Document



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________________________________________
Form 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2019
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number 001-33383
__________________________________________________________________________
Super Micro Computer, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
77-0353939
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
980 Rock Avenue
San Jose, CA 95131
(Address of principal executive offices, including zip code)
(408) 503-8000
(Registrant’s telephone number, including area code)
__________________________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock, $0.001 par value per share
SMCI
OTC
Securities registered pursuant to section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x
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 ¨     No x 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes  ¨     No  x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x
  
Accelerated filer  ¨
Non-accelerated filer  ¨  
  
Smaller reporting company  ¨
Emerging growth company ¨  
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b of the Exchange Act)    Yes  ¨    No  x
The aggregate market value of the registrant’s common stock held by non-affiliates, based upon the closing price of the common stock on December 31, 2018, as reported by the OTC Market, was $596,876,261. Shares of common stock held by each executive officer and director and by each person who owns 5% or more of the outstanding common stock, based on filings with the Securities Exchange Commission, have been excluded since such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
As of November 30, 2019, there were 50,085,282 shares of the registrant’s common stock, $0.001 par value, outstanding, which is the only class of common stock of the registrant issued.
DOCUMENTS INCORPORATED BY REFERENCE
None






SUPER MICRO COMPUTER, INC.

ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2019

TABLE OF CONTENTS
 
 
 
Page
 
 
PART I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
PART II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
PART III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
PART IV
 
Item 15.
 

Unless the context requires otherwise, the words “Super Micro,” “Supermicro,” “we,” “Company,” “us” and “our” in this document refer to Super Micro Computer, Inc. and where appropriate, our wholly owned subsidiaries. Supermicro, the Company logo and our other registered or common law trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of Super Micro Computer, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Annual Report on Form 10-K are the property of their respective owners.


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Explanatory Note

We are filing this comprehensive Annual Report on Form 10-K (this “Annual Report”) for the fiscal year ended June 30, 2019 with expanded financial and other disclosures in lieu of filing a separate Annual Report on Form 10-K for the fiscal year ended June 30, 2018 and separate Quarterly Reports on Form 10-Q for the quarterly periods ended September 30, 2017, December 31, 2017, and March 31, 2018. Prior to the filing of this Annual Report, we filed separate Quarterly Reports on Form 10-Q for the quarterly periods ended September 30, 2018, December 31, 2018, and March 31, 2019 (collectively, the “2019 10-Qs”). This Annual Report is being filed to facilitate the dissemination of financial and other information to investors. We do not intend to file a separate Annual Report on Form 10-K for the fiscal year ended June 30, 2018 or Quarterly Reports on Form 10-Q for the quarterly periods ended September 30, 2017, December 31, 2017 and March 31, 2018.

We did not file our Annual Report on Form 10-K for the fiscal year ended June 30, 2017 (the “2017 10-K”) until May 17, 2019. On that date we also filed amended Quarterly Reports on Form 10-Q/A for the quarters ended September 30, 2016, December 31, 2016 and March 31, 2017 (the “2017 Amended Quarterly Reports” and with the 2017 10-K, the “2017 Reports”). Some of the financial statements contained in the 2017 Reports were restated. The circumstances leading to the need to restate those financial statements, and our efforts to investigate, assess and remediate those matters, are more fully described in those reports.

Our delay in the filing of this Annual Report was primarily due to the time required to (a) complete the preparation of the 2017 Reports, including the restatement of certain of our previously issued consolidated financial statements; (b) prepare the financial statements for each of the quarters in our fiscal year ended June 30, 2018; (c) prepare and file the Quarterly Reports on Form 10-Q for each of the quarters in our fiscal year ended June 30, 2019; (d) prepare the consolidated financial statements for the fiscal years ended June 30, 2019 and 2018; and (e) prepare other disclosures contained herein.


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
    
This Annual Report 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, as amended that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology including “would,” “could,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” the negative of these terms or other comparable terminology. In evaluating these statements, you should specifically consider various factors, including the risks described below, under Part I, Item 1A, “Risk Factors”, and in other parts of this Form 10-K as well as in our other filings with the SEC. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Annual Report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
    
We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. We cannot guarantee future results, levels of activity, performance or achievements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

PART I

Item 1.        Business

Overview

We are a Silicon Valley founded, headquartered and operated provider of application-optimized high performance and high-efficiency server and storage systems. We develop and provide end-to-end green computing solutions to the cloud computing, data centers, enterprise, big data, artificial intelligence ("AI"), High-Performance Computing ("HPC"), edge computing and Internet of Things/embedded (“IoT”) markets. Our solutions range from complete server, storage, modular blade servers, blades and workstations to full racks, networking devices, server management software, server sub-systems and global support and services. We offer our customers a high degree of flexibility and customization by providing a broad array of server configurations from which they can choose the optimal solutions to fit their computing needs. Our server and storage systems, subsystems and accessories are architecturally designed to provide high levels of reliability, quality, configurability, and scalability.

We perform the majority of our research and development efforts, at our San Jose, California headquarters, which we believe increases the efficiency of communication and collaboration between design teams, streamlines the development process and reduces time-to-market. This building block approach allows us to provide a broad range of products and enables us to build and deliver application-optimized solutions based upon customers’ requirements.

Our resource-saving architecture continues our tradition of leading the market with green IT innovation. Leveraging an overall architecture that optimizes data center power, cooling, shared resources and refresh cycles, we believe this approach helps the environment and provides total cost of ownership (“TCO”) savings for our customers. Furthermore, our architecture disaggregates central processing units (“CPU”) and memory, which allows each resource to be refreshed independently thereby allowing data centers to reduce refresh cycle costs.

We conduct our operations principally from our Silicon Valley headquarters in California and subsidiaries in Taiwan and the Netherlands. Our sales and marketing activities are conducted through a combination of our direct sales force and indirect sales channel partners. In our indirect sales channels, we work with distributors, value added resellers, system integrators, and original equipment manufacturers ("OEMs") to market and sell our optimized solutions to their end customers. During each of the fiscal years 2019 and 2018, we sold to over 850 direct customers in over 110 countries. During the same periods, through our indirect sales channels, we have also sold to numerous end users. We commenced operations in 1993 and have been profitable every year since inception.





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The Supermicro Solution

We develop and manufacture high-performance server and storage solutions based upon an innovative, modular and open architecture. Our primary competitive advantages are the breadth of our product portfolio that can better match exact customer requirements and our ability to deliver new technologies to market faster. Our integrated internal research and development resources along with our deep understanding of complex computing and storage requirements enable us to deliver the advanced functionality and capabilities required by our customers. We believe that our approach provides us with greater flexibility to quickly and efficiently develop optimized server solutions for our customers’ specific application requirements.

Rapid Time-to-Market Server Solutions

Our in-house design competencies, control of design of many of the components used within our server and storage systems and our building block architecture enable us to rapidly develop, build and test server and storage systems, subsystems and accessories with unique configurations. As a result, when new technologies are brought to market, we are generally able to quickly design, integrate and assemble a broad portfolio of solutions by leveraging common building blocks across product lines. We work closely with the leading microprocessor, graphics processing units (“GPU”), memory, disk/flash, and interconnect vendors and other hardware and software suppliers to coordinate the design of our new products with their product release schedules, thereby enhancing our ability to rapidly introduce new products incorporating the latest technology.

Improved Power Efficiency and Thermal Management

We believe that we are an industry leader in power-saving technology. We have designed flexible power management systems, which customize or eliminate components to reduce overall power consumption. We have developed proprietary power supplies capable of integration across a wide range of server system form factors which can significantly enhance power efficiency. We have also developed thermal management technologies to reduce the effects of heat dissipation from our servers. Our products achieve a competitive price-to-performance ratio while minimizing energy costs and reducing the risk of server malfunction caused by overheating. We have also developed power management software that controls power consumption of server clusters by policy-based administration.

High-Density Servers
 
Our servers are designed to enable customers to maximize computing power while minimizing the physical space utilized, which allows our customers to deploy our server and storage systems in scale-out configurations. Our systems can offer significantly more memory, hard drive, solid-state drive (“SSD”), storage and expansion slots than traditional server and storage systems with a comparable server form factor. For example, our BigTwin® solutions contain two or four full feature dual-processor hot-pluggable compute nodes with All-Flash Non-Volatile Memory express (“NVMe”) support in a two rack unit (“2U”) server. This high-density design is well suited for our customers that require highly space-efficient solutions and delivers better efficiency through sharing resources across systems.

Strategy

Our objective is to be the world’s leading provider of application-optimized, high-performance server, storage and networking solutions. Achieving this objective requires continuous development and innovation of our solutions with better price-performance and architectural advantages compared with our prior generation of solutions and with solutions offered by our competitors. We believe that our ability to innovate and execute will enable us to maintain or improve our relative competitive position in many product areas and provide us with additional long-term growth opportunities. Key elements of our strategy include sustaining our time-to-market advantage, enhancing our software management solutions, expanding our service and support offerings, further optimizing our global operating structure and deepening our relationships with customers, partners, suppliers and manufacturers.

Maintain Our Time-to-Market Advantage

We believe one of our major competitive advantages is our ability to rapidly incorporate the latest technological innovations into our products. We intend to maintain our time-to-market advantage by continuing our investment in our research and development efforts to rapidly develop new proprietary server, storage and networking solutions based on industry-standard components. We plan to continue to work closely with technology partners such as Intel Corporation (“Intel”), Nvidia Corporation (“Nvidia”) and Advanced Micro Devices, Inc. (“AMD”), to develop products that are compatible with the latest generation of industry-standard technologies and maintain our time-to-market advantage.


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Enhance Our Software Management Solutions

We have introduced and plan to continue to develop additional server, storage and networking management software capabilities as well as partner with software suppliers for software solutions that are integrated with our server products. We have invested in system management software like industry standard Redfish APIs for automation, RAS functionality to improve quality, and diagnostics to help reduce debug times. We have partnerships with security researchers, and have also invested in security technologies and testing tools like Root of Trust for improving product security on BIOS and BMC images. This strategy will enable our customers to simplify and automate the large scale deployment, configuration and monitoring of our servers.

Expand Our Service and Support Offerings

We intend to continue to expand our global customer service and support offerings that enable our customers to purchase service and support together with our complete server and storage systems as complete solution packages. Our service and support are designed to help our customers improve uptime, reduce costs and enhance the productivity of our products. We believe that continued enhancement of these offerings will support the continued growth of our business and increase our market-penetration with enterprise customers.

Further Optimize Our Global Operating Structure

We plan to continue to increase our worldwide manufacturing capacity and logistics abilities in the United States, the Netherlands and Taiwan to more efficiently serve our customers and lower our overall manufacturing costs. We remain focused on our global tax structure to optimally manage our tax obligations. Within our global operating structure, we employ stringent due diligence and qualification processes to select our contract manufacturers, which we regularly audit for process, quality, security and control. Our global manufacturing process is designed to ensure the end-to-end security of our products.

Deepen Our Relationships with Suppliers and Manufacturers
    
Our efficient supply chain and combined internal and outsourced manufacturing strategy allow us to build application optimized systems while minimizing costs. We plan to continue leveraging our relationships with suppliers and contract manufacturers, two of which are related parties, to maintain and improve our cost structure as we benefit from economies of scale.

We have also partnered with industry leading software suppliers, including Microsoft, RedHat and SAP for software solutions that are integrated with our server and storage systems.

Products and Services

We offer a broad range of application-optimized server solutions, including storage, rackmount and blade server and storage systems and subsystems and accessories, which can be used to build complete server and storage systems serving a variety of markets, including cloud computing, data center, enterprise, big data, HPC, AI, 5G, IoT, embedded and edge computing. The percentage of our net sales represented by sales of server and storage systems increased to 81.7% in fiscal year 2019 from 79.3% in fiscal year 2018 and from 70.0% in fiscal year 2017, and the percentage of our net sales represented by sales of subsystems and accessories was 18.3% in fiscal year 2019, 20.7% in fiscal year 2018 and 30.0% in fiscal year 2017.
    
Server and Storage Systems

We sell server and storage systems in rackmount, blade, and multi-node (Twin) form factors, which support single, dual, and multiprocessor architectures. A summary of our server and storage systems and their markets are listed below.
    
Our SuperBlade® and MicroBlade™ system families are each designed to share common computing resources, thereby saving space and power over standard rackmount servers. We believe that with our SuperBlade and MicroBlade servers, leveraging our unique disaggregated resource-saving architectures customers can upgrade individual compute modules and other Blade resources for multiple generations of technology, thereby reducing their overall acquisition costs and environmental impact.

Our SuperStorage systems provide high-density storage while leveraging high-efficiency power to maximize performance-per-watt savings to reduce TCO for enterprise data centers, big data, and other high-performance applications. For example, our All-Flash NVMe systems can deliver better performance and efficiency than traditional storage solutions; and our

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Simply Double SuperStorage systems which include twice the number of hotswap bays as 2U industry-standard systems, offer up to twice the storage capacity and input/output operations per second in the same amount of space.

Our Twin family of multi-node server systems including 1U and 2U Twin™, 1U and 2U TwinPro™, 4U FatTwin™, and new 2U BigTwin™ are optimized for density, performance, and power efficiency for customers' storage, HPC, Hyper-converged infrastructure and cloud computing requirements. The new 2U four-node BigTwin delivers double the density of traditional rackmounts while supporting maximum performance and functionality with up to 205 watt Intel Xeon Scalable Processors, 24 DIMMS and All-Flash NVMe.

Our Ultra Server systems in 1U and 2U platforms are designed to deliver performance, flexibility, scalability and serviceability that are ideal for demanding enterprise workloads. They provide enterprise IT professionals with the ability to select a single server platform that can easily be reconfigured for many applications reducing qualification time and lowering spare inventory required.

Our GPU or accelerated computing server systems in 1U, 2U, 4U, 10U, and blade platforms deliver advanced parallel processing capabilities built on the latest GPU designs, and provide high performance in calculation-intensive applications. We work closely with GPU leaders, specifically Nvidia, Intel and others to offer a rich set of GPU based systems.
    
Our multi-processor product line supports four and eight-socket configurations for high-performance memory-intensive enterprise applications with 192 DIMMS for up to 36 terabytes memory capacity and 23 PCI-E expansion slots. We recently expanded our offerings to support SAP HANA in-memory databases with optimal performance.

Our Data Center Optimized server systems deliver superior performance-per-watt to optimize data center TCO with an improved thermal architecture utilizing efficient power components and offset processors to help eliminate CPU preheating and support a 5+ year product life cycle.

Our MicroCloud server systems are high density, multi-node UP servers with up to 24 hot-pluggable nodes in a compact 3U form factor. MicroCloud integrates advanced technologies within a compact functional design to deliver high performance in environments with space and power constraints. These combined features provide a cost-effective solution for IT professionals implementing new hosting architectures for small and medium sized businesses and public/private cloud computing applications.
    
Our IoT server and storage systems are compact, smart and secure products that reside on the edge of the network, connecting smart sensors and devices to the cloud over wireless or wired networks. These server and storage systems are built on open architectures to ensure interoperability, ease of services deployment and enable a broad ecosystem of solution providers. The IoT server and storage systems empower users to securely aggregate, share and filter data for analysis. These server and storage systems help ensure that data generated by devices can travel securely and efficiently from the edge of the network to the cloud and back, without replacing existing infrastructure.

Our internally developed switch products include our 1G/10G/40G/100G Ethernet, InfiniBand and Omni Path switches for rack-mount servers. These switches enable us to offer more complete solutions for our customers.

Data center, cloud and HPC customers can use Supermicro as a one-stop shop for complete rack level solutions. Our SuperRack total server solutions provide rack level solutions that incorporate server, storage, networking and software with a wide range of flexible accessory options. Our SuperRack total solutions offer testing and validation, complete installation, user-friendly cabling and cable identification, and effortless integration of our high density server, storage and blade systems.
    
Server Software Management Solutions

Our open industry-standard remote system management solutions, such as our Server Management suite, including Supermicro Server Manager (“SSM”), Supermicro Power Management software (“SPM”), Supermicro Update Manager (“SUM”), and SuperDoctor 5, have been designed to help manage large-scale heterogeneous data center environments from the cloud to the edge.

Server Subsystems and Accessories

In addition to our complete systems business, we offer a large array of modular server subsystems and accessories such as serverboards, chassis, power supplies and other accessories. These subsystems are the foundation of our server solutions and span product offerings from the entry-level single and dual processor server segment to the high-end multi-

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processor market. The majority of the subsystems and accessories we sell individually are optimized to work together and are ultimately integrated into complete server and storage systems.

Serverboards

We design our serverboards with the latest hardware technologies and infrastructure software. Each serverboard is designed and optimized to adhere to specific physical, electrical, and design requirements to work with certain combinations of chassis and power supplies and achieve maximum functionality.

 Chassis and Power Supplies

Our chassis are designed to efficiently house our servers while maintaining interoperability, adhering to industry standards, and increasing output efficiency through power supply design. We believe that our latest generation of power supplies achieves the maximum power efficiency commercially available to date. Our server chassis come with hot-plug, heavy-duty fans, fan speed control, and an advanced air shroud design to maximize airflow and system reliability.
 
Supermicro Global Services

We provide global service and support offerings for our direct and OEM customers and our indirect sales channel partners directly or through approved distributors and third-party partners. Our services include server and storage system integration, configuration and software upgrades and updates. We also identify service requirements, create and execute project plans, conduct verification testing and training and provide technical documentation.

Global Services: Our strategic direct and OEM customers may purchase a variety of on-site support service plans. Our service plans vary depending on specific services, response times, coverage hours and duration, repair priority levels, spare parts requirements, logistics, data privacy and security needs. Our Global Services team provides help desk services and on-site product support for our server and storage systems.

Support Services: Our customer support services offer competitive market warranties, generally from one-to-three years, and warranty extension options for products sold by our direct sales team and approved indirect sales channel partners. Our customer support team provides ongoing maintenance and technical support for our products through our website and 24-hour continuous direct phone-based support.

Research and Development
    
We perform the majority of our research and development activities in-house in San Jose, California, increasing the communication and collaboration between design teams to streamline the development process and reducing time-to-market. We believe that the combination of our focus on internal research and development activities, our close working relationships with customers and vendors and our modular design approach allows us to minimize time-to-market. We continue to invest in reducing our design and manufacturing costs and improving the performance, cost-effectiveness and power and space-efficiency of our solutions.

Our research and development teams focus on the development of new and enhanced products that can support emerging technological and engineering innovations while highly optimizing the overall system performance. Much of our research and development activity relates to the new product cycles of leading processor vendors. We work closely with Intel, Nvidia and AMD, among others, to develop products that are compatible with the latest generation of industry-standard technologies under development. Our collaborative approach with these vendors allows us to coordinate the design of our new products with their product release schedules, thereby enhancing our ability to rapidly introduce new products incorporating the latest technology. We work closely with their respective development teams to optimize system performance and reduce system-level issues. Similarly, we work very closely with our customers to identify their needs and develop our new product plans accordingly.

Customers

During each of the fiscal years 2019 and 2018, we sold to over 850 direct customers in over 110 countries. During the same periods, through our indirect sales channels, we have also sold to numerous end users. These customers represent a diverse set of market verticals including cloud computing, data center, enterprise, artificial intelligence and machine learning, big data, HPC and IoT. In fiscal years 2019 and 2018, no customer represented greater than 10% of our total net sales.


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Sales and Marketing

Our sales and marketing activities are conducted through a combination of our direct sales force and our indirect sales channel partners. Our direct sales force is primarily focused on selling complete systems and solutions, including management software and global services to large scale cloud, enterprise and OEM customers.

We work with distributors, value-added resellers, system integrators, and OEMs to market and sell application optimized solutions to their end customers. We provide sales and marketing assistance and training to our indirect sales channel partners and OEMs, who in turn provide service and support to end customers. We leverage our relationships in our indirect sales channel and with our OEMs to penetrate select industry segments where our products can provide a superior alternative to existing solutions.

We maintain close contact with our indirect sales channel partners and end customers. We often collaborate during the sales process with our indirect sales channel partners and the end customer’s technical staff to help determine the optimal system configuration for the customer’s needs. Our interaction with our indirect sales channel partners and end customers allows us to monitor customer requirements and develop new products to meet their needs.

International Sales

Our global sales efforts are supported both by our international offices in the Netherlands, Taiwan, United Kingdom, China and Japan as well as by our United States based sales team. Product fulfillment and first level support for our international customers are provided by Supermicro Global Services and through our indirect sales channel and OEMs. Sales to customers located outside of the United States represented 41.9%, 43.4% and 42.8% of net sales in fiscal years 2019, 2018 and 2017, respectively.

Marketing

Our marketing programs are designed to create a global awareness and branding for our company, understanding of the unique value we bring to customers, and inform existing and potential customers, the trade press, indirect sales channel partners and OEMs about the capabilities and benefits of using our products and solutions. Our marketing efforts support the sale and distribution of our products through direct sales and indirect channels. We rely on a variety of marketing vehicles, including advertising, public relations, web, social media, participation in industry trade shows and conferences to help gain market acceptance. We provide funds for cooperative marketing to our indirect sales channel partners to extend the reach of our marketing efforts. We also actively utilize our suppliers’ cooperative marketing programs and jointly benefit from their marketing development funds to which we are entitled.
 
Intellectual Property

We seek to protect our intellectual property rights with a combination of patents, trademarks, copyrights, trade secret laws, and disclosure restrictions. We rely primarily on trade secrets, technical know-how, and other unpatented proprietary information relating to our design and product development activities. We also enter into confidentiality and proprietary rights agreements with our employees, consultants, and other third parties and control access to our designs, documentation and other proprietary information.

Manufacturing and Quality Control

We manufacture the majority of our systems at our San Jose, California headquarters. We believe we are the only major server and storage vendor that designs, develops, and manufactures the majority of their systems in the United States. Global assembly, test and quality control of our servers are performed at our manufacturing facilities in San Jose, California, the Netherlands, and Taiwan. Each of our facilities has been certified according to ISO 9001, ISO 14001 and/or ISO 13485 standards. Our suppliers and contract manufacturers are required to support the same standards to maintain consistent product and service quality and continuous improvement of quality and environmental performance.
        
We use several third-party suppliers and contract manufacturers for materials and sub-assemblies, such as serverboards, chassis, disk drives, SSDs, power supplies, fans and computer processors. We believe that selectively using outsourced manufacturing services allows us to focus on our core competencies in product design and development and increases our operational flexibility. We believe our manufacturing strategy allows us to adjust manufacturing capacity in response to changes in customer demand and to rapidly introduce new products to the market. We use Ablecom Technology, Inc. (“Ablecom”) and its affiliate Compuware Technology, Inc. ("Compuware"), both of which are related parties, for contract

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design and manufacturing coordination support. We work with Ablecom to optimize modular designs for our chassis and several other components. Ablecom also coordinates the manufacturing of chassis for us. In addition to providing a large volume of contract manufacturing services to us, Ablecom warehouses multiple components and subassemblies manufactured by various suppliers before shipment to our facilities in the United States, Europe and Asia. We also have a series of agreements with Compuware, including multiple product development, production and service agreements, product manufacturing agreements and lease agreements for office space. See Part II, Item 8, Note 12, “Related Party Transactions” to the consolidated financial statements and Part III, Item 13, “Certain Relationships and Related Transactions and Director Independence.”

We monitor our inventory continuously to be able to meet customer delivery requirements and to avoid inventory obsolescence. Due to our building-block designs, our inventory can generally be used with multiple different products, lowering working capital requirements and reducing the risk of inventory write-downs.

Competition

The market for our products is highly competitive, rapidly evolving and subject to new technological developments, changing customer needs and new product introductions. In particular, in recent years the market has been subject to substantial change. We compete primarily with large vendors of X86 based general purpose servers and components. In addition, we also compete with smaller vendors that specialize in the sale of server components and systems. Over the last several years, we have experienced increased competition from Original Design Manufacturers ("ODMs”) that benefit from their scale and very low cost manufacturing and are increasingly offering their own branded products. We believe our principal competitors include:

Global technology vendors such as Cisco, Dell, Hewlett-Packard Enterprise, Huawei, IBM, and Lenovo; and
ODMs, such as Inspur, Quanta Computer, and Wiwynn Corporation.

The principal competitive factors in our market include the following:

First to market with new emerging technologies;
High product performance, efficiency and reliability;
Early identification of emerging opportunities;
Cost-effectiveness;
Interoperability of products;
Scalability; and
Localized and responsive customer support on a worldwide basis.

We believe that we compete favorably with respect to most of these factors. However, most of our competitors have longer operating histories, significantly greater resources, greater name recognition and deeper market penetration. They may be able to devote greater resources to the development, promotion and sale of their products than we can, which could allow them to respond more quickly to new technologies and changes in customer needs. See Part I, Item 1A, "Risk Factors" risk titled “The market in which we participate is highly competitive, and if we do not compete effectively, we may not be able to increase our market penetration, grow our net sales or improve our gross margins.”

Employees

As of June 30, 2019, we employed 3,670 full time employees, consisting of 1,533 employees in research and development, 430 employees in sales and marketing, 362 employees in general and administrative and 1,345 employees in manufacturing. Of these employees, 2,281 employees are based in our San Jose facilities. As of June 30, 2018, we employed 3,266 full time employees, consisting of 1,346 employees in research and development, 390 employees in sales and marketing,316 employees in general and administrative and 1,214 employees in manufacturing. Of these employees, 2,090 employees are based in our San Jose facilities. We consider our highly qualified and motivated employees to be a key factor in our business success. Our employees are not represented by any collective bargaining organization, and we have never experienced a work stoppage. We believe that our relations with our employees are good.

Corporate Information

We were founded in, and maintain our worldwide headquarters and the majority of our employees in San Jose, California. We are one of the largest employers in the City of San Jose and an active member of the San Jose and Silicon Valley community.


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We were incorporated in California in September 1993. We reincorporated in Delaware in March 2007. Our common stock is quoted on the OTC Markets under the symbol "SMCI.” Our principal executive offices are located at 980 Rock Avenue, San Jose, CA 95131, and our telephone number is (408) 503-8000. Our website address is www.supermicro.com.

Financial Information about Segments and Geographic Areas

Please see Part II, Item 8, Note 17, “Segment Reporting” to the consolidated financial statements in this Annual Report for information regarding our international operations, and see Part I, Item 1A, “Risk Factors” for further information on risks associated with our international operations.

Working Capital

We focus considerable attention on managing our inventories and other working-capital-related items. We manage inventories by communicating with our customers and partners and using our industry experience to forecast demand. We place manufacturing orders for our products that are based on forecasted demand. We generally maintain substantial inventories of our products because the computer server industry is characterized by short lead-time orders and quick delivery schedules. As a result, we do not have a significant backlog of unfilled customer orders.

Available Information

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are available free of charge, on or through our website at www.supermicro.com, as soon as reasonably practicable after we electronically file such reports with, or furnish those reports to, the SEC. Information contained on our website is not incorporated by reference in, or made part of this Annual Report or our other filings with or reports furnished to the SEC. The SEC also maintains a website that contains our SEC filings.
 

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Item 1A.    Risk Factors

Risks Related to Our Material Weaknesses in Internal Control Over Financial Reporting and Related Matters

We face risks related to being delinquent in our SEC reporting obligations.
    
Primarily due to the matters that led to our restatement of prior financial statements and the material weaknesses identified in connection therewith, which are more fully detailed in our 2017 10-K, immediately prior to the filing of this Annual Report, our SEC filings, including our Annual Reports on Form 10-K for the fiscal years ended June 30, 2018 and 2019 and our Quarterly Reports on Form 10-Q for the quarterly periods ended September 30, 2017, December 31, 2017, March 31, 2018, September 30, 2018, December 31, 2018, March 31, 2019 and September 30, 2019, were delinquent. Following this filing, our only delinquent report will be our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2019. While we cannot give assurance as to when we will file this outstanding quarterly report, our current intention is to file it in or before January 2020, and thereafter resume a timely filing schedule with respect to our future SEC reports. We expect to continue to face many of the risks and challenges related to the matters that led to the delay in the filing of our 2017 10-K, including the following:

We may fail to remediate material weaknesses in our internal control over financial reporting and other material weaknesses may be identified in the future, which would adversely affect the accuracy and timing of our financial reporting;
Failure to timely file our SEC reports and make our current financial information available, has placed, and will continue to place, downward pressure on our stock price and result in the continued inability of our employees to sell the shares of our common stock underlying their awards granted pursuant to our equity compensation plans, which has adversely affected, and may continue to adversely affect, hiring and employee retention;
Further delay in the filing of our SEC reports will delay our ability to seek the relisting of our common stock on a national securities exchange, and as a result, may continue to reduce the liquidity of our common stock;
Litigation and claims as well as regulatory examinations, investigations, proceedings and orders arising out of our failure to file SEC reports on a timely basis, including the reasons and causes for such failure to file, will continue to divert management attention and resources from the operation of our business;
We may not be able to recapture lost business or business opportunities due to ongoing reputational harm; and
Negative reports or actions on our commercial credit ratings would increase our costs of, or reduce our access to, future commercial credit arrangements and limit our ability to refinance existing indebtedness.

If one or more of the foregoing risks or challenges persist, our business, operations and financial condition are likely to be materially and adversely affected.

We have identified material weaknesses in our internal control over financial reporting, which could, if not remediated, adversely affect our ability to report our financial condition and results of operations in a timely and accurate manner.

We have concluded that our internal control over financial reporting was not effective as of June 30, 2019 due to the existence of material weaknesses in such controls, and we have also concluded that our disclosure controls and procedures were not effective as of June 30, 2019 due to material weaknesses in our internal control over financial reporting, all as described in Part II, Item 9A, “Controls and Procedures” of this Annual Report. While we have initiated remediation measures to address the identified material weaknesses, we cannot provide assurance that our remediation efforts will be adequate to allow us to conclude that such controls will be effective in the future. We also cannot assure you that additional material weaknesses in our internal control over financial reporting will not arise or be identified in the future. We intend to continue our control remediation activities and to continue to improve our overall control environment and our operational, information technology, financial systems, and infrastructure procedures and controls, as well as to continue to train, retain and manage our personnel who are essential to effective internal controls. In doing so, we will continue to incur expenses and expend management time on compliance-related issues. If we are unable to successfully complete our remediation efforts or favorably assess the effectiveness of our internal control over financial reporting, our operating results, financial position, ability to accurately report our financial results and timely file our SEC reports, and stock price could be adversely affected.

Moreover, because of the inherent limitations of any control system, material misstatements due to error or fraud may not be prevented or detected on a timely basis, or at all. If we are unable to provide reliable and timely financial reports in the future, our business and reputation may be further harmed. Restated financial statements and failures in internal controls may also cause us to fail to meet reporting obligations, negatively affect investor and customer confidence in our management or result in adverse publicity and concerns from investors and customers, any of which could have a negative effect on the price of

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our common stock, subject us to further regulatory investigations, potential penalties or stockholder litigation, and have a material adverse impact on our business and financial condition.

The circumstances that led to the delay in the filing of our 2017 10-K, and our efforts to investigate, assess and remediate those matters have also caused substantial delays in the preparation and filing of our annual and quarterly reports for periods after June 30, 2017, including this Annual Report.

Our ability to resume a timely filing schedule with respect to our SEC reporting is subject to a number of contingencies, including whether and how quickly we are able to effectively remediate the identified material weaknesses in our internal control over financial reporting. We cannot give assurances as to when we will file our Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, our current intention is to file it in or before January 2020, and thereafter resume a timely filing schedule with respect to our future SEC reports.

Investors will need to evaluate certain decisions with respect to our common stock in light of our lack of current financial information due to our inability to file our Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, on a timely basis. Accordingly, any investment in our common stock involves a greater degree of risk. Our lack of current public information may have an adverse impact on investor confidence, which could lead to a reduction in our stock price. In addition, for so long as we are not current in our SEC filings, we are precluded from registering our securities with the SEC for offer and sale. This precludes us from raising debt or equity financing in the public markets, limits our access to the private markets and also limits our ability to use stock options and other equity-based awards to attract, retain and provide incentives to our employees.

The delisting of our common stock may continue to have a material adverse effect on the trading and price of our common stock, and we cannot assure you that our common stock will be relisted, or that once relisted, it will remain listed.

As a result of the delay in the filing of our periodic reports with the SEC, we were unable to comply with Nasdaq’s listing standards and our common stock was suspended from trading on The Nasdaq Global Select Market effective August 23, 2018 and formally delisted effective March 22, 2019.
The delisting of our common stock from Nasdaq has had and may continue to have a material adverse effect on us by, among other things, causing investors to dispose of our shares and limiting:
The liquidity of our common stock;
The market price of our common stock;
The number of institutional and other investors that will consider investing in our common stock;
The availability of information concerning the trading prices and volume of our common stock;
The number of broker-dealers willing to execute trades in shares of our common stock; and
Our ability to obtain equity or debt financing for the continuation of our operations.

Following the filing of our Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2019 and any other required filings with the SEC, and compliance with any other prerequisite requirements, we intend to apply to relist our common stock on a national securities exchange. However, while we are working expeditiously to relist our common stock, no assurances can be provided that we will be able to do so in a timely manner or at all. If we are unable to relist our common stock, or even if our common stock is relisted, no assurance can be provided that an active trading market will develop or, if one develops, that it will continue. The lack of an active trading market may limit the liquidity of an investment in our common stock, meaning you may not be able to sell any shares of common stock you own at times, or at prices, attractive to you. Any of these factors may materially adversely affect the price of our common stock.

The outcome of litigation and other claims as well as regulatory examinations, investigations, proceedings and orders arising out of the matters that led to the delay in the filing of our 2017 10-K and our other SEC reports are unpredictable, and any orders, actions or rulings not in our favor could have a material adverse effect on our business, results of operations and financial condition.

Our company and certain of our current and former executive officers are defendants in certain legal proceedings and putative class actions. Please see Part I, Item 3, “Legal Proceedings.” These proceedings have resulted in significant expenses and the diversion of management attention from our business. In addition, the circumstances that led to the delay in the filing of our 2017 10-K and our continued SEC filing delays have created the risk of additional litigation and claims by investors and examinations, investigations, proceedings and orders by regulatory authorities. These include a broad range of potential actions that may be taken against us by the SEC or other regulatory agencies, including a cease and desist order, suspension of trading

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of our securities, deregistration of our securities, sanctioning of our officers and directors and/or the assessment of possible civil monetary penalties. Any such further actions could be expensive and damaging to our business, results of operations and financial condition.

We have incurred significant expenses related to the matters that led to the delay in the filing of our 2017 10-K and expect to continue to incur significant expenses related to the remediation of deficiencies in our internal control over financial reporting and disclosure controls and procedures, and any resulting litigation.

We have devoted substantial internal and external resources towards investigating, discovering, understanding and remediating the matters that led to the delay in the filing of our 2017 10-K (all as described in the 2017 10-K). As a result of these efforts, we have incurred substantial incremental fees and expenses for additional accounting, financial and other consulting and professional services, as well as the implementation and maintenance of systems and processes that will need to be updated, supplemented or replaced. Specifically, in connection with these efforts, we incurred professional fees of approximately $67 million in fiscal year 2019 and $42 million in fiscal year 2018, and we continue to incur additional fees in the current fiscal year. We have taken a number of steps in order to strengthen our corporate culture, sales processes, and accounting function so as to allow us to be able to provide timely and accurate financial reporting. To the extent these steps are not successful, we could be required to devote significant additional time and incur significant additional expenses. Even if these steps are successful, we expect to continue to incur significant legal fees in future periods as we address litigation and regulatory action arising from the matters that led to the delay in the filing our 2017 10-K. The expenses we are incurring in this regard, as well as the substantial time devoted by our management to identify and address the internal control deficiencies, could have a material adverse effect on our business, results of operations and financial condition.

If we are unable to become current in our SEC reports by June 30, 2020, we may lose the right to convert our existing credit facility into a five-year revolving credit facility, and may be unable to access outside financing.

              Under the terms of the credit agreement with Bank of America, N.A. (“Bank of America”), dated April 19, 2018, as amended in June 2019, we are required to deliver our audited financial statements for the fiscal years ended June 30, 2018 and 2019 by March 31, 2020. With the filing of this Annual Report, we have satisfied that requirement.  The credit facility expires on June 30, 2020, although we have the right to convert it to a five-year revolving credit facility if we are current in all SEC filing obligations and meet certain other conditions. If we are unable to become current in our SEC filing obligations by that date, we may lose the ability to elect for such a conversion, and any amounts then outstanding under the existing credit facility could become due and payable. As of November 30, 2019, we did not have any outstanding principal obligations under the Bank of America credit facility.

We may be unable to secure other outside financing, if needed, to fund ongoing operations and other capital needs. Any sources of financing that may be available to us could also be at higher costs and require us to satisfy more restrictive covenants, which could limit or restrict our operations, cash flows and earnings. We cannot ensure that additional financing would be available to us, or be sufficient or available on satisfactory terms. In addition, unless and until we have filed all required reports with the SEC, we will be precluded from registering our securities with the SEC for offer and sale, and the failure to timely file our SEC reports will limit our ability to use “short-form” Form S-3 registration statements for registering our securities for sale with the SEC until we again meet the filing requirements of Form S-3 including having timely filed all Exchange Act reports required to be filed during the twelve calendar months prior to the filing of the registration statement on Form S-3.

The matters leading to the delay in the filing of our 2017 10-K and our lack of effective internal control over financial reporting, including adverse publicity and potential concerns from our customers, have had and could continue to have an adverse effect on our business and financial condition.

We have been and could continue to be the subject of negative publicity focused on the matters that led to the delay in the filing of our 2017 10-K. We may be adversely impacted by negative reactions to this publicity from our customers or others with whom we do business. Concerns include the time and effort required to address our accounting and control environment and our ability to be a long-term provider to our customers. The continued occurrence of any of the foregoing could harm our business and have an adverse effect on our financial condition.

If we are unable to maintain the effectiveness of our internal control over financial reporting, our operating results, financial position and stock price could be adversely affected.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, our management is required to report on the effectiveness of our internal control over financial reporting in our annual reports, and annually our independent auditors must attest to and

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report on the effectiveness of our internal control over financial reporting. It is necessary for us to maintain effective internal control over financial reporting to prevent fraud and errors and to maintain effective disclosure controls and procedures so that we can provide timely and reliable financial and other information. A failure to maintain adequate internal controls may adversely affect our ability to provide financial statements that accurately reflect our financial condition and report information on a timely basis.

As described in Part II, Item 9A, “Controls and Procedures” of this Annual Report, we have concluded that there are material weaknesses in our internal control over financial reporting and that our disclosure controls and procedures were ineffective as of June 30, 2019. This adversely affected our ability to timely and accurately report our results of operations and financial condition. We cannot ensure that other errors or material weaknesses will not be identified in the future. If we fail to maintain an effective system of internal control over financial reporting, the accuracy and timeliness of our financial reporting may be adversely affected.

Although we are working to remediate our material weaknesses, and are focused on re-establishing effective internal controls over financial reporting in order to prevent and detect material misstatements in our annual and quarterly financial statements and prevent fraud, we cannot ensure that such efforts will be effective. If we fail to maintain effective internal controls in future periods, this could further cause investors to lose confidence in our reported financial and other information, and our operating results, financial position and stock price could be adversely affected.

Risks Related to Our Business and Industry

Our quarterly operating results will likely fluctuate in the future, which could cause rapid declines in our stock price.

We believe that our quarterly operating results will continue to be subject to fluctuation due to various factors, many of which are beyond our control. Factors that may affect quarterly operating results include:
    
Fluctuations based upon seasonality, with the quarters ending March 31 and September 30 typically being weaker;
Fluctuations in the timing and size of large customer orders;
Variability of our margins based on the mix of server and storage systems, subsystems and accessories we sell and the percentage of our sales to internet data center, cloud computing customers or certain geographical regions;
Fluctuations in availability and costs associated with key components, particularly memory, storage solutions, and other materials needed to satisfy customer requirements;
The timing of the introduction of new products by leading microprocessor vendors and other suppliers;
Changes in our product pricing policies, including those made in response to new product announcements;
Mix of whether customer purchases are of partially or fully integrated systems or subsystems and accessories and whether made directly or through our indirect sales channel partners;
The effect of mergers and acquisitions among our competitors, suppliers, customers, or partners;
General economic conditions in our geographic markets;
Geopolitical tensions, including trade wars, tariffs and/or sanctions in our geographic markets;
Impact of regulatory changes on our cost of doing business; and
Costs associated with the circumstances leading to the restatement of our previously issued financial statements, and our efforts to investigate, assess and remediate those matters, as well as related legal proceedings.

In addition, customers may hesitate to purchase, or not continue to purchase, our products based upon our delay in the filing of our reports with the SEC and/or past unwarranted reports about security risks associated with the use of our products. Accordingly, it is difficult to accurately forecast our growth and results of operations on a quarterly basis. If we fail to meet expectations of investors or analysts, our stock price may fall rapidly and without notice. Furthermore, the fluctuation of quarterly operating results may render less meaningful period-to-period comparisons of our operating results, and you should not rely upon them as an indication of future performance.

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

We have become increasingly dependent upon larger sales to grow our business. In particular, in recent years, we have completed larger sales to leading internet data center and cloud customers and large enterprise customers. No single customer accounted for 10% or more of net sales in fiscal years 2019, 2018 or 2017. If customers buy our products in greater volumes and their business becomes a larger percentage of our net sales, we may grow increasingly dependent on those customers to maintain our growth. If our largest customers do not purchase our products at the levels, in the timeframes or within the geographies that we expect, our ability to maintain or grow our net sales will be adversely affected.

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Increased sales to larger customers may also cause fluctuations in results of operations. Large orders are generally subject to intense competition and pricing pressure which can have an adverse impact on our margins and results of operations. Likewise, larger customers may seek to fulfill all or substantially all of their requirements in a single or a few orders, and not make another significant purchase for a substantial period of time. Accordingly, a significant increase in revenue during the period in which we recognize the revenue from a large customer may be followed by a period of time during which the customer either does not purchase any products or only a small number of our products.

Additionally, as we and our partners focus increasingly on selling to larger customers and attracting larger orders, we expect greater costs of sales. Our sales cycle may become longer and more expensive, as larger customers typically spend more time negotiating contracts than smaller customers. Larger customers often seek greater levels of support in the implementation and use of our server solutions.

As a result of the above factors, our quarter-to-quarter results of operations may be subject to greater fluctuation and our stock price may be adversely affected.

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

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

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

Increases in average selling prices for our server solutions have significantly contributed to increases in net sales in some of the periods covered by this Annual Report. As with most electronics based products, average selling prices of server and storage products are typically highest at the time of introduction of new products, which utilize the latest technology, and tend to decrease over time as such products become commoditized and are ultimately replaced by even newer generation products. We cannot predict the timing or amount of any decline in the average selling prices of our server solutions that we may experience in the future. In some instances, our agreements with our indirect sales channel partners limit our ability to reduce prices unless we make such price reductions available to them, or price protect their inventory. If we are unable to decrease the average per unit manufacturing costs faster than the rate at which average selling prices continue to decline, our business, financial condition and results of operations will be harmed.

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

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

Because we often acquire materials and key components on an as needed basis, we may be limited in our ability to effectively and efficiently respond to customer orders because of the then-current availability or the terms and pricing of these materials and key components. Our industry has experienced materials shortages and delivery delays in the past, and we may experience shortages or delays of critical materials in the future. From time to time, we have been forced to delay the introduction of certain of our products or the fulfillment of customer orders as a result of shortages of materials and key components, which can adversely impact our revenue. If shortages, supply or demand imbalances or delays arise, the prices of these materials and key components may increase or the materials and key components may not be available at all. In the event of shortages, some of our larger competitors may have greater abilities to obtain materials and key components due to their larger purchasing power. We may not be able to secure enough key components or materials at reasonable prices or of acceptable quality to build new products to meet customer demand, which could adversely affect our business, results of

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operations and financial condition. In addition, from time to time, we have accepted customer orders with various types of component pricing protection. Such arrangements have increased our exposure to component pricing fluctuations and have adversely affected our financial results in certain quarters.

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

Adverse economic conditions may harm our business.

Our business depends on the overall demand for our products and on the economic health of our current and prospective customers. We market and sell our products both domestically and in international markets. If economic conditions, including currency exchange rates, in the areas in which we market and sell our products and other key potential markets for our products continue to remain uncertain or deteriorate, our customers may delay or reduce their spending on our products. If our customers or potential customers experience economic hardship, this could reduce the demand for our products, delay and lengthen sales cycles, lower prices for our products, and lead to slower growth or even a decline in our revenues, operating results and cash flows.

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

To offer greater choices and optimization of our products to benefit our customers, we maintain a high level of inventory. If we fail to maintain sufficient inventory, we may not be able to meet demand for our products on a timely basis, and our sales may suffer. If we overestimate customer demand for our products, we could experience excess inventory of our products and be unable to sell those products at a reasonable price, or at all. As a result, we may need to record higher inventory reserves. In addition, from time to time we assume greater inventory risk in connection with the purchase or manufacture of more specialized components in connection with higher volume sales opportunities. We have from time to time experienced inventory write downs associated with higher volume sales that were not completed as anticipated. We expect that we will experience such write downs from time to time in the future related to existing and future commitments. Excess or obsolete inventory levels for these or other reasons could result in unexpected expenses or increases in our reserves against potential future charges which would adversely affect our business, results of operations and financial condition.
 
We may encounter difficulties with our ERP systems.

Many companies have experienced delays and difficulties with the implementation of new or changed ERP systems that have had a negative effect on their business. We have incurred and expect to continue to incur additional expenses related to our ERP systems, as we continue to further enhance and develop them, including by automating certain internal controls. See Part II, Item 9A, "Controls and Procedures" of this Annual Report for a more fulsome description of our material weaknesses and remediation efforts surrounding our ERP systems. Any future disruptions, delays or deficiencies in the design and further enhancement of our ERP system could result in potentially much higher costs than we currently anticipate and could adversely affect our ability to provide services, fulfill contractual obligations, file reports with the SEC in a timely manner and/or otherwise operate our business, or otherwise impact our controls environment. Any of these consequences could have an adverse effect on our business, results of operations and financial condition.

System security violations, data protection breaches, cyber-attacks and other related cyber-security issues could disrupt our internal operations or compromise the security of our products, and any such disruption could reduce our expected revenues, increase our expenses, damage our reputation and adversely affect our stock price.
 
Experienced computer programmers and hackers may be able to penetrate our network and misappropriate or compromise our confidential information or that of third parties, create system disruptions or cause shutdowns. Computer programmers and hackers also may be able to develop and deploy viruses, worms and other malicious software programs that attack our products or otherwise exploit any security vulnerabilities of our products. While we employ a number of protective measures, including firewalls, anti-virus and endpoint detection and response technologies, these measures may fail to prevent or detect attacks on our systems. We experienced unauthorized intrusions into our network between 2011 and 2018. None of

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these intrusions, individually or in the aggregate, has had a material adverse effect on our business, operations, or products. We have taken steps to enhance the security of our network and computer systems but, despite these efforts, we may experience future intrusions, which could adversely affect our business, operations, or products. In addition, our hardware and software or third party components and software that we utilize in our products may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation or security of the products. The costs to us to eliminate or mitigate cyber or other security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant and, if our efforts to address these problems are not successful, could result in interruptions, delays, cessation of service and loss of existing or potential customers that may impede our sales, manufacturing, distribution or other critical functions. Any claim that our products or systems are subject to a cyber-security risk, whether valid or not, could damage our reputation and adversely impact our revenues and results of operations.

We manage and store various proprietary information and sensitive or confidential data relating to our business as well as information from our suppliers and customers. Breaches of our or any of our third party suppliers’ security measures or the accidental loss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential data about us or our customers or suppliers, including the potential loss or disclosure of such information or data as a result of fraud, trickery or other forms of deception, could expose us or our customers or suppliers to a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation or otherwise harm our business.

To the extent we experience cyber-security incidents in the future, our relationships with our customers and suppliers may be materially impacted, our brand and reputation may be harmed and we could incur substantial costs in responding to and remediating the incidents and in resolving any investigations or disputes that may arise with respect to them, any of which would cause our business, operations, or products to be adversely affected. In addition, the cost and operational consequences of implementing and adding further data protection measures could be significant. 

Because our products and services may store, process and use data, some of which contains personal information, we are subject to complex and evolving federal, state and foreign laws and regulations regarding privacy, data protection and other matters, which are subject to change.
 
We are subject to a variety of laws and regulations in the United States and other countries that involve matters central to our business, including with respect to user privacy, rights of publicity, data protection, content, protection of minors and consumer protection. These laws can be particularly restrictive in countries outside the United States. Both in the United States and abroad, these laws and regulations constantly evolve and remain subject to significant change. In addition, the application and interpretation of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate. Because our products and services store, process and use data, some of which contains personal information, we are subject to complex and evolving federal, state and foreign laws and regulations regarding privacy, data protection and other matters. Many of these laws and regulations are subject to change and uncertain interpretation and even our inadvertent failure to comply with such laws and regulations could result in investigations, claims, damages to our reputation, changes to our business practices, increased cost of operations and declines in user growth, retention or engagement, any of which could materially adversely affect our business, results of operations and financial condition. Costs to comply with and implement these privacy-related and data protection measures could be significant.
 
Global privacy legislation, enforcement, and policy activity for privacy and data protection are rapidly expanding and creating a complex regulatory compliance environment. Costs to comply with and implement these privacy-related and data protection measures could be significant. For example, the EU General Data Protection Regulation 2016/679 (“GDPR”), which came into effect on May 25, 2018, imposes stringent EU data protection requirements on companies established in the European Union or companies that offer goods or services to, or monitor the behavior of, individuals in the European Union. The GDPR establishes a robust framework of data subjects’ rights and imposes onerous accountability obligations on companies, with penalties for noncompliance of up to the greater of 20 million euros or four percent of annual global revenue. In addition, numerous states in the U.S. are also expanding data protection through legislation. For example, in June 2018, California enacted the California Consumer Privacy Act, which takes effect on January 1, 2020, and will give California residents expanded privacy rights and protections and provide for civil penalties for violations and a private right of action for data breaches. At the same time, certain developing countries in which we do business have already or are also currently considering adopting privacy and data protection laws and regulations. While we have implemented policies and procedures to address GDPR and other data privacy requirements, failure to comply or concerns about our practices or compliance with GDPR or other privacy-related laws and regulations could materially adversely affect our business, results of operations and financial condition.



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

Since inception, we have conducted a substantial majority of our manufacturing operations in San Jose, California. We continue to increase our manufacturing capacity in Taiwan and in the Netherlands. If we are unable to successfully ramp up our international manufacturing capacity, we may incur unanticipated costs, difficulties in making timely delivery of products or suffer other business disruptions which could adversely impact our results of operations.

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

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

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

Managing our business for long-term growth also requires us to successfully manage a substantial increase in our number of employees. We must continue to hire, train and manage new employees as needed. Our failure to timely file our SEC reports and the delisting of our common stock on Nasdaq has adversely impacted our ability to attract new employees and retain existing employees and will likely continue to adversely impact us as long as these circumstances persist. If our new hires perform poorly, or if we are unsuccessful in hiring, training, managing and integrating these new employees, or if we are not successful in retaining our existing employees, our business may be harmed. The additional headcount we have added and may continue to add has increased and will continue to increase our cost base, which will make it more difficult for us to offset any future revenue shortfalls by offsetting expense reductions in the short term. If we fail to successfully manage our growth, we will be unable to execute our business plan.

Our future effective income tax rates could be affected by changes in the relative mix of our operations and income among different geographic regions and by changes in domestic and foreign income tax laws, which could affect our future operating results, financial condition and cash flows.

We seek to structure our worldwide operations to take advantage of certain international tax planning opportunities and incentives. Our future effective income tax rates could be adversely affected if tax authorities challenge our international tax structure or if the relative mix of our United States and international income changes for any reason, or due to changes in U.S. or international tax laws. In particular, a substantial portion of our revenue is generated from customers located outside the United States. Prior to December 22, 2017, foreign withholding taxes and United States income taxes were not provided on undistributed earnings for certain non-United States subsidiaries, because such earnings were intended to be indefinitely reinvested in the operations of those subsidiaries. On December 22, 2017, the U.S. federal government enacted the Tax Cuts and Jobs Act (“2017 Tax Reform Act”). As a result of the 2017 Tax Reform Act, we recorded a one-time write down of our U.S. deferred tax assets and liabilities resulting from the U.S. federal corporate income tax rate decrease from 35% to 21%, and a one-time transition tax, in our income tax provision for the fiscal year ended June 30, 2018. We expect further guidance may be forthcoming from federal and state tax agencies, which could result in additional impacts. See Part II, Item 8, Note 14, “Income Taxes” to the consolidated financial statements in this Annual Report for further discussion of the impact of the 2017 Tax Reform Act.

The effectiveness of our tax planning activities is based upon certain assumptions that we make regarding our future operating performance and tax laws. We continue to optimize our tax structure to align with our business operations and growth

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strategy. We cannot assure you that we will be able to lower our effective tax rate as a result of our current or future tax planning activities nor that such rate will not increase in the future.

If negative publicity arises with respect to us, our employees, our third-party service providers or our partners, our business and operating results could be adversely affected, regardless of whether the negative publicity is true.

Negative publicity about our company or our products, even if inaccurate or untrue, could adversely affect our reputation and the confidence in our products, which could harm our business and operating results. For example, in October 2018, a news article was published alleging that malicious hardware chips were implanted on our motherboards during the manufacturing process at the facilities of a contract manufacturer in China. We undertook a thorough investigation of this claim with the assistance of a leading, independent third-party investigations firm wherein we tested a representative sample of our motherboards, including the specific type of motherboard depicted in the news article and motherboards purchased by companies referenced in the article, as well as more recently manufactured motherboards. After completing these examinations as well as a range of functional tests, the investigations firm reported that it had found no evidence of malicious hardware on our motherboards. In addition, neither the publisher of the news article nor any of our customers have ever provided a single example of any such altered motherboard. However, despite repeated denials of any tampering by our customers and us, and the announcement of the results of this independent investigation, this false allegation had a substantial negative impact on the trading price of our common stock and our reputation and it may continue to have a negative impact in the future.

Harm to our reputation can also arise from many other sources, including employee misconduct, as has been experienced in the past, and misconduct by our partners and outsourced service providers. Additionally, negative publicity with respect to our partners or service providers could also affect our business and operating results to the extent that we rely on these partners or if our customers or prospective customers associate our company with these partners.

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

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

Our principal competitors include global technology companies such as Cisco, Dell, Hewlett-Packard Enterprise, Huawei, IBM, and Lenovo. In addition, we also compete with a number of other vendors who also sell application optimized servers, contract manufacturers and original design manufacturers (“ODMs”), such as Inspur, Quanta Computer, and Wiwynn Corporation. ODMs sell server solutions marketed or sold under a third-party brand.

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

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

Some of our current or potential ODM competitors are also currently or have in the past been suppliers to us. As a result, they may possess sensitive knowledge or experience which may be used against us competitively and/or which may

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require us to alter our supply arrangements or sources in a way which could adversely impact our cost of sales or results of operations.

Our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. Competitors may seek to copy our innovations and use cost advantages from greater size to compete aggressively with us on price. Certain customers are also current or prospective competitors and as a result, assistance that we provide to them as customers may ultimately result in increased competitive pressure against us. Furthermore, because of these advantages, even if our application optimized server and storage solutions are more effective than the products that our competitors offer, potential customers might accept competitive products in lieu of purchasing our products. The challenges we face from larger competitors will become even greater if consolidation or collaboration between or among our competitors occurs in our industry. Also, initiatives like the Open Compute Project, a project to establish more industry standard data center configurations, could have the impact of supporting an approach which is less favorable to the flexibility and customization that we offer. These changes could have a significant impact on the market and impact our results of operations. For all of these reasons, we may not be able to compete successfully against our current or future competitors, and if we do not compete effectively, our ability to increase our net sales may be impaired.

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

We expect that our direct sales force will continue to grow as larger customers increasingly require a direct sales approach. Competition for direct sales personnel with the advanced sales skills and technical knowledge we need is intense, and we face significant competition for direct sales personnel from our competitors. Our ability to grow our revenue in the future will depend, in large part, on our success in recruiting, training, retaining and successfully managing sufficient qualified direct sales personnel. We have experienced much greater turnover in our sales and marketing personnel as compared to other departments and other companies, which we believe has been due in part to our employees' inability to exercise their stock options since our registration statement on Form S-8 lost its effectiveness due to our delinquent filings. New hires require significant training and may take six months or longer before they reach full productivity. Our recent hires and planned hires may not become as productive as we would like, and we may be unable to hire sufficient numbers of qualified individuals in the future in the markets where we do business. If we are unable to hire, develop and retain sufficient numbers of productive sales personnel, our customer relationships and resulting sales of our server solutions will suffer.

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

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

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

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

We rely on a limited number of suppliers for certain raw materials used to manufacture our products.

Certain raw materials used in the manufacture of our products are available from a limited number of suppliers. Shortages could occur in these essential materials due to an interruption of supply or increased demand in the industry. One of our suppliers accounted for 21.8%, 26.0% and 31.0% of total purchases of raw materials for the fiscal years ended June 30, 2019, 2018 and 2017, respectively. Ablecom and Compuware, related parties, accounted for 9.2%, 9.0% and 11.1% of our total

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cost of sales for the fiscal years ended June 30, 2019, 2018 and 2017, respectively. If any of our largest suppliers discontinue their operations or if our relationships with them are adversely impacted, we could experience a material adverse effect on our business, results of operations and financial condition.

We rely on indirect sales channels for a significant percentage of our revenue and any disruption in these channels could adversely affect our sales.

Sales of our products through our indirect sales channel accounted for 39.3%, 41.5% and 47.8% of our net sales in fiscal years 2019, 2018 and 2017, respectively. We depend on our indirect sales channel partners to assist us in promoting market acceptance of our products and anticipate that a significant portion of our revenues will continue to result from sales through indirect channels. To maintain and potentially increase our revenue and profitability, we will have to successfully preserve and expand our existing distribution relationships as well as develop new channel relationships. Our indirect sales channel partners also sell products offered by our competitors and may elect to focus their efforts on these sales. If our competitors offer our indirect sales channel more favorable terms or have more products available to meet the needs of their customers, or utilize the leverage of broader product lines sold through the indirect sales channel, those channel partners may de-emphasize or decline to carry our products. In addition, the order decision-making process in our indirect sales channel is complex and involves several factors, including end customer demand, warehouse allocation and marketing resources, which can make it difficult to accurately predict total sales for the quarter until late in the quarter. We also do not control the pricing or discounts offered by our indirect sales channel partners to the end customers. To maintain our participation in the marketing programs of our indirect sales channel partners, we have provided and expect to continue to offer cooperative marketing arrangements and offer short-term pricing concessions.

The discontinuation of cooperative marketing arrangements or pricing concessions could have a negative effect on our business, results of operations and financial condition. Our indirect sales channel partners could also modify their business practices, such as payment terms, inventory levels or order patterns. If we are unable to maintain successful relationships in our indirect sales channel or expand our channel or we experience unexpected changes in payment terms, inventory levels or other practices in our indirect sales channel, our business will suffer.

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

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

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

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

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

Our server and storage solutions are critical to our customers’ business operations. Our customers require our server and storage solutions to perform at a high level, contain valuable features and be extremely reliable. The design of our server and storage solutions is sophisticated and complex, and the process for manufacturing, assembling and testing our server solutions is challenging. Occasionally, our design or manufacturing processes may fail to deliver products of the quality that our customers require. For example, in the past certain vendors have provided us with defective components that failed under

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certain applications. As a result, our products needed to be repaired and we incurred costs in connection with the recall and diverted resources from other projects.

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

Conflicts of interest may arise between us and Ablecom and Compuware, and those conflicts may adversely affect our operations.
    
We use Ablecom, a related party, for contract design and manufacturing coordination support and warehousing, and Compuware, also a related party and an affiliate of Ablecom, for distribution, contract manufacturing and warehousing. We work with Ablecom to optimize modular designs for our chassis and certain of other components. We outsource to Compuware a portion of our design activities and a significant part of our manufacturing of subassemblies, particularly power supplies. Our purchases of products from Ablecom and Compuware represented 9.2%, 9.0%, and 11.1% of our cost of sales for fiscal years 2019, 2018 and 2017, respectively. Ablecom and Compuware’s sales to us constitute a substantial majority of Ablecom and Compuware’s net sales. Ablecom and Compuware are both privately-held Taiwan-based companies. In addition, we have entered into a distribution agreement with Compuware, under which we have appointed Compuware as a nonexclusive distributor of our products in Taiwan, China and Australia.

Steve Liang, Ablecom’s Chief Executive Officer and largest shareholder, is the brother of Charles Liang, our President, Chief Executive Officer and Chairman of our board of directors (“the Board”). Steve Liang owned approximately 0.4% of our common stock as of June 30, 2017, but owned no shares as of June 30, 2018 and thereafter. Charles Liang and his spouse, Sara Liu, our Co-Founder, Senior Vice President and director, jointly own approximately 10.5% of Ablecom’s capital stock, while Mr. Steve Liang and other family members own approximately 28.8% of Ablecom’s outstanding common stock. Bill Liang, a brother of both Charles Liang and Steve Liang, also is a member of the Board of Directors of Ablecom. Certain family members of Yih-Shyan (Wally) Liaw, who until January 2018 was our Senior Vice President of International Sales and director, own approximately 11.7% of Ablecom’s capital stock.
    
Bill Liang is also the Chief Executive Officer of Compuware, a member of Compuware’s Board of Directors and a holder of a significant equity interest in Compuware. Steve Liang is also a member of Compuware’s Board of Directors and is an equity holder of Compuware.

Mr. Charles Liang as our Chief Executive Officer and Chairman of the Board and as a significant stockholder of our company, has considerable influence over the management of our business relationships. Accordingly, we may be disadvantaged by the economic interests of Mr. Charles Liang and Ms. Sara Liu as stockholders of Ablecom and Mr. Charles Liang's personal relationship with Ablecom’s Chief Executive Officer. We may not negotiate or enforce contractual terms as aggressively with Ablecom or Compuware as we might with an unrelated party, and the commercial terms of our agreements may be less favorable than we might obtain in negotiations with third parties. If our business dealings with Ablecom or Compuware are not as favorable to us as arms-length transactions, our results of operations may be harmed.

If Ablecom or Compuware are acquired or sold, new ownership could reassess the business and strategy of Ablecom or Compuware, and as a result, our supply chain could be disrupted or the terms and conditions of our agreements with Ablecom or Compuware may change. As a result, our operations could be negatively impacted or costs could increase, either of which could adversely affect our margins and results of operations.

Our reliance on Ablecom could be subject to risks associated with our reliance on a limited source of contract manufacturing services and inventory warehousing.

We plan to continue to maintain our manufacturing relationship with Ablecom in Asia. In order to provide a larger volume of contract manufacturing services for us, we anticipate that Ablecom will continue to warehouse for us an increasing

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number of components and subassemblies manufactured by multiple suppliers prior to shipment to our facilities in the United States and Europe. We also anticipate that we will continue to lease office space from Ablecom in Taiwan to support our research and development efforts. We operate a joint management company with Ablecom to manage the common areas shared by us and Ablecom for our separately constructed manufacturing facilities in Taiwan.

If our commercial relationship with Ablecom deteriorates, we may experience delays in our ability to fulfill customer orders. Similarly, if Ablecom’s facility in Asia is subject to damage, destruction or other disruptions, our inventory may be damaged or destroyed, and we may be unable to find adequate alternative providers of contract manufacturing services in the time that we or our customers require. We could lose orders and be unable to develop or sell some products cost-effectively or on a timely basis, if at all.

Currently, we purchase contract manufacturing services primarily for our chassis products from Ablecom. If our commercial relationship with Ablecom were to deteriorate or terminate, establishing direct relationships with those entities supplying Ablecom with key materials for our products or identifying and negotiating agreements with alternative providers of warehouse and contract manufacturing services might take a considerable amount of time and require a significant investment of resources. Pursuant to our agreements with Ablecom and subject to certain exceptions, Ablecom has the exclusive right to be our supplier of the specific products developed under such agreements. As a result, if we are unable to obtain such products from Ablecom on terms acceptable to us, we may need to discontinue a product or develop substitute products, identify a new supplier, change our design and acquire new tooling, all of which could result in delays in our product availability and increased costs. If we need to use other suppliers, we may not be able to establish business arrangements that are, individually or in the aggregate, as favorable as the terms and conditions we have established with Ablecom. If any of these things should occur, our net sales, margins and earnings could significantly decrease, which would have a material adverse effect on our business, results of operations and financial condition.

Our growth into markets outside the United States exposes us to risks inherent in international business operations.

We market and sell our systems and subsystems and accessories both inside and outside the United States. We intend to expand our international sales efforts, especially into Asia, and we are expanding our business operations in Europe and Asia, particularly in China, Taiwan, the Netherlands and Japan. In particular, we have made, and continue to make, substantial investments for the purchase of land and the development of new facilities in Taiwan to accommodate our expected growth and the migration of a substantial portion of our contract manufacturing operations from China to Taiwan. Our international expansion efforts may not be successful. Our international operations expose us to risks and challenges that we would otherwise not face if we conducted our business only in the United States, such as:

Heightened price sensitivity from customers in emerging markets;
Our ability to establish local manufacturing, support and service functions, and to form channel relationships with value added resellers in non-United States markets;
Localization of our systems and components, including translation into foreign languages and the associated expenses;
Compliance with multiple, conflicting and changing governmental laws and regulations;
Foreign currency fluctuations;
Limited visibility into sales of our products by our channel partners;
Greater concentration of competitors in some foreign markets than in the United States;
Laws favoring local competitors;
Weaker legal protections of intellectual property rights and mechanisms for enforcing those rights;
Market disruptions created by public health crises in regions outside the United States, such as Avian flu, SARS and other diseases;
Import and export tariffs;
Difficulties in staffing and the costs of managing foreign operations, including challenges presented by relationships with workers’ councils and labor unions; and
Changing regional economic and political conditions.

These factors could limit our future international sales or otherwise adversely impact our operations or our results of operations.

Our results of operations may be subject to fluctuations based upon our investment in corporate ventures.

We have a 30% minority interest in a China corporate venture that was established to market and sell corporate venture branded systems in China based upon products and technology we supply. We record earnings and losses from the

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corporate venture using the equity method of accounting. Our loss exposure is limited to the remainder of our equity investment in the corporate venture which as of June 30, 2019 and 2018 was $1.7 million and $2.4 million, respectively. Although we currently do not intend to make any additional investment in this corporate venture, if we were to do so in the future, our exposure to potential losses would increase. We may make investments in other corporate ventures. We do not control this corporate venture and any fluctuation in the results of operations of the corporate venture or any other similar transaction that we may enter into in the future could adversely impact, or result in fluctuations in, our results of operations.

The United States could withdraw from or materially modify certain international trade agreements, or change tariff, trade, or tax provisions related to the global manufacturing and sales of our products in ways that we currently cannot predict.

A portion of our business activities are conducted in foreign countries, including the Netherlands, Taiwan, China, United Kingdom and Japan. Our business benefits from free trade agreements, and we also rely on various U.S. corporate tax provisions related to international commerce as we manufacture, market and sell our products globally. Starting in July 2018, the U.S. announced a series of lists covering thousands of categories of Chinese origin products subject to potential special tariffs of 10% to 25% of import value, in addition to the regular tariffs that have historically applied to such products. Many categories of Chinese imports became subject to the 10% additional tariff in September 2018, including certain components in our products. This 10% additional tariff was increased to 25% effective May 10, 2019. In addition, on August 1, 2019, President Trump announced that a special 15% tariff will be imposed on the approximately $300 billion of inbound trade from China not already subject to a special tariff. Based on prior announcements by the Trump Administration, it is possible that the special 15% tariff could be increased to 25% in the future. The precise impact of the special tariffs on Chinese products is impossible to predict at this time. As a result of these tariffs and the uncertainty surrounding the impact of any future special tariffs on Chinese products, we have begun to migrate a substantial portion of our subcontracted business operations from China to Taiwan. We are continuing to evaluate the impact of the announced and other proposed tariffs on products and components that we import from China, and we may experience a material increase in the cost of our products, which may result in our products becoming less attractive relative to products offered by our competitors.

These developments, or the perception that any of them could occur, may have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global trade and, in particular, trade between the impacted nations and the United States. Any of these factors, or any changes to U.S. corporate tax policies related to international commerce, could depress economic activity and have a material adverse effect on our business, financial condition and results of operations.

Failure to comply with the U.S. Foreign Corrupt Practices Act, other applicable anti-corruption and anti-bribery laws, and applicable trade control laws could subject us to penalties and other adverse consequences.

We manufacture and sell our products in several countries outside of the United States, both to direct and OEM customers as well as through our indirect sales channel. Our operations are subject to the U.S. Foreign Corrupt Practices Act (the “FCPA”) as well as the anti-corruption and anti-bribery laws in the countries where we do business. The FCPA prohibits covered parties from offering, promising, authorizing or giving anything of value, directly or indirectly, to a “foreign government official” with the intent of improperly influencing the official’s act or decision, inducing the official to act or refrain from acting in violation of lawful duty or obtaining or retaining an improper business advantage. The FCPA also requires publicly traded companies to maintain records that accurately and fairly represent their transactions, and to have an adequate system of internal accounting controls. In addition, other applicable anti-corruption laws prohibit bribery of domestic government officials, and some laws that may apply to our operations prohibit commercial bribery, including giving or receiving improper payments to or from non-government parties, as well as so-called “facilitation” payments. In addition, we are subject to U.S. and other applicable trade control regulations that restrict with whom we may transact business, including the trade sanctions enforced by the U.S. Treasury, Office of Foreign Assets Control. If we fail to comply with laws and regulations restricting dealings with sanctioned countries, we may be subject to civil or criminal penalties. Any future violations could have an adverse impact on our ability to sell our products to United States federal, state and local government and related entities.

In addition, while we have implemented policies, internal controls and other measures reasonably designed to promote compliance with applicable anti-corruption and anti-bribery laws and regulations, and certain safeguards designed to ensure compliance with U.S. trade control laws, our employees or agents have in the past engaged and may in the future engage in improper conduct for which we could be held responsible. If we, or our employees or agents acting on our behalf, are found to have engaged in practices that violate these laws and regulations, we could suffer severe fines and penalties, profit disgorgement, injunctions on future conduct, securities litigation, bans on transacting government business and other consequences that may have a material adverse effect on our business, results of operations and financial condition. In addition,

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our brand and reputation, our sales activities or our stock price could be adversely affected if we become the subject of any negative publicity related to actual or potential violations of anti-corruption, anti-bribery or trade control laws and regulations.

Any failure to protect our intellectual property rights, trade secrets and technical know-how could impair our brand and our competitiveness.

Our ability to prevent competitors from gaining access to our technology is essential to our success. If we fail to protect our intellectual property rights adequately, we may lose an important advantage in the markets in which we compete. Trademark, patent, copyright and trade secret laws in the United States and other jurisdictions as well as our internal confidentiality procedures and contractual provisions are the core of our efforts to protect our proprietary technology and our brand. Our patents and other intellectual property rights may be challenged by others or invalidated through administrative process or litigation, and we may initiate claims or litigation against third parties for infringement of our proprietary rights. Such administrative proceedings and litigation are inherently uncertain and divert resources that could be put towards other business priorities. We may not be able to obtain a favorable outcome and may spend considerable resources in our efforts to defend and protect our intellectual property.

Furthermore, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain. Effective patent, trademark, copyright and trade secret protection may not be available to us in every country in which our products are available. The laws of some foreign countries may not be as protective of intellectual property rights as those in the United States, and mechanisms for enforcement of intellectual property rights may be inadequate.

Accordingly, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property and using our technology for their competitive advantage. Any such infringement or misappropriation could have a material adverse effect on our business, results of operations and financial condition.

Resolution of claims that we have violated or may violate the intellectual property rights of others could require us to indemnify our customers, indirect sales channel partners or vendors, redesign our products, or pay significant royalties to third parties, and materially harm our business.

Our industry is marked by a large number of patents, copyrights, trade secrets and trademarks and by frequent litigation based on allegations of infringement or other violation of intellectual property rights. Our primary competitors have substantially greater numbers of issued patents than we have which may position us less favorably in the event of any claims or litigation with them. Other third parties have in the past sent us correspondence regarding their intellectual property or filed claims that our products infringe or violate third parties’ intellectual property rights. In addition, increasingly non-operating companies are purchasing patents and bringing claims against technology companies. We have been subject to several such claims and may be subject to such claims in the future.

Successful intellectual property claims against us from others could result in significant financial liability or prevent us from operating our business or portions of our business as we currently conduct it or as we may later conduct it. In addition, resolution of claims may require us to redesign our technology, to obtain licenses to use intellectual property belonging to third parties, which we may not be able to obtain on reasonable terms, to cease using the technology covered by those rights, and to indemnify our customers, indirect sales channel partners or vendors. Any claim, regardless of its merits, could be expensive and time consuming to defend against, and divert the attention of our technical and management resources.

If we lose Charles Liang, our President, Chief Executive Officer and Chairman, or any other current key employee or are unable to attract additional key employees, we may not be able to implement our business strategy in a timely manner.

Our future success depends in large part upon the continued service of our current executive management team and other current key employees. In particular, Charles Liang, our President, Chief Executive Officer and Chairman of the Board, is critical to the overall management of our company as well as to our strategic direction. Mr. Liang co-founded our company and has been our Chief Executive Officer since our inception. His experience in running our business and his personal involvement in key relationships with suppliers, customers and strategic partners are extremely valuable to our company. We currently do not have a succession plan for the replacement of Mr. Liang if it were to become necessary. Additionally, we are particularly dependent on the continued service of our existing research and development personnel because of the complexity of our products and technologies. Our employment arrangements with our executives and employees do not require them to provide services to us for any specific length of time, and they can terminate their employment with us at any time, with or without notice, without penalty. The loss of services of any of these executives or of one or more other key members of our team could seriously harm our business.

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If we are unable to attract and integrate additional key employees in a manner that enables us to scale our business and operations effectively, or if we do not maintain competitive compensation policies to retain our employees, our ability to operate effectively and efficiently could be limited.

To execute our growth plan, we must attract additional highly qualified personnel, including additional engineers and executive staff. Competition for qualified personnel is intense, especially in Silicon Valley, where we are headquartered. We have experienced in the past and may continue to experience difficulty in hiring and retaining highly skilled employees with appropriate qualifications. The delay in the filing of our required Exchange Act period reports with the SEC precludes us from registering our securities with the SEC for offer and sale and limits our ability to use stock options and other equity-based awards to attract, retain and provide incentives to employees. Since September 2017, our employees have been unable to sell their holdings of our common stock, which has contributed to the loss of experienced engineering and sales personnel. If we are unable to attract and integrate additional key employees in a manner that enables us to scale our business and operations effectively, or if we do not maintain competitive compensation policies to retain our employees, our ability to operate effectively and efficiently could be limited.

Backlog does not provide a substantial portion of our net sales in any quarter.

Our net sales are difficult to forecast because we do not have sufficient backlog of unfilled orders or sufficient recurring revenue to meet our quarterly net sales targets at the beginning of a quarter. Rather, a majority of our net sales in any quarter depend upon customer orders that we receive and fulfill in that quarter. Because our expense levels are based in part on our expectations as to future net sales and to a large extent are fixed in the short term, we might be unable to adjust spending in time to compensate for any shortfall in net sales. Accordingly, any significant shortfall of revenues in relation to our expectations would harm our operating results.

Our business and operations are especially subject to the risks of earthquakes and other natural catastrophic events.

Our corporate headquarters, including our most significant research and development and manufacturing operations, are located in the Silicon Valley area of Northern California, a region known for seismic activity. We have also established significant manufacturing and research and development operations in Taiwan which is also subject to seismic activity risks. We do not currently have a comprehensive disaster recovery program and as a result, a significant natural disaster, such as an earthquake, could have a material adverse impact on our business, operating results, and financial condition. Although we are in the process of preparing such a program, there is no assurance that it will be effective in the event of such a disaster.

Our operations involve the use of hazardous and toxic materials, and we must comply with environmental laws and regulations, which can be expensive, and may affect our business, results of operations and financial condition.

We are subject to federal, state and local regulations relating to the use, handling, storage, disposal and human exposure to hazardous and toxic materials. If we were to violate or become liable under environmental laws in the future as a result of our inability to obtain permits, human error, accident, equipment failure or other causes, we could be subject to fines, costs or civil or criminal sanctions, face third-party property damage or personal injury claims or be required to incur substantial investigation or remediation costs, which could be material, or experience disruptions in our operations, any of which could have a material adverse effect on our business, results of operations and financial condition. In addition, environmental laws could become more stringent over time imposing greater compliance costs and increasing risks and penalties associated with violations, which could harm our business, results of operations and financial condition.

We also face increasing complexity in our product design as we adjust to new and future requirements relating to the materials composition of our products, including the restrictions on lead and other hazardous substances applicable to specified electronic products placed on the market in the European Union (Restriction on the Use of Hazardous Substances Directive 2002/95/EC, also known as the RoHS Directive). We are also subject to laws and regulations such as California’s “Proposition 65” which requires that clear and reasonable warnings be given to consumers who are exposed to certain chemicals deemed by the State of California to be dangerous, such as lead. We expect that our operations will be affected by other new environmental laws and regulations on an ongoing basis. Although we cannot predict the ultimate impact of any such new laws and regulations, they will likely result in additional costs, and could require that we change the design and/or manufacturing of our products, any of which could have a material adverse effect on our business, results of operations and financial condition.
    
We are also subject to the Section 1502 of the Dodd Frank Act concerning the supply of certain minerals coming from the conflict zones in and around the Democratic Republic of Congo. This United States legislation includes disclosure requirements regarding the use of conflict minerals mined from the Democratic Republic of Congo and adjoining countries and

26





procedures regarding a manufacturer’s efforts to prevent the sourcing of such conflict minerals. These requirements could affect the sourcing and availability of minerals used in the manufacture of semiconductor or other devices. As a result, there may only be a limited pool of suppliers who provide conflict-free metals, and we cannot assure you that we will be able to obtain products in sufficient quantities or at competitive prices.

Risks Related to Owning Our Stock

The trading price of our common stock is likely to be volatile, and you might not be able to sell your shares at or above the price at which you purchased the shares.

The trading prices of technology company securities historically have been highly volatile and the trading price of our common stock has been and is likely to continue to be subject to wide fluctuations. Factors, in addition to those outlined elsewhere in this filing, that may affect the trading price of our common stock include:

The risk that we are not able to relist our common stock on a national securities exchange;
The outcome of litigation and claims as well as regulatory examinations, investigations, proceedings and orders arising out of our failure to file SEC reports on a timely basis, the circumstances leading to the need to restate certain of our previously issued financial statements, and our efforts to investigate, assess and remediate related matters;
Actual or anticipated variations in our operating results, including failure to achieve previously provided guidance;
Announcements of technological innovations, new products or product enhancements, strategic alliances or significant agreements by us or by our competitors;
Changes in recommendations by any securities analysts that elect to follow our common stock;
The financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
False or misleading press releases or articles regarding our company or our products;
The loss of a key customer;
The loss of key personnel;
Technological advancements rendering our products less valuable;
Lawsuits filed against us, including those described in Part I, Item 3, “Legal Proceedings”;
Changes in operating performance and stock market valuations of other companies that sell similar products;
Price and volume fluctuations in the overall stock market;
Market conditions in our industry, the industries of our customers and the economy as a whole; and
Other events or factors, including those resulting from war, incidents of terrorism, political instability or responses to these events.

Future sales of shares by existing stockholders could cause our stock price to decline.

Attempts by existing stockholders to sell substantial amounts of our common stock in the public market could cause the trading price of our common stock to decline significantly. All of our shares are eligible for sale in the public market, including shares held by directors, executive officers and other affiliates, sales of which are subject to volume limitations and other requirements under Rule 144 under the Securities Act. In addition, shares subject to outstanding options and reserved for future issuance under our stock option plans are eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements. If these additional shares are sold, or if it is perceived that they will be sold in the public market, the trading price of our common stock could decline.

If securities analysts do not resume research or reporting about our business or if they downgrade our stock, the price of our stock could decline.

There is currently only one industry analyst covering our common stock as of the date of this Annual Report. The research and reports that industry or financial analysts publish about us or our business likely have an effect on the trading price of our common stock. If an industry analyst decides not to cover our company, or if an industry analyst decides to cease covering our company at some point in the future, we could lose visibility in the market, which in turn could cause our stock price to decline. If industry analysts do not resume research reports on our business or downgrade our stock, our stock price would likely decline rapidly in response.



27





The concentration of our capital stock ownership with insiders will likely limit your ability to influence corporate matters.

As of November 30, 2019, our executive officers, directors, current five percent or greater stockholders and affiliated entities together beneficially owned 24.2% of our common stock, net of treasury stock. As a result, these stockholders, acting together, have significant influence over all matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions. Corporate action might be taken even if other stockholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.

Provisions of our certificate of incorporation and bylaws and Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, as a result, depress the trading price of our common stock.

Our certificate of incorporation and bylaws contain provisions that could discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:

Establish a classified Board of Directors so that not all members of our Board are generally elected at one time, provided that in our next annual meeting we will elect all of the members of our Board due to our inability to hold annual meetings for the preceding two fiscal years;
Require super-majority voting to amend some provisions in our certificate of incorporation and bylaws;
Authorize the issuance of “blank check” preferred stock that our Board could issue to increase the number of outstanding shares and to discourage a takeover attempt;
Limit the ability of our stockholders to call special meetings of stockholders;
Prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
Provide that our Board is expressly authorized to adopt, alter or repeal our bylaws; and
Establish advance notice requirements for nominations for election to our Board or for proposing matters that can be acted upon by stockholders at stockholder meetings.

In addition, we are subject to Section 203 of the Delaware General Corporation Law, which, subject to some exceptions, prohibits “business combinations” between a Delaware corporation and an “interested stockholder,” which is generally defined as a stockholder who becomes a beneficial owner of 15% or more of a Delaware corporation’s voting stock for a three-year period following the date that the stockholder became an interested stockholder. Section 203 could have the effect of delaying, deferring or preventing a change in control that our stockholders might consider to be in their best interests.

These anti-takeover defenses could discourage, delay or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors of their choosing and cause us to take corporate actions other than those stockholders desire.

Our common stock is currently quoted on the OTC Market, which may have an unfavorable impact on our stock price and liquidity.
 
Effective at the open of business on August 23, 2018, our common stock was suspended from trading on the Nasdaq Global Select Market, and our common stock was subsequently delisted on March 22, 2019. Since the date our common stock was suspended from trading on the Nasdaq Global Select Market, our common stock has been quoted on the OTC Market. The OTC Market is a significantly more limited market than Nasdaq. The quotation of our shares on the OTC Market may result in a less liquid market available for existing and potential stockholders to trade shares of our common stock, could depress the trading price of our common stock and could have a long-term adverse impact on our ability to raise capital in the future.

We do not expect to pay any cash dividends for the foreseeable future.

We do not anticipate that we will pay any cash dividends to holders of our common stock in the foreseeable future. In addition, under the terms of the credit agreement with Bank of America, dated April 19, 2018, we cannot pay any dividends, with limited exceptions. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment. Investors seeking cash dividends in the foreseeable future should not purchase our common stock.
 

28





Item 1B.    Unresolved Staff Comments

None.

Item 2.        Properties

As of June 30, 2019, we owned approximately 1,308,000 square feet and leased approximately 768,000 square feet of office and manufacturing space. Our long-lived assets located outside of the United States represented 21.5%, 22.9% and 22.1% of total long-lived assets in fiscal years 2019, 2018 and 2017, respectively. See Part II, Item 8, Note 17, “Segment Reporting” to the consolidated financial statements in this Annual Report for a summary of long-lived assets by geographic region.

Our principal executive offices, research and development center and production operations are located in San Jose, California where we own approximately 1,097,000 square feet of office and manufacturing space. These facilities are subject to a revolving line of credit with $1.1 million outstanding as of June 30, 2019. We lease approximately 246,000 square feet of warehouse space in Fremont, California under a lease that expires in July 2020, lease approximately 46,000 square feet of office space in San Jose, California under a lease that expires in January 2022, and lease approximately 5,000 square feet of office in Jersey City, New Jersey under a lease that expires in July 2020. Our European headquarters for manufacturing and service operations is located in Den Bosch, the Netherlands where we lease approximately 165,000 square feet of office and manufacturing space under three leases, which expire in July 2025 and June 2026. In Asia, our manufacturing facilities are located in Taoyuan County, Taiwan where we own approximately 211,000 square feet of office and manufacturing space on 7.0 acres of land. These manufacturing facilities are subject to an existing term loan with $22.5 million remaining outstanding as of June 30, 2019. Our research and development center, service operations, and warehouse space in Asia are located in an approximately 106,000 square feet facility in Taipei, Taiwan under eleven leases that expire at various dates ranging from October 2019 through July 2022 and an approximately 194,000 square feet facility in Taoyuan, Taiwan under seven leases that expire in December 2021. We lease approximately 3,000 square feet of office space in Shanghai and Beijing, China for sales and service operations under two leases that expire in April 2020 and August 2020, respectively. In addition, we lease approximately 3,000 square feet of office space in Japan under two leases, which expire in January 2020 and April 2020, respectively.

Additionally, we own 36 acres of land in San Jose, California that would allow us to expand our Green Computing Park. We remodeled one warehouse with approximately 310,000 square feet of storage space and completed the construction of a new manufacturing and warehouse building with approximately 182,000 square feet of manufacturing space in August 2015. In fiscal years 2018 and 2019, we continued to engage several contractors for the development and construction of improvements on the property. We completed the construction of a second new manufacturing and warehouse building in the first quarter of fiscal year 2018. We financed this development through our operating cash flows and borrowings from banks. See Part II, Item 8, Note 10, “Short-term Debt” to the consolidated financial statements in this Annual Report for a discussion of our company’s short-term debt.

We believe that our existing properties, including both owned and leased, are in good condition and are suitable for the conduct of our business.

Item 3.        Legal Proceedings

From time to time, we have been involved in various legal proceedings arising from the course of business activities. In management’s opinion, the resolution of any matters will not have a material adverse effect on our consolidated financial condition, results of operations or liquidity.

On September 4, 2015, a complaint was filed against us, our CEO, and our former CFO in the U.S. District Court for the Northern District of California (Deason v. Super Micro Computer, Inc., et al., No. 15-cv-04049). The complaint claimed that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 because of alleged misrepresentations and/or omissions in public statements which supposedly were revealed when we announced on August 31, 2015 that the filing of our Annual Report on Form 10-K for fiscal year 2015 would be delayed to allow us to complete an investigation into certain marketing expenses. On January 12, 2018, after an initial round of successful motion to dismiss briefing leading to Plaintiff filing an amended complaint, we and the named individual defendants filed another motion to dismiss on the grounds that the amended complaint failed to state a claim because it did not plead falsity or scienter. On June 27, 2018, the Court granted our motion to dismiss without leave to amend and entered judgment in favor of us and the other defendants. On July 24, 2018, Plaintiff filed a notice of appeal to the 9th Circuit Court of Appeals; however, Plaintiff subsequently filed a voluntary notice dismissing the appeal and, thus, ending the litigation on November 1, 2018.

29





On February 8, 2018, two putative class action complaints were filed against us, our CEO, and our former CFO in the U.S. District Court for the Northern District of California (Hessefort v. Super Micro Computer, Inc., et al., No. 18-cv-00838 and United Union of Roofers v. Super Micro Computer, Inc., et al., No. 18-cv-00850). The complaints contain similar allegations, claiming that the defendants violated Section 10(b) of the Securities Exchange Act due to alleged misrepresentations and/or omissions in public statements regarding recognition of revenue. The court subsequently appointed New York Hotel Trades Council & Hotel Association of New York City, Inc. Pension Fund as lead plaintiff and it filed an amended complaint naming our Senior Vice President of Investor Relations as an additional defendant. On June 21, 2019, plaintiff filed a further amended complaint naming our former Senior Vice President of International Sales, Corporate Secretary, and Director as an additional defendant. On July 26, 2019, we filed a motion to dismiss which remains pending. We believe the allegations filed are without merit, and intend to vigorously defend against the lawsuit.

We cooperated with the SEC in its investigation of marketing expenses that contained certain irregularities discovered by our management, which irregularities were disclosed on August 31, 2015. In addition, we have received subpoenas from the SEC in connection with the matters underlying our inability to timely file our Form 10-K for the fiscal year ending June 30, 2017. We also received a subpoena from the SEC following the publication of a false and widely discredited news article in October 2018 concerning our products. We are cooperating fully to comply with these government requests.

Due to the inherent uncertainties of legal proceedings, we cannot predict the outcome of these proceedings at this time, and we can give no assurance that they will not have a material adverse effect on our financial position or results of operations.

Item 4.        Mine Safety Disclosures
    
Not applicable.

30





PART II
 
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Effective at the open of business on August 23, 2018, our common stock was suspended from trading on the Nasdaq Global Select Market. Effective March 22, 2019, our common stock was delisted from the Nasdaq Global Select Market. Since the date our common stock was suspended from trading on the Nasdaq Global Select Market, our common stock has been quoted on the OTC Market and is currently traded under the symbol “SMCI.” Any OTC Market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. Prior to the suspension, we had traded on the Nasdaq Global Select Market since March 29, 2007, and prior to that time there was no public market for our common stock.
 
Holders

As of November 30, 2019, there were 31 registered stockholders of record of our common stock. Because most of our shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial stockholders represented by these holders of record.

Dividend Policy

We have never declared or paid cash dividends on our capital stock. We intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future. Under the terms of the credit agreement with Bank of America, dated April 19, 2018, we may not pay any dividends.

Equity Compensation Plan

Please see Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters of this Annual Report for disclosure relating to our equity compensation plans.

Stock Performance Graph

This performance graph shall not be deemed “soliciting material” or to be "filed" with the SEC for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of Super Micro Computer, Inc. under the Securities Act of 1933, as amended, or the Exchange Act.    

The following graph compares our cumulative five-year total stockholder return on our common stock with the cumulative return of the Nasdaq Computer Index, the Nasdaq Composite Index and a new industry peer group, which we refer to as the FY2019 Peer Group, consisting of: Cray Inc., Extreme Networks, Inc., Infinera Corporation, NetApp, Inc., and NetGear, Inc. In selecting the companies for inclusion in the FY2019 Peer Group, we considered and selected companies with similar industry comparability, net revenues, and operating income as our company. Due to our delisting from the Nasdaq Global Select Market on March 22, 2019, we have added the FY2019 Industry Peer Group.

The graph reflects an investment of $100 (with reinvestment of all dividends, if any) in our common stock, the Nasdaq Computer Index, the Nasdaq Composite Index and the FY2019 Peer Group, on June 30, 2014 and our relative performance tracked through June 30, 2019. The stockholder return shown on the graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future stockholder returns.


31




https://cdn.kscope.io/f703738ea2a813d247a9af5751227a07-chart-63882cae5fef527ea7fa07.jpg

 
 
6/30/2014
 
6/30/2015
 
6/30/2016
 
6/30/2017
 
6/30/2018
 
6/30/2019
Super Micro Computer, Inc.
 
100.00

 
117.06

 
98.34

 
97.55

 
93.59

 
76.57

FY2019 Peer Group
 
100.00

 
105.68

 
101.44

 
109.63

 
169.32

 
140.32

Nasdaq Composite Index
 
100.00

 
113.13

 
109.86

 
139.30

 
170.37

 
181.62

Nasdaq Computer Index
 
100.00

 
110.81

 
112.37

 
153.16

 
198.30

 
214.60


Recent Sales of Unregistered Securities

During fiscal years 2018 and 2019 we granted a consultant restricted stock units covering a total of 26,491 shares of our common stock for services rendered. The restricted stock units were fully vested at the time of grant. The issuances did not involve a public offering of securities and we believe that the transactions were exempt from the registration requirements of the Securities Act pursuant to Section 4(a)(2) thereof and Rule 506 of Regulation D promulgated thereunder.

Issuer Purchases of Equity Securities
    
None.


32





Item 6.        Selected Financial Data

The following selected consolidated financial data should be read in conjunction with Part I, Item 7, "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and the notes thereto included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report to fully understand factors that may affect the comparability of the information presented below. We derived the selected consolidated balance sheet data as of June 30, 2019 and 2018, and the consolidated statement of operations data for the years ended June 30, 2019, 2018 and 2017 from our audited consolidated financial statements and accompanying notes included in this Annual Report. The consolidated balance sheet data as of June 30, 2017, 2016 and 2015, and the consolidated statement of operations data for the years ended June 30, 2016 and 2015 are derived from our audited consolidated financial statements which are not included in this Annual Report. Operating results for any year are not necessarily indicative of results to be expected for any future periods.

 
Years Ended June 30,
 
2019
 
2018
 
2017
 
2016
 
2015
 
(in thousands, except per share data)
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
 
 
Net sales
$
3,500,360

 
$
3,360,492

 
$
2,484,929

 
$
2,225,022

 
$
1,954,353

Cost of sales
3,004,838

 
2,930,498

 
2,134,971

 
1,894,521

 
1,647,769

Gross profit
495,522

 
429,994

 
349,958

 
330,501

 
306,584

Operating expenses:
 
 
 
 
 
 
 
 
 
Research and development
179,907

 
165,104

 
143,992

 
124,223

 
101,402

Sales and marketing
77,154

 
71,579

 
66,445

 
58,338

 
47,496

General and administrative
141,228

 
98,597

 
44,646

 
40,449

 
25,040

Total operating expenses
398,289

 
335,280

 
255,083

 
223,010

 
173,938

Income from operations
97,233

 
94,714

 
94,875

 
107,491

 
132,646

Other income (expense), net
(1,020
)
 
(773
)
 
(984
)
 
1,507

 
956

Interest expense
(6,690
)
 
(5,726
)
 
(2,300
)
 
(1,594
)
 
(965
)
Income before income tax provision
89,523

 
88,215

 
91,591

 
107,404

 
132,637

Income tax provision
(14,884
)
 
(38,443
)
 
(24,434
)
 
(35,323
)
 
(40,082
)
Share of loss from equity investee, net of taxes
(2,721
)
 
(3,607
)
 
(303
)
 

 

Net income
$
71,918

 
$
46,165

 
$
66,854

 
$
72,081

 
$
92,555

Net income per common share:
 
 
 
 
 
 
 
 
 
Basic
$
1.44

 
$
0.94

 
$
1.38

 
$
1.50

 
$
1.99

Diluted
$
1.39

 
$
0.89

 
$
1.29

 
$
1.39

 
$
1.85

Shares used in per share calculation:
 
 
 
 
 
 
 
 
 
Basic
49,917

 
49,345

 
48,383

 
47,917

 
46,434

Diluted
51,716

 
52,151

 
51,679

 
51,836

 
50,094

 
 
 
 
 
 
 
 
 
 
Stock-based compensation:
 
 
 
 
 
 
 
 
 
Cost of sales
$
1,663

 
$
1,812

 
$
1,382

 
$
1,157

 
$
962

Research and development
12,981

 
13,893

 
12,559

 
10,651

 
9,195

Sales and marketing
1,805

 
1,980

 
2,144

 
1,934

 
1,601

General and administrative
4,735

 
6,971

 
3,580

 
3,188

 
2,678

Total stock-based compensation
$
21,184

 
$
24,656

 
$
19,665

 
$
16,930

 
$
14,436



33





 
As of June 30,
 
2019
 
2018
 
2017
 
2016
 
2015
 
(in thousands)
Consolidated Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
248,164

 
$
115,377

 
$
110,606

 
$
178,820

 
$
92,920

Working capital
815,802

 
719,321

 
588,636

 
544,698

 
438,144

Total assets
1,682,594

 
1,769,505

 
1,515,130

 
1,191,483

 
1,122,031

Long-term obligations
135,449

 
114,296

 
68,754

 
85,200

 
26,062

Total stockholders’ equity
941,176

 
843,652

 
773,846

 
696,653

 
593,585



34





Item 7.        Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report, particularly under the heading "Risk Factors."

Nasdaq Delisting of our Common Stock

As a result of the delay in filing our periodic reports with the SEC and failure to hold an annual meeting, we were unable to comply with the Nasdaq listing standards and our common stock was suspended from trading on the Nasdaq Global Select Market effective August 23, 2018 and formally delisted effective March 22, 2019. Following the suspension of trading, our common stock has been quoted on the OTC Market and is currently traded under the symbol “SMCI.” For further information regarding trading in our common stock, refer to Part II, Item 5, “Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in this Annual Report.

Overview

We are a global leader and innovator of high-performance, high-efficiency server and storage technology. We develop and provide end-to-end green computing solutions to the cloud computing, data centers, enterprise, big data, AI, HPC, edge computing and IoT markets. Our solutions range from complete server, storage, modular blade servers, blades and workstations to full racks, networking devices, server management software, server sub-systems and global support and services.

We commenced operations in 1993 and have been profitable every year since inception. For fiscal years 2019, 2018 and 2017, our net income was $71.9 million, $46.2 million and $66.9 million, respectively. In order to increase our sales and profits, we believe that we must continue to develop flexible and application optimized server and storage solutions and be among the first to market with new features and products. We must also continue to expand our software and customer service and support offerings, particularly as we increasingly focus on larger enterprise customers. We measure our financial success based on various indicators, including growth in net sales, gross profit margin and operating margin. Among the key non-financial indicators of our success is our ability to rapidly introduce new products and deliver the latest application-optimized server and storage solutions. In this regard, we work closely with microprocessor and other key component vendors to take advantage of new technologies as they are introduced. Historically, our ability to introduce new products rapidly has allowed us to benefit from technology transitions such as the introduction of new microprocessors and storage technologies, and as a result, we monitor the introduction cycles of Intel Corporation, Advanced Micro Devices, Inc., Nvidia Corporation, Samsung Electronics Company Limited, Micron Technology, Inc. and others carefully. This also impacts our research and development expenditures as we continue to invest more in our current and future product development efforts.

During fiscal years 2018 and 2019, we continued to concentrate our efforts on selling server and storage systems to larger customers such as enterprise and data center customers. As a result of these efforts, sales of server and storage systems represented sequentially greater percentages of our net sales over the course of the two fiscal years, rising from 70.0% of net sales in fiscal year 2017 to 79.3% in fiscal year 2018 and 81.7% in fiscal year 2019. Server and storage systems generally have higher average selling prices and provide an opportunity to sell services. The substantial increase in our net sales from fiscal year 2017 to fiscal year 2018 reflected both this concentration on selling server and storage systems and an increased demand for our products. The further increase in our net sales from fiscal year 2018 to fiscal year 2019, which was less substantial than the prior year’s increase in net sales, reflected our continued concentration on selling server and storage systems, but also reflected a softening demand for our products due to an overall market slowdown in the second half of fiscal year 2019. In addition, adverse publicity associated with false assertions made against our company in a news article published in October 2018 and the unrelated suspension of trading in our common stock on NASDAQ in August 2018 may have been factors contributing to the slower growth in our net sales for fiscal year 2019.

Financial Highlights

The following is a summary of financial highlights of fiscal years 2019 and 2018:

Net sales increased by 4.2% and 35.2% in fiscal years 2019 and 2018, respectively, as compared to fiscal years 2018 and 2017, respectively.


35




Gross margin increased to 14.2% in fiscal year 2019 from 12.8% in fiscal year 2018, primarily due to lower prices for key components, a favorable geographic mix with less competitive pricing, and increased service revenues that have higher margins. Gross margin in fiscal year 2018 decreased by 130 basis points from 14.1% in fiscal year 2017 primarily due to higher costs of key components resulting from shortages of memory and SSDs, higher volume of server and storage systems sales configured with these key components and a less favorable geographical mix of sales resulting in a higher cost of sales.

Operating expenses increased by 18.8% and 31.4% in fiscal years 2019 and 2018, respectively, as compared to fiscal years 2018 and 2017, respectively. The increase in both fiscal years was primarily due to an increase in professional fees incurred to investigate, assess and begin remediating the causes that led to the delay in filing our periodic reports with the SEC and the associated restatement of certain of our previously issued financial statements, as well as an increase in the number of employees to support our growth.

Net income increased to $71.9 million as compared to $46.2 million in fiscal year 2018, which was primarily due to a reduction in our effective tax rate to 16.6% as compared to 43.6% in fiscal year 2018 and a $1.3 million increase in income before taxes. Net income in fiscal year 2018 decreased by $20.7 million from $66.9 million in fiscal year 2017 primarily due to an increase in our effective tax rate to 43.6% in fiscal year 2018, in part due to the remeasurement of our deferred tax assets under the 2017 Tax Reform Act, as compared to 26.7% in fiscal year 2017.

Our cash and cash equivalents were $248.2 million, $115.4 million and $110.6 million at the end of fiscal years 2019, 2018, and 2017, respectively. In fiscal year 2019, we generated net cash of $141.8 million, of which $262.6 million was generated from operating activities related to increased net income and improved working capital management while we invested $24.8 million primarily in new manufacturing capacity and used $95.8 million in financing activities primarily to repay outstanding loans. In fiscal year 2018, we generated net cash of $7.6 million, of which $84.3 million was generated from operating activities related to improved working capital management while we invested $25.9 million primarily in new manufacturing capacity and used $50.8 million in financing activities to primarily repay outstanding loans.

Subsequent Events

For details, see Part II, Item 8, Note 19, “Subsequent Events” in our notes to the consolidated financial statements in this Annual Report.

Critical Accounting Policies

General

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, net sales and expenses. We evaluate our estimates on an on-going basis, and base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making the judgments we make about the carrying values of assets and liabilities that are not readily apparent from other sources. Because these estimates can vary depending on the situation, actual results may differ from the estimates. Making estimates and judgments about future events is inherently unpredictable and is subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, it could have a material impact on our results of operations, financial position and statement of cash flows.

A summary of significant accounting policies is included in Part II, Item 8, Note 1, “Organization and Summary of Significant Accounting Policies” in our notes to the consolidated financial statements in this Annual Report. Management believes the following are the most critical accounting policies and reflect the significant estimates and assumptions used in the preparation of the consolidated financial statements.

Revenue recognition for periods after adoption of ASC 606 as of July 1, 2018

We adopted the new accounting guidance issued by the Financial Accounting Standards Board (“FASB”), Revenue from Contracts with Customers, (“ASC 606”) as of July 1, 2018 using the modified retrospective method for all contracts not completed as of the date of adoption. For contracts that were modified before the effective date, we considered the effect of all

36





modifications when identifying performance obligations and allocating transaction price, which did not have a material effect on the adjustment to retained earnings. We recognized the cumulative effect of initially applying ASC 606 as an adjustment to the opening balance of retained earnings. The comparative information has not been recast and continues to be reported under the accounting standards in effect for those periods.

ASC 606 provides a unified model in determining when and how revenue is recognized with the core principle that revenue should be recognized when a customer obtains control of the promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

We generate revenues from the sale of server and storage systems, subsystems, accessories, services, server software management solutions, and support services.

Product sales. We recognize revenue from sales of products as control is transferred to customers, which generally happens at the point of shipment or upon delivery, unless customer acceptance is uncertain.  Products sold are delivered via shipment from our facilities or drop shipment directly to our customer from our vendor. We may use distributors to sell products to end customers. Revenue from distributors is recognized when the distributor obtains control of the product, which generally happens at the point of shipment or upon delivery, unless customer acceptance is uncertain, and in the amount of consideration to which we expect to be entitled.

As part of determining the transaction price in contracts with customers, we estimate reserves for future sales returns based on a review of our history of actual returns for each major product line. Based upon historical experience a refund liability is recorded at the time of sale for estimated product returns and an asset is recognized for the amount expected to be recorded in inventory upon product return, less the expected recovery costs. We also reduce revenue for the estimated costs of customer and distributor programs and incentive offerings such as price protection and rebates as well as the estimated costs of cooperative marketing arrangements where the fair value of the benefit derived from the costs cannot be reasonably estimated.  Any provision for customer and distributor programs and other discounts is recorded as a reduction of revenue at the time of sale based on an evaluation of the contract terms and historical experience.

Services sales. Our sale of services mainly consists of extended warranty and on-site services. Revenue related to extended warranty commences upon the expiration of the standard warranty period and is recognized ratably over the contractual period as we stand ready to perform any required warranty service. Revenue related to on-site services commences upon recognition of the product sale and is recognized ratably over the contractual period as the on-site services are made available to the customer.  These service contracts are typically one to five years in length. Service revenue has been less than 10% of net sales for all periods presented and is not separately disclosed.

Contracts with multiple promised goods and services. Certain of our contracts contain multiple promised goods and services. Performance obligations in a contract are identified based on the promised goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the services is separately identifiable from other promises in the contract. If these criteria are not met, the promised goods and services are accounted for as a combined performance obligation. Revenue allocated to each performance obligation is recognized at the time the related performance obligation is satisfied by transferring control of the promised good or service to a customer.

If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price basis. We determine standalone selling prices based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, we estimate the standalone selling price taking into account available information, such as internally approved pricing guidelines with respect to geographies, customer type, internal costs, and gross margin objectives, for the related performance obligations.

When we receive consideration from a customer prior to transferring goods or services to the customer, we record a contract liability (deferred revenue). We also recognize deferred revenue when we have an unconditional right to consideration (i.e., a receivable) before transfer of control of goods or services to a customer.

We consider shipping & handling activities as costs to fulfill the sales of products. Shipping revenue is included in net sales when control of the product is transferred to the customer, and the related shipping and handling costs are included in cost

37





of products sold. Taxes imposed by governmental authorities on our revenue producing activities with customers, such as sales taxes and value added taxes, are excluded from net sales.

Revenue recognition for periods prior to adoption of ASC 606 as of July 1, 2018

Product sales. We recognize revenue from sales of products upon meeting all of the following revenue recognition criteria, which is typically met upon shipment or delivery of our  products to customers, unless customer acceptance  is uncertain or significant obligations to the  customer remain: (i) persuasive evidence of an arrangement exists through   customer contracts and  orders, (ii) the customer takes title and assumes the risks and rewards of ownership, (iii) the sales price charged is fixed or determinable as evidenced by customer contracts and orders and (iv) collectibility is reasonably assured.

We estimate reserves for future sales returns based on a review of our history of actual returns for each major product line. We also reduce revenue for customer and distributor programs and incentive offerings such as price protection and rebates as well as cooperative marketing arrangements where the fair value of the benefit identified from the costs cannot be reasonably estimated.

We may use distributors to sell products to end customers. Revenue from distributors may be recognized on sell-in or sell-through basis depending on the terms of the arrangement with the distributor.

We record costs related to shipping and handling in sales and marketing expenses. Shipping and handling fees billed to customers are included in net sales.

Services sales. Our sale of services mainly consists of extended warranty and on-site services. These services are sold at the time of the sale of the underlying products. Revenue related to extended warranty commences upon the expiration of the standard warranty period and is recognized ratably over the contractual period. Revenue related to on-site services commences upon recognition of the product sale and is recognized ratably over the contractual period. These service contracts are typically one to five years in length. Service revenue has been less than 10% of net sales for all periods presented and is not separately disclosed.

Multiple-element arrangements. Certain of our arrangements contain multiple elements, consisting of both our products and services. Revenue allocated to each element is recognized when all the revenue recognition criteria are met for that element.

We allocate arrangement consideration at the inception of an arrangement to all deliverables, if they represent a separate unit of accounting, based on their relative estimated stand-alone selling prices. A deliverable qualifies as a separate unit of accounting when the delivered element has stand-alone value to the customer. The guidance establishes the following hierarchy to determine the relative estimated stand-alone selling price to be used for allocating arrangement consideration to deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price (“TPE”) if VSOE is not available, or (iii) the vendor's best estimated selling price (“BESP”) if neither VSOE nor TPE are available.

We do not have VSOE for deliverables in our arrangements, and TPE is generally not available because our products are highly differentiated, and we are unable to obtain reliable information on the products and pricing practices of our competitors. BESP reflects our estimate of what the selling price of a deliverable would be if it were sold regularly on a stand-alone basis.

As such, BESP is generally used to allocate the total arrangement consideration at the arrangement inception. We determine BESP for a product by considering multiple factors including, but not limited to, geographies, customer types, internal costs, gross margin objectives and pricing practices.

Product Warranties

We offer product warranties ranging from 15 to 39 months against any defective products. These standard warranties are assurance type warranties and we do not offer any services beyond the assurance that the product will continue working as specified. Therefore, under recently adopted guidance, ASC 606, these warranties are not considered separate performance obligations in the arrangement. Based on historical experience, we accrue for estimated returns of defective products at the time revenue is recognized. We monitor warranty obligations and may make revisions to its warranty reserve if actual costs of product repair and replacement are significantly higher or lower than estimated. Accruals for anticipated future warranty costs are charged to cost of sales and included in accrued liabilities and other long-term liabilities. Warranty accruals are based on

38





estimates that are updated on an ongoing basis taking into consideration inputs such as new product introductions, changes in the volume of claims compared with our historical experience, and the changes in the cost of servicing warranty claims. We account for the effect of such changes in estimates prospectively.

Inventories

Inventories are stated at weighted average cost, subject to lower of cost or net realizable value. Net realizable value is the estimated selling price of our products in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Inventories consist of purchased parts and raw materials (principally electronic components), work in process (principally products being assembled) and finished goods. We evaluate inventory on a quarterly basis for lower of cost or net realizable value and excess and obsolescence and, as necessary, write down the valuation of units based upon our forecasted usage and sales, anticipated selling price, product obsolescence and other factors. Once inventory is written down, its new value is maintained until it is sold or scrapped. Prior to July 1, 2017, inventories were stated at weighted-average cost, subject to lower of cost or market.
We receive various rebate incentives from certain suppliers based on our contractual arrangements, including volume-based rebates. The rebates earned are recognized as a reduction of cost of inventories and reduce the cost of sales in the period when the related inventory is sold.

Income Taxes

We account for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net of operating loss carry-forwards and other tax credits measured by applying enacted tax laws related to the financial statement periods. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.

We recognize tax liabilities for uncertain income tax positions on the income tax return based on the two-step process. The first step is to determine whether it is more likely than not that each income tax position would be sustained upon audit. The second step is to estimate and measure the tax benefit as the amount that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority. Estimating these amounts requires us to determine the probability of various possible outcomes. We evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on the consideration of several factors, including changes in facts or circumstances, changes in applicable tax law, settlement of issues under audit and new exposures. If we later determine that our exposure is lower or that the liability is not sufficient to cover our revised expectations, we adjust the liability and effect a related charge in our tax provision during the period in which we make such a determination.

Stock-Based Compensation

We measure and recognize compensation expense for all share-based awards made to employees and non-employees, including stock options and restricted stock units ("RSUs"). The share-based awards granted to non-employees have not been material to date. We are required to estimate the fair value of share-based awards on the date of grant. We recognize the grant date fair value of all share-based awards over the requisite service period and account for forfeitures as they occur. Prior to July 1, 2017, we estimated forfeitures and expensed the value of awards that were ultimately expected to vest over the requisite service periods. The fair value of RSUs with service conditions or performance conditions is based on the closing market price of our common stock on the date of grant. The fair value for RSUs with service conditions, or time-based RSUs, is amortized on a straight-line basis over the requisite service period. The fair value for RSUs with performance conditions ("PRSUs") is recognized on a ratable basis over the requisite service period when it is probable the performance conditions of the awards will be met. We reassess the probability of vesting at each reporting period and adjust our total compensation cost of the awards based on this probability assessment.

We estimate the fair value of stock options granted using a Black-Scholes option pricing model and a single option award approach. This model requires us to make estimates and assumptions with respect to the expected term of the option and the expected volatility of the price of our common stock. The expected term represents the period that our stock-based awards are expected to be outstanding and was determined based on our historical experience. The expected volatility is based on the implied and historical volatility of our common stock. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.

Variable Interest Entities

39






We determine at the inception of each arrangement whether an entity in which we hold an investment or in which we have other variable interests is considered a variable interest entity ("VIE"). We consolidate VIEs when we are the primary beneficiary. The primary beneficiary of a VIE is the party that meets both of the following criteria: (1) has the power to make decisions that most significantly affect the economic performance of the VIE and (2) has the obligation to absorb losses or the right to receive benefits that in either case could potentially be significant to the VIE. Periodically, we assess whether any changes in the interest or relationship with the entity affect the determination of whether the entity is still a VIE and, if so, whether we are the primary beneficiary. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interest in accordance with applicable GAAP.

We have concluded that Ablecom Technology, Inc. ("Ablecom") and its affiliate, Compuware Technology, Inc. ("Compuware") are VIEs in accordance with applicable accounting standards and guidance; however, we are not the primary beneficiary as we do not have the power to direct the activities that are most significant to the entities and therefore, we do not consolidate these entities. In performing this analysis, we considered our explicit arrangements with Ablecom and Compuware, including the supplier arrangements. Also, as a result of the substantial related party relationships between us and these two companies, we considered whether any implicit arrangements exist that would cause us to protect those related parties’ interests from suffering losses. We determined that no material implicit arrangements exist with Ablecom, Compuware, or their shareholders.

We and Ablecom jointly established Super Micro Asia Science and Technology Park, Inc. (the “Management Company”) in Taiwan to manage the common areas shared by us and Ablecom for our separately constructed manufacturing facilities. In fiscal year 2012, each company contributed $0.2 million and owns 50% of the Management Company. We have concluded that the Management Company is a VIE and we are the primary beneficiary as we have the power to direct the activities that are most significant to the Management Company. For the fiscal years ended 2019, 2018 and 2017, the accounts of the Management Company have been consolidated with our accounts, and a noncontrolling interest has been recorded for Ablecom’s interest in the net assets and operations of the Management Company. Net income (loss) attributable to Ablecom’s interest was not material for the periods presented and was included in general and administrative expenses in our consolidated statements of operations.

Results of Operations

Net Sales

Net sales consist of sales of our server and storage solutions, including systems and related services and subsystems and accessories. The main factors that impact our net sales are the number of compute nodes sold, the average selling prices per node for our server and storage system sales and units shipped and the average selling price per unit for our subsystem and accessories. The prices for our server and storage systems range widely depending upon the configuration, including the number of compute nodes in a server system as well as the level of integration of key components such as SSDs, and memory, and the prices for our subsystems and accessories can also vary widely based on whether a customer is purchasing power supplies, server boards, chassis or other accessories. A compute node is an independent hardware configuration within a server system capable of having its own CPU, memory and storage and that is capable of running its own instance of a non-virtualized operating system. The number of compute nodes sold, which can vary by product, is an important metric we use to track our business. Measuring volume using compute nodes enables more consistent measurement across different server form factors and across different vendors. As with most electronics-based product life cycles, average selling prices typically are highest at the time of introduction of new products that utilize the latest technology and tend to decrease over time as such products mature in the market and are replaced by next generation products. Additionally, in order to remain competitive throughout all industry cycles, we actively change our selling price per unit in response to changes in costs for key components such as memory and SSDs.

The following table presents net sales by product type for fiscal years 2019, 2018 and 2017 (dollars in millions):


40





 
Years Ended June 30,
 
2019 over 2018 Change
 
2018 over 2017 Change
 
2019
 
2018
 
2017
 
$
 
%
 
$
 
%
Server and storage systems
$
2,858.6

 
$
2,663.6

 
$
1,740.6

 
$
195.0

 
7.3
 %
 
$
923.0

 
53.0
 %
Percentage of total net sales
81.7
%
 
79.3
%
 
70.0
%
 
 
 
 
 
 
 
 
Subsystems and accessories
641.7

 
696.9

 
744.3

 
(55.2
)
 
(7.9
)%
 
(47.4
)
 
(6.4
)%
Percentage of total net sales
18.3
%
 
20.7
%
 
30.0
%
 
 
 
 
 
 
 
 
Total net sales
$
3,500.3

 
$
3,360.5

 
$
2,484.9

 
$
139.8

 
4.2
 %
 
$
875.6

 
35.2
 %

Fiscal Year 2019 Compared with Fiscal Year 2018

In fiscal year 2019, we continued our strategy of focusing on selling server and storage systems to larger customers such as enterprise and internet data center and cloud customers. The year-over-year increase in server and storage systems sales was primarily due to an increase of average selling price per compute node by approximately 15%, offset by a decrease of approximately 6.5% in the number of units of compute nodes shipped, which is attributable to an overall market slowdown in the second half of fiscal year 2019. The increase in the average selling prices of our server and storage systems was primarily due to higher sales of our complete systems configured with higher density computing and more memory and storage capacity. During the first half of fiscal year 2019, we increased our average selling prices primarily to remain consistent with the increases in the cost of memory and SSDs on a year-over year basis. During October 2018, a 10% tariff was applied to certain key components made in China and was partially incorporated into our average selling prices to the extent that component sourcing alternatives were not available. As costs for memory and SSDs began to decline in the second half of fiscal year 2019, our average selling prices to customers declined accordingly. The year-over-year decrease in net sales of our subsystems and accessories in fiscal year 2019 was primarily due to lower sales of subsystems and accessories through our indirect sales channel.

Fiscal Year 2018 Compared with Fiscal Year 2017
    
In fiscal year 2018, we continued our strategy of focusing on selling server and storage systems to larger customers such as enterprise and internet data center and cloud customers. The substantial increase year-over-year in server and storage systems sales was primarily due to an increase of average selling price per compute node by approximately 32% and an increase of approximately 14% in the number of units of compute nodes shipped due to an increased demand for our products. The increase in the average selling prices of our server and storage systems was primarily due to higher sales of our complete systems configured with higher density computing and more memory and storage capacity. During fiscal year 2018, our average selling prices to customers increased as a result of the increases in the cost of memory and SSDs. The year-over-year decrease in net sales of our subsystems and accessories in fiscal year 2018 was primarily due to lower sales of subsystem and accessories through our indirect sales channel as we continued to promote our sales of server and storage systems to our direct customers and OEMs.

The following table presents the percentages of net sales from products sold through our indirect sales channel and to our direct customers and OEMs for fiscal years 2019, 2018 and 2017:

 
Years Ended June 30,
 
2019 over 2018 Change
 
2018 over 2017 Change
 
2019
 
2018
 
2017
 
%
 
%
Indirect sales channel
39.3
%
 
41.5
%
 
47.8
%
 
(2.2
)%
 
(6.3
)%
Direct customers and OEMs
60.7
%
 
58.5
%
 
52.2
%
 
2.2
 %
 
6.3
 %
Total net sales
100.0
%
 
100.0
%
 
100.0
%
 
 
 
 

Fiscal Year 2019 Compared with Fiscal Year 2018

The year-over-year decrease in net sales through our indirect sales channel as a percentage of total net sales was primarily due to the higher sales to our direct customers and OEMs. The year-over-year increase in net sales to direct customers and OEMs as a percentage of total net sales was primarily due to higher sales of our server and storage systems to internet data center and cloud, enterprise and OEM customers.

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Fiscal Year 2018 Compared with Fiscal Year 2017

The year-over-year decrease in net sales through our indirect sales channel as a percentage of total net sales was primarily due to the lower sales of our subsystems and accessories, which are typically sold through our indirect sales channel. The year-over-year increase in net sales to direct customers and OEMs as a percentage of total net sales was primarily due to the higher volume of sales of our server and storage systems to our internet data center and cloud, enterprise and OEM customers.

The following table presents percentages of net sales by geographic region for fiscal years 2019, 2018 and 2017:
 
Years Ended June 30,
 
2019 over 2018 Change
 
2018 over 2017 Change
 
2019
 
2018
 
2017
 
%
 
%
United States
58.1
%
 
56.6
%
 
57.2
%
 
1.5
 %
 
(0.6
)%
Europe
17.5
%
 
16.3
%
 
18.3
%
 
1.2
 %
 
(2.0
)%
Asia
20.3
%
 
22.7
%
 
20.2
%
 
(2.4
)%
 
2.5
 %
Others
4.1
%
 
4.4
%
 
4.3
%
 
(0.3
)%
 
0.1
 %
Total net sales
100.0
%
 
100.0
%
 
100.0
%
 
 
 
 

Fiscal Year 2019 Compared with Fiscal Year 2018

The year-over-year increase in net sales in the United States as a percentage of total net sales was primarily due to the higher sales of our server and storage systems to our direct customers and OEMs. The year-over-year decrease in net sales in Asia as a percentage of total net sales was due primarily to decreased sales through our indirect sales channel in China, partially offset by increased sales in Taiwan to enterprise datacenter customers. The increased percentage of net sales in Europe was primarily due to higher sales in the Netherlands to enterprise and cloud computing customers.

Fiscal Year 2018 Compared with Fiscal Year 2017

The year-over-year decline in net sales in the United States and Europe as a percentage of total net sales was primarily due to higher sales growth in Asia, particularly China and Taiwan, as compared to other regions.

Cost of Sales and Gross Margin

Cost of sales primarily consists of the costs to manufacture our products, including the costs of materials, contract manufacturing, shipping, personnel and related expenses including stock-based compensation, equipment and facility expenses, warranty costs and inventory excess and obsolescence provisions. The primary factors that impact our cost of sales are the mix of products sold and cost of materials, which include purchased parts and material costs, shipping costs, salary and benefits and overhead costs related to production. Cost of sales as a percentage of net sales may increase over time if decreases in average selling prices are not offset by corresponding decreases in our costs. Our cost of sales as a percentage of net sales is also impacted by the extent to which we are able to efficiently utilize our expanding manufacturing capacity. Because we generally do not have long-term fixed supply agreements, our cost of sales is subject to change based on the cost of materials and market conditions. As a result, our cost of sales as a percentage of net sales in any period can increase due to significant component price increases resulting from component shortages.

We use several suppliers and contract manufacturers to design and manufacture subsystems in accordance with our specifications, with most final assembly and testing performed at our manufacturing facility in San Jose, California. During the fiscal years 2019 and 2018, we continued to expand manufacturing and service operations in Taiwan and the Netherlands primarily to support our Asian and European customers and have continued to work on improving our utilization of our overseas manufacturing capacity. We work with Ablecom, one of our key contract manufacturers and also a related party to optimize modular designs for our chassis and certain of other components. We also outsource to Compuware, also a related party, a portion of our design activities and a significant part of our manufacturing of components, particularly power supplies. Our purchases of products from Ablecom and Compuware represented 9.2%, 9.0% and 11.1% of our cost of sales for fiscal years 2019, 2018 and 2017, respectively. For further details on our dealings with related parties, see Part II, Item 8, Note 12, “Related Party Transactions.”

Cost of sales and gross margin for fiscal years 2019, 2018 and 2017, are as follows (dollars in millions):

42







Years Ended June 30,

2019 over 2018 Change

2018 over 2017 Change

2019

2018

2017

$

%

$

%
Cost of sales
$
3,004.8


$
2,930.5


$
2,135.0


$
74.3


2.5
%

$
795.5


37.3
 %
Gross profit
495.5


430.0


350.0


65.5


15.2
%

80.0


22.9
 %
Gross margin
14.2
%

12.8
%

14.1
%



1.4
%




(1.3
)%

Fiscal Year 2019 Compared with Fiscal Year 2018

The year-over-year increase in cost of sales was primarily attributable to an increase of $25.8 million in product cost related to the increase in net sales volume, increased expense of $23.3 million in the provision for excess inventory and obsolescence, an increase in overhead costs of $10.7 million attributable to increased tariffs for import of components from China, an increase of $8.6 million in compensation and benefits including stock-based compensation as a result of an increase in annual salaries and benefits and an increase in the number of operations personnel we employ to support the growth of our business, and an increase of warranty provision of $5.4 million related to the increase in net sales.

The year-over-year increase in the gross margin percentage was primarily due to lower costs of memory and SSDs components in the second half of fiscal year 2019 and the timing of adjusting our average selling prices. In addition, in fiscal year 2019 as compared with fiscal year 2018, we had lower net sales in Asia where pricing is typically lower and the market there is more competitive which resulted in a shift in geographic mix that had a positive impact on our gross margin percentage.

Fiscal Year 2018 Compared with Fiscal Year 2017

The year-over-year increase in cost of sales was primarily attributable to an increase of $772.6 million in product costs due to an increase in key component prices in combination with an increase in net sales volume, an increase of $7.8 million in compensation and benefits including stock-based compensation as a result of an increase in annual salaries and benefits and an increase in the number of operations personnel to support the growth of our business, an increase of $6.9 million in facility expense as a result of the expansion of our Green Computing Park in San Jose, California and an increase of $11.6 million in overhead costs due to an increase in freight charges and other manufacturing costs driven by the increase in net sales, offset by a decrease of $6.1 million in the provision for excess inventory and obsolescence.

The year-over-year decrease in the gross margin percentage was primarily due to lower sales of our subsystems and accessories and higher sales of our server and storage systems, which reflected higher costs in key component sourcing due to component shortages, partially offset by higher average selling prices per compute node. In fiscal year 2018, the growth in net sales in Asia was higher than in fiscal year 2017, which negatively impacted our gross margin due to more competitive pricing in Asia as compared to other regions.

Operating Expenses

Research and development expenses consist of personnel expenses including: salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our research and development personnel, as well as product development costs such as materials and supplies, consulting services, third-party testing services and equipment and facility expenses related to our research and development activities. All research and development costs are expensed as incurred. We occasionally receive non-recurring engineering funding from certain suppliers and customers for joint development. Under these arrangements, we are reimbursed for certain research and development costs that we incur as part of the joint development efforts with our suppliers and customers. These amounts offset a portion of the related research and development expenses and have the effect of reducing our reported research and development expenses.

Sales and marketing expenses consist primarily of personnel expenses, including: salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our sales and marketing personnel, costs for tradeshows, independent sales representative fees and marketing programs. From time to time, we receive cooperative marketing funding from certain suppliers. Under these arrangements, we are reimbursed for certain marketing costs that we incur as part of the joint promotion of our products and those of our suppliers. These amounts offset a portion of the related expenses and have the effect of reducing our reported sales and marketing expenses. The timing, magnitude and estimated usage of these programs can result in significant variations in reported sales and marketing expenses from period to period. Spending on cooperative marketing, reimbursed by our suppliers, typically increases in connection with new product releases by our suppliers.


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General and administrative expenses consist primarily of general corporate costs, including personnel expenses such as: salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our general and administrative personnel, financial reporting, information technology, corporate governance and compliance and outside legal, audit, tax fees, insurance and bad debt.

Operating expenses for fiscal years 2019, 2018 and 2017 are as follows (dollars in millions):
 
Years Ended June 30,
 
2019 over 2018 Change
 
2018 over 2017 Change
 
2019
 
2018
 
2017
 
$
 
%
 
$
 
%
Research and development
$
179.9

 
$
165.1

 
$
144.0

 
$
14.8

 
9.0
%
 
$
21.1

 
14.7
%
Percentage of total net sales
5.1
%
 
4.9
%
 
5.8
%
 
 
 
 
 
 
 
 
Sales and marketing
77.2

 
71.6

 
66.4

 
5.6

 
7.8
%
 
5.2

 
7.8
%
Percentage of total net sales
2.2
%
 
2.1
%
 
2.7
%
 
 
 
 
 
 
 
 
General and administrative
141.2

 
98.6

 
44.7

 
42.6

 
43.2
%
 
53.9

 
120.6
%
Percentage of total net sales
4.0
%
 
2.9
%
 
1.8
%
 
 
 
 
 
 
 
 
Total operating expenses
$
398.3

 
$
335.3

 
$
255.1

 
63.0

 
18.8
%
 
80.2

 
31.4
%
Percentage of total net sales
11.4
%
 
10.0
%
 
10.3
%
 
 
 
 
 
 
 
 
    
Fiscal Year 2019 Compared with Fiscal Year 2018
    
The year-over-year increase in research and development expenses was due to an increase of $16.0 million in personnel expenses, an decrease of $3.3 million in reimbursements received for certain research and development costs that we incur as part of the joint development of our and our suppliers’ and customers’ products, offset by a decrease of $6.1 million in product development costs. Our personnel expenses increased primarily as a result of an increase in annual salaries and benefits, and an increase in the number of research and development personnel to support our expanded product development initiatives and to support the growth of our business in many market verticals.

The year-over-year increase in sales and marketing expenses was due to an increase of $6.1 million in personnel expenses, as a result of an increase in annual salaries and benefits and an increase in the number of sales and marketing personnel, offset by a $1.5 million decrease in expenses related to advertising and promotion activities.

The year-over-year increase in general and administrative expenses was attributable to an increase of $31.7 million in professional fees that were primarily incurred to investigate, assess and begin remediating the causes that led to the delay in filing our periodic reports with the SEC and the associated restatement of certain of our previously issued financial statements, an increase of $7.2 million in bad debt provision expenses primarily as a result of our inability to collect receivables from certain international customers and an increase of $2.7 million primarily attributable to increase in sales tax accrual and insurance costs.

Fiscal Year 2018 Compared with Fiscal Year 2017
    
The year-over-year increase in research and development expenses was due to an increase of $21.1 million in personnel expenses, an decrease of $4.2 million in reimbursements received for certain research and development costs that we incur as part of the joint development of our and our suppliers’ and customers’ products, offset by a decrease of $3.9 million in product development costs and $1.1 million increase of deferred gain related to our remaining performance obligations in association with the contribution of certain technology rights to the equity investee in China. Our personnel expenses increased primarily as a result of an increase in annual salaries and benefits and an increase in the number of research and development personnel to support our product development and growth of business.
 
The year-over-year increase in sales and marketing expenses was due to an increase of $7.0 million in personnel expenses, as a result of an increase in annual salaries and benefits and an increase in the number of sales and marketing personnel, offset by a decrease of $1.8 million in advertising and promotion expenses driven by higher reimbursements received under our cooperative marketing arrangements with certain vendors.

The year-over-year increase in general and administrative expenses was due to an increase of $45.8 million in professional fees that were primarily incurred to investigate, assess and begin remediating the causes that led to the delay in filing our periodic reports with the SEC and the associated restatement of certain of our previously issued financial statements

44





and an increase of $8.1 million in personnel expenses. Our personnel expenses in general and administrative expenses increased primarily as a result of an increase in annual salaries and benefits and an increase in the number of personnel to support our expanded business.

Interest and Other Expense, Net

Other expense, net consists primarily of interest earned on our investment and cash balances and foreign exchange gains and losses.

Interest expense represents interest expense on our term loans and lines of credit.

Interest and other expense, net for fiscal years 2019, 2018 and 2017 are as follows (dollars in millions):
 
Years Ended June 30,
 
2019 over 2018 Change
 
2018 over 2017 Change
 
2019
 
2018
 
2017
 
$
 
%
 
$
 
%
Other expense, net
$
(1.0
)
 
$
(0.8
)
 
$
(1.0
)
 
$
(0.2
)
 
25.0
%
 
$
0.2

 
(20.0
)%
Interest expense
(6.7
)
 
(5.7
)
 
(2.3
)
 
(1.0
)
 
17.5
%
 
(3.4
)
 
147.8
 %
Interest and other expense, net
$
(7.7
)
 
$
(6.5
)
 
$
(3.3
)
 
$
(1.2
)
 
18.5
%
 
$
(3.2
)
 
97.0
 %

Fiscal Year 2019 Compared with Fiscal Year 2018

The year-over-year increase in interest and other expense, net was primarily due to an increase of $1.0 million in interest expense related to amortization of loan origination fees in connection with refinancing of our debt in the last quarter of fiscal year 2018, an increase in other expense of $2.1 million primarily as a result of an impairment recorded for certain investments, offset by an increase of $1.9 million attributable to increase in interest income on our interest bearing deposits and foreign exchange gain due to favorable foreign currency fluctuations.

Fiscal Year 2018 Compared with Fiscal Year 2017

The year-over-year increase in interest and other expense, net was primarily due to an increase of $3.4 million in interest expense attributable to increased borrowings under our credit facilities to support our growth.

Provision for Income Taxes

Our income tax provision is based on our taxable income generated in the jurisdictions in which we operate, primarily the United States, Taiwan, and the Netherlands. Our effective tax rate differs from the statutory rate primarily due to research and development tax credits, foreign derived intangible income deduction, and foreign tax credits, which were partially offset by state taxes, stock based compensation, taxes on foreign earnings, and unrecognized tax benefits. A reconciliation of the federal statutory income tax rate to our effective tax rate is set forth in Part II, Item 8, Note 14, “Income Taxes” to the consolidated financial statements in this Annual Report.

Provision for income taxes and effective tax rates for fiscal years 2019, 2018 and 2017 are as follows (dollars in millions):
 
Years Ended June 30,
 
2019 over 2018 Change
 
2018 over 2017 Change
 
2019
 
2018
 
2017
 
$
 
%
 
$
 
%
Income tax provision
$
14.9

 
$
38.4

 
$
24.4

 
$
(23.5
)
 
(61.2
)%
 
$
14.0

 
57.4
%
Percentage of total net sales
0.4
%
 
1.1
%
 
1.0
%
 
 
 
 
 
 
 
 
Effective tax rate
16.6
%
 
43.6
%
 
26.7
%
 
 
 
 
 
 
 
 

Fiscal Year 2019 Compared with Fiscal Year 2018

The year-over-year decrease in the effective tax rate was primarily due to a reduction of the statutory tax rate from 28.1% to 21% as a result of the tax reform, and a prior year recording of a one-time $12.9 million write down of U.S. deferred tax assets and liabilities, and a one-time transition tax of $2.8 million, all as a result of the 2017 Tax Reform Act.



45





Fiscal Year 2018 Compared with Fiscal Year 2017

The year-over-year increase in the effective tax rate was primarily due to a $12.9 million one-time write down of U.S. deferred tax assets and liabilities, resulting from the U.S. federal corporate income tax rate decrease from 35% to 21% effective January 1, 2018, and the U.S. federal one-time transition tax of $2.8 million, each as a result of the 2017 Tax Reform Act. The Company’s statutory tax rate was reduced from 35% in 2017 to 28.1% in 2018 which includes a blended rate for the current year related to tax reform. The blended rate was a result of rate change from 35% to 21%, effective as of January 1, 2018, for all taxpayers, including fiscal year tax payers.

Liquidity and Capital Resources

We have financed our growth primarily with funds generated from operations, in addition to utilizing borrowing facilities, particularly in relation to the financing of real property acquisitions as well as working capital. Our cash and cash equivalents were $248.2 million and $115.4 million as of June 30, 2019 and 2018, respectively. Our cash in foreign locations was $124.6 million and $114.0 million as of June 30, 2019 and 2018, respectively.
Amounts held outside of the U.S. are generally utilized to support non-U.S. liquidity needs. Due to the enactment of the 2017 Tax Reform Act, all of our cash, cash equivalents and investments held by foreign subsidiaries were subject to U.S. taxation under the one-time transition tax as further discussed in Part II, Item 8, Note 14, "Income Taxes". Subsequent repatriations generally will not be taxable from a U.S. federal tax perspective but may be subject to state income or foreign withholding tax. Where local restrictions prevent an efficient intercompany transfer of funds, our intent is to keep cash balances outside of the U.S. and to meet liquidity needs through ongoing cash flows, external borrowings, or both. We do not expect restrictions or potential taxes incurred on repatriation of amounts held outside of the U.S. to have a material effect on our overall liquidity, financial condition or results of operations.
We believe that our current cash, cash equivalents, credit lines and internally generated cash flows will be generally sufficient to support our operating businesses, remediation efforts, maturing debt and interest payments for the twelve months following the issuance of these consolidated financial statements.

Our key cash flow metrics were as follows (dollars in millions):
 
Years Ended June 30,
 
2019 over 2018
 
2018 over 2017
 
2019
 
2018
 
2017
 
 
Net cash provided by (used in) operating activities
$
262.6

 
$
84.3

 
$
(96.2
)
 
$
178.3

 
$
180.5

Net cash used in investing activities
$
(24.8
)
 
$
(25.9
)
 
$
(29.4
)
 
$
1.1

 
$
3.5

Net cash (used in) provided by financing activities
$
(95.8
)
 
$
(50.8
)
 
$
57.7

 
$
(45.0
)
 
$
(108.5
)
Net increase (decrease) in cash, cash equivalents and restricted cash
$
141.8

 
$
7.6

 
$
(67.9
)
 
$
134.2

 
$
75.5


Operating Activities

Net cash provided by operating activities increased by $178.3 million for fiscal year 2019 as compared to fiscal year 2018. The increase was due primarily to a reduction of net working capital of $160.6 million due to improved working capital management and reduced costs for key components in the second half of fiscal year 2019, higher net income in fiscal year 2019 of $25.8 million, the change in the non-cash charges related to an increase in excess and obsolete inventory of $23.3 million for aged inventory and $7.2 million for bad debt, partially offset by a reduction of $30.7 million in the non-cash charges related to the change in our deferred income tax assets, primarily as a result of the 2017 Tax Reform Act and a decrease of $8.0 million from the change in deferred revenue compared to prior year, related to the lower growth in services business year-over-year.

Net cash provided by operating activities increased by $180.5 million for fiscal year 2018 as compared to fiscal year 2017. The increase was due primarily to a reduction of net working capital of $136.1 million due to improved working capital management in the second half of fiscal year 2018, an increase of $36.5 million from the change in deferred revenue related to the growth in our services business year-over-year, an increase in the non-cash charges related to the change in our deferred income tax assets of $19.0 million, primarily as a result of the 2017 Tax Reform Act, partially offset by lower net income of $20.7 million for the period.

Investing Activities


46





Net cash used in investing activities was $24.8 million, $25.9 million and $29.4 million for the fiscal years 2019, 2018 and 2017, respectively, as we continued to invest in our Green Computing Park in San Jose to expand our capacity and office space.

Financing Activities

Net cash used in financing activities increased by $45.0 million for fiscal year 2019 as compared to fiscal year 2018 primarily due to increased debt repayments of $43.1 million. Net cash used in financing activities was $50.8 million in fiscal year 2018 primarily due to net debt repayments of $48.7 million as compared to net cash provided by financing activities in fiscal year 2017 of $57.7 million related to net debt borrowings of $66.6 million and $10.9 million raised from the proceeds from the exercise of stock options, partially offset by stock repurchases of $18.5 million.
 

Other Factors Affecting Liquidity and Capital Resources

Activities under Revolving Lines of Credit and Term Loans

Bank of America

2016 Bank of America Credit Facility

In June 2016, we entered into a credit agreement with Bank of America (the “2016 Bank of America Credit Facility”). Prior to its maturity in April 2018, we repaid and terminated the 2016 Bank of America Credit Facility using the proceeds from our 2018 Bank of America Credit Facility (defined below). Immediately prior to its termination, the 2016 Bank of America Credit Facility (giving effect to all amendments since the inception of the 2016 Bank of America Credit Facility), provided for (i) a $85.0 million revolving line of credit including a $5.0 million letter of credit sublimit, (ii) a $20.0 million revolving line of credit for our Taiwan and the Netherlands entities, and (iii) a five-year $50.0 million term loan. The 2016 Bank of America Credit Facility term loan was secured by seven buildings located in San Jose, California and the property, plant and equipment and the inventory in those buildings. The principal and interest of the 2016 Bank of America Credit Facility term loan were payable monthly through June 30, 2021 with an interest rate at the LIBOR rate plus 1.25% per annum. The interest rate for the $85.0 million revolving line of credit was at the LIBOR rate plus 1.25% per annum. The interest rate of the $20.0 million revolving line of credit was equal to a minimum of 0.9% per annum plus the lender's cost of funds, as defined in the agreements.

2018 Bank of America Credit Facility

In April 2018, we entered into a revolving line of credit with Bank of America (the "2018 Bank of America Credit Facility"), which replaced the 2016 Bank of America Credit Facility. The 2018 Bank of America Credit Facility provides for a revolving credit line and other financial accommodations of up to $250.0 million extended by certain lenders, including a $5.0 million letter of credit sublimit, which was extended to $15.0 million in October 2019. The 2018 Bank of America Credit Facility was originally set to expire after 364 days and has been extended to June 30, 2020 through subsequent amendments. Prior to its maturity, at our option and if certain conditions are satisfied, including being current on all of our delinquent quarterly and annual filings with the SEC, the 2018 Bank of America Credit Facility may convert into a five-year revolving credit facility. If and upon such conversion, the lenders for the 2018 Bank of America Credit Facility shall extend, in aggregate, a principal amount of up to $400.0 million. Prior to the 2018 Bank of America Credit Facility’s conversion to the five-year revolving credit facility, interest shall accrue at the LIBOR rate plus 2.75% per annum. Upon the 2018 Bank of America Credit Facility converting to the five-year revolving credit facility, interest shall accrue at the LIBOR rate plus an amount between 1.50% and 2.00% for loans to both Super Micro Computer and Super Micro Computer B.V. Under the terms of the 2018 Bank of America Credit Facility, we are required to grant the lenders a continuing security interest in and lien upon all amounts credited to any of our deposit accounts. Interest accrued on any loans under the 2018 Bank of America Credit Facility is due on the first day of each month, and the loans are due and payable in full on the termination date of the 2018 Bank of America Credit Facility, unless payment is required earlier as determined by the lenders. Voluntary prepayments are permitted without early repayment fees or penalties. The terms of the arrangement require any amounts in the deposit accounts to be applied against our line of credit the next business day. Subject to customary exceptions, the 2018 Bank of America Credit Facility is secured by substantially all of Super Micro Computer’s assets. If converted to a five-year revolving credit facility, Super Micro Computer’s assets, and at our option, Super Micro Computer B.V.'s assets will be used as collateral for the 2018 Bank of America Credit Facility. Under the terms of the 2018 Bank of America Credit Facility, we are not permitted to either repurchase our shares or pay any dividends.


47





In the fourth fiscal quarter of 2018, we paid $3.2 million in fees to the lenders and third parties in connection with the 2018 Bank of America Credit Facility. The replacement of the 2016 Bank of America Credit Facility by the 2018 Bank of America Credit Facility is accounted for as a modification of the existing credit facility to the extent the lenders before and after the modification were the same. Any unamortized fees relating to the 2016 Bank of America Credit Facility and the fees paid for the 2018 Bank of America Credit Facility are amortized over the term of the 2018 Bank of America Credit Facility as interest expense in our consolidated statements of operation and any unamortized amounts are classified within prepaid and other current assets in our consolidated balance sheets.

On January 31, 2019, we paid a fee and entered into an amendment of the 2018 Bank of America Credit Facility that resulted in the extension of the maturity date from April 19, 2019 to June 30, 2019. On June 27, 2019, we entered into a second amendment of the 2018 Bank of America Credit Facility that extended the maturity date from June 30, 2019 to June 30, 2020.

As of June 30, 2019 and 2018, the total outstanding borrowings under the 2018 Bank of America Credit facility were $1.1 million and $67.3 million, respectively. The interest rates under the 2018 Bank of America Credit Facility as of June 30, 2019 and 2018 were 4.5% per annum and 4.75% per annum, respectively. As of June 30, 2019, a $3.2 million letter of credit was outstanding under the 2018 Bank of America Credit Facility. The balance of debt issuance costs outstanding were $0.3 million and $2.8 million as of June 30, 2019 and 2018, respectively. As of June 30, 2019, our available borrowing capacity under the 2018 Bank of America Credit Facility was $245.7 million, subject to the borrowing base limitation and compliance with other applicable terms.

CTBC Bank

In April 2016, we entered into a credit agreement with CTBC Bank Co., Ltd ("CTBC Bank") that provides for (i) a 12-month NTD $700.0 million ($21.6 million U.S. dollar equivalent) term loan facility secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum, which was adjusted monthly, the term loan facility also included a 12-month guarantee of up to NTD $100.0 million ($3.1 million U.S. dollar equivalent) with an annual fee equal to 0.50% per annum, and (ii) a 12-month revolving line of credit of up to 80.0% of eligible accounts receivable in an aggregate amount of up to $40.0 million with an interest rate equal to the lender's established USD interest rate plus 0.30% per annum, which was adjusted monthly (collectively, the “2016 CTBC Credit Facility”). The total borrowings allowed under the 2016 CTBC Credit Facility was capped at $40.0 million. We extended the 2016 CTBC Credit Facility to mature on May 31, 2017.

In May 2017, we renewed the 2016 CTBC Credit Facility, such that it provided for (i) a 12-month NTD $700.0 million ($23.0 million U.S. dollar equivalent) term loan facility secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum, which was adjusted monthly, which term loan facility also included a 12-month guarantee of up to NTD $100.0 million ($3.3 million U.S. dollar equivalent) with an annual fee equal to 0.5% per annum, and (ii) a 12-month revolving line of credit of up to 80.0% of eligible accounts receivable in an aggregate amount of up to $50.0 million with an interest rate equal to the lender's established USD interest rate plus an interest rate ranging from 0.40% to 0.45% per annum, which was adjusted monthly. The total borrowings allowed under the renewed 2016 CTBC Credit Facility were capped at $50.0 million. The 2016 CTBC Credit Facility was to mature on April 30, 2018 but prior to the maturity, we entered into the 2018 CTBC Credit Facility (defined below) with CTBC Bank in January 2018, which replaced the 2016 CTBC Credit Facility.

In January 2018, we entered into a credit agreement with CTBC Bank that provided for (i) a 12-month NTD $700.0 million ($23.6 million U.S. dollar equivalent) term loan facility secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum, which was adjusted monthly, which term loan facility also included a 12-month guarantee of up to NTD $100.0 million ($3.4 million U.S. dollar equivalent) with an annual fee equal to 0.50% per annum, and (ii) a 12-month NTD $1,500.0 million ($50.5 million U.S. dollar equivalent) term loan facility with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum, which was adjusted monthly (collectively, the “2018 CTBC Credit Facility”). The total borrowings allowed under the 2018 CTBC Credit Facility was initially capped at $50.0 million and in August 2018 was reduced to $40.0 million. In June 2019 prior to its maturity, the 2018 CTBC Credit Facility was replaced by the 2019 CTBC Credit Facility (defined below).

In June 2019, we entered into a credit agreement with CTBC Bank that provides for (i) a 12-month NTD $700.0 million ($22.5 million U.S. dollar equivalent) term loan facility secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum which is adjusted monthly, which term loan facility also includes a 12-month guarantee of up to NTD $100.0 million ($3.2 million U.S. dollar equivalent) with an annual fee equal to 0.50% per annum, (ii) a 180-day NTD $1,500.0 million ($48.2 million U.S. dollar equivalent) term loan facility up to 100% of eligible accounts receivable in an aggregate amount with an interest rate equal to the lender's established

48





NTD interest rate ranging from 0.30% to 0.50% per annum which is adjusted monthly, and (ⅲ) a 12-month revolving line of credit of up to 100% of eligible accounts receivable in an aggregate amount of up to $50.0 million with an interest rate equal to the lender's established USD interest rate plus an interest rate ranging from 0.30% to 0.50% per annum which is adjusted monthly (collectively, the “2019 CTBC Credit Facility”). The total borrowings allowed under the 2019 CTBC Credit Facility was capped at $50.0 million. The 2019 CTBC Credit Facility is to mature on June 30, 2020.

The total outstanding borrowings under the 2019 and 2018 CTBC Credit Facility term loans were denominated in NTD and remeasured into U.S. dollars of $22.5 million and $22.9 million at June 30, 2019 and 2018, respectively. At June 30, 2019, we did not have any outstanding balance under the 2019 CTBC Credit Facility revolving line of credit. As of June 30, 2018, the total outstanding borrowings under the 2018 CTBC Credit Facility revolving line of credit was $25.9 million in U.S. dollars. The interest rate for these loans were 0.93% per annum as of June 30, 2019 and 0.95% per annum as of June 30, 2018. At June 30, 2019, the amount available for future borrowing under the 2019 CTBC Credit Facility was $27.5 million. As of June 30, 2019, the net book value of land and building located in Bade, Taiwan collateralizing the 2019 CTBC Credit Facility term loan was $25.8 million.

Covenant Compliance

2018 Bank of America Credit Facility

The credit agreement with Bank of America related to the 2018 Bank of America Credit Facility contains customary representations and warranties and customary affirmative and negative covenants applicable to us and our subsidiaries. The credit agreement contains a financial covenant, which requires that we maintain a Fixed Charge Coverage Ratio, as defined in the agreement of at least 1.00 for each twelve-month period while a Trigger Period, as defined in the agreement, is in effect. We have been in compliance with all the covenants under the 2018 Bank of America Credit Facility.

On September 7, 2018, Bank of America issued an extension letter to us in connection with the 2018 Bank of America Credit Facility, which extended the delivery date of our audited consolidated financial statements, compliance certificates and other material reports for the fiscal year ended June 30, 2018 to January 31, 2019. On January 31, 2019, we entered into an amendment of the loan and security agreement with respect to the 2018 Bank of America Credit Facility to, among other matters, (a) extend the delivery date of our audited consolidated financial statements, compliance certificates and other material reports for the fiscal year ended June 30, 2018 to June 30, 2019, and (b) require the delivery, by no later than March 31, 2019 of our audited consolidated financial statements for the fiscal year ended June 30, 2019. In April 2019, we paid a fee to extend the delivery to June 30, 2019 of our audited consolidated financial statements for the fiscal year ended June 30, 2017. In connection with the second amendment of the 2018 Bank of America Credit Facility to extend the maturity of the 2018 Bank of America Credit Facility, we are required to deliver our audited consolidated financial statements for the fiscal year ended June 30, 2018 by December 31, 2019, and deliver our audited consolidated financial statements for the fiscal year ended June 30, 2019 by March 31, 2020. If we elect to deliver the audited consolidated financial statements for the fiscal years ended June 30, 2019 and 2018 together in a combined filing with the SEC, we are required to deliver our audited financial statements by March 31, 2020.

CTBC Bank

There are no financial covenants associated with the 2018 CTBC Credit Facility or the 2019 CTBC Credit Facility.
 
Share Repurchase Program

In July 2016, our Board of Directors adopted a program to repurchase from time to time at management’s discretion up to $100.0 million of our common stock in the open market or in private transactions during the next twelve months at prevailing market prices. In fiscal year 2017, we purchased 888,097 shares of our common stock in the open market at a weighted average price of $20.79 per share for approximately $18.5 million. Repurchases were made under the program using our cash on hand. The repurchase program ended in July 2017. Under the terms of the 2018 Bank of America Credit Facility, we are not permitted to repurchase our common stock.

Contractual Obligations

The following table describes our contractual obligations as of June 30, 2019:
 

49





 
Payments Due by Period
 
 Less Than 
1 Year
 
1 to 3
 Years    
 
3 to 5
Years    
 
More Than
5 Years
 
Total     
 
(in thousands)
Operating leases
$
6,582

 
$
6,270

 
$
2,341

 
$
2,279

 
$
17,472

Capital leases, including interest
164

 
143

 
1

 

 
308

Debt, including interest (1)
23,906

 

 

 

 
23,906

Purchase commitments (2)
299,542

 
246

 

 

 
299,788

Total (3)
$
330,194

 
$
6,659

 
$
2,342

 
$
2,279

 
$
341,474

 
__________________________
(1)
Amount reflects total anticipated cash payments, including anticipated interest payments based on the interest rates under our 2018 Bank of America Credit Facility and 2019 CTBC Credit Facility at June 30, 2019.
(2)
Amount reflects total gross purchase commitments under our manufacturing arrangements with third-party contract manufacturers or vendors. See Part II, Item 8, Note 15, “Commitments and Contingencies” to the consolidated financial statements in this Annual Report for a discussion of purchase commitments.
(3)
The table above excludes liabilities for deferred revenue of $203.4 million, $5.0 million of deferred gain related to our remaining performance obligations in association with the contribution of certain technology rights to a privately-held company located in China, and unrecognized tax benefits and related interest and penalties accrual of $20.1 million. Deferred revenue represents billed services in advance which include extended warranty, on-site technical support, and software maintenance. We have not provided a detailed estimate of the payment timing of unrecognized tax benefits due to the uncertainty of when the related tax settlements will become due. See Part II, Item 8, Note 14, “Income Taxes” to the consolidated financial statements in this Annual Report for a discussion of income taxes.

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

Recent Accounting Pronouncements

For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements, see Part II, Item 8, Note 1, “Organization and Summary of Significant Accounting Policies” to the consolidated financial statements in this Annual Report.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Quarterly Results of Operations

As described in the Explanatory Note, we are presenting our quarterly results of operations for the periods ended March 31, 2018, December 31, 2017 and September 30, 2017 herein, in lieu of filing separate Quarterly Reports on Form 10-Q for such periods.

Net Sales

The following table presents net sales by product type for the three months ended March 31, 2018 and 2017, December 31, 2017 and 2016, and September 30, 2017 and 2016 (dollars in millions):


50





 
Three months ended
March 31,
 
Change
 
Three months ended
December 31,
 
Change
 
Three months ended
September 30,
 
Change
 
2018
 
2017
 
$
 
%
 
2017
 
2016
 
$
 
%
 
2017
 
2016
 
$
 
%
Server and storage systems
$
669.1

 
$
427.6

 
$
241.5

 
56.5
 %
 
$
629.7

 
$
456.1

 
$
173.6

 
38.1
 %
 
$
542.4

 
$
358.9

 
$
183.5

 
51.1
%
% of total net sales
80.1
%
 
69.6
%
 
 
 
 
 
76.1
%
 
68.8
%
 
 
 
 
 
75.7
%
 
67.9
%
 
 
 
 
Subsystems and accessories
166.0

 
187.2

 
(21.2
)
 
(11.3
)%
 
$
197.3

 
$
207.1

 
$
(9.8
)
 
(4.7
)%
 
$
174.3

 
$
169.9

 
$
4.4

 
2.6
%
% of total net sales
19.9
%
 
30.4
%
 
 
 
 
 
23.9
%
 
31.2
%
 
 
 
 
 
24.3
%
 
32.1
%
 
 
 
 
Total net sales
$
835.1

 
$
614.8

 
$
220.3

 
35.8
 %
 
$
827.0

 
$
663.2

 
$
163.8

 
24.7
 %
 
$
716.7

 
$
528.8

 
$
187.9

 
35.5
%

The period-over-period substantial increase in our net sales in fiscal year 2018, as compared to fiscal year 2017, reflects our continued trend of concentrating our efforts on selling server and storage systems to larger customers such as internet data center and cloud computing and enterprise customers and a stronger industry-wide market for server and storage solutions.

Comparison of Three Months Ended March 31, 2018 and 2017

The period-over-period increase in server and storage systems sales was primarily due to an increase in the average selling price per compute node by approximately by 25% and an increase in the number of units of compute nodes shipped of approximately 22%. The period-over-period decrease in sales of subsystems and accessories was primarily due to a decrease in the volume of subsystems and accessories shipped of approximately 26%, offset by an increase in the average selling price per unit by approximately 11%.

Comparison of Three Months Ended December 31, 2017 and 2016

The period-over-period increase in server and storage systems sales was primarily due to an increase of average selling price per compute node by approximately 23% and an increase in the number of units of compute nodes shipped, of approximately 16%. The period-over-period decrease in sales of subsystems and accessories is primarily due to a decrease in the volume of subsystems and accessories shipped of approximately 18%, offset by an increase in the average selling price per unit by approximately 14%.

Comparison of Three Months Ended September 30, 2017 and 2016

The period-over-period increase in server and storage systems sales was primarily due to an increase of average selling price per compute node by approximately 43%. The increase in the average selling prices of our server and storage systems was primarily due to higher sales of our complete systems configured with higher density computing and more memory and storage capacity and as a result of the increases in the cost of memory and SSDs. The period-over-period increase in sales of subsystems and accessories is primarily due to an increase in the average selling price per unit by approximately 8%, offset by a decrease in the number of units shipped by approximately 8%.

The following table presents the percentages of net sales from products sold through our indirect sales channel and to our direct customers and OEMs for the three months ended March 31, 2018 and 2017, December 31, 2017 and 2016, and September 30, 2017 and 2016:

 
Three months ended
March 31,
 
Change
 
Three months ended
December 31,
 
Change
 
Three months ended
September 30,
 
Change
 
2018
 
2017
 
%
 
2017
 
2016
 
%
 
2017
 
2016
 
%
Indirect sales channel
42.8
%
 
46.6
%
 
(3.8
)%
 
41.5
%
 
46.5
%
 
(5.0
)%
 
47.3
%
 
50.7
%
 
(3.4
)%
Direct customers and OEMs
57.2
%
 
53.4
%
 
3.8
 %
 
58.5
%
 
53.5
%
 
5.0
 %
 
52.7
%
 
49.3
%
 
3.4
 %
Total net sales
100.0
%
 
100.0
%
 
 
 
100.0
%
 
100.0
%
 
 
 
100.0
%
 
100.0
%
 
 

The period-over-period decrease in net sales through our indirect sales channel as a percentage of total net sales in each of the three month periods presented in fiscal year 2018, as compared with the corresponding three month periods in fiscal year 2017 were primarily due to the lower sales of our subsystems and accessories. The period-over-period increase in net sales

51





to direct customers and OEMs as a percentage of total net sales in each of the three month periods presented in fiscal year 2018, as compared with the corresponding three month periods in fiscal year 2017 were primarily due to the increased volume of our server and storage systems to our internet data center and cloud, enterprise and OEM customers, in addition to higher average selling prices.

The following table presents percentages of net sales by geographic region for the three months ended March 31, 2018 and 2017, December 31, 2017 and 2016, and September 30, 2017 and 2016:

 
Three months ended
March 31,
 
Change
 
Three months ended
December 31,
 
Change
 
Three months ended
September 30,
 
Change
 
2018
 
2017
 
%
 
2017
 
2016
 
%
 
2017
 
2016
 
%
United States
54.5
%
 
56.4
%
 
(1.9
)%
 
54.3
%
 
58.5
%
 
(4.2
)%
 
57.6
%
 
58.9
%
 
(1.3
)%
Europe
18.0
%
 
17.1
%
 
0.9
 %
 
16.5
%
 
18.8
%
 
(2.3
)%
 
14.8
%
 
20.3
%
 
(5.5
)%
Asia
22.5
%
 
21.5
%
 
1.0
 %
 
24.8
%
 
18.7
%
 
6.1
 %
 
23.6
%
 
16.5
%
 
7.1
 %
Other
5.0
%
 
5.0
%
 
 %
 
4.4
%
 
4.0
%
 
0.4
 %
 
4.0
%
 
4.3
%
 
(0.3
)%
Total net sales
100.0
%
 
100.0
%
 
 
 
100.0
%
 
100.0
%
 
 
 
100.0
%
 
100.0
%
 
 

Comparison of Three Months Ended March 31, 2018 and 2017

The period-over-period decline in net sales in the United States as a percentage of total net sales was primarily due to higher sales growth of our server and storage systems in China, Taiwan, the Netherlands, United Kingdom and Germany as compared to the United States. The higher sales in Asia and Europe were due to the higher sales of our server and storage systems to our internet data center and cloud, enterprise and OEM customers.

Comparison of Three Months Ended December 31, 2017 and 2016

The period-over-period decline in net sales in the United States and Europe as a percentage of total net sales was primarily due to higher sales growth of our server and storage systems in Asia, particularly China and Taiwan as compared to the United States and Europe. The higher sales in Asia were due to the higher sales of our server and storage systems to our internet data center and cloud, enterprise and OEM customers.

Comparison of Three Months Ended September 30, 2017 and 2016

The period-over-period net sales in the United States, Europe and other countries declined as a percentage of total net sales primarily due to higher sales growth of our server and storage systems in Asia, particularly China and Taiwan as compared to the United States, Europe and other countries. The higher sales in Asia were due to the higher sales of our server and storage systems to our internet data center and cloud, enterprise and OEM customers.

The following table presents net sales by product type for the nine months ended March 31, 2018 and six months ended December 31, 2017 (dollars in millions):

 
Nine months ended
March 31,
 
Change
 
Six months ended
December 31,
 
Change
 
2018
 
2017
 
$
 
%
 
2017
 
2016
 
$
 
%
Server and storage systems
$
1,841.2

 
$
1,242.6

 
$
598.6

 
48.2
 %
 
$
1,172.1

 
$
815.0

 
$
357.1

 
43.8
 %
% of total net sales
77.4
%
 
68.8
%
 
 
 
 
 
75.9
%
 
68.4
%
 
 
 
 
Subsystems and accessories
$
537.6

 
$
564.2

 
$
(26.6
)
 
(4.7
)%
 
$
371.6

 
$
376.9

 
$
(5.3
)
 
(1.4
)%
% of total net sales
22.6
%
 
31.2
%
 
 
 
 
 
24.1
%
 
31.6
%