Super Micro Computer, Inc. - Quarter Report: 2011 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

For the quarterly period ended September 30, 2011

or

For the transition period from            to            

Commission file number 001-33383

Super Micro Computer, Inc.

(Exact name of Registrant as specified in its charter)

980 Rock Avenue

San Jose, CA 95131

(Address of principal executive offices)

(408) 503-8000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of October 27, 2011 there were 40,479,571 shares of the registrant’s common stock, $0.001 par value, outstanding, which is the only class of common or voting stock of the registrant issued.

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Table of Contents

FORM 10-Q

SUPER MICRO COMPUTER, INC.

INDEX

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PART I: FINANCIAL INFORMATION

SUPER MICRO COMPUTER, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share amounts)

(unaudited)

See accompanying notes to condensed consolidated financial statements.

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SUPER MICRO COMPUTER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

See accompanying notes to condensed consolidated financial statements.

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SUPER MICRO COMPUTER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes to condensed consolidated financial statements.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Organization and Basis of Presentation

Organization

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

Basis of Presentation

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

The unaudited condensed consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) and include the accounts of the Company and its wholly-owned subsidiaries. Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements for the fiscal year ended June 30, 2011 included in its Annual Report on Form 10-K, as filed with the SEC (the “Annual Report”).

The unaudited condensed consolidated financial statements included herein reflect all adjustments, including normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, results of operations and cash flows for the periods presented. The condensed consolidated results of operations for the three months ended September 30, 2011 and 2010 are not necessarily indicative of the results that may be expected for future quarters or for the fiscal year ending June 30, 2012.

Reclassification

The following prior period balance sheet amounts have been combined into other report lines to conform with the current period presentation: 1) short-term investments of $59,000 was combined into prepaid expense and other assets, 2) restricted cash of $409,000 was combined into other assets, 3) advances from receivable financing arrangements of $1,000,000 and current portion of capital lease obligations of $36,000 was combined into accrued liabilities and 4) long-term capital lease obligation-net of current portion of $50,000 was combined with other long-term liabilities.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 2. Stock-based Compensation and Stockholders’ Equity

Stock Option Plan

In January 2011, the Board of Directors approved an amendment to the 2006 Equity Incentive Plan (the “2006 Plan”) that increased by 2,000,000 the aggregate maximum number of shares that may be issued under the 2006 Plan. The amendment to the 2006 Plan was approved by the Company’s stockholders in February 2011. This authorized number of shares that may be issued under the 2006 Plan automatically increases on July 1 each year through 2016, by an amount equal to (a) three percent of the number of shares of stock issued and outstanding on the immediately preceding June 30, or (b) a lesser amount determined by the Board of Directors. The exercise price per share for incentive stock options granted to employees owning shares representing more than 10% of the Company at the time of grant cannot be less than 110% of the fair value. Nonqualified stock options and incentive stock options granted to all other persons shall be granted at a price not less than 100% of the fair value. Options generally expire ten years after the date of grant and options vest over four years; 25% at the end of one year and one sixteenth per quarter thereafter. In the three months ended September 30, 2011 and 2010, the Company granted options for the purchase of 452,900 and 469,760 shares under the 2006 Plan, respectively. At September 30, 2011, 2,556,521 shares of common stock were available for future grant under the 2006 Plan.

Restricted Stock Awards

Restricted stock awards are share awards that provide the rights to a set number of shares of the Company’s stock on the grant date. In August 2008, the Compensation Committee of the Board of Directors of the Company (the “Committee”) approved the terms of an agreement (the “Option Exercise Agreement”) with Charles Liang, a director and President and Chief Executive Officer of the Company, pursuant to which Mr. Liang exercised a fully vested option previously granted to him for the purchase of 925,000 shares. The option was exercised using a “net-exercise” procedure in which he was issued a number of shares representing the spread between the option exercise price and the then current market value of the shares subject to the option (898,205 shares based upon the market value as of the date of exercise). The shares issued upon exercise of the option are subject to vesting over a five-year vesting period. Vesting of the shares subject to the award may accelerate in certain circumstances pursuant to the terms of the applicable Option Exercise Agreement. The Company determined that there was no incremental fair value of the option exchanged for the award. 538,923 and 359,282 shares were vested as of September 30, 2011 and June 30, 2011, respectively.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Determining Fair Value

Valuation and amortization method — The Company estimates the fair value of stock options granted using the Black-Scholes-option-pricing formula and a single option award approach. This fair value is then amortized ratably over the requisite service periods of the awards, which is generally the vesting period.

Expected Term — The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on an analysis of the relevant peer companies’ post-vest termination rates and the exercise factors for the stock options granted prior to June 30, 2011. For stock options granted after June 30, 2011, expected term is based on a combination of the Company’s peer group and the Company’s historical experience.

Expected Volatility — Expected volatility is based on a combination of the implied and historical volatility for its peer group and the Company’s historical volatility for the stock options granted prior to September 30, 2009. For stock options granted after September 30, 2009, expected volatility is based solely on the Company’s historical volatility.

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

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

Estimated Forfeitures — The estimated forfeiture rate is based on the Company’s historical forfeiture rates and the estimate is revised in subsequent periods if actual forfeitures differ from the estimate.

The fair value of stock option grants for the three months ended September 30, 2011 and 2010 was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The following table shows total stock-based compensation expense included in the condensed consolidated statements of operations for the three months ended September 30, 2011 and 2010 (in thousands).

The cash flows resulting from the tax benefits for tax deductions resulting from the exercise of stock options in excess of the compensation expense recorded for those options (excess tax benefits) issued or modified since July 1, 2006 are classified as cash from financing activities. Excess tax benefits for stock options issued prior to July 1, 2006 are classified as cash from operating activities. The Company had $899,000 and $996,000 of excess tax benefits accounted in the Company’s additional paid-in capital in the three months ended September 30, 2011 and 2010, respectively. The Company had excess tax benefits that are classified as cash from financing activities of $937,000 and $648,000 in the three months ended September 30, 2011 and 2010, respectively, for options issued since July 1, 2006. Excess tax benefits for stock options issued prior to July 1, 2006 continue to be classified as cash from operating activities.

Stock Option and Awards Activity

The following table summarizes stock option activity during the three months ended September 30, 2011 under all stock option plans:

The total pretax intrinsic value of options exercised was $425,000 and $2,201,000 for the three months ended September 30, 2011 and 2010, respectively. As of September 30, 2011, the Company’s total unrecognized compensation cost related to non-vested stock-based awards granted since July 1, 2006 to employees and non-employee directors was approximately $18,396,000, which will be recognized over a weighted-average vesting period of approximately 2.4 years.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The following table summarizes the Company’s restricted stock award activity for the three months ended September 30, 2011:

The total pretax intrinsic value of restricted stock awards vested was $2,375,000 and $1,915,000 for the three months ended September 30, 2011 and 2010, respectively. In the three months ended September 30, 2011 and 2010, upon vesting, 179,641 shares of restricted stock awards were net share-settled such that the Company withheld 83,857 shares with value equivalent to an officer’s minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld were based on the value of the restricted stock awards on their vesting date as determined by the Company’s closing stock price. Total payments for the officer’s tax obligations to the taxing authorities were $1,109,000 and $762,000 for the three months ended September 30, 2011 and 2010, respectively, and are reflected as a financing activity within the Condensed Consolidated Statements of Cash Flows. These net-share settlements had the effect of share repurchases by the Company as they reduced and retired the number of shares that would have otherwise been issued as a result of the vesting and did not represent an expense to the Company.

The total intrinsic value of the outstanding restricted stock awards was $4,502,000 and $8,671,000 as of September 30, 2011 and June 30, 2011, respectively. There is no incremental fair value to be recognized as compensation expense in connection with the unvested restricted stock awards of 359,282 shares as of September 30, 2011.

Note 3. Comprehensive Income

The components of comprehensive income, net of taxes, are as follows (in thousands):

Note 4. Net Income Per Common Share

The Company’s restricted share awards subject to repurchase and settled in shares of common stock upon vesting have the nonforfeitable right to receive dividends on an equal basis with common stock and therefore are considered participating securities that must be included in the calculation of net income per share using the two-class method. Under the two-class method, basic and diluted net income per common share are determined by calculating net income per share for common stock and participating securities based on participation rights in undistributed earnings. Diluted net income per common share also considers the dilutive effect of in-the-money stock options, calculated using the treasury stock method. Under the treasury stock method, the amount of assumed proceeds from unexercised stock options includes the amount of compensation cost attributable to future services not yet recognized, assumed proceeds from the exercise of the options, and the incremental income tax benefit or liability as if the options were exercised during the period.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The computation of basic and diluted net income per common share using the two-class method is as follows (in thousands, except per share amounts):

For the three months ended September 30, 2011 and 2010, the Company had stock options outstanding that could potentially dilute basic earnings per common share in the future, but were excluded from the computation of diluted net income per common share in the periods presented, as their effect would have been anti-dilutive. The shares of common stock issuable upon exercise of such anti-dilutive outstanding stock options were 2,877,000 and 2,925,000 for the three months ended September 30, 2011 and 2010, respectively.

Note 5. Balance Sheet Components (in thousands)

Inventory:

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The Company recorded a provision (benefit) for excess and obsolete inventory totaling $2,362,000 and ($90,000) in the three months ended September 30, 2011 and 2010, respectively.

Property, Plant and Equipment:

Other Assets:

Other assets consist primarily of a deposit for land in Taiwan totaling $8,707,000 that is adjacent to land that was purchased in August 2010, a long-term prepaid royalty license of $2,031,000 and an investment in a privately held company of $750,000. The title to the land in Taiwan is expected to transfer in the first half of fiscal year 2012.

Product Warranties:

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 6. Long-term Investments

As of September 30, 2011 and June 30, 2011, the Company held $3,669,000 and $5,188,000, respectively, of auction-rate securities (“auction rate securities”), net of unrealized losses, representing its interest in auction rate preferred shares in a closed end mutual fund invested in municipal securities and student loans guaranteed by the Federal Family Education Loan Program; such auction rate securities were rated AAA or CAA3 at September 30, 2011 and AAA or BAA at June 30, 2011. These auction rate preferred shares have no stated maturity date and the stated maturity dates for these auction rate student loans range from 2035 to 2040.

During February 2008, the auctions for these auction rate securities began to fail to obtain sufficient bids to establish a clearing rate and the securities were not saleable in the auction, thereby losing the short-term liquidity previously provided by the auction process. As a result, as of September 30, 2011 and June 30, 2011, $3,669,000 and $5,188,000 of these auction rate securities have been classified as long-term available-for-sale investments, respectively.

The Company has used a discounted cash flow model to estimate the fair value of the auction rate securities as of September 30, 2011 and June 30, 2011. The material factors used in preparing the discounted cash flow model are 1) the discount rate utilized to present value the cash flows, 2) the time period until redemption and 3) the estimated rate of return. Management derives the estimates by obtaining input from market data on the applicable discount rate, estimated time to maturity and estimated rate of return. The changes in fair value have been primarily due to changes in the estimated rate of return and a change in the estimated redemption period. Changes in these estimates or in the market conditions for these investments are likely in the future based upon the then current market conditions for these investments and may affect the fair value of these investments. Based on this assessment of fair value, the Company determined there was a recovery in fair value of its auction rate securities of $156,000 during the three months ended September 30, 2011 and there was no change in fair value of its auction rate securities during the three months ended September 30, 2010, and a cumulative total decline of $181,000 and $337,000 as of September 30, 2011 and June 30, 2011, respectively. That amount has been recorded as a component of other comprehensive income. As of September 30, 2011 and June 30, 2011, the Company has recorded an accumulated unrealized loss of $109,000 and $204,000, net of deferred income taxes, respectively. The Company deems this loss to be temporary as it will not likely be required to sell the securities before their anticipated recovery and the Company has the intent and financial ability to hold these investments until recovery of cost.

Although the investment impairment is considered to be temporary, these investments are not currently liquid and in the event the Company needs to access these funds, the Company will not be able to do so without a loss of principal. The Company plans to continue to monitor the liquidity situation in the marketplace and the creditworthiness of its holdings and will perform periodic impairment analyses. During the three months ended September 30, 2011 and 2010, $1,675,000 and $900,000 of these auction rate securities were redeemed at par, respectively.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 7. Fair Value Disclosure

The Company accounts for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. The Company categorizes each of its fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

The financial assets of the Company measured at fair value on a recurring basis are included in cash equivalents and long-term investments. The Company’s money market funds are classified within Level 1 of the fair value hierarchy which is based on quoted market prices of the identical underlying securities in active markets. The Company’s long-term auction rate securities investments are classified within Level 3 of the fair value hierarchy which did not have observable inputs for its auction rate securities as of September 30, 2011 and June 30, 2011.

The following table sets forth the Company’s cash equivalents and long-term investments as of September 30, 2011 and June 30, 2011 which are measured at fair value on a recurring basis by level within the fair value hierarchy. These are classified based on the lowest level of input that is significant to the fair value measurement, (in thousands):

The above table excludes $86,315,000 and $65,656,000 of cash balances held on deposit at banks and $453,000 and $468,000 of certificates of deposit held by the Company as of September 30, 2011 and June 30, 2011, respectively.

The following table provides a reconciliation of the Company’s financial assets measured at fair value on a recurring basis, consisting of long-term auction rate securities, using significant unobservable inputs (Level 3) for the three months ended September 30, 2011 and 2010 (in thousands):

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The Company’s short-term investments as of September 30, 2011 and June 30, 2011 were $59,000 and are grouped in prepaid expense and other assets. There was no unrealized holding gain and losses for the periods.

The following is a summary of the Company’s long-term investments as of September 30, 2011 and June 30, 2011 (in thousands):

The Company measures the fair value of outstanding debt for disclosure purposes on a recurring basis. As of September 30, 2011 and June 30, 2011, its current and non-current long-term debt of $30,600,000 and $28,151,000, respectively, is reported at amortized cost. The fair value of the outstanding debts is based on borrowing rates currently available to the Company for loans with similar terms, and approximates amortized cost.

Note 8. Advances from Receivable Financing Arrangements

The Company has accounts receivable financing agreements with certain financing companies whereby the financing companies pay the Company for sales transactions that have been pre-approved by these financing companies. The financing companies then collect the receivable from the customers. Such sales transactions totaled $7,933,000 and $5,993,000 for the three months ended September 30, 2011 and 2010, respectively. At September 30, 2011 and June 30, 2011, $1,187,000 and $1,000,000, respectively, remained uncollected from customers subject to these arrangements. Such amounts have been recorded as advances from receivable financing arrangements within the accrued liabilities as the Company has obligations to repurchase inventories seized by the financing companies from defaulting customers. Historically, the Company has not been required to repurchase inventories from the financing companies. These financing arrangements bear interest at rates ranging from 0.95% to 1.15% per month depending on the customers’ payment terms at September 30, 2011 and June 30, 2011.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 9. Short-term and Long-term Obligations

Long-term obligations consisted of the following (in thousands):

In June 2010, the Company obtained a revolving line of credit totaling $25,000,000 that matures on June 15, 2013 with an interest rate at the LIBOR rate plus 1.50% per annum. The Company used $18,553,000 of the line of credit to purchase three buildings in San Jose, California. The loan is secured by all the Company’s assets except for the three buildings purchased in San Jose, California. In December 2010, the Company repaid $13,854,000 of the line of credit by obtaining a new term loan from another bank for $13,875,000 and the remaining $4,699,000 of the line of credit has been extended to be paid-off by June 15, 2013. The term loan is secured by the three buildings purchased in San Jose, California in June 2010 and the principal and interest are payable monthly through October 1, 2013 with an interest rate at the LIBOR rate plus 1.75% per annum. The LIBOR rate was 0.22% at September 30, 2011.

In March 2011, the Company drew an additional $9,855,000 from the revolving line of credit with an interest rate equal to the lender’s established interest rate which is adjusted monthly and paid $9,195,000 for a deposit to purchase land in Taiwan that is adjacent to the land that was purchased in August 2010. The title to the land in Taiwan is expected to transfer in the first half of fiscal year 2012. In August and September 2011, the Company also drew an additional $3,156,000 from the revolving line of credit for the construction of facilities in Taiwan. The interest rate was 1.64% at September 30, 2011 and June 30, 2011.

As of September 30, 2011 and June 30, 2011, the total outstanding borrowings under these loans were $30,600,000 and $28,151,000, respectively. As of September 30, 2011, the unused revolving line of credit was $7,859,000 and the Company was in compliance with the financial covenants associated with these loans.

As of September 30, 2011 and June 30, 2011, the total assets except for the three buildings purchased in San Jose, California in June 2010 collateralizing the line of credit were $469,963,000 and $446,347,000, respectively. As of September 30, 2011, the gross cost and net book value of the land, building and related improvements collateralizing the term loan were $18,503,000 and $18,216,000, respectively.

In August 2011, the Company entered into an amendment to the credit agreement with Bank of America, N.A. which permits the Company to make investments in its wholly-owned subsidiaries or a non-wholly-owned subsidiary if the aggregate amount of the Company’s investments in that subsidiary never exceeds an amount equal to 5% of the Company’s total consolidated assets.

In October 2011, the Company entered into a second amendment to the credit agreement with Bank of America, N.A. which provided for (i) a $40,000,000 revolving line of credit facility that replaced the existing $25,000,000 revolving line of credit and (ii) a five-year $14,000,000 term loan facility to pay off the outstanding term loan of $13,412,500. The term loan is secured by the three buildings purchased in San Jose, California in June 2010 and the principal and interest are payable monthly through September 30, 2016 with an interest rate at the LIBOR rate plus 1.50% per annum. The interest rate for the revolving line of credit is at the LIBOR rate plus 1.25% per annum.

In October 2011, the Company also obtained a revolving line of credit from China Trust Bank totaling $11,150,000 that matures on July 31, 2012 with an interest rate equal to the lender’s established interest rate plus 0.5% which is adjusted monthly. In addition, the Company drew $4,481,000 from this revolving line of credit with an interest rate at 1.44% per annum.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 10. Related-party and Other Transactions

Ablecom Technology Inc. — Ablecom, a Taiwan corporation, together with one of its subsidiaries, Compuware (collectively “Ablecom”), is one of the Company’s major contract manufacturers. Ablecom’s ownership of Compuware is below 50% but Compuware remains a related party as Ablecom still has significant influence over the operations. Ablecom’s chief executive officer, Steve Liang, is the brother of Charles Liang, the Company’s President, Chief Executive Officer and Chairman of the Board of Directors, and owns approximately 1.1% of the Company’s common stock. Charles Liang and his wife, also an officer of the Company, collectively own approximately 10.5% of Ablecom, while Steve Liang and other family members owned approximately 35.9% of Ablecom at September 30, 2011 and June 30, 2011.

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

Under the product design and manufacturing agreements, the Company outsources a portion of its design activities and a significant part of its manufacturing of components such as server chassis to Ablecom. Ablecom agrees to design products according to the Company’s specifications. Additionally, Ablecom agrees to build the tools needed to manufacture the products. Under the product design and manufacturing agreements, the Company commits to purchase a minimum quantity over a set period. The purchase price of the products manufactured by Ablecom is negotiated on a purchase order by purchase order basis at each purchase date. However, a fixed charge is added to the price of each unit purchased until the agreed minimum number of units is purchased. In August 2007, the Company entered into a new product development, manufacturing and service agreement with Ablecom. Under the new agreement, the Company has agreed to pay for the cost of blade server tooling and engineering services and will pay for those items when the work has been completed. In this case no fixed charge is added to future purchases for reimbursement of tooling costs. In September 2009, the Company entered into a similar product development agreement with Ablecom. Under this agreement, the Company has agreed to pay for the cost of chassis and related product tooling and engineering services and will pay for those items when the work has been completed. In this case no fixed charge is added to future purchases for reimbursement of tooling costs.

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

Ablecom’s net sales to the Company and its net sales of the Company’s products to others comprise a substantial majority of Ablecom’s net sales. The Company purchased products from Ablecom totaling $37,393,000 and $36,418,000 and sold products to Ablecom totaling $2,835,000 and $2,133,000 for the three months ended September 30, 2011 and 2010, respectively.

Amounts owed to the Company by Ablecom as of September 30, 2011 and June 30, 2011, were $499,000 and $527,000, respectively. Amounts owed to Ablecom by the Company as of September 30, 2011 and June 30, 2011, were $27,241,000 and $34,210,000, respectively. For the three months ended September 30, 2011, the Company paid Ablecom the majority of invoiced dollars between 53 and 101 days of invoice. For the three months ended September 30, 2011 and 2010, the Company paid $975,000 and $791,000, respectively, in tooling assets and miscellaneous costs to Ablecom.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The Company’s exposure to loss as a result of its involvement with Ablecom is limited to (a) potential losses on its purchase orders in the event of an unforeseen decline in the market price and/or demand of the Company’s products such that the Company incurs a loss on the sale or cannot sell the products and (b) potential losses on outstanding accounts receivable from Ablecom in the event of an unforeseen deterioration in the financial condition of Ablecom such that Ablecom defaults on its payable to the Company. Outstanding purchase orders with Ablecom were $46,100,000 and $38,326,000 at September 30, 2011 and June 30, 2011, respectively, representing the maximum exposure to loss relating to (a) above. The Company does not have any direct or indirect guarantees of losses of Ablecom.

Note 11. Income Taxes

The Company recorded provisions for income taxes of $4,845,000 and $4,653,000 for the three months ended September 30, 2011 and 2010, respectively. The effective tax rate was 36.3% and 39.2% for the three months ended September 30, 2011 and 2010, respectively. The effective tax rate of 36.3% is estimated to be higher than the federal statutory rate primarily due to the impact of state taxes, stock option expenses, and the expiration of federal research & development tax credits on December 31, 2011.

As of September 30, 2011, the Company had a liability for gross unrecognized tax benefits of $7,224,000, substantially all of which, if recognized, would affect the Company’s effective tax rate. During the three months ended September 30, 2011, there was no material change in the total amount of the liability for gross unrecognized tax benefits.

The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the consolidated statements of operations. As of September 30, 2011, the Company had a liability for accrued interest and penalties related to the unrecognized tax benefits of $662,000. During the three months ended September 30, 2011, there was no material change in the total amount of the liability for accrued interest and penalties related to the unrecognized tax benefits.

The Company files U.S. federal, U.S. state, and foreign income tax returns. The Company is generally no longer subject to tax examinations for years prior to the fiscal year beginning July 1, 2003.

It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease in the next 12 months. Such changes could occur based on the normal expiration of various statues of limitations or the possible conclusion of ongoing tax examinations in various jurisdictions. The Company is currently under audit by the Internal Revenue Service and the Netherlands tax authorities, but does not expect the outcome of these examinations will have a material impact on its financial position, results of operations or liquidity in the next 12 months.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 12. Commitments and Contingencies

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

Purchase Commitments — In connection with supplier agreements, the Company has agreements to purchase certain units of inventory and non-inventory items through fiscal year 2012. As of September 30, 2011, these remaining non-cancelable commitments were $98,866,000, which will be paid within a year.

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SUPER MICRO COMPUTER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Note 13. Segment Reporting

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

International net sales are based on the country to which the products were shipped. The following is a summary for the three months ended September 30, 2011 and 2010, of net sales by geographic region (in thousands):

The following is a summary of long-lived assets, excluding financial instruments, deferred tax assets, other assets, goodwill and intangible assets (in thousands):

The following is a summary of net sales by product type (dollars in thousands):

Subsystems and accessories are comprised of serverboards, chassis and accessories. Server systems constitute an assembly of subsystems and accessories done by the Company. No customer represented greater than 10% of the Company’s total net sales nor did net sales in any country other than the United States represent greater than 10% of the Company’s total net sales in the three months ended September 30, 2011 and 2010. No customer accounted for 10% or more of the Company’s accounts receivable as of September 30, 2011 and June 30, 2011.

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This section and other parts of this Form 10-Q contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology including “would,” “could,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” the negative of these terms or other comparable terminology. In evaluating these statements, you should specifically consider various factors, including the risks described under “Risk Factors” below and in other parts of this Form 10-Q as well as in our other filings with the SEC. These factors may cause our actual results to differ materially from those anticipated or implied in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We cannot guarantee future results, levels of activity, performance or achievements.

Overview

We are a global leader in server technology and green computing innovation. We develop and provide high performance server solutions based on an innovative, modular and open-standard architecture. Our solutions include a range of complete rackmount, workstation, storage, graphic processing unit and blade server systems, as well as subsystems and accessories which can be used by distributors, OEMs and end customers to assemble server systems. To date, we have generated the majority of our net sales from subsystems. In recent years our growth in net sales has been driven by the growth in the market for application optimized server systems. Net sales of optimized servers were $97.6 million and $74.0 million for the three months ended September 30, 2011 and 2010, respectively. Net sales of subsystems and accessories were $150.3 million and $133.2 million for the three months ended September 30, 2011 and 2010, respectively. The increase in our net sales in the three months ended September 30, 2011 compared with the three months ended September 30, 2010 was primarily due to increased sales in server solutions including SuperBlade, our GPU, storage and rack solutions.

We commenced operations in 1993 and have been profitable every year since inception. Our net sales were $247.9 million and $207.2 million for the three months ended September 30, 2011 and 2010, respectively. Our net income was $8.5 million and $7.2 million for the three months ended September 30, 2011 and 2010, respectively. Our increase in profitability in the three months ended September 30, 2011 was primarily attributable to the increase in our gross profit resulting from our increased net sales of server solutions in the three months ended September 30, 2011 offset by higher operating expenses primarily in research and development as we continued to invest in headcount to drive our innovation and product portfolio especially in preparation for new product releases.

We sell our server systems and subsystems and accessories primarily through distributors and to a lesser extent to OEMs as well as through our direct sales force. We derived approximately 55.8% and 60.2% of our net sales from products sold to distributors, and 44.2% and 39.8% from sales to OEMs and to end customers for the three months ended September 30, 2011 and 2010, respectively. None of our customers accounted for 10% or more of our net sales in the three months ended September 30, 2011 and 2010. We derived approximately 62.1% and 58.7% of our net sales from customers in the United States for the three months ended September 30, 2011 and 2010, respectively. We derived approximately 37.9% and 41.3% of our net sales from customers outside the United States for the three months ended September 30, 2011 and 2010, respectively.

We perform the majority of our research and development efforts in-house. Research and development expenses represented approximately 5.6% and 5.0% of our net sales for the three months ended September 30, 2011 and 2010, respectively.

We use several suppliers and contract manufacturers to design and manufacture subsystems and accessories in accordance with our specifications, with most final assembly and testing performed at our manufacturing facility in San Jose, California. During fiscal year 2011, we continued to invest in expanding our operations both in San Jose, California and at our subsidiaries in the Netherlands and Taiwan in order to support our growth. We have increased manufacturing and service operations in the Netherlands and Taiwan to support our European and Asian customers and we plan to continue expanding our overseas manufacturing capacity through fiscal year 2012. One of our key suppliers is

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Ablecom, a related party, which supplies us with contract design and manufacturing support. For the three months ended September 30, 2011 and 2010, our purchases from Ablecom represented approximately 18.0% and 20.9% of our cost of sales, respectively. The decrease in percentage of cost of sales in the three months ended September 30, 2011 was primarily related to server systems sales composing a higher percentage of our net sales and a change in product mix which resulted in a higher percentage of server subsystems and accessories being purchased from other suppliers. Ablecom’s sales to us constitute a substantial majority of Ablecom’s net sales. We continue to maintain our manufacturing relationship with Ablecom in Asia in an effort to reduce our product costs and do not have any current plans to reduce our reliance on Ablecom product purchases. In addition to providing a larger volume of contract manufacturing services for us, Ablecom continues to warehouse for us a number of components and subassemblies manufactured by multiple suppliers prior to shipment to our facilities in the U.S. and Europe. We typically negotiate the price of products that we purchase from Ablecom on a quarterly basis; however, either party may re-negotiate the price of products with each order. As a result of our relationship with Ablecom, it is possible that Ablecom may in the future sell products to us at a price higher or lower than we could obtain from an unrelated third party supplier. This may result in our future reporting of gross profit as a percentage of net sales that is less than or in excess of what we might have obtained absent our relationship with Ablecom.

In order to continue to increase our net sales and profits, we believe that we must continue to develop flexible and customizable server solutions and be among the first to market with new features and products. We measure our financial success based on various indicators, including growth in net sales, gross profit as a percentage of net sales, operating income as a percentage of net sales, levels of inventory, and days sales outstanding, or DSOs. In connection with these efforts, we monitor daily and weekly sales and shipment reports. Among the key non-financial indicators of our success is our ability to rapidly introduce new products and deliver the latest application optimized server solutions. In this regard, we work closely with microprocessor and other component vendors to take advantage of new technologies as they are introduced. Historically, our ability to introduce new products rapidly has allowed us to benefit from the introduction of new microprocessors and as a result we monitor the introduction cycles of Intel and AMD carefully. This also impacts our research and development expenditures. For example, in the past, our results have been adversely impacted by customer order delays in anticipation of the introduction of the new lines of microprocessors and research and development expenditures necessary for us to prepare for the introduction.

Other Financial Highlights

The following is a summary of other financial highlights of the first quarter of fiscal year 2012:

We believe that our cash position, our balance sheet, our visibility into our supply chain and our financing capabilities position us well to operate in the next 12 months.

Fiscal Year

Our fiscal year ends on June 30. References to fiscal year 2012, for example, refer to the fiscal year ending June 30, 2012.

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Revenues and Expenses

Net sales. Net sales consist of sales of our server solutions, including server systems, subsystems and accessories. The main factors which impact our net sales are unit volumes shipped and average selling prices. The prices for server systems range widely depending upon the configuration, and the prices for our subsystems and accessories vary based on the type. As with most electronics-based products, average selling prices typically are highest at the time of introduction of new products which utilize the latest technology and tend to decrease over time as such products mature in the market and are replaced by next generation products.

Cost of sales. Cost of sales primarily consists of the costs to manufacture our products, including the costs of materials, contract manufacturing, shipping, personnel and related expenses, equipment and facility expenses, warranty costs and inventory excess and obsolete provisions. The primary factors that impact our cost of sales are the mix of products sold and cost of materials, which include raw material costs, shipping costs and salary and benefits related to production. Cost of sales as a percentage of net sales may increase over time if decreases in average selling prices are not offset by corresponding decreases in our costs. Our cost of sales as a percentage of net sales is also impacted by the percentage of our net sales that reflect more commoditized components, such as memory and hard drives. Our cost of sales, as a percentage of net sales, is generally lower on server systems than on subsystems and accessories. Because we do not have long-term fixed supply agreements, our cost of sales is subject to change based on market conditions.

Research and development expenses. Research and development expenses consist of the personnel and related expenses of our research and development teams, and materials and supplies, consulting services, third party testing services and equipment and facility expenses related to our research and development activities. All research and development costs are expensed as incurred. We occasionally receive non-recurring engineering, or NRE funding from certain suppliers and customers towards our development efforts. Under these programs, we are reimbursed for certain research and development costs that we incur as part of the joint development of our products and those of our suppliers and customers. These amounts offset a portion of the related research and development expenses and have the effect of reducing our reported research and development expenses.

Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries and commissions for our sales and marketing personnel, costs for tradeshows, independent sales representative fees and marketing programs. From time to time, we receive cooperative marketing funding from certain suppliers. Under these programs, we are reimbursed for certain marketing costs that we incur as part of the joint promotion of our products and those of our suppliers. These amounts offset a portion of the related expenses and have the effect of reducing our reported sales and marketing expenses. Similarly, we from time to time offer our distributors cooperative marketing funding which has the effect of increasing our expenses. The timing, magnitude and estimated usage of our programs and those of our suppliers can result in significant variations in reported sales and marketing expenses from period to period. Spending on cooperative marketing, either by us or our suppliers, typically increases in connection with significant product releases by us or our suppliers.

General and administrative expenses. General and administrative expenses consist primarily of general corporate costs, including personnel expenses, financial reporting, corporate governance and compliance and outside legal, audit and tax fees.

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Interest and other income, net. Interest and other income, net represents the net of our interest income on investments or interest expense on the building loans for our own facilities offset by interest earned on our cash and investments balances.

Income tax provision. Our income tax provision is based on our taxable income generated in the jurisdictions in which we operate, currently primarily the United States and the Netherlands and to a lesser extent, Taiwan. Our effective tax rate differs from the statutory rate primarily due to research and development tax credits and the domestic production activities deduction which were partially offset by the impact of state taxes and stock option expenses.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenues and expenses. We evaluate our estimates on an on-going basis, including those related to allowances for doubtful accounts and sales returns, cooperative marketing accruals, investment valuations, inventory valuations, income taxes, warranty obligations and stock-based compensation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making the judgments we make about the carrying values of assets and liabilities that are not readily apparent from other sources. Because these estimates can vary depending on the situation, actual results may differ from the estimates.

We believe the following are our most critical accounting policies as they require our more significant judgments in the preparation of our financial statements.

Revenue recognition. We recognize revenue from sales of products, when persuasive evidence of an arrangement exists, shipment has occurred and title has transferred, the sales price is fixed or determinable, collection of the resulting receivable is reasonably assured, and all significant obligations have been met. Generally this occurs at the time of shipment when risk of loss and title has passed to the customer. Our standard arrangement with our customers includes a signed purchase order or contract, 30 to 60 days payment terms, Ex-works terms, except for a few customers who have free-on-board destination terms or customer acceptance provisions, and revenue is recognized when the products arrive or are accepted at the destination. We generally do not provide for non-warranty rights of return except for products which have “Out-of-box” failure, where customers could return these products for credit within 30 days of receiving the items. Certain distributors and OEMs are also permitted to return products in unopened boxes, limited to purchases over a specified period of time, generally within 60 to 90 days of the purchase, or to products in the distributor’s or OEM’s inventory at certain times (such as the termination of the agreement or product obsolescence). In addition, we have a sale arrangement with an OEM that has limited product return rights. To estimate reserves for future sales returns, we regularly review our history of actual returns for each major product line. We also communicate regularly with our distributors to gather information about end customer satisfaction, and to determine the volume of inventory in the channel. Reserves for future returns are adjusted as necessary, based on returns experience, returns expectations and communication with our distributors.

In addition, certain customers have acceptance provisions and revenue is deferred until the customers provide the necessary acceptance. At September 30, 2011 and June 30, 2011, we had deferred revenue of $1.3 million and $2.4 million and related deferred product costs of $1.0 million and $1.9 million, respectively, related to shipments to customers pending acceptances.

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Probability of collection is assessed on a customer-by-customer basis. Customers are subjected to a credit review process that evaluates the customers’ financial position and ability to pay. If it is determined from the outset of an arrangement that collection is not probable based upon the review process, the customers are required to pay cash in advance of shipment. We also make estimates of the uncollectibility of accounts receivables, analyzing accounts receivable and historical bad debts, customer concentrations, customer-credit-worthiness, current economic trends and changes in customer payment terms to evaluate the adequacy of the allowance for doubtful accounts. On a quarterly basis, we evaluate aged items in the accounts receivable aging report and provide an allowance in an amount we deem adequate for doubtful accounts. If management were to make different judgments or utilize different estimates, material differences in the amount of our reported operating expenses could result. We provide for price protection to certain distributors. We assess the market competition and product technology obsolescence, and make price adjustments based on our judgment. Upon each announcement of price reductions, the accrual for price protection is calculated based on our distributors’ inventory on hand. Such reserves are recorded as a reduction to revenue at the time we reduce the product prices.

We have an immaterial amount of service revenue relating to non-warranty repairs, which is recognized upon shipment of the repaired units to customers. Service revenue has been less than 10% of net sales for all periods presented and is not separately disclosed.

Cooperative marketing accruals. We have arrangements with resellers of our products to reimburse the resellers for cooperative marketing costs meeting specified criteria. We accrue the cooperative marketing costs based on these arrangements and our estimate for resellers’ claims for marketing activities. We record marketing costs meeting such specified criteria within sales and marketing expenses in the accompanying condensed consolidated statements of operations. For those marketing costs that do not meet the specified criteria, the amounts are recorded as a reduction to sales in the condensed consolidated statements of operations.

Impairment of long-term investments. Impairment of long-term investments relates to the unrealized loss on the carrying value of our investments in auction rate securities; such securities were rated AAA at the date of purchase. The liquidity and fair value of these securities has been negatively impacted by the uncertainty in the credit markets and exposure of these securities to the financial condition of bond insurance companies. We have received all interest payments due on these instruments on a timely basis. Each of these securities has been subject to auction processes for which there had been insufficient bidders on the scheduled rollover dates and the auctions have subsequently failed. When these securities lost the short-term liquidity previously provided by the auction processes, we reclassified these securities as long-term investments. For the securities with the stated maturity less than a year, the securities were classified as short-term available-for-sale investments. We have used a discounted cash flow model to estimate the fair value of these investments as of September 30, 2011 and June 30, 2011. The material factors used in preparing the discounted cash flow model are 1) the discount rate utilized to present value the cash flows, 2) the time period until redemption and 3) the estimated rate of return. Management derives the estimates by obtaining input from market data on the applicable discount rate, estimated time to maturity and estimated rate of return. The changes in fair value have been primarily due to changes in the estimated rate of return and a change in the estimated period to liquidity. The fair value of our investment portfolio may change between 1% to 3% by increasing or decreasing the rate of return used by 1% or by increasing or decreasing the term used by 1 year. Changes in these estimates or in the market conditions for these investments are likely in the future based upon the then current market conditions for these investments and may affect the fair value of these investments. The accumulated unrealized loss as of September 30, 2011 and June 30, 2011 was $0.1 million and $0.2 million, net of deferred income taxes, on the securities, respectively. We deem this loss to be temporary as we determined that we will not likely be required to sell the securities before their anticipated recovery and we have the intent and ability to hold our investments until recovery of cost.

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Product warranties. We offer product warranties ranging from 15 to 39 months against any defective product. We accrue for estimated returns of defective products at the time revenue is recognized, based on historical warranty experience and recent trends. We monitor warranty obligations and may make revisions to our warranty reserve if actual costs of product repair and replacement are significantly higher or lower than estimated. Accruals for anticipated future warranty costs are charged to cost of sales and included in accrued liabilities. The liability for product warranties was $4.4 million and $4.7 million as of September 30, 2011 and June 30, 2011, respectively. The provision for warranty reserve was $2.2 million and $2.6 million in the three months ended September 30, 2011 and 2010, respectively. Our estimates and assumptions used have been historically close to actual. The change in estimated liability for pre-existing warranties was a decrease of $0.3 million and a decrease of $0.5 million in the three months ended September 30, 2011 and 2010, respectively. As a result of our decrease in warranty claims in the three months ended September 30, 2011, the provision for warranty reserve decreased $0.4 million compared to the three months ended September 30, 2010. If in future periods, we experience or anticipate an increase or decrease in warranty claims as a result of new product introductions or change in unit volumes compared with our historical experience, or if the cost of servicing warranty claims is greater or lesser than expected, we intend to adjust our estimates appropriately.

Inventory valuation. Inventory is valued at the lower of cost or market. We evaluate inventory on a quarterly basis for lower of cost or market and excess and obsolescence and, as necessary, write down the valuation of units to lower of cost or market or for excess and obsolescence based upon the number of units that are unlikely to be sold given the estimated demand for the following twelve months. This evaluation takes into account matters including expected demand, anticipated sales price, product obsolescence and other factors. If actual future demand for our products is less than currently forecasted, additional inventory adjustments may be required. Once a reserve is established, it is maintained until the product to which it relates is sold or scrapped. If a unit that has been written down is subsequently sold, the cost associated with the revenue from this unit is reduced to the extent of the write down, resulting in an increase in gross profit. We monitor the extent to which previously written down inventory is sold at amounts greater or less than carrying value, and based on this analysis, adjust our estimate for determining future write downs. If in future periods, we experience or anticipate a change in recovery rate compared with our historical experience, our gross margin would be affected. Our provision (benefits) for inventory was $2.4 million and ($0.1) million in the three months ended September 30, 2011 and 2010, respectively.

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

We recognize the tax liability for uncertain income tax positions on the income tax return based on the two-step process. The first step is to determine whether it is more likely than not that each income tax position would be sustained upon audit. The second step is to estimate and measure the tax benefit as the amount that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority. Estimating these amounts requires us to determine the probability of various possible outcomes. We evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on the consideration of several factors, including changes in facts or circumstances, changes in applicable tax law, settlement of issues under audit and new exposures. If we later determine that our exposure is lower or that the liability is not sufficient to cover our revised expectations, we adjust the liability and effect a related change in our tax provision during the period in which we make such determination. See Note 11 of Notes to Condensed Consolidated Financial Statements for the impact on our condensed consolidated financial statements.

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Stock-based compensation. We measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, known as the requisite service period (usually the vesting period). Compensation expense for options granted to employees after July 1, 2006, was $2.3 million and $1.8 million for the three months ended September 30, 2011 and 2010, respectively.

As of September 30, 2011, the total unrecognized compensation cost, adjusted for estimated forfeitures, related to unvested stock options granted to employees and non-employee directors, was $18.4 million, which is expected to be recognized as an expense over a weighted-average period of approximately 2.4 years. See Note 2 of Notes to Condensed Consolidated Financial Statements for additional information.

We estimated the fair value of stock options granted using a Black-Scholes option-pricing model and a single option award approach. This model requires us to make estimates and assumptions with respect to the expected term of the option, the expected volatility of the price of our common stock and the expected forfeiture rate. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.

The expected term represents the period that our stock-based awards are expected to be outstanding and was determined based on an analysis of the relevant peer companies’ post-vest termination rates and the exercise behavior for the stock options granted prior to June 30, 2011. For stock options granted after June 30, 2011, expected term is based on a combination of our peer group and our historical experience. The expected volatility is based on a combination of the implied and historical volatility of our relevant peer group for the stock options granted prior to September 30, 2009. For stock options granted after September 30, 2009, expected volatility is based solely on our historical volatility. In addition, forfeitures of share-based awards are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest.

Variable interest entities. In June 2009, the FASB issued authoritative guidance on the consolidation of variable interest entities, which is effective for fiscal years beginning after November 15, 2009 and interim periods therein and thereafter. The new guidance requires revised evaluations of whether entities represent variable interest entities, ongoing assessments of control over such entities, and additional disclosures for variable interests. We adopted this standard and have analyzed our relationship with Ablecom and its subsidiaries (collectively “Ablecom”). We have analyzed and concluded that Ablecom is a variable interest entity in accordance with applicable accounting standards and guidance; however, we are not the primary beneficiary of Ablecom and therefore, we do not consolidate Ablecom. In performing our analysis, we considered our explicit arrangements with Ablecom including the supplier and distributor arrangements. Also, as a result of the substantial related party relationship between the two companies, we considered whether any implicit arrangements exist that would cause us to protect those related parties’ interests in Ablecom from suffering losses. We determined that no implicit arrangements exist with Ablecom or its shareholders. Such an arrangement would be inconsistent with the fiduciary duty that we have towards our stockholders who do not own shares in Ablecom.

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Results of Operations

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

Comparison of Three Months Ended September 30, 2011 and 2010

Net sales. Net sales increased by $40.7 million, or 19.6%, to $247.9 million from $207.2 million, for the three months ended September 30, 2011 and 2010, respectively. This increase was due primarily to an increase in the average selling price of our server systems and an increase in unit volumes of our server systems and subsystems and accessories.

For the three months ended September 30, 2011, the approximate number of server system units sold increased 14.0% to 57,000 compared to 50,000 for the three months ended September 30, 2010. The average selling price of server system units increased 13.3% to approximately $1,700 in the three months ended September 30, 2011 compared to approximately $1,500 in the three months ended September 30, 2010. The average selling prices of our server systems increased principally due to an increase in average selling prices of our sales of complete integrated-high-end servers solutions to OEM and end customers and higher average selling prices of SuperBlades, offset in part by declines in average selling prices of 6000 Series configuration of servers. Sales of server systems increased by $23.6 million or 31.9% from the three months ended September 30, 2010 to the three months ended September 30, 2011, primarily due to higher sales of complete integrated-high-end servers solutions to OEM and end customers and higher sales of SuperBlades, GPU, storage and rack solutions. Sales of server systems represented 39.4% of our net sales for the three months ended September 30, 2011 as compared to 35.7% of our net sales for the three months ended September 30, 2010.

For the three months ended September 30, 2011, the approximate number of subsystems and accessories units sold increased 2.4% to 973,000 compared to 950,000 for the three months ended September 30, 2010. Sales of subsystems and accessories units increased by $17.1 million or 12.8% from the three months ended September 30, 2010 to the three months ended September 30, 2011, primarily related to higher sales of bundled server solutions to OEM and system integrators who increasingly are purchasing additional accessories from us and completing the final assembly themselves. Sales of subsystems and accessories represented 60.6% of our net sales for the three months ended September 30, 2011 as compared to 64.3% of our net sales for the three months ended September 30, 2010.

For the three months ended September 30, 2011 and 2010, we derived approximately 55.8% and 60.2%, respectively, of our net sales from products sold to distributors and we derived approximately 44.2% and 39.8%, respectively, from sales to OEMs and to end customers. For the three months ended September 30, 2011, customers in the United States, Europe, and Asia accounted for approximately 62.1%, 18.8% and 15.8%, of our net sales, respectively, as compared to 58.7%, 22.4% and 15.7%, respectively, for the three months ended September 30, 2010.

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Cost of sales. Cost of sales increased by $34.1 million, or 19.6%, to $208.3 million from $174.1 million, for the three months ended September 30, 2011 and 2010, respectively. Cost of sales as a percentage of net sales was 84.0% and 84.1% for the three months ended September 30, 2011 and 2010, respectively. The increase in absolute dollars of cost of sales was primarily attributable to the increase in net sales, an increase of $2.5 million in provision for inventory reserve offset in part by a decrease of $0.7 million in freight-in charges and a decrease of $0.4 million in provision for warranty reserve. In the three months ended September 30, 2011, we recorded a $2.2 million expense, or 0.9% of net sales, related to the provision for warranty reserve as compared to $2.6 million, or 1.3% of net sales, in the three months ended September 30, 2010. The decrease in the provision for warranty reserve was primarily due to lower warranty claims in the three months ended September 30, 2011. If in future periods we experience or anticipate an increase or decrease in warranty claims as a result of new product introductions or a change in unit volumes compared with our historical experience, or if the cost of servicing warranty claims is greater or less than expected, our gross margin would be affected. In the three months ended September 30, 2011, we recorded a $2.4 million expense, or 1.0% of net sales, related to the inventory provision as compared to $0.1 million benefit, or 0.0% of net sales, in the three months ended September 30, 2010. The increase in the inventory provision was primarily for older products as a result of product transitions.

Research and development expenses. Research and development expenses increased by $3.4 million, or 32.3%, to $13.8 million from $10.4 million for the three months ended September 30, 2011 and 2010, respectively. Research and development expenses were 5.6% and 5.0% of net sales for the three months ended September 30, 2011 and 2010, respectively. The increase in absolute dollars was primarily due to an increase of $2.5 million in compensation and benefits, resulting from growth in research and development personnel, including higher stock-based compensation expense related to expanded product development initiatives in the United States and in Taiwan, an increase of $0.3 million in development costs associated with new products and a decrease of $0.2 million in non-recurring engineering funding from certain suppliers and customers.

Research and development expenses include stock-based compensation expense of $1.3 million and $0.9 million for the three months ended September 30, 2011 and 2010, respectively.

Sales and marketing expenses. Sales and marketing expenses increased by $1.5 million, or 24.2%, to $7.7 million from $6.2 million, for the three months ended September 30, 2011 and 2010, respectively. Sales and marketing expenses were 3.1% and 3.0% of net sales for the three months ended September 30, 2011 and 2010, respectively. The increase in absolute dollars was primarily due to an increase of $1.3 million in compensation and benefits resulting from growth in sales and marketing personnel, an increase of $0.3 million in advertising and promotion expenses, an increase of $0.1 million in trade show and travel expenses offset in part by a decrease of $0.4 million in cooperative marketing funding to customers.

Sales and marketing expenses include stock-based compensation expense of $0.3 million for both three months ended September 30, 2011 and 2010.

General and administrative expenses. General and administrative expenses increased by $0.2 million, or 4.7%, to $4.6 million from $4.4 million, for the three months ended September 30, 2011 and 2010, respectively. General and administrative expenses were 1.8% and 2.1% of net sales for the three months ended September 30, 2011 and 2010, respectively. The increase in absolute dollars was primarily due to an increase of $0.2 million in compensation and benefits, an increase of $0.3 million in audit and tax expenses offset in part by a decrease of $0.3 million in legal fees.

General and administrative expenses include stock-based compensation expense of $0.6 million and $0.5 million for the three months ended September 30, 2011 and 2010, respectively.

Interest and other expense, net. Interest and other expense, net increased by $38,000, to $0.2 million of expense from $0.1 million of expense, for the three months ended September 30, 2011 compared to the three months ended September 30, 2010, of which $0.2 million was interest expense for both three months ended September 30, 2011 and 2010. The net change was primarily due to higher interest expense as our average debt outstanding for the three months ended September 30, 2011 was $29.0 million versus $18.6 million in the three months ended September 30, 2010. Interest rates were not significantly different in the three months ended September 30, 2011 compared to the three months ended September 30, 2010. We expect that our interest expense will increase in the future as we plan to obtain additional financing from banks to fund the construction of facilities in Taiwan and the expansion of our headquarters office in San Jose.

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Provision for income taxes. Provision for income taxes increased $0.2 million, or 4.1% to $4.8 million from $4.7 million for the three months ended September 30, 2011 and 2010, respectively. The effective tax rate was 36.3% and 39.2% for the three months ended September 30, 2011 and 2010, respectively. The effective tax rate of 36.3% is estimated to be higher than the federal statutory rate primarily due to the impact of state taxes, stock option expenses, and the expiration of federal research & development tax credits on December 31, 2011.

Liquidity and Capital Resources

Since our inception, we have financed our growth primarily with funds generated from operations and from the proceeds of our initial public offering. In addition, we have from time to time utilized borrowing facilities, particularly in relation to the financing of real property acquisitions. Our cash, cash equivalents and short-term investments were $92.3 million and $70.0 million as of September 30, 2011 and June 30, 2011, respectively.

Operating Activities. Net cash provided by operating activities was $25.1 million and $16.9 million for the three months ended September 30, 2011 and 2010, respectively. Net cash provided by our operating activities for the three months ended September 30, 2011 consisted of our net income of $8.5 million, an increase in accounts payable of $9.9 million, an increase in income tax payable/receivable, net of $4.1 million, an allowance for sales returns of $3.1 million, a provision for inventory of $2.4 million, stock-based compensation expense of $2.3 million, depreciation expense of $1.5 million, a decrease in inventory of $1.3 million which was offset in part by an increase in accounts receivable of $5.9 million. Net cash provided by our operating activities for the three months ended September 30, 2010 consisted of our net income of $7.2 million, an increase in accounts payable of $17.6 million, an increase in accrued liabilities of $4.3 million, an increase in deferred income taxes of $2.7 million, stock-based compensation expense of $1.8 million, an allowance for sales returns of $1.3 million and a depreciation expense of $1.3 million, which was substantially offset by an increase in inventory of $15.8 million and an increase in prepaid expense and other assets of $3.8 million.

The increase for the three months ended September 30, 2011 in accounts receivable was primarily due to higher net sales during the three months ended September 30, 2011. The increase for the three months ended September 30, 2011 in accounts payable was primarily due to timing of payments to our vendors. The decrease for the three months ended September 30, 2011 in inventory was in part due to the sale of inventory accumulated as a result of the Japan earthquake. We anticipate that our accounts receivable, sales returns, inventory and accounts payable will increase to the extent we continue to grow our product lines and our business.

The increase for the three months ended September 30, 2010 in inventory, accounts payable and accrued liabilities was due to an increase in demand for our products resulting from a recovering economy and to support our growth.

Investing activities. Net cash used in our investing activities was $6.4 million for both three months ended September 30, 2011 and 2010, respectively. In the three months ended September 30, 2011, $8.0 million was related to the purchase of property, plant and equipment primarily related to the construction of facilities in Taiwan and the headquarters office expansion in San Jose, California. This was offset by the redemption at par of investments in auction rate securities of $1.7 million. In the three months ended September 30, 2010, $7.3 million was related to the purchase of property, plant and equipment offset in part by the redemption at par of investments in auction rate securities of $0.9 million.

We anticipate to close the title on the land in Taiwan, consisting of approximately 2.2 acres, and finalize the purchase price in the first half of fiscal year 2012 as we continue to develop and expand our manufacturing and service operations in Asia. We also plan to expand our headquarters facilities in San Jose, California. The construction of facilities in Taiwan and the headquarters expansion in San Jose, California began in the fourth quarter of fiscal year 2011 and will continue through fiscal year 2012. The anticipated costs to build the Taiwan facilities and the headquarters office expansion in San Jose, California through fiscal year 2012 are approximately $7.0 million. We plan to finance these projects through our operating cash flows and additional financing from banks through fiscal year 2012.

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Financing activities. Net cash provided by our financing activities was $3.6 million and $0.4 million for the three months ended September 30, 2011 and 2010, respectively. In the three months ended September 30, 2011 and 2010, $0.6 million was related to the proceeds from the exercise of stock options. We withheld shares and paid the minimum tax withholding on behalf of one executive officer for his restricted stock awards of $1.1 million and $0.8 million for the three months ended September 30, 2011 and 2010, respectively. In the three months ended September 30, 2011, we borrowed $3.2 million of our revolving line of credit and repaid $0.1 million in loan. In the three months ended September 30, 2011 and 2010, excess tax benefits from stock-based compensation were $0.9 million and $0.6 million, respectively. We expect the net cash provided by financing activities will increase in the quarter ending December 31, 2011 as we obtained a new term loan of $14.0 million and paid off the outstanding term loan for $13.4 million in October 2011 without prepayment penalty and we intend to obtain additional financing from banks to construct our manufacturing building in Taiwan and support our building expansion in San Jose, California.

We expect to experience continued growth in our working capital requirements and capital expenditures as we continue to expand our business. Our long-term future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support our product development efforts, the expansion of sales and marketing activities, the timing of our introductions of new products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products. We intend to fund this continued expansion through cash generated by operations and by drawing on the revolving credit facility or through other debt financing. However we cannot be certain whether such financing will be available on commercially reasonable or otherwise favorable terms or that such financing will be available at all. We anticipate that working capital and capital expenditures will constitute a material use of our cash resources. We have sufficient cash on hand to continue to operate in the next 12 months.

Other factors affecting liquidity and capital resources

Activities under Revolving Line of Credits and Term Loans

As of September 30, 2011, we had a revolving line of credit totaling $25.0 million that matures on June 15, 2013 with an interest rate at the LIBOR rate plus 1.50% per annum. In June 2010, we used $18.6 million of the line of credit to purchase three buildings in San Jose, California. The loan was secured by all our assets except for the three buildings purchased in San Jose, California. In December 2010, we repaid $13.9 million of the line of credit by obtaining a term loan for the same amount and the remaining $4.7 million of the line of credit has been extended to be repaid by June 15, 2013. The term loan is secured by the three buildings purchased in San Jose, California in June 2010 and the principal and interest are payable monthly through October 1, 2013 with an interest rate at the LIBOR rate plus 1.75% per annum. The LIBOR rate was 0.22% at September 30, 2011.

In March 2011, we drew an additional $9.9 million of the revolving line of credit with an interest rate equal to the lender’s established interest rate which is adjusted monthly and paid $9.2 million for a deposit to purchase land in Taiwan. In August and September 2011, we also drew an additional $3.2 million from the revolving line of credit for the construction of our Taiwan facilities. The interest rate was 1.64% at September 30, 2011 and June 30, 2011.

As of September 30, 2011 and June 30, 2011, the total outstanding borrowing under these loans was $30.6 million and $28.2 million, respectively. As of September 30, 2011, the unused revolving line of credit was $7.9 million and we were in compliance with financial covenants associated with these loans in all material respects.

In October 2011, we entered into a second amendment to our credit agreement with Bank of America, N.A. which provided for (i) a $40.0 million revolving line of credit facility that replaced the existing $25.0 million revolving line of credit and (ii) a five-year $14.0 million term loan facility to pay off the outstanding term loan of $13.4 million. The term loan is secured by the three buildings purchased in San Jose, California in June 2010 and the principal and interest are payable monthly through September 30, 2016 with an interest rate at the LIBOR rate plus 1.50% per annum. The interest rate for the revolving line of credit is at the LIBOR rate plus 1.25% per annum.

In October 2011, we also obtained a revolving line of credit from China Trust Bank totaling $11.2 million that matures on July 31, 2012 with an interest rate equal to the lender’s established interest rate plus 0.5% which is adjusted monthly. In addition, we drew $4.5 million from this revolving line of credit with an interest rate at 1.44% per annum.

Contract Manufacturers

For the three months ended September 30, 2011, we paid our contract manufacturers within 38 to 76 days of invoice and Ablecom between 53 and 101 days of invoice. Ablecom, a Taiwan corporation, is one of our major contract manufacturers and a related party. As of September 30, 2011 and June 30, 2011 amounts owed to Ablecom by us were approximately $27.2 million and $34.2 million, respectively.

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Auction Rate Securities Valuation

As of September 30, 2011, we held $3.7 million of auction rate securities, net of unrealized losses, representing our interest in auction rate preferred shares in a closed end mutual fund invested in municipal securities and auction rate student loans guaranteed by the Federal Family Education Loan Program; such auction rate securities were rated AAA or CAA3 at September 30, 2011. These auction rate preferred shares have no stated maturity date and the stated maturity dates for these auction rate student loans range from 2035 to 2040.

During February 2008, the auctions for these auction rate securities began to fail to obtain sufficient bids to establish a clearing rate and were not saleable in the auction, thereby losing the short-term liquidity previously provided by the auction process. As a result, as of September 30, 2011, $3.7 million of these auction rate securities have been classified as long-term available-for-sale investments. Based on our assessment of fair value at September 30, 2011, we have recorded an accumulated unrealized loss of $0.1 million, net of deferred income taxes, on long-term auction rate securities. During the three months ended September 30, 2011 and 2010, $1.7 million and $0.9 million of these auction rate securities were redeemed at par, respectively.

Contractual Obligations

The following table describes our contractual obligations as of September 30, 2011: