10-Q 1 a10q2011q2.htm FORM 10-Q WebFilings | EDGAR view

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 24, 2010
Or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from                 to
Commission File Number 000-51333
 
SILICON GRAPHICS INTERNATIONAL CORP.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
32-0047154
 
 
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
46600 Landing Parkway
Fremont, California 94538
(Address of principal executive offices, including zip code)
(510) 933-8300
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  o    No  o 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer   o
Accelerated filer  x
Non-accelerated filer  o
Smaller reporting company   o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No   x 
As of January 27, 2011, there were 30,307,348 shares of the registrant's common stock outstanding.
 


SILICON GRAPHICS INTERNATIONAL CORP.
TABLE OF CONTENTS
 
 
 
Page
PART I
 2
Item 1.
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
PART II
 42
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 
 


PART I - FINANCIAL INFORMATION
 
ITEM 1. Financial Statements (unaudited).
 
SILICON GRAPHICS INTERNATIONAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
December 24, 2010
 
December 25, 2009
 
December 24, 2010
 
December 25, 2009
 
 
 
 
 
 
 
 
Revenue
 
 
 
 
 
 
 
Product
$
114,719
 
 
$
 
 
$
177,076
 
 
$
 
Service
32,959
 
 
 
 
66,678
 
 
 
Combined product and service
29,846
 
 
94,137
 
 
46,664
 
 
194,260
 
Total revenue (Note 3):
177,524
 
 
94,137
 
 
290,418
 
 
194,260
 
Cost of revenue
 
 
 
 
 
 
 
Product
85,989
 
 
 
 
135,171
 
 
 
Service
18,392
 
 
 
 
37,571
 
 
 
Combined product and service
20,814
 
 
75,451
 
 
34,350
 
 
153,206
 
Total cost of revenue
125,195
 
 
75,451
 
 
207,092
 
 
153,206
 
Gross profit
52,329
 
 
18,686
 
 
83,326
 
 
41,054
 
Operating expenses:
 
 
 
 
 
 
 
Research and development
13,415
 
 
14,374
 
 
27,168
 
 
25,719
 
Sales and marketing
18,021
 
 
16,850
 
 
32,959
 
 
31,617
 
General and administrative
11,770
 
 
12,975
 
 
24,524
 
 
26,786
 
Restructuring
166
 
 
1,715
 
 
801
 
 
2,218
 
Acquisition-related
 
 
(968
)
 
 
 
(557
)
Total operating expenses
43,372
 
 
44,946
 
 
85,452
 
 
85,783
 
Income (loss) from operations
8,957
 
 
(26,260
)
 
(2,126
)
 
(44,729
)
Total other expense:
 
 
 
 
 
 
 
Interest income, net
96
 
 
104
 
 
226
 
 
228
 
Other expense, net
(4,595
)
 
(1,519
)
 
(4,180
)
 
(914
)
Total other expense
(4,499
)
 
(1,415
)
 
(3,954
)
 
(686
)
Income (loss) from continuing operations before income taxes
4,458
 
 
(27,675
)
 
(6,080
)
 
(45,415
)
Income tax provision (benefit) from continuing operations
734
 
 
(4,548
)
 
1,383
 
 
(4,486
)
Net income (loss) from continuing operations
3,724
 
 
(23,127
)
 
(7,463
)
 
(40,929
)
Discontinued operations (Note 19):
 
 
 
 
 
 
 
Income from discontinued operations, net of tax
 
 
84
 
 
 
 
264
 
Net income (loss)
$
3,724
 
 
$
(23,043
)
 
$
(7,463
)
 
$
(40,665
)
 
 
 
 
 
 
 
 
Net income (loss) per share, basic:
 
 
 
 
 
 
 
Continuing operations
$
0.12
 
 
$
(0.77
)
 
$
(0.25
)
 
$
(1.37
)
Discontinued operations
 
 
 
 
 
 
0.01
 
Basic net income (loss) per share
$
0.12
 
 
$
(0.77
)
 
$
(0.25
)
 
$
(1.36
)
 
 
 
 
 
 
 
 
Net income (loss) per share, diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.12
 
 
$
(0.77
)
 
$
(0.25
)
 
$
(1.37
)
Discontinued operations
 
 
 
 
 
 
0.01
 
Diluted net income (loss) per share
$
0.12
 
 
$
(0.77
)
 
$
(0.25
)
 
$
(1.36
)
 
 
 
 
 
 
 
 
Shares used in computing net income (loss) per share
 
 
 
 
 
 
 
Basic
30,321
 
 
29,952
 
 
30,429
 
 
29,960
 
Diluted
30,836
 
 
29,952
 
 
30,429
 
 
29,960
 
See accompanying notes.

2


SILICON GRAPHICS INTERNATIONAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)
 
 
 
December 24,
2010
 
June 25,
2010
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
100,941
 
 
$
129,343
 
Current portion of restricted cash and cash equivalents
1,144
 
 
830
 
Accounts receivable, net of allowance for doubtful accounts of $2,016 and $1,646 as of December 24, 2010 and June 25, 2010, respectively
103,538
 
 
79,464
 
Inventories
79,074
 
 
89,929
 
Deferred cost of revenue
57,637
 
 
45,255
 
Prepaid expenses and other current assets
19,574
 
 
15,967
 
Total current assets
361,908
 
 
360,788
 
Non-current portion of restricted cash and cash equivalents
3,241
 
 
3,102
 
Long-term investments
6,207
 
 
7,475
 
Property and equipment, net
26,204
 
 
28,172
 
Intangible assets, net
12,608
 
 
16,223
 
Non-current portion of deferred cost of revenue
56,885
 
 
49,109
 
Other assets
29,400
 
 
32,343
 
Total assets
$
496,453
 
 
$
497,212
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
41,452
 
 
$
49,204
 
Accrued compensation
21,017
 
 
21,885
 
Other current liabilities
33,630
 
 
27,608
 
Current portion of deferred revenue
138,019
 
 
137,596
 
Total current liabilities
234,118
 
 
236,293
 
Non-current portion of deferred revenue
98,346
 
 
91,989
 
Long-term income taxes payable
23,400
 
 
21,715
 
Other non-current liabilities
12,390
 
 
12,286
 
Total liabilities
368,254
 
 
362,283
 
Commitments and contingencies (Note 23)
 
 
 
Stockholders' equity:
 
 
 
Preferred stock, par value $0.001 per share; 12,000 shares authorized; none outstanding
 
 
 
Common stock, par value $0.001 per share; 120,000 shares authorized; 31,056 shares and 30,709 shares issued at December 24, 2010 and June 25, 2010, respectively
31
 
 
31
 
Additional paid-in capital
462,607
 
 
459,339
 
Treasury stock, at cost (749 shares and 244 shares at December 24, 2010 and June 25, 2010, respectively)
(4,912
)
 
(1,022
)
Accumulated other comprehensive loss
(548
)
 
(1,903
)
Accumulated deficit
(328,979
)
 
(321,516
)
Total stockholders' equity
128,199
 
 
134,929
 
Total liabilities and stockholders' equity
$
496,453
 
 
$
497,212
 
 
See accompanying notes.

3


SILICON GRAPHICS INTERNATIONAL CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended
 
December 24, 2010
 
December 25, 2009
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(7,463
)
 
$
(40,665
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
8,600
 
 
9,729
 
Share-based compensation
2,453
 
 
2,423
 
Impairment of investment in SGI Japan Ltd.
2,904
 
 
 
Realized loss on investments
1,151
 
 
 
Provision (recovery) for doubtful accounts receivable
352
 
 
(107
)
Loss on disposal of property and equipment
54
 
 
273
 
Deferred income taxes
(91
)
 
 
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(24,426
)
 
(12,235
)
Inventories
10,855
 
 
32,383
 
Deferred cost of revenue
(20,158
)
 
(55,405
)
Prepaid expenses and other assets
(3,607
)
 
1,687
 
Other long term assets
185
 
 
(1,905
)
Accounts payable
(7,968
)
 
(21,741
)
Accrued compensation
(880
)
 
(2
)
Other liabilities
7,857
 
 
2,323
 
Deferred revenue
6,780
 
 
101,375
 
Net cash provided by (used in) operating activities
(23,402
)
 
18,133
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of property and equipment
(2,901
)
 
(2,983
)
Increase in restricted cash and cash equivalents
(453
)
 
(1,180
)
Proceeds from sales of long-term investments
1,192
 
 
 
Proceeds from maturities of long-term investments
225
 
 
50
 
Net cash used in investing activities
(1,937
)
 
(4,113
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repurchases of restricted stock
(380
)
 
(354
)
Purchase of treasury stock
(3,890
)
 
 
Proceeds from issuance of common stock upon exercise of stock options
227
 
 
150
 
Proceeds from issuance of common stock under ESPP plan
980
 
 
268
 
Net cash provided by (used in) financing activities
(3,063
)
 
64
 
Net increase (decrease) in cash and cash equivalents
(28,402
)
 
14,084
 
Cash and cash equivalents-beginning of period
129,343
 
 
128,714
 
Cash and cash equivalents-end of period
$
100,941
 
 
$
142,798
 
NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Property and equipment purchases in accounts payable
$
216
 
 
$
381
 
Unrealized loss on investments
$
 
 
$
(12
)
 
 
 
 
SUPPLEMENTAL DISCLOSURE OF OTHER CASH FLOW INFORMATION:
 
 
 
Income taxes paid
$
64
 
 
$
875
 
 
See accompanying notes.

4


SILICON GRAPHICS INTERNATIONAL CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
1. DESCRIPTION OF BUSINESS
Silicon Graphics International Corp. (“SGI” or the “Company”) was originally incorporated as Rackable Corporation which later changed its name to Rackable Systems, Inc. (“Rackable Systems” or “Legacy Rackable”) prior to changing its name to SGI. Rackable Systems was incorporated in the state of Delaware in December 2002. On May 8, 2009, Rackable Systems completed the acquisition of substantially all of the assets, excluding certain assets unrelated to the ongoing business, and assumed certain liabilities of Silicon Graphics, Inc. (“Legacy SGI”). This acquisition was consummated pursuant to the terms of an Asset Purchase Agreement dated March 31, 2009, as amended on April 30, 2009, which was approved by the United States Bankruptcy Court for the Southern District of New York for Silicon Graphics, Inc. Effective May 18, 2009, Rackable Systems changed its name to Silicon Graphics International Corp.
The Company's headquarters is located in Fremont, California. The Company operates in 26 countries, with its primary manufacturing facilities located in Chippewa Falls, Wisconsin. The principal business of the Company is the design, manufacture and implementation of highly scalable compute servers, high-capacity storage systems and high-end computing and data management systems. In addition to the broad line of mid-range to high-end computing servers, data storage and data center technologies, the Company provides global customer support and professional services related to these products. The Company's products are used by the scientific, technical and business communities to solve challenging data intensive computing, data management and visualization problems. The vertical markets the Company serves include the federal government, defense and strategic systems, weather and climate, physical sciences, life sciences, energy (including oil and gas), aerospace and automotive, Internet, financial services, media and entertainment, and business intelligence and data analytics.
 
2. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Basis of Presentation. The accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the periods presented. These unaudited condensed consolidated financial statements also have been prepared pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) applicable to interim financial information. The results for the interim periods are not necessarily indicative of results for the entire year or any future periods. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements for the fiscal year ended June 25, 2010, which are included in the Company's Annual Report on Form 10-K filed with the SEC on September 8, 2010.
Reclassifications. The Company reclassified certain costs that were previously reported as sales and marketing expense to research and development expense to conform to the Company's internal reporting structure. Accordingly, $1.3 million and $2.6 million of costs reported for the three months and six months ended December 25, 2009, respectively, have been reclassified from sales and marketing expense to research and development expense to conform to the current period's presentation. The reclassification did not impact the Company's previously reported net revenues, gross profit, operating income, net income or earnings per share.
Fiscal Year. The Company has a 52 or 53-week fiscal year ending on the last Friday in June. Fiscal year 2011 will be comprised of 52-weeks and will end on June 24, 2011. Fiscal year 2010 was comprised of 52-weeks and ended on June 25, 2010. The Company's fiscal quarters generally have 13-week quarters ending on the last Friday of the respective period. The second quarter of fiscal year 2011 and fiscal year 2010 ended on December 24, 2010 and December 25, 2009, respectively; and each period was comprised of 13 weeks or 91 days. The Company's next 53-week fiscal year will be fiscal year 2012, and the first quarter of fiscal year 2012 will be comprised of 14 weeks or 98 days.
Principles of Consolidation. The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.
Estimates and Assumptions. The preparation of unaudited condensed consolidated financial statements in accordance with generally accepted accounting principles in the United States of America (“US GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses as presented in the unaudited condensed consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management's best knowledge of current events and actions that may impact the Company in the future, actual results may be different from the estimates. The Company's critical accounting policies are those that affect the Company's financial statements materially and

5

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

involve difficult, subjective or complex judgments by management and include revenue recognition, share-based compensation, restructuring reserve, allowance for doubtful accounts, inventory valuation, impairment of long-lived assets, fair value measurements and impairments, warranty reserve, and accounting for income taxes.
Discontinued Operations. In October 2008, the Company committed to a formal plan to abandon the RapidScale product line (“RapidScale”). The Company has accounted for the RapidScale product line as a discontinued operation. The results of operations of the RapidScale product line have been reclassified and presented as discontinued operations, net of tax, for fiscal year 2010. The cash flows of the RapidScale product line have not been reported separately within the unaudited condensed consolidated statement of cash flows based upon materiality (see Note 19). The results of operations of the RapidScale product line for fiscal year 2011 are not material.
 
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Recent Accounting Policy Changes.
There have been no significant changes in the Company's significant accounting policies for the six months ended December 24, 2010 as compared to those disclosed in the Company's Annual Report on Form 10-K for the year ended June 25, 2010, except for the changes in revenue recognition as a result of new accounting standards as described below.
Revenue Recognition.
The Company enters into sales contracts to deliver multiple products and/or services. A typical multiple-element arrangement includes product, customer support services and professional services. The Company also sells software products as part of certain multiple-element arrangements. In addition to selling multiple-element arrangements, the Company also sells certain products and services on a stand-alone basis.
Product revenue. The Company recognizes revenue from sales of products, primarily hardware, when persuasive evidence of an arrangement exists, shipment has occurred and title has transferred, the sales price is fixed or determinable, and collection of the resulting receivable is reasonably assured. In customer arrangements where a formal acceptance of products or services is required by the customer, revenue is recognized upon meeting such acceptance criteria.
Service revenue. Service revenue includes customer support services, primarily hardware maintenance services, and professional services, which include consulting services and integration services of third-party products. Revenue from extended service contracts, that is not subject to deferral under the Company's revenue recognition policy applicable to sales contracts entered into prior to fiscal year 2011 discussed below and are expressly priced separately from the hardware, is recognized ratably over the contract term, generally one to three years. Professional services are offered under time and material or fixed fee-based contracts or as part of multiple-element arrangements. Professional services revenue is recognized as services are performed.
Multiple-element arrangements. The Company's multiple-element arrangements include products, customer support services and/or professional services. Certain multiple-element arrangements include software products integrated with the hardware (“Hardware Appliance”) and the Company provides unspecified software updates and enhancements to the software through its service contracts. For arrangements which do not include Hardware Appliances and where services are included, the Company recognizes revenue from the sale of products prior to the completion of services as product sales are not dependent on services to be functional.
In October 2009, the Financial Accounting Standards Board ("FASB") amended the Accounting Standards Codification (“ASC”) as summarized in Accounting Standards Update ("ASU") No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. ASU 2009-14 amends industry specific revenue accounting guidance for software and software related transactions to exclude from its scope tangible products containing software components and non-software components that function together to deliver the product's essential functionality. ASU 2009-13 amends the accounting for multiple-element arrangements to provide guidance on how the deliverables in an arrangement should be separated and eliminates the use of the residual method. ASU 2009-13 also requires an entity to allocate revenue using the relative selling price method. The standard establishes a hierarchy of evidence to determine the stand-alone selling price of a deliverable based on vendor-specific objective evidence ("VSOE"), third-party evidence ("TPE"), and the best estimate of selling price ("BESP"). If VSOE is available, it would be used to determine the selling price of a deliverable. If VSOE is not available, the entity would determine whether TPE is available. If so, TPE must be used to determine the selling price. If TPE is not available, then the BESP would be used.

6

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

Effective June 26, 2010, the Company adopted the provisions of ASU 2009-13 and ASU 2009-14 for new and materially modified arrangements originating after June 25, 2010. The adoption of ASU 2009-13 and ASU 2009-14 was material to the Company's financial results, increasing revenues by $45.5 million and $57.7 million for the three and six months ended December 24, 2010, respectively, and increasing gross profit by $19.2 million and $24.6 million for the three and six months ended December 24, 2010, respectively. The impact was due to the recognition of revenue that would have been previously deferred for multiple-element arrangements which include Hardware Appliances or arrangements where the undelivered element is post contract customer support ("PCS") for which the Company was unable to establish VSOE of fair value of the element. The new standard allows for deliverables for which revenue would have been previously deferred to be separated and recognized as delivered, rather than over the longest service delivery period as a single unit with other elements in the arrangement. The Company expects the adoption of ASU 2009-13 and ASU 2009-14 to be material to future periods; however, the Company cannot reasonably estimate the effect of adopting these standards on future financial periods as the impact will vary depending on the nature and volume of new or materially modified arrangements in any given period.
For fiscal year 2011 and future periods, pursuant to the guidance of ASU 2009-13, when a sales arrangement contains multiple elements, such as products, software, customer support services, and/or professional services, the Company allocates revenue to each element based on the aforementioned selling price hierarchy. In multiple element arrangements where software is essential to the functionality of the products, revenue is allocated to each separate unit of accounting for each of the non-software deliverables and to the software deliverables as a group using the relative selling prices of each of the deliverables in the arrangement based on the aforementioned selling price hierarchy. If the arrangement contains more than one software deliverable, the arrangement consideration allocated to the software deliverables as a group is then recognized as one unit of accounting using the guidance for recognizing software revenue, as amended.
The Company limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges.
The Company evaluates each deliverable in an arrangement to determine whether they represent separate units of accounting. The delivered item constitutes a separate unit of accounting when it has standalone value and there are no customer-negotiated refunds or return rights for the delivered elements. If the arrangement includes a customer-negotiated refund or return right relative to the delivered item and the delivery and performance of the undelivered item is considered probable and substantially in the Company's control, the delivered element constitutes a separate unit of accounting. In instances when the aforementioned criteria are not met, the deliverable is combined with the undelivered elements and revenue recognition is determined for the combined unit as a single unit. Allocation of the consideration is determined at arrangement inception on the basis of each unit's relative selling price.
The Company has not consistently established VSOE of fair value of any of its products or services. In addition, the Company has not established TPE as there are no similar or interchangeable competitor products or services in standalone sales to similarly situated customers. Therefore, revenue from these multiple-element arrangements is allocated based on the BESP. The objective of BESP is to determine the price at which the Company would transact a sale if a product or service were sold on a stand-alone basis. The Company determines BESP for product or service by considering multiple factors including, but not limited to, overall market conditions, including geographic or regional specific market factors, competitive positioning, competitor actions, profit objectives and pricing practices. The determination of BESP is a formal process within the Company that includes review and approval by the Company's management. In addition, the Company regularly reviews VSOE and TPE for its products and services, in addition to BESP.
For fiscal year 2010 and sales contracts entered into prior to fiscal year 2011, the Company recognizes revenue pursuant to the previous guidance for multiple-element arrangements. For arrangements which do not include Hardware Appliances and where services are included, the Company recognizes revenue from the sale of products prior to the completion of services as the services are not essential to the functionality of the products. For certain multiple-element arrangements, the Company delivers software products integrated with the Hardware Appliance and provides unspecified software updates and enhancements to the software through its PCS. For arrangements which include Hardware Appliances or arrangements where the undelivered element is PCS, the Company had not established VSOE of fair value of the element. Therefore, revenue and related cost of revenue from these arrangements are deferred and recognized ratably over the PCS period as combined product and service revenue in the unaudited condensed statements of operations.
 
 

7

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

Recently Issued Accounting Standards.
In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (“ASU 2010-06”), which requires new disclosures about significant transfers in and out of Level 1 and Level 2 and separate disclosures about purchases, sales, issuances, and settlements with respect to Level 3 measurements. ASU 2010-16 also clarifies existing fair value disclosures about valuation techniques and inputs used to measure fair value. The new disclosures and clarifications of existing disclosures were effective for the Company during the three months ended September 24, 2010, except for the disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements, which will be effective for the Company beginning June 25, 2011 (fiscal year 2012). As the provisions of ASU 2010-06 relate to disclosure requirements only, the revised guidance did not have a material impact on our financial statements during the six months ended December 24, 2010.
 
4. FINANCIAL INSTRUMENTS AND FAIR VALUE
The Company measures its assets and liabilities at fair value based upon the expected exit price, representing the amount that would be received on the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value reflects the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model.
The Company uses a three-level fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
•    
Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
•    
Level 2 - Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and
•    
Level 3 - Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
The Company's assessment of the hierarchy level of the assets or liabilities measured at fair value is determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company consider an active market to be one in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis, and view an inactive market as one in which there are a few transactions for the asset or liability, the prices are not current, or price quotations vary substantially either over time or among market makers. Where appropriate, the Company or the counterparty's non-performance risk is considered in determining the fair values of liabilities and assets, respectively.
Long-term Investments
Long-term investments consist of auction rate securities ("ARS"), which are investments with contractual maturities generally between zero and 50 years. The Company's ARS consist of investments that are backed by pools of student loans, the majority of which are ultimately guaranteed by the U.S. Department of Education. Beginning in February 2008, certain ARS failed auction due to sell orders exceeding buy orders. Given the recent disruptions in the credit markets and the fact that the liquidity for these types of securities remains uncertain, the Company has classified the ARS of $6.2 million as long-term investments in the accompanying unaudited condensed consolidated balance sheets as the Company's ability to liquidate such securities in the next 12 months is uncertain.
Long-term investments consist of the following (in thousands):

8

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

 
Amortized
Cost
 
Gross
Unrealized
Gain 
 
Gross
Unrealized
Loss
 
Estimated Fair
Value 
December 24, 2010
 
 
 
 
 
 
 
Auction rate securities
$
6,207
 
 
$
 
 
$
 
 
$
6,207
 
June 25, 2010
 
 
 
 
 
 
 
Auction rate securities
$
8,775
 
 
$
 
 
$
(1,300
)
 
$
7,475
 
On November 16, 2010, the Company sold one of its ARS and received approximately $1.2 million in cash proceeds. The fair value of the ARS was approximately $1.1 million at the time of the sale. As a result, the Company recognized a gain of approximately $0.1 million in the unaudited condensed consolidated statements of operations during the three months ended December 24, 2010.
As of December 24, 2010, the Company re-assessed the fair value of its ARS and the Company determined that there was an increase in fair value primarily due to changes in the estimated rate of return used in the discounted cash flow model to estimate the fair value of the ARS. However, the change in fair value was immaterial for the three months ended December 24, 2010. For the six months ended December 24, 2010, the Company has recognized unrealized losses of $1.2 million in the unaudited condensed consolidated statements of operations. The unrealized losses were recognized as the Company entered into an 'offer to sell' with a secondary market broker for all of its ARS and the Company determined that an other-than-temporary impairment had occurred with respect to its entire ARS portfolio.
As of June 25, 2010, the Company recorded a temporary impairment loss within accumulated other comprehensive loss of $1.3 million. The unrealized losses on the investments in ARS were caused by market declines as a result of the recent disruption in the credit markets. Because the decline in market value was attributable to changes in market conditions and not credit quality, and the Company did not intend to sell nor likely be required to sell these investments prior to the recovery of the entire amortized cost basis, the Company did not consider the investments in ARS to be other-than temporarily impaired at June 25, 2010.
Fair Value of Financial Instruments
The following table sets forth the financial instruments measured at fair value on a recurring basis as of December 24, 2010 (in thousands):
 
Level 1
 
Level 2 
 
Level 3 
 
Assets at fair
value 
December 24, 2010
 
 
 
 
 
 
 
Cash equivalents
 
 
 
 
 
 
 
Money market funds
$
1,615
 
 
$
 
 
$
 
 
$
1,615
 
U.S. treasury bills
15,554
 
 
 
 
 
 
15,554
 
Long-term investments
 
 
 
 
 
 
 
Auction rate securities
 
 
 
 
6,207
 
 
6,207
 
Total
$
17,169
 
 
$
 
 
$
6,207
 
 
$
23,376
 
The Company's money market funds and U.S. treasury bills are classified within Level 1 of the fair value hierarchy as they are valued using quoted market prices of the identical underlying securities in active markets.
There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the three and six months ended December 24, 2010.
The Company's ARS are classified within Level 3 of the fair value hierarchy as the fair value of ARS is estimated using an income (discounted cash flow) approach that incorporates both observable and unobservable inputs to discount the expected future cash flows. The material factors used in preparing the discounted cash flow model are 1) the discount rate utilized to present value the cash flows, 2) the time period until redemption and 3) the estimated rate of return. The Company derives the estimates by obtaining input from market data on the applicable discount rate, estimated time to maturity and estimated rate of return. The changes in fair value have been primarily due to changes in the estimated rate of return. Changes in these estimates or in the market conditions for these investments are likely in the future based upon the current market conditions for these investments and may affect the fair value of these investments.

9

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

The changes in Level 3 assets measured at fair value on a recurring basis for the six months ended December 24, 2010 were as follows (in thousands):
Six Months Ended December 24, 2010
ARS
Beginning balance at June 25, 2010
$
7,475
 
Redemption at par value
(225
)
Total realized gains included in net income
101
 
Sale of securities
(1,144
)
Ending balance at December 24, 2010
$
6,207
 
The Company may also be required to measure certain assets or liabilities at fair value on a nonrecurring basis. The fair values of accounts receivable, accounts payable, and accrued liabilities approximates their carrying values because of the short-term nature of these instruments. The investment in SGI Japan Ltd. ("SGI Japan") is accounted for under the cost method and fair value of the investment is measured using comparison to companies in Japan, analysis of the financial condition of SGI Japan, and conditions reflected in the capital markets. During the three months ended December 24, 2010, the Company determined that there had been an other-than-temporary impairment of its investment in SGI Japan. As a result, the Company wrote down the investment by $2.9 million, which represented the difference between the investment's carrying value and the estimated fair value of the investment. The Company included the impairment loss in other expense, net, for the three and six months ended December 24, 2010. The value of the investment in SGI Japan after the write down was $2.1 million, which represented the estimated fair value of the investment at December 24, 2010. As of June 25, 2010, the fair value of the investment in SGI Japan was $5.0 million.
 
5. INVENTORIES
Inventories consist of the following (in thousands):
 
December 24,
2010
 
June 25,
2010
Finished goods
$
21,644
 
 
$
37,525
 
Work in process
17,150
 
 
13,875
 
Raw materials
40,280
 
 
38,529
 
Total inventories
$
79,074
 
 
$
89,929
 
 
6. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of the following (in thousands):
 
December 24,
2010
 
June 25,
2010
Non-trade accounts receivable
$
2,816
 
 
$
4,794
 
Prepaid taxes
1,605
 
 
2,128
 
Value-added tax receivable
12,001
 
 
5,272
 
Deferred income taxes
463
 
 
463
 
Other prepaid and current assets
2,689
 
 
3,310
 
Total prepaid expenses and other current assets
$
19,574
 
 
$
15,967
 
 

10

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

7. PROPERTY AND EQUIPMENT, NET
Property and equipment, net consist of the following (dollars in thousands):
 
Estimated
Useful Life
 
December 24,
2010
 
June 25,
2010
Land
N/A
 
$
799
 
 
$
799
 
Building
30-32
 
11,228
 
 
11,062
 
Computer equipment and software
2-6
 
19,639
 
 
17,830
 
Manufacturing equipment
2-7
 
5,548
 
 
5,451
 
Leasehold improvements
2-7
 
7,201
 
 
7,501
 
Furniture and fixtures
2-7
 
1,534
 
 
1,532
 
Vehicles
5
 
104
 
 
104
 
Construction in progress
N/A
 
693
 
 
428
 
 
 
 
46,746
 
 
44,707
 
Less accumulated depreciation and amortization
 
 
(20,542
)
 
(16,535
)
Total property and equipment, net
 
 
$
26,204
 
 
$
28,172
 
Depreciation and amortization expense was $1.9 million and $3.1 million for the three months ended December 24, 2010 and December 25, 2009, respectively. Depreciation and amortization expense was $5.0 million and $6.0 million for the six months ended December 24, 2010 and December 25, 2009, respectively.
 
8. INTANGIBLE ASSETS, NET
The following table details the Company's intangible asset balance by major asset class (dollars in thousands):
Intangible Asset Class
 
Weighted
Average
Useful Life
(in Years)
 
December 24, 2010
 
Gross
Carrying
Amount 
 
Accumulated
Amortization 
 
Net
Customer relationships
 
5
 
$
6,900
 
 
$
(2,300
)
 
$
4,600
 
Purchased technology
 
5
 
7,800
 
 
(2,353
)
 
5,447
 
Customer backlog
 
(a)
 
5,100
 
 
(5,092
)
 
8
 
Trademark/trade name portfolio
 
5
 
3,667
 
 
(1,231
)
 
2,436
 
Patents & other
 
2
 
200
 
 
(83
)
 
117
 
Total
 
 
 
$
23,667
 
 
$
(11,059
)
 
$
12,608
 
Intangible Asset Class
 
Weighted
Average
Useful Life
(in Years)
 
June 25, 2010
 
Gross
Carrying
Amount 
 
Accumulated
Amortization
 
Net
Customer relationships
 
5
 
$
6,900
 
 
$
(1,610
)
 
$
5,290
 
Purchased technology
 
4
 
5,300
 
 
(1,434
)
 
3,866
 
Customer backlog
 
(a)
 
5,100
 
 
(3,517
)
 
1,583
 
Trademark/trade name portfolio
 
5
 
3,667
 
 
(849
)
 
2,818
 
Patents & other
 
2
 
200
 
 
(34
)
 
166
 
Subtotal
 
 
 
21,167
 
 
(7,444
)
 
13,723
 
In-process research & development costs not subject to amortization
 
(b)
 
2,500
 
 
 
 
2,500
 
Total
 
 
 
$
23,667
 
 
$
(7,444
)
 
$
16,223
 
(a)    
The customer backlog intangible asset is amortized as all revenue recognition criteria is accomplished for a particular

11

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

(a)    
customer order, reflecting the use of the asset.
(b)    
In-process research and development is accounted for as an indefinite-lived intangible asset until completion or abandonment of the associated research and development efforts. During the three months ended September 24, 2010, the Company completed the associated research and development efforts and transferred the in-process research and development costs to purchased technology category.
Intangible assets amortization expense was $2.6 million and $2.2 million in the three months ended December 24, 2010 and December 25, 2009, respectively. Intangible assets amortization expense was $3.6 million and $3.7 million in the six months ended December 24, 2010 and December 25, 2009, respectively.
As of December 24, 2010, the expected amortization expense for all intangible assets is as follows (in thousands):
Fiscal Year 
 
Amortization
Expense
2011 (remaining six months)
 
$
2,048
 
2012
 
3,902
 
2013
 
3,113
 
2014
 
2,645
 
2015
 
300
 
2016 and thereafter
 
600
 
Total amortization
 
$
12,608
 
 
9. OTHER ASSETS
Other assets consist of the following (in thousands):
 
December 24,
2010
 
June 25,
2010
Long-term service inventory
$
15,927
 
 
$
16,135
 
Restricted pension plan assets
7,641
 
 
6,945
 
Investment in SGI Japan
2,096
 
 
5,000
 
Residual value of leased equipment
416
 
 
763
 
Long-term refundable deposits
1,276
 
 
1,154
 
Other assets
2,044
 
 
2,346
 
Total other assets
$
29,400
 
 
$
32,343
 
 
10. OTHER CURRENT LIABILITIES
Other current liabilities consist of the following (in thousands):
 
December 24,
2010
 
June 25,
2010
Accrued warranty, current portion
$
2,509
 
 
$
2,859
 
Accrued sales and use tax payable
15,934
 
 
8,083
 
Income taxes payable
1,055
 
 
1,214
 
Accrued restructuring
569
 
 
1,311
 
Accrued professional services fees
1,372
 
 
1,874
 
Royalty reserve
714
 
 
927
 
Other
11,477
 
 
11,340
 
Total other current liabilities
$
33,630
 
 
$
27,608
 
 

12

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

11. OTHER NON-CURRENT LIABILITIES
Other non-current liabilities consist of the following (in thousands):
 
December 24,
2010
 
June 25,
2010
Pension liability
$
7,621
 
 
$
7,012
 
Deferred income taxes
342
 
 
342
 
Accrued warranty, non-current portion
1,218
 
 
1,527
 
Deferred rent, non-current portion
853
 
 
981
 
Other
2,356
 
 
2,424
 
Total other non-current liabilities
$
12,390
 
 
$
12,286
 
 
12. WARRANTY RESERVE
Activity in the warranty reserve, which is included in other current and non-current liabilities, is as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Balance at beginning of period
$
3,519
 
 
$
8,005
 
 
$
4,386
 
 
$
8,572
 
Current period accrual
858
 
 
255
 
 
1,281
 
 
882
 
Warranty expenditures charged to accrual
(939
)
 
(908
)
 
(1,861
)
 
(2,102
)
Changes in accrual for pre-existing warranties
288
 
 
 
 
(80
)
 
 
Balance at end of period
$
3,726
 
 
$
7,352
 
 
$
3,726
 
 
$
7,352
 
 
13. RESTRUCTURING ACTIVITY
On July 27, 2009, management approved restructuring actions to reduce the Company's European workforce and vacate certain facilities in Europe. The total amount expected to be incurred in connection with the restructuring activity is $9.0 million. The Company expects employee severance to be substantially paid during the remainder of fiscal year 2011 and the Company expects to substantially fulfill the remaining contractual obligations related to the facilities exit costs by fiscal year 2012. As of December 24, 2010, the total cost incurred in connection with the restructuring was $8.5 million.
The total restructuring expense is as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Employee terminations
$
178
 
 
$
1,612
 
 
$
738
 
 
$
1,951
 
Facilities exits costs
 
 
103
 
 
75
 
 
267
 
Total restructuring expense
$
178
 
 
$
1,715
 
 
$
813
 
 
$
2,218
 
Activity in accrued restructuring during the six months ended December 24, 2010 is as follows (in thousands):
 
Employee
Terminations
 
Facilities
Exit Costs 
 
Total
Balance at June 25, 2010
$
1,268
 
 
$
337
 
 
$
1,605
 
Costs incurred
560
 
 
75
 
 
635
 
Cash payments
(1,179
)
 
(67
)
 
(1,246
)
Balance at Septebmer 24, 2010
649
 
345
 
994
 
Costs incurred
178
 
 
 
 
178
 
Cash payments
(312
)
 
(67
)
 
(379
)
Balance at December 24, 2010
$
515
 
 
$
278
 
 
$
793
 

13

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

The restructuring liability balance of $0.8 million as of December 24, 2010 includes $0.6 million recorded in other current liabilities and $0.2 million recorded in other non-current liabilities in the accompanying unaudited condensed consolidated balance sheets.
 
14. SHARE-BASED COMPENSATION
Share-Based Benefit Plans
In 2005, the Company's Board of Directors adopted and its stockholders approved the Company's 2005 Equity Incentive Plan (“2005 Plan”), 2005 Non-Employee Directors' Stock Option Plan and 2005 Employee Stock Purchase Plan (“2005 ESPP Plan”). In January 2006, the Company's Board of Directors adopted the 2006 New Recruit Equity Incentive Plan (“New Recruit Plan”), which allows the Company to grant non-statutory stock awards for up to 1,000,000 shares of common stock to newly hired employees as an inducement to join the Company. No grants may be made under the New Recruit Plan to persons who are continuing employees or directors.
Determining Fair Value
The fair value of share-based awards was estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions for the following periods:
 
Three Months Ended 
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Option Plans Shares
 
 
 
 
 
 
 
Risk-free interest rate
1.1
%
 
2.0
%
 
1.4
%
 
2.6
%
Volatility
53.2
%
 
61.2
%
 
53.8
%
 
61.8
%
Weighted average expected life (in years)
4.80
 
 
5.00
 
 
4.80
 
 
5.00
 
Weighted average fair value
$
3.35
 
 
$
3.35
 
 
$
3.16
 
 
$
2.88
 
ESPP Plan shares
 
 
 
 
 
 
 
Risk-free interest rate
0.3
%
 
0.6
%
 
0.3
%
 
0.6
%
Volatility
51.0
%
 
60.0
%
 
51.0
%
 
60.0
%
Weighted average expected life (in years)
1.25
 
 
1.25
 
 
1.25
 
 
1.25
 
Weighted average fair value
$
2.32
 
 
$
2.03
 
 
$
2.32
 
 
$
2.03
 
The computation of expected life is based on an analysis of the relevant industry sector post-vest termination rates and exercise factors. In the three and six months ended December 24, 2010, expected volatility is based on the implied and historical volatility for the Company. The interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term. Where the expected term of the Company's share-based awards do not correspond with the terms for which interest rates are quoted, the Company performs a straight-line interpolation to determine the rate from the available term maturities. As share-based compensation expense recognized in the accompanying unaudited condensed consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimated.
Share-Based Compensation Expense
Total share-based compensation expense is as follows (in thousands):

14

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

 
Three Months Ended 
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Cost of revenue
$
133
 
 
$
146
 
 
$
311
 
 
$
410
 
Research and development
117
 
 
194
 
 
279
 
 
385
 
Sales and marketing
236
 
 
188
 
 
445
 
 
121
 
General and administrative
775
 
 
815
 
 
1,418
 
 
1,613
 
Continuing operations
1,261
 
 
1,343
 
 
2,453
 
 
2,529
 
Discontinued operations
 
 
 
 
 
 
(106
)
Total share-based compensation expense
$
1,261
 
 
$
1,343
 
 
$
2,453
 
 
$
2,423
 
Stock Options and Restricted Stock Awards Activity
Summary of stock option activity is as follows:
 
Shares
 
Weighted
Average
Exercise
Price 
 
Weighted
Average
Remaining
Contractual term
in years 
 
Aggregate
Intrinsic
Value
Balance at June 25, 2010
3,752,920
 
 
$
9.85
 
 
 
 
 
Options granted
50,000
 
 
6.91
 
 
 
 
 
Options exercised
(49,830
)
 
4.56
 
 
 
 
 
Options cancelled
(254,489
)
 
7.76
 
 
 
 
 
Balance at December 24, 2010
3,498,601
 
 
$
10.03
 
 
7.23
 
 
$
4,988,105
 
Vested and expected to vest at December 24, 2010
3,215,294
 
 
$
10.34
 
 
7.11
 
 
$
4,205,645
 
Exercisable at December 24, 2010
2,106,429
 
 
$
11.85
 
 
6.49
 
 
$
1,627,886
 
The total intrinsic value of options exercised in the six months ended December 24, 2010 and December 25, 2009 were $0.2 million and $0.1 million, respectively.
As of December 24, 2010, there was $1.7 million of total unrecognized compensation cost related to non-vested stock options, which is expected to be recognized over a weighted average period of 1.2 years.
The following table summarizes the Company's restricted stock awards (“RSA”) activity for the six months ended December 24, 2010:
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value 
Balance at June 25, 2010
41,252
 
 
$
13.91
 
Released
(23,439
)
 
$
14.37
 
Balance at December 24, 2010
17,813
 
 
$
13.31
 
As of December 24, 2010, there was $0.2 million of total unrecognized compensation cost related to RSA, which is expected to be recognized over a weighted average period of approximately 4 months.
The following table summarizes the Company's restricted stock units (“RSU”) activity for the six months ended December 24, 2010.

15

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

 
Number of
Shares 
Balance at June 25, 2010
314,348
 
Awarded
558,043
 
Released
(128,519
)
Forfeited
(17,975
)
Balance at December 24, 2010
725,897
 
Vested and expected to vest at December 24, 2010
568,915
 
As of December 24, 2010, there was $4.0 million of total unrecognized compensation cost related to RSU, which is expected to be recognized over a weighted average period of 3.0 years.
During the six months ended December 24, 2010, 53,097 shares of common stock were delivered to the Company in payment of $0.4 million of withholding tax obligations arising from the release of RSA and RSU. The withholding tax obligations were based upon the fair market value of the Company's common stock on the vesting date.
At December 24, 2010, the total compensation cost related to options to purchase the Company's common stock under the 2005 ESPP Plan not yet recognized was approximately $0.5 million. This cost will be amortized on a straight-line basis over approximately 1.6 years. The following table shows the shares issued, and their respective weighted-average purchase price per share, pursuant to the 2005 ESPP Plan during the three and six months ended December 24, 2010 and December 25, 2009.
 
 
December 24,
2010
 
December 25,
2009
Shares issued
 
221,823
 
 
79,548
 
Weighted-average purchase price per share
 
$
4.42
 
 
$
3.37
 
 
15. STOCKHOLDERS' EQUITY
Stock Repurchase Program
In February 2009, the Company's Board of Directors authorized a share repurchase program of up to $40.0 million of its common stock. Under the program, the Company was able to purchase shares of common stock through open market transactions and privately negotiated purchases at prices deemed appropriate by management. The timing and amount of repurchase transactions under this program will depend on market conditions, corporate and regulatory considerations, and other relevant considerations. The shares the Company repurchases will be held in treasury for general corporate purposes, including issuance under employee equity incentive plans. The program was suspended in April 2009, and on August 31, 2010, the Company's Board of Directors authorized the Company to resume its stock repurchase program. The program may be discontinued at any time by the Board of Directors.
During the three months ended December 24, 2010, the Company repurchased and held in treasury 329,100 shares of outstanding common stock for a total of $2.6 million. During the six months ended December 24, 2010, the Company repurchased and held in treasury 505,100 shares of outstanding common stock for a total of $3.9 million. Such repurchases were accounted for at cost and reflected as treasury stock in the accompanying unaudited condensed balance sheets. No shares of outstanding common stock were repurchased during the three and six months ended December 25, 2009.
As of December 24, 2010, the Company held in treasury 748,795 shares for a total of $4.9 million. The Company has $35.1 million in remaining authorization for the stock repurchase program as of December 24, 2010.
Accumulated Other Comprehensive Loss
The following table summarized the components of accumulated other comprehensive loss as of December 24, 2010 and June 25, 2010 (in thousands):

16

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

 
December 24, 2010
 
June 25, 2010
Net unrealized losses on investments
$
 
 
$
(1,355
)
Losses on pension assets
(548
)
 
(548
)
Accumulated other comprehensive loss
$
(548
)
 
$
(1,903
)
Comprehensive Income (Loss)
Comprehensive income (loss) for the three and six months ended December 24, 2010 and December 25, 2009 consists of unrealized gain (loss) on investments classified as available-for-sale and unrecognized loss related to defined benefit pension. The tax effect of unrealized gain (loss) on available-for-sale investments and unrecognized loss on pension assets has been taken into account, if applicable.
 
Three Months Ended 
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Net income (loss)
$
3,724
 
 
$
(23,043
)
 
$
(7,463
)
 
$
(40,665
)
Change in unrealized gain (loss) on investments
 
 
(113
)
 
1,355
 
 
(12
)
Change in unrecognized loss on pension assets
 
 
 
 
 
 
(59
)
Comprehensive income (loss)
$
3,724
 
 
$
(23,156
)
 
$
(6,108
)
 
$
(40,736
)
 
16. EARNINGS PER SHARE
Basic net income (loss) per common share and diluted net loss per common share is computed by dividing unaudited consolidated net loss by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing unaudited consolidated net income by the weighted average number of common shares outstanding and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares are determined by applying the treasury stock method to the assumed exercise of outstanding stock options, the assumed vesting of outstanding restricted stock awards, and the assumed issuance of common stock under the employee stock purchase plan. Potentially dilutive common shares are excluded when the effect would be to reduce a net loss per share. As the Company had a net loss in the six months ended December 24, 2010 and the three and six months December 25, 2009, basic and diluted net loss per share are the same for these periods.
The following table sets forth the computation of basic and diluted net loss per share for the three and six months ended December 24, 2010 and December 25, 2009 (in thousands, except per share amount):

17

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

 
Three Months Ended 
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Numerators:
 
 
 
 
 
 
 
Income (loss) from continuing operations, net of tax
$
3,724
 
 
$
(23,127
)
 
$
(7,463
)
 
$
(40,929
)
Income from discontinued operations, net of tax
 
 
84
 
 
 
 
264
 
Net income (loss)
$
3,724
 
 
$
(23,043
)
 
$
(7,463
)
 
$
(40,665
)
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted-average common shares used in computing net income (loss) per share:
 
 
 
 
 
 
 
Basic
30,321
 
 
29,952
 
 
30,429
 
 
29,960
 
Dilutive potential common shares
515
 
 
 
 
 
 
 
Diluted
30,836
 
 
29,952
 
 
30,429
 
 
29,960
 
 
 
 
 
 
 
 
 
Net income (loss) per share, basic:
 
 
 
 
 
 
 
Continuing operations
$
0.12
 
 
$
(0.77
)
 
$
(0.25
)
 
$
(1.37
)
Discontinued operations
 
 
 
 
 
 
0.01
 
Basic net income (loss) per share
$
0.12
 
 
$
(0.77
)
 
$
(0.25
)
 
$
(1.36
)
 
 
 
 
 
 
 
 
Net income (loss) per share, diluted:
 
 
 
 
 
 
 
Continuing operations
$
0.12
 
 
$
(0.77
)
 
$
(0.25
)
 
$
(1.37
)
Discontinued operations
 
 
 
 
 
 
0.01
 
Diluted net income (loss) per share
$
0.12
 
 
$
(0.77
)
 
$
(0.25
)
 
$
(1.36
)
For the three and six months ended December 24, 2010, options and awards to purchase 3.5 million shares and 0.7 million shares, respectively, of common stock were outstanding but not included in the computation of basic net income (loss) per share because these were antidilutive under the treasury stock method compared to options and awards to purchase 4.0 million shares and 0.5 million shares, respectively, for the same periods in fiscal year 2010. Furthermore, for the three months ended December 24, 2010, 2.2 million shares and 0.1 million shares of average dilutive potential common shares associated with stock options and awards, respectively, were excluded from the diluted shares calculation because the result would have been antidilutive.
 
 
17. EMPLOYEE BENEFIT PLAN
Defined Benefit Plans
The Company sponsors defined benefit plans covering certain of its international employees in the United Kingdom and Germany. No new employees are eligible to join these plans. Pension benefits associated with these plans generally are based on each participant's years of service, compensation, and age at retirement or termination. The Company funds the pension plans in amounts sufficient to meet the minimum requirements of the local laws and regulations. Additional funding may be provided as deemed appropriate.
The projected benefit obligation ("PBO") and the assets of the United Kingdom plan have been transferred to an insurance company and the Company is not responsible for any additional contributions to the plan to fund the benefit payments to the employees. However, the Company continues to pay the annual administrative costs of the plan.
German Plan
The German plan is managed by an insurance company and the insurance company makes investment decisions with the guidelines set by the German regulation. The plan assets are invested as part of the insurance company's general fund and the

18

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

Company does not have control over the target allocation or visibility of the investment strategies of these investments.
The Company has life insurance policies with cash surrender values that have been earmarked by the Company to partly cover the underfunded status of the plan of $8.3 million and $8.4 million as of December 24, 2010 and December 25, 2009, respectively. The cash surrender value of the life insurance plan balance is $7.9 million, of which $0.3 million is included in other current assets and $7.6 million is included in other assets in the accompanying unaudited condensed consolidated balance sheets.
The net periodic benefit cost of the German plan was comprised of the following components during the three and six months ended December 24, 2010 and December 25, 2009 (in thousands):
 
Three Months Ended
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Net periodic benefit cost
 
 
 
 
 
 
 
Service cost
$
133
 
 
$
34
 
 
$
161
 
 
$
66
 
Interest expense
30
 
 
149
 
 
154
 
 
292
 
Expected return on plan assets
(22
)
 
(25
)
 
(43
)
 
(51
)
Net periodic benefit cost
$
141
 
 
$
158
 
 
$
272
 
 
$
307
 
The Company does not expect to make any contributions to the German plan during the next fiscal year as contributions are not required by funding regulations or laws and the cash surrender value of the life insurance plan earmarked by the Company substantially covers the under-funded status of the German plan.
Defined Contribution Plan
Effective September 1, 2003, the Company established a 401(k) retirement plan covering substantially all employees. The plan provides for voluntary salary reduction contributions up to the maximum allowed under Internal Revenue Service rules. The Company can make annual contributions to the plan at the discretion of the Board of Directors. There were no contributions for the three and six months ended December 24, 2010 and December 25, 2009, respectively.
 
18. INCOME TAXES
The Company recorded a tax expense of $0.7 million and $1.4 million for the three and six months ended December 24, 2010. The tax expense was computed based on the Company's projected financial results for the year ending June 24, 2011 and amounts related to unrecognized tax benefits and interest. The effective tax rate used to record the tax expense differed from the combined federal and net state statutory income tax rate for the three months and six months ended December 24, 2010 primarily due to domestic operating losses generated from which the Company does not benefit, tax expense incurred by the Company's foreign subsidiaries with operating income, and a tax expense of $1.3 million from the Company's unrecognized tax benefits and related interest recorded during the period.
The Company recorded a tax benefit of $4.5 million for the three and six months ended December 25, 2009. The income tax benefit included a discrete tax benefit of $4.9 million resulting from the November 6, 2009 enactment of the Worker, Homeownership, and Business Assistance Act of 2009 (the Act). The Act provides an election for federal taxpayers to increase the carry back period for an applicable net operating loss to three to five years from two years. Additional amounts recorded include a discrete tax benefit of $0.3 million related to a research and development credit claim for fiscal 2006, net of unrecognized tax benefits, and tax expense of $0.3 million for unrecognized tax benefits and related interest. The effective tax rate used to record the tax benefit differed from the combined federal and net state statutory income tax rate for the three months ended December 25, 2009 primarily due to the Company's tax benefit attributable to the utilization of tax attributes in the prior years and operating losses generated during the period from which the Company does not benefit.
As of December 24, 2010, the Company has provided a partial valuation allowance against our net deferred tax assets. Management continues to evaluate the realizability of deferred tax assets and related valuation allowance. If management's assessment of the deferred tax assets or the corresponding valuation allowance were to change, the Company would record the related adjustment to income during the period in which management makes the determination.
The Company had approximately $11.3 million of gross unrecognized tax benefit as of December 24, 2010, primarily due

19

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

to the recognition of tax benefits as a result of Legacy SGI's tax contingency recorded in the acquisition, of which $9.5 million, when recognized, will impact the effective tax rate. During the three and six months months ended December 24, 2010, the Company recorded a net increase of $2.3 million and $2.9 million, respectively, in taxes, accrued interest, penalties and foreign currency associated with unrecognized tax benefits.
 
19. DISCONTINUED OPERATIONS
In October 2008, the Company committed to a formal plan to abandon the RapidScaleTM product line, which was reviewed and approved by management with appropriate authority, and was communicated to the affected employees. The Company continues to honor service contracts with existing RapidScale customers, but had no other significant continuing involvement in the operations of the RapidScale product line subsequent to the abandonment.
The results of operations of the RapidScale product line were reclassified and included in discontinued operations, net of tax, within the accompanying unaudited condensed consolidated statements of operations for the three and six months ended December 25, 2009. Results of operations of the RapidScale product line for the three and six months ended December 24, 2010 were immaterial and were not reclassified.
The following summarizes the results of discontinued operations (in thousands):
 
Three Months Ended
 
Six Months Ended
 
December 25,
2009
 
December 25,
2009
Revenue
$
85
 
 
$
205
 
Cost of revenue
14
 
 
51
 
Gross profit
71
 
 
154
 
Operating expenses:
 
 
 
Research and development
 
 
(105
)
Sales and marketing
(14
)
 
(14
)
General and administrative
1
 
 
15
 
Total operating expenses
(13
)
 
(104
)
Income from discontinued operations
84
 
 
258
 
Total other income
 
 
6
 
Income from discontinued operations
$
84
 
 
$
264
 
 
20. SEGMENT INFORMATION
The Company's operating segments are determined based upon several criteria including: the Company's internal organizational structure; the manner in which the Company's operations are managed; the criteria used by the Company's Chief Executive Officer, the Chief Operating Decision Maker (“CODM”), to evaluate segment performance; and the availability of separate financial information. The Company's business is organized as two operating segments, products and services. Due to their similar economic characteristics, production processes, and distribution methods, the Company groups the product lines as the product operating segment and service offerings as the service operating segment. The Company's CODM reviews financial information presented on a consolidated basis, accompanied by disaggregated information about revenue by product and service for purposes of allocating resources and evaluating financial performance. The products and services metrics are derived on a contractual basis.
Segment Results
The following table presents revenues, cost of revenues and gross margin for the Company's products and services segments for the three and six months ended December 24, 2010 and December 25, 2009 (dollars in thousands):

20

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

 
Three Months Ended 
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Revenue
 
 
 
 
 
 
 
Products
$
140,150
 
 
$
57,067
 
 
$
216,952
 
 
$
119,698
 
Services
37,374
 
 
37,070
 
 
73,466
 
 
74,562
 
Total
$
177,524
 
 
$
94,137
 
 
$
290,418
 
 
$
194,260
 
Cost of revenue
 
 
 
 
 
 
 
 
 
Products
$
106,803
 
 
$
53,238
 
 
$
168,263
 
 
$
110,988
 
Services
18,392
 
 
22,213
 
 
38,829
 
 
42,218
 
Total
$
125,195
 
 
$
75,451
 
 
$
207,092
 
 
$
153,206
 
Gross profit
 
 
 
 
 
 
 
 
 
Products
$
33,347
 
 
$
3,829
 
 
$
48,689
 
 
$
8,710
 
Services
18,982
 
 
14,857
 
 
34,637
 
 
32,344
 
Total
$
52,329
 
 
$
18,686
 
 
$
83,326
 
 
$
41,054
 
Gross margin:
 
 
 
 
 
 
 
 
 
Products
23.8
%
 
6.7
%
 
22.4
%
 
7.3
%
Services
50.8
%
 
40.1
%
 
47.1
%
 
43.4
%
Total
29.5
%
 
19.8
%
 
28.7
%
 
21.1
%
Revenue and cost of revenue is the only discrete financial information the Company has available for its segments. For this reason, the Company is not able to provide other financial results or assets by segment.
Operating segments do not sell products to each other, and accordingly, there is no inter-segment revenue to be reported.
The Company does not assess the performance of its geographic regions on other measures of income or expense, such as depreciation and amortization, operating income or net income. In addition, the Company's assets are located primarily in the United States and are not allocated to any specific region. The Company does not measure the performance of its geographic regions on any asset-based metrics. Therefore, geographic information is presented only for revenues.
Customer information
For the three and six months ended December 24, 2010, Amazon accounted for approximately 10% and 12% of the Company's revenue, respectively. For the three and six months ended December 25, 2009, Amazon accounted for approximately 19% and 15% of the Company's revenue. No other customers accounted for more than 10% of the Company's revenue for the three and six months ended December 24, 2010 and December 25, 2009.
At December 24, 2010, Amazon accounted for approximately 16% of the Company's accounts receivable. No other single customer accounted for more than 10% of the Company's trade accounts receivable at December 24, 2010 and June 25, 2010.
Geographic Information
Revenue from both domestic and international customers (based on the address of the customer on the invoice) was as follows (in thousands):
 
Three Months Ended 
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Domestic revenue
$
106,374
 
 
$
68,816
 
 
$
187,508
 
 
$
142,997
 
International revenue
71,150
 
 
25,321
 
 
102,910
 
 
51,263
 
Total revenue
$
177,524
 
 
$
94,137
 
 
$
290,418
 
 
$
194,260
 
No individual foreign country's revenue was material for disclosure purposes.
Approximately 92% and 91% of the Company's property and equipment, net was located in the United States as of

21

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

December 24, 2010 and June 25, 2010, respectively.
 
21. RELATED PARTY TRANSACTIONS
The Company owns approximately 10% of the outstanding stock of SGI Japan, which was acquired in the acquisition of Legacy SGI, and the Company's Chief Executive Officer is a member of SGI Japan's Board of Directors. The investment in SGI Japan of $2.1 million is accounted for under the cost method and is included in other assets in the accompanying unaudited condensed consolidated balance sheets. During the three months ended December 24, 2010, the Company determined that there had been an other-than-temporary impairment of its investment in SGI Japan. As a result, the Company wrote down the investment from $5.0 million to $2.1 million, which represented the estimated fair value of the investment at December 24, 2010.
Product revenues and cost of product revenues from sales to SGI Japan are as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
December 24,
2010
 
December 25,
2009
 
December 24,
2010
 
December 25,
2009
Product revenue
$
8,672
 
 
$
5,759
 
 
$
12,689
 
 
$
6,370
 
Cost of product revenue
$
5,695
 
 
$
3,563
 
 
$
8,105
 
 
$
3,923
 
Amounts receivable from and payable to SGI Japan were as follows (in thousands):
 
December 24,
2010
 
June 25,
2010
Amounts receivable from SGI Japan
$
4,532
 
 
$
8,845
 
Amounts payable to SGI Japan
$
149
 
 
$
127
 
 
22. FINANCIAL GUARANTEES
The Company has issued financial guarantees to cover rent on leased facilities and equipment, to government authorities for value-added tax and other taxes, and to various other parties to support payments in advance of future delivery on goods and services. The majority of the Company's financial guarantees have terms of one year or more. The maximum potential obligation under financial guarantees at December 24, 2010 was $4.9 million for which the Company has $4.4 million of assets held as collateral. The full amount of the assets held as collateral are included in short-term and long-term restricted cash and cash equivalents in the unaudited condensed consolidated balance sheets.
 
23. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its facilities and office buildings under operating leases that expire at various dates through March 2017. Certain leases also contain escalation and renewal option clauses calling for increased rents. Where a lease contains an escalation clause or a concession such as a rent holiday, rent expense is recognized using the straight line method over the term of the lease. In addition to the minimum future lease commitments presented below, the leases generally require that the Company pay property taxes, insurance, maintenance and repair costs. Also, under certain leases, the Company is granted an option to terminate the lease early by providing an advance notice and paying an early termination fee. The Company does not intend early termination of the leases and hence the future minimum operating lease commitments disclosed herein consist of the total lease payments through the end of the initial lease terms.
Future minimum lease payments under non-cancelable operating leases are as follows (in thousands):

22

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

Fiscal Year
 
2011 (remaining six months)
$
3,314
 
2012
5,935
 
2013
4,925
 
2014
2,661
 
2015
886
 
2016 and thereafter
514
 
Total
$
18,235
 
Rent expense for the three months ended December 24, 2010 and December 25, 2009 was $1.4 million and $1.5 million, respectively. Rent expense for the six months ended December 24, 2010 and December 25, 2009 was $2.8 million and $3.3 million, respectively.
Purchase Commitments
In connection with supplier agreements, the Company has agreements to purchase certain units of inventory and non-inventory items through 2012. As of December 24, 2010, these remaining non-cancelable commitments were $14.0 million of which $12.2 million will be paid in fiscal year 2011.
Future non-cancelable purchase commitments are as follows (in thousands):
Fiscal Year
 
2011 (remaining six months)
$
12,164
 
2012
1,871
 
Total
$
14,035
 
Indemnification Agreements
The Company enters into standard indemnification agreements with its customers and certain other business partners in the ordinary course of business. These agreements include provisions for indemnifying the customer against any claim brought by a third party to the extent any such claim alleges that the Company's product infringes a patent, copyright or trademark, or misappropriates a trade secret, of that third-party. The agreements generally limit the scope of the available remedies in a variety of industry-standard methods, including, but not limited to, product usage and geography-based limitations, a right to control the defense or settlement of any claim, and a right to replace or modify the infringing products to make them non-infringing. The Company has not incurred significant expenses related to these indemnification agreements and no material claims for such indemnifications were outstanding as of December 24, 2010. As a result, the Company believes the estimated fair value of these indemnification agreements, if any, to be immaterial; accordingly, no liability has been recorded with respect to such indemnifications as of December 24, 2010.
Contingencies
The Company may, from time to time, be involved in lawsuits, claims, investigations and proceedings that arise in the ordinary course of business. The Company records a provision for a liability when management believes that it is both probable that a liability has been incurred and it can reasonably estimate the amount of the loss. The Company believes it has adequate provisions for any such matters. The Company reviews these provisions at least quarterly and adjusts these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case.
In fiscal 2005, as a result of anonymous allegations and allegations by an ex-employee, Legacy SGI conducted an internal investigation into whether certain systems were delivered to an entity in China in possible violation of U.S. export laws. Legacy SGI voluntarily shared information with respect to the investigation with the U.S. Department of Commerce. The Company cannot be assured that the U.S. Department of Commerce or other agencies of the U.S. government will not institute any proceedings against it in the future. In addition, from time to time, the Company receives inquiries from regulatory agencies informally requesting information or documentation. There can be no assurance in any given case that such informal review will not lead to further proceedings involving the Company in the future.

23

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

On May 1, 2007, Legacy SGI received a legal notice from counsel to Bharat Heavy Electricals Ltd. (“BHEL”), located in India, alleging delay in and failure to deliver products and technical problems with its hardware and software in relation to the establishment of a facility in Hyderabad. The Company assumed this claim in connection with its acquisition of Legacy SGI assets, and is currently engaged in arbitration. On January 21, 2008, BHEL filed its statement of claim against Silicon Graphics Systems (India) Pvt. Ltd. for a sum of Indian Rupee (“INR”) 78,478,200 ($1.7 million based on the conversion rate on December 24, 2010) plus interest and costs. On February 29, 2008, the Company filed its reply as well as a counter claim for a sum of INR 27,453,007 ($0.6 million based on the conversion rate on December 24, 2010) plus interest and costs. The proceeding has commenced and a hearing is scheduled for February 2011. The Company cannot currently predict the outcome of this dispute nor determine the amount or a reasonable range of potential loss, if any.
On January 16, 2009, the Company and certain of its former officers were sued in the United States District Court for the Northern District of California, in a matter captioned In Re Rackable Systems, Inc. Securities Litigation, Case No. C-09-0222-CW. On April 16, 2009, the Court appointed Elroy Whittaker as Lead Plaintiff and the Law Firm of Glancy Binkow & Goldberg LLP as Lead Plaintiff's Counsel. Lead Plaintiff filed a consolidated amended complaint (the “Amended Complaint”) on June 15, 2009. The Amended Complaint asserts claims for violations of (i) Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and (ii) Section 20(a) of the Exchange Act. The allegations relate to the drops in the Company's share price in early 2007 relating to its earnings reports for 2006 and Q4 2006. On April 9, 2010, the Company and its former officers filed a Motion to Dismiss the Supplemental Second Amended Complaint. The Court granted the Motion to Dismiss and entered judgment dismissing the action with prejudice on August 31, 2010. Because Lead Plaintiffs did not appeal the dismissal, the Court's judgment is now final and the action is terminated.
On March 10, 2009, the Company and certain of its present and former directors and officers were sued in the Superior Court of the State of California for Alameda County, in a shareholder derivative lawsuit captioned Milo v. Barton, et al, Case No. R30944-0474. The complaint alleges that the defendants engaged in various acts and omissions that resulted in the drops of our share price in early 2007, and asserts claims for alleged breaches of defendants' fiduciary duties, waste of corporate assets, and unjust enrichment. The complaint seeks compensatory damages in an unspecified amount, unspecified equitable or injunctive relief, disgorgement of unspecified compensation earned by the defendants, and an award of an unspecified amount for plaintiff's costs and attorney's fees. On January 18, 2011, defendants filed a demurrer to the complaint on the grounds that plaintiff failed to plead that a pre-suit demand on the Company's Board of Directors was excused under controlling state law. The hearing on defendants' demurrer is scheduled for May 31, 2011. The Company cannot currently predict the outcome of this dispute nor determine the amount or a reasonable range of potential loss, if any.
On December 3, 2009, the Company initiated an arbitration proceeding captioned Silicon Graphics Intl. Corp., f/k/a Rackable Systems, Inc. v. Thomas Weisel Partners Group, Inc., et al., FINRA Arb. No. 09-06849, against its former investment advisor Thomas Weisel Partners LLC (“TWP”), as well as TWP's parent company Thomas Wiesel Partners Group, Inc., to remedy TWP's alleged mismanagement and wrongful advice pertaining to the Company's investments in allegedly unsuitable and illiquid investments called “auction rate securities” (“ARS”). Due to market conditions, the ARS at issue are still held by the Company, as described elsewhere herein. The Company filed its arbitration claim with the Financial Industry Regulatory Authority (“FINRA”), and asserts various causes of action including breach of fiduciary duty, unsuitability, and breach of contract. The Company is seeking remedies including rescission; restitution; disgorgement; and compensatory, consequential, and punitive damages, and requests a damages award in excess of $9.0 million, exclusive of punitive damages and other potential relief. TWP filed its Answer on February 4, 2010. The parties have commenced discovery and the arbitration is currently scheduled to commence in February 2011. The Company believes that a settlement is more likely than not to occur within the next three months and the Company does not anticipate that this matter will have a material impact on the Company's financial condition or results of operations.
Third parties in the past have asserted, and may in the future assert, intellectual property infringement claims against the Company, and such future claims, if proved, could require the Company to pay substantial damages or to redesign its existing products or pay fees to obtain cross-license agreements. Litigation may be necessary in the future to enforce or defend the Company's intellectual property rights, to protect the Company's trade secrets or to determine the validity and scope of its proprietary rights or the proprietary rights of others. Any such litigation could result in substantial costs and diversion of management resources, either of which could harm the Company's business, operating results and financial condition. Further, many of the Company's current and potential competitors have the ability to dedicate substantially greater resources to enforcing and defending their intellectual property rights than the Company.
The Company is not aware of any pending disputes, including those disputes and settlements described above, that would be likely to have a material adverse effect on its consolidated financial condition, results of operations or liquidity. However,

24

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

litigation is subject to inherent uncertainties and costs and unfavorable outcomes could occur. An unfavorable outcome could include the payment of monetary damages, cash or other settlement, or an injunction prohibiting it from selling one or more products. If an unfavorable resolution were to occur, there exists the possibility of a material adverse impact on the Company's consolidated financial condition, results of operations or cash flows of the period in which the resolution occurs or on future periods.
 

25


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements included or incorporated by reference in this Form 10-Q other than statements of historical fact, are forward-looking statements. Investors can identify these and other forward-looking statements by the use of words such as “estimate,” “may,” “will,” “could,” “anticipate,” “expect,” “intend,” “believe,” “continue” or the negative of such terms, or other similar expressions. Forward-looking statements also include the assumptions underlying or relating to such statements.
Our actual results could differ materially from those projected in the forward-looking statements included herein as a result of a number of factors, risks and uncertainties, including, among others, the effect that the current economic and credit crises may continue to have on our business, the risk factors set forth in, Part I, Item 2 -”Management's Discussion and Analysis of Financial Condition and Results of Operations,” Part II, Item 1A- "Risk Factors,” and elsewhere in this Form 10-Q and the risks detailed from time to time in our future U.S. Securities and Exchange Commission reports. The information included in this Form 10-Q is as of the filing date with the Securities and Exchange Commission and future events or circumstances could differ materially from the forward-looking statements included herein. We assume no duty to update any of the forward-looking statements after the date of this report or to conform these statements to actual results except as required by law. Accordingly, we caution readers not to place undue reliance on such statements. We expressly disclaim any obligation to update or alter our forward-looking statements, whether, as a result of new information, future events or otherwise.
The following discussion and analysis should be read in conjunction with the condensed financial statements and notes thereto in Item 1 in this Form 10-Q and with our financial statements and notes thereto for the year ended June 25, 2010, contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on September 8, 2010.
“Silicon Graphics,” “SGI,” “Eco-Logical,” “RapidScale,” “CloudRack,” “ICE Cube,” “COPAN,” “Rackable,” “Altix,” and the “Silicon Graphics” logo are trademarks or registered trademarks of Silicon Graphics International Corp. or its subsidiaries in the U.S. and/or other countries. Other trademarks or service marks appearing in this report may be trademarks or service marks of other owners.
Overview
We are a global leader in large-scale clustered computing and storage, high-performance compute and storage, and data center technologies integrated with a choice of software, customer support services and professional services. We are dedicated to solving the information technology ("IT") industry's most demanding business and technology challenges by delivering clustered computing and storage solutions, high performance computing and storage solutions, Eco-Logical™ data center solutions, cloud computing solutions, software and services. We develop, market, and sell a broad line of low cost, mid-range and high-end computing servers and data storage products as well as differentiating software. We sell infrastructure products purpose-built for large-scale data center deployments. In addition, we provide global customer support and professional services related to our products. We are also a leading developer of enterprise class, high-performance features for the Linux operating system that provide our customers with a standard Linux operating environment combined with our differentiated yet un-intrusive Linux capabilities that are designed to improve performance, simplify system management, and provide a more robust development environment.
Our products and services are used by the scientific, technical, and business communities to solve challenging data-intensive computing, data management and visualization problems. These problems typically require large amounts of computing power and fast and efficient data movement both within the computing system and to and from large-scale data storage installations. Enterprises have also begun to deploy large-scale computing and storage installations by aggregating large numbers of relatively inexpensive, open-standard modular computing and storage systems. Our end-users employ our systems to access, analyze, transform, manage, visualize and store very large amounts of data in real time or near real time. By running low-cost operating systems such as Linux® and Microsoft® Windows®, we believe that we enable enterprises to meet their computing and storage requirements at a lower total cost of ownership and provide enterprises with greater flexibility and scalability. The vertical markets we serve include the federal government, defense and strategic systems, weather and climate, physical sciences, life sciences, energy (including oil and gas), aerospace and automotive, Internet, financial services, media and entertainment, and business intelligence and data analytics.
We are positioning ourselves to grow market share and become a leader in the technical computing market. We continue to deploy our sales and support organizations to focus on the vertical markets we serve. We believe technical computing is relevant across the vertical markets we serve and offers us opportunities for continued industry diversification and to compete internationally.
In fiscal year 2011, our strategy and operations are focused on growing our revenue, improving our gross margins, and controlling our operating expenses. Our results during the three and six months ended December 24, 2010 are consistent with

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our fiscal year 2011 strategy. Excluding the impact from new accounting standards for revenue recognition discussed below, we increased our revenue by $37.9 million comparing the three months ended December 24, 2010 and December 25, 2009 and $38.4 million comparing the six months ended December 24, 2010 and December 25, 2009. We increased our gross margin by 970 basis points from 19.8% in the three months ended December 25, 2009 to 29.5% in the three months ended December 24, 2010 and by 760 basis points from 21.1% in the six months ended December 25, 2009 to 28.7% in the six months ended December 24, 2010. Our operating expenses remain flat in the three and six months ended December 24, 2010 as compared to the three and six months ended December 25, 2009. We believe we are on track to continue to execute according to our fiscal year 2011 strategy.
In fiscal year 2011, we adopted new accounting standards for revenue recognition which was required to be adopted for fiscal years beginning on or after June 15, 2010. Under these new accounting standards, we are recognizing, and not deferring, more product revenue prospectively beginning with the first quarter of fiscal year 2011. Our total revenue and gross margin in the three months ended December 24, 2010 was $177.5 million and 29.5%, respectively. Our total revenue and gross margin in the six months ended December 24, 2010 was $290.4 million and 28.7%, respectively. Under the previous accounting standards for revenue recognition, our total revenue and gross margin would have been $132.1 million and 25.1%, respectively, in the three months ended December 24, 2010 and $232.7 million and 25.2%, respectively, in the six months ended December 24, 2010
We believe that focused investments in research and development are critical to our future performance and competitiveness in the marketplace. Our investments in this area will directly relate to enhancement of our current product line, development of new products that achieve market acceptance, and our ability to meet an expanding range of customer requirements. As such, we expect to continue to spend on current and future product development efforts.
 
Results of Operations
Summarized below is the result of our operations for the three and six months ended December 24, 2010 compared to the three and six months ended December 25, 2009.
Comparison of the three and six months ended December 24, 2010 and December 25, 2009
Financial Highlights
•    
We posted record revenue of $177.5 million in the three months ended December 24, 2010. Revenue increased $83.4 million or 89% to $177.5 million in the three months ended December 24, 2010 from $94.1 million in the three months ended December 25, 2009. Our higher revenue resulted partially from the required adoption of new accounting standards for revenue recognition which resulted in us recognizing more revenue upon delivery or acceptance and from increase in sales of high performance compute server and storage products. The required adoption of these new accounting standards for revenue recognition resulted in $45.5 million and $26.2 million incremental increase in revenue and cost of revenue in the three months ended December 24, 2010, respectively.
•    
We increased our gross margin by 970 basis points from 19.8% in the three months ended December 25, 2009 to 29.5% in the three months ended December 24, 2010. Our gross margin increased by 760 basis points from 21.1% for the six months ended December 25, 2009 to 28.7% for the six months ended December 24, 2010.
•    
As a result of increased revenue and gross margin, our gross profit increased $33.6 million or 180% to $52.3 million in the three months ended December 24, 2010 from $18.7 million in the three months ended December 25, 2009. In addition, our gross profit increased $42.3 million or 103% to $83.3 million in the six months ended December 24, 2010 from $41.1 million in the six months ended December 25, 2009. The increase in gross profit of $19.2 million and $24.6 million is attributable to the required adoption of the new accountings standards for revenue recognition in the three and six months ended December 24, 2010, respectively.
Revenue, cost of revenue, gross profit and gross margin
The following table presents revenue, cost of revenue, gross profit, and gross margin for the three and six months ended December 24, 2010 and December 25, 2009 (in thousands except percentages):

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Three Months Ended
 
Change
 
Six Months Ended
 
Change
 
 
December 24, 2010
 
December 25, 2009
 
$
 
%
 
December 24, 2010
 
December 25, 2009
 
$
 
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product revenue
 
$
114,719
 
 
$
 
 
$
114,719
 
 
n/a
 
 
$
177,076
 
 
$
 
 
$
177,076
 
 
n/a
 
Service revenue
 
32,959
 
 
 
 
32,959
 
 
n/a
 
 
66,678
 
 
 
 
66,678
 
 
n/a
 
Combined product and service revenue
 
29,846
 
 
94,137
 
 
(64,291
)
 
(68
)%
 
46,664
 
 
194,260
 
 
(147,596
)
 
(76
)%
Total revenue
 
$
177,524
 
 
$
94,137
 
 
$
83,387
 
 
89
 %
 
$
290,418
 
 
$
194,260
 
 
$
96,158
 
 
49
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of product revenue
 
$
85,989
 
 
$
 
 
$
85,989
 
 
n/a
 
 
$
135,171
 
 
 
 
$
135,171
 
 
n/a
 
Cost of service revenue
 
18,392
 
 
 
 
18,392
 
 
n/a
 
 
37,571
 
 
 
 
37,571
 
 
n/a
 
Combined product and service cost of revenue
 
20,814
 
 
75,451
 
 
(54,637
)
 
(72
)%
 
34,350
 
 
153,206
 
 
(118,856
)
 
(78
)%
Total cost of revenue
 
$
125,195
 
 
$
75,451
 
 
$
49,744
 
 
66
 %
 
$
207,092
 
 
$
153,206
 
 
$
53,886
 
 
35
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product gross profit
 
$
28,730
 
 
$
 
 
$
28,730
 
 
n/a
 
 
$
41,905
 
 
$
 
 
$
41,905
 
 
n/a
 
Service gross profit
 
14,567
 
 
 
 
14,567
 
 
n/a
 
 
29,107
 
 
 
 
29,107
 
 
n/a
 
Combined product and service gross profit
 
9,032
 
 
18,686
 
 
(9,654
)
 
(52
)%
 
12,314
 
 
41,054
 
 
(28,740
)
 
(70
)%
Total gross profit
 
$