-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OfQUyhQbM/MYoRbBhn0Nk4/zvHhVrXiB44Da2UTTLwH0VH4IA26QBCeGzFbZfq0N EX4XrybcxDF9lkhDOuhxvQ== 0001047469-98-035735.txt : 19980929 0001047469-98-035735.hdr.sgml : 19980929 ACCESSION NUMBER: 0001047469-98-035735 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980928 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SILICON GRAPHICS INC /CA/ CENTRAL INDEX KEY: 0000802301 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC COMPUTERS [3571] IRS NUMBER: 942789662 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10441 FILM NUMBER: 98716530 BUSINESS ADDRESS: STREET 1: 2011 N SHORELINE BLVD STREET 2: MS 6U-710 CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043-1389 BUSINESS PHONE: 4159601980 MAIL ADDRESS: STREET 1: 2011 N SHORELINE BLVD STREET 2: POST OFFICE BOX 7311 MS 6U-710 CITY: MOUNTAIN VIEW STATE: CA ZIP: 94043-1389 10-K 1 FORM 10-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K (Mark One) [X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the fiscal year ended June 30, 1998. [ ] 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 1-10441 SILICON GRAPHICS, INC. (Exact name of registrant as specified in its charter) DELAWARE 94-2789662 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 2011 NORTH SHORELINE BOULEVARD, MOUNTAIN VIEW, CALIFORNIA 94043-1389 (Address of principal executive offices and zip code) Registrant's telephone number, including area code: (650) 960-1980 ------------------------ Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED: - ------------------------------------ ----------------------------- Common Stock, $0.001 par value New York Stock Exchange Preferred Share Purchase Rights New York Stock Exchange 5 1/4% Senior Convertible Notes New York Stock Exchange
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the registrant's voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on September 1, 1998 on the New York Stock Exchange as reported in The Wall Street Journal, was approximately $1,461 million. Shares of voting stock held by each executive officer and director and by each person who owns 5% or more of any class of registrant's voting stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. AS OF SEPTEMBER 1, 1998, THE REGISTRANT HAD OUTSTANDING 186,062,597 SHARES OF COMMON STOCK. DOCUMENTS INCORPORATED BY REFERENCE Parts of the Proxy Statement for registrant's Annual Meeting of Stockholders to be held October 27, 1998 are incorporated by reference into Part III, and parts of the registrant's annual report to stockholders for the fiscal year ended June 30, 1998 are incorporated by reference into Parts I, II and IV of this Report on Form 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS GENERAL Silicon Graphics is a leader in high-performance computing. The Company's broad range of visual computing systems deliver advanced 3D graphics and computing capabilities for engineering and creative professionals. Silicon Graphics-Registered Trademark- servers and Cray-Registered Trademark- Research supercomputers are the market leaders in technical computing applications, with a growing presence in strategic business analysis, internet data center and media serving applications. The Company's Alias|Wavefront subsidiary markets applications software targeted at engineering and creative professionals in the digital content creation and manufacturing sectors. The Company's MIPS Technologies, Inc. subsidiary designs and licenses RISC processor intellectual property and core technology for the digital consumer and high-end control-oriented embedded markets. PRODUCTS The Company's computer systems range from desktop workstations to servers and supercomputers. Most of these systems are designed around MIPS-Registered Trademark- RISC microprocessors developed by the Company and the IRIX-TM- operating system, which is the Company's enhanced version of the UNIX operating system. VISUAL COMPUTING PRODUCTS Silicon Graphics desktop workstations combine key elements of workgroup collaboration, interactive media and computing at a range of prices and performance. Systems in this family can be used for tasks as diverse as manipulating 3D models for computer-aided design (CAD), crunching numbers for chemistry and geographic information systems applications, or functioning as a tool for video editing, animation rendering, technical publishing, World Wide Web and intranet authoring and serving, and software development. IRIX-BASED DESKTOP SYSTEMS The O2-TM- family of entry-level desktop workstations feature advanced 3D graphics and imaging, real-time video capability and interactive and professional quality graphics, audio and imaging capabilities. The O2 workstation has significant appeal in markets such as mechanical CAD, chemistry, color publishing, film and video, software development, education and media authoring. The Octane-TM- family of single and dual processor workstations is designed to provide the strongest graphics and computational capability available in the desktop category, for applications such as 3D solids modeling, mechanical CAD, digital prototyping, 3D visualization, animation, architectural design and professional audio and video production. ADVANCED GRAPHICS SYSTEMS The Onyx2-TM- family of graphics supercomputers uses multiple microprocessors and sophisticated graphics subsystems to handle the most demanding visual computing tasks. Graphics subsystems available with these servers include the Onyx2Reality-TM- and InfiniteReality-TM- graphics subsystems. The Onyx2 family is well-suited for applications such as computational chemistry, oil and gas research, molecular modeling, global weather modeling, structural dynamics, fluid dynamics, image processing, visual simulation, medical imaging and chemistry, interactive entertainment and digital film and video production. WINDOWS NT-BASED DESKTOP SYSTEMS The Company has announced it will introduce desktop visual computing workstations based on the Microsoft-Registered Trademark- Windows-Registered Trademark- NT operating system and Intel microprocessors in the first half of fiscal 1999. These systems are not expected to provide significant revenue until the second half of fiscal 1999. ALIAS/WAVEFRONT The Company's Alias|Wavefront division supplies modeling and animation application software used by creative professionals in the entertainment, industrial design and visualization and graphic design markets. Its industry-leading products run on the Windows NT and IRIX operating systems and include the Maya-TM- family of 3D entertainment products, StudioPaint 3D-TM-, and the Alias Studio-TM- and AutoStudio-TM- industrial design and visualization products. Alias|Wavefront is based in Toronto, Canada with sales offices across North America, Europe and Asia and worldwide distribution. SERVERS AND SUPERCOMPUTERS ORIGIN200 The Origin200-TM- is a deskside server employing from one to four processors. The Origin200 server is designed for departmental and other workgroup serving applications as well as Web serving. ORIGIN2000 The Origin2000-TM- family of high-performance servers is based on the Company's innovative cache coherent non-uniform memory access (ccNUMA) architecture, which offers the ability to scale from as few as four to as many as hundreds of processors while maintaining almost linear performance per processor. This "pay as you go" flexibility is highly attractive to customers because it allows them to buy what they need today, add as needed while protecting their investment, and redeploy when conditions change. Key applications in the technical and scientific markets include finite element analysis (to determine the impact of elements like stress and temperature), quantum chemistry calculation, seismic analysis and computational fluid dynamics. The Origin 2000 line is also targeted at certain enterprise segments that have bandwidth and computational requirements similar to those of the technical market. These "technical enterprise" markets include strategic business analysis (data mining to analyze and organize database information), internet data centers and digital asset management. The CRAY T3E-TM- highly scalable supercomputing systems employ a highly parallel architecture ranging from 16 to as many as 2,048 processors for a broad range of scientific and industrial applications as diverse as petroleum exploration, aerospace engineering and defense applications. VECTOR SYSTEMS The Cray T90-TM- series of supercomputers delivers maximum performance for vectorized supercomputing applications. The large memory bandwidth of T90 systems make them ideal for problems involving huge amounts of data, such as weather and climate modeling and large-scale auto engineering. The Cray SV1-TM- series introduced in August 1998 uses CMOS technology to deliver scalable supercomputing for vector applications, suitable for use by customers in manufacturing, government, and science and research for new product design, research, weather forecasting, national security and other critical applications. MIPS RISC MICROPROCESSORS The Company's system products, except the Cray T3E and vector supercomputers and the forthcoming Windows NT-based desktop systems, are based on the MIPS-Registered Trademark- RISC microprocessor architecture designed by the Company and its subsidiary MIPS Technologies, Inc. ("MTI"). The MIPS RISC microprocessor designs incorporate a general purpose architecture and instruction set designed for high performance over a wide range of applications. The MIPS RISC microprocessor designs make efficient use of instruction "pipelining" techniques and proprietary compilers, allowing -2- significant performance gains to be realized by optimizing the tradeoff between compiler and microprocessor functions. The versatility of the MIPS RISC architecture makes it suitable for computer applications from entry-level desktop systems up to supercomputers. However, the Company's computers represent only a small percentage of the worldwide consumption of MIPS RISC microprocessors. MIPS RISC microprocessors are also used in a wide variety of noncomputer applications, including disk drives, printers and copiers and, increasingly, in consumer electronics products such as video game systems, set-top boxes, digital cameras, and handheld computing devices running the Microsoft Windows CE operating system. In 1998, the Company organized MTI as an independent company focused on technology development and licensing for the digital consumer and embedded markets. As a result of the initial public offering of MTI shares in July 1998, Silicon Graphics owns about 85% of MTI. Silicon Graphics continues to develop MIPS microprocessors for its own computer systems as part of its computer systems organization. APPLICATIONS SOFTWARE Because the Company has historically developed only a very limited set of applications software, its customers must either develop or license from a third party the software necessary to address their needs. The Company maintains active programs to encourage independent software development for its systems, including training, technology support and cooperative marketing. The Company believes that there are currently over 2,600 registered application software programs offered for use on its systems. MARKETING, SALES AND DISTRIBUTION The Company sells its system products through its own direct sales force and through several indirect channels. In fiscal 1998 direct sales accounted for approximately half of the Company's product revenues. The direct sales and support organization operates throughout the United States and in all significant international markets. The Company serves smaller international markets through distributors. The principal indirect channels through which the Company operates are the following: - VARS, or value added resellers, are software companies that develop or customize their proprietary software specifically for use with the special graphics hardware of the Company's workstations. VARs purchase workstations from the Company or its North American distributor, incorporate their applications software and resell the systems to end-users. - VADS, or value added dealers, are typically direct sales organizations that sell primarily into a single vertical market and incorporate appropriate specialized third-party software with the Company's hardware for sale to their customers. - SYSTEMS INTEGRATORS include Silicon Graphics systems in much larger systems customized for use by the federal government and large commercial clients. Many of the Company's resellers are served through Access Graphics, an independent company that functions as a master reseller of the Company's system products. Information with respect to international operations and export sales may be found in Note 15 to the Consolidated Financial Statements incorporated by reference in Part II below. See also "Risks That Affect Our Business" below. Although no customer accounted for 10% or more of the Company's total revenues for fiscal 1998, 1997 or 1996, a significant reduction or delay in sales to major customers -3- could adversely affect the Company's operating results. CUSTOMER SERVICE AND SUPPORT The Company believes that the quality and reliability of its system products and the ongoing support of such products are important elements of its competitive strategy. The Company's customer service organization includes field service engineers, field product and applications specialists, product support engineers, training specialists and administrative support personnel. In addition, the Company provides customer education through regularly scheduled courses in system software administration, applications programming and hardware maintenance. The Company provides local customer support from its regional sales and service offices located in North America, Western Europe and the Pacific Rim, with spare parts inventory stored at each location. International distributors provide training and support for products sold by them. The Company typically provides a standard "return to factory" hardware warranty against defects in materials and workmanship for periods of up to one year. PROFESSIONAL SERVICES The Company believes that its future success, particularly in the server sector, will depend in part on its ability to offer a wider variety of solutions-oriented services, including consulting, custom engineering and systems integration services. The Company's efforts to date in this area have been small in scale and have not materially contributed to revenues. However, the Company expects over time to increase its investment in professional services. RESEARCH AND DEVELOPMENT The Company's research and development program is directed principally toward maintaining and enhancing the Company's competitive position through incorporating the latest advances in microprocessor, hardware, software and networking technologies. This effort is focused specifically on developing and enhancing its computing architectures, graphics subsystems, compiler software, operating system, applications software and development tools. Simultaneously, the Company seeks to develop new ways in which to increase product reliability, reduce manufacturing costs and improve product development lead times. As the evolution to industry-standard instead of proprietary components continues, the Company's ability to focus its research and development investments in areas where it has specific competencies for innovation will become increasingly important. There are no assurances that the Company will be able to sufficiently focus its development efforts or that its investments will yield sufficient differentiation to achieve and sustain a competitive advantage. During fiscal 1998, 1997 and 1996, the Company spent approximately $459 million, $479 million, and $353 million, respectively, on research and development. Those amounts represented 14.8%, 13.1%, and 12.1%, respectively, of revenues. The Company is committed to continuing innovation and differentiation and as a result will most likely continue to make research and development investments that are above average for the computer industry as a percentage of revenues. MANUFACTURING The Company's manufacturing operations primarily involve assembling high level subassemblies and systems and testing major purchased subassemblies. All products are subjected to substantial environmental stress and electronic testing prior to shipment to customers. -4- The Company primarily manufactures and ships its products from its facilities in Mountain View and Sunnyvale, California, Chippewa Falls, Wisconsin and near Neuchatel, Switzerland. During the latter half of fiscal 1998, the Company reviewed its manufacturing strategy for the next several years and decided to consolidate its manufacturing operations in its existing facilities in two locations: Wisconsin and Switzerland. During calendar 1999, both of these facilities will transition to an exclusive focus on servers, advanced graphics systems and supercomputers. The Company plans to transition the manufacture of its desktop systems to contract manufacturing partners during calendar 1999. The Company continually evaluates the allocation of manufacturing activities among the Company's own operations and those of suppliers and subcontractors. This allocation may be affected by fluctuations in the volume of business, geopolitical, economic and technological developments and other factors. Most of the Company's products incorporate components that are available from only one or limited sources. Key components include application specific integrated circuits ("ASICs"), storage products, especially RAID-based products, and certain memory products. Reliance on single or limited source vendors involves several risks, including the possibility of a shortage of certain key components that meet the Company's product specifications. Risks also include long lead times, reduced control over delivery schedules, and the possibility of charges for excess and obsolete inventory. The Company also has single sources for certain peripherals, communications controllers and power supplies, and the monitors and plastic cabinets used across the Company's system products. The Company believes that, in most of these cases, alternative sources of supply could be developed over a period of time. However, a reduction or interruption in supply or a significant increase in the price of one or more single or limited source components would, at least in the short term, adversely affect the Company's operating results. Many of the Company's suppliers are located outside the United States, especially in Japan. The prices of parts from these suppliers have been and may be affected significantly by such factors as protectionist measures and changes in currency exchange rates between the United States and other countries. In addition, changes in the availability of certain memory chips (DRAMs, SRAMs and VRAMs) have caused, and in the future may cause, significant changes in their prices. COMPETITION The computer industry is highly competitive and is characterized by rapid technological advances in both hardware and software development. These advances result in frequent new product introductions, short product life cycles and increased new product capabilities, typically representing significant price/performance improvements. The principal competitive factors in the Company's market are product features, price/performance, networking capabilities, product quality and reliability, ease of use, capabilities of the system software, availability of applications software, customer support, product availability, corporate reputation and price. The strong competition faced throughout the Company's product line can result in significant discounting from list price. The Company's principal competition has historically come from other workstation and computer system manufacturers and, to a lesser extent, from graphics subsystem and terminal vendors and graphics integrated circuit manufacturers. The principal workstation and computer manufacturers that compete in the Company's markets are Compaq, Dell Computer, Hewlett Packard, IBM and Sun Microsystems. The Company is facing increasing competition at the lowest end of the workstation market from systems based on personal computer technologies such as the -5- Windows NT operating system, Intel microprocessors and graphics acceleration cards. In the high end of the supercomputer market, the Company faces competition from IBM as well as from NEC, Hitachi and Fujitsu. PROPRIETARY RIGHTS AND LICENSES The Company has been granted or has applications pending for a significant number of U.S. patents, and will continue to seek patent coverage for its inventions in both the United States and foreign countries. The Company also has applied for and holds various trademark registrations in the United States and in selected foreign countries. The Company will continue to seek protection for its inventions, trademarks, maskworks and copyrights where appropriate. As is customary in its industry, the Company licenses from third parties a wide range of software for its internal use and for the use of its customers. The Company licenses the UNIX operating system on a non-exclusive basis from Novell, Inc., and sublicenses it to its customers. The Company's ability to compete may be affected by its ability to protect proprietary information and to obtain necessary licenses on commercially reasonable terms. The extent to which U.S. and international intellectual property laws protect the Company's products, and the enforceability of end-user license agreements, have not been fully determined, and the computer industry has seen a substantial increase in litigation with respect to intellectual property matters. Such litigation or changes in the interpretation of intellectual property laws could expand or reduce the extent to which the Company or its competitors are able to protect their intellectual property or require changes in the design of products which could have an adverse impact on the Company. The Company has several intellectual property lawsuits pending against it today. There can be no assurance that the Company will not be made a party to significant litigation regarding intellectual property matters in the future. See "Legal Proceedings." RISKS THAT AFFECT OUR BUSINESS Silicon Graphics operates in a rapidly changing environment that involves a number of risks, some of which are beyond the Company's control. The following discussion highlights some of these risks. BUSINESS TRANSITION. Two of the principal market sectors in which the Company competes -- UNIX workstations and vector supercomputers -- have declined over the past year, and the Company believes that these declines represent long-term trends. The Company's goal is to transition an increasing proportion of its revenues to growing markets, including Intel-Registered Trademark--based Windows NT workstations and UNIX based scalable servers such as the Company's Origin server product family. The Company's ability to achieve its revenue objectives over the next several quarters will largely depend on the extent to which growth in the Origin family and (beginning in the second half of fiscal 1999) Windows NT workstation products compensates for the expected decline in the other market sectors. In April 1998, the Company made a series of announcements concerning its strategic plans for the next several years. Key elements of the strategy include a continued focus on the technical and technical enterprise markets, with a product roadmap that will, over the next several years, merge the Company's vector supercomputer and scalable server families. The Company also announced an alliance with Intel Corporation that will result in the Company's transition to the Intel microprocessor architecture. While the Company believes that its strategies will result in its return to growth and profitability, the effects will not be reflected in any significant way in the Company's results until the latter half of fiscal 1999, and may not be fully reflected until fiscal 2000. -6- DESKTOP SYSTEM STRATEGY. The Company has under development a family of desktop systems that will be based upon Intel microprocessors and the Windows NT operating system. There can be no assurance that these systems will be introduced as scheduled in the first half of fiscal 1999, and in any event they will not account for any significant revenue before the latter half of fiscal 1999. Success in this market segment will require that the Company adapt to very different requirements: high volume, lower margins, low-cost manufacturing and distribution, marketing to a broader audience, and new approaches to customer interface and support. The Company will also be required to maintain and extend its customer relationships through a complex product transition and to support a product line which includes multiple operating systems. In particular, although the Company plans to continue to invest in and support its current line of UNIX/MIPS-based workstations, there is a risk that revenue from this business will be materially reduced by the announcement of the new product family. The Company believes that its future success will largely depend on its making the right strategic choices in this market segment and on effective execution. SERVER STRATEGY. Sustaining growth in the Company's scalable server business is an important element of its strategic plans for the next several years. Sustained growth will require, among other things, adapting to a longer sales cycle and the need to deliver more complete solutions, establishing a presence in emerging enterprise markets in which the Company has not traditionally participated, working effectively with independent software providers to ensure that important applications for the market segments targeted by the Company are available on the Company's platform, and ultimately, managing a successful and timely transition to the Intel architecture. EXPENSE REDUCTION PROGRAM. During fiscal 1998, the Company announced and began to implement a restructuring program aimed at bringing its expenses more in line with current revenue levels and restoring long-term profitability to the Company. The Company is seeking to further reduce its fiscal 1999 operating expenses significantly below the level of fiscal 1998 operating expenses. As part of this effort, the Company expects, through the elimination of positions and managed hiring, to end fiscal 1999 with approximately 1,000 fewer employees than it had at the end of fiscal 1998. These steps, and generally tighter operating expense controls, are part of an overall program to reduce the Company's expense structure. While the Company's objective is to reduce its costs in ways that will not have a material impact on revenue levels, there can be no assurance that this will be achieved. DEPENDENCE ON PARTNERS AND SUPPLIERS. The Company's business has always involved close collaboration with partners and suppliers. However, many elements of the Company's current business strategy, including the introduction of Intel-based Windows NT workstations, the longer-term transition to the Intel architecture, and additional outsourcing of manufacturing, will increase the Company's dependence on Microsoft, Intel and other partners, and on its manufacturing partners and other component suppliers. The Company's business could be adversely affected, for example, if Intel or Microsoft fail to meet product release schedules, or if unanticipated quality issues arise with products from these suppliers. PERIOD TO PERIOD FLUCTUATIONS. The Company's operating results may fluctuate for a number of reasons. Delivery cycles are typically short, other than for supercomputer and certain large-scale server products. Well over half of each quarter's revenue results from orders booked and shipped during the third month, and disproportionately in the latter half of that month. These factors make the forecasting of revenue inherently uncertain. Because the Company plans its operating expenses, many of which are relatively fixed in the short term, on expected revenue, even a relatively small revenue shortfall may cause a period's results to be substantially below expectations. Such a revenue shortfall could arise from any number of factors, including lower than expected demand, supply constraints, delays in the availability of new products, transit interruptions, overall economic conditions or natural disasters. Demand can also be adversely affected by product and technology transition announcements by the Company or its competitors. The timing of customer acceptance of certain large-scale server products may also have a significant effect on periodic operating results. -7- Margins are heavily influenced by mix considerations, including geographic concentrations, the mix of product and service revenue, and the mix of server and desktop product revenue including the mix of configurations within these product categories. The Company's results have followed a seasonal pattern, with stronger sequential growth in the second and fourth fiscal quarters, reflecting the buying patterns of the Company's customers. The Company's stock price, like that of other technology companies, is subject to significant volatility. If revenue or earnings in any quarter fail to meet the investment community's expectations, there could be an immediate impact on the Company's stock price. The stock price may also be affected by broader market trends unrelated to the Company's performance. PROCESS RE-ENGINEERING. The Company is undertaking a series of programs aimed at redesigning some of its core business processes, including forecasting, supply chain management, order fulfillment and collection of accounts receivable. The goals of these programs include more predictable operational performance, lower operating expenses, greater quality and customer satisfaction, and improved asset management. The Company believes that the success of these programs is critical to its long-term competitive position. Implementing these changes will require, among other things, enhanced information systems, substantial training and disciplined execution. There can be no assurance that these programs will be implemented successfully, or that disruptions to the Company's operations will not occur in the process. PRODUCT DEVELOPMENT AND INTRODUCTION. The Company's continued success depends on its ability to develop and rapidly bring to market highly differentiated, technologically complex and innovative products. Product transitions are a recurring part of the Company's business. A number of risks are inherent in this process. The development of new technology and products is increasingly complex and uncertain, which increases the risk of delays. The introduction of a new computer system requires close collaboration and continued technological advancement involving multiple hardware and software design teams, internal and external manufacturing teams, outside suppliers of key components such as semiconductor and storage products and outsourced manufacturing partners. The failure of any one of these elements could cause the Company's new products to fail to meet specifications or to miss the aggressive timetables that the Company establishes. There is no assurance that acceptance of the Company's new systems will not be affected by delays in this process. Short product life cycles place a premium on the Company's ability to manage the transition to new products. The Company often announces new products in the early part of a quarter, while the product is in the final stages of development, and seeks to manufacture and ship the product in volume during the same quarter. The Company's results could be adversely affected by such factors as development delays, the release of products to manufacturing late in any quarter, quality or yield problems experienced by suppliers, variations in product costs and excess inventories of older products and components. In addition, some customers may delay purchasing existing products in anticipation of new product introductions. YEAR 2000 COMPLIANCE Many computer systems and applications experience problems handling dates beyond the year 1999 and will need to be modified before the year 2000 in order to remain functional As for many other companies, the year 2000 computer issue poses a potential risk for the Company both as a user of information systems in the operation of its business and as a supplier of computer systems and related software, including operating system software, to customers. The Company has completed an assessment of its core business information systems, many of which are provided by outside suppliers, for year 2000 readiness and is extending that review to -8- include a wide variety of other information systems and related business processes used in its operations. The Company plans to have changes to critical systems implemented by the third quarter of calendar 1999 to allow time for testing. Most of the Company's mission critical applications are believed to be year 2000 compliant, including the Company's Oracle information system which was recently upgraded to the most recent version. Although its assessment is ongoing, the Company currently believes that resolving these matters will not have a material adverse effect on its financial condition or results of operations. The Company is implementing a program to support customer efforts to achieve year 2000 compliance. This program includes encouraging customers and independent software vendors to adopt the Company's recently released IRIX 6.5 operating system, which the Company believes is year 2000 compliant, and additional customer support procedures. The Company also has made available software upgrades for some earlier releases of its IRIX operating system. The Company believes that the hardware systems it expects to support beyond 1999, when running on compliant operating systems, will be year 2000 compliant. The Company's older products may require upgrade or replacement to become year 2000 compliant. The Company believes that it generally is not legally responsible for costs incurred by customers to achieve their year 2000 compliance. However, the Company may experience increasing customer satisfaction costs relating to this issues over the next few years. The Company is also assessing the possible effect on its operations of the year 2000 readiness of critical suppliers of products and services. The Company's reliance on its key suppliers, and therefore on the proper functioning of their information systems and software, is increasing, and there can be no assurance that another company's failure to address year 2000 issues could not have an adverse effect on the Company. The Company expects to complete a preliminary estimate of year 2000 project costs during the first half of fiscal 1999. The Company believes that it is unlikely to experience a material adverse impact on its financial condition or results of operations due to year 2000 compliance issues. However, since the assessment process is ongoing, year 2000 complications are not fully known, and potential liability issues are not clear, the full potential impact of the year 2000 on the Company is not known at this time. COMPETITION. The computer industry is highly competitive, with rapid technological advances and constantly improving price/performance. Most of the Company's competitors have substantially greater technical, marketing and financial resources and, in some segments, a larger installed base of customers and a wider range of available applications software. Competition may result in significant discounting and lower gross margins. IMPACT OF GOVERNMENT CUSTOMERS. A significant portion of the Company's revenue is derived from sales to the U.S. government, either directly by the Company or through system integrators and other resellers. Sales to the government present risks in addition to those involved in sales to commercial customers, including potential disruptions due to appropriation and spending patterns and the government's reservation of the right to cancel contracts for its convenience. EXPORT REGULATION. The Company's sales to foreign customers are subject to export regulations. Sales of many of the Company's high-end products require clearance and export licenses from the U.S. Department of Commerce under these regulations. The Department of Commerce is currently investigating the Company's compliance with the export regulations in connection with the sale of several computer systems to a customer in Russia during fiscal 1997. The Company believes that this matter will be resolved without a significant adverse effect on the Company's business. However, there is no assurance that this matter will not have an unforeseen outcome that could impair the conduct of the Company's business outside the United States. -9- The Company's international sales would also be adversely affected if such regulations were tightened, or if they are not modified over time to reflect the increasing performance of the Company's products. INTELLECTUAL PROPERTY. The Company routinely receives communications from third parties asserting patent or other rights covering the Company's products and technologies. Based upon the Company's evaluation, it may take no action or it may seek to obtain a license. In any given case there is a risk that a license will not be available on terms that the Company considers reasonable, or that litigation will ensue. The Company currently has patent infringement lawsuits pending against it. The Company expects that, as the number of hardware and software patents issued continues to increase, and as competition in the markets addressed by the Company intensifies, the volume of these intellectual property claims will also increase. EMPLOYEES. The Company's success depends on its ability to continue to attract, retain and motivate highly qualified technical, marketing and management personnel, who are in great demand. The current uncertainties surrounding the Company have increased the challenges of retaining world-class talent. BUSINESS DISRUPTION. The Company's corporate headquarters, including most of its research and development operations and manufacturing facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity. A significant earthquake could materially affect operating results. The Company is not insured for most losses and business interruptions of this kind. EURO CONVERSION. As with many multinational companies operating in Europe, beginning in January 1999, Silicon Graphics will be affected by the conversion of 11 European currencies into a common business currency, the euro. Based on its preliminary assessment, the Company does not believe the conversion will have a material impact on the competitiveness of its products in Europe, where there already exists substantial price transparency, or increase the likelihood of contract cancellations. The Company also believes its current accounting systems will accommodate the euro conversion with minimal intervention and does not expect to experience material adverse tax consequences as a result of the conversion. The convergence of currencies into the euro is expected to reduce the Company's overall currency risk and simplify the Company's currency risk management process, including its use of derivatives to manage that risk. The costs of addressing the euro conversion are not expected to be material and will be charged to operations as incurred. MARKET RISK. In the normal course of business, the financial position of the Company is routinely subjected to a variety of risks, including market risk associated with interest rate movements and currency rate movements on non-U.S. dollar denominated assets and liabilities, as well as collectibility of accounts receivable. The Company regularly assesses these risks and has established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, the Company does not anticipate material losses in these areas. For purposes of specific risk analysis, the Company uses sensitivity analysis to determine the impacts that market risk exposures may have on the fair values of the Company's debt and financial instruments. The financial instruments included in the sensitivity analysis consist of all of the Company's cash and cash equivalents, marketable investments, short-term and long-term debt and all derivative financial instruments. Currency forward contracts and currency options constitute the Company's portfolio of derivative financial instruments. To perform sensitivity analysis, the Company assesses the risk of loss in fair values from the impact of hypothetical changes in interest rates and foreign currency exchange rates on market sensitive instruments. The market values for interest risk are computed based on the present value of future -10- cash flows as impacted by the changes in rates attributable to the market risk being measured. The discount rates used for the present value computations were selected based on market interest rates in effect at June 30, 1998 and 1997. The market values for foreign exchange risk are computed based on spot rates in effect at June 30, 1998 and 1997. The market values that result from these computations are compared to the market values of these financial instruments at June 30, 1998 and 1997. The differences in this comparison are the hypothetical gains or losses associated with each type of risk. The results of the sensitivity analysis at June 30, 1998 and 1997 are as follows: Interest Rate Risk: A 10% decrease in the levels of interest rates with all other variables held constant would result in a decrease in the fair values of the Company's financial instruments by $14 million and $3 million, respectively. A 10% increase in the levels of interest rates with all other variables held constant would result in an increase in the fair values of the Company's financial instruments by $12 million and $3 million, respectively. Foreign Currency Exchange Rate Risk: A 10% movement in levels of foreign currency exchange rates, 20% for Asian currencies, against the U.S. dollar with all other variables held constant would result in a decrease in the fair values of the Company's financial instruments by $14 million and $44 million, respectively, or an increase in the fair values of the Company's financial instruments by $12 million and $34 million, respectively. EMPLOYEES As of June 30, 1998, the Company had approximately 10,286 full-time employees, as compared to approximately 10,930 at June 30, 1997. The Company's future success will depend, in part, on its ability to continue to attract, retain and motivate highly qualified technical, marketing and management personnel, who are in great demand. The Company has never had a work stoppage, and no employees are represented by a labor union. The Company has workers' councils where required by European Union or other applicable laws. The Company believes that its employee relations are good. CORPORATE DATA The Company was originally incorporated as a California corporation in November 1981, and reincorporated as a Delaware corporation in January 1990. ITEM 2. PROPERTIES The Company believes that, while it currently has or is developing sufficient facilities to conduct its operations during fiscal 1999, it will continue to acquire both leased and owned facilities throughout the world as its business requires. The Company leases sales, service and administrative offices worldwide and has its principal corporate and manufacturing facilities in the following locations: CALIFORNIA The Company's corporate offices and its primary research and development and manufacturing operations are located in Mountain View, California, where the Company leases or owns a total of about 1,923,000 square feet. These facilities include a ten-building campus facility of about 726,500 square feet, leased by the Company through the years 2000 to 2005; a four-building, 500,000 square foot campus facility completed in fiscal 1997 on 22 acres of leased land in the same area; and a sales headquarters building comprising approximately 112,000 square feet and located on 7.5 acres owned by the Company near its Mountain View headquarters. The Company also leases eleven other buildings near its Mountain View headquarters, comprising approximately 585,000 square feet. The Company is currently developing a general purpose office facility of about -11- 400,000 square feet on leased land in the same area. MINNESOTA AND WISCONSIN The Company also owns manufacturing, research and development and service facilities of about 595,000 square feet in Chippewa Falls, Wisconsin and research and development, sales and administrative facilities of about 495,000 square feet in Eagan, Minnesota. SWITZERLAND The Company's European manufacturing and support center near Neuchatel, Switzerland is located in a facility owned by the Company, consisting of about 170,000 square feet. ITEM 3. LEGAL PROCEEDINGS The Company is defending the lawsuits described below. The Company believes that it has good defenses to the claims in each of these lawsuits and is defending each of them vigorously. The Company is defending putative securities class action lawsuits filed in the U.S. District Court for the Northern District of California (the "Northern District") and in California Superior Court for the County of Santa Clara in December 1997 and January 1998 alleging that the Company and certain of its officers made material misrepresentations and omissions during the period from July to October 1997. The Company is also defending a securities class action lawsuit filed in January 1996 in the Northern District of California alleging that the Company and certain of its officers and directors made material misrepresentations and omissions during the period from September to December 1995. The lawsuit was dismissed with prejudice by the District Court in May 1996. The plaintiffs' appeal to the U.S. Court of Appeals for the Ninth Circuit is pending. The Company is also defending a securities class action lawsuit involving MIPS Computer Systems, Inc., ("MCSI") which the Company acquired in June 1992. The MCSI case, which was filed in 1992 in the Northern District of California, alleges that MCSI and certain of its officers and directors made material misrepresentations and omissions during the period from January to October of 1991. In September 1996, the U.S. Court of Appeals for the Ninth Circuit reversed the summary judgment granted in defendants' favor in June 1994. In October 1997, the defendants' petition for review by the U.S. Supreme Court was denied. The case is presently pending before the District Court. A trial date for the lawsuit is currently set for March 1999. The Company also is defending a securities class action lawsuit involving Alias Research Inc., which the Company acquired in June 1995. The Alias case, which was filed in 1991 in the U.S. District Court for the District of Connecticut, alleges that Alias and certain of its former officers and directors made material misrepresentations and omissions during the period from May 1991 to April 1992. In October 1997, the defendants' motion to dismiss the amended complaint was granted. The plaintiffs' appeal to the U.S. Court of Appeals for the Second Circuit is pending. The Company was also defending a patent infringement lawsuit filed by Martin Marietta Corp. in the U.S. District Court for the Middle District of Florida in September 1995. The Company had filed a counterclaim seeking to invalidate the principal patent at issue in the lawsuit and the U.S. Patent and Trademark Office is re-examining the patent at Martin Marietta's request. In July 1998, the lawsuit was dismissed pursuant to a joint notice of settlement. The Company routinely receives communications from third parties asserting patent or other rights covering the Company's products and technologies. Based upon the Company's evaluation, it may take no action or it may seek to obtain a license. There can be no assurance in any given case that a license will be available on terms the Company considers reasonable, or that litigation will not ensue. -12- Management is not aware of any pending disputes, including those described above, that would be likely to have a material adverse effect on the Company's financial condition, results of operations or liquidity. However, management's evaluation of the likely impact of these pending disputes could change in the future. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company and their ages as of July 1, 1998 are as follows:
EXECUTIVE OFFICER NAME AGE POSITION AND PRINCIPAL OCCUPATION SINCE ---- --- --------------------------------- --------- Richard E. Belluzzo 44 Chairman, Chief Executive Officer and Director 1998 Keith H. Watson 43 Executive Vice President, Worldwide Sales and 1998 Marketing Kenneth L. Coleman 55 Senior Vice President, Customer and Professional 1987 Services Steven J. Gomo 46 Senior Vice President, Chief Financial Officer 1998 William M. Kelly 44 Senior Vice President, Corporate Operations and 1994 Secretary Betsy Rafael 37 Vice President, Corporate Controller 1998
Executive officers of the Company are elected annually by the Board of Directors and serve at the Board's discretion. There are no family relationships among any directors, nominees for director or executive officers of the Company. Except as set forth below, all of the officers have been associated with the Company in their present positions for more than five years. Mr. Belluzzo was appointed Chairman and Chief Executive Officer of the Company in January 1998. Prior to that, he was employed by the Hewlett-Packard Company for twenty-two years, serving since 1995 as Executive Vice President and General Manager of the computer organization. From 1993 to 1995, Mr. Belluzzo was General Manager of the Computer Products Organization and he served as General Manager of the InkJet Products Group from 1991 to 1993. He was elected a Vice President in 1992 and a Senior Vice President in January 1995. Mr. Watson joined the Company in April 1998 as Executive Vice President, Worldwide Sales and Marketing. Prior to joining the Company, he was employed for 19 years by the Hewlett-Packard Company where he served most recently as Vice President and General Manager, Worldwide Commercial Channels Organization. Prior to June 1996, he was General Manager of Asia Pacific in the Computer Products Organization. Mr. Coleman assumed his current responsibilities in 1997. From 1987 to 1997 he served as Senior Vice President, Administration of the Company. Mr. Gomo joined the Company in February 1998 as Senior Vice President and Chief Financial Officer. Prior to that, he was employed by the Hewlett-Packard Company serving most recently as the General Manager of its InkJet Manufacturing Operations. -13- Mr. Kelly assumed his current responsibilities in 1997 and served as acting Chief Financial Officer from May 1997 to February 1998. He joined the Company in 1994 as Vice President, Business Development, General Counsel and Secretary. During 1996, Mr. Kelly also served as Senior Vice President, Silicon Interactive Group. Prior to joining the Company, Mr. Kelly had practiced law since 1978 with the firm of Shearman & Sterling, most recently as co-managing partner of that firm's San Francisco office. Ms. Rafael became Vice President, Corporate Controller in May 1998. She joined the Company in November 1994 and served in a variety of capacities in the North American field organization. Prior to joining the Company, Ms. Rafael was employed by Sun Microsystems in the SunService Division. -14- PART II With the exception of the information specifically incorporated by reference from the Company's 1998 Annual Report to Stockholders (the "1998 Annual Report") in Parts I, II and IV of this Form 10-K, the 1998 Annual Report is not to be deemed filed as part of this Report. ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this Item is incorporated by reference to the section entitled "Price Range of Common Stock" on page 24 of the Company's 1998 Annual Report. ITEM 6. SELECTED FINANCIAL DATA The information required by this Item is incorporated by reference to the section entitled "Selected Consolidated Financial Data" on page 23 of the Company's 1998 Annual Report. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this Item is incorporated by reference to the section entitled "Management's Discussion and Analysis" on pages 25 through 34 of the Company's 1998 Annual Report. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information required by this Item is incorporated by reference to the section entitled "Management's Discussion and Analysis - Risks That Affect Our Business - Market Risk" on page 34 of the Company's 1998 Annual Report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item is incorporate by reference to the consolidated financial statements and notes thereto and to the section entitled "Quarterly Data" on pages 24 and 35 through 57 of the Company's 1998 Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. -15- PART III Certain information required by Part III is omitted from this Report in that the Company has filed its definitive proxy statement pursuant to Regulation 14A (the "1998 Proxy Statement") not later than 120 days after the end of the fiscal year covered by this Report, and certain information included therein is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information concerning the Company's directors required by this Item is incorporated by reference to the information set forth in the 1998 Proxy Statement on pages 3 and 4 under the heading "Proposal No. 1 - Election of Directors - Directors and Nominee for Director." The information concerning executive officers and family relationships required by this Item is incorporated by reference to the section in Part I hereof entitled "Executive Officers of the Registrant." The information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, required by this Item is incorporated by reference to information set forth on page 15 of the 1998 Proxy Statement under the heading "Executive Officer Compensation - Compliance with Section 16(a) of the Exchange Act." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to information set forth in the 1998 Proxy Statement on page 5 under the headings "Proposal No. 1 - Election of Directors - Compensation Committee Interlocks and Insider Participation" and "- Director Compensation"; on pages 13 through 15 under the headings "Executive Officer Compensation - Summary Compensation Table", "- Option Grants in Fiscal 1998" and "- Option Exercises in Fiscal Year 1998 and Fiscal Year-End Option Values"; on pages 10 through 12 under the heading "Report of the Compensation and Human Resources Committee of the Board of Directors"; and on page 18 under the heading "Company Stock Price Performance Graph". ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to the information set forth in the 1998 Proxy Statement on pages 1 and 2 under the headings "Information Concerning Solicitation and Voting - Record Date and Principal Share Ownership" and "- Voting and Solicitation" and on page 9 under the heading "Other Information - Security Ownership of Management." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference to the information set forth in the 1998 Proxy Statement on pages 15 through 17 under the heading "Certain Transactions." -16- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this Report: 1. FINANCIAL STATEMENTS. The following consolidated financial statements and supplementary information of Silicon Graphics, Inc., and Report of Independent Auditors are incorporated by reference to pages 24 and 35 through 58 of the Registrant's 1998 Annual Report: Consolidated Statements of Operations - Years Ended June 30, 1998, 1997 and 1996 Consolidated Balance Sheets - June 30, 1998 and 1997 Consolidated Statements of Cash Flows - Years Ended June 30, 1998, 1997 and 1996 Consolidated Statements of Stockholders' Equity - Years Ended June 30, 1998, 1997 and 1996 Notes to Consolidated Financial Statements Report of Independent Auditors SUPPLEMENTARY INFORMATION Quarterly Data (Unaudited) 2. FINANCIAL STATEMENT SCHEDULES. The following financial statement schedule of Silicon Graphics, Inc. is filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Silicon Graphics, Inc.
Schedule Description Page - -------- ----------- ---- II Valuation and Qualifying Accounts S-1
Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the consolidated financial statements or notes thereto. 3. EXHIBITS. The following Exhibits are filed as part of, or incorporated by reference into, this Report: 3.1.1(9) Restated Certificate of Incorporation of the Company. 3.1.2(13) Certificate of Designation of the Series E Preferred Stock filed June 13, 1995. 3.2(16) Bylaws of the Company, as amended. 4.1(5) Amended and Restated Preferred Shares Rights Agreement, dated as of May 6, 1992 between the Company and The First National Bank of Boston, including the Certificate of Designation of Rights, Preferences and Privileges of Series B Participating Preferred Stock, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C respectively. 4.4(10) First Amendment to Rights Agreement dated as of May 2, 1995 between the -17- Company and The First National Bank of Boston. 4.3(9) Indenture dated November 1, 1993 between the Company and The First National Bank of Boston, as Trustee. 4.4(16) Indenture dated February 1, 1986 between Cray Research, Inc. and Manufacturers Hanover Trust Company, as Trustee. 4.5(16) First Supplemental Indenture dated June 30, 1996 between the Company, Cray Research, Inc., and Chemical Bank (formerly Manufacturers Hanover Trust Company). 4.6(20) Indenture dated as of September 1, 1997 between the Company and State Street Bank and Trust Company of California, N.A., as Trustee. 9.1(13) Voting and Exchange Trust Agreement between the Company and Montreal Trust Company of Canada dated June 15, 1995. 10.1(1) Software Agreement dated as of January 4, 1986, as supplemented June 6, 1986, and Sublicensing Agreement dated as of June 9, 1986 between the Company and AT&T Information Systems Inc. 10.2(2) Software License Agreement dated January 24, 1986, between the Company and AT&T Information Systems Inc. 10.3(3) Stock Purchase Agreement dated March 2, 1990 among the Company, NKK Corporation and NKK U.S.A. Corporation. 10.4(6) Exchange Agreement dated August 14, 1992 among the Company, NKK Corporation and NKK U.S.A. Corporation. 10.5(6) Form of Indemnification Agreement entered into between the Company and its directors, executive officers and certain other agents. 10.6(6) Form of Indemnification Agreement entered into between the Company and its directors, executive officers and certain other agents. (Revised) 10.7(22)* Form of Employment Continuation Agreement entered into between the Company and its executive officers, as amended and restated as of November 14, 1997. 10.8(22)* Form of Agreement entered into by the Company with its executive officers, dated as of November 14, 1997. 10.9(21)* Promissory Note dated June 18, 1997 issued to the Company by William M. Kelly. 10.10* Consulting Agreement dated June 30, 1998 between the Company and Robert H. Ewald. 10.11(22)* Agreement dated as of December 31, 1997 between the Company and Edward R. McCracken. 10.12(22)* Agreement dated as of January 22, 1998 between the Company and Richard E. Belluzzo. 10.13(23)* Amendment and Waiver dated as of April 20, 1998 to Agreement between the Company and Richard E. Belluzzo 10.14(19)* 1984 Incentive Stock Option Plan, as amended, and amended form of Incentive Stock Option Agreement. 10.15(9)* Directors' Stock Option Plan and form of Stock Option Agreement as amended -18- as of October 31, 1994. 10.16(6)* 1985 Stock Incentive Program. 10.17(6)* 1986 Incentive Stock Option Plan, as amended, and amended forms of Incentive Stock Option Agreement and Nonstatutory Stock Option Agreement. 10.18(4)* 1987 Stock Option Plan and form of Stock Option Agreement. 10.19(15)* Amended and Restated 1989 Employee Benefit Stock Plan and form of stock option agreement. 10.20(7)* 1993 Long-Term Incentive Stock Plan and form of stock option agreement. 10.21(14)* 1996 Supplemental Non-Executive Equity Incentive Plan and form of stock option agreement. 10.22(17)* Employee Stock Purchase Plan, as amended as of October 30, 1996. 10.23(8)* Non-Qualified Deferred Compensation Plan dated as of September 9, 1994. 10.24(19)* Addendum to the Non-Qualified Deferred Compensation Plan. 10.25(14) Credit Agreement dated as of April 12, 1996 between the Company and Bank of America, National Trust and Savings Association. 10.26(13) Ground Lease between Silicon Graphics Real Estate Inc. and the City of Mountain View dated March 7, 1995. 10.27(13) Agreement for Lease between the Company and Virtual Funding, Limited Partnership dated November 18, 1993. 10.28(13) Amendment No. 1 to Agreement for Lease between the Company and Virtual Funding, Limited Partnership dated March 15, 1995. 10.29(13) Lease Agreement between the Company and Virtual Funding, Limited Partnership dated November 18, 1993. 10.30(13) Amendment No. 1 to Lease Agreement between the Company and Virtual Funding, Limited Partnership dated March 15, 1995. 10.31(18) Guaranty from the Company to Virtual Funding Limited Partnership dated as of November 18, 1993. 10.32(18) Amendment No. 1 to Guaranty from the Company to Virtual Funding, Limited Partnership dated as of March 15, 1995. 10.33(18) Amendment No. 2 to Guaranty from the Company to Virtual Funding Limited Partnership dated as of March 7, 1997. 10.34(11)* Alias Research Inc.'s 1988 Employee Share Ownership Plan Option Agreement. 10.35(11)* Alias Research Inc.'s 1989 Employee Share Ownership Plan Option Agreement. 10.36(11)* Alias Research Inc.'s 1990 Employee Share Ownership Plan and standard forms of Option Agreements. 10.37(11)* Alias Research Inc.'s 1994 Stock Plan and standard forms of Option Agreements. 10.38(12)* Wavefront Technologies, Inc. 1990 Stock Option Plan with standard form of Option Agreement. -19- 10.39(15)* Cray Research, Inc. 1989 Non-Employee Directors' Stock Option Plan and form of stock option agreement. 13.1 Excerpts from Annual Report for the year ended June 30, 1998. 21.1 List of Subsidiaries. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 27.1 Financial Data Schedule.
- ----------- * This exhibit is a management contract or compensatory plan required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c). (1) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-1 (No. 33-8892), which became effective October 29, 1986. (2) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-1 (No. 33-12863), which became effective March 31, 1987. (3) Incorporated by reference to exhibits to the Company's Current Report on Form 8-K dated March 16, 1990. (4) Incorporated by reference to exhibits to the Company's Post-Effective Amendment to Registration Statement on Form S-8 (No. 33-16529), which became effective June 18, 1990. (5) Incorporated by reference to exhibits to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1992. (6) Incorporated by reference to exhibits to the Company's Annual Report on Form 10-K for the year ended June 30, 1992. (7) Incorporated by reference to exhibits to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1993. (8) Incorporated by reference to exhibits to the Company's Annual Report on Form 10-K for the year ended June 30, 1994. -20- (9) Incorporated by reference to exhibits to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1994. (10) Incorporated by reference to exhibits to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1995. (11) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-8 (No. 33-60215), which became effective June 14, 1995. (12) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-8 (No. 33-60213), which became effective June 14, 1995. (13) Incorporated by reference to exhibits to the Company's Annual Report on Form 10-K for the year ended June 30, 1995. (14) Incorporated by reference to exhibits to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1996. (15) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-8 (No. 333-06403), which became effective June 20, 1996. (16) Incorporated by reference to exhibits to the Company's Annual Report on Form 10-K for the period ended June 30, 1996, as amended. (17) Incorporated by reference to exhibits to the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1996. (18) Incorporated by reference to exhibits to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1997. (19) Incorporated by reference to exhibits to the Company's Annual Report on Form 10-K for the year ended June 30, 1991. (20) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-4 (No. 333-32379), which became effective August 7, 1997. (21) Incorporated by reference to exhibits to the Company's Annual Report on Form 10-K for the year ended June 30, 1997. (22) Incorporated by reference to exhibits to the Company's Quarterly Report on Form 10-Q for the period ended December 31, 1997. (23) Incorporated by reference to exhibits to the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1998. (b) REPORTS ON FORM 8-K. No Current Reports on Form 8-K were filed during the quarter ended June 30, 1998. -21- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. SILICON GRAPHICS, INC. By: /s/ RICHARD E. BELLUZZO ---------------------------------------- Richard E. Belluzzo CHAIRMAN AND CHIEF EXECUTIVE OFFICER Dated: September 25, 1998 -22- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ Richard E. Belluzzo Chairman, Chief Executive Officer September 25, 1998 and Director (Principal Executive Officer) /s/ Robert R. Bishop Chairman, Silicon Graphics World September 25, 1998 Trade Corporation, and Director /s/ Steven J. Gomo Senior Vice President, Finance and September 25, 1998 Chief Financial Officer (Principal Financial Officer) /s/ Betsy Rafael Vice President, Corporate Controller September 25, 1998 (Principal Accounting Officer) _______________________ Allen F. Jacobson Director September 25, 1998 /s/ C. Richard Kramlich Director September 25, 1998 /s/ Robert A. Lutz Director September 25, 1998 /s/ James A. McDivitt Director September 25, 1998 _______________________ Lucille Shapiro, Ph.D. Director September 25, 1998 /s/ Robert B. Shapiro Director September 25, 1998 /s/ James G. Treybig Director September 25, 1998
-23- SCHEDULE II SILICON GRAPHICS, INC. VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
ADDITIONS ----------------- BALANCE AT CHARGED TO BALANCE BEGINNING COSTS AND DEDUCTIONS AT END OF DESCRIPTION OF PERIOD EXPENSES OTHER WRITE-OFFS PERIOD ----------- ---------- ---------- ------- ---------- --------- Year ended June 30, 1996 Accounts receivable allowances $13,465 $ 4,292 $6,383* $ (373) $23,767 Year ended June 30, 1997 Accounts receivable allowances $23,767 $ 8,427 $ 0 $ (8,138) $24,056 Year ended June 30, 1998 Accounts receivable allowances $24,056 $ 622 $ 0 $ (7,215) $17,463 Restructuring--operating asset reserves $ 0 $37,780 $ 0 $(33,560) $ 4,220 Charge for impairment of long-lived assets $ 0 $46,640 $ 0 $(46,640) $ 0
* Acquired Cray Research valuation allowance. -24- EX-10.10 2 EXHIBIT 10.10 CONSULTING AGREEMENT This Consulting Agreement ("Agreement") is effective as of June 30, 1998 by and between Silicon Graphics, Inc. (the "Company") and Robert H. Ewald ("Consultant"). RECITALS Consultant's employment with the Company has terminated effective June 30, 1998 (the "Separation Date"). The Company wishes to have Consultant remain available to contribute to certain projects and activities of the Company. Accordingly, the Company and Consultant have agreed that Consultant will change his relationship with the Company from that of an employee to that of a consultant on the terms set forth in this agreement. AGREEMENT In consideration of the mutual promises made herein, the Company and Consultant hereby agree as follows: 1. CHANGE OF STATUS. Consultant and Company have entered into a letter agreement dated contemporaneously herewith (the "Separation Agreement") governing the terms of Consultant's resignation as an employee of Company. 2. CONSULTING RELATIONSHIP. (a) Commencing on July 1, 1998 (the "Consulting Period Effective Date") and continuing through the earlier of June 30, 1999 or the date this agreement is terminated under Paragraph 8 below (the "Consulting Period"), Consultant shall serve as an independent consultant to the Company. (b) During the Consulting Period, Consultant shall provide such reasonable services as are agreed to by Consultant and the Company. Consultant shall be available during the Consulting Period for such reasonable hours on an as needed basis as are mutually agreed upon by the parties. Consultant's duty to provide consulting services shall be limited to those areas over which Consultant had direct management responsibility while an employee of the Company. Nothing in this Agreement shall be construed to prohibit Consultant from accepting full-time employment with another employer during the Consulting Period, subject to his obligations under Paragraphs 4, 6 and 7. Nothing in this Agreement shall be construed to prohibit Consultant from being unavailable to provide consulting services on site, so long as Consultant is available by telephone upon no less than seventy-two (72) hours advance notice. Any travel time required of Consultant shall be included as consulting time. Consultant shall at all times be an independent contractor to the Company, and nothing in this agreement shall in any 1 way be construed to constitute Consultant as an agent, employee or representative of the Company. (c) The Company agrees that the workstation Consultant used as an employee of the Company shall be available for use by Consultant from his home, shall be maintained by the Company during the Consulting Period and shall become his personal property upon the Separation Date, but any ongoing fees, expenses, and access charges related to such equipment will be Consultant's sole responsibility Consultant understands and agrees that the net book value of the workstation on the Company's books and records at the end of the Consulting Period, if any, will be reported as additional compensation to him and that he will be responsible for any associated individual taxes. Consultant will be allowed to use the Company's network on terms and conditions similar to those provided to other independent contractors to provide requested consulting services during the Consulting Period; provided that such access will be subject to termination in the event that Consultant accepts employment or a consulting project with a direct competitor of the Company. 3. COMPENSATION. (a) In consideration for Consultant's agreement to provide consulting services during the Consulting Period as provided herein and his faithful adherence to the terms and conditions of this agreement, the Company shall pay Consultant a monthly Consulting Fee equal to one-twelfth of the annual base salary that Consultant was earning as of the Separation Date. Such compensation shall be paid in monthly installments within fifteen business days after receipt of Consultant's monthly invoice, but no earlier than the fifteenth business day of each month. The Company shall reimburse Consultant for any reasonable out-of-pocket expenses incurred by Consultant in providing services under this Agreement, provided that Consultant has received prior approval for incurring such expenses from the Company. The Company's payment obligations under this agreement in the event that it is terminated prior to June 30, 1999, will be governed by Paragraphs 8 and 9(g) below. (b) The attached Personnel Option Status Summary sets forth the details concerning all outstanding options to purchase Common Stock and all shares of restricted stock of the Company held by Consultant. All restricted stock granted to Consultant by the Company shall continue to be released from the Company's repurchase right (at the rate provided in Consultant's applicable restricted stock award agreement) during the Consulting Period. All outstanding stock options listed on the attached summary shall remain outstanding and continue vesting (at their normal rate provided in the applicable stock option or stock award agreement) during the Consulting Period. Any other stock options held by Consultant will be unaffected by the terms of this Agreement and will terminate to the extent they are not exercised within thirty (30) or ninety (90) days (depending on the terms of the respective option agreements) after the Separation Date. - 2 - (c) Consultant is advised that as a result of the conversion of his status from employee to Consultant, any incentive stock options ("ISOs") will become non-statutory options ("NSOs"), to the extent they are not exercised within ninety (90) days after the date Consultant ceases to be an employee. If Consultant's consulting relationship terminates for any reason, then all vesting shall immediately stop, and Consultant's ability to exercise such options shall be governed by the terms of each of the respective option agreements. (d) Notwithstanding the termination of the employment continuation agreement dated as of July 10, 1989 and amended as of October 21, 1993 and November 14, 1997 between Consultant and the Company (the "Employment Continuation Agreement"), if a Change in Control of the Company (as defined in the Employment Continuation Agreement) occurs during the Consulting Period, Consultant shall have the rights provided under Section 3(b) of the Employment Continuation Agreement with respect to his then outstanding stock options to the extent that such rights could have been exercised by him if the Employment Continuation Agreement had been in effect and had Consultant been an employee of the Company at the time of the Change in Control. (e) During the Consulting Period, the Company shall provide to Consultant medical, dental and vision continuation benefits through COBRA and Company shall pay the COBRA premiums until the earlier of (i) the date the Consultant and Consultant's covered dependents become covered under another employer's group health plan providing benefits and levels of coverage comparable to that of the Company or (ii) the termination of the Consulting Period as specified herein. The Company shall also pay or reimburse Consultant for financial and tax consulting services and an annual physical exam in accordance with the Company's executive perquisite program until the earlier of (i) the termination of the Consulting Period, or (ii) the date at which Consultant accepts full-time employment with another employer. The provisions of the executive perquisite program covering an automobile allowance, cellular telephone charges and life insurance premiums will not be applicable during the Consulting Period. (f) The Company will, upon repayment of the remaining balance, forgive an amount equal to $633,445 on Consultant's loan in the aggregate amount of $1,317,414 (including accrued interest) on July 31, 1998. The forgiveness of the loan will be reported as additional compensation to Consultant and Consultant will be responsible for reimbursing the Company for the employee share of applicable payroll taxes and for paying any additional federal, state and local taxes imposed on Consultant associated with this income. The remaining balance of the loan in the amount of $683,969 will be due and payable to the Company in accordance with its terms on July 31, 1998. Upon payment, the Company shall return to Consultant the original promissory notes executed by Consultant marked paid in full, and shall immediately release and reconvey all security for said notes. (g) Other than the provisions set forth in the Separation Agreement, the existing Indemnification Agreement dated July 1, 1996 between Consultant and the - 3 - Company, in Consultant's stock option and stock award agreements and herein, Consultant has no expectation of, and shall make no other claims for payment or any other compensation or benefits from the Company. 4. CONFIDENTIAL INFORMATION. Consultant acknowledges that, because of his position with the Company, he has specific knowledge of many types of information that are confidential and proprietary to the Company, including, without limitation, its current and planned technology, its current and planned sales, marketing, and corporate strategies; strategic customer and business partners; and the organizational structure, identity, skills and interests of its employees. Consultant agrees to keep and treat all such proprietary information as confidential and he acknowledges and reaffirms his obligations to the Company under the Proprietary Information and Invention Agreement between Consultant and the Company, wherein Consultant agreed to keep and treat all such proprietary information as confidential. Those obligations survive the termination of Consultant's employment or consulting relationship with the Company and the termination of this agreement. 5. TAX CONSEQUENCES. Consultant acknowledges that he is obligated to report as income all compensation received by Consultant pursuant to this agreement, and Consultant acknowledges his obligation to pay all federal, state or local income, self-employment or other taxes relating to such compensation or any amounts realized upon exercise of Consultant's options, and any penalties or assessments thereon. Except as referred to in Paragraph 3(c), the Company gives no opinions and makes no representations with respect to the potential or actual tax consequences or liabilities, if any, associated with the payment of any amounts to Consultant under the terms of this Agreement or the continued vesting of Consultant's options. Consultant assumes sole responsibility for any tax liability that results from the payment of any compensation described herein. 6. NON-SOLICITATION. Consultant agrees that during the term of the Consulting Agreement, he shall not, directly or indirectly solicit or influence any person in the employment of the Company or any affiliated entity to (i) terminate such employment, (ii) accept employment, or enter into any consulting arrangement, with any entity other than the Company or any affiliated entity or (iii) interfere with the customers, suppliers, clients or business of the Company or any affiliated entity in any manner. 7. COOPERATION. Consultant agrees, upon the Company's or its agent's request and reasonable notice, to cooperate with the Company in connection with any claim or litigation or other matter about which Consultant may have relevant information. Upon request, Consultant will also provide the Company with information that Consultant obtained from his employment with the Company regarding the Company's business or operations. Additionally, he will immediately notify the Company's General Counsel if he receives any written or oral request for information from any persons (other than his full-time employer), or their counsel, who are asserting or investigating claims or litigation asserted against, or otherwise adverse to, the Company, unless Consultant is - 4 - legally required not to disclose such request for information. Consultant will not disclose information to such persons except as required by legal process. Consultant will not disclose to anyone, except the Company, confidential or privileged matters obtained from or related to his employment with the Company, except as required by law. 8. TERM AND TERMINATION. (a) Consultant's consulting relationship may be terminated by the Company on a "for cause" basis at any time as provided in this Paragraph 8 if, Consultant (i) willfully, flagrantly or continuously fails to perform the consulting services as Consultant is obligated to provide in accordance with Paragraph 2(b) after written demand for substantial performance is delivered to Consultant specifically identifying the manner in which Consultant has failed to perform such services, and Consultant's failure to perform continues for a period of ten (10) days following receipt of such demand for performance from the Company; (ii) violates any material provision of this agreement, including without limitation, the confidential information provision of Paragraph 4, the non-solicitation provisions of Paragraph 6, and the cooperation provision of Paragraph 7 (iii) commits any act of moral turpitude in connection with his performance of the consulting services, or (iv) otherwise commits any egregious or malicious act injurious to the Company, its business or reputation. The Company shall give thirty (30) days notice to Consultant of the termination of the agreement pursuant to this Paragraph 8 and shall provide Consultant with a reasonable time within said thirty (30) day period in which to respond to and cure the alleged problem. In the event Consultant cures the problem within the cure period, the Company shall not terminate this Agreement. The Company will have no obligation to make any further payments under this Agreement following a "for cause" termination in accordance with this Paragraph 8. Any such termination by the Company shall be in addition to and shall not affect any other remedies to which the Company may be entitled as a result of the event leading to such termination. (b) Notwithstanding the expiration and/or termination of this agreement, the provisions of Paragraphs 4 (Confidential Information), 6(b) (Non-Solicitation) and 7 (Cooperation) by their terms, shall survive the expiration and/or termination of this agreement. 9. GENERAL (a) ENTIRE AGREEMENT. Except as set forth in the Separation Agreement, this agreement represents the entire agreement and understanding between the Company and the Consultant concerning Consultant's consulting relationship and the termination of Consultant's employment relationship with the Company, and, except as specifically provided herein, supersedes and replaces all prior agreements and understandings, written and oral, concerning Consultant's relationship with the Company and his compensation by the Company, other than the Indemnification Agreement and the stock option and stock award agreements referred to in Paragraphs 3(g) and 3(b) above. In particular, except as otherwise provided herein, Consultant agrees that the employment - 5 - continuation agreement dated July 10, 1989 and amended October 21, 1993 and November 14, 1997 between Consultant and the Company terminated as of the Separation Date. Nothing in this Agreement shall affect Consultant's right to coverage under the Company's Directors and Officers liability insurance for actions taken while Consultant was an officer or a director of the Company. Neither party has relied upon any representations or statements made by the other party hereto which are not specifically set forth in this agreement. (b) SETTLEMENT OF OUTSTANDING OBLIGATIONS. Consultant agrees that this Agreement, the Separation Agreement, the Indemnification Agreement and the stock option or stock award agreements represent settlement in full of all outstanding obligations owed to Consultant by the Company as a result of his employment by the Company or his change in status, including without limitation all obligations for current or past salary, bonus or severance payments. (c) NOTICES. Notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when personally delivered, or sent by facsimile transmission or, if mailed, five (5) days after the date of deposit in the United States mails, registered or certified mail, return receipt requested, postage prepaid, addressed to the respective addresses as follows: (i) if to the Company, to: Silicon Graphics, Inc. 2011 N. Shoreline Blvd. Mountain View, California 94043-1389 Attention: Larry Hicks, M/S 741 Fax: 650-932-0910 with a copy to: Silicon Graphics, Inc. 2011 N. Shoreline Blvd. Mountain View, California 94043-1389 Attention: Legal Services, M/S 710 Fax: 650-933-7096 (ii) if to Consultant, to: Bo Ewald Fax: with a copy to: Steven K. Ewald, Esq. - 6 - Harrigan, Ruff, Sbardellati & Moore 101 West Broadway, Suite 1600 San Diego, CA 92101 Fax: 619-233-1537 (d) WAIVERS AND AMENDMENTS. This agreement may be amended, terminated or extended, or the terms hereof may be waived, only by a written instrument signed by the parties. No delay in exercising any right hereunder shall operate as a waiver thereof, nor shall any waiver or partial exercise of a right preclude any other or further exercise thereof or any other right. (e) GOVERNING LAW. This agreement shall be entered into and governed by the laws of the State of California. (f) DISPUTES. To dispute any failure to make payments claimed to be due hereunder, Consultant must give written notice of such dispute to the Company within sixty (60) days after the date on which a payment claimed by Consultant to be due hereunder was due to be made. In the event of any dispute, claim, question, or disagreement arising out of or relating to this agreement or the breach thereof, the parties hereto agree to first use their best efforts to settle such matters in an amicable manner. Initially, they shall consult and negotiate with each other, in good faith and, recognizing their mutual interests, attempt to reach a just and equitable solution satisfactory to both parties. If they do not reach such resolution within a period of sixty (60) days, then upon written notice by either party to the other, any unresolved dispute, claim or differences shall be submitted to confidential mediation by a mutually agreed upon mediator. Either party may, without inconsistency with this agreement, apply to any court having jurisdiction hereof and seek injunctive relief so as to maintain the status quo until such time as the mediation is concluded or the controversy is otherwise resolved. The site of the mediation shall be in the County of Santa Clara, California. Each party shall each bear its own costs and expenses and an equal share of the mediators' and any similar administrative expenses. (g) ASSIGNMENT AND ASSUMPTION. This agreement, and Consultant's rights and obligations hereunder, are personal in nature and accordingly may not be assigned by Consultant, except for an assignment by Consultant to a corporation, trust, partnership or other legal entity established by him for personal financial or tax purposes. If Consultant becomes disabled and is unable to provide consulting services during the Consulting Period, except for all stock option and stock award vesting terminating, all payments contemplated by this Agreement shall be paid in accordance with the terms hereof. If Consultant's consulting relationship terminates by reason of death, except for all stock option and stock award vesting terminating, Consultant's estate's eligibility to any outstanding and all continuing consulting compensation payments provided hereunder shall survive. This agreement and its rights, together with its obligations hereunder, shall be assumed by the successors in interest of the Company in connection with any sale, transfer or other disposition of all or substantially all of its assets or - 7 - business, whether by merger, consolidation or otherwise. Such successor or assignee to the business or assets shall be bound by the terms and provisions of this agreement. (h) COUNTERPARTS. This agreement may be executed in counterparts, and each counterpart shall have the same force and effect as an original and shall constitute an effective, binding agreement on the part of each of the parties. 10. VOLUNTARY EXECUTION OF AGREEMENT. This agreement is executed voluntarily and without any duress or undue influence on the part or on behalf of the parties hereto. The parties acknowledge that: (a) They have carefully read this agreement; (b) They have been advised and represented in the preparation, negotiation, review and execution of this agreement by legal counsel of their own choice; (c) They understand the scope, terms, consequences and effects of this agreement; and (d) They are fully aware of the legal and binding effect of this agreement. IN WITNESS WHEREOF, the parties have executed this agreement as of the dates set forth below. CONSULTANT: COMPANY: Silicon Graphics, Inc. /s/ Robert H. Ewald /s/ Kirk Froggatt - ---------------------------- ------------------------------------ Robert H. Ewald Kirk Froggatt, Senior Vice President Date: Date: - 8 - EX-13.1 3 EXHIBIT 13.1 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------------------------------------------------------------------------------------- QUARTERLY DATA - ----------------------------------------------------------------------------------------------------------------------------------- Fiscal 1998 (unaudited) ----------------------------------------------- (in thousands, except per share amounts) June 30 March 31 Dec. 31 Sept. 30 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue $ 773,561 $ 708,291 $850,765 $767,993 Costs and expenses: Cost of revenue 542,355 504,282 478,991 437,923 Research and development 113,746 111,975 117,113 116,354 Selling, general and administrative 304,829 250,917 251,262 261,421 Other operating expense (1) 90,320 43,393 52,729 19,101 ----------------------------------------------- Operating loss (277,689) (202,276) (49,330) (66,806) Interest and other income (expense), net 218 (267) 1,538 (2,307) ----------------------------------------------- Loss before income taxes (277,471) (202,543) (47,792) (69,113) Net loss (220,041) (152,569) (31,479) (55,538) Net loss per share - basic and diluted $ (1.17) $ (0.81) $ (0.17) $ (0.31) Shares used in the calculation of net loss per share - basic and diluted 187,472 187,643 187,874 182,160 Fiscal 1997 (unaudited) ----------------------------------------------- (in thousands, except per share amounts) June 30 March 31 Dec. 31 Sept. 30 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue $1,162,317 $909,370 $825,312 $765,602 Costs and expenses: Cost of revenue 597,622 517,292 456,937 450,695 Research and development 125,196 121,532 124,094 108,279 Selling, general and administrative 297,712 254,086 254,348 232,167 Other operating expense (2) 3,110 2,482 2,331 2,834 ----------------------------------------------- Operating income (loss) 138,677 13,978 (12,398) (28,373) Interest and other income (expense), net (9,323) (2,156) (1,397) (818) ----------------------------------------------- Income (loss) before income taxes 129,354 11,822 (13,795) (29,191) Net income (loss) 102,403 10,538 (12,789) (21,601) Net income (loss) per share: Basic $ 0.57 $ 0.06 $ (0.07) $ (0.13) Diluted $ 0.54 $ 0.06 $ (0.07) $ (0.13) Shares used in the calculation of net income (loss) per share: Basic 177,911 176,382 174,926 172,974 Diluted 190,863 184,555 174,926 172,974
(1) Amounts include a $17 million write-off of acquired in-process technology in the first quarter; restructuring charges of $53 million, $44 million, and $47 million in the second, third and fourth quarters, respectively; and a $47 million charge for long-lived asset impairment in the fourth quarter. (2) Amounts represent merger-related expenses.
- ----------------------------------------------------------------------------------------------------------------------------------- PRICE RANGE OF COMMON STOCK - ----------------------------------------------------------------------------------------------------------------------------------- The Company's Common Stock is traded on the New York Stock Exchange under the symbol of SGI. The following table sets forth, for the periods indicated, the high, low and close prices for the Common Stock as reported on the NYSE. Fiscal 1998 Fiscal 1997 - ----------------------------------------------------------------------------------------------------------------------------------- Low High Close Low High Close - ----------------------------------------------------------------------------------------------------------------------------------- First Quarter $ 15.00 $ 30.19 $ 26.25 $ 20.00 $ 25.75 $ 22.13 Second Quarter 11.56 27.50 12.44 17.88 27.63 25.50 Third Quarter 10.94 16.19 13.94 19.25 28.38 19.50 Fourth Quarter 11.06 16.38 12.13 12.63 20.25 15.00
The Company had 9,238 stockholders of record as of June 30, 1998. The Company has not paid any dividends on its common stock. The Company currently intends to retain earnings for use in its business and does not anticipate paying cash dividends to common stockholders. ITEM 6. SELECTED FINANCIAL DATA
- ----------------------------------------------------------------------------------------------------------------------------------- SELECTED CONSOLIDATED FINANCIAL DATA - ----------------------------------------------------------------------------------------------------------------------------------- Years ended June 30 1998 1997 1996 (1) 1995 1994 - ----------------------------------------------------------------------------------------------------------------------------------- Operating Data (in thousands, except per share amounts): Total revenue $3,100,610 $3,662,601 $2,921,316 $2,228,268 $1,537,766 Costs and expenses: Cost of revenue 1,963,551 2,022,546 1,482,439 1,032,059 735,388 Research and development 459,188 479,101 353,461 247,678 190,796 Selling, general and administrative 1,068,429 1,038,313 807,830 619,259 417,753 Other operating expense (2) 205,543 10,757 103,193 22,000 - ---------- ---------- ---------- ---------- ---------- Operating (loss) income (596,101) 111,884 174,393 307,272 193,829 Interest and other (expense) income, net (818) (13,694) 10,413 9,447 4,779 Minority interest in net loss of Cray Research - - 3,982 - - ---------- ---------- ---------- ---------- ---------- (Loss) income before income taxes (596,919) 98,190 188,788 316,719 198,608 Net (loss) income (459,627) 78,551 115,037 224,856 141,814 Net (loss) income per share: Basic $ (2.47) $ 0.44 $ 0.70 $ 1.44 $ 0.98 Diluted $ (2.47) $ 0.43 $ 0.65 $ 1.26 $ 0.85 Shares used in the calculation of net (loss) income per share: Basic 186,149 175,548 162,658 156,437 144,301 Diluted 186,149 182,637 175,790 182,837 167,112 Balance Sheet Data (in thousands): Cash, cash equivalents and marketable investments $ 736,720 $ 374,292 $ 456,937 $ 780,012 $ 604,444 Working capital 968,700 1,229,388 994,817 889,371 645,296 Total assets 2,964,706 3,344,592 3,158,246 2,206,619 1,567,052 Long-term debt and other 403,522 419,144 381,490 287,267 252,645 Stockholders' equity 1,464,512 1,839,242 1,675,318 1,346,170 937,169 Statistical Data: Number of employees 10,286 10,930 10,485 6,308 4,707 Revenue/employee (average; in thousands) $ 291 $ 343 $ 373 $ 400 $ 346 Long-term debt and other/total capitalization 22% 19% 19% 18% 21%
(1) Amounts reflect the April 2, 1996 acquisition of Cray Research, which was accounted for as a purchase. See Notes 2 and 3 to the consolidated financial statements. (2) Fiscal 1998 amount includes restructuring charges ($144 million), a charge for long-lived asset impairment ($47 million) and a write-off of acquired in-process technology ($17 million). Fiscal 1997 amount represents merger-related expenses. Fiscal 1996 amount includes write-off of acquired in-process technology ($98 million) and merger-related expenses. Fiscal 1995 amount represents merger-related expenses. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The matters addressed in this discussion, with the exception of the historical information presented, are forward-looking statements involving risks and uncertainties, including year 2000 compliance and other risks discussed under the heading "Risks That Affect Our Business" and elsewhere in this report. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. INTRODUCTION The following tables and discussion present certain financial information on a comparative basis. The Company's fiscal 1998 results reflect certain charges attributable to its decision to restructure its business. This process included a reevaluation of its core competencies, technology roadmap and business model in an effort to bring its expenses more in line with current revenue levels and restore long-term profitability to the Company. The Company's fiscal 1996 results reflect the fourth quarter acquisition of Cray Research in a business combination accounted for under the purchase method. To provide a meaningful comparison of fiscal 1997 and fiscal 1996 results, revenue, gross margin, research and development and selling, general and administrative expenses are presented on a pro forma combined basis (as if the acquisition had occurred at the beginning of fiscal 1996 and excluding the results of the Cray Business Systems Division which was disposed in the first quarter of fiscal 1997) in addition to the actual fiscal 1996 results. OPERATING ITEMS AS A PERCENTAGE OF TOTAL REVENUE - ------------------------------------------------------------------------------ (PERCENTAGES MAY NOT ADD DUE TO ROUNDING)
Fiscal Years Ended June 30 ---------------------------------- Pro forma 1998 1997 1996 1996 ---- ---- --------- ----- Product and other revenue 80.3% 84.3% 84.7% 87.4% Service revenue 19.7 15.7 15.3 12.6 ----- ----- ----- ----- Total revenue 100.0 100.0 100.0 100.0 Gross margin 36.7(3) 44.8(1) 47.1(1) 49.3(1) Research and development expenses 14.8 13.1 12.3 12.1 Selling, general & administrative expenses 34.5 28.3 26.8 27.7 Other operating expense 6.6(4) 0.3 3.0(2) 3.5 ----- ----- ----- ----- Operating margin (19.2)% 3.1% 5.0%(2) 6.0%
(1) Gross margin before Cray Research purchase accounting adjustments would have been 45.9% for fiscal 1997, 47.6% for fiscal 1996 on a pro forma basis and 49.9% for fiscal 1996. (2) Excludes $22 million of pre-merger Cray Research restructuring charges. (3) Excluding $115 million of Cray product transition-related charges and a $30 million charge to write-off excess spares, gross margin would have been 41.3%. (4) Includes restructuring charges ($144 million), a charge for long-lived asset impairment ($47 million) and a write-off of acquired in-process technology ($17 million). YEAR OVER YEAR PERCENTAGE CHANGE - ------------------------------------------------------------------------------
Fiscal 1998/ Fiscal 1997/ Fiscal 1997 Pro Forma Fiscal 1996 ------------ --------------------- Product and other revenue (19%) 7% Service revenue 6% 10% Total revenue (15%) 7% Gross profit (31%) 2% Research and development expenses (4%) 14% Selling, general and administrative expenses 3% 13%
-1- REVENUE BY GEOGRAPHY - ------------------------------------------------------------------------------
($ in millions) Fiscal Years Ended June 30 Fiscal Year/Year Increase ---------------------------------- ------------------------- Pro Forma 1998 vs 1997 vs 1998 1997 1996 1996 1997 Pro Forma 1996 -------- ------- --------- -------- ------- -------------- United States $ 1,625 $1,927 $ 1,582 $ 1,412 (16%) 22% Europe 832 936 1,034 836 (11%) (9)% Rest of World(1) 644 800 804 673 (20%) ---% -------- ------- ------- -------- Total revenue $ 3,101 $ 3,663 $ 3,420 $ 2,921 (15%) 7% -------- ------- ------- -------- -------- ------- ------- --------
Fiscal Years Ended June 30 (as a percentage of total revenue) -------------------------------- Pro Forma 1998 1997 1996 1996 ---- ---- --------- ---- United States 52% 53% 46% 48% Europe 27% 26% 30% 29% Rest of World(1) 21% 21% 24% 23%
- ----------------- (1) Includes Japan, other Asia-Pacific countries, Canada and Latin America REVENUE BY PRODUCT LINE - ------------------------------------------------------------------------------
Fiscal Years Ended June 30 (as a percentage of product revenue, ------------------------------------ excluding other revenue) Pro Forma 1998 1997 1996 1996 ---- ---- --------- ---- Servers (primarily from the Cray, POWER CHALLENGE-TRADEMARK-, CHALLENGE-Registered Trademark- and Origin-TRADEMARK- families) 51% 50% 34% 25% Graphics Systems (primarily from the Indy-TM-, OCTANE-Registered Trademark-, O2-TM- and Onyx-Registered Trademark- families) 49% 50% 66% 75% - ------------------------------------------------------------------------------
REVENUE The Company's product and other revenue are derived primarily from shipment of computer systems products, with subsystem and software revenue, fees and royalty payments comprising the remainder. Service revenue is comprised of hardware and software support and maintenance. Revenue for fiscal 1998 decreased $562 million or 15% compared with fiscal 1997, reflecting a decline in product and other revenue across all product lines and regions, offset somewhat by an increase in service revenue. The effects of strong competition, particularly in the shrinking UNIX workstation market, as well as a weakening vector supercomputer market, resulted in decreased graphics systems and vector supercomputer unit volumes, offset somewhat by an increase in UNIX based server unit volumes. Overall product revenue per unit also decreased in fiscal 1998 compared with fiscal 1997. The Company believes that the declines in the UNIX workstation and vector supercomputer markets are long-term trends, and that its future success will require that a larger proportion of its revenues come from growing markets including the market for scalable servers such as the Origin family and Windows NT based workstations such as those planned for introduction in fiscal 1999. Revenue may also be affected by customer perceptions of the Company's longer-term strategy and its ability to execute the necessary business transitions. See "Risks That Affect Our Business." -2- Service revenue increased in fiscal 1998 and 1997, but at a slower rate in fiscal 1998 due principally to the decrease in year-over-year product revenue. Service revenue grew to 20% of total revenue reflecting both the reduced level of systems revenue and a long-term trend of proportionately higher service revenue in the total revenue mix. In fiscal 1998, the Company's geographic revenue mix remained relatively consistent compared with fiscal 1997. Revenue declined across all major geographic regions, with the most significant reductions noted in the United States, for reasons cited previously, as well as in Asia-Pacific markets which are experiencing overall economic weakness. Revenue growth in fiscal 1997 compared with pro forma fiscal 1996 reflected increased shipments of servers and graphics systems, as well as increased service revenue supporting a larger installed base. The revenue growth rate declined substantially from 31% in fiscal 1996 to 7% in fiscal 1997. However, the 1996 revenue growth rate of 31% includes incremental Cray Research revenue for the fourth quarter of fiscal 1996. Excluding the effect of Cray Research revenue for the fourth quarter of fiscal 1996, the fiscal 1996 growth rate would have been 24%. Factors contributing to the lower fiscal 1997 revenue growth included significant product transitions that were not completed until the fourth quarter, as well as softness in international business, particularly in Europe. The mix of revenue from the Company's servers and graphics systems changed significantly in fiscal 1997 compared with pro forma fiscal 1996. While the Company experienced revenue growth across its server product line, particularly in the high performance segments, graphics systems revenue was down. Server and graphics systems unit volumes increased in fiscal 1997 compared with pro forma fiscal 1996. In fiscal 1997, server product revenue per unit increased and graphics systems revenue per unit decreased compared with pro forma fiscal 1996, while overall product revenue per unit remained substantially unchanged. International business contributed proportionately less revenue in fiscal 1997 than in pro forma fiscal 1996, principally due to weakness in the Company's European business, as well as slower revenue growth in Japan. Japan and Europe were adversely affected by a strengthened U.S. dollar in both fiscal 1998 and 1997. The Company's consolidated backlog at June 30, 1998 was $360 million, down from $537 million at June 30, 1997, primarily reflecting a reduction in the vector supercomputer business. GROSS MARGIN Cost of product and other revenue includes costs related to product shipments, including materials, labor, overhead and other direct or allocated costs involved in their manufacture or delivery. Costs associated with non-recurring engineering revenue are recognized in research and development expense. Cost of service revenue includes all costs incurred in the support and maintenance of the Company's products. The Company's overall gross margin decreased to 36.7% in fiscal 1998 from 44.8% in fiscal 1997. Gross margin for fiscal 1998 would have been 41.3% without non-recurring charges of approximately $115 million, or 3.7 points, related to refocusing the Company's supercomputer product roadmap and $30 million, or 0.9 points, for the write-down of excess spares in the fourth quarter of fiscal 1998. Excluding the impact of these charges, the decline was due principally to competitive pricing pressures noted across all product lines and manufacturing inefficiencies resulting from lower than expected volumes. The Company believes it will continue to experience margin pressure, particularly in its supercomputer and desktop product lines. In particular, the Company's forthcoming windows NT based systems will compete directly in the high-end of the personal computer marketplace in which gross margins are typically well below the average gross margin levels that the Company has historically recorded. See "Risks That Affect Our Business." -3- In fiscal 1997, the overall gross margin decreased to 44.8% from 47.1% in pro forma fiscal 1996. The decline was due principally to product transition costs and higher revenue in the U.S. where margins typically are lower than international margins. OPERATING EXPENSE The Company's total operating expense was 49.3% of total revenue in fiscal 1998, or 55.9% including the impact of special charges. This level of operating expense is unacceptably high given both the revenue levels achieved in fiscal 1998 and the long-term margin pressure that the Company is experiencing as it increasingly competes in higher-volume, lower-margin markets. The Company initiated a series of restructuring and other actions to reduce its headcount and operating expense level during fiscal 1998, and further operating expense reductions will be necessary in fiscal 1999. RESEARCH AND DEVELOPMENT Research and development spending decreased 4% in absolute dollars (to $459 million from $479 million), but increased as a percentage of total revenue (to 14.8% from 13.1%) in fiscal 1998 compared with fiscal 1997. The decrease in absolute dollars resulted from efforts to control spending through more focused project selection and management. As a percentage of total revenue, research and development spending increased principally due to the decrease in revenue. Research and development spending increased 14% in absolute dollars (to $479 million from $424 million) and as a percentage of total revenue (to 13.1% from 12.3%) in fiscal 1997 compared with pro forma fiscal 1996 as the Company continued its new product development programs across its product lines. The Company expects research and development spending in fiscal 1999 to decline compared with the fiscal 1998 level due to reduced headcount and continued focus on expense management. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses increased 3% in absolute dollars (to $1,068 million from $1,038 million) and as a percentage of total revenue (to 34.5% from 28.3%) in fiscal 1998 compared with fiscal 1997. The increase resulted primarily from costs associated with outside consulting, business process re-engineering, and an increase in marketing and advertising costs. The fiscal 1998 increase was somewhat offset by lower selling commissions due to lower revenue. As a percentage of total revenue, selling, general and administrative spending increased principally due to the decrease in revenue. Selling, general and administrative expenses increased 13% in absolute dollars (to $1,038 million from $916 million) and as a percentage of total revenue (to 28.3% from 26.8%) in fiscal 1997 compared with pro forma fiscal 1996. The increase resulted principally from introducing new products to the market, and from an increase in sales personnel during fiscal 1997. The Company expects selling, general and administrative expenses in fiscal 1999 to decline compared with the fiscal 1998 level due to planned reductions in spending on outside consulting, reduced administrative headcount and other spending controls. OTHER OPERATING EXPENSE Other operating expense of $206 million for fiscal 1998 consists of restructuring charges of $144 million, a charge for impairment of long-lived assets of $47 million and merger-related expenses of $15 million. In the second quarter of fiscal 1998, the Company announced and began to implement a restructuring program aimed at bringing its expenses more in line with current revenue levels and restoring long-term profitability to the Company. The process of developing this program continued during the balance of fiscal 1998 and included a reevaluation of the Company's core competencies, technology roadmap and business model, as well as development of its fiscal 1999 operating plan. The Company's restructuring activity has consisted primarily of eliminating approximately 1,700 positions, approximately 1,000 of which were eliminated as of June 30, 1998, writing down certain operating assets (including purchased intangibles and goodwill from the ParaGraph acquisition), vacating certain leased facilities and canceling certain contracts. Furthermore, as a result of this process, the Company found it necessary to downsize its vector supercomputer business, necessitating an evaluation of the ongoing value of the associated plant and equipment and intangible assets. Based on this evaluation, the Company determined that assets (principally a specific-use manufacturing facility, supercomputers used in -4- product design, support and manufacturing and other machinery and equipment) with a carrying amount of $50 million were impaired and wrote them down by $47 million to their fair value. Fair value was principally based on an independent appraisal and estimated exchange and resale value. Merger-related expenses in fiscal 1998 included a $17 million charge for acquired in-process technology resulting from the acquisition of ParaGraph, partially offset by reductions of approximately $2 million in merger-related accruals from fiscal 1997 and 1996. Other operating expense for fiscal 1997 and 1996 of $11 million and $103 million, respectively, relates to the Cray Research acquisition and consists principally of costs associated with the integration of Silicon Graphics and Cray Research information systems, accounting processes and human resource activities. In fiscal 1996, the Company also recognized a $98 million charge for acquired in-process technology in connection with the acquisition of Cray Research. INTEREST AND OTHER INTEREST EXPENSE Interest expense in fiscal 1998 remained relatively consistent with fiscal 1997 interest expense. Interest expense increased in fiscal 1997 principally as a result of borrowings associated with the Cray Research acquisition. The Company does not expect a significant change in the level of interest expense in fiscal 1999. INTEREST INCOME AND OTHER, NET Interest income and other, net for fiscal 1998 increased 114% compared with fiscal 1997. This increase reflects higher interest income attributable to significantly higher average invested cash balances, offset in part by an increase in costs associated with the Company's currency hedging program and foreign exchange losses on unhedged currencies. Also included in fiscal 1998 are charges related to fees incurred in connection with the Company's exchange of its Senior Convertible Notes for its Zero Coupon Debentures. Interest income and other, net for fiscal 1997 decreased 66% compared with fiscal 1996, reflecting lower interest income due to significantly lower average invested cash balances, costs associated with the expansion of the Company's economic hedging program and the write-off of an investment in a software company. The Company does not expect a significant change in the level of interest income and other in fiscal 1999. (BENEFIT FROM) PROVISION FOR INCOME TAXES The consolidated effective tax benefit rate for fiscal 1998 was approximately 23% compared with tax provision rates of 20% in fiscal 1997 and 39% in fiscal 1996. The fiscal 1998 benefit rate differs from the federal statutory rate primarily due to foreign losses for which no benefit has been recognized, the write-off of acquired in-process technology and goodwill for which there was no tax benefit, and the establishment of reserves for certain deferred tax assets not expected to be realized. The 1997 provision rate was lower than the 1996 provision rate primarily as a result of the reinstated U.S. federal research tax credit, proportionately higher earnings in low tax jurisdictions, and proportionately higher foreign sales corporation benefits, offset partially by foreign losses for which no benefit was recorded. The 1996 provision rate also reflected the impact of the write-off of acquired in-process technology for which there was no tax benefit. At June 30, 1998, the Company had gross deferred tax assets arising from deductible temporary differences, tax losses and tax credits of $643 million. The gross deferred tax assets are offset by a valuation allowance of $75 million and deferred tax liabilities of $40 million. Realization of the majority of the net deferred tax assets is dependent on the Company's ability to generate approximately $1 billion of future taxable income. Management believes that it is more likely than not that the assets will be realized based on forecasted income. However, there can be no assurance that the Company will meet its expectations of future income. Management will evaluate the realizability of the deferred tax assets quarterly and assess the need for additional valuation allowances. The Company has not historically provided for U.S. federal income taxes on undistributed earnings of foreign subsidiaries which it intends to permanently reinvest in those operations. The cumulative income -5- tax benefit attributable to these permanently reinvested earnings is estimated to be $85 million at June 30, 1998. IMPACT OF CURRENCY Because a significant portion of the Company's revenue is from sales outside the United States, and many key components are produced outside the United States, the Company's results can be significantly affected by changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which the Company distributes its products. Most worldwide currencies weakened versus the U.S. dollar in fiscal 1998, which resulted in assets and liabilities denominated in local currencies being translated into fewer dollars. The currency rate changes also resulted in an unfavorable impact on revenue of approximately 3%, 3% and 2% in fiscal 1998, 1997 and 1996, respectively, FINANCIAL CONDITION Despite the Company operating at a loss, its financial condition improved substantially during fiscal 1998 primarily due to improved management of inventory and accounts receivable. At June 30, 1998, cash, cash equivalents and short- and long-term investments totaled $737 million compared with $374 million at June 30, 1997. Operating activities generated $643 million in fiscal 1998, compared with $170 million in fiscal 1997 and $212 million in fiscal 1996. The fiscal 1998 net loss was affected by a number of charges that did not use cash including a $47 million charge for long-lived asset impairment, a $32 million charge for the write-off of purchased intangibles and goodwill resulting from the disposal of ParaGraph and a $30 million charge for the write-down of excess spares. These and other non-deductible charges resulted in significant deferred tax benefit provisions that did not provide cash. The Company made a concerted effort to improve its asset management practices in fiscal 1998 which resulted in significant reductions in accounts receivable and inventories generating $731 million in cash. Fiscal 1997 and 1996 net income was also affected by a number of charges that did not use cash. Fiscal 1997 included $42 million of reduced gross margin associated with the write-up of acquired Cray Research inventories and service contracts and a $4 million charge for the write-off of an investment in a software company. Fiscal 1996 included a $98 million write-off of acquired in-process technology and $18 million of reduced gross margin associated with the write-up of acquired Cray Research inventories. The impact of the fiscal 1996 charges was somewhat offset by increased deferred tax benefit provisions, as well as the minority interest in Cray Research loss, which did not provide cash. The growth in fiscal 1997 accounts receivable reflects higher sales levels and longer collection cycles. Inventory purchases grew significantly in fiscal 1997 in support of product transitions as well as to support higher anticipated revenue levels that did not occur. Investing activities, other than changes in the Company's marketable investments, consumed $269 million in cash during fiscal 1998, compared with $301 million during fiscal 1997 and $659 million during fiscal 1996. Cash outlays for capital expenditures were lower in fiscal 1998 than in fiscal 1997 due to increased focus on capital spending. The Company expects the level of capital expenditures as a percentage of total revenue in fiscal 1999 to be relatively consistent with the level in fiscal 1998. Cash outlays for other assets in fiscal 1998 and 1997 principally resulted from the acquisition of spare parts. The fiscal 1996 tender offer for Cray Research used approximately $408 million of cash, net of cash acquired. In September 1997, the Company exchanged $231 million principal amount of new 5.25% Senior Convertible Notes due 2004 (the "Senior Notes") for approximately 98% of its outstanding Zero Coupon Convertible Debentures due 2013 (the "Zero Coupon Debentures") in order to reduce the risk of an acceleration of maturity on the Zero Coupon Debentures. There was no change in the carrying value of the Company's debt as a result of this exchange. During fiscal 1998, the Company's financing activities included the repayment of approximately $63 million in short- and long-term borrowings. The volume of borrowing activity during fiscal 1998 compared with fiscal 1997 decreased correspondingly with higher cash flows from operating activities. In each of the past three years the Company's employee stock plans -6- have also been an additional source of cash. To mitigate the dilutive effect of the stock plans, the Company's board of directors has authorized the repurchase of up to 22.5 million shares of common stock. Under this program, 4,700,000 shares of common stock were repurchased in fiscal 1998 for $63 million and 2,452,600 shares of common stock were repurchased in fiscal 1996 for $76 million. At June 30, 1998, the Company's principal sources of liquidity included cash, cash equivalents and marketable investments of $737 million and up to $250 million available under its revolving credit facility that expires in April 1999. The Company's cash and marketable investments, along with the credit facility, cash generated from operations and other resources available to the Company, should be adequate to fund the Company's projected cash flow needs, including those related to restructuring charges taken in fiscal 1998. The Company believes that the level of financial resources is an important competitive factor in the computer industry and, accordingly, may elect to raise additional capital through debt or equity financing in anticipation of future needs. RISKS THAT AFFECT OUR BUSINESS Silicon Graphics operates in a rapidly changing environment that involves a number of risks, some of which are beyond the Company's control. The following discussion highlights some of these risks. BUSINESS TRANSITION. Two of the principal market sectors in which the Company competes -- UNIX workstations and vector supercomputers -- have declined over the past year, and the Company believes that these declines represent long-term trends. The Company's goal is to transition an increasing proportion of its revenues to growing markets, including Intel-Registered Trademark--based Windows NT workstations and UNIX based scalable servers such as the Company's Origin server product family. The Company's ability to achieve its revenue objectives over the next several quarters will largely depend on the extent to which growth in the Origin family and (beginning in the second half of fiscal 1999) Windows NT workstation products compensates for the expected decline in the other market sectors. In April 1998, the Company made a series of announcements concerning its strategic plans for the next several years. Key elements of the strategy include a continued focus on the technical and technical enterprise markets, with a product roadmap that will, over the next several years, merge the Company's vector supercomputer and scalable server families. The Company also announced an alliance with Intel Corporation that will result in the Company's transition to the Intel microprocessor architecture. While the Company believes that its strategies will result in its return to growth and profitability, the effects will not be reflected in any significant way in the Company's results until the latter half of fiscal 1999, and may not be fully reflected until fiscal 2000. DESKTOP SYSTEM STRATEGY. The Company has under development a family of desktop systems that will be based upon Intel microprocessors and the Windows NT operating system. There can be no assurance that these systems will be introduced as scheduled in the first half of fiscal 1999, and in any event they will not account for any significant revenue before the latter half of fiscal 1999. Success in this market segment will require that the Company adapt to very different requirements: high volume, lower margins, low-cost manufacturing and distribution, marketing to a broader audience, and new approaches to customer interface and support. The Company will also be required to maintain and extend its customer relationships through a complex product transition and to support a product line which includes multiple operating systems. In particular, although the Company plans to continue to invest in and support its current line of UNIX/MIPS-based workstations, there is a risk that revenue from this business will be materially reduced by the announcement of the new product family. The Company believes that its future success will largely depend on its making the right strategic choices in this market segment and on effective execution. SERVER STRATEGY. Sustaining growth in the Company's scalable server business is an important element of its strategic plans for the next several years. Sustained growth will require, among other things, adapting to a -7- longer sales cycle and the need to deliver more complete solutions, establishing a presence in emerging enterprise markets in which the Company has not traditionally participated, working effectively with independent software providers to ensure that important applications for the market segments targeted by the Company are available on the Company's platform, and ultimately, managing a successful and timely transition to the Intel architecture. EXPENSE REDUCTION PROGRAM. During fiscal 1998, the Company announced and began to implement a restructuring program aimed at bringing its expenses more in line with current revenue levels and restoring long-term profitability to the Company. The Company is seeking to further reduce its fiscal 1999 operating expenses significantly below the level of fiscal 1998 operating expenses. As part of this effort, the Company expects, through the elimination of positions and managed hiring, to end fiscal 1999 with approximately 1,000 fewer employees than it had at the end of fiscal 1998. These steps, and generally tighter operating expense controls, are part of an overall program to reduce the Company's expense structure. While the Company's objective is to reduce its costs in ways that will not have a material impact on revenue levels, there can be no assurance that this will be achieved. DEPENDENCE ON PARTNERS AND SUPPLIERS. The Company's business has always involved close collaboration with partners and suppliers. However, many elements of the Company's current business strategy, including the introduction of Intel-based Windows NT workstations, the longer-term transition to the Intel architecture, and additional outsourcing of manufacturing, will increase the Company's dependence on Microsoft, Intel and other partners, and on its manufacturing partners and other component suppliers. The Company's business could be adversely affected, for example, if Intel or Microsoft fail to meet product release schedules, or if unanticipated quality issues arise with products from these suppliers. PERIOD TO PERIOD FLUCTUATIONS. The Company's operating results may fluctuate for a number of reasons. Delivery cycles are typically short, other than for supercomputer and certain large-scale server products. Well over half of each quarter's revenue results from orders booked and shipped during the third month, and disproportionately in the latter half of that month. These factors make the forecasting of revenue inherently uncertain. Because the Company plans its operating expenses, many of which are relatively fixed in the short term, on expected revenue, even a relatively small revenue shortfall may cause a period's results to be substantially below expectations. Such a revenue shortfall could arise from any number of factors, including lower than expected demand, supply constraints, delays in the availability of new products, transit interruptions, overall economic conditions or natural disasters. Demand can also be adversely affected by product and technology transition announcements by the Company or its competitors. The timing of customer acceptance of certain large-scale server products may also have a significant effect on periodic operating results. Margins are heavily influenced by mix considerations, including geographic concentrations, the mix of product and service revenue, and the mix of server and desktop product revenue including the mix of configurations within these product categories. The Company's results have followed a seasonal pattern, with stronger sequential growth in the second and fourth fiscal quarters, reflecting the buying patterns of the Company's customers. The Company's stock price, like that of other technology companies, is subject to significant volatility. If revenue or earnings in any quarter fail to meet the investment community's expectations, there could be an immediate impact on the Company's stock price. The stock price may also be affected by broader market trends unrelated to the Company's performance. PROCESS RE-ENGINEERING. The Company is undertaking a series of programs aimed at redesigning some of its core business processes, including forecasting, supply chain management, order fulfillment and collection of accounts receivable. The goals of these programs include more predictable operational performance, lower operating expenses, greater quality and customer satisfaction, and improved asset management. The Company believes that the success of these programs is critical to its long-term competitive position. Implementing these changes will require, among other things, enhanced information systems, substantial training and disciplined execution. There can be no assurance that these programs -8- will be implemented successfully, or that disruptions to the Company's operations will not occur in the process. PRODUCT DEVELOPMENT AND INTRODUCTION. The Company's continued success depends on its ability to develop and rapidly bring to market highly differentiated, technologically complex and innovative products. Product transitions are a recurring part of the Company's business. A number of risks are inherent in this process. The development of new technology and products is increasingly complex and uncertain, which increases the risk of delays. The introduction of a new computer system requires close collaboration and continued technological advancement involving multiple hardware and software design teams, internal and external manufacturing teams, outside suppliers of key components such as semiconductor and storage products and outsourced manufacturing partners. The failure of any one of these elements could cause the Company's new products to fail to meet specifications or to miss the aggressive timetables that the Company establishes. There is no assurance that acceptance of the Company's new systems will not be affected by delays in this process. Short product life cycles place a premium on the Company's ability to manage the transition to new products. The Company often announces new products in the early part of a quarter, while the product is in the final stages of development, and seeks to manufacture and ship the product in volume during the same quarter. The Company's results could be adversely affected by such factors as development delays, the release of products to manufacturing late in any quarter, quality or yield problems experienced by suppliers, variations in product costs and excess inventories of older products and components. In addition, some customers may delay purchasing existing products in anticipation of new product introductions. YEAR 2000 COMPLIANCE Many computer systems and applications experience problems handling dates beyond the year 1999 and will need to be modified before the year 2000 in order to remain functional As for many other companies, the year 2000 computer issue poses a potential risk for the Company both as a user of information systems in the operation of its business and as a supplier of computer systems and related software, including operating system software, to customers. The Company has completed an assessment of its core business information systems, many of which are provided by outside suppliers, for year 2000 readiness and is extending that review to include a wide variety of other information systems and related business processes used in its operations. The Company plans to have changes to critical systems implemented by the third quarter of calendar 1999 to allow time for testing. Most of the Company's mission critical applications are believed to be year 2000 compliant, including the Company's Oracle information system which was recently upgraded to the most recent version. Although its assessment is ongoing, the Company currently believes that resolving these matters will not have a material adverse effect on its financial condition or results of operations. The Company is implementing a program to support customer efforts to achieve year 2000 compliance. This program includes encouraging customers and independent software vendors to adopt the Company's recently released IRIX 6.5 operating system, which the Company believes is year 2000 compliant, and additional customer support procedures. The Company also has made available software upgrades for some earlier releases of its IRIX operating system. The Company believes that the hardware systems it expects to support beyond 1999, when running on compliant operating systems, will be year 2000 compliant. The Company's older products may require upgrade or replacement to become year 2000 compliant. The Company believes that it generally is not legally responsible for costs incurred by customers to achieve their year 2000 compliance. However, the Company may experience increasing customer satisfaction costs relating to this issues over the next few years. The Company is also assessing the possible effect on its operations of the year 2000 readiness of critical suppliers of products and services. The Company's reliance on its key suppliers, and therefore on the proper functioning of their information systems and software, is increasing, and there can be no assurance -9- that another company's failure to address year 2000 issues could not have an adverse effect on the Company. The Company expects to complete a preliminary estimate of year 2000 project costs during the first quarter of fiscal 1999. The Company believes that it is unlikely to experience a material adverse impact on its financial condition or results of operations due to year 2000 compliance issues. However, since the assessment process is ongoing, year 2000 complications are not fully known, and potential liability issues are not clear, the full potential impact of the year 2000 on the Company is not known at this time. COMPETITION. The computer industry is highly competitive, with rapid technological advances and constantly improving price/performance. Most of the Company's competitors have substantially greater technical, marketing and financial resources and, in some segments, a larger installed base of customers and a wider range of available applications software. Competition may result in significant discounting and lower gross margins. IMPACT OF GOVERNMENT CUSTOMERS. A significant portion of the Company's revenue is derived from sales to the U.S. government, either directly by the Company or through system integrators and other resellers. Sales to the government present risks in addition to those involved in sales to commercial customers, including potential disruptions due to appropriation and spending patterns and the government's reservation of the right to cancel contracts for its convenience. EXPORT REGULATION. The Company's sales to foreign customers are subject to export regulations. Sales of many of the Company's high-end products require clearance and export licenses from the U.S. Department of Commerce under these regulations. The Department of Commerce is currently investigating the Company's compliance with the export regulations in connection with the sale of several computer systems to a customer in Russia during fiscal 1997. The Company believes that this matter will be resolved without a significant adverse effect on the Company's business. However, there is no assurance that this matter will not have an unforeseen outcome that could impair the conduct of the Company's business outside the United States. The Company's international sales would also be adversely affected if such regulations were tightened, or if they are not modified over time to reflect the increasing performance of the Company's products. INTELLECTUAL PROPERTY. The Company routinely receives communications from third parties asserting patent or other rights covering the Company's products and technologies. Based upon the Company's evaluation, it may take no action or it may seek to obtain a license. In any given case there is a risk that a license will not be available on terms that the Company considers reasonable, or that litigation will ensue. The Company currently has patent infringement lawsuits pending against it. The Company expects that, as the number of hardware and software patents issued continues to increase, and as competition in the markets addressed by the Company intensifies, the volume of these intellectual property claims will also increase. EMPLOYEES. The Company's success depends on its ability to continue to attract, retain and motivate highly qualified technical, marketing and management personnel, who are in great demand. The current uncertainties surrounding the Company have increased the challenges of retaining world-class talent. BUSINESS DISRUPTION. The Company's corporate headquarters, including most of its research and development operations and manufacturing facilities, are located in the Silicon Valley area of Northern California, a region known for seismic activity. A significant earthquake could materially affect operating results. The Company is not insured for most losses and business interruptions of this kind. EURO CONVERSION. As with many multinational companies operating in Europe, beginning in January 1999, Silicon Graphics will be affected by the conversion of 11 European currencies into a common business currency, the euro. Based on its preliminary assessment, the Company does not believe the conversion will have a material impact on the competitiveness of its products in Europe, where there -10- already exists substantial price transparency, or increase the likelihood of contract cancellations. The Company also believes its current accounting systems will accommodate the euro conversion with minimal intervention and does not expect to experience material adverse tax consequences as a result of the conversion. The convergence of currencies into the euro is expected to reduce the Company's overall currency risk and simplify the Company's currency risk management process, including its use of derivatives to manage that risk. The costs of addressing the euro conversion are not expected to be material and will be charged to operations as incurred. MARKET RISK. In the normal course of business, the financial position of the Company is routinely subjected to a variety of risks, including market risk associated with interest rate movements and currency rate movements on non-U.S. dollar denominated assets and liabilities, as well as collectibility of accounts receivable. The Company regularly assesses these risks and has established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, the Company does not anticipate material losses in these areas. For purposes of specific risk analysis, the Company uses sensitivity analysis to determine the impacts that market risk exposures may have on the fair values of the Company's debt and financial instruments. The financial instruments included in the sensitivity analysis consist of all of the Company's cash and cash equivalents, marketable investments, short-term and long-term debt and all derivative financial instruments. Currency forward contracts and currency options constitute the Company's portfolio of derivative financial instruments. To perform sensitivity analysis, the Company assesses the risk of loss in fair values from the impact of hypothetical changes in interest rates and foreign currency exchange rates on market sensitive instruments. The market values for interest risk are computed based on the present value of future cash flows as impacted by the changes in rates attributable to the market risk being measured. The discount rates used for the present value computations were selected based on market interest rates in effect at June 30, 1998 and 1997. The market values for foreign exchange risk are computed based on spot rates in effect at June 30, 1998 and 1997. The market values that result from these computations are compared to the market values of these financial instruments at June 30, 1998 and 1997. The differences in this comparison are the hypothetical gains or losses associated with each type of risk. The results of the sensitivity analysis at June 30, 1998 and 1997 are as follows: Interest Rate Risk: A 10% decrease in the levels of interest rates with all other variables held constant would result in a decrease in the fair values of the Company's financial instruments by $14 million and $3 million, respectively. A 10% increase in the levels of interest rates with all other variables held constant would result in an increase in the fair values of the Company's financial instruments by $12 million and $3 million, respectively. Foreign Currency Exchange Rate Risk: A 10% movement in levels of foreign currency exchange rates, 20% for Asian currencies, against the U.S. dollar with all other variables held constant would result in a decrease in the fair values of the Company's financial instruments by $14 million and $44 million, respectively, or an increase in the fair values of the Company's financial instruments by $12 million and $34 million, respectively. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information required under this Item 7A is included in the section above entitled Market Risk. -11-
- ----------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS - ----------------------------------------------------------------------------------------------------------- Years ended June 30 -------------------------------------------- (In thousands, except per share amounts) 1998 1997 1996(1) ---------- ---------- ---------- Revenue: Product and other revenue $2,489,983 $3,086,791 $2,553,128 Service revenue 610,627 575,810 368,188 ---------- ---------- ---------- Total revenue 3,100,610 3,662,601 2,921,316 Costs and Expenses: Cost of product and other revenue 1,580,647 1,697,277 1,279,742 Cost of service revenue 382,904 325,269 202,697 Research and development 459,188 479,101 353,461 Selling, general and administrative 1,068,429 1,038,313 807,830 Other operating expense 205,543 10,757 103,193 ---------- ---------- ---------- Total costs and expenses 3,696,711 3,550,717 2,746,923 ---------- ---------- ---------- Operating (loss) income (596,101) 111,884 174,393 Interest expense (24,665) (24,836) (22,365) Interest income and other, net 23,847 11,142 32,778 Minority interest in net loss of Cray Research - - 3,982 ---------- ---------- ---------- (Loss) income before income taxes (596,919) 98,190 188,788 (Benefit from) provision for income taxes (137,292) 19,639 73,751 ---------- ---------- ---------- Net (loss) income $ (459,627) $ 78,551 $ 115,037 ---------- ---------- ---------- ---------- ---------- ---------- Net (loss) income per share: Basic $ (2.47) $ 0.44 $ 0.70 ---------- ---------- ---------- ---------- ---------- ---------- Diluted $ (2.47) $ 0.43 $ 0.65 ---------- ---------- ---------- ---------- ---------- ---------- Shares used in the calculation of net (loss) income per share: Basic 186,149 175,548 162,658 Diluted 186,149 182,637 175,790
(1) Amounts reflect the April 2, 1996 acquisition of Cray Research, which was accounted for as a purchase. See Notes 2 and 3 to the consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements.
- --------------------------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS - --------------------------------------------------------------------------------------------------------------- At June 30 --------------------------- (Dollars in thousands) 1998 1997 ---------- ---------- ASSETS: Current assets: Cash and cash equivalents $ 506,639 $ 227,222 Short-term marketable investments 230,081 60,109 Accounts receivable, net of allowance for doubtful accounts of $17,463 in 1998; $24,056 in 1997 665,420 1,131,647 Inventories 322,823 628,064 Deferred tax assets 240,838 188,617 Prepaid expenses and other current assets 99,571 79,935 ---------- ---------- Total current assets 2,065,372 2,315,594 Other marketable investments - 86,961 Property and equipment, net of accumulated depreciation and amortization 445,420 525,452 Net long-term deferred tax assets 189,806 79,496 Other assets 264,108 337,089 ---------- ---------- $2,964,706 $3,344,592 ---------- ---------- ---------- ---------- LIABILITIES AND STOCKHOLDERS' EQUITY: Current liabilities: Short-term borrowings $ - $ 44,763 Accounts payable 215,260 258,884 Accrued compensation 160,609 125,076 Income taxes payable 23,041 47,480 Other current liabilities 363,436 264,152 Deferred revenue 329,525 337,691 Current portion of long-term debt 4,801 8,160 ---------- ---------- Total current liabilities 1,096,672 1,086,206 Long-term debt and other 403,522 419,144 Commitments and contingencies Stockholders' equity: Preferred stock, $.001 par value, issuable in series; 2,000,000 shares authorized; shares issued and outstanding: 17,500 16,998 16,998 Common stock, $.001 par value, and additional paid-in capital; 500,000,000 shares authorized; shares issued: 189,519,187 in 1998; 179,033,487 in 1997 1,407,108 1,263,185 Retained earnings 65,415 537,238 Treasury stock, at cost: 1,995,797 shares in 1998; 28 shares in 1997 (25,976) - Accumulated translation adjustment and other 967 21,821 ---------- ---------- Total stockholders' equity 1,464,512 1,839,242 ---------- ---------- $2,964,706 $3,344,592 ---------- ---------- ---------- ----------
The accompanying notes are an integral part of these consolidated financial statements.
- -------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS - -------------------------------------------------------------------------------------------------- Years ended June 30 ----------------------------------- (In thousands) 1998 1997 1996(1) --------- -------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $(459,627) $78,551 $115,037 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation and amortization 314,581 354,319 197,836 Write-off of acquired in-process technology 16,900 - 98,208 Changes in deferred tax assets and liabilities (162,540) (18,918) (66,776) Other 171,608 4,690 (3,050) Changes in operating assets and liabilities (net of effects of acquisitions): Accounts receivable 467,055 (152,773) (202,061) Inventories 264,226 (211,013) (19,632) Accounts payable (44,257) (2,236) 38,109 Other assets and liabilities 75,432 117,614 54,015 --------- --------- --------- Total adjustments 1,103,005 91,683 96,649 --------- --------- --------- Net cash provided by operating activities 643,378 170,234 211,686 CASH FLOWS FROM INVESTING ACTIVITIES: Available-for-sale investments: Purchases (230,368) (6,036) (1,006,107) Sales 43,000 16,162 1,232,419 Maturities 104,485 44,274 52,938 Acquisitions, net of cash acquired 831 - (408,144) Capital expenditures (195,137) (214,989) (188,853) Increase in other assets (74,636) (86,359) (62,388) --------- --------- --------- Net cash used in investing activities (351,825) (246,948) (380,135) CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of debt 18,735 123,807 137,509 Payments of debt principal (62,838) (153,730) (24,894) Sale of common stock 95,241 77,304 81,578 Repurchase of common stock (62,749) - (76,014) Cash dividends-preferred stock (525) (525) (525) --------- --------- --------- Net cash (used in) provided by financing activities (12,136) 46,856 117,654 --------- --------- --------- Net increase (decrease) in cash and cash equivalents 279,417 (29,858) (50,795) Cash and cash equivalents at beginning of year 227,222 257,080 307,875 --------- --------- --------- Cash and cash equivalents at end of year $506,639 $ 227,222 $ 257,080 --------- --------- --------- --------- --------- ---------
(1) Amounts reflect the April 2, 1996 acquisition of Cray Research, which was accounted for as a purchase. See Notes 2 and 3 to the consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements.
- ----------------------------------------------------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - ----------------------------------------------------------------------------------------------------------------------------------- Accumulated Common Stock Translation Total Three years ended June 30, 1998 Preferred and Additional Retained Treasury Adjustment Stockholders' (In thousands) Stock Paid-in-Capital Earnings Stock and Other Equity - ----------------------------------------------------------------------------------------------------------------------------------- Balance, June 30, 1995 $ 16,998 $ 903,300 $385,915 $ - $ 39,957 $ 1,346,170 Common stock issued under employee plans including related tax benefits (4,606 shares) - 72,618 - - 72,618 Common stock issued for Cray Research acquisition (7,325 shares) - 197,042 - - - 197,042 Convertible preferred stock, Series A preferred dividends - - (525) - - (525) Purchase (2,453 shares) and issuance (2,417 shares) of treasury stock under employee plans--net - - (39,116) (867) - (39,983) Currency translation adjustment - - - - (12,047) (12,047) Change in unrealized gains (losses) on available- for-sale securities, net of tax - - - - (2,994) (2,994) Net income - - 115,037 - - 115,037 - ----------------------------------------------------------------------------------------------------------------------------------- Balance, June 30, 1996 (1) 16,998 1,172,960 461,311 (867) 24,916 1,675,318 Common stock issued under employee plans including related tax benefits (6,623 shares) - 90,225 - - - 90,225 Convertible preferred stock, Series A preferred dividends - - (525) - - (525) Issuance of treasury stock under employee plans (36 shares) (2,099) 867 (1,232) Currency translation adjustment - - - - (4,303) (4,303) Change in unrealized gains (losses) on available-for-sale securities, net of tax - - - - 1,208 1,208 Net income - - 78,551 - - 78,551 - ----------------------------------------------------------------------------------------------------------------------------------- Balance, June 30, 1997 16,998 1,263,185 537,238 - 21,821 1,839,242 Common stock issued under employee plans including related tax benefits (7,551 shares) - 95,194 95,194 Common stock issued for ParaGraph acquisition (2,935 shares) 48,729 48,729 Convertible preferred stock, Series A preferred dividends - (525) - (525) Purchase (4,700 shares) and issuance (2,704 shares) of treasury stock under employee plans--net (11,671) (25,976) (37,647) Currency translation adjustment - (21,416) (21,416) Change in unrealized gains (losses) on available- for-sale securities, net of tax - 562 562 Net loss - (459,627) (459,627) - ----------------------------------------------------------------------------------------------------------------------------------- Balance, June 30, 1998 $ 16,998 $ 1,407,108 $ 65,415 $(25,976) $ 967 $1,464,512 - ----------------------------------------------------------------------------------------------------------------------------------- - -----------------------------------------------------------------------------------------------------------------------------------
(1) Amounts reflect the April 2, 1996 acquisition of Cray Research, which was accounted for as a purchase. See Notes 2 and 3 to the consolidated financial statements. The accompanying notes are an integral part of these consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. NATURE OF OPERATIONS Silicon Graphics, Inc. ("Silicon Graphics" or the "Company") is a leader in high-performance computing. The Company's broad range of workstations and graphics servers deliver advanced 3D graphics and computing capabilities for engineering and creative professionals. The Company's highly scalable servers also have a growing presence in the enterprise market, with a particular emphasis on Internet, large corporate data and telecommunications applications. The Company's products are primarily manufactured in Mountain View, California with other manufacturing facilities located in the Midwest and Europe. The Company distributes its products through its direct sales force, as well as through indirect channels including resellers and distributors. Product and other revenue consists primarily of revenue from system and software product shipments, as well as the sale of software distribution rights, system leasing, technology licensing agreements and non-recurring engineering ("NRE") contracts. Service revenue results primarily from customer support and maintenance contracts. Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after elimination of significant intercompany transactions and balances. The Company acquired Cray Research, Inc. in a merger effected in the fourth quarter of fiscal 1996. The Cray Research operating results were consolidated with those of the Company at April 2, 1996, and the consolidated results reflect a 25% minority interest in the Cray Research operating results for the period from April 2, 1996 through June 30, 1996. FOREIGN CURRENCY TRANSLATION The Company translates the assets and liabilities of its foreign subsidiaries stated in local functional currencies to U.S. dollars at the rates of exchange in effect at the end of the period. Revenues and expenses are translated using rates of exchange in effect during the period. Gains and losses from currency translation are included in stockholders' equity. Currency transaction gains or losses are recognized in interest income and other, net and, net of hedging gains or losses, have not been significant to the Company's operating results in any period. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. CASH EQUIVALENTS AND MARKETABLE INVESTMENTS Cash equivalents consist of high quality money market instruments with original maturities of 90 days or less. Short-term marketable investments consist of both high quality money market instruments and high quality debt securities with maturities of one year or less, and are stated at fair value. Other marketable investments consist primarily of high quality debt securities with maturities greater than one year and less than two years, and are stated at fair value. The Company's cash equivalents and marketable investments are all classified as available-for-sale. The cost of securities when sold is based upon specific identification. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in interest income and other, net. Unrealized gains and losses (net of tax) on securities classified as available-for-sale are included in stockholders' equity. FAIR VALUES OF FINANCIAL INSTRUMENTS The carrying values of short-term debt approximate fair value due to the short period of time to maturity. Fair values of cash equivalents, marketable investments, long-term debt, foreign exchange forward contracts and interest swaps are based on quoted market prices or pricing models using current market rates. DERIVATIVE FINANCIAL INSTRUMENTS Silicon Graphics uses derivatives to moderate the financial market risks of its business operations. The Company has used derivative products to hedge the foreign currency and interest rate market exposures underlying certain assets and liabilities and commitments related to customer transactions. The Company's accounting policies for these instruments are based on its designation of such instruments as hedging transactions. The Company designates an instrument as a hedge based in part on its effectiveness in risk reduction and one-to-one matching of derivative instruments to underlying transactions. Gains and losses on currency forward contracts that hedge firmly committed customer transactions and on currency purchased options that hedge probable anticipated, but not firmly committed, customer transactions are deferred and recognized in revenue in the same period that the underlying transactions are settled. Gains and losses on currency forward contracts that hedge existing assets and liabilities are recognized in interest and other income, net, in the same period as losses and gains on the underlying transactions are recognized and generally offset. Gains and losses on any derivatives not meeting the above criteria would be recognized in income in the current period. The differential between fixed and floating rates to be paid or received on interest rate swaps is accrued and recognized as an adjustment to interest expense over the life of the agreements. The related amount payable or receivable is included in other current assets or accrued liabilities. EQUITY INSTRUMENTS INDEXED TO THE COMPANY'S COMMON STOCK Proceeds received from the sale of equity instruments and amounts paid upon the purchase of equity instruments are recorded as a component of stockholders' equity. Subsequent changes in the fair value of the equity instrument contracts are not recognized. The Company has the ability to determine whether the contracts are settled in cash or stock. If the contracts are ultimately settled in cash, the amount of cash paid or received is recorded as a component of stockholders' equity. INVENTORIES Manufacturing inventories are stated at the lower of cost (first-in, first-out) or market. Demonstration systems are stated at cost less depreciation generally based on an eighteen-month life. PROPERTY AND EQUIPMENT Property and equipment is stated at cost and depreciation is computed using the straight-line method. Useful lives of two to five years are used for machinery and equipment and furniture and fixtures; leasehold improvements are amortized over the shorter of their useful lives or the term of the lease. The Company's buildings are depreciated over twenty-five to forty years and improvements over eight to fifteen years. OTHER ASSETS Included in other assets are intangible assets related to the acquisition of Cray Research in fiscal 1996, and goodwill associated with the acquisition of Silicon Graphics World Trade Corporation in fiscal 1991. Amortization of these purchased intangibles and goodwill is provided on a straight-line basis over the respective useful lives of the assets ranging from two to twenty years. Also included in other assets are purchased technologies and spare parts that are generally amortized on a straight-line basis over the course of their respective useful lives ranging from two to ten years. REVENUE RECOGNITION Product revenue is generally recognized when the product is shipped to the customer and the Company has no additional performance obligations. Sales of certain high performance systems, including most Cray Research-branded systems, may be made on the basis of contracts that include acceptance criteria. In these instances, revenue (net of trade-in allowances) is recognized upon acceptance by the customer or independent distributor, or in the case of a conversion from lease to purchase, at the time of the customer's election to convert. Operating system software fees are recognized when the product has been shipped, provided that the Company has no additional performance obligations. Application software fees are recognized when the product is delivered, provided that the Company has no additional performance obligations. Royalty revenue, under technology agreements, is generally recognized in the quarter in which a report is received from a licensee detailing the shipments of products incorporating the Company's intellectual property components. Engineering services, which are performed on a best efforts basis, are recognized as revenue when the defined milestones are completed and the milestone payment is probable of collection. Revenue related to future commitments under service contracts is deferred and recognized ratably over the related contract term. PRODUCT WARRANTY The Company provides at the time of sale for the estimated cost to warrant its products against defects in materials and workmanship for a period of up to one year. ADVERTISING COSTS The Company accounts for advertising costs as expense in the period in which they are incurred. Advertising expense for the years ended June 30, 1998, 1997 and 1996 was $55.6 million, $42.5 million and $37.5 million, respectively. PER SHARE DATA In fiscal 1998, the Company adopted Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). Basic earnings per share is based on the weighted effect of all common shares issued and outstanding, and is calculated by dividing net income available to common stockholders by the weighted average shares outstanding during the period. Diluted earnings per share is calculated by dividing net income available to common stockholders, adjusted for the effect, if any, from assumed conversion of all potentially dilutive common shares outstanding, by the weighted average number of common shares used in the basic earnings per share calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive common shares outstanding. All historical earnings per share amounts have been restated to conform to the provisions of this statement. STOCK COMPENSATION The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS 123"). As allowed by SFAS 123, the Company accounts for stock-based employee compensation arrangements under the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"). As a result, no expense has been recognized for options to purchase Silicon Graphics common stock granted with an exercise price equal to fair market value at the date of grant or in connection with the Silicon Graphics stock purchase plan. For Silicon Graphics stock options that have been granted at discounted prices and for awards of restricted Silicon Graphics common stock, the Company accrues compensation expense over the vesting period for the difference between the exercise or purchase price and the fair market value on the measurement date. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board issued Statement No. 130, Reporting Comprehensive Income ("SFAS 130"), and Statement No. 131, Disclosures about Segments of an Enterprise and Related Information ("SFAS 131"). The Company is required to adopt these Statements in fiscal 1999. SFAS 130 establishes new standards for reporting and displaying comprehensive income and its components. SFAS 131 requires disclosure of certain information regarding operating segments, products and services, geographic areas of operation and major customers. Adoption of these Statements is expected to have no impact on the Company's consolidated financial position, results of operations or cash flows. In October 1997, the AICPA issued Statement of Position (SOP) 97-2, Software Revenue Recognition, which supersedes SOP 91-1. The Company will be required to adopt SOP 97-2 for software transactions entered into beginning July 1, 1998, and retroactive application to years prior to adoption is prohibited. SOP 97-2, as amended by SOP 98-4, generally requires revenue earned on software arrangements involving multiple elements (i.e., software products, upgrades/enhancements, postcontract customer support, installation, training, etc.) to be allocated to each element based on the relative fair value of the elements. The fair value of an element must be based on evidence which is specific to the vendor. The revenue allocated to software products generally is recognized upon delivery of the products. The revenue allocated to postcontract customer support generally is recognized ratably over the term of the support and revenue allocated to service elements generally is recognized as the services are performed. If a vendor does not have evidence of the fair value for all elements in a multiple-element arrangement, all revenue from the arrangement is deferred until such evidence exists or until all elements are delivered. Management has not yet determined what the effect of SOP 97-2 will be on the Company's consolidated financial position, results of operations or cash flows. In June 1998, the Financial Accounting Standards Board issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activity ("SFAS 133"), which is required to be adopted in years beginning after June 15, 1999. The Statement permits early adoption as of the beginning of any fiscal quarter; however, the Company has yet to determine its date of adoption. The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges of underlying transactions must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. Management has not yet determined what the effect of Statement 133 will be on the Company's consolidated financial position, results of operations or cash flows. RECLASSIFICATIONS Certain prior year amounts on the Consolidated Balance Sheets and Consolidated Statements of Stockholders' Equity have been reclassified to conform to the current year presentation. Note 3. BUSINESS COMBINATIONS ACQUISITION OF PARAGRAPH On September 30, 1997, the Company completed its acquisition of ParaGraph International, Inc. ("ParaGraph"), a software company, in exchange for cash and shares of the Company's common stock for an aggregate purchase price of approximately $50 million, including direct acquisition costs. The Company accounted for the acquisition using the purchase method. The purchase price was allocated based on an independent valuation and consisted principally of acquired in-process technology ($17 million), included in other operating expenses, and goodwill ($34 million). See Note 4 regarding the subsequent write-off of goodwill in the third quarter of fiscal 1998. ACQUISITION OF CRAY RESEARCH On April 2, 1996, Silicon Graphics acquired approximately 75% of the outstanding shares of common stock of Cray Research for cash. On June 30, 1996, the Company acquired the remaining outstanding Cray Research shares in a merger by exchanging one share of Silicon Graphics common stock for each remaining share of Cray Research common stock. Silicon Graphics also assumed the outstanding Cray Research employee stock options. The aggregate purchase price (including direct acquisition costs) was approximately $767 million in cash, common stock and the value associated with options to purchase the Company's common stock. The Company has accounted for the acquisition using the purchase method. The following is a summary of the purchase price allocation (in millions): Inventories and service contracts $ 281.5 Property, plant and equipment 143.7 Intangible assets 84.3 Accrual for exit costs (39.4) Other assets/liabilities, net 198.5 Acquired in-process technology 98.2 -------- $ 766.8 -------- --------
At the acquisition date, intangible assets included $24.5 million of completed technology and an aggregate of $59.8 million for customer lists, trade name and workforce-in-place. Completed technology had been assigned a four year life, workforce-in-place a five year life and customer lists and trade name 15 year lives. In June 1998, as a result of a $52 million reduction in the acquired Cray deferred tax asset valuation allowance, these intangible assets were written down to a carrying value of $7 million and will be amortized over two years. See Note 14. The $98.2 million allocated to acquired in-process technology was expensed in fiscal 1996 as required under generally accepted accounting principles, and is included in other operating expense. Note 4. OTHER OPERATING EXPENSE Other operating expense is as follows (in thousands):
Years ended June 30 ------------------------------- 1998 1997 1996 -------- ------- -------- Write-off of acquired in-process technology and other merger-related expenses $ 14,905 $10,757 $103,193 Restructuring 143,998 -- -- Charge for impairment of long-lived assets 46,640 -- -- -------- ------- -------- $205,543 $10,757 $103,193 -------- ------- -------- -------- ------- --------
WRITE-OFF OF ACQUIRED IN-PROCESS TECHNOLOGY AND OTHER MERGER-RELATED EXPENSES The 1998 amount includes a $17 million charge for acquired in-process technology from the acquisition of Paragraph, partially offset by reductions in merger-related accruals from fiscal 1997 and 1996. The 1997 amount consists of merger related-expenses. The 1996 amount includes a $98 million charge for acquired in-process technology from the acquisition of Cray as well as merger-related expenses. Merger-related expenses consist principally of costs associated with the integration of Silicon Graphics and Cray information systems, accounting processes and marketing and human resources activities. RESTRUCTURING In the second quarter of fiscal 1998, the Company announced and began to implement a restructuring program aimed at bringing its expenses more in line with the current revenue levels and restoring long-term profitability to the Company. The process of developing this program continued during the balance of fiscal 1998 and included a reevaluation of the Company's core competencies, technology roadmap and business model, as well as development of its fiscal 1999 operating plan. The Company's restructuring activity in fiscal 1998 consisted primarily of eliminating approximately 1,700 positions, approximately 1,000 of which were eliminated as of June 30, 1998, writing down certain operating assets, vacating certain leased facilities and canceling certain contracts. Through June 30, 1998, these actions have resulted in aggregate charges of $144 million, of which approximately $93 million have used or will use cash, and $51 million were non-cash charges. The Company expects that the remaining $64 million accrued balance at June 30, 1998 will result in cash expenditures of approximately $59 million over the next twelve months and will be financed through current working capital. The following table depicts the fiscal 1998 restructuring activity:
Total Spending/ Balance at Category Restructuring Charges Charges June 30, 1998 - ---------------------------------------------------------------------------------------- (in thousands) Severance and related charges $ 83,962 $ (34,559) $ 49,403 Operating asset reserves 37,780 (33,560) 4,220 Canceled contracts 4,675 (2,620) 2,055 Vacated facilities 8,960 (1,686) 7,274 Other 8,621 (7,727) 894 --------- ---------- --------- $143,998 $ (80,152) $ 63,846 --------- ---------- --------- --------- ---------- ---------
As part of its evaluation of the Company's core competencies and technology roadmap, management decided in the third quarter to cease pursuing development of certain software products and market opportunities. As a result of that decision, operating asset reserves include a $32 million charge to write-off purchased intangibles and goodwill associated with the September 1997 acquisition of ParaGraph. CHARGE FOR IMPAIRMENT OF LONG-LIVED ASSETS As a result of the processes described above, the Company also found it necessary to downsize its vector supercomputer business, necessitating an evaluation of the ongoing value of the associated plant and equipment and intangible assets. Based on this evaluation, the Company determined that assets (principally a specific-use manufacturing facility; supercomputers used in product design, support and manufacturing and other machinery and equipment) with a carrying amount of $50 million were impaired and wrote them down by $47 million to their fair value. Fair value was principally based on an independent appraisal and estimated exchange and resale value. Note 5. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted (loss) income per share:
Years ended June 30 ------------------------------------------ 1998 1997 1996 - ----------------------------------------------------------------------------------------------- (in thousands, except per share amounts) Net (loss) income $ (459,627) $ 78,551 $ 115,037 Less preferred stock dividends (525) (525) (525) ----------- --------- ---------- Net (loss) income available to common stockholders $ (460,152) $ 78,026 $ 114,512 ----------- --------- ---------- ----------- --------- ---------- Weighted average shares outstanding--basic 186,149 175,548 162,658 Employee stock options -- 7,089 13,132 ----------- --------- ---------- Weighted average shares outstanding--diluted 186,149 182,637 175,790 ----------- --------- ---------- ----------- --------- ---------- Net (loss) income per share: Basic $ (2.47) $ 0.44 $ 0.70 ----------- --------- ---------- ----------- --------- ---------- Diluted $ (2.47) $ 0.43 $ 0.65 ----------- --------- ---------- ----------- --------- ---------- Potentially dilutive securities excluded from computations because they are anti-dilutive 12,187 9,144 8,895 ----------- --------- ---------- ----------- --------- ----------
Note 6. FINANCIAL INSTRUMENTS CASH EQUIVALENTS AND MARKETABLE INVESTMENTS The following table summarizes by major security type the fair value of the Company's cash equivalents and marketable investments at June 30, 1998 and 1997 (in thousands):
1998 1997 - ------------------------------------------------------------------ U.S. commercial paper 296,789 -- U.S. Treasury securities and obligations of U.S. government agencies $ 151,933 $146,337 Certificates of deposit and time deposits 93,590 -- Money market preferreds 40,000 -- Repurchase agreements 36,000 35,000 Money market funds 17,800 14,400 Other -- 733 ---------- -------- Total 636,112 196,470 Less amounts classified as cash equivalents (406,031) (49,400) ---------- -------- Total marketable investments $ 230,081 $147,070 ---------- -------- ---------- --------
At June 30, 1998 and 1997, the amortized cost of cash equivalents and marketable investments approximates fair value. Gross unrealized gains and losses were not significant in fiscal 1998 or 1997. Gross realized gains and losses on sales of available-for-sale securities were not significant in fiscal 1998, 1997 or 1996. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The notional principal amounts of the Company's currency forward contracts at June 30, 1998 and 1997 were $103 million and $296 million, respectively. The notional principal amount of the Company's currency options at June 30, 1998 was $79 million. There were no currency options outstanding at June 30, 1997. The notional principal amounts for off-balance-sheet instruments provide one measure of the transaction volume outstanding at year end, and do not represent the amount of the Company's exposure to credit loss or market risk. Credit risk is the Company's gross exposure to potential accounting loss on currency forward contracts if all counterparties failed to perform as agreed at the contracted rates and contracts had to be replaced at rates prevailing at each respective date. The Company transacts business in various foreign currencies, including the major European currencies and the Japanese yen. The Company has established revenue and balance sheet hedging programs to protect against reductions in value and volatility of future cash flows caused by changes in foreign exchange rates. The Company uses derivatives in the form of currency forward contracts and currency options in its programs. All currency forward contracts related to recorded transactions expire within one year. All currency forward contracts related to firmly committed customer transactions expire within two and one-half years. All currency options related to anticipated, but not firmly committed, transactions expire within three months. Deferred gains and losses on contracts related to firmly committed transactions were immaterial at June 30, 1998 and 1997. Deferred gains and losses on currency options at June 30, 1998 were immaterial. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and estimated fair values of the Company's financial instruments at June 30, 1998 and 1997 are summarized as follows (in thousands):
1998 1997 ----------------------- ------------------------- Carrying Carrying Amount Fair Value Amount Fair Value - ------------------------------------------------------------------------------------------------ Cash and cash equivalents $ 506,639 $ 506,639 $ 227,222 $ 227,222 Marketable investments 230,081 230,081 147,070 147,070 Debt instruments 371,261 331,525 424,958 414,547 Currency forward contracts (3,577) (822) 1,004 88 Currency options 592 163 -- --
Note 7. CONCENTRATION OF CREDIT AND OTHER RISKS CREDIT RISK Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash investments, currency forward contracts and trade receivables. The Company places its investments and transacts its currency forward contracts with high-credit-quality counterparties and, by policy, limits the amount of credit exposure to any one counterparty, and generally does not require collateral. The credit risk on receivables due from counterparties related to currency forward contracts is immaterial at June 30, 1998 and 1997. The Company performs ongoing credit evaluations of its customers and, except in connection with the sales of supercomputers, generally does not require collateral. The Company maintains reserves for potential credit losses and such losses have been within management's expectations. PRODUCTION Most of the Company's products incorporate components that are available from only one or from a limited number of suppliers. Many of these components are custom designed and manufactured, with lead times from order to delivery that can exceed 90 days. Shortages of various essential materials could occur due to interruption of supply or increased demand in the industry. In addition, the Company increasingly outsources certain aspects of its production to third parties. If the Company were unable to procure certain such components or sustain its outsourced production capacity, it could affect the Company's ability to meet demand for its products which would have an adverse effect upon its results. INTERNATIONAL OPERATIONS Approximately half of the Company's revenue is derived from sales outside the United States, with approximately 20% being derived from Asia-Pacific customers. In addition, many key components are produced outside the United States. Therefore, the Company's results could be negatively affected by such factors as changes in foreign currency exchange rates, trade protection measures, longer accounts receivable collection patterns, and changes in regional or worldwide economic or political conditions. The risks of its international operations are mitigated in part by the Company's foreign exchange hedging program and by the extent to which the Company's sales and manufacturing activities are geographically distributed. The Company's sales to foreign customers also are subject to export regulations, with sales of most of the Company's high-end products requiring clearance and export licenses from the U.S. Department of Commerce. These regulations are currently under review by the U.S. government. The Company's export sales would be adversely affected if such regulations were tightened, or if they are not modified over time to reflect the increasing performance of the Company's products. The Department of Commerce is currently reviewing the Company's compliance with the export control regulations in connection with the shipment of several computer systems to a customer in the Russian Federation in fiscal 1997. The Company believes it has complied with all applicable regulations. However, if the Company's export privileges were limited or denied, the Company's results would be adversely affected. Note 8. INVENTORIES Inventories at June 30, 1998 and 1997 are as follows (in thousands):
1998 1997 - ------------------------------------------------------------------ Components and subassemblies $ 114,139 $ 235,492 Work-in-process 74,961 235,426 Finished goods 47,917 74,519 Demonstration systems 85,806 82,627 ---------- ---------- Total inventories $ 322,823 $ 628,064 ---------- ---------- ---------- ----------
Note 9. PROPERTY AND EQUIPMENT Property and equipment at June 30, 1998 and 1997 are as follows (in thousands):
1998 1997 - ------------------------------------------------------------------ Land and buildings $ 119,977 $ 120,906 Machinery and equipment 514,665 591,008 Furniture and fixtures 109,346 108,183 Leasehold improvements 121,938 120,598 ---------- ---------- 865,926 940,695 Accumulated depreciation and amortization (420,506) (415,243) ---------- ---------- Net property and equipment $ 445,420 $ 525,452 ---------- ---------- ---------- ----------
Note 10. BORROWING ARRANGEMENTS SHORT-TERM BORROWINGS Short-term borrowings at June 30, 1998 and 1997 are as follows (in thousands):
1998 1997 - -------------------------------------------------------------------------------- Reverse repurchase agreements at 6.10%, collateralized by marketable investments $ -- $ 40,800 Other bank borrowings at 10.5% to 16.5% -- 3,963 ------- --------- $ -- $ 44,763 ------- --------- ------- ---------
The Company also has an unsecured $250 million revolving credit facility that expires in April 1999. At both June 30, 1998 and 1997 this facility was unused. Interest on borrowings would be based upon either a prime rate, LIBOR rate or competitive bid rate at the Company's option. Under this credit facility, the Company is subject to certain commitment and utilization fees on the unused portion of the committed amount. Fees incurred were not material during the last three fiscal years. Covenants governing the credit facility require the maintenance of certain financial ratios. At June 30, 1998, the Company was in compliance with these covenants. LONG-TERM DEBT Long-term debt at June 30, 1998 and 1997 is as follows (in thousands):
1998 1997 - ------------------------------------------------------------------------------------ Senior Convertible Notes due September 2004 at 5.25% $ 230,591 $ -- Zero Coupon Convertible Subordinated Debentures due November 2013 at 4.15%, net of unamortized discount of $3,313 ($222,370 in 1997) 3,777 232,630 Convertible Subordinated Debentures due February 2011 at 6.125%, net of unamortized discount of $16,154 ($16,897 in 1997) 65,846 65,103 Swiss Franc mortgage due June 2017 at 3.77% (3.64% in 1997), which resets quarterly 19,893 19,619 Japanese Yen fixed rate loan due December 2001 at 2.06% 42,005 52,752 Other 9,149 10,090 ---------- --------- 371,261 380,194 Less amounts due within one year (4,801) (8,160) ---------- --------- Amounts due after one year $ 366,460 $ 372,034 ---------- --------- ---------- ---------
In November 1993, the Company issued Zero Coupon Convertible Subordinated Debentures (the "Zero Coupon Debentures") with an ultimate maturity amount of $455 million. In September 1997, the Company completed an offer to exchange its newly registered Senior Convertible Notes (the "Senior Notes") for up to all of its existing Zero Coupon Debentures. The Senior Notes are convertible into shares of common stock at a conversion price equal to $36.25 per share. The Senior Notes are redeemable at the option of the Company, beginning in 2002, at varying prices based on the year of redemption. The Senior Notes are redeemable at the option of the holder in the event of the sale of all, or substantially all, of the Company's common stock for consideration other than common stock traded on a U.S. exchange or approved for quotation on the Nasdaq National Market. The offer was structured to exchange that principal amount of Senior Notes equal to the accreted value of each $1,000 principal at maturity Zero Coupon Debenture. Under current generally accepted accounting principles, the exchange did not constitute an extinguishment of debt and, accordingly, as a result of the exchange there was no change in the overall carrying value of the Company's debt. The Company took a charge of approximately $2.6 million for the Senior Notes issuance costs upon closing. The Zero Coupon Debentures are redeemable at any time, at the option of the Company, at redemption prices equal to the issue price ($439.77 per debenture) plus accrued original issue discount to the date of redemption. At the option of the holder, each Zero Coupon Debenture is convertible into 16.269 shares of common stock of the Company at any time. Also at the option of the holder, the Zero Coupon Debentures will be purchased by the Company on November 2, 2003 or November 2, 2008, at purchase prices equal to the issue price plus accrued original issue discount to such purchase date. The Company, at its option, may elect to pay any such purchase price in cash or shares of common stock, or any combination thereof. The Zero Coupon Debentures are redeemable at the option of the holder in the event of the sale of all, or substantially all, of the Company's common stock for consideration other than common stock traded on a U.S. exchange or approved for quotation on the Nasdaq National Market. Related to the Zero Coupon Debentures, the Company had a swap agreement to receive fixed, pay floating rate interest on a notional amount of $200.1 million that expired in November 1996. In connection with the Cray Research acquisition, the Company assumed the Cray Research Convertible Subordinated Debentures. These debentures are convertible into the Company's common stock at a conversion price of $78 per share at any time prior to maturity and may be redeemed at the Company's option at a price of 100%. In 1994 Cray Research repurchased a portion of the debentures with a face value of $23.0 million. The repurchase satisfied the first four required annual sinking fund payments of $5.8 million originally scheduled for the years 1997 through 2000. Remaining annual sinking fund payments of $5.8 million each are scheduled from 2001 to 2010 with a final maturity payment of $24.5 million in 2011. Principal maturities of long-term debt at June 30, 1998 are as follows (in millions): 1999 - $4.8 2000 - $6.1; 2001 - $3.8; 2002 - $44.1; 2003 - $2.1 and $310.4, thereafter. Note 11. LEASING ARRANGEMENTS AS LESSOR The Company has entered into certain lease arrangements which are accounted for as sales. The net investment in sales-type leases at June 30, 1998 and 1997 is summarized as follows (in thousands):
1998 1997 - -------------------------------------------------------------------- Total minimum lease payments receivable $ 1,284 $ 31,090 Less unearned interest income (47) (3,102) -------------------- Net investment in sales-type leases 1,236 27,988 Less current portion (1,113) (13,526) -------------------- Long-term portion included in other assets $ 124 $ 14,462 -------------------- --------------------
Future minimum lease rents on noncancelable sales-type lease agreements at June 30, 1998 are as follows (in millions): 1999 - $1.2; and 2000 - $0.1. Note 12. LEASING ARRANGEMENTS AS LESSEE The Company leases certain of its facilities and some of its equipment under non-cancelable operating lease arrangements. Future minimum annual lease payments under operating leases, net of subleases and rental income, at June 30, 1998 are as follows (in millions): 1999 - $74.3; 2000 - $62.9; 2001 - $48.0; 2002 - $36.4; 2003 - $20.2 and $206.2, thereafter. Aggregate operating lease rent expense in fiscal 1998, 1997 and 1996 was (in millions): $106.8, $97.7 and $76.7, respectively. Under one of its lease agreements, as amended, the Company is contingently liable for the residual value of five buildings at the end of their lease terms. The lease for one of the buildings expires in 2000 and the lease for the other four buildings expires in 2002. However, the Company has the option to extend these leases for an additional 35 years after expiration. If at the end of the final lease renewal, or upon the Company's option to terminate the lease at any time, the Company does not purchase the property or arrange a third-party purchase, then the Company would be obligated to the lessor for a guaranteed payment equal to a specified percentage of the lessor's purchase price for the properties. The Company would also be obligated to the lessor for all or some portion of this amount if the price paid by a third party for the property is below a specified percentage of the lessor's purchase price. The total amount related to the five properties, for which the Company would be contingently liable, is approximately $93.4 million at the end of the lease terms. Note 13. STOCKHOLDERS' EQUITY PREFERRED STOCK TRANSACTIONS NKK Corporation ("NKK") owns 17,500 shares of Series A convertible preferred stock (see Note 17). The preferred stock pays a 3% cumulative annual dividend, has preference upon liquidation in the amount of the purchase price and has aggregate voting rights equivalent to 1,400,000 shares of common stock. The preferred stock is convertible into the common stock of the Company at certain times at the then-current price of the common stock. The preferred stock is perpetual, but is subject to redemption at the option of the Company at certain times if the market price of the common stock is below $8.75 per share. STOCK AWARD PLANS The Company has various stock award plans which provide for the grant of incentive and nonstatutory stock options and the issuance of restricted stock to employees and certain other persons who provide consulting or advisory services to the Company. Incentive stock options are granted at not less than the fair market value on the date of grant; the prices of nonstatutory stock option grants and restricted stock are determined by the board of directors. Under the plans, options and restricted stock generally vest over a fifty-month period from the date of grant. In addition, the Company has a Directors' Stock Option Plan which allows for the grant of nonstatutory stock options to nonemployee directors at not less than the fair market value at the date of grant. Eligible directors are granted an option to purchase 30,000 shares of common stock on the date of their initial election as a director. On November 1 of each year, each eligible director is granted an option to purchase an additional 10,000 shares of common stock. These options generally vest in installments over a four year period. At June 30, 1998, 803,000 shares were available for future option grants under the Directors' Stock Option Plan. At June 30, 1998, 1997 and 1996, outstanding options to purchase 17,337,552, 18,346,324 and 20,442,299 shares, respectively, were exercisable and 580,316, 303,620 and 213,855 shares of restricted stock, respectively, were subject to repurchase. Activity under all of the stock award plans was as follows:
Outstanding Options -------------------------- Weighted Shares Available Number Average Three years ended June 30, 1998 For Grant of Shares Exercise Price - ----------------------------------------------------------------------------------------- Balance at June 30, 1995 2,492,136 31,974,937 $14.70 Additional shares authorized for issuance 7,116,758 Cray Research options assumed 2,540,543 3,894,570 $26.92 Options granted (9,305,575) 9,305,575 $28.31 Options exercised (5,283,368) $ 8.65 Options forfeited 1,835,013 (1,835,013) $26.91 Restricted shares granted (232,500) Restricted shares returned 20,000 Plan shares expired (160) ----------- ----------- Balance at June 30, 1996 4,466,215 38,056,701 $19.53 Additional shares authorized for issuance 6,833,106 Options granted (18,817,420) 18,817,420 $20.49 Options exercised (3,703,246) $10.47 Options forfeited 4,862,813 (4,862,813) $26.98 Options canceled 13,554,514 (13,554,514) $27.37 Restricted shares granted (209,000) Restricted shares returned 58,900 ----------- ----------- Balance at June 30, 1997 10,749,128 34,753,548 $16.92 Additional shares authorized for issuance 6,266,172 Options granted (11,536,447) 11,536,447 $13.18 Options exercised (6,146,202) $ 8.93 Options forfeited 5,748,950 (5,748,950) $19.86 Restricted shares granted (612,762) Restricted shares returned 217,250 Plan shares expired (118) ----------- ----------- Balance at June 30, 1998 10,832,173 34,394,843 $16.59 ----------- ----------- ----------- -----------
Additional information about options outstanding at June 30, 1998 is as follows:
Options Outstanding Options Exercisable ----------------------------------------- --------------------------- Weighted Average Exercise Price Number of Contractual Weighted Average Number of Weighted Average Range Shares Life (years) Exercise Price Shares Exercise Price - ------------------------------------------------------------- --------------------------- $ 0.96 - $ 11.25 7,022,205 5.4 $ 8.42 3,969,956 $ 6.28 $ 11.31 - $ 18.88 18,972,933 7.7 $ 15.74 7,216,884 $ 16.05 $ 19.13 - $ 30.38 7,502,951 6.8 $ 24.40 5,423,513 $ 24.31 $ 31.00 - $ 46.38 896,754 6.1 $ 33.34 727,199 $ 33.33 ---------- ---------- $ 0.96 - $ 46.38 34,394,843 7.0 $ 16.59 17,337,552 $ 17.12 ---------- ---------- ---------- ----------
STOCK PURCHASE PLAN The Company has an employee stock purchase plan under which eligible employees may purchase stock at 85% of the lower of the closing prices for the stock at the beginning of a twenty four-month offering period or the end of each six-month purchase period. The purchase periods generally begin in May and November. Purchases are limited to 10% of each employee's compensation. At June 30, 1998, 18,503,014 shares had been issued under the plan and 2,556,986 shares were reserved for future issuance. GRANT DATE FAIR VALUES The weighted average estimated fair value of employee stock options granted at grant date market prices during fiscal 1998, 1997 and 1996 was $6.32, $5.94 and $11.48 per share, respectively. The weighted average exercise price of employee stock options granted at grant date market prices during fiscal 1998, 1997 and 1996 was $13.20, $20.56 and $29.24 per share, respectively. The weighted average estimated fair value of employee stock options granted at below grant date market prices during fiscal 1998, 1997 and 1996 was $10.92, $13.54 and $16.68 per share, respectively. The weighted average exercise price of employee stock options granted at below grant date market prices during fiscal 1998, 1997 and 1996 was $8.91, $12.56 and $13.44 per share, respectively. The weighted average fair value of restricted stock granted during fiscal 1998, 1997 and 1996 was $20.79, $18.93 and $27.45 per share, respectively. The weighted average estimated fair value of shares granted under the Stock Purchase Plan during fiscal 1998, 1997 and 1996 was $5.81, $7.06 and $15.30 per share, respectively. The weighted average fair value of options granted has been estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:
Employee Stock Options Stock Purchase Plan Shares -------------------------- -------------------------- Years ended June 30 1998 1997 1996 1998 1997 1996 - ------------------------------------------------------------------------------------- Expected life (in years) 2.3 2.7 3.8 0.5 0.5 0.5 Risk-free interest rate 5.58% 6.38% 5.18% 5.68% 5.45% 5.49% Volatility 0.61 0.50 0.45 0.76 0.57 0.45 Dividend yield 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
PRO FORMA INFORMATION The Company has elected to follow APB 25 in accounting for its employee stock options. Under APB 25, no compensation expense is recognized in the Company's financial statements except in connection with the grant of restricted stock for nominal consideration and unless the exercise price of the Company's employee stock options is less than the market price of the underlying stock on the date of grant. Total compensation expense recognized in the Company's financial statements for stock-based awards under APB 25 for fiscal 1998, 1997 and 1996 was $12.7 million, $5.4 million and $4.0 million, respectively. Pro forma information regarding net income and earnings per share has been determined as if the Company had accounted for its employee stock options and employee stock purchase plan under the fair value method prescribed by SFAS 123. For purposes of pro forma disclosures, the estimated fair value of the stock awards is amortized to expense over the vesting periods. The Company's pro forma information is as follows (in thousands, except per share amounts):
Years ended June 30 1998 1997 1996 - -------------------------------------------------------------------------------- Pro forma net (loss) income $ (538,260) $ (14) $ 73,154 Pro forma net (loss) income per share: Basic $ (2.89) $ -- $ 0.45 Diluted $ (2.89) $ -- $ 0.41
The effects on pro forma disclosures of applying SFAS 123 are not likely to be representative of the effects on pro forma disclosures of future years. Because SFAS 123 is applicable only to options granted subsequent to June 30, 1995, the pro forma effect will not be fully reflected until fiscal 1999. STOCKHOLDER RIGHTS PLAN The Company has a stockholder rights plan (the "Rights Plan") which provides existing stockholders with the right to purchase one one-thousandth (0.001) preferred share for each share of common stock held in the event of certain changes in the Company's ownership. The Rights Plan may serve as a deterrent to certain abusive takeover tactics which are not in the best interests of stockholders. STOCK REPURCHASE PROGRAM The Company's board of directors has authorized the repurchase of up to 22.5 million shares of its common stock, either in the open market or in private transactions. The Company repurchased 4,700,000 shares of common stock at a cost of $62.7 million and 2,452,600 shares of common stock at a cost of $76.0 million in 1998 and 1996, respectively. The Company utilizes equity instrument contracts to facilitate its repurchase of common stock. At June 30, 1998, the Company held equity instrument contracts that relate to the purchase of 1.8 million shares of common stock at an average cost of $17.34 per share. Additionally, at June 30, 1998, the Company has sold put obligations covering 1.8 million shares at an average exercise price of $13.17. The equity instruments are exercisable only at expiration, with expiration dates in the second quarter of fiscal 1999. Repurchased shares are available for use under the Company's employee stock plans and for other corporate purposes. COMMON SHARES RESERVED The Company has reserved in the aggregate 55,196,415 shares of common stock issuable upon conversion of the Senior Notes, Zero Coupon Debentures, convertible subordinated debentures, as well as shares issuable under its stock award and purchase plans. Note 14. INCOME TAXES The components of (loss) income before income taxes are as follows (in thousands):
Years ended June 30 1998 1997 1996 - ---------------------------------------------------------------------------------- United States $ (601,962) $ 84,508 $ 106,176 International 5,043 13,682 82,612 ---------- -------- --------- $ (596,919) $ 98,190 $ 188,788 ---------- -------- --------- ---------- -------- ---------
The (benefit from) provision for income taxes consists of the following (in thousands):
Years ended June 30 1998 1997 1996 - ---------------------------------------------------------------------------------- Federal: Current $ 26,346 $ 11,153 $ 111,970 Deferred (185,555) 18,897 (49,246) State: Current 25,488 20,771 13,540 Deferred (31,762) (17,796) (4,299) Foreign: Current 12,727 6,633 17,021 Deferred 15,464 (20,019) (15,235) --------- -------- -------- $(137,292) $ 19,639 $ 73,751 --------- -------- -------- --------- -------- --------
The (benefit from) provision for income taxes reconciles to the amounts computed by applying the statutory federal rate to income (loss) before income taxes as follows (in thousands):
Years ended June 30 1998 1997 1996 - ---------------------------------------------------------------------------------- Tax at U.S. federal statutory rate $(208,922) $34,366 $66,076 State taxes, net of federal tax benefit (4,078) 1,934 6,006 Earnings subject to foreign taxes at lower rates -- (16,599) (33,149) Income of Foreign Sales Corporation not subject to U.S. tax -- (6,170) (8,355) Acquired in-process technology and non-deductible goodwill 16,800 -- 34,373 Research and experimentation credits (670) (7,748) -- Foreign losses without tax benefit 43,606 9,140 -- Foreign tax credits with no tax benefit 13,355 -- -- Other 2,617 4,716 8,800 --------- ------- ------- (Benefit from) provision for income taxes $(137,292) $19,639 $73,751 --------- ------- ------- --------- ------- -------
No provision for residual federal taxes has been made on approximately $241.5 million of accumulated undistributed earnings of certain of the Company's foreign subsidiaries since it is the Company's intention to permanently invest such earnings in foreign operations. The Company has been granted exemptions from tax on income from certain manufacturing operations located outside the U.S. for years through 2006. The cumulative income tax benefits attributable to the tax status of this subsidiary are estimated to be $84.5 million at June 30, 1998. The tax effects of temporary differences and carryforwards that give rise to significant portions of deferred tax assets and liabilities at June 30, 1998 and 1997 are as follows (in thousands):
1998 1997 - ------------------------------------------------------------------------------- Deferred tax assets: Net operating loss carryforwards $103,705 $126,939 General business credit carryforwards 53,449 8,970 Foreign tax credit carryforwards 33,677 28,629 Depreciation 40,435 57,675 Capitalized research expenditures 32,768 -- Inventory valuation 143,428 80,354 Nondeductible vacation pay accrual 16,648 19,123 Intercompany profit elimination 64,283 14,117 Merger expenses 9,433 12,174 Reserves not currently deductible 67,907 7,934 Other 77,574 45,588 -------- -------- Subtotal 643,307 401,503 Valuation allowance (74,824) (69,047) -------- -------- Total deferred tax assets 568,483 332,456 Deferred tax liabilities: Foreign taxes on unremitted foreign earnings, net of related U.S. tax liability 30,665 23,717 Intangibles 2,742 26,703 Other 6,139 6,422 -------- -------- Total deferred tax liabilities 39,546 56,842 -------- -------- Total $528,937 $275,614 -------- -------- -------- --------
At June 30, 1998, the Company had gross deferred tax assets arising from deductible temporary differences, tax losses, and tax credits of $643.3 million. The gross deferred tax assets are offset by a valuation allowance of $74.8 million and deferred tax liabilities of $39.5 million. Realization of the majority of the net deferred tax assets is dependent on the Company's ability to generate approximately $1.0 billion of future taxable income. Management believes that it is more likely than not that the assets will be realized based on forecasted income. However, there can be no assurance that the Company will meet its expectations of future income. Management will evaluate the realizability of the deferred tax assets quarterly and assess the need for additional valuation allowances. At June 30, 1998, the Company had United States federal and various foreign jurisdictional net operating loss carryforwards of approximately $132.4 million and $141.0 million, respectively. The federal losses will expire in the fiscal years ending 2007 through 2011 and the foreign losses will expire beginning in the fiscal year ending 1999. At June 30, 1998, the Company also had general business credit carryovers of approximately $37.8 million for United States federal tax purposes, expiring in the fiscal years ending 2000 through 2013. In addition, the Company had foreign tax credit carryforwards of approximately $33.7 million which expire in the fiscal years ending 1999 through 2003. As a result of the acquisition by Silicon Graphics, Cray Research experienced a "change in ownership" as defined under Section 382 of the Internal Revenue Code and is subject to certain limitations on the utilization of its pre-acquisition net operating loss and tax credit carryforwards. As of June 30, 1997, the Company has provided a valuation allowance for deferred tax assets of approximately $59.0 million. In 1998, the Company reduced this valuation allowance by $51.5 million due to the realization of certain tax attributes related to the Cray Research acquisition. This reduction in the valuation allowance reduced noncurrent intangible assets related to the acquisition of Cray Research (see Note 3). The remaining $7.5 million valuation allowance reduces foreign tax credit carryforwards that may expire prior to utilization due to the Section 382 limitations. Additionally, the Company has established valuation allowances in the current year of approximately $57.3 million for certain foreign tax credits, foreign net operating loss, and other carryforwards which are at risk of expiring prior to utilization. Of this amount, $10.6 million relates to benefits of stock option deductions which, if recognized, will be allocated directly to paid in capital. Note 15. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION The Company, operating in a single industry segment, designs, manufactures and services high-performance computing systems and software. Information regarding operations in different geographic areas is as follows (in thousands):
Years ended June 30 ------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------------------- Net sales to unaffiliated customers: United States $ 1,625,403 $ 1,927,104 $ 1,412,137 Europe 830,819 936,184 836,053 Rest of World 644,388 799,313 673,126 ----------- ----------- ----------- Total net sales $ 3,100,610 $ 3,662,601 $ 2,921,316 ----------- ----------- ----------- ----------- ----------- ----------- Transfers between geographic areas (eliminated in consolidation): United States $ 569,238 $ 750,098 $ 698,816 Europe 92,798 70,731 65,583 Rest of World -- -- -- ----------- ----------- ----------- Total transfers $ 662,036 $ 820,829 $ 764,399 ----------- ----------- ----------- ----------- ----------- ----------- Operating (loss) income: United States $ (717,586) $ 33,661 $ 67,466 Europe 116,261 56,859 121,049 Rest of World (12,979) 8,614 (12,847) Eliminations 18,203 12,750 (1,275) Corporate (loss) income, net (818) (13,694) 14,395 ----------- ----------- ----------- (Loss) income before income taxes $ (596,919) $ 98,190 $ 188,788 ----------- ----------- ----------- ----------- ----------- ----------- Identifiable assets: United States $ 1,345,904 $ 2,127,957 $ 1,735,411 Europe 245,752 332,849 478,129 Rest of World 283,255 293,162 280,897 Eliminations (211,201) (224,236) (310,815) Corporate assets 1,300,996 814,860 974,624 ----------- ----------- ----------- Total assets $ 2,964,706 $ 3,344,592 $ 3,158,246 ----------- ----------- ----------- ----------- ----------- -----------
"Europe" includes Europe and the Middle East. "Rest of World" includes principally Japan and the Asia-Pacific region. Net revenue from sales to unaffiliated customers is based on the location of the customer. Intercompany transfers between geographic areas are accounted for by using the transfer prices in effect for the respective subsidiaries. Operating income and identifiable assets are classified based on the location of the Company's facilities. Corporate assets include cash and cash equivalents, marketable investments, deferred tax assets and certain other assets. Corporate (loss) income, net, is interest and other income (expense), net. Note 16. BENEFIT PLANS 401(k) RETIREMENT SAVINGS PLAN The Company provides a 401(k) investment plan covering substantially all of its U.S. employees. The plan provides for a minimum 25% Company match of an employee's contribution up to a specified limit, but allows for a larger matching subject to certain regulatory limitations. The Company's matching contributions for fiscal 1998, 1997 and 1996, were $7.4 million, $11.0 million and $4.7 million, respectively. DEFERRED COMPENSATION PLAN The Company has a Non-Qualified Deferred Compensation Plan that allows eligible executives and directors to defer a portion of their compensation. The deferred compensation, together with Company matching amounts and accumulated earnings, is accrued but unfunded. Such deferred compensation is distributable in cash and at June 30, 1998 and 1997, amounted to approximately $6 million and $5 million, respectively. A participant may elect to receive such deferred amounts in one payment or in annual installments no sooner than two years following each annual election. Participant contributions are always 100% vested and Company matching contributions vest as directed by the board of directors. There have been no Company matching contributions to date. Note 17. RELATED PARTY TRANSACTIONS The Company has from time to time engaged in significant transactions with related parties in the ordinary course of business. Related parties include: Northrop Grumman Corporation and Chrysler Corporation, as a director of both Northrop Grumman and Chrysler became a member of the Company's board of directors in fiscal 1996; NKK through its indirect ownership of 100% of Series A Convertible Preferred Stock (see Note 13) and Tandem Computers, Incorporated, in fiscal 1996 only, as a former director of Tandem is also on the Company's board of directors. Product and other revenue for the years ended June 30, 1998, 1997 and 1996 included, in the aggregate, sales to related parties in the amount of $86.9 million, $59.9 million and $72.9 million, respectively. The aggregate amount receivable from related parties for the year ended June 30, 1998 was $24.5 million; amounts for the years ended June 30, 1997 and 1996 were immaterial. Purchases from and amounts payable to such related parties were immaterial at June 30, 1998, 1997 and 1996. Note 18. CONSOLIDATED STATEMENT OF CASH FLOWS Other adjustments to reconcile net loss to net cash provided by operating activities in fiscal 1998 include a reduction in the carrying value of Cray purchased intangibles associated with the reduction in the acquired Cray deferred tax asset valuation allowance ($51 million), a charge for impairment of long-lived assets ($47 million), the write-off of ParaGraph purchased intangibles and goodwill ($32 million),a write-off of excess spares ($30 million) and an accrual of compensation expense related to employee stock awards ($13 million). Supplemental disclosures of cash flow information (in thousands):
Years ended June 30 1998 1997 1996 - ---------------------------------------------------------------------------------- Cash paid during the year for: Interest $ 14,100 $ 10,200 $ 9,600 Income taxes, net of refunds 9,200 29,000 122,000
Supplemental schedule of noncash investing and financing activities (in thousands):
Years ended June 30 1998 1997 1996 - ---------------------------------------------------------------------------------- Tax benefit from stock options $ 11,700 $ 6,300 $ 23,000 Capital lease financings 6,300 -- 200 Exchange of Senior Notes for Zero Coupon Debentures 230,600 -- --
Note 19. CONTINGENCIES The Company is defending the lawsuits described below. The Company believes that it has good defenses to the claims in each of these lawsuits and is defending each of them vigorously. The Company is defending putative securities class action lawsuits filed in the U.S. District Court for the Northern District of California (the "Northern District") and in California Superior Court for the County of Santa Clara in December 1997 and January 1998 alleging that the Company and certain of its officers made material misrepresentations and omissions during the period from July to October 1997. The Company is also defending a securities class action lawsuit filed in January 1996 in the Northern District of California alleging that the Company and certain of its officers and directors made material misrepresentations and omissions during the period from September to December 1995. The lawsuit was dismissed with prejudice by the District Court in May 1996. The plaintiffs' appeal to the U.S. Court of Appeals for the Ninth Circuit is pending. The Company is also defending a securities class action lawsuit involving MIPS Computer Systems, Inc., ("MCSI") which the Company acquired in June 1992. The MCSI case, which was filed in 1992 in the Northern District of California, alleges that MCSI and certain of its officers and directors made material misrepresentations and omissions during the period from January to October of 1991. In September 1996, the U.S. Court of Appeals for the Ninth Circuit reversed the summary judgment granted in defendants' favor in June 1994. In October 1997, the defendants' petition for review by the U.S. Supreme Court was denied. The case is presently pending before the District Court. A trial date for the lawsuit is currently set for March 1999. The Company also is defending a securities class action lawsuit involving Alias Research Inc., which the Company acquired in June 1995. The Alias case, which was filed in 1991 in the U.S. District Court for the District of Connecticut, alleges that Alias and certain of its former officers and directors made material misrepresentations and omissions during the period from May 1991 to April 1992. In October 1997, the defendants' motion to dismiss the amended complaint was granted. The plaintiffs' appeal to the U.S. Court of Appeals for the Second Circuit is pending. The Company was also defending a patent infringement lawsuit filed by Martin Marietta Corp. in the U.S. District Court for the Middle District of Florida in September 1995. The Company had filed a counterclaim seeking to invalidate the principal patent at issue in the lawsuit and the U.S. Patent and Trademark Office is re-examining the patent at Martin Marietta's request. In July 1998, the lawsuit was dismissed pursuant to a joint notice of settlement, subject to the parties' right within 60 days to file a joint form of final order or to seek to reopen the case for further proceedings. The Company routinely receives communications from third parties asserting patent or other rights covering the Company's products and technologies. Based upon the Company's evaluation, it may take no action or it may seek to obtain a license. There can be no assurance in any given case that a license will be available on terms the Company considers reasonable, or that litigation will not ensue. Management is not aware of any pending disputes, including those described above, that would be likely to have a material adverse effect on the Company's financial condition, results of operations or liquidity. However, management's evaluation of the likely impact of these pending disputes could change in the future. Note 20. INITIAL PUBLIC OFFERING OF MIPS TECHNOLOGIES, INC. On July 6, 1998, the Company closed an initial public offering of the common stock of its subsidiary, MIPS Technologies, Inc. ("MIPS"), a company formed by Silicon Graphics that designs and develops RISC based microprocessor intellectual property for imbedded systems applications targeting the emerging market for digital consumer products. The offering consisted of the sale of 4,250,000 shares of MIPS common stock by the Company for net proceeds of approximately $55 million and 1,250,000 shares of MIPS common stock by MIPS for net proceeds to MIPS of approximately $16 million. Following the offering there are 37,250,000 shares of MIPS common stock outstanding and the Company retains an approximately 85% ownership interest in MIPS. The Company will continue to consolidate the results of MIPS' operations for so long as it retains a greater than 50% ownership interest in MIPS. Note 21. STOCK OPTION REPRICING (UNAUDITED) In July 1998, the Company effected an option exchange program to allow employees (excluding senior executives) to exchange their out-of-the-money options for new options at a more favorable exercise price. The new options, which have an exercise price of $11.125, the fair value on the date the exchange was announced, will vest over the longer of two years or the original vesting schedule and cannot be exercised prior to January 1999. As a result of the exchange, options to purchase approximately 12,800,000 shares with a weighted average exercise price of $19.70 were exchanged for new options. REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF SILICON GRAPHICS, INC. We have audited the accompanying consolidated balance sheets of Silicon Graphics, Inc. as of June 30, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material aspects, the consolidated financial position of Silicon Graphics, Inc. at June 30, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. Palo Alto, California July 21, 1998 EX-21.1 4 EXHIBIT 21.1 Exhibit 21.1 SILICON GRAPHICS, INC. SUBSIDIARIES
Jurisdiction of Name Incorporation ---- --------------- Alias|Wavefront, Inc. California ParaGraph International, Inc. California Cray Research, Inc. Delaware Cray Asia/Pacific, Inc. Delaware Cray Financial Corporation Delaware Cray Research (America Latina) Ltd. Delaware Cray Research (Eastern Europe) Ltd. Delaware Cray Research (India) Ltd. Delaware Cray Research International, Inc. Delaware MIPS Technologies, Inc. Delaware Silicon Graphics Real Estate, Inc. Delaware Silicon Graphics World Trade Corporation Delaware Silicon Studio, Inc. Delaware Silicon Graphics S.A. Argentina Silicon Graphics Pty Limited Australia Silicon Graphics Computer Systems Ges.m.b.H. Austria Silicon Graphics International Inc. Barbados Silicon Graphics S.A./N.V. Belgium Alias|Wavefront N.V. Belgium Silicon Graphics Comercio e Servicos Limitada Brazil 831495 Ontario Ltd. Canada Cray Research (Canada) Inc. Canada Silicon Graphics Limited Canada Wavefront Canada Limited Canada Silicon Graphics S. A. Chile Silicon Graphics spolecnost s rucerum omezenym Czech Republic Silicon Graphics A/S Denmark Silicon Graphics OY Finland Silicon Graphics France Alias|Wavefront S.A. France APTOS Application Software Technologies GmbH Germany Silicon Graphics GmbH Germany Alias|Wavefront GmbH Germany Silicon Graphics A.E. Greece Silicon Graphics Limited Hong Kong Silicon Graphics Kft. Hungary Jurisdiction of Name Incorporation ---- --------------- Silicon Graphics Systems (India) Private Ltd India Cray Research (Israel) Ltd. Israel Silicon Graphics Biomedical (1995) Ltd. Israel Silicon Graphics Computer Systems Limited Israel Alias|Wavefront Srl Italy Silicon Graphics S.p.A. Italy Wavefront Technologies, Srl Italy Cray Foreign Sales Corporation, Ltd. Jamaica Alias|Wavefront K.K. Japan Nihon Silicon Graphics Cray K.K. Japan Korea Silicon Graphics Ltd. South Korea Silicon Graphics Research (Malaysia) Sdn. Bhd. Malaysia Silicon Graphics S.A. de C.V. Mexico Silicon Graphics B.V. Netherlands Silicon Graphics Europe Trade B.V. Netherlands Silicon Graphics World Trade B.V. Netherlands Silicon Graphics Limited New Zealand Silicon Graphics A/S Norway Silicon Graphics Computer Engineering and Technology People's Republic (China) Co. Ltd. of China Silicon Graphics Sp.z.o.o. Poland Cray-S.G.-Sistemas Informatico, Sociedada Unipessoal, LDA Portugal Silicon Graphics LLC Russia Parallel Graphics LLC Russia Silicon Graphics Pte. Limited Singapore Silicon Graphics (Pty) Limited South Africa Silicon Graphics, S.A. Spain Silicon Graphics AB Sweden Silicon Graphics S.A. Switzerland Silicon Graphics Manufacturing S.A. Switzerland Silicon Graphics Limited Taiwan Silicon Graphics Bilbisayar Sistemleri Anonim Siket Turkey Alias|Wavefront Limited United Kingdom Alias Sonata Limited United Kingdom Cray Research (UK) Ltd. United Kingdom Silicon Graphics Application Systems Limited United Kingdom Silicon Graphics Limited United Kingdom AWAVE Limited United Kingdom Silicon Graphics Manufacturing Finance Limited Jersey Channel Islands Silicon Graphics S.A. Venezuela
-2- EX-23.1 5 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of Silicon Graphics, Inc. of our report dated July 21, 1998 included in the 1998 Annual Report to Stockholders of Silicon Graphics, Inc. Our audits also included the consolidated financial statement schedule of Silicon Graphics, Inc. listed in item 14(a)2. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements (Form S -8 File Nos. 33-11703, 33-16529, 33-18717, 33-26003, 33-34919, 33-38536, 33-40879, 33-44305, 33-44333, 33-48890, 33-59098, 33-65190, 33-50999, 33-51275, 33-58017, 33-60213, 33-60215, 333-01211, 333-06403, 333-08651, 333-15977 and 333-40849) pertaining to the Employee Stock Purchase Plan, 1987 Stock Option Plan, 1986 Incentive Stock Option Plan, 1985 Stock Incentive Program, 1984 Incentive Stock Option Plan, 1982 Stock Option Plan, Directors' Stock Option Plan and Subsidiary Stock Agreement, 1993 Long-Term Incentive Stock Plan and the 1996 Supplemental Non-Executive Equity Incentive Plan of Silicon Graphics, Inc.; the 1990 Stock Option Plan of Wavefront Technologies, Inc.; and the 1988 Employee Share Ownership Plan, 1989 Employee Share Ownership Plan, 1990 Employee Share Ownership Plan, and the 1994 Stock Plan of Alias Research Inc. and the Amended and Restated 1989 Employee Benefit Stock Plan, and 1989 Non-Employee Directors' Stock Option Plan of Cray Research, Inc. of our report dated July 21, 1998 with respect to the consolidated financial statements of Silicon Graphics, Inc. incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K). /s/ ERNST & YOUNG LLP Palo Alto, California September 28, 1998 EX-27.1 6 EXHIBIT 27.1 (FDS)
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET, CONSOLIDATED STATEMENT OF OPERATIONS AND CONSOLIDATED STATEMENT OF CASH FLOWS INCLUDED IN THE COMPANY'S FORM 10-K FOR THE PERIODS ENDING JUNE 30, 1998, 1997 AND 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND THE NOTES THERETO. 1,000 12-MOS 12-MOS 12-MOS JUN-30-1998 JUN-30-1997 JUN-30-1996 JUL-01-1997 JUL-01-1996 JUL-01-1995 JUN-30-1998 JUN-30-1997 JUN-30-1996 506,639 227,222 257,080 230,081 60,109 38,316 682,883 1,155,703 1,002,641 17,463 24,056 23,767 322,823 628,064 520,045 2,065,372 2,315,594 2,096,255 865,926 940,695 825,359 420,506 415,243 360,480 2,964,706 3,344,592 3,158,246 1,096,672 1,086,206 1,101,438 366,460 372,034 302,029 0 0 0 16,998 16,998 16,998 168 178 173 1,447,346 1,822,066 1,658,147 2,964,706 3,344,592 3,158,246 2,489,983 3,086,791 2,553,128 3,100,610 3,662,601 2,921,316 1,580,647 1,697,277 1,279,742 1,963,551 2,022,546 1,482,439 664,731 489,858 456,654 616 8,427 4,292 24,665 24,836 22,365 (596,919) 98,190 188,788 137,292 19,639 73,751 (459,627) 78,551 115,037 0 0 0 0 0 0 0 0 0 (459,627) 78,551 115,037 (2.47) .44 .70 (2.47) .43 .65 THIS STATEMENT HAS BEEN RESTATED AS A RESULT OF SFAS 128, EARNINGS PER SHARE.
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