SMCI-2015.03.31-10Q
Table of Contents    

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________________________________________
Form 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2015
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 001-33383
__________________________________________________________________________
Super Micro Computer, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
77-0353939
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
980 Rock Avenue
San Jose, CA 95131
(Address of principal executive offices) (Zip Code)
(408) 503-8000
(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  ¨
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  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
o
Accelerated filer
x
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of April 28, 2015 there were 47,265,389 shares of the registrant’s common stock, $0.001 par value, outstanding, which is the only class of common stock of the registrant issued.




Table of Contents    

SUPER MICRO COMPUTER, INC.

QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED MARCH 31, 2015

TABLE OF CONTENTS
 
 
 
Page
PART I
 
ITEM 1.
 
 

 
 
 
ITEM 2.
ITEM 3.
ITEM 4.
PART II
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 3.
ITEM 4.
ITEM 5.
ITEM 6.
 

    



Table of Contents    

PART I: FINANCIAL INFORMATION

Item 1.    
SUPER MICRO COMPUTER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited) 
 
March 31,
 
June 30,
 
2015
 
2014
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
109,245

 
$
96,872

Accounts receivable, net of allowances of $1,495 and $1,922 at March 31, 2015 and June 30, 2014, respectively (including amounts receivable from a related party of $4,602 and $621 at March 31, 2015 and June 30, 2014, respectively)
221,561

 
212,738

Inventory
430,382

 
315,837

Deferred income taxes-current
21,296

 
16,842

Prepaid income taxes
7,291

 
5,555

Prepaid expenses and other current assets
5,477

 
6,237

Total current assets
795,252

 
654,081

Long-term investments
2,647

 
2,647

Property, plant and equipment, net
153,332

 
130,589

Deferred income taxes-noncurrent
5,887

 
6,154

Other assets
3,843

 
2,854

Total assets
$
960,961

 
$
796,325

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable (including amounts due to a related party of $51,922 and $48,969 at March 31, 2015 and June 30, 2014, respectively)
$
261,603

 
$
219,354

Accrued liabilities
44,391

 
37,564

Income taxes payable
8,337

 
11,414

Short-term debt and current portion of long-term debt
44,836

 
42,554

Total current liabilities
359,167

 
310,886

Long-term debt-net of current portion
1,633

 
3,733

Other long-term liabilities
14,408

 
12,475

Total liabilities
375,208

 
327,094

Commitments and contingencies (Note 10)


 


Stockholders’ equity:
 
 
 
Common stock and additional paid-in capital, $0.001 par value
 
 
 
Authorized shares: 100,000,000
 
 
 
Issued shares: 47,682,302 and 45,739,936 at March 31, 2015 and June 30, 2014, respectively
240,436

 
199,062

Treasury stock (at cost), 445,028 shares at March 31, 2015 and June 30, 2014
(2,030
)
 
(2,030
)
Accumulated other comprehensive loss
(74
)
 
(63
)
Retained earnings
347,248

 
272,087

Total Super Micro Computer, Inc. stockholders’ equity
585,580

 
469,056

Noncontrolling interest
173

 
175

Total stockholders’ equity
585,753

 
469,231

Total liabilities and stockholders’ equity
$
960,961

 
$
796,325


See accompanying notes to condensed consolidated financial statements.

          1


Table of Contents    


SUPER MICRO COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2015
 
2014
 
2015
 
2014
Net sales (including related party sales of $6,067 and $3,418 in the three months ended March 31, 2015 and 2014, respectively, and $43,524 and $10,805 in the nine months ended March 31, 2015 and 2014, respectively)
$
471,225

 
$
373,755

 
$
1,417,561

 
$
1,039,133

Cost of sales (including related party purchases of $58,002 and $45,398 in the three months ended March 31, 2015 and 2014, respectively, and $169,918 and $145,139 in the nine months ended March 31, 2015 and 2014, respectively)
394,405

 
316,491

 
1,187,096

 
879,985

Gross profit
76,820

 
57,264

 
230,465

 
159,148

Operating expenses:
 
 
 
 
 
 
 
Research and development
25,542

 
20,570

 
72,516

 
61,234

Sales and marketing
12,496

 
9,416

 
34,656

 
27,257

General and administrative
7,334

 
5,806

 
17,334

 
16,938

Total operating expenses
45,372

 
35,792

 
124,506

 
105,429

Income from operations
31,448

 
21,472

 
105,959

 
53,719

Interest and other income, net
21

 
10

 
92

 
73

Interest expense
(277
)
 
(156
)
 
(656
)
 
(535
)
Income before income tax provision
31,192

 
21,326

 
105,395


53,257

Income tax provision
8,136

 
4,752

 
30,234

 
15,649

Net income
$
23,056

 
$
16,574

 
$
75,161

 
$
37,608

Net income per common share:
 
 
 
 
 
 
 
Basic
$
0.49

 
$
0.38

 
$
1.63

 
$
0.87

Diluted
$
0.44

 
$
0.35

 
$
1.47

 
$
0.82

Weighted-average shares used in calculation of net income per common share:
 
 
 
 
 
 
 
Basic
46,824

 
43,992

 
46,138

 
43,128

Diluted
52,008

 
47,424

 
51,102

 
45,857


See accompanying notes to condensed consolidated financial statements.


          2


Table of Contents    



SUPER MICRO COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2015
 
2014
 
2015
 
2014
Net income
$
23,056

 
$
16,574

 
$
75,161

 
$
37,608

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Foreign currency translation gain (loss)
5

 
(4
)
 
(11
)
 
(5
)
Unrealized gain (loss) on investments

 

 

 

Total other comprehensive income
5

 
(4
)
 
(11
)
 
(5
)
Comprehensive income
$
23,061

 
$
16,570

 
$
75,150

 
$
37,603



See accompanying notes to condensed consolidated financial statements.

          3


Table of Contents    


SUPER MICRO COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Nine Months Ended
March 31,
 
2015
 
2014
OPERATING ACTIVITIES:
 
 
 
Net income
$
75,161

 
$
37,608

Reconciliation of net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
5,930

 
4,590

Stock-based compensation expense
9,727

 
8,183

Excess tax benefits from stock-based compensation
(7,229
)
 
(2,719
)
Allowance for doubtful accounts
194

 
1,384

Provision for inventory
4,462

 
2,427

Exchange gain
(595
)
 
(334
)
Deferred income taxes
(4,197
)
 
(3,847
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net (including changes in related party balances of $(3,981) and $505 during the nine months ended March 31, 2015 and 2014, respectively)
(9,017
)
 
(34,072
)
Inventory
(119,007
)
 
(43,346
)
Prepaid expenses and other assets
675

 
1,417

Accounts payable (including changes in related party balances of $2,953 and $(8,250) during the nine months ended March 31, 2015 and 2014, respectively)
38,712

 
32,492

Income taxes payable, net
5,814

 
9,879

Accrued liabilities
6,748

 
(1,767
)
Other long-term liabilities
1,686

 
579

Net cash provided by operating activities
9,064

 
12,474

INVESTING ACTIVITIES:
 
 
 
Restricted cash
(418
)
 
401

Investment in a privately held company
(661
)
 

Purchases of property, plant and equipment
(24,637
)
 
(36,779
)
Net cash used in investing activities
(25,716
)
 
(36,378
)
FINANCING ACTIVITIES:
 
 
 
Proceeds from exercise of stock options
21,071

 
19,154

Minimum tax withholding paid on behalf of an officer for restricted stock awards

 
(651
)
Excess tax benefits from stock-based compensation
7,229

 
2,719

Proceeds from debt
36,400

 
17,354

Repayment of debt
(35,300
)
 
(5,620
)
Payment of obligations under capital leases
(96
)
 
(26
)
Advances (payments) under receivable financing arrangements
669

 
(8
)
Net cash provided by financing activities
29,973

 
32,922

Effect of exchange rate fluctuations on cash
(948
)
 
(342
)
Net decrease in cash and cash equivalents
12,373

 
8,676

Cash and cash equivalents at beginning of period
96,872

 
93,038

Cash and cash equivalents at end of period
$
109,245

 
$
101,714

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
649

 
$
533

Cash paid for taxes, net of refunds
$
27,455

 
$
8,940

Non-cash investing and financing activities:
 
 
 
Equipment purchased under capital leases
$
428

 
$
175

       Accrued costs for property, plant and equipment purchases
$
12,511

 
$
2,055


See accompanying notes to condensed consolidated financial statements.

          4


Table of Contents    

SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1.        Summary of Significant Accounting Policies

Organization

Super Micro Computer, Inc. (“Super Micro Computer”) was incorporated in 1993. Super Micro Computer is a global leader in server technology and green computing innovation. Super Micro Computer develops and provides high performance server solutions based upon an innovative, modular and open-standard architecture. Super Micro Computer has operations primarily in San Jose, California, the Netherlands, Taiwan, China and Japan.

Basis of Presentation
 
The condensed consolidated financial statements reflect the condensed consolidated balance sheets, results of operations, comprehensive income and cash flows of Super Micro Computer, Inc. and its wholly-owned subsidiaries (collectively, the “Company”). All intercompany accounts and transactions have been eliminated in consolidation.

The unaudited condensed consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) and include the accounts of the Company and its wholly-owned subsidiaries. Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the fiscal year ended June 30, 2014 included in its Annual Report on Form 10-K, as filed with the SEC (the “Annual Report”).

The unaudited condensed consolidated financial statements included herein reflect all adjustments, including normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, results of operations and cash flows for the periods presented. The condensed consolidated results of operations for the three and nine months ended March 31, 2015 are not necessarily indicative of the results that may be expected for future quarters or for the fiscal year ending June 30, 2015.

The Company consolidates its investment in Super Micro Asia Science and Technology Park, Inc. as it is variable interest entity and the Company is the primary beneficiary. The noncontrolling interest is presented as a separate component from the Company's equity in the equity section of the condensed consolidated balance sheets. Net income attributable to the noncontrolling interest is not presented separately in the condensed consolidated statements of operations and is included in the general and administrative expenses as the amount is not material for any of the fiscal periods presented.

Fair Value of Financial Instruments

The Company accounts for certain assets and liabilities at fair value. Accounts receivable and accounts payable are carried at cost, which approximates fair value due to the short maturity of these instruments. Cash equivalents and long-term investments are carried at fair value. Short-term and long-term debt is carried at amortized cost, which approximates its fair value based on borrowing rates currently available to the Company for loans with similar terms. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. The Company categorizes each of its fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2 - Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and
Level 3 - Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

          5


Table of Contents
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)


Net Income Per Common Share

The Company’s restricted share awards subject to repurchase and settled in shares of common stock upon vesting have the nonforfeitable right to receive dividends on an equal basis with common stock and therefore are considered participating securities that must be included in the calculation of net income per share using the two-class method. Under the two-class method, basic and diluted net income per common share is determined by calculating net income per share for common stock and participating securities based on participation rights in undistributed earnings. Diluted net income per common share is calculated by adjusting outstanding shares, assuming any dilutive effects of stock incentive awards calculated using the treasury stock method. Under the treasury stock method, an increase in the fair market value of our common stock results in a greater dilutive effect from outstanding stock options and restricted stock units. Additionally, the exercise of employee stock options and the vesting of restricted stock units results in a further dilutive effect on net income per share.

Adoption of New Accounting Pronouncements

In March 2013, the FASB issued authoritative guidance associated with a parent company’s accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. The standard applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity. The adoption of this guidance did not have a material impact on the Company's results of operations or financial position.

In July 2013, the FASB issued authoritative guidance associated with the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. It requires a liability related to an unrecognized tax benefit to offset a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if a settlement is required or expected in the event the uncertain tax position is disallowed. The adoption of this guidance did not have a material impact on the Company's results of operations or financial position.

In May 2014, the FASB issued new accounting guidance related to revenue recognition. This new standard replaces all current U.S. GAAP guidance on revenue, eliminates all industry-specific guidance and provides a unified model in determining when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance can be applied either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The new standard is effective for the Company on July 1, 2018. The Company is currently evaluating the effect the guidance will have on the Company's financial statement disclosures, results of operations and financial position.

In April 2015, the FASB issued new accounting guidance related to presentation of debt issue costs. The new standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. The new standard is effective for the Company on July 1, 2016. The Company is currently evaluating the effect the guidance will have on the Company's financial statement disclosures, results of operations and financial position.

Note 2.        Stock-based Compensation and Stockholders’ Equity

Equity Incentive Plan

The authorized number of shares that may be issued under the Company's 2006 Equity Incentive Plan (the "2006 Plan") automatically increases on July 1 each year through 2016, by an amount equal to (a) 3.0% of shares of stock issued and outstanding on the immediately preceding June 30, or (b) a lesser amount determined by the Board of Directors. The exercise price per share for incentive stock options granted to employees owning shares representing more than 10% of the Company at the time of grant cannot be less than 110% of the fair value. Nonqualified stock options and incentive stock options granted to all other persons shall be granted at a price not less than 100% of the fair value. Options generally expire ten years after the date of grant and options and restricted stock units vest over four years; 25% at the end of one year and one sixteenth per

          6


Table of Contents
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

quarter thereafter. The 2006 Plan is the successor equity incentive plan to the Company's 1998 Stock Option Plan. As of March 31, 2015, the Company had 626,715 authorized shares available for future issuance under the 2006 Plan.

Determining Fair Value

Valuation and amortization method—The Company estimates the fair value of stock options granted using the Black-Scholes-option-pricing formula and a single option award approach. The fair value of restricted stock units is based on the closing market price of the Company's common stock on the date of grant. This fair value is then amortized ratably over the requisite service periods of the awards, which is generally the vesting period.

Expected Term—The Company’s expected term represents the period that the Company’s 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 the exercise factors for the stock options granted prior to June 30, 2011. For stock options and restricted stock units granted after June 30, 2011, the expected term is based on a combination of the Company's peer group and the Company's historical experience.

Expected Volatility—Expected volatility is based on a combination of the Company's implied and historical volatility.

Expected Dividend—The Black-Scholes valuation model calls for a single expected dividend yield as an input and the Company has no plans to pay dividends.

Risk-Free Interest Rate—The risk-free interest rate used in the Black-Scholes valuation method is based on the U.S. Treasury zero coupon issues in effect at the time of grant for periods corresponding with the expected term of option.

Estimated Forfeitures—The estimated forfeiture rate is based on the Company’s historical forfeiture rates and the estimate is revised in subsequent periods if actual forfeitures differ from the estimate.
 
The fair value of stock option grants for the three and nine months ended March 31, 2015 and 2014 was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2015
 
2014
 
2015
 
2014
Risk-free interest rate
1.35% - 1.58%

 
1.69% - 1.81%

 
1.35% - 1.76%

 
1.53% - 1.81%

Expected life
5.40 years

 
5.58 years

 
5.40 - 5.44 years

 
5.49 - 5.58 years

Dividend yield
%
 
%
 
%
 
%
Volatility
47.60% - 48.26%

 
43.48% - 44.66%

 
46.93% - 49.31%

 
43.48% - 50.07%

Weighted-average fair value
$
15.92

 
$
7.70

 
$
12.59

 
$
6.67


The following table shows total stock-based compensation expense included in the condensed consolidated statements of operations for the three and nine months ended March 31, 2015 and 2014 (in thousands):
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2015
 
2014
 
2015
 
2014
Cost of sales
$
222

 
$
246

 
$
651

 
$
726

Research and development
2,255

 
1,723

 
6,148

 
4,993

Sales and marketing
369

 
306

 
1,148

 
925

General and administrative
720

 
531

 
1,780

 
1,539

Stock-based compensation expense before taxes
3,566

 
2,806

 
9,727

 
8,183

Income tax impact
(1,355
)
 
(1,477
)
 
(2,747
)
 
(2,146
)
Stock-based compensation expense, net
$
2,211

 
$
1,329

 
$
6,980

 
$
6,037

    

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Table of Contents
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

The cash flows resulting from the tax benefits for tax deductions resulting from the exercise of stock options in excess of the compensation expense recorded for those options (excess tax benefits) issued or modified since July 1, 2006 are classified as cash from financing activities. Excess tax benefits for stock options issued prior to July 1, 2006 are classified as cash from operating activities. The Company had $10,576,000 and $4,533,000 of excess tax benefits recorded in additional paid-in capital in the nine months ended March 31, 2015 and 2014, respectively. The Company had excess tax benefits that are classified as cash from financing activities of $7,229,000 and $2,719,000 in the nine months ended March 31, 2015 and 2014, respectively, for options issued since July 1, 2006.

As of March 31, 2015, the Company’s total unrecognized compensation cost related to non-vested stock-based awards granted since July 1, 2006 to employees and non-employee directors was $28,958,000, which will be recognized over a remaining weighted-average vesting period of approximately 2.39 years.

Stock Option Activity

The following table summarizes stock option activity during the nine months ended March 31, 2015 under all stock option plans: 
 
 
Options
Outstanding
 
Weighted
Average
Exercise
Price per
Share
 
Weighted
Average
Remaining
Contractual
Term
(in Years)
 
Aggregate
Intrinsic
Value
(in thousands)
Balance as of June 30, 2014 (7,558,631 shares exercisable at weighted average exercise price of $11.05 per share)
 
10,905,602

 
$
12.24

 
 
 
 
Granted
 
1,058,760

 
$
27.99

 

 
 
Exercised
 
(1,942,366
)
 
$
10.85

 
 
 
 
Forfeited
 
(153,960
)
 
$
18.94

 
 
 
 
Balance as of March 31, 2015
 
9,868,036

 
$
14.10

 
6.13
 
$
189,102

Options vested and expected to vest at March 31, 2015
 
9,658,434

 
$
13.91

 
6.07
 
$
186,852

Options vested and exercisable at March 31, 2015
 
6,988,101

 
$
11.97

 
5.11
 
$
148,459


The total pretax intrinsic value of options exercised was $22,231,000 and $44,301,000 during the three and nine months ended March 31, 2015, respectively, and $14,746,000 and $19,961,000 for the three and nine months ended March 31, 2014, respectively.

Restricted Stock Unit Activity

In January 2015, the Company began to grant restricted stock units to employees. The Company grants restricted stock units to certain employees as part of its regular employee equity compensation review program as well as to selected new hires. Restricted stock units are share awards that entitle the holder to receive freely tradable shares of the Company's common stock upon vesting and settlement.

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Table of Contents
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)


The following table summarizes restricted stock unit activity during the nine months ended March 31, 2015 under the 2006 Plan: 
 
 
Restricted Stock Units
Outstanding
 
Weighted
Average
Grant-Date Fair Value per Share
 
Aggregate
Intrinsic
Value
(in thousands)
Balance as of June 30, 2014
 

 
$

 
 
Granted
 
233,930

 
$
35.07

 
 
Vested
 

 
$

 
 
Forfeited
 
(51,050
)
 
$
35.07

 
 
Balance as of March 31, 2015
 
182,880

 
$
35.07

 
$
6,073

    
        
Restricted Stock Award Activity

The Company had no restricted stock award activity for the three and nine months ended March 31, 2015 and the three months ended March 31, 2014. The total pretax intrinsic value of restricted stock awards vested was $2,337,000 for the nine months ended March 31, 2014. In the nine months ended March 31, 2014, upon vesting, 179,641 shares of restricted stock awards were partially net share-settled such that the Company withheld 50,000 shares with value equivalent to an officer's minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld were based on the value of the restricted stock awards on their vesting date as determined by the Company’s closing stock price. Total payments for an officer's tax obligations to the taxing authorities were $651,000 in the nine months ended March 31, 2014 and are reflected as a financing activity within the consolidated statements of cash flows. These net-share settlements had the effect of share repurchases by the Company as they reduced and retired the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to the Company. There are no unvested restricted stock awards at March 31, 2015.

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Table of Contents
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)


Note 3.        Net Income Per Common Share

The computation of basic and diluted using the two-class method is as follows (in thousands, except per share amounts):
    
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2015
 
2014
 
2015
 
2014
Basic net income per common share calculation
 
 
 
 
 
 
 
Net income
$
23,056

 
$
16,574

 
$
75,161

 
$
37,608

Less: Undistributed earnings allocated to participating securities

 
(1
)
 

 
(34
)
Net income attributable to common shares—basic
$
23,056

 
$
16,573

 
$
75,161

 
$
37,574

Weighted-average number of common shares used to compute basic net income per common share
46,824

 
43,992

 
46,138

 
43,128

Basic net income per common share
$
0.49

 
$
0.38

 
$
1.63

 
$
0.87

Diluted net income per common share calculation
 
 
 
 
 
 
 
Net income
$
23,056

 
$
16,574

 
$
75,161

 
$
37,608

Less: Undistributed earnings allocated to participating securities

 
(1
)
 

 
(32
)
Net income attributable to common shares—diluted
$
23,056

 
$
16,573

 
$
75,161

 
$
37,576

Weighted-average number of common shares used to compute basic net income per common share
46,824

 
43,992

 
46,138

 
43,128

Dilutive effect of options to purchase common stock
5,184

 
3,432

 
4,964

 
2,729

Weighted-average number of common shares used to compute diluted net income per common share
52,008

 
47,424

 
51,102

 
45,857

Diluted net income per common share
$
0.44

 
$
0.35

 
$
1.47

 
$
0.82


For the three and nine months ended March 31, 2015 and 2014, the Company had stock options and restricted stock units outstanding that could potentially dilute basic earnings per share in the future, but were excluded from the computation of diluted net income per share in the periods presented, as their effect would have been anti-dilutive. The shares of anti-dilutive common share equivalents resulting from outstanding equity awards were 175,000 and 627,000 for the three and nine months ended March 31, 2015, respectively, and 2,142,000 and 3,892,000 for the three and nine months ended March 31, 2014, respectively.

Note 4.        Balance Sheet Components

The following tables provide details of the selected balance sheet items (in thousands):
Inventory:
 
March 31,
2015
 
June 30,
2014
Finished goods
$
320,213

 
$
246,803

Work in process
38,093

 
18,794

Purchased parts and raw materials
72,076

 
50,240

Total inventory
$
430,382

 
$
315,837


The Company recorded a provision for lower of cost or market and excess and obsolete inventory totaling $287,000 and $4,462,000 in the three and nine months ended March 31, 2015, respectively, and $889,000 and $2,427,000 in the three and nine months ended March 31, 2014, respectively.


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SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Property, Plant, and Equipment:
 
March 31,
2015
 
June 30,
2014
Land
$
63,962

 
$
63,962

Buildings
51,959

 
51,959

Building and leasehold improvements
8,281

 
7,683

Buildings construction in progress (1)
17,247

 
587

Machinery and equipment
39,736

 
34,342

Furniture and fixtures
7,029

 
5,892

Purchased software
3,811

 
3,606

Purchased software construction in progress (2)
7,024

 
2,548

 
199,049

 
170,579

Accumulated depreciation and amortization
(45,717
)
 
(39,990
)
Property, plant and equipment, net
$
153,332

 
$
130,589

     
(1) In connection with the purchase of the property located in San Jose, California, the Company engaged several contractors for the development and construction of improvements on the property, which is still in progress.
(2) The Company continues its implementation of a new enterprise resource planning, or ERP, system and has capitalized the costs of the new ERP software and certain expenses associated directly with the development of the ERP system, which is still in progress.

Other Assets:
 
March 31,
2015
 
June 30,
2014
Prepaid royalty license
$
1,059

 
$
1,246

Restricted cash
838

 
450

Investment in a privately held company
1,411

 
750

Others
535

 
408

Total other assets
$
3,843


$
2,854


Restricted cash consists primarily of certificates of deposits pledged as security for one irrevocable letter of credit required in connection with a warehouse lease in Fremont, California, one deposit to an escrow account required by the Company's worker's compensation program and bank guarantees in connection with office leases in the Netherlands. In December 2014, the Company made an investment in a privately held company of $661,000.

11

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SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)


Accrued Liabilities:
 
March 31,
2015
 
June 30,
2014
Accrued payroll and related expenses
$
14,145

 
$
11,624

Customer deposits
7,102

 
4,185

Accrued warranty costs
7,209

 
7,083

Accrued cooperative marketing expenses
5,428

 
4,387

Others
10,507

 
10,285

Total accrued liabilities
$
44,391

 
$
37,564


Product Warranties:
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2015
 
2014
 
2015
 
2014
Balance, beginning of period
$
6,960

 
$
6,822

 
$
7,083

 
$
6,472

Provision for warranty
3,968

 
3,517

 
10,928

 
10,458

Costs charged to accrual
(3,706
)
 
(3,558
)
 
(10,476
)
 
(10,222
)
Change in estimated liability for pre-existing warranties
(13
)
 
140

 
(326
)
 
213

Balance, end of period
$
7,209

 
$
6,921

 
$
7,209

 
$
6,921


Note 5.        Long-term Investments

As of March 31, 2015 and June 30, 2014, the Company held $2,647,000 of auction-rate securities (“auction rate securities”), net of unrealized losses, representing its interest in auction rate preferred shares in a closed end mutual fund invested in municipal securities; such auction rate securities were rated AAA or AA2 at March 31, 2015 and June 30, 2014. These auction rate preferred shares have no stated maturity date.

During February 2008, the auctions for these auction rate securities began to fail to obtain sufficient bids to establish a clearing rate and the securities were not salable in the auction, thereby losing the short-term liquidity previously provided by the auction process. As a result, as of March 31, 2015 and June 30, 2014, $2,647,000 of these auction rate securities have been classified as long-term available-for-sale investments.

The Company has used a discounted cash flow model to estimate the fair value of the auction rate securities as of March 31, 2015 and June 30, 2014. The material factors used in preparing the discounted cash flow model are (i) the discount rate utilized to present value the cash flows, (ii) the time period until redemption and (iii) the estimated rate of return. As of March 31, 2015, the discount rate, the time period until redemption and the estimated rate of return were 1.82%, 3 years and 0.41%, respectively. Management derives the estimates by obtaining input from market data on the applicable discount rate, estimated time to redemption 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 redemption period. The fair value of the Company's investment portfolio may change between 1% 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. On a quarterly basis, the Company reviews the inputs to assess their continued appropriateness and consistency. If any significant differences were to be noted, they would be researched in order to determine the reason. However, historically, no significant differences have been noted. The Company has consistently applied these valuation techniques in all periods presented and believes it has obtained the most accurate information available for the auction rate securities. Movement of these inputs would not significantly impact the fair value of the auction rate securities.

Based on this assessment of fair value, the Company determined there were no changes in fair value of its auction rate securities during the three and nine months ended March 31, 2015 and 2014. There was a cumulative total decline of $103,000 as of March 31, 2015 and June 30, 2014. That amount has been recorded as a component of other comprehensive income. As of

12

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SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

March 31, 2015 and June 30, 2014, the Company has recorded an accumulated unrealized loss of $62,000, net of deferred income taxes, on long-term auction rate securities. The Company deems this loss to be temporary as it will not likely be required to sell the securities before their anticipated recovery and the Company has the intent and financial ability to hold these investments until recovery of cost.

Although the investment impairment is considered to be temporary, these investments are not currently liquid and in the event the Company needs to access these funds, the Company will not be able to do so without a loss of principal. The Company plans to continue to monitor the liquidity situation in the marketplace and the creditworthiness of its holdings and will perform a periodic impairment analysis. In the three and nine months ended March 31, 2015 and 2014, there were no auction rate securities redeemed or sold.

Note 6.        Fair Value Disclosure

The financial assets of the Company measured at fair value on a recurring basis are included in cash equivalents and long-term investments. The Company’s money market funds are classified within Level 1 of the fair value hierarchy which is based on quoted market prices for the identical underlying securities in active markets. The Company’s long-term auction rate securities investments are classified within Level 3 of the fair value hierarchy which did not have observable inputs for its auction rate securities as of March 31, 2015 and June 30, 2014. Refer to Note 1 for a discussion of the Company’s policies regarding the fair value hierarchy. The Company’s methodology for valuing these investments is the discounted cash flow model and is described in Note 5.

The following table sets forth the Company’s cash equivalents and long-term investments as of March 31, 2015 and June 30, 2014 which are measured at fair value on a recurring basis by level within the fair value hierarchy. These are classified based on the lowest level of input that is significant to the fair value measurement (in thousands):

March 31, 2015
Level 1
 
Level 2
 
Level 3
 
Asset at
Fair Value
Money market funds
$
311

 
$

 
$

 
$
311

Auction rate securities

 

 
2,647

 
2,647

Total
$
311

 
$

 
$
2,647

 
$
2,958

 
 
 
 
 
 
 
 
June 30, 2014
Level 1
 
Level 2
 
Level 3
 
Asset at
Fair Value
Money market funds
$
311

 
$

 
$

 
$
311

Auction rate securities

 

 
2,647

 
2,647

Total
$
311

 
$

 
$
2,647

 
$
2,958


The above table excludes $108,705,000 and $96,324,000 of cash and $1,126,000 and $746,000 of certificates of deposit held by the Company as of March 31, 2015 and June 30, 2014, respectively. There were no transfers between Level 1, Level 2 or Level 3 securities in the three and nine months ended March 31, 2015 and 2014.

The following table provides a reconciliation of the Company’s financial assets measured at fair value on a recurring basis, consisting of long-term auction rate securities, using significant unobservable inputs (Level 3) for the three and nine months ended March 31, 2015 and 2014 (in thousands):

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SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2015
 
2014
 
2015
 
2014
Balance as of beginning of period
$
2,647

 
$
2,637

 
$
2,647

 
$
2,637

Total realized gains or (losses) included in net income

 

 

 

Total unrealized gains or (losses) included in other comprehensive income

 

 

 

Sales and settlements at par

 

 

 

Transfers in and/or out of Level 3

 

 

 

Balance as of end of period
$
2,647

 
$
2,637

 
$
2,647

 
$
2,637

    
The following is a summary of the Company’s long-term investments as of March 31, 2015 and June 30, 2014 (in thousands):
 
 
March 31, 2015
 
Amortized
Cost
 
Gross
Unrealized
Holding
Gains
 
Gross
Unrealized
Holding
Losses
 
Fair Value
Auction rate securities
$
2,750

 
$

 
$
(103
)
 
$
2,647

 
 
 
 
 
 
 
 
 
June 30, 2014
 
Amortized
Cost
 
Gross
Unrealized
Holding
Gains
 
Gross
Unrealized
Holding
Losses
 
Fair Value
Auction rate securities
$
2,750

 
$

 
$
(103
)
 
$
2,647

 
The Company measures the fair value of outstanding debt for disclosure purposes on a recurring basis. As of March 31, 2015 and June 30, 2014, short-term and long-term debt of $46,469,000 and $46,287,000, respectively, are reported at amortized cost. This outstanding debt is classified as Level 2 as they are not actively traded and are valued using a discounted cash flow model that uses observable market inputs. Based on the discounted cash flow model, the fair value of the outstanding debt approximates amortized cost. 

Note 7.        Short-term and Long-term Obligations

Short-term and long-term obligations as of March 31, 2015 and June 30, 2014 consisted of the following (in thousands):
 
 
March 31,
2015
 
June 30,
2014
Line of credit:
 
 
 
Bank of America
$
11,199

 
$
17,699

CTBC Bank
9,700

 

Total line of credit
20,899

 
17,699

Building term loans:
 
 
 
Bank of America
4,433

 
6,533

CTBC Bank
21,137

 
22,055

Total building term loans
25,570

 
28,588

Total debt
46,469

 
46,287

Current portion
(44,836
)
 
(42,554
)
Long-term portion
$
1,633

 
$
3,733


          14


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SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)


Activities under Revolving Lines of Credit and Term Loans

Bank of America

In October 2011, the Company entered into an amendment to the existing credit agreement with Bank of America N.A. ("Bank of America") which provided for (i) a $40,000,000 revolving line of credit facility that matured on June 15, 2013 and (ii) a five-year $14,000,000 term loan facility. The term loan is secured by the three buildings located in San Jose, California and the principal and interest are payable monthly through September 30, 2016 with an interest rate at the LIBOR rate plus 1.50% per annum. The credit agreement was subsequently amended to extend the maturity date of the revolving line of credit facility to November 15, 2015.
    
The line of credit facility provides for borrowings denominated both in U.S. dollars and in Taiwanese dollars. For borrowings denominated in U.S. dollars, the interest rate for the revolving line of credit is at the LIBOR rate plus 1.25% per annum. The LIBOR rate was 0.17% at March 31, 2015. For borrowings denominated in Taiwanese dollars, the interest rate is equal to the lender's established interest rate which is adjusted monthly.

As of March 31, 2015 and June 30, 2014, the total outstanding borrowings under the Bank of America term loan was $4,433,000 and $6,533,000, respectively. The total outstanding borrowings under the Bank of America line of credit was $11,199,000 and $17,699,000 as of March 31, 2015 and June 30, 2014, respectively. The interest rates for these loans ranged from 0.82% to 1.67% per annum at March 31, 2015 and 1.19% to 1.65% per annum at June 30, 2014. As of March 31, 2015, the unused revolving line of credit with Bank of America was $28,801,000.

In April 2015, the Company drew an additional $10,000,000 from Bank of America line of credit with an interest rate at 1.43% per annum to support the Company's growth and expansion of its business.
    
CTBC Bank

In October 2011, the Company obtained an unsecured revolving line of credit from CTBC Bank Co., Ltd ("CTBC Bank", formerly, China Trust Bank) totaling NT$300,000,000 Taiwanese dollar or $9,898,000 U.S. dollar equivalents. In July 2012, the Company increased the credit facility to NT$450,000,000 Taiwanese dollar or $14,912,000 U.S. dollar equivalents. The term loan was secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender’s established interest rate plus 0.30% which is adjusted monthly.     

In November 2013, the Company entered into an amendment to the existing credit agreement with CTBC Bank to increase the credit facility amount and extend the maturity date to November 30, 2014. The amendment provides for (i) a 13-month NT$700,000,000 or $23,787,000 U.S. dollar equivalents term loan secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum which is adjusted monthly and (ii) a 13-month unsecured term loan up to NT$100,000,000 or $3,398,000 U.S. dollar equivalents, and a 13-month revolving line of credit up to 80% of eligible accounts receivable in an aggregate amount of up to NT$500,000,000 or $16,991,000 U.S. dollar equivalents with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum or lender's established USD interest rate plus 0.30% per annum which is adjusted monthly. The total borrowings allowed under the credit agreement are capped at NT$1,000,000,000 or $33,981,000 U.S. dollar equivalents.
    
In December 2014, the Company entered into a second amendment to the existing credit agreement with CTBC Bank to extend the maturity date to November 30, 2015. The amendment provides for (i) a 12-month NT$700,000,000 or $22,017,000 U.S. dollar equivalents term loan secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum which is adjusted monthly and (ii) a 12-month revolving line of credit up to 80% of eligible accounts receivable in an aggregate amount of up to $17,000,000 with an interest rate equal to the lender's established USD interest rate plus 0.30% per annum which is adjusted monthly. The total borrowings allowed under the credit agreement are capped at NT$1,000,000,000 or $31,453,000 U.S. dollar equivalents.

The total outstanding borrowings under the CTBC Bank term loan was denominated in Taiwanese dollars and was translated into U.S. dollars of $21,137,000 and $22,055,000 at March 31, 2015 and June 30, 2014, respectively. The total outstanding borrowings under the CTBC Bank revolving line of credit was $9,700,000 and $0 at March 31, 2015 and June 30, 2014, respectively. The interest rate for these loans were ranged from 0.81% to 1.15% at March 31, 2015 and 1.15%

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SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

per annum at June 30, 2014. At March 31, 2015, NT$37,118,000 or $1,189,000 U.S. dollar equivalents were available for future borrowing under this credit agreement.
    

Covenant Compliance

The credit agreement with Bank of America contains customary representations and warranties and customary affirmative and negative covenants applicable to the Company and its subsidiaries. The credit agreement contains certain financial covenants, including the following:
 
 
Not to incur on a consolidated basis, a net loss before taxes and extraordinary items in any two consecutive quarterly accounting periods;
 
 
The Company’s funded debt to EBITDA ratio (ratio of all outstanding liabilities for borrowed money and other interest-bearing liabilities, including current and long-term debt, less the non-current portion of subordinated liabilities to EBITDA) shall not be greater than 2.00;
 
 
The Company’s unencumbered liquid assets, as defined in the agreement, held in the United States shall have an aggregate market value of not less than $30,000,000, measured as of the last day of each fiscal quarter and the last day of each fiscal year.
    
As of March 31, 2015 and June 30, 2014, total assets of $916,396,000 and $751,396,000, respectively, collateralized the line of credit with Bank of America and were all of the assets of the Company except for the three buildings purchased in San Jose, California in June 2010 and the land and building located in Bade, Taiwan. As of March 31, 2015 and June 30, 2014, total assets collateralizing the term loan with Bank of America were $17,411,000 and $17,584,000, respectively. As of March 31, 2015, the Company was in compliance with all financial covenants associated with the credit agreement with Bank of America.
    
As of March 31, 2015 and June 30, 2014, the land and building located in Bade, Taiwan collateralizing the term loan with CTBC Bank was $27,154,000 and $27,345,000, respectively. There are no financial covenants associated with the term loan with CTBC Bank at March 31, 2015.
    
Note 8.        Related-party and Other Transactions

Ablecom Technology Inc.—Ablecom, a Taiwan corporation, together with one of its subsidiaries, Compuware (collectively “Ablecom”), is one of the Company’s major contract manufacturers. Ablecom’s ownership of Compuware is below 50% but Compuware remains a related party as Ablecom still has significant influence over the operations. Ablecom’s chief executive officer, Steve Liang, is the brother of Charles Liang, the Company’s President, Chief Executive Officer and Chairman of the Board of Directors. Ablecom owns approximately 0.6% of the Company’s common stock. Charles Liang and his wife, also an officer of the Company, collectively own approximately 10.5% of Ablecom, while Steve Liang and other family members own approximately 42.9% of Ablecom at March 31, 2015.

The Company has product design and manufacturing services agreements (“product design and manufacturing agreements”) and a distribution agreement (“distribution agreement”) with Ablecom.

Under the product design and manufacturing agreements, the Company outsources a portion of its design activities and a significant part of its manufacturing of components such as server chassis to Ablecom. Ablecom agrees to design products according to the Company’s specifications. Additionally, Ablecom agrees to build the tools needed to manufacture the products. The Company has agreed to pay for Ablecom's cost of chassis and related product tooling and engineering services and will pay for those items when the work has been completed.

Under the distribution agreement, Ablecom purchases server products from the Company for distribution in Taiwan. The Company believes that the pricing and terms under the distribution agreement are similar to the pricing and terms of distribution arrangements the Company has with similar, third party distributors.

Ablecom’s net sales to the Company and its net sales of the Company’s products to others comprise a substantial majority of Ablecom’s net sales. The Company purchased products from Ablecom totaling $58,002,000 and $169,918,000, and sold products to Ablecom totaling $6,067,000 and $43,524,000 for the three and nine months ended March 31, 2015,

          16


Table of Contents
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

respectively. The Company purchased products from Ablecom totaling $45,398,000 and $145,139,000 and sold products to Ablecom totaling $3,418,000 and $10,805,000 for the three and nine months ended March 31, 2014, respectively.

Amounts owed to the Company by Ablecom as of March 31, 2015 and June 30, 2014, were $4,602,000 and $621,000, respectively. Amounts owed to Ablecom by the Company as of March 31, 2015 and June 30, 2014, were $51,922,000 and $48,969,000, respectively. For the three and nine months ended March 31, 2015, the Company paid Ablecom the majority of invoiced dollars between 48 and 105 days of invoice date. For the three and nine months ended March 31, 2015, the Company paid $231,000 and $4,728,000, respectively, for tooling assets and miscellaneous costs to Ablecom. For the three and nine months ended March 31, 2014, the Company paid $2,187,000 and $5,923,000, respectively, for tooling assets and miscellaneous costs to Ablecom.

The Company’s exposure to loss as a result of its involvement with Ablecom is limited to (a) potential losses on its purchase orders in the event of an unforeseen decline in the market price and/or demand of the Company’s products such that the Company incurs a loss on the sale or cannot sell the products and (b) potential losses on outstanding accounts receivable from Ablecom in the event of an unforeseen deterioration in the financial condition of Ablecom such that Ablecom defaults on its payable to the Company. Outstanding purchase orders with Ablecom were $88,593,000 and $64,464,000 at March 31, 2015 and June 30, 2014, respectively, representing the maximum exposure to loss relating to (a) above. The Company does not have any direct or indirect guarantees of losses of Ablecom.

In May 2012, the Company and Ablecom jointly established Super Micro Asia Science and Technology Park, Inc. ("Management Company") in Taiwan to manage the common areas shared by the Company and Ablecom for their separately constructed manufacturing facilities. Each company contributed $168,000 and owns 50% of the Management Company. Although the operations of the Management Company are independent of the Company, through governance rights, the Company has the ability to direct the Management Company's business strategies. Therefore, the Company has concluded that the Management Company is a variable interest entity of the Company as the Company is the primary beneficiary of the Management Company. The accounts of the Management Company are consolidated with the accounts of the Company, and a noncontrolling interest has been recorded for the Ablecom's interests in the net assets and operations of the Management Company. In the three and nine months ended March 31, 2015, $4,000 and $(3,000), respectively, of net income (loss) attributable to Ablecom's interest was included in the Company's general and administrative expenses in the condensed consolidated statements of operations. In the three and nine months ended March 31, 2014, $6,000 and $(7,000), respectively, of net income (loss) attributable to Ablecom's interest was included in the Company's general and administrative expenses in the condensed consolidated statements of operations.

Note 9.        Income Taxes

The Company recorded provisions for income taxes of $8,136,000 and $30,234,000 for the three and nine months ended March 31, 2015, respectively, and $4,752,000 and $15,649,000 for the three and nine months ended March 31, 2014, respectively. The effective tax rate was 26.1% and 28.7% for the three and nine months ended March 31, 2015, respectively, and 22.3% and 29.4% for the three and nine months ended March 31, 2014, respectively. The effective tax rate for the three and nine months ended March 31, 2015 is estimated to be lower than the federal statutory rate primarily due to the reinstatement of the U.S. federal research and development (“R&D”) tax credit, the benefit from disqualifying dispositions of shares issued upon exercise of incentive stock options and higher income taxed by foreign jurisdictions with lower tax rates, in part offset by the impact of stock option expenses. The effective tax rates for three and nine months ended March 31, 2014 were estimated to be lower than the federal statutory rate primarily due to the benefit from disqualifying dispositions of shares issued upon exercise of incentive stock options and foreign tax credits, which are in part offset by an increase in state tax expenses.
              
               As of March 31, 2015, the Company had a liability for gross unrecognized tax benefits of $11,728,000, substantially all of which, if recognized, would affect the Company's effective tax rate. During the three and nine months ended March 31, 2015, there were no material changes in the total amount of the liability for gross unrecognized tax benefits. The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the condensed consolidated statements of operations. As of March 31, 2015, the Company had accrued $841,000 of interest and penalties relating to unrecognized tax benefits.

The Company is subject to U.S. federal income tax as well as income taxes in many state and foreign jurisdictions. The statutes of limitation for U.S. federal and state income taxes remain open in general for tax years 2011 through 2014. The Company's tax returns for its most significant foreign jurisdictions remain open for examination in general for tax years 2008 through 2014. The Company does not expect its unrecognized tax benefits to change materially over the next 12 months.

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Table of Contents
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

    
Note 10.        Commitments and Contingencies

Litigation and Claims— The Company is involved in various legal proceedings arising from the normal course of business activities. The Company defends itself vigorously against any such claims. In management’s opinion, the resolution of any such pending matters will not have a material adverse effect on the Company’s consolidated financial condition, results of operations or liquidity.

Purchase Commitments— The Company has agreements to purchase certain units of inventory and non-inventory items through fiscal year 2017. As of March 31, 2015, these remaining non-cancellable commitments were $491,188,000 compared to $211,090,000 as of June 30, 2014.
    
Included in the above non-cancellable commitments are hard disk drive purchase commitments totaling approximately $237,389,000 as of March 31, 2015, an increase from $45,210,000 as of June 30, 2014 and will be paid through January 2017. The Company entered into amendments to its existing purchase agreements with selected suppliers of hard disk drives in order to ensure continuity of supply for these components. The agreements provide for some variation in the amount of units the Company is required to purchase and the suppliers may modify the purchase price for these components due to significant changes in market or component supply conditions. Product mix for these components may be negotiated quarterly and the purchase price for these components will be reviewed quarterly with the suppliers. The Company negotiates the purchase price with the suppliers on an ongoing basis based upon market rates.

Note 11.        Segment Reporting

The Company operates in one operating segment that develops and provides high performance server solutions based upon an innovative, modular and open-standard architecture. The Company’s chief operating decision maker is the Chief Executive Officer.

International net sales are based on the country and region to which the products were shipped. The following is a summary for the three and nine months ended March 31, 2015 and 2014, of net sales by geographic region (in thousands):
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2015
 
2014
 
2015
 
2014
Net sales:
 
 
 
 
 
 
 
United States
$
273,631

 
$
203,638

 
$
803,757

 
$
558,423

Europe
88,259

 
81,165

 
269,404

 
237,327

Asia
74,772

 
78,373

 
241,785

 
215,556

Other
34,563

 
10,579

 
102,615

 
27,827

 
$
471,225

 
$
373,755

 
$
1,417,561

 
$
1,039,133


The following is a summary of long-lived assets, excluding financial instruments, deferred tax assets, other assets, goodwill and intangible assets (in thousands):
 
 
March 31,
2015
 
June 30,
2014
Long-lived assets:
 
 
 
United States
$
115,288

 
$
94,119

Asia
37,754

 
36,123

Europe
290

 
347

 
$
153,332

 
$
130,589


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Table of Contents
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)


The following is a summary of net sales by product type (in thousands):
 
 
Three Months Ended
March 31,
 
Nine Months Ended
March 31,
 
2015
 
2014
 
2015
 
2014
 
Amount
 
Percent of
Net Sales
 
Amount
 
Percent of
Net Sales
 
Amount
 
Percent of
Net Sales
 
Amount
 
Percent of
Net Sales
Server systems
$
301,953

 
64.1
%
 
$
187,282

 
50.1
%
 
$
859,818

 
60.7
%
 
$
504,637

 
48.6
%
Subsystems and accessories
169,272

 
35.9
%
 
186,473

 
49.9
%
 
557,743

 
39.3
%
 
534,496

 
51.4
%
Total
$
471,225

 
100.0
%
 
$
373,755

 
100.0
%
 
$
1,417,561

 
100.0
%
 
$
1,039,133

 
100.0
%
 
Subsystems and accessories are comprised of serverboards, chassis and accessories. Server systems constitute subsystems and accessories assembled by the Company. One customer represented 13.9% and 12.5% of the Company’s total net sales in the three and nine months ended March 31, 2015, respectively, and no customer represented greater than 10% of the Company’s total net sales in the three and nine months ended March 31, 2014. No country other than the United States represents greater than 10% of the Company’s total net sales in the three and nine months ended March 31, 2015 and 2014. No customer accounted for 10% or more of the Company's accounts receivable as of March 31, 2015 and June 30, 2014.

Item 2.        Management's Discussion and Analysis of Financial Condition and Results of Operations

This section and other parts of this Form 10-Q contain “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, as amended that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology including “would,” “could,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” the negative of these terms or other comparable terminology. In evaluating these statements, you should specifically consider various factors, including the risks described under “Risk Factors” below and in other parts of this Form 10-Q as well as in our other filings with the SEC. These factors may cause our actual results to differ materially from those anticipated or implied in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We cannot guarantee future results, levels of activity, performance or achievements.
                                    
Overview

We are a global leader in high-performance, high-efficiency server technology and innovation. We develop and provide end-to-end green computing solutions to the Data Center, Cloud Computing, Enterprise IT, Big Data, HPC and Embedded markets. Our solutions range from complete server, storage, blade and workstations to full racks, networking devices, server management software and technology support and services. Net sales of optimized servers were $302.0 million and $859.8 million for the three and nine months ended March 31, 2015, respectively, and $187.3 million and $504.6 million for the three and nine months ended March 31, 2014, respectively, and net sales of subsystems and accessories were $169.3 million and $557.7 million for the three and nine months ended March 31, 2015, respectively, and $186.5 million and $534.5 million for the three and nine months ended March 31, 2014, respectively. The increase in our net sales in the three and nine months ended March 31, 2015 compared with the three and nine months ended March 31, 2014 was primarily due to an increase in sales of complete server systems such as our storage servers and Twin family of servers and to a lesser extent an increase in sales of our GPU/Xeon Phi and blade servers which offer higher density computing and more memory and hard disk drive capacity. The percentage of our net sales represented by sales of complete server systems increased to 64.1% and 60.7% in the three and nine months ended March 31, 2015, respectively, from 50.1% and 48.6% in the three and nine months ended March 31, 2014, respectively.

We commenced operations in 1993 and have been profitable every year since inception. Our net sales were $471.2 million and $1,417.6 million for the three and nine months ended March 31, 2015, respectively, and $373.8 million and $1,039.1 million for the three and nine months ended March 31, 2014, respectively. Our net income was $23.1 million and $75.2 million for the three and nine months ended March 31, 2015, respectively, and $16.6 million and $37.6 million for the three and nine months ended March 31, 2014, respectively. Our increase in net income in the three and nine months ended

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March 31, 2015 was primarily attributable to an increase in our gross profit resulting primarily from higher sales and improved gross margin, partially offset by higher income tax expenses attributable to higher operating income.

We sell our server systems and subsystems and accessories primarily through distributors and Original Equipment Manufacturers, or OEMs, as well as through our direct sales force. We derived 46.1% and 50.3% of our net sales from products sold to distributors and derived 53.9% and 49.7% from sales to OEMs and to end customers for the three and nine months ended March 31, 2015, respectively, and 51.9% and 55.1% of our net sales from products sold to distributors, and 48.1% and 44.9% from sales to OEMs and to end customers for the three and nine months ended March 31, 2014, respectively. One of our customers accounted for 13.9% and 12.5% of our net sales in the three and nine months ended March 31, 2015, and none of our customers accounted for 10% or more of our net sales in the three and nine months ended March 31, 2014. We derived 58.1% and 56.7% of our net sales from customers in the United States for the three and nine months ended March 31, 2015, respectively, and 54.5% and 53.7% for the three and nine months ended March 31, 2014, respectively.

We perform the majority of our research and development efforts in-house. Research and development expenses represented 5.4% and 5.1% of our net sales for the three and nine months ended March 31, 2015, respectively, and 5.5% and 5.9% of our net sales for the three and nine months ended March 31, 2014, 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 facilities. During fiscal year 2015, we have continued to increase manufacturing and service operations in Taiwan and the Netherlands to support our Asian and European customers and we have increased our utilization of our overseas manufacturing capacity. One of our key suppliers is Ablecom, a related party, which supplies us with contract design and manufacturing support. For the three and nine months ended March 31, 2015, our purchases from Ablecom represented 14.7% and 14.3% of our cost of sales, respectively, compared to 14.4% and 16.5% of our cost of sales for the three and nine months ended March 31, 2014, respectively. Ablecom’s sales to us constitute a substantial majority of Ablecom’s net sales. We continue to maintain our manufacturing relationship with Ablecom in Asia in an effort to reduce our cost of sales. 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 United States 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.

Other Financial Highlights

The following is a summary of other financial highlights of the third quarter of fiscal year 2015:

Net cash provided by operating activities was $9.1 million and $12.5 million during the nine months ended March 31, 2015 and 2014, respectively. Our cash and cash equivalents, together with our investments, were $112.0 million at the end of the third quarter of fiscal year 2015, compared with $99.6 million at the end of fiscal year 2014.
 
Days sales outstanding in accounts receivable (“DSO”) at the end of the third quarter of fiscal year 2015 was 46 days, compared with 42 days at the end of the fourth quarter of fiscal year 2014.

Our inventory balance was $430.4 million at the end of the third quarter of fiscal year 2015, compared with $315.8 million at the end of the fiscal year 2014. Days sales of inventory (“DSI”) at the end of the third quarter of fiscal year 2015 was 96 days, compared with 77 days at the end of the fourth quarter of fiscal year

          20


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2014. The increase in our inventory was in anticipation of growth of our business in our seasonally strong June quarter and was also impacted by timing of deliveries as a result of the west coast port strike in February 2015.

Our purchase commitments with contract manufacturers and suppliers were $491.2 million at the end of the third quarter of fiscal year 2015 and $211.1 million at the end of the fiscal year 2014. Included in the above non-cancellable commitments are hard disk drive purchase commitments totaling approximately $237.4 million, which have terms expiring through January 2017. See Note 10 of Notes to our Condensed Consolidated Financial Statements for a discussion of purchase commitments.

Fiscal Year

Our fiscal year ends on June 30. References to fiscal year 2015, for example, refer to the fiscal year ending June 30, 2015.

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, but generally higher in the case of sales of server systems to internet data system customers. Because we have only limited 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 incentive bonuses 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.

Interest and other expense, net. Interest and other expense, net represents interest expense on our term loans and line of credit, offset by interest earned on our investment and cash balances.


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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, Taiwan, the Netherlands, and to a lesser extent, China and Japan. Our effective tax rate differs from the statutory rate primarily due to research and development tax credits, the domestic production activities deduction and lower taxes in foreign jurisdictions which were partially offset by the impact of state taxes and stock option expenses. In recent years, our effective tax rate from period to period has been significantly impacted by delays in the approval of extensions of the U.S. research and development tax credit.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated 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. Actual results may differ from the estimates.

We believe the following are our most critical accounting policies as they require 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, for which revenue is recognized when the products arrive 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). 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 March 31, 2015 and June 30, 2014, we had deferred revenue of $0.5 million and $7.7 million and related deferred product costs of $0.2 million and $6.7 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 concentration, customer-credit-worthiness, current economic trends and changes in customer payment terms to evaluate the adequacy of the 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. Our provision for bad debt was $0.3 million and $0.2 million in the three and nine months ended March 31, 2015, respectively, and $0.3 million and $1.4 million in the three and nine months ended March 31, 2014, respectively. If a major customer's credit worthiness deteriorates, if actual defaults are higher than our historical experience, or if other circumstances arise, our estimates of the recoverability of amounts due to us could be overstated, and additional allowances could be required, which could have an adverse impact on our reported operating expenses. 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.


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Table of Contents    

We have an immaterial amount of service revenue relating to on-site service and non-warranty repairs. Revenue for on-site service is recognized over the contracted service period, and revenue for non-warranty repair service 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.

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 $7.2 million and $7.1 million as of March 31, 2015 and June 30, 2014, respectively. The provision for warranty reserve was $4.0 million and $10.9 million in the three and nine months ended March 31, 2015, respectively, and $3.5 million and $10.5 million in the three and nine months ended March 31, 2014, respectively. Our estimates and assumptions used have been historically close to actual. The change in estimated liability for pre-existing warranties was ($13,000) and $(0.3) million in the three and nine months ended March 31, 2015, respectively, and $0.1 million and $0.2 million in the three and nine months ended March 31, 2014, respectively. As a result of our higher cost of servicing warranty claims from higher net sales in the three months ended March 31, 2015, the provision for warranty reserve increased $0.5 million compared to the three months ended March 31, 2014. 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 based upon the number of units that are unlikely to be sold based upon estimated demand for the following twelve months as well as historical usage and sales activity. This evaluation takes into account matters including expected demand, historical usage and sales, 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 $0.3 million and $4.5 million in the three and nine months ended March 31, 2015, respectively, and $0.9 million and $2.4 million in the three and nine months ended March 31, 2014, 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 9 of Notes to Condensed Consolidated Financial Statements for the impact on our condensed consolidated financial statements.

Stock-based compensation. We measure and recognize the compensation expense for all share-based awards made to employees and non-employee members of our Board of Directors including employee stock options and restricted stock units. We are required to estimate the fair value of share-based awards on the date of grant. The value of awards that are ultimately expected to vest is recognized as an expense over the requisite service periods. The fair value of our restricted stock units is based on the closing market price of our common stock on the date of grant. 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

          23


Table of Contents    

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 for the stock options granted prior to June 30, 2011. For stock options and restricted stock units granted after June 30, 2011, expected term is based on a combination of our peer group and our historical experience. The expected volatility is based on a combination of our implied and 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 and restricted stock unit forfeitures and record stock-based compensation expense only for those awards that are expected to vest.

Compensation expense for options and restricted stock units granted to employees was $3.6 million and $9.7 million for the three and nine months ended March 31, 2015, respectively, and $2.8 million and $8.2 million for the three and nine months ended March 31, 2014, respectively.     As of March 31, 2015, the total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested stock options and restricted stock units granted since July 1, 2006 to employees and non-employee members of the Board of Directors, was $29.0 million, which is expected to be recognized as an expense over a weighted-average period of approximately 2.39 years. See Note 2 of Notes to our Condensed Consolidated Financial Statements for additional information.

Variable interest entities. We have concluded that Ablecom and its subsidiaries ("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.

In May 2012, we and Ablecom jointly established Super Micro Asia Science and Technology Park, Inc. ("Management Company") in Taiwan to manage the common areas shared by us and Ablecom for our separately constructed manufacturing facilities. Each company contributed $168,000 and owns 50% of the Management Company. Although the operations of the Management Company are independent of us, through governance rights, we have the ability to direct the Management Company's business strategies. Therefore, we have concluded that the Management Company is a variable interest entity of us as we are the primary beneficiary of the Management Company. As of March 31, 2015, the accounts of the Management Company have been consolidated with our accounts, and a noncontrolling interest has been recorded for Ablecom's interests in the net assets and operations of the Management Company. In the three and nine months ended March 31, 2015, $4,000, $(3,000), respectively, of net income (loss) attributable to Ablecom's interest was included in the Company's general and administrative expenses in the condensed consolidated statements of operations. In the three and nine months ended March 31, 2014 $6,000 and $(7,000), respectively, of net income (loss) attributable to Ablecom's interest was included in our general and administrative expenses in the condensed consolidated statements of operations.

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Results of Operations

The following table sets forth our financial results, as a percentage of net sales for the periods indicated:

 
Three Months Ended
 March 31,
 
Nine Months Ended
 March 31,
 
2015
 
2014
 
2015
 
2014
Net sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of sales
83.7

 
84.7

 
83.7

 
84.7

Gross profit
16.3

 
15.3

 
16.3

 
15.3

Operating expenses:
 
 
 
 
 
 
 
Research and development
5.4

 
5.5

 
5.1

 
5.9

Sales and marketing
2.6

 
2.5

 
2.5

 
2.6

General and administrative
1.6

 
1.6

 
1.2

 
1.6

Total operating expenses
9.6

 
9.6

 
8.8

 
10.1

Income from operations
6.7

 
5.7

 
7.5

 
5.2

Interest and other income, net

 

 

 

Interest expense
(0.1
)
 

 
(0.1
)
 
(0.1
)
Income before income tax provision
6.6

 
5.7

 
7.4

 
5.1

Income tax provision
1.7

 
1.3

 
2.1

 
1.5

Net income
4.9
 %
 
4.4
 %
 
5.3
 %
 
3.6
 %

Comparison of Three Months Ended March 31, 2015 and 2014

Net sales. Net sales increased by $97.5 million, or 26.1%, to $471.2 million from $373.8 million, for the three months ended March 31, 2015 and 2014, respectively. This increase was due primarily to an increase in the average selling price of our server systems and to a lesser extent an increase in unit volumes of server systems as we sold more higher density server systems.

For the three months ended March 31, 2015, the number of server system units sold increased 6.9% to 77,000 compared to 72,000 for the three months ended March 31, 2014. The average selling price of server system units increased 50.0% to $3,900 in the three months ended March 31, 2015 compared to $2,600 in the three months ended March 31, 2014. The average selling prices of our server systems increased primarily due to an increase in average selling prices of our complete server systems such as our storage servers and Twin family of servers and to a lesser extent the increase in sales of our GPU/Xeon Phi and blade servers which offer higher density computing and more memory and hard disk drive capacity. Sales of server systems increased by $114.7 million or 61.2% from the three months ended March 31, 2014 to the three months ended March 31, 2015, primarily due to the increased sales of the products described above. Sales of server systems represented 64.1% of our net sales for the three months ended March 31, 2015 compared to 50.1% of our net sales for the three months ended March 31, 2014.

For the three months ended March 31, 2015 and 2014, the number of subsystems and accessories units sold was 1.0 million and 1.1 million, respectively. Sales of subsystems and accessories decreased by $17.2 million or 9.2% from the three months ended March 31, 2014 to the three months ended March 31, 2015, primarily related to a decreased volume of chassis and serverboards sold to our distributors and system integrators who are completing the final assembly themselves. Sales of subsystems and accessories represented 35.9% of our net sales for the three months ended March 31, 2015 as compared to 49.9% of our net sales for the three months ended March 31, 2014.

For the three months ended March 31, 2015 and 2014, we derived 46.1% and 51.9%, respectively, of our net sales from products sold to distributors and we derived 53.9% and 48.1%, respectively, from sales to OEMs and to end customers. For the three months ended March 31, 2015, customers in the United States, Europe and Asia accounted for 58.1%, 18.7% and 15.9%, of our net sales, respectively, as compared to 54.5%, 21.7% and 21.0% of our net sales, respectively, for the three months ended March 31, 2014.

Cost of sales. Cost of sales increased by $77.9 million, or 24.6%, to $394.4 million from $316.5 million, for the three months ended March 31, 2015 and 2014, respectively. Cost of sales as a percentage of net sales was 83.7% and 84.7% for the

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three months ended March 31, 2015 and 2014, respectively. The increase in absolute dollars of cost of sales was primarily attributable to the increase in net sales offset partly by a decrease of $0.6 million in provision for inventory reserve. The lower cost of sales as a percentage of net sales was primarily due to lower costs resulting from the increased scale of our business and an increase in the mix of complete server system sales. In the three months ended March 31, 2015, we recorded a $0.3 million expense, net of recovery, or 0.1% of net sales, related to the inventory provision as compared to $0.9 million, or 0.2% of net sales, in the three months ended March 31, 2014. The decrease in the inventory provision was primarily due to lower inventory reserves for specific products.

In the three months ended March 31, 2015, we recorded a $4.0 million expense, or 0.8% of net sales, related to the provision for warranty reserve as compared to $3.5 million, or 0.9% of net sales, in the three months ended March 31, 2014. The increase in the provision for warranty reserve was primarily due to higher cost of servicing warranty claims from higher net sales in the three months ended March 31, 2015. 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.

Research and development expenses. Research and development expenses increased by $5.0 million, or 24.2%, to $25.5 million from $20.6 million, for the three months ended March 31, 2015 and 2014, respectively. Research and development expenses were 5.4% and 5.5% of net sales for the three months ended March 31, 2015 and 2014, respectively. The increase in absolute dollars was primarily due to an increase of $4.5 million in compensation and benefits resulting from annual salary increases and growth in research and development personnel related to expanded product development initiatives in the United States and in Taiwan. The decrease as a percentage of net sales was primarily due to the increase in net sales in the three months ended March 31, 2015.

Research and development expenses include stock-based compensation expense of $2.3 million and $1.7 million for the three months ended March 31, 2015 and 2014, respectively.

Sales and marketing expenses. Sales and marketing expenses increased by $3.1 million, or 32.7%, to $12.5 million from $9.4 million, for the three months ended March 31, 2015 and 2014, respectively. Sales and marketing expenses were 2.6% and 2.5% of net sales for the three months ended March 31, 2015 and 2014, respectively. The increase in absolute dollars was primarily due to an increase of $2.1 million in compensation and benefits resulting from growth in sales and marketing personnel and an increase of $0.7 million in advertising and marketing promotional expenses.

Sales and marketing expenses include stock-based compensation expense of $0.4 million and $0.3 million for the three months ended March 31, 2015 and 2014, respectively.

General and administrative expenses. General and administrative expenses increased by $1.5 million, or 26.3%, to $7.3 million from $5.8 million, for the three months ended March 31, 2015 and 2014, respectively. General and administrative expenses were 1.6% of net sales for both the three months ended March 31, 2015 and 2014. The increase in absolute dollars was primarily due to a change of our foreign currency transaction expense from $0.1 million of gain to $0.7 million of loss and an increase of $0.6 million in compensation and benefits to support the expansion of our operations at our headquarters and operations in Taiwan.

General and administrative expenses include stock-based compensation expense of $0.7 million and $0.5 million for the three months ended March 31, 2015 and 2014, respectively.

Interest and other expense, net. Interest and other expense, net, was $0.3 million and $0.1 million of expense for the three months ended March 31, 2015 and 2014, respectively, which primarily represented $0.3 million and $0.2 million of interest expense for the three months ended March 31, 2015 and 2014, respectively.

Provision for income taxes. Provision for income taxes increased by $3.4 million, or 71.2%, to $8.1 million from $4.8 million, for the three months ended March 31, 2015 and 2014, respectively. The effective tax rate was 26.1% and 22.3% for the three months ended March 31, 2015 and 2014, respectively. The higher income tax provision for the three months ended March 31, 2015 was primarily attributable to our higher operating income. The higher effective tax rate for the three months ended March 31, 2015 was primarily due to the lower domestic production activity deduction, partially offset by the benefits from the U.S. federal R&D credits and higher income taxed by foreign jurisdictions with lower tax rates.

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Comparison of Nine Months Ended March 31, 2015 and 2014

Net sales. Net sales increased by $378.4 million, or 36.4%, to $1,417.6 million from $1,039.1 million, for the nine months ended March 31, 2015 and 2014, respectively. This increase was due primarily to an increase in the average selling price of our server systems and to a lesser extent an increase in unit volumes of server systems as we sold more higher density server systems.

For the nine months ended March 31, 2015, the number of server system units sold increased 19.5% to 227,000 compared to 190,000 for the nine months ended March 31, 2014. The average selling price of server system units increased 40.7% to $3,800 in the nine months ended March 31, 2015 compared to $2,700 in the nine months ended March 31, 2014. The average selling prices of our server systems increased primarily due to an increase in average selling prices of our complete server systems such as our storage servers and Twin family of servers and to a lesser extent the increase in sales of our GPU/Xeon Phi and blade servers which offer higher density computing and more memory and hard disk drive capacity. Sales of server systems increased by $355.2 million or 70.4% from the nine months ended March 31, 2014 to the nine months ended March 31, 2015, primarily due to the increased sales of the products described above. Sales of server systems represented 60.7% of our net sales for the nine months ended March 31, 2015 compared to 48.6% of our net sales for the nine months ended March 31, 2014.

For the nine months ended March 31, 2015, the number of subsystems and accessories units sold increased 2.1% to 3.4 million compared to 3.3 million for the nine months ended March 31, 2014. Sales of subsystems and accessories increased by $23.2 million or 4.3% from the nine months ended March 31, 2014 to the nine months ended March 31, 2015, primarily related to an increased volume of hard disk drives and memory bundled with our server solutions sold to our distributors and system integrators who are purchasing additional accessories from us and completing the final assembly themselves. Sales of subsystems and accessories represented 39.3% of our net sales for the nine months ended March 31, 2015 as compared to 51.4% of our net sales for the nine months ended March 31, 2014.

For the nine months ended March 31, 2015 and 2014, we derived 50.3% and 55.1%, respectively, of our net sales from products sold to distributors and we derived 49.7% and 44.9%, respectively, from sales to OEMs and to end customers. For the nine months ended March 31, 2015, customers in the United States, Europe and Asia accounted for 56.7%, 19.0% and 17.1%, of our net sales, respectively, as compared to 53.7%, 22.8% and 20.7% of our net sales, respectively, for the nine months ended March 31, 2014.

Cost of sales. Cost of sales increased by $307.1 million, or 34.9%, to $1,187.1 million from $880.0 million, for the nine months ended March 31, 2015 and 2014, respectively. Cost of sales as a percentage of net sales was 83.7% and 84.7% for the nine months ended March 31, 2015 and 2014, respectively. The increase in absolute dollars of cost of sales was primarily attributable to the increase in net sales and an increase of $2.0 million in provision for inventory reserve. The lower cost of sales as a percentage of net sales was primarily due to lower costs resulting from the increased scale of our business and an increase in the mix of complete server system sales. In the nine months ended March 31, 2015, we recorded a $4.5 million expense, net of recovery, or 0.3% of net sales, related to the inventory provision as compared to $2.4 million, or 0.2% of net sales, in the nine months ended March 31, 2014. The increase in the inventory provision was primarily due to higher inventory reserves for specific products.

In the nine months ended March 31, 2015, we recorded a $10.9 million expense, or 0.8% of net sales, related to the provision for warranty reserve as compared to $10.5 million, or 1.0% of net sales, in the nine months ended March 31, 2014. The increase in the provision for warranty reserve was primarily due to higher cost of servicing warranty claims from higher net sales in the nine months ended March 31, 2015. 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.

Research and development expenses. Research and development expenses increased by $11.3 million, or 18.4%, to $72.5 million from $61.2 million, for the nine months ended March 31, 2015 and 2014, respectively. Research and development expenses were 5.1% and 5.9% of net sales for the nine months ended March 31, 2015 and 2014, respectively. The increase in absolute dollars was primarily due to an increase of $13.3 million in compensation and benefits resulting from annual salary increases and growth in research and development personnel related to expanded product development initiatives in the United States and in Taiwan, partially offset by $2.8 million refund of value added taxes on research and development expenses and an increase of $2.0 million in non-recurring engineering funding from certain suppliers and customers. The decrease as a percentage of net sales was primarily due to the increase in net sales in the nine months ended March 31, 2015.


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Research and development expenses include stock-based compensation expense of $6.1 million and $5.0 million for the nine months ended March 31, 2015 and 2014, respectively.

Sales and marketing expenses. Sales and marketing expenses increased by $7.4 million, or 27.1%, to $34.7 million from $27.3 million, for the nine months ended March 31, 2015 and 2014, respectively. Sales and marketing expenses were 2.5% and 2.6% of net sales for the nine months ended March 31, 2015 and 2014, respectively. The increase in absolute dollars was primarily due to an increase of $5.8 million in compensation and benefits resulting from growth in sales and marketing personnel and an increase of $1.5 million in advertising, marketing promotional and trade show expenses. The decrease as a percentage of net sales was primarily due to the increase in net sales in the nine months ended March 31, 2015.

Sales and marketing expenses include stock-based compensation expense of $1.1 million and $0.9 million for the nine months ended March 31, 2015 and 2014, respectively.

General and administrative expenses. General and administrative expenses increased by $0.4 million, or 2.3%, to $17.3 million from $16.9 million, for the nine months ended March 31, 2015 and 2014, respectively. General and administrative expenses were 1.2% and 1.6% of net sales for the nine months ended March 31, 2015 and 2014, respectively. The increase in absolute dollars was primarily due to an increase of $1.5 million in compensation and benefits, a decrease of $0.7 million in miscellaneous income relating to the settlement of our outstanding accounts payable with one vendor in the prior year offset in part by a decrease of $1.2 million in bad debt expenses. The decrease as a percentage of net sales was primarily due to the increase in net sales in the nine months ended March 31, 2015.

General and administrative expenses include stock-based compensation expense of $1.8 million and $1.5 million for the nine months ended March 31, 2015 and 2014, respectively.

Interest and other expense, net. Interest and other expense, net, was $0.6 million and $0.5 million of expense for the nine months ended March 31, 2015 and 2014, respectively, which primarily represented $0.7 million and $0.5 million of interest expense for the nine months ended March 31, 2015 and 2014, respectively.

Provision for income taxes. Provision for income taxes increased by $14.6 million, or 93.2%, to $30.2 million from $15.6 million, for the nine months ended March 31, 2015 and 2014, respectively. The effective tax rate was 28.7% and 29.4% for the nine months ended March 31, 2015 and 2014, respectively. The higher income tax provision for the nine months ended March 31, 2015 was primarily attributable to our higher operating income. The effective tax rate for the nine months ended March 31, 2015 was lower primarily due to the benefit from higher foreign tax credits and higher income taxed by foreign jurisdiction with lower tax rates.

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. In addition, we have, from time to time, utilized borrowing facilities, particularly in relation to the financing of real property acquisitions and improvements. Our cash and cash equivalents and short-term investments were $109.3 million and $96.9 million as of March 31, 2015 and June 30, 2014, respectively. Our cash in foreign locations was $22.8 million and $28.3 million at March 31, 2015 and June 30, 2014, respectively. It is management's intention to reinvest the undistributed foreign earnings indefinitely in foreign operations.

Operating Activities. Net cash provided by operating activities was $9.1 million and $12.5 million for the nine months ended March 31, 2015 and 2014, respectively.

Net cash provided by our operating activities for the nine months ended March 31, 2015 was primarily due to our net income of $75.2 million, an increase in accounts payable of $38.7 million, stock-based compensation expense of $9.7 million, an increase in accrued liabilities of $6.7 million, an increase in net income taxes payable of $5.8 million, depreciation expense of $5.9 million and provision for lower of cost or market and excess and obsolete inventory of $4.5 million, which were partially offset by an increase in inventory of $119.0 million, an increase in accounts receivable of $9.0 million and an excess tax benefits from stock-based compensation of $7.2 million.

Net cash provided by our operating activities for the nine months ended March 31, 2014 was primarily due to our net income of $37.6 million, an increase in accounts payable of $32.5 million, an increase in income tax payable of $9.9 million, stock-based compensation expense of $8.2 million, and depreciation expense of $4.6 million, which were partially offset by an increase in inventory of $43.3 million and an increase in accounts receivable of $34.1 million.

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The increase for the nine months ended March 31, 2015 in accounts receivable was primarily due to an increase in our net sales late in the quarter ended March 31, 2015. The increase for the nine months ended March 31, 2015 in inventory and accounts payable was primarily due to higher purchases in anticipation of the growth of our business in our seasonally strong June quarter and was also impacted by the timing of deliveries as a result of the west coast port strike in February 2015. We anticipate that accounts receivable, inventory and accounts payable will increase to the extent we continue to grow our product lines and our business.

The increase for the nine months ended March 31, 2014 in accounts receivable was primarily due to an increase in our sales in the quarter ended March 31, 2014. The increase for the nine months ended March 31, 2014 in accounts payable was due to higher purchases and timing of payments to our vendors. The increase for the nine months ended March 31, 2014 in inventory was due to support the anticipated level of growth in net sales in fiscal year 2014.
    
Investing activities. Net cash used in our investing activities was $25.7 million and $36.4 million for the nine months ended March 31, 2015 and 2014, respectively. In the nine months ended March 31, 2015, $24.6 million was related to the purchase of property, plant and equipment, of which $13.4 million was related to the development and construction of improvements on our property in San Jose, California, which is still in progress. In the nine months ended March 31, 2014, $36.8 million was related to the purchase of property, plant and equipment, of which $30.2 million was related to the real property purchased in San Jose, California in October 2013.
We plan to develop five manufacturing buildings through fiscal 2016 on the real property we purchased in San Jose, California, to serve as our Green Computing Park. We anticipate total costs of approximately $26.3 million through July 2015 for this development which we plan to finance using our operating cash flows and additional borrowings from banks.

Financing activities. Net cash provided by our financing activities was $30.0 million and $32.9 million for the nine months ended March 31, 2015 and 2014, respectively. In the nine months ended March 31, 2015, we received $21.1 million related to the proceeds from the exercise of stock options. Further, we borrowed an additional $36.4 million under our revolving line of credit from Bank of America and CTBC Bank and repaid $35.3 million in loans in the nine months ended March 31, 2015. In the nine months ended March 31, 2015, excess tax benefits from stock-based compensation were $7.2 million. We expect the net cash provided by financing activities will increase throughout fiscal year 2015 as we intend to obtain additional financing from banks to construct our manufacturing buildings at our Green Computing Park in San Jose, California.

In the nine months ended March 31, 2014, we received $19.2 million related to proceeds from the exercise of stock options. We withheld shares and paid the minimum tax withholding mainly on behalf of one executive officer for his restricted stock awards of $0.7 million for the nine months ended March 31, 2014. Further, we borrowed an additional $6.8 million under the line of credit from Bank of America, borrowed $7.1 million from the CTBC Bank secured term loan, and borrowed $3.5 million of our CTBC Bank revolving line of credit and repaid $5.6 million in loans in the nine months ended March 31, 2014. In the nine months ended March 31, 2014, excess tax benefits from stock-based compensation were $2.7 million.
 
We expect to experience continued growth in our working capital requirements and capital expenditures as we continue to expand our business. 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 intend to fund this continued expansion through cash generated by operations and by drawing on our 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 for at least the next 12 months.

Other factors affecting liquidity and capital resources

Activities under Revolving Lines of Credit and Term Loans

Bank of America
In October 2011, we entered into an amendment to our existing credit agreement with Bank of America, which provided for (i) a $40.0 million revolving line of credit facility through June 15, 2013 and (ii) a five-year $14.0 million term loan facility. The term loan is secured by three buildings located in San Jose, California and the principal and interest are

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payable monthly through September 30, 2016 with an interest rate at the LIBOR rate plus 1.50% per annum. The credit agreement was subsequently amended to extend the maturity date of the revolving line of credit to November 15, 2015.

The line of credit facility provides for borrowings denominated both in U.S. dollars and in Taiwanese dollars. For borrowings denominated in U.S. dollars, the interest rate for the revolving line of credit is at the LIBOR rate plus 1.25% per annum. The LIBOR rate was 0.17% at March 31, 2015. For borrowings denominated in Taiwanese dollars, the interest rate for the revolving line of credit is equal to the lender's established interest rate which is adjusted monthly.

As of March 31, 2015 and June 30, 2014, the total outstanding borrowings under the Bank of America term loan were $4.4 million and $6.5 million, respectively. The total outstanding borrowings under the Bank of America line of credit were $11.2 million and $17.7 million as of March 31, 2015 and June 30, 2014, respectively. The interest rates for these loans ranged from 0.82% to 1.67% per annum at March 31, 2015 and 1.19% to 1.65% per annum at June 30, 2014. As of March 31, 2015, the unused revolving line of credit under Bank of America was $28.8 million.

In April 2015, we drew an additional $10.0 million from Bank of America line of credit with an interest rate at 1.43% per annum to support the our growth and expansion of our business.
    
CTBC Bank    
In October 2011, we obtained an unsecured revolving line of credit from CTBC Bank totaling NT$300.0 million or $9.9 million U.S. dollars equivalents. In July 2012, we increased the credit line to NT$450.0 million or $14.9 million U.S. dollars equivalents. The term loan was secured by the land and building located in Bade, Taiwan with an interest rate at the lender's established interest rate plus 0.3% which is adjusted monthly.

In November 2013, we entered into an amendment to our existing credit agreement with CTBC Bank to increase the credit facility amount and extend the maturity date to November 30, 2014. The amendment provides for (i) a 13-month NT$700.0 million or $23.8 million U.S. dollar equivalents term loan secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum which is adjusted monthly and (ii) a 13-month unsecured term loan up to NT$100.0 million or $3.4 million U.S. dollar equivalents, and a 13-month revolving line of credit up to 80% of eligible accounts receivable in an aggregate amount of up to NT$500.0 million or $17.0 million U.S. dollar equivalents with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum or lender's established USD interest rate plus 0.30% per annum which is adjusted monthly. The total borrowings allowed under the credit agreement is capped at NT$1.0 billion or $34.0 million U.S. dollar equivalents.

In December 2014, we entered into a second amendment to our existing credit agreement with CTBC Bank to extend the maturity date to November 30, 2015. The amendment provides for (i) a 12-month NT$700.0 million or $22.0 million U.S. dollar equivalents term loan secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum which is adjusted monthly and (ii) a 12-month revolving line of credit up to 80% of eligible accounts receivable in an aggregate amount of up to $17.0 million with an interest rate equal to the lender's established USD interest rate plus 0.30% per annum which is adjusted monthly. The total borrowings allowed under the credit agreement is capped at NT$1,000.0 million or $31.5 million U.S. dollar equivalents.

The total outstanding borrowings under the CTBC Bank term loan was denominated in Taiwanese dollars and was translated into U.S. dollars of $21.1 million and $22.1 million as of March 31, 2015 and June 30, 2014, respectively. The total outstanding borrowings under the CTBC Bank revolving line of credit was $9.7 million and $0 at March 31, 2015 and June 30, 2014, respectively. The interest rates for these loans ranged from 0.81% to 1.15% and 1.15% per annum at March 31, 2015 and June 30, 2014, respectively. At March 31, 2015, NT$37.1 million or $1.2 million U.S. dollar equivalents were available for future borrowing under this credit agreement.

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Covenant Compliance
Our credit agreement with Bank of America contains customary representations and warranties and customary affirmative and negative covenants applicable to the Company and its subsidiaries. The credit agreement contains certain financial covenants, including the following:
 
 
Not to incur on a consolidated basis, a net loss before taxes and extraordinary items in any two consecutive quarterly accounting periods;
 
 
The Company’s funded debt to EBITDA ratio (ratio of all outstanding liabilities for borrowed money and other interest-bearing liabilities, including current and long-term debt, less the non-current portion of subordinated liabilities to EBITDA) shall not be greater than 2.00;
 
 
The Company’s unencumbered liquid assets, as defined in the agreement, held in the United States shall have an aggregate market value of not less than $30,000,000, measured as of the last day of each fiscal quarter and the last day of each fiscal year.
    
As of March 31, 2015, our total assets of $916.4 million collateralized the line of credit with Bank of America and were all of our assets except for the three buildings purchased in San Jose, California in June 2010 and the land and building located in Bade, Taiwan. As of March 31, 2015, total assets collateralizing the term loan with Bank of America were $17.4 million. As of March 31, 2015, the Company was in compliance with all financial covenants associated with the term loan and line of credit with Bank of America.

As of March 31, 2015, the net book value of land and building located in Bade, Taiwan collateralizing the term loan with CTBC Bank was $27.2 million. There are no financial covenants associated with the term loan with CTBC Bank at March 31, 2015.

Contract Manufacturers
For the three and nine months ended March 31, 2015, we paid our contract manufacturers within 36 to 75 days of invoice and Ablecom between 48 to 105 days of invoice. Ablecom, a Taiwan corporation, is one of our major contract manufacturers and a related party. As of March 31, 2015 and June 30, 2014, amounts owed to Ablecom by us were approximately $51.9 million and $49.0 million, respectively.

Auction Rate Securities Valuation
As of March 31, 2015, we held $2.6 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; the auction rate security was rated AAA or AA2 at March 31, 2015. These auction rate preferred shares have no stated maturity date.

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 March 31, 2015, $2.6 million of these auction rate securities have been classified as long-term available-for-sale investments. Based on our assessment of fair value at March 31, 2015, we have recorded an accumulated unrealized loss of $0.1 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. In the three and nine months ended March 31, 2015 and 2014, there were no auction rate securities redeemed or sold.


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Contractual Obligations

The following table describes our contractual obligations as of March 31, 2015:
 
 
Payments Due by Period
 
 Less Than 
1 Year
 
1 to 3
    Years    
 
3 to 5
    Years    
 
More Than
5 Years
 
Total     
 
(in thousands)
Operating leases
$
2,689

 
$
2,777

 
$
1,555

 
$
3,513

 
$
10,534

Capital leases, including interest
197

 
363

 
190

 

 
750

Long-term debt, including interest (1)
44,893

 
1,643

 

 

 
46,536

Purchase commitments (2)
376,773

 
114,415

 

 

 
491,188

Total (3)
$
424,552

 
$
119,198

 
$
1,745

 
$
3,513

 
$
549,008

 
__________________________
(1)
Amount reflects total anticipated cash payments, including anticipated interest payments based on the interest rate at March 31, 2015.
(2)
Amount reflects total gross purchase commitments under our manufacturing arrangements with third-party contract manufacturers or vendors. Our purchase obligations included $237.4 million of hard disk drive purchase commitments at March 31, 2015, which will be paid through January 2017. See Note 10 of Notes to our Condensed Consolidated Financial Statements for a discussion of purchase commitments.
(3)
The table above excludes liabilities for deferred revenue, net of cost, of $6.3 million and unrecognized tax benefits and related interest and penalties accrual of $10.6 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.

We expect to fund our remaining contractual obligations from our ongoing operations and existing cash and cash equivalents on hand.

Adoption of New Accounting Pronouncements

In March 2013, the FASB issued authoritative guidance associated with a parent company’s accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. The standard applies to the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity. The adoption of this guidance did not have a material impact on our results of operations or financial position.

In July 2013, the FASB issued authoritative guidance associated with the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. It requires a liability related to an unrecognized tax benefit to offset a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if a settlement is required or expected in the event the uncertain tax position is disallowed. The adoption of this guidance did not have a material impact on our results of operations or financial position.

In May 2014, the FASB issued new accounting guidance related to revenue recognition. This new standard replaces all current U.S. GAAP guidance on revenue, eliminates all industry-specific guidance and provides a unified model in determining when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance can be applied either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The new standard is effective for us on July 1, 2018. We are currently evaluating the effect the guidance will have on our financial statement disclosures, results of operations and financial position.

In April 2015, the FASB issued new accounting guidance related to presentation of debt issue costs. The new standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. The new standard is effective for us on July 1, 2016. We are currently evaluating the effect the guidance will have on our financial statement disclosures, results of operations and financial position.



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Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

The primary objectives of our investment activities are to preserve principal, provide liquidity and maximize income without significantly increasing the risk. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the fair value of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in money market funds and certificates of deposit. Our long-term investments include auction rate securities, which have been classified as long-term due to the lack of a liquid market for these securities. Since our results of operations are not dependent on investments, the risk associated with fluctuating interest rates is limited to our investment portfolio, and we believe that a 10% change in interest rates would not have a significant impact on our results of operations. As of March 31, 2015, our investments were in money market funds, certificates of deposits and auction rate securities.

We are exposed to changes in interest rates as a result of our borrowings under our term loan and revolving lines of credit. The interest rates for the term loans and the revolving lines of credit ranged from 0.81% to 1.67% at March 31, 2015 and 1.15% to 1.65% at June 30, 2014. Based on the outstanding principal indebtedness of $46.5 million under our credit facilities as of March 31, 2015, we believe that a 10% change in interest rates would not have a significant impact on our results of operations.

Liquidity Risk

As of March 31, 2015, we held $2.6 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; the auction rate security was rated AAA or AA2 at March 31, 2015. These auction rate preferred shares have no stated maturity date. 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 March 31, 2015, $2.6 million of these auction rate securities have been classified as long-term available-for-sale investments. Based on our assessment of fair value at March 31, 2015, we have recorded an accumulated unrealized loss of $0.1 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. During the three and nine months ended March 31, 2015 and 2014, no auction rate securities were redeemed or sold.

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 our 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 March 31, 2015, 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 March 31, 2015 in respect to these securities and, if a liquid market does not develop for these investments, we could be required to hold them to market recovery.

Foreign Currency Risk

To date, our international customer and supplier agreements have been denominated primarily in U.S. dollars, and accordingly, we have limited exposure to foreign currency exchange rate fluctuations from customer agreements, and do not currently engage in foreign currency hedging transactions. However, the functional currency of our operations in the Netherlands and Taiwan is the U.S. dollar and our local accounts including financing arrangements are denominated in the local currency in the Netherlands and Taiwan, respectively, and thus we are subject to foreign currency exchange rate fluctuations associated with re-measurement to U.S. dollars. Such fluctuations have not been significant historically. Foreign exchange gain (loss) for the three and nine months ended March 31, 2015 was $(0.7) million and $0.6 million, respectively, and for both three and nine months ended March 31, 2014 was $0.1 million.

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Item 4.    Controls and Procedures

Evaluation of Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The evaluation considered the procedures designed to ensure that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of March 31, 2015.

Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2015 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

PART II: OTHER INFORMATION
 
Item 1.        Legal Proceedings

From time to time, we have been involved in various legal proceedings arising from the normal course of business activities. We defend ourselves vigorously against any such claims. In management's opinion, the resolution of any pending matters will not have a material adverse effect on our consolidated financial condition, results of operations, or liquidity.

Item 1A.    Risk Factors

The Risk Factors included in our Annual Report on Form 10-K for the year ended June 30, 2014 have not materially changed. You should carefully consider the following risk factors, as well as the other information in this Form 10-Q. If any of the following risks actually occurs, our business, financial condition and results of operations would suffer. In this case, the trading price of our common stock would likely decline and you might lose all or part of your investment in our common stock. Additional risks that we currently do not know about or that we currently believe to be immaterial may also impair our business operations.

Risks Related to Our Business and Industry
Our quarterly operating results will likely fluctuate in the future, which could cause rapid declines in our stock price.
As our business continues to grow, we believe that our quarterly operating results will be subject to greater fluctuation due to various factors, many of which are beyond our control. Factors that may affect quarterly operating results in the future include:
 
 
fluctuations based upon seasonality, with the quarters ending March 31 and September 30 typically being weaker;
 
 
unpredictability of the timing and size of customer orders, since most of our customers purchase our products on a purchase order basis rather than pursuant to a long term contract;
 
 
fluctuations in availability and costs associated with key components and other materials needed to satisfy customer requirements;
 
 
variability of our margins based on the mix of server systems, subsystems and accessories we sell and the percentage of our sales to internet datacenter cloud customers or geographical regions;
 
 
the timing of the introduction of new products by leading microprocessor vendors and other suppliers;
 
 
our ability to introduce new and innovative server solutions that appeal to our customers;

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changes in tax rates, particularly with respect to the availability of research and development credits;
 
 
our ability to address technology issues as they arise, improve our products’ functionality and expand our product offerings;
 
 
changes in our product pricing policies, including those made in response to new product announcements and pricing changes of our competitors;
 
 
mix of whether customer purchases are of full systems or subsystems and accessories and whether made directly or through indirect sales channels;
 
 
the effect of mergers and acquisitions among our competitors, suppliers or partners;
 
 
general economic conditions in our geographic markets; and
 
 
impact of regulatory changes on our cost of doing business.
    
Accordingly, it is difficult to accurately forecast our growth and results of operations on a quarterly basis. If we fail to meet expectations of investors or analysts, our stock price may fall rapidly and without notice. Furthermore, the fluctuation of quarterly operating results may render less meaningful period-to-period comparisons of our operating results, and you should not rely upon them as an indication of future performance.

As we increasingly target larger customers and larger sales opportunities, our customer base may become more concentrated, our cost of sales may increase, our margins may be lower and our sales may be less predictable.

As our business continues to grow, we have become increasingly dependent upon larger sales to maintain our rate of growth. In particular, in recent years, we have completed larger sales to datacenters, leading internet companies and for other cloud computing applications. One of our customers accounted for 13.9% and 12.5% of our net sales in the three and nine months ended March 31, 2015, respectively. As customers buy our products in greater volumes and their business becomes a larger percentage of our net sales, we may grow increasingly dependent on those customers to maintain our growth. If our largest customers do not purchase our products at the levels, timeframes or geographies that we expect, our ability to maintain or grow our net sales will be adversely affected.

Additionally, as we and our partners focus increasingly on selling to larger customers and attracting larger orders, we expect greater costs of sales. Our sales cycle may become longer and more expensive, as larger customers typically spend more time negotiating contracts than smaller customers. Larger customers often seek to gain greater pricing concessions, as well as greater levels of support in the implementation and use of our server solutions. These factors can result in lower margins for our products.
    
Increased sales to larger companies may also cause fluctuations in results of operations. A larger customer may seek to fulfill all or substantially all of its requirements in a single order, and not make another purchase for a significant period of time. Accordingly, a significant increase in revenue during the period in which we recognize the revenue from the sale may be followed by a period of time during which the customer purchases none or few of our products. A significant decline in net sales in periods following a significant order could adversely affect our revenues and net income. Likewise, large orders are generally subject to intense pricing pressure which can have an adverse impact on our margins and results of operations. As a result, our quarter-to-quarter results of operations may be subject to greater fluctuation and our stock price may be adversely affected.

We may fail to meet publicly announced financial guidance or other expectations about our business, which would cause our stock to decline in value.

We typically provide forward looking financial guidance when we announce our financial results from the prior quarter. We undertake no obligation to update such guidance at any time. Frequently in the past, our financial results have failed to meet the guidance we provided. There are a number of reasons why we might fail, including, but not limited to, the factors described in the preceding Risk Factors and other Risk Factors set forth in this item.

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Increases in average selling prices for our server solutions have significantly contributed to our increases in net sales. Such prices are subject to decline if customers do not continue to purchase our latest generation products or additional components, which could harm our results of operations.

Increases in average selling prices have significantly contributed to our increases in net sales. As with most electronics based products, average selling prices of servers 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 become commoditized and are ultimately replaced by even newer generation products. As our business continues to grow, we may increasingly be subject to this industry risk. We cannot predict the timing or amount of any decline in the average selling prices of our server solutions that we may experience in the future. In some instances, our agreements with our distributors limit our ability to reduce prices unless we make such price reductions available to them, or price protect their inventory. If we are unable to decrease per unit manufacturing costs faster than the rate at which average selling prices continue to decline, our business, financial condition and results of operations will be harmed. In addition, our average selling prices have increased rapidly in recent periods as we have sold more products including additional components such as more memory and hard disk drive capacity. There is no assurance that our average selling prices will continue to increase and may decline due to decreased demand for, or lower prices of, the additional components that we sell with our server solutions.

Our cost structure and ability to deliver server solutions to customers in a timely manner may be adversely affected by volatility of the market for core components and materials for our products.

Prices of materials and core components utilized in the manufacture of our server solutions, such as serverboards, chassis, central processing units, or CPUs, memory and hard drives represent a significant portion of our cost of sales. We generally do not enter into long-term supply contracts for these materials and core components, but instead purchase these materials and components on a purchase order basis. Prices of these core components and materials are volatile, and, as a result, it is difficult to predict expense levels and operating results. In addition, if our business growth renders it necessary or appropriate to transition to longer term contracts with materials and core component suppliers, our costs may increase and our gross margins could correspondingly decrease.

Because we often acquire materials and core components on an as needed basis, we may be limited in our ability to effectively and efficiently respond to customer orders because of the then-current availability or the terms and pricing of materials and core components. Our industry has experienced materials shortages and delivery delays in the past, and we may experience shortages or delays of critical materials in the future. From time to time, we have been forced to delay the introduction of certain of our products or the fulfillment of customer orders as a result of shortages of materials and core components. For example, we were unable to fulfill certain orders at the end of the quarter ended June 30, 2010 due to component shortages, and our net sales were adversely impacted in fiscal year 2013 and 2012 by disk drive shortages resulting from the flooding in Thailand. If shortages or delays arise, the prices of these materials and core components may increase or the materials and core components may not be available at all. In addition, in the event of shortages, some of our larger competitors may have greater abilities to obtain materials and core components due to their larger purchasing power. We may not be able to secure enough core components or materials at reasonable prices or of acceptable quality to build new products to meet customer demand, which could adversely affect our business and financial results.

If we were to lose any of our current supply or contract manufacturing relationships, the process of identifying and qualifying a new supplier or contract manufacturer who will meet our quality and delivery requirements, and who will appropriately safeguard our intellectual property, may require a significant investment of time and resources, adversely affecting our ability to satisfy customer purchase orders and delaying our ability to rapidly introduce new products to market. Similarly, if any of our suppliers were to cancel, materially change contracts or commitments to us or fail to meet the quality or delivery requirements needed to satisfy customer demand for our products, whether due to shortages or other reasons, our reputation and relationships with customers could be damaged. We could lose orders, be unable to develop or sell some products cost-effectively or on a timely basis, if at all, and have significantly decreased revenues, margins and earnings, which would have a material adverse effect on our business.

We may incur additional expenses and suffer lower margins if our expectations regarding long term hard disk drive or other inventory commitments prove incorrect.

Notwithstanding our general practice of not entering into long term supply contracts, we have entered into purchase agreements with selected suppliers of hard disk drives and certain other components in order to ensure continuity of supply. Our hard disk drive purchase commitments totaled approximately $237.4 million as of March 31, 2015, an increase from $45.2 million as of June 30, 2014 and will be paid through January 2017. Higher costs compared to the lower selling prices for these

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components incurred under these agreements contributed to our lower gross profit in fiscal year 2013 and will likely impact our gross profit in the future. Our existing and any other similar future supply commitments that we may enter into expose us to risk for lower margins or loss on disposal of such inventory if our expectations of customer demand are incorrect and the market price of the material or component inventory decline. Likewise if we fail to enter into commitments we may be exposed to limited available of supply or higher inventory costs which could result in lower net sales and adversely impact gross margin and net income.

We may lose sales or incur unexpected expenses relating to insufficient, excess or obsolete inventory.

As a result of our strategy to provide greater choice and customization of our products to our customers, we are required to maintain a high level of inventory. If we fail to maintain sufficient inventory, we may not be able to meet demand for our products on a timely basis, and our sales may suffer. If we overestimate customer demand for our products, we could experience excess inventory of our products and be unable to sell those products at a reasonable price, or at all. As a result, we may need to record higher inventory reserves. In addition, from time to time we assume greater inventory risk in connection with the purchase or manufacture of more specialized components in connection with higher volume sales opportunities. We have from time to time experienced inventory write downs associated with higher volume sales that were not completed as anticipated. For example, we recorded a reserve in the quarters ended March 31, 2013 and June 30, 2013 relating to specialized inventory purchased for one customer. We expect that we will experience such write downs from time to time in the future related to existing and future commitments. If we are later able to sell inventory with respect to which we have taken a reserve at a profit, it may increase the quarterly variances in our operating results. Additionally, the rapid pace of innovation in our industry could render significant portions of our existing inventory obsolete. Certain of our distributors and OEMs have rights to return products, 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 termination of the agreement or product obsolescence. Any returns under these arrangements could result in additional obsolete inventory. In addition, server systems, subsystems and accessories that have been customized and later returned by those of our customers and partners who have return rights or stock rotation rights may be unusable for other purposes or may require reformation at additional cost to be made ready for sale to other customers. Excess or obsolete inventory levels for these or other reasons could result in unexpected expenses or increases in our reserves against potential future charges which would adversely affect our business and financial results. For example, during the nine months ended March 31, 2015 and 2014, we recorded inventory write-downs charged to cost of sales for lower of cost or market and excess and obsolete inventory of $4.5 million and $2.4 million, respectively. For additional information regarding customer return rights, see “Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies-Inventory Valuation.”

We may encounter difficulties with our ERP systems.

We are currently in the process of implementing a new enterprise resource planning, or ERP, system and expect to commence using the new ERP during calendar year 2015. We have incurred and expect to continue to incur additional expenses for our implementation. Many companies have experienced delays and difficulties with the implementation of new or changed ERP systems that have had a negative effect on their business. Any disruptions, delays or deficiencies in the design and implementation of a revised or new ERP system could result in potentially much higher costs than we had anticipated and could adversely affect our ability to develop new products, provide services, fulfill contractual obligations, file reports with the SEC in a timely manner and/or otherwise operate our business, or otherwise impact our controls environment. Any of these consequences could have an adverse effect on our results of operations and financial condition.

If we do not successfully manage the expansion of our international manufacturing operations, our business could be harmed.

Since inception we have conducted a substantial majority of our manufacturing operations near our corporate headquarters in California. We are increasing our utilization of manufacturing operations in Taiwan and in the Netherlands. The commencement or scaling of new manufacturing operations in new locations, particularly in other jurisdictions, entails additional risks and challenges. If we are unable to successfully ramp up these operations we may incur unanticipated costs, difficulties in making timely delivery of products or suffer other business disruptions which could adversely impact our results of operations.

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We may not be able to successfully manage our planned growth and expansion.

Over time we expect to continue to make investments to pursue new customers and expand our product offerings to grow our business rapidly. We expect that our annual operating expenses will continue to increase as we invest in sales and marketing, research and development, manufacturing and production infrastructure, and strengthen customer service and support resources for our customers. Our failure to expand operational and financial systems timely or efficiently could result in additional operating inefficiencies, which could increase our costs and expenses more than we had planned and prevent us from successfully executing our business plan. We may not be able to offset the costs of operation expansion by leveraging the economies of scale from our growth in negotiations with our suppliers and contract manufacturers. Additionally, if we increase our operating expenses in anticipation of the growth of our business and this growth does not meet our expectations, our financial results will be negatively impacted.

If our business grows, we will have to manage additional product design projects, materials procurement processes, and sales efforts and marketing for an increasing number of SKUs, as well as expand the number and scope of our relationships with suppliers, distributors and end customers. If we fail to manage these additional responsibilities and relationships successfully, we may incur significant costs, which may negatively impact our operating results. Additionally, in our efforts to be first to market with new products with innovative functionality and features, we may devote significant research and development resources to products and product features for which a market does not develop quickly, or at all. If we are not able to predict market trends accurately, we may not benefit from such research and development activities, and our results of operations may suffer.

The market in which we participate is highly competitive, and if we do not compete effectively, we may not be able to increase our market penetration, grow our net sales or improve our gross margins.

The market for server solutions is intensely competitive and rapidly changing. Barriers to entry in our market are relatively low and we expect increased challenges from existing as well as new competitors. Some of our principal competitors offer server solutions at a lower price, which has resulted in pricing pressures on sales of our server solutions. We expect further downward pricing pressure from our competitors and expect that we will have to price some of our server solutions aggressively to increase our market share with respect to those products or geographies, particularly for internet datacenter customers and other large sale opportunities. If we are unable to maintain the margins on our server solutions, our operating results could be negatively impacted. In addition, if we do not develop new innovative server solutions, or enhance the reliability, performance, efficiency and other features of our existing server solutions, our customers may turn to our competitors for alternatives. In addition, pricing pressures and increased competition generally may also result in reduced sales, less efficient utilization of our manufacturing operations, lower margins or the failure of our products to achieve or maintain widespread market acceptance, any of which could have a material adverse effect on our business, results of operations and financial condition.

Our principal competitors include global technology companies such as Dell, Inc., Hewlett-Packard Company, IBM, Cisco and Intel. In addition, we also compete with a number of other vendors who also sell application optimized servers, contract manufacturers and original design manufacturers, or ODMs, such as Quanta Computer Incorporated. ODMs sell server solutions marketed or sold under a third party brand.

Many of our competitors enjoy substantial competitive advantages, such as:

greater name recognition and deeper market penetration;
longer operating histories;
larger sales and marketing organizations and research and development teams and budgets;
more established relationships with customers, contract manufacturers and suppliers and better channels to reach larger customer bases and larger sales volume allowing for better costs;
larger customer service and support organizations with greater geographic scope;
a broader and more diversified array of products and services; and
substantially greater financial, technical and other resources.

As a result, our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. Competitors may seek to copy our innovations and use cost advantages from greater size to compete aggressively with us on price. Certain customers are also current or prospective competitors and as a result, assistance that we provide to them as customers may ultimately result in increased competitive pressure against us. Furthermore, because of these advantages, even if our application optimized server solutions are more

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effective than the products that our competitors offer, potential customers might accept competitive products in lieu of purchasing our products. The challenges we face from larger competitors will become even greater if consolidation or collaboration between or among our competitors occurs in our industry. In addition, in recent periods each of Hewlett-Packard, Dell and IBM have experienced or initiated substantial changes. Also initiatives like the Open Compute Project, or OCP, a project to establish more industry standard datacenter configurations, could have the impact of supporting an approach which is less favorable to the flexibility and customization that we offer. These changes could have a significant impact on the market and impact our results of operations. For all of these reasons, we may not be able to compete successfully against our current or future competitors, and if we do not compete effectively, our ability to increase our net sales may be impaired.

Any failure to adequately expand or retain our sales force will impede our growth.

We expect that our direct sales force will continue to grow as larger customers increasingly require a direct sales approach. Competition for direct sales personnel with the advanced sales skills and technical knowledge we need is intense. Our ability to grow our revenue in the future will depend, in large part, on our success in recruiting, training, retaining and successfully managing sufficient qualified direct sales personnel. We have traditionally experienced much greater turnover in our sales and marketing personnel as compared to other departments and other companies. New hires require significant training and may take six months or longer before they reach full productivity. Our recent hires and planned hires may not become as productive as we would like, and we may be unable to hire sufficient numbers of qualified individuals in the future in the markets where we do business. If we are unable to hire, develop and retain sufficient numbers of productive sales personnel, sales of our server solutions will suffer.

We must work closely with our suppliers to make timely new product introductions.

We rely on our close working relationships with our suppliers, including Intel, AMD and Nvidia, to anticipate and deliver new products on a timely basis when new generation materials and core components are made available. Intel, AMD and Nvidia are the only suppliers of the microprocessors we use in our server systems. If we are not able to maintain our relationships with our suppliers or continue to leverage their research and development capabilities to develop new technologies desired by our customers, our ability to quickly offer advanced technology and product innovations to our customers would be impaired. We have no long term agreements that obligate our suppliers to continue to work with us or to supply us with products.

Our suppliers’ failure to improve the functionality and performance of materials and core components for our products may impair or delay our ability to deliver innovative products to our customers.

We need our material and core component suppliers, such as Intel, AMD and Nvidia, to provide us with core components that are innovative, reliable and attractive to our customers. Due to the pace of innovation in our industry, many of our customers may delay or reduce purchase decisions until they believe that they are receiving best of breed products that will not be rendered obsolete by an impending technological development. Accordingly, demand for new server systems that incorporate new products and features is significantly impacted by our suppliers’ new product introduction schedules and the functionality, performance and reliability of those new products. If our materials and core component suppliers fail to deliver new and improved materials and core components for our products, we may not be able to satisfy customer demand for our products in a timely manner, or at all. If our suppliers’ components do not function properly, we may incur additional costs and our relationships with our customers may be adversely affected.

As our business grows, we expect that we may be exposed to greater customer credit risks.

Historically, we have offered limited credit terms to our customers. As our customer base expands, as our orders increase in size, and as we obtain more direct customers, we expect to offer increased credit terms and flexible payment programs to our customers. Doing so may subject us to increased credit risk, higher accounts receivable with longer days outstanding, and increases in charges or reserves, which could have a material adverse effect on our business, results of operations and financial condition.

We principally rely on indirect sales channels for the sale and distribution of our products and any disruption in these channels could adversely affect our sales.

Historically, a majority of our revenues have resulted from sales of our products through third party distributors and resellers, which sales accounted for 46.1% and 50.3% of our net sales in the three and nine months ended March 31, 2015, respectively, and 51.9% and 55.1% in the three and nine months ended March 31, 2014, respectively. We depend on our distributors to assist us in promoting market acceptance of our products and anticipate that a majority of our revenues will

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continue to result from sales through indirect channels. To maintain and potentially increase our revenue and profitability, we will have to successfully preserve and expand our existing distribution relationships as well as develop new distribution relationships. Our distributors also sell products offered by our competitors and may elect to focus their efforts on these sales. If our competitors offer our distributors more favorable terms or have more products available to meet the needs of their customers, or utilize the leverage of broader product lines sold through the distributors, those distributors may de-emphasize or decline to carry our products. In addition, our distributors’ order decision-making process is complex and involves several factors, including end customer demand, warehouse allocation and marketing resources, which can make it difficult to accurately predict total sales for the quarter until late in the quarter. We also do not control the pricing or discounts offered by distributors to end customers. To maintain our participation in distributors’ marketing programs, in the past we have provided cooperative marketing arrangements or made short-term pricing concessions.

The discontinuation of cooperative marketing arrangements or pricing concessions could have a negative effect on our business. Our distributors could also modify their business practices, such as payment terms, inventory levels or order patterns. If we are unable to maintain successful relationships with distributors or expand our distribution channels or we experience unexpected changes in payment terms, inventory levels or other practices by our distributors, our business will suffer.

Our direct sales efforts may create confusion for our end customers and harm our relationships with our distributors and OEMs.

We expect our direct sales force to continue to grow as our business grows. As our direct sales force becomes larger, our direct sales efforts may lead to conflicts with our distributors and OEMs, who may view our direct sales efforts as undermining their efforts to sell our products. If a distributor or OEM deems our direct sales efforts to be inappropriate, the distributor or OEM may not effectively market our products, may emphasize alternative products from competitors, or may seek to terminate our business relationship. Disruptions in our distribution channels could cause our revenues to decrease or fail to grow as expected. Our failure to implement an effective direct sales strategy that maintains and expands our relationships with our distributors and OEMs could lead to a decline in sales and adversely affect our results of operations.

Our research and development expenditures, as a percentage of our net sales, are considerably higher than many of our competitors and our earnings will depend upon maintaining revenues and margins that offset these expenditures.

Our strategy is to focus on being consistently rapid-to-market with flexible and customizable server systems that take advantage of our own internal development and the latest technologies offered by microprocessor manufacturers and other component vendors. Consistent with this strategy, we spend higher amounts, as a percentage of revenues, on research and development costs than many of our competitors. If we cannot sell our products in sufficient volume and with adequate gross margins to compensate for such investment in research and development, our earnings may be materially and adversely affected.

Our failure to deliver high quality server solutions could damage our reputation and diminish demand for our products.

Our server solutions are critical to our customers’ business operations. Our customers require our server solutions to perform at a high level, contain valuable features and be extremely reliable. The design of our server solutions is sophisticated and complex, and the process for manufacturing, assembling and testing our server solutions is challenging. Occasionally, our design or manufacturing processes may fail to deliver products of the quality that our customers require. For example, in the past a vendor provided us with a defective capacitor that failed under certain heavy use applications. As a result, our product needed to be repaired. Though the vendor agreed to pay for a large percentage of the costs of the repairs, we incurred costs in connection with the recall and diverted resources from other projects.

New flaws or limitations in our server solutions may be detected in the future. Part of our strategy is to bring new products to market quickly, and first-generation products may have a higher likelihood of containing undetected flaws. If our customers discover defects or other performance problems with our products, our customers’ businesses, and our reputation, may be damaged. Customers may elect to delay or withhold payment for defective or underperforming server solutions, request remedial action, terminate contracts for untimely delivery, or elect not to order additional server solutions, which could result in an increase in our provision for doubtful accounts, an increase in collection cycles for accounts receivable or subject us to the expense and risk of litigation. We may incur expense in recalling, refurbishing or repairing defective server solutions. If we do not properly address customer concerns about our products, our reputation and relationships with our customers may be harmed. For all of these reasons, customer dissatisfaction with the quality of our products could substantially impair our ability to grow our business.


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Conflicts of interest may arise between us and Ablecom Technology Inc., one of our major contract manufacturers, and those conflicts may adversely affect our operations.

We use Ablecom, a related party, for contract design and manufacturing coordination support. We work with Ablecom to optimize modular designs for our chassis and certain of other components. Our purchases from Ablecom represented 14.7% and 14.3% of our cost of sales for the three and nine months ended March 31, 2015, respectively, and 14.4% and 16.5% for the three and nine months ended March 31, 2014, respectively. Ablecom’s sales to us constitute a substantial majority of Ablecom’s net sales. Ablecom is a privately-held Taiwan-based company.

Steve Liang, Ablecom’s Chief Executive Officer and largest shareholder, is the brother of Charles L