which were partially offset by the impact of state taxes and stock option expenses. A reconciliation of the federal statutory income tax rate to our effective tax rate is set forth in Note 12 of Notes to Consolidated Financial Statements. Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. We evaluate our estimates on an on-going basis, including those related to allowances for doubtful accounts and sales returns, cooperative marketing accruals, investment valuations, inventory valuations, income taxes, warranty obligations and stock-based compensation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making the judgments we make about the carrying values of assets and liabilities that are not readily apparent from other sources. Because these estimates can vary depending on the situation, actual results may differ from the estimates. We believe the following are our most critical accounting policies as they require our more significant judgments in the preparation of our financial statements. Revenue recognition. We recognize revenue from sales of products, when persuasive evidence of an arrangement exists, shipment has occurred and title has transferred, the sales price is fixed or determinable, collection of the resulting receivable is reasonably assured, and all significant obligations have been met. Generally this occurs at the time of shipment when risk of loss and title has passed to the customer. Our standard arrangement with our customers includes a signed purchase order or contract, 30 to 60 days payment terms, Ex-works terms, except for a few customers who have free-on-board destination terms or customer acceptance provisions, and revenue is recognized when the products arrive or are accepted at the destination. We generally do not provide for non-warranty rights of return except for products which have "Out-of-box" failure, where customers could return these products for credit within 30 days of receiving the items. Certain distributors and OEMs are also permitted to return products in unopened boxes, limited to purchases over a specified period of time, generally within 60 to 90 days of the purchase, or to products in the distributor's or OEM's inventory at certain times (such as the termination of the agreement or product obsolescence). In addition, we have a sale arrangement with an OEM that has limited product return rights. To estimate reserves for future sales returns, we regularly review our history of actual returns for each major product line. We also communicate regularly with our distributors to gather information about end customer satisfaction, and to determine the volume of inventory in the channel. Reserves for future returns are adjusted as necessary, based on returns experience, returns expectations and communication with our distributors. In addition, certain customers have acceptance provisions and revenue is deferred until the customers provide the necessary acceptance. At June 30, 2011 and 2010, we had deferred revenue of $2.4 million and $1.3 million and related deferred product costs of $1.9 million and $1.3 million, respectively, related to shipments to customers pending acceptances. Probability of collection is assessed on a customer-by-customer basis. Customers are subjected to a credit review process that evaluates the customers' financial position and ability to pay. If it is determined from the outset of an arrangement that collection is not probable based upon the review process, the customers are required to pay cash in advance of shipment. We also make estimates of the uncollectibility of accounts receivables, analyzing accounts receivable and historical bad debts, customer concentrations, customer-credit-worthiness, current economic trends and changes in customer payment terms to evaluate the adequacy of the 40-------------------------------------------------------------------------------- Table of Contents allowance for doubtful accounts. On a quarterly basis, we evaluate aged items in the accounts receivable aging report and provide an allowance in an amount we deem adequate for doubtful accounts. If management were to make different judgments or utilize different estimates, material differences in the amount of our reported operating expenses could result. We provide for price protection to certain distributors. We assess the market competition and product technology obsolescence, and make price adjustments based on our judgment. Upon each announcement of price reductions, the accrual for price protection is calculated based on our distributors' inventory on hand. Such reserves are recorded as a reduction to revenue at the time we reduce the product prices. We have an immaterial amount of service revenue relating to non-warranty repairs, which is recognized upon shipment of the repaired units to customers. Service revenue has been less than 10% of net sales for all periods presented and is not separately disclosed. Cooperative marketing accruals. We have arrangements with resellers of our products to reimburse the resellers for cooperative marketing costs meeting specified criteria. We accrue the cooperative marketing costs based on these arrangements and our estimate for resellers' claims for marketing activities. We record marketing costs meeting such specified criteria within sales and marketing expenses in the accompanying condensed consolidated statements of operations. For those marketing costs that do not meet the specified criteria, the amounts are recorded as a reduction to sales in the accompanying condensed consolidated statements of operations. Impairment of short-term and long-term investments. Impairment of short-term and long-term investments relates to the unrealized loss on the carrying value of our investments in auction rate securities; such securities were rated AAA at the date of purchase. The liquidity and fair value of these securities has been negatively impacted by the uncertainty in the credit markets and exposure of these securities to the financial condition of bond insurance companies. We have received all interest payments due on these instruments on a timely basis. Each of these securities has been subject to auction processes for which there has been insufficient bidders on the scheduled rollover dates and the auctions have subsequently failed. When these securities lost the short-term liquidity previously provided by the auction processes, we reclassified these securities as long-term investments. For the securities with the stated maturity less than a year, the securities were classified as short-term available-for-sale investments. We have used a discounted cash flow model to estimate the fair value of these investments as of June 30, 2011 and 2010. The material factors used in preparing the discounted cash flow model are 1) the discount rate utilized to present value the cash flows, 2) the time period until redemption and 3) the estimated rate of return. Management derives the estimates by obtaining input from market data on the applicable discount rate, estimated time to maturity and estimated rate of return. The changes in fair value have been primarily due to changes in the estimated rate of return and a change in the estimated period to liquidity. The fair value of our investment portfolio may change between 2% to 3% by increasing or decreasing the rate of return used by 1% or by increasing or decreasing the term used by 1 year. Changes in these estimates or in the market conditions for these investments are likely in the future based upon the then current market conditions for these investments and may affect the fair value of these investments. As of June 30, 2011 and 2010 we have recorded an accumulated unrealized loss of $0.2 million, net of deferred income taxes, on the securities. We deem this loss to be temporary as we determined that we will not likely be required to sell the securities before their anticipated recovery and we have the intent and ability to hold our investments until recovery of cost. Product warranties. We offer product warranties ranging from 15 to 39 months against any defective product. We accrue for estimated returns of defective products at the time revenue is recognized, based on historical warranty experience and recent trends. We monitor warranty obligations and may make revisions to our warranty reserve if actual costs of product repair and replacement are significantly higher or lower than estimated. Accruals for anticipated future warranty costs are charged to cost of sales and included in accrued liabilities. The liability for product warranties was $4.7 million as of June 30, 2011, compared with $4.6 million as of June 30, 2010. The provision for warranty reserve was $9.6 million, $8.5 million and $6.7 million in fiscal years 2011, 2010 and 2009, respectively. Our estimates and assumptions used have been historically close to actual. The change in estimated liability for pre-existing warranties was ($0.9) million, ($0.9) million and $0.3 41-------------------------------------------------------------------------------- Table of Contents million in fiscal years 2011, 2010 and 2009, respectively. As we experienced an increase in net sales in fiscal year 2011, the provision for warranty reserve increased $1.1 million compared to fiscal year 2010. As we experienced an increase in net sales in fiscal year 2010, the provision for warranty reserve increased $1.8 million compared to fiscal year 2009. If in future periods, we experience or anticipate an increase or decrease in warranty claims as a result of new product introductions or change in unit volumes compared with our historical experience, or if the cost of servicing warranty claims is greater or lesser than expected, we intend to adjust our estimates appropriately. Inventory valuation. Inventory is valued at the lower of cost or market. We evaluate inventory on a quarterly basis for lower of cost or market and excess and obsolescence and, as necessary, write down the valuation of units to lower of cost or market or for excess and obsolescence based upon the number of units that are unlikely to be sold based upon estimated demand for the following twelve months. This evaluation takes into account matters including expected demand, anticipated sales price, product obsolescence and other factors. If actual future demand for our products is less than currently forecasted, additional inventory adjustments may be required. Once a reserve is established, it is maintained until the product to which it relates is sold or scrapped. If a unit that has been written down is subsequently sold, the cost associated with the revenue from this unit is reduced to the extent of the write down, resulting in an increase in gross profit. We monitor the extent to which previously written down inventory is sold at amounts greater or less than carrying value, and based on this analysis, adjust our estimate for determining future write downs. If in future periods, we experience or anticipate a change in recovery rate compared with our historical experience, our gross margin would be affected. Our provision for inventory was $3.4 million, $2.6 million and $1.5 million in fiscal years 2011, 2010 and 2009, respectively. Accounting for income taxes. We account for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net operating loss carry-forwards and other tax credits measured by applying currently enacted tax laws. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized. We recognize the tax liability for uncertain income tax positions on the income tax return based on the two-step process. The first step is to determine whether it is more likely than not that each income tax position would be sustained upon audit. The second step is to estimate and measure the tax benefit as the amount that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority. Estimating these amounts requires us to determine the probability of various possible outcomes. We evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on the consideration of several factors, including changes in facts or circumstances, changes in applicable tax law, settlement of issues under audit and new exposures. If we later determine that our exposure is lower or that the liability is not sufficient to cover our revised expectations, we adjust the liability and effect a related change in our tax provision during the period in which we make such determination. See Note 12 of Notes to Consolidated Financial Statements for the impact on our consolidated financial statements. Stock-based compensation. Effective July 1, 2006, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period. Prior to July 1, 2006, we have recorded compensation expense for stock options with exercise prices less than the fair value of the underlying common stock at the option grant date. Amortization of deferred stock compensation, resulting from such stock options granted to employees and directors, when the exercise price of our stock options was less than the deemed market price of the underlying stock on the date of the grant, for the years ended June 30, 2011, 2010 and 2009, was $0, $0.1 million and $0.6 million, respectively. Since July 1, 2006, the Company measures the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period). 42-------------------------------------------------------------------------------- Table of Contents Compensation expense for options granted to employees after July 1, 2006, was $8.1 million, $6.3 million and $5.1 million for the years ended June 30, 2011, 2010 and 2009, respectively. As of June 30, 2011, the total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested stock options granted since July 1, 2006 to employees and non-employee directors, was $18.2 million, which is expected to be recognized as an expense over a weighted-average period of approximately 2.42 years. See Note 11 of Notes to our Consolidated Financial Statements for additional information. We estimated the fair value of stock options granted using a Black-Scholes option-pricing model and a single option award approach. This model requires us to make estimates and assumptions with respect to the expected term of the option, the expected volatility of the price of our common stock and the expected forfeiture rate. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period. The expected term represents the period that our stock-based awards are expected to be outstanding and was determined based on an analysis of the relevant peer companies' post-vest termination rates and exercise behavior. The expected volatility is based on a combination of the implied and historical volatility of our relevant peer group for the stock options granted prior to September 30, 2009. For stock options granted after September 30, 2009, expected volatility is based solely on our historical volatility. In addition, forfeitures of share-based awards are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. Variable interest entities. In June 2009, the FASB issued authoritative guidance on the consolidation of variable interest entities, which is effective for fiscal years beginning after November 15, 2009 and interim periods therein and thereafter. The new guidance requires revised evaluations of whether entities represent variable interest entities, ongoing assessments of control over such entities, and additional disclosures for variable interests. We adopted this standard and have analyzed our relationship with Ablecom and its subsidiaries (collectively "Ablecom"). We have concluded that Ablecom is a variable interest entity in accordance with applicable accounting standards and guidance; however, we are not the primary beneficiary of Ablecom and therefore, we do not consolidate Ablecom. In performing our analysis, we considered our explicit arrangements with Ablecom including the supplier and distributor arrangements. Also, as a result of the substantial related party relationship between the two companies, we considered whether any implicit arrangements exist that would cause us to protect those related parties' interests in Ablecom from suffering losses. We determined that no implicit arrangements exist with Ablecom or its shareholders. Such an arrangement would be inconsistent with the fiduciary duty that we have towards our stockholders who do not own shares in Ablecom. 43-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth our financial results, as a percentage of net sales for the periods indicated: Years Ended June 30, 2011 2010 2009 Net sales 100.0 % 100.0 % 100.0 % Cost of sales 84.0 84.1 82.5 Gross profit 16.0 15.9 17.5 Operating expenses: Research and development 5.1 5.2 6.8 Sales and marketing 2.8 2.8 3.4 General and administrative 1.9 2.1 2.7 Provision for litigation loss 0.0 0.2 0.0 Total operating expenses 9.8 10.3 12.9 Income from operations 6.2 5.6 4.6 Interest and other income, net 0.0 0.0 0.1 Interest expense (0.0 ) (0.0 ) (0.2 ) Income before income tax provision 6.2 5.6 4.5 Income tax provision 1.9 1.9 1.3 Net income 4.3 % 3.7 % 3.2 % Comparison of Fiscal Years Ended June 30, 2011 and 2010 Net sales. Net sales increased by $221.1 million, or 30.7%, to $942.6 million from $721.4 million, for fiscal year 2011 and 2010, respectively. This increase was due primarily to an increase in unit volumes of server systems and subsystems and accessories and an increase in average selling prices of server systems. For fiscal year 2011, the number of units sold increased 40.5% to 4.8 million compared to 3.4 million for fiscal year 2010. For fiscal year 2011, the number of server system units sold increased 25.6% to 221,000 compared to 176,000 for fiscal year 2010. The average selling price of server system units increased 14.3% to $1,600 in fiscal year 2011 compared to $1,400 in fiscal year 2010. The average selling prices of our server systems increased principally due to an increase in our sales of complete integrated, high-end server solutions to OEM and end customers and higher average selling prices of 1000, 6000 and 7000 Series configuration of servers which incorporated additional features such as higher density, memory and hard disk drive capacity and higher average selling prices of SuperBlades® offset in part by declines in average selling prices of more mature products. Sales of server systems increased by $106.1 million or 43.3% from fiscal year 2010 to fiscal year 2011, primarily due to higher sales of OEM and end customers, higher sales of SuperBaldes®, higher sales of 1000, 2000, 6000 and 7000 Series configuration of servers including storage and GPU solutions offset in part by lower sales of more mature products. Sales of server systems represented 37.3% of our net sales for fiscal year 2011 compared to 34.0% of our net sales for fiscal year 2010. For fiscal year 2011, the number of subsystems and accessories units sold increased 41.3% to 4.6 million compared to 3.3 million for fiscal year 2010. Sales of subsystems and accessories increased by $115.1 million or 24.2% from fiscal year 2010 to fiscal year 2011, primarily due to higher sales of bundled server solutions to OEM and system integrators who increasingly are purchasing additional accessories from us and completing the final assembly themselves. Sales of subsystems and accessories represented 62.7% of our net sales for fiscal year 2011 as compared to 66.0% of our net sales for fiscal year 2010. For fiscal year 2011 and 2010, we derived 56.1% and 66.7%, respectively, of our net sales from products sold to distributors and we derived 43.9% and 33.3%, respectively, from sales to OEMs and to end customers. For fiscal year 2011, customers in the United 44 -------------------------------------------------------------------------------- Table of Contents States, Europe and Asia accounted for 58.3%, 21.4% and 16.9%, of our net sales, respectively, as compared to 60.1%, 21.7% and 14.8%, respectively, for fiscal year 2010. Cost of sales. Cost of sales increased by $185.0 million, or 30.5%, to $791.5 million from $606.4 million, for fiscal year 2011 and 2010, respectively. Cost of sales as a percentage of net sales was 84.0% and 84.1% for fiscal year 2011 and 2010, respectively. The increase in absolute dollars of cost of sales was primarily attributable to the increase in net sales, an increase of $7.3 million in freight-in charges, an increase of $1.1 million in provision for warranty reserve and an increase of $0.7 million in provision for inventory reserve. The lower cost of sales as a percentage of net sales was primarily due to an increase in sales of server systems and an increase in sales to OEM and end customers. In fiscal year 2011, we recorded a $9.6 million expense, or 1.0% of net sales, related to the provision for warranty reserve as compared to $8.5 million, or 1.2% of net sales, in fiscal year 2010. The increase in the provision for warranty reserve was primarily due to higher net sales in fiscal year 2011. If in future periods we experience or anticipate an increase or decrease in warranty claims as a result of new product introductions or change in unit volumes compared with our historical experience, or if the cost of servicing warranty claims is greater or lesser than expected, our gross margin would be affected. In fiscal year 2011, we recorded a $3.4 million expense, or 0.4% of net sales, related to the inventory provision as compared to $2.6 million, or 0.4% of net sales, in fiscal year 2010. The increase in the inventory provision was primarily for older products as a result of product transitions. Research and development expenses. Research and development expenses increased by $10.7 million, or 28.7%, to $48.1 million from $37.4 million, for fiscal year 2011 and 2010, respectively. Research and development expenses were 5.1% and 5.2% of net sales for fiscal year 2011 and 2010, respectively. The increase in absolute dollars was primarily due to an increase of $8.5 million in compensation and benefits resulting from growth in research and development personnel, including higher stock-based compensation expense related to expanded product development initiatives in the U.S. and in Taiwan, an increase of $3.0 million in development costs associated with new products offset in part by an increase of $0.8 million in non-recurring engineering funding from certain suppliers and customers. Research and development expenses include stock-based compensation expense of $4.1 million and $3.1 million for fiscal year 2011 and 2010, respectively. Sales and marketing expenses. Sales and marketing expenses increased by $6.4 million, or 31.3%, to $26.9 million from $20.5 million, for fiscal year 2011 and 2010, respectively. Sales and marketing expenses were 2.8% of net sales for both fiscal year 2011 and 2010. The increase in absolute dollars was primarily due to an increase of $4.3 million in compensation and benefits resulting from growth in sales and marketing personnel, including higher stock-based compensation expense, an increase of $1.1 million in advertising and promotion expense, an increase of $0.6 million in cooperative marketing funding to customers and an increase of $0.4 million in trade show and travel expenses. Sales and marketing expenses include stock-based compensation expense of $1.1 million and $0.9 million for fiscal year 2011 and 2010, respectively. General and administrative expenses. General and administrative expenses increased by $2.1 million, or 13.9%, to $17.4 million from $15.3 million, for fiscal year 2011 and 2010, respectively. General and administrative expenses were 1.9% and 2.1% of net sales for fiscal year 2011 and 2010, respectively. The increase in absolute dollars was primarily due to an increase of $2.4 million in compensation and benefits, including higher stock-based compensation expense, in part to support the expansion of our operations at our headquarters and operations in Taiwan, an increase of $0.6 million in customs fee accrual related to prior periods, an increase of $0.4 million in legal fees offset in part by an increase of $1.0 million in rental income and an increase of $0.6 million in foreign currency transaction gain. General and administrative expenses include stock-based compensation expense of $2.1 million and $1.9 million for fiscal year 2011 and 2010, respectively. 45-------------------------------------------------------------------------------- Table of Contents Provision for litigation loss. There was no loss from litigation expense for fiscal year 2011. For fiscal year 2010, there was a $1.1 million expense due to a settlement payment related to the Digitechnic lawsuit. (See Note 13 of Notes to Consolidated Financial Statements.) Interest and other expense, net. Interest and other expense changed by $0.3 million, to $0.6 million of expense from $0.3 million of expense, for fiscal year 2011 and 2010, respectively, which included $0.7 million and $0.4 million of interest expense for fiscal year 2011 and 2010, respectively. The net change was primarily due to higher interest expense as our average debt outstanding for fiscal year 2011 was $21.5 million versus $2.5 million in fiscal year 2010. Interest rates were not significantly different in fiscal year 2011 compared to 2010. We expect that our interest expenses will increase in the future as we plan to obtain additional financing from banks to fund the construction of the Taiwan facilities and the expansion of our headquarters office in San Jose. Provision for income taxes. Provision for income taxes increased by $4.3 million, or 31.8%, to $17.9 million from $13.6 million, for the fiscal year 2011 and 2010, respectively. The effective tax rate was 30.8% and 33.5% for fiscal year 2011 and 2010, respectively. The effective tax rate was lower for fiscal year 2011 primarily due to the reinstatement of Federal research and development tax credits and domestic production activities deduction which were partially offset by the impact of state taxes and stock option expenses. Comparison of Fiscal Years Ended June 30, 2010 and 2009 Net sales. Net sales increased by $215.8 million, or 42.7%, to $721.4 million from $505.6 million, for fiscal year 2010 and 2009, respectively. This increase was due primarily to an increase in unit volumes of subsystems and accessories and average selling prices of server systems. For fiscal year 2010, the number of units sold increased 54.4% to 3.4 million compared to 2.2 million for fiscal year 2009. For fiscal year 2010, the number of server system units sold increased 12.1% to 176,000 compared to 157,000 for fiscal year 2009. The average selling price of server system units increased 12.0% to $1,400 in fiscal year 2010 compared to $1,250 in fiscal year 2009. The average selling prices of our server systems increased principally due to higher average selling prices of our 6000 Series configuration of servers which incorporated additional features offset in part by declines in average selling prices of more mature products. Sales of server systems increased by $48.6 million or 24.7% from fiscal year 2009 to fiscal year 2010, primarily due to higher sales of our 6000 Series configuration of servers and higher sales to system integrators offset in part by lower sales of more mature products. Sales of server systems represented 34.0% of our net sales for fiscal year 2010 compared to 38.9% of our net sales for fiscal year 2009. For fiscal year 2010, the number of subsystems and accessories units sold increased 57.6% to 3.3 million compared to 2.1 million for fiscal year 2009. Sales of subsystems and accessories increased by $167.3 million or 54.1% from fiscal year 2009 to fiscal year 2010, primarily due to higher sales to distributors, resellers and system integrators who increasingly are purchasing additional accessories from us and completing the final assembly themselves. Sales of subsystems and accessories represented 66.0% of our net sales for fiscal year 2010 as compared to 61.1% of our net sales for fiscal year 2009. For fiscal year 2010 and 2009, we derived 66.7% and 64.9%, respectively, of our net sales from products sold to distributors and we derived 33.3% and 35.1%, respectively, from sales to OEMs and to end customers. For fiscal year 2010, customers in the United States, Europe and Asia accounted for 60.1%, 21.7% and 14.8%, of our net sales, respectively, as compared to 64.4%, 21.5% and 11.2%, respectively, for fiscal year 2009. Cost of sales. Cost of sales increased by $189.5 million, or 45.5%, to $606.4 million from $416.9 million, for fiscal year 2010 and 2009, respectively. Cost of sales as a percentage of net sales was 84.1% and 82.5% for fiscal year 2010 and 2009, respectively. The increase in absolute dollars of cost of sales was primarily attributable to the increase in net sales, an increase of $3.3 million in freight-in charges, an increase of $1.8 million in provision for warranty reserve and an increase of $1.2 million in provision for inventory reserve. The higher cost of sales as a percentage of net sales was primarily due to a lower percentage of sales from server systems and a higher percentage of sales of subsystem and accessories and increased sales to distributors, 46-------------------------------------------------------------------------------- Table of Contents resellers and system integrators. In fiscal year 2010, we recorded a $8.5 million expense, or 1.2% of net sales, related to the provision for warranty reserve as compared to $6.7 million, or 1.3% of net sales, in fiscal year 2009. The increase in the provision for warranty reserve was primarily due to higher net sales in fiscal year 2010. If in future periods we experience or anticipate an increase or decrease in warranty claims as a result of new product introductions or change in unit volumes compared with our historical experience, or if the cost of servicing warranty claims is greater or lesser than expected, our gross margin would be affected. In fiscal year 2010, we recorded a $2.6 million expense, or 0.4% of net sales, related to the inventory provision as compared to $1.5 million, or 0.3% of net sales, in fiscal year 2009. The increase in the inventory provision was primarily for older products as a result of product transitions. Research and development expenses. Research and development expenses increased by $2.9 million, or 8.3%, to $37.4 million from $34.5 million, for fiscal year 2010 and 2009, respectively. Research and development expenses were 5.2% and 6.8% of net sales for fiscal year 2010 and 2009, respectively. The increase in absolute dollars was primarily due to an increase of $4.0 million in compensation and benefits resulting from growth in research and development personnel, including higher stock-based compensation expense to support the expansion of our operations at our headquarters and operations in the Netherlands and Taiwan and a decrease of $0.2 million in non-recurring engineering funding from certain suppliers and customers. This increase was offset in part by a decrease of $1.3 million in development costs associated with new products. Research and development expenses include stock-based compensation expense of $3.1 million and $2.6 million for fiscal year 2010 and 2009, respectively. Sales and marketing expenses. Sales and marketing expenses increased by $3.3 million, or 19.5%, to $20.5 million from $17.1 million, for fiscal year 2010 and 2009, respectively. Sales and marketing expenses were 2.8% and 3.4% of net sales for fiscal year 2010 and 2009, respectively. The increase in absolute dollars was primarily due to an increase of $2.0 million in compensation and benefits resulting from growth in sales and marketing personnel, including higher stock-based compensation expense, a decrease of $0.4 million in cooperative marketing funding from vendors, an increase of $0.4 million in advertising and promotion expenses and an increase of $0.3 million in trade show expenses. Sales and marketing expenses include stock-based compensation expense of $0.9 million and $0.8 million for fiscal year 2010 and 2009, respectively. General and administrative expenses. General and administrative expenses increased by $1.5 million, or 10.8%, to $15.3 million from $13.8 million, for fiscal year 2010 and 2009, respectively. General and administrative expenses were 2.1% and 2.7% of net sales for fiscal year 2010 and 2009, respectively. The increase in absolute dollars was primarily due to an increase of $0.9 million in compensation and benefits, including higher stock-based compensation expense, in part to support the expansion of our operations at our headquarters and operations in the Netherlands and Taiwan and an increase of $0.5 million in bad debt expenses. General and administrative expenses include stock-based compensation expense of $1.9 million and $1.6 million for fiscal year 2010 and 2009, respectively. Provision for litigation loss. Loss from litigation was $1.1 million for fiscal year 2010. There was no provision for fiscal year 2009. The provision was due to a settlement payment related to the Digitechnic lawsuit. (See Note 13 of Notes to Consolidated Financial Statements.) Interest and other expense, net. Interest and other expense was reduced by $0.2 million, to $0.3 million of expense from $0.5 million of expense, for fiscal year 2010 and 2009, respectively, of which $0.4 million and $0.9 million was interest expense for fiscal year 2010 and 2009, respectively. The net change was due to lower interest income of $0.4 million resulting from lower interest rates and lower interest expense of $0.5 million as the Company paid off two outstanding building loans in July and August 2009. We expect the interest expenses 47 -------------------------------------------------------------------------------- Table of Contents will increase in the future as we have borrowed $18.6 million to purchase properties in San Jose, California in June 2010 and intend to obtain additional financing to purchase land and to fund building construction in Taiwan in fiscal year 2011. Provision for income taxes. Provision for income taxes increased by $6.9 million, or 102.5%, to $13.6 million from $6.7 million, for the fiscal year 2010 and 2009, respectively. The effective tax rate was 33.5% and 29.4% for fiscal year 2010 and 2009, respectively. The increase in the effective tax rate was primarily due to the expiration of the federal research and development tax credit in fiscal year 2010. Liquidity and Capital Resources Since our inception, we have financed our growth primarily with funds generated from operations and from the proceeds of our initial public offering. Our cash and cash equivalents and short-term investments were $70.0 million and $73.5 million as of June 30, 2011 and 2010, respectively. Operating Activities. Net cash provided by (used in) operating activities was $8.5 million, ($2.2) million and $21.8 million for fiscal years 2011, 2010 and 2009, respectively. Net cash provided by our operating activities for fiscal year 2011 was primarily due to our net income of $40.2 million, an increase in accounts payable of $16.9 million, stock-based compensation expense of $8.1 million, allowance for sales returns of $6.6 million, an increase in net income taxes payable of $5.7 million, depreciation expense of $5.5 million, an increase in accrued liabilities of $5.3 million, which was partially offset by an increase in inventory of $60.5 million and an increase in accounts receivable of $19.2 million. Net cash used in our operating activities for fiscal year 2010 was primarily due to our net income of $26.9 million, an increase in accounts payable of $21.8 million, an increase in net income taxes payable of $9.5 million, stock-based compensation expense of $6.5 million, an increase in accrued liabilities of $5.5 million and allowance for sales returns of $5.3 million which were offset by an increase in inventory of $48.2 million and an increase in accounts receivable of $33.3 million. Net cash provided by our operating activities for fiscal year 2009 was primarily due to our net income of $16.1 million, stock-based compensation expense of $5.7 million, an increase in net income taxes payable of $4.8 million and allowance for sales returns of $4.2 million which was substantially offset by a decrease in accounts payable of $6.9 million and an increase in inventory of $5.8 million. The increase for fiscal year 2011 in accounts receivable was primarily due to higher net sales during fiscal year 2011. The increase for fiscal year 2011 in inventory, accounts payable and accrued liabilities was in part due to an increase in demand for our products resulting from a recovering economy, in part to support our growth and in part due to our increasing manufacturing activities in the Netherlands and Taiwan. We anticipate that accounts receivable, sales returns, inventory and accounts payable will continue to increase to the extent we continue to grow our product lines and our business. The increase for fiscal year 2010 in accounts receivable was primarily due to higher net sales during fiscal year 2010. The increase for fiscal year 2010 in inventory, accounts payable and accrued liabilities was due to an increase in demand for our products resulting from a recovering economy and to support the growth of the Company. The decrease for fiscal year 2009 in sales returns was primarily due to lower net sales during fiscal year 2009 as a result of reductions in information technology spending in response to the global economic downturn and to a lesser extent was impacted by delayed customer orders in anticipation of the release by Intel of its Nehalem line of microprocessors in the quarter ended March 31, 2009. The decrease for fiscal year 2009 in accounts payable was primarily due to timing of payments to our vendors. The increase for fiscal year 2009 in inventory was primarily due to our increased purchases of X8 Nehalem products which were launched at the end of March 31, 2009. Investing activities. Net cash used in our investing activities was $24.8 million, $11.8 million and $2.7 million for fiscal years 2011, 2010 and 2009, respectively. In fiscal year 2011, $16.2 million was related to the 48-------------------------------------------------------------------------------- Table of Contents purchase of property, plant and equipment including $6.1 million related to the land purchased in Taiwan in August 2010 and $9.2 million was related to a deposit made in March 2011 for land in Taiwan. This was offset by the redemption at par of investments in auction rate securities of $1.5 million. In fiscal year 2010, $22.2 million was related to the purchase of property, plant and equipment offset in part by the redemption at par of investments in auction rate securities of $8.9 million. In fiscal year 2009, $3.6 million was related to the purchase of property, plant and equipment offset in part by the redemption at par of investments in auction rate securities of $0.9 million. We anticipate to close the title on the land deposit in Taiwan and finalize the purchase price, consisting of approximately 2.2 acres, in the first half of fiscal year 2012 to develop our manufacturing and service operations in Asia. We also plan to expand our headquarters office in San Jose, California. The construction of the Taiwan facilities and the headquarters office expansion in San Jose, California began in the fourth quarter of fiscal year 2011 and will continue through fiscal year 2012. The anticipated costs for the next twelve months to build the Taiwan facilities and the headquarters office expansion in San Jose, California are approximately $16.9 million. We plan to finance these projects through our operating cash flows and additional financing from banks in fiscal year 2012. Financing activities. Net cash provided by (used in) our financing activities was $13.6 million, $16.3 million and ($0.3) million for fiscal years 2011, 2010 and 2009, respectively. In fiscal year 2011, we received $10.3 million related to the proceeds from the exercise of stock options. We withheld shares and paid the minimum tax withholding on behalf of several executive officers and an employee for their stock options and restricted stock awards of $8.4 million for fiscal year 2011. Further, we obtained a new term loan of $13.9 million and borrowed $9.9 million of our revolving line of credit. We repaid $14.1 million in loans for fiscal year 2011. We expect the net cash provided by financing activities will increase in the quarter ending September 30, 2011 as we intend to obtain additional financing from banks to construct our manufacturing building in Taiwan and support our building expansion in San Jose, California. In fiscal year 2010, $18.6 million was related to proceeds from the revolving line of credit associated with the purchase of three buildings and $6.4 million was proceeds from exercise of stock options and $1.5 million was related to the excess tax benefits from stock-based compensation. In fiscal year 2009, we repurchased 445,028 shares of treasury stock for $2.0 million and received $2.1 million of proceeds from the exercise of stock options. We expect to experience continued growth in our working capital requirements and capital expenditures as we continue to expand our business. We intend to fund this continued expansion through cash generated by operations and by drawing on the revolving credit facility or through other debt financing. However we cannot be certain whether such financing will be available on commercially reasonable or otherwise favorable terms or that such financing will be available at all. We anticipate that working capital and capital expenditures will constitute a material use of our cash resources. We have sufficient cash on hand to continue to operate in the next 12 months. Other factors affecting liquidity and capital resources As of June 30, 2011, we had a revolving line of credit totaling $25.0 million that matures on June 15, 2013 with an interest rate at the LIBOR rate plus 1.50% per annum. In June 2010, we used $18.6 million of the line of credit to purchase three buildings with approximately 167,000 square feet of space in San Jose, California adjacent to our headquarters. The loan is secured by all our assets except for the three buildings purchased in San Jose, California, and we were required to obtain a mortgage loan to pay-off this line of credit by December 2010. In December 2010, we repaid $13.9 million of the line of credit by obtaining a term loan for the same amount and the remaining $4.7 million of the line of credit has been extended to be repaid by June 15, 2013. The term loan is secured by the three buildings purchased in San Jose, California in June 2010 and the principal and interest are payable monthly through October 1, 2013 with an interest rate at the LIBOR rate plus 1.75% per annum. The LIBOR rate was 0.19% at June 30, 2011. 49 -------------------------------------------------------------------------------- Table of Contents In March 2011, we drew an additional $9.9 million of the line of credit with an interest rate equal to the lender's established interest rate which is adjusted monthly and paid $9.2 million for a deposit to purchase land in Taiwan. The interest rate was 1.64% at June 30, 2011. As of June 30, 2011 and June 30, 2010, the total outstanding borrowing under these loans was $28.2 million and $18.6 million, respectively. As of June 30, 2011, the unused revolving line of credit was $10.4 million and we were not in compliance with the investment covenant associated with these loans; however, we obtained waivers as of June 30, 2011 from the lenders in August 2011 regarding such non-compliance. In addition, we have historically paid our contract manufacturers within 38 to 76 days of invoice and Ablecom between 53 and 100 days of invoice. As of June 30, 2011 and 2010 amounts owed to Ablecom by us were $34.2 million and $19.5 million, respectively. In February 2008, we leased an office building of approximately 246,000 square feet in Fremont, California with total payment obligations of $6.8 million over the next 4.1 years as of June 30, 2011. We also obtained an irrevocable standby letter of credit required by the landlord of the office lease totaling $121,000. This amount has been classified as a restricted cash as of June 30, 2011. As of June 30, 2011, we held $5.2 million of auction rate securities, net of unrealized losses, representing our interest in auction rate preferred shares in a closed end mutual fund invested in municipal securities and auction rate student loans guaranteed by the Federal Family Education Loan Program; such auction rate securities were rated AAA or BAA at June 30, 2011. These auction rate preferred shares have no stated maturity date and stated maturity dates for these auction rate student loans range from 2035 to 2040. During February 2008, the auctions for these auction rate securities began to fail to obtain sufficient bids to establish a clearing rate and were not saleable in the auction, thereby losing the short-term liquidity previously provided by the auction process. As a result, as of June 30, 2011, $5.2 million of these auction rate securities have been classified as long-term available-for-sale investments. Based on our assessment of fair value at June 30, 2011, we have recorded an accumulated unrealized loss of $0.2 million, net of deferred income taxes, on long-term auction rate securities. The unrealized loss was deemed to be temporary and has been recorded as a component of accumulated other comprehensive loss. Although we have determined that we will not likely be required to sell the securities before the anticipated recovery and we have the intent and ability to hold these investments until successful auctions occur, these investments are not currently liquid and in the event we need to access these funds, we will not be able to do so without a loss of principal. There can be no assurances that these investments will be settled in the short term or that they will not become other-than-temporarily impaired subsequent to June 30, 2011, as the market for these investments is presently uncertain. In any event, we do not have a present need to access these funds for operational purposes. We will continue to monitor and evaluate these investments as there is no assurance as to when the market for these investments will allow us to liquidate them. We may be required to record impairment charges in periods subsequent to June 30, 2011 with respect to these securities and, if a liquid market does not develop for these investments, we could be required to hold them to maturity. In fiscal year 2011, 2010 and 2009, $1.5 million, $8.9 million and $0.9 million of these auction rate securities were redeemed at par, respectively. Our long-term future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support our product development efforts, the expansion of sales and marketing activities, the timing of our introductions of new products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products. We could be required, or could elect, to seek additional funding through public or private equity or debt financing and additional funds may not be available on terms acceptable to us or at all. 50-------------------------------------------------------------------------------- Table of Contents Contractual Obligations The following table describes our contractual obligations as of June 30, 2011: Payments Due by Period Less Than 1 to 3 3 to 5 More Than 1 Year Years Years 5 Years Total (in thousands) Operating leases $ 3,210 $ 4,609 $ 2,859 $ 32 $ 10,710 Capital leases, including interest 41 51 5 - 97 Long-term debt, including interest (1) 827 27,942 - - 28,769 License arrangements 511 911 228 - 1,650 Purchase commitments (2) 91,812 - - - 91,812 Total $ 96,401 $ 33,513 $ 3,092 $ 32 $ 133,038 (1) Amount reflects total anticipated cash payments, including anticipated interest payments based on the interest rate at June 30, 2011. (2) Amount reflects total gross purchase commitments under our manufacturing arrangements with third-party contract manufacturers or vendors. The table above excludes liabilities for deferred revenue for warranty services of $2.4 million and unrecognized tax benefits and related interest and penalties accrual of $7.2 million. We have not provided a detailed estimate of the payment timing of unrecognized tax benefits due to the uncertainty of when the related tax settlements will become due. See Note 12 of Notes to our Consolidated Financial Statements in Item 8 of this Form 10-K for a discussion of income taxes. We expect to fund our remaining contractual obligations from our ongoing operations and existing cash and cash equivalents on hand. Recent Accounting Pronouncements In May 2011, the FASB issued additional guidance on fair value measurements that clarifies the application of existing guidance and disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. The updated guidance is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of this guidance will not have a material impact on our consolidated financial position and results of operations. In June 2011, the FASB issued guidance regarding the presentation of comprehensive income. The new standard requires the presentation of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new standard also requires presentation of adjustments for items that are reclassified from other comprehensive income to net income in the statement where the components of net income and the components of other comprehensive income are presented. The updated guidance is effective on a retrospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of this guidance will not have a material impact on our consolidated financial position and results of operations. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements. 51-------------------------------------------------------------------------------- Table of Contents |