Product Warranties

9 Months Ended

Sep. 30, 2011

Product Warranties [Abstract]

Product Warranties

7. Product Warranties

Our standard warranty provides that if our systems do not function to published specifications, we will repair or replace the defective component or system without charge generally for a period of approximately three years. We generally extend to our customers the warranties provided to us by our suppliers and, accordingly, the majority of our warranty obligations to customers are intended to be covered by corresponding supplier warranties. For warranty costs not covered by our suppliers, we provide for estimated warranty costs in the period the revenue is recognized. There can be no assurance that our suppliers will continue to provide such warranties to us in the future or that our warranty obligations to our customers will be covered by corresponding warranties from our suppliers, the absence of which could have a material effect on our financial statements. Estimated liabilities for product warranties are included in accrued expenses.

In October 2009, we discovered a quality issue associated with certain power supply devices provided by a long-term component supplier, which resulted in a higher than expected level of power supply failures to us and our customers. While we were able to promptly identify and resolve the cause of the failures, we are required to provide replacement products or make repairs to the affected power supply units that had been sold between March and October 2009. Through June 30, 2011, our component supplier had repaired all of the faulty power supplies at no cost to us, and reimbursed us for our out-of-pocket costs which has constituted a reimbursement to customers for certain out-of-pocket costs they incurred in connection with these power supply failures. The total amount reimbursed to us by our component supplier approximated $1.0 million through June 30, 2011.

In the second quarter of 2011, a material customer provided us with a framework estimating the potential claims precipitated by the power supply failures. The customer indicated that the estimate for claims was preliminary and that the timing, the amount and the form of any potential settlement are negotiable. Based on our analysis of the situation, including the preliminary framework provided by the customer, we estimated that we had incurred a probable loss which is estimable for certain third-party material and service costs incurred by our customer related to replacing failed power supplies of approximately $1.3 million and recorded an estimated current liability within "Accrued expenses" on our condensed consolidated balance sheet as of June 30, 2011. In addition, we disclosed that it was possible that these claims could increase by $0 to $3 million, and we did not record a liability as we were unable to establish the basis or reasonably estimate the size of the additional claims.

During the third quarter of 2011, the customer provided an updated framework on the potential claims and initiated the process for negotiating a potential settlement. As previously disclosed, the customer's preliminary framework of potential claims provided to us included additional costs related to the customer's internal overhead for other internal indirect costs, in addition to third-party direct costs described above. Given the complexities involved in dealing with material customer relationships and the fact that substantive negotiations did not commence until the third quarter of 2011, there was a significant degree of uncertainty as to the ultimate resolution of the potential claims as of the second quarter of 2011. Our discussions with this customer during the third quarter of 2011 resulted in a better understanding for the basis of such claims, and the ability to better evaluate our potential exposure to the power supply failures, and consequently enabled us to make a more reasonable estimate as to the likelihood and potential amount of such claims. Based on preliminary discussions for settlement and our analysis of the framework provided by the customer including future potential claims through the warranty period, we estimated that we have incurred a probable loss of approximately $2.8 million. Consequently, in addition to the $1.3 million previously recognized as of June 30, 2011, we recorded an estimated liability of $1.5 million as of September 30, 2011 within "Accrued expenses" on our condensed consolidated balance sheet.

Based on our current expectation of how any such additional product quality claims will ultimately be settled, and given the uncertainties regarding the applicability of the customer's internal overhead and other indirect costs included in the potential claims, the incurrence of an additional loss is reasonably possible, and we believe it could be in the range of $0 to $1.1 million as of September 30, 2011. We do not believe, however, that the incurrence of an additional loss is probable at this time and therefore, no additional liability has been recorded on our condensed consolidated balance sheet as of September 30, 2011.

During the second quarter of 2011, based on the advice of legal counsel, we established that our component supplier is contractually obligated to reimburse us for fair and reasonable costs we incur with our customers associated with these power supply failures. Our component supplier had continued to re-work and distribute to our customer the affected population of power supplies at no cost to us. In addition, at the time, our collection experience with similar amounts already reimbursed to us by our supplier and our belief that our component supplier and its parent companies had the financial ability to continue to reimburse us for any additional costs we may incur, we recorded a current asset within "Prepaid expenses and other assets" on our condensed consolidated balance sheet of $1.3 million as of June 30, 2011.

During the third quarter of 2011, as the claims from our customer became clearer, we commenced negotiations with our component supplier for fair and reasonable costs that we have and are likely to incur through the warranty period associated with this component failure. While we have not agreed to an amount to cover the costs associated with replacing customers' power supplies, we continue to maintain that we have legal recourse against this component supplier. During the course of these negotiations, we determined that the supplier was not willing to make an up-front cash payment for the settlement amount, but indicated that it was willing to provide some form of reimbursement for costs incurred, in the form of cash and/or note receivable of $0.5 million plus future product rebates. Based on these discussions and the preliminary reimbursement being proposed, we have reduced the previously recorded current asset of $1.3 million within "Prepaid expenses and other assets" to $0.5 million as of September 30, 2011. In addition, we have commenced discussions with our General Liability and Errors and Omissions Insurance and underwriters and will continue to pursue our rights to cover any damages we incur and not reimbursed by our supplier. The insurance company has issued a reservation of rights letter to us and at this time, it is not possible to estimate to what extent, if any, we will be covered by our carrier. As of September 30, 2011, we have not assumed or recorded any insurance reimbursement.

To the extent that we are unsuccessful in negotiating settlement agreements with our customer and our component supplier on mutually beneficial terms, or our component supplier does not continue to reimburse us for the expenses incurred by us or our customers, and we are unsuccessful in recovering such expenses from our insurance provider, we could incur additional expenses which could potentially have a material effect on our financial statements.

Our warranty accrual and cost activity is as follows as of and for the three and nine months ended September 30, (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2011			2010			2011
Balance, beginning of period	$	1,223		$	2,156		$	993		$	982
Charged to operations		557			2,190			2,086			4,457
Deductions for costs incurred		(669	)		(669	)		(1,958	)		(1,762	)
Balance, end of period	$	1,121		$	3,677		$	1,121		$	3,677

The table above includes $2.8 million of charges recorded to cost of sales related to the liability established for certain third-party material and service costs incurred by our customer related to replacing failed power supplies. The table above does not include the corresponding $0.5 million benefit recorded within cost of sales related to the current asset established for the recovery of such costs incurred by our customer which are to be reimbursed to us by our component supplier.