-----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, MLTWz15Sg4F6tRE8P8H+xsyPmj4hcGMa6BOvEe3QoeLuLVSSfOyK2T68S5zC/Kmr sEoZQuDrXR/FRSw7g/FcxA== 0001047469-99-021296.txt : 19990519 0001047469-99-021296.hdr.sgml : 19990519 ACCESSION NUMBER: 0001047469-99-021296 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990518 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-Q SEC ACT: SEC FILE NUMBER: 001-10441 FILM NUMBER: 99628937 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-Q 1 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities - --- Exchange Act of 1934. For the quarterly period ended MARCH 31, 1999. or Transition report pursuant to Section 13 or 15(d) of the Securities - --- Exchange Act of 1934. For the transition period from to . COMMISSION FILE NUMBER 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 No.) 1600 AMPHITHEATRE PKWY., MOUNTAIN VIEW, CALIFORNIA 94043-1351 (Address of principal executive offices) (Zip Code) (650) 960-1980 (Registrant's telephone number, including area code) ------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- As of April 30, 1999 there were 188,774,262 shares of Common Stock outstanding. -1- SILICON GRAPHICS, INC. QUARTERLY REPORT ON FORM 10-Q TABLE OF CONTENTS
PAGE NO. PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited): Condensed Consolidated Balance Sheets................................................................ 3 Condensed Consolidated Statements of Operations...................................................... 4 Condensed Consolidated Statements of Cash Flows...................................................... 5 Notes to Condensed Consolidated Financial Statements................................................. 6 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition..................................................... 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk .......................................... 19 PART II - OTHER INFORMATION Item 1 Legal Proceedings.................................................................................... 20 Item 6. Exhibits and Reports on Form 8-K..................................................................... 20 Signatures .................................................................................................. 21 Index to Exhibits ........................................................................................... 22
TRADEMARKS USED IN THIS FORM 10-Q: Silicon Graphics, OCTANE, Onyx, O2 and IRIX are registered trademarks and Origin and Onyx2 are trademarks of Silicon Graphics, Inc. CRAY and UNICOS are registered trademarks of Cray Research, LLC. MIPS is a registered trademark of MIPS Technologies, Inc. UNIX is a registered trademark in the United States and other countries, licensed exclusively through X/Open Company Ltd. Windows NT is a registered trademark of Microsoft Corporation. Intel is a registered trademark of Intel Corporation. -2- PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SILICON GRAPHICS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
March 31, June 30, 1999 1998 (1) ----------- ----------- (unaudited) ASSETS Current assets: Cash and cash equivalents.................................... $ 343,967 $ 506,639 Short-term marketable investments............................ 156,786 230,081 Accounts receivable, net..................................... 488,099 665,420 Inventories.................................................. 241,338 322,823 Prepaid expenses and other current assets.................... 368,781 340,409 ----------- ----------- Total current assets..................................... 1,598,971 2,065,372 Restricted investments............................................ 167,771 -- Property and equipment, net....................................... 392,586 445,420 Other assets...................................................... 579,063 453,914 ----------- ----------- $ 2,738,391 $ 2,964,706 ----------- ----------- ----------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable............................................. $ 176,533 $ 215,260 Other current liabilities.................................... 820,220 881,412 ----------- ----------- Total current liabilities................................ 996,753 1,096,672 Long-term debt and other.......................................... 392,466 403,522 Stockholders' equity: Preferred stock.............................................. 16,998 16,998 Common stock and additional paid-in capital.................. 1,422,811 1,407,108 Retained earnings (accumulated deficit)...................... (51,473) 65,415 Treasury stock............................................... (41,149) (25,976) Accumulated other comprehensive income....................... 1,985 967 ----------- ----------- Total stockholders' equity............................... 1,349,172 1,464,512 ----------- ----------- $ 2,738,391 $ 2,964,706 ----------- ----------- ----------- -----------
(1) The balance sheet at June 30, 1998 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. -3- SILICON GRAPHICS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) (In thousands, except per share amounts)
Three Months Nine Months Ended March 31, Ended March 31, -------------------------- -------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Product and other revenue............................ $ 454,733 $ 552,385 $ 1,427,770 $ 1,870,181 Service revenue...................................... 164,442 155,906 492,584 456,868 --------- --------- ----------- ---------- Total revenue................................... 619,175 708,291 1,920,354 2,327,049 Costs and expenses: Cost of product and other revenue............... 256,740 415,222 833,601 1,160,101 Cost of service revenue......................... 102,896 89,060 299,748 261,095 Research and development........................ 93,331 111,975 292,648 345,442 Selling, general and administrative............. 215,574 250,917 670,507 763,600 Other operating expense (1)..................... (6,000) 43,393 (14,000) 115,223 --------- --------- ----------- ---------- Total costs and expenses.................... 662,541 910,567 2,082,504 2,645,461 --------- --------- ----------- ---------- Operating loss ...................................... (43,366) (202,276) (162,150) (318,412) Gain on sale of a portion of SGI interest in MIPS (2) -- -- 53,963 -- Interest and other income (expense), net............. (7,358) (267) (13,591) (1,036) --------- --------- ----------- ---------- Loss before income taxes............................. (50,724) (202,543) (121,778) (319,448) Income tax benefit................................... (10,767) (49,974) (17,814) (79,862) --------- --------- ----------- ---------- Net loss............................................. (39,957) (152,569) (103,964) (239,586) Preferred stock dividend requirement................. (131) (131) (394) (394) --------- --------- ----------- ---------- Net loss available to common stockholders............ $ (40,088) $ (152,700) $ (104,358) $ (239,980) --------- --------- ----------- ---------- --------- --------- ----------- ---------- Net loss per common share - basic and diluted........ $ (0.21) $ (0.81) $ (0.56) $ (1.29) --------- --------- ----------- ---------- --------- --------- ----------- ---------- Common shares outstanding - basic and diluted........ 186,685 187,643 186,477 185,892 --------- --------- ----------- ---------- --------- --------- ----------- ----------
(1) Amount represents a change in previously estimated restructuring costs in the three- and nine-month periods ended March 31, 1999. Amount primarily represents an estimated restructuring charge in the three- and nine-month periods ended March 31, 1998 as well as a write-off of acquired in-process technology in the nine-month period ended March 31, 1998. (2) Relates to the initial public offering of a minority interest in the Company's subsidiary, MIPS Technologies, Inc. ("MIPS") THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. -4- SILICON GRAPHICS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (In thousands)
Nine Months Ended March 31, ----------------------------------- 1999 1998 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ............................................................ $(103,964) $(239,586) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization..................................... 165,994 230,816 Write-off of acquired in-process technology....................... -- 16,900 Gain on sale of a portion of SGI interest in MIPS................. (53,963) -- Other............................................................. 14,365 32,537 Changes in operating assets and liabilities: Accounts receivable............................................. 177,321 517,918 Inventories..................................................... 72,423 181,059 Accounts payable................................................ (38,971) (60,221) Other assets and liabilities.................................... (125,721) (29,752) --------- --------- Total adjustments............................................. 211,448 889,257 --------- --------- Net cash provided by operating activities......................... 107,484 649,671 CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures................................................... (113,462) (148,903) Proceeds from sale of a portion of SGI interest in MIPS................ 53,963 -- Increase in other assets............................................... (88,102) (85,369) Purchases of restricted investments.................................... (244,186) -- Proceeds from the maturities of restricted investments................. 76,415 -- Available-for-sale investments: Purchases......................................................... (341,724) (181,948) Sales............................................................. 197,740 28,000 Maturities........................................................ 217,511 35,222 --------- --------- Net cash used in investing activities............................. (241,845) (352,998) CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of debt....................................................... 7,446 12,965 Payments of debt principal............................................. (21,858) (61,302) Sale of SGI common stock............................................... 38,665 70,792 Repurchase of SGI common stock......................................... (68,042) (31,263) Sale of MIPS common stock.............................................. 15,872 -- Cash dividends - preferred stock....................................... (394) (394) --------- --------- Net cash used in financing activities............................. (28,311) (9,202) --------- --------- Net (decrease) increase in cash and cash equivalents................... (162,672) 287,471 Cash and cash equivalents at beginning of period....................... 506,639 227,222 --------- --------- Cash and cash equivalents at end of period............................. $ 343,967 $ 514,693 --------- --------- --------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. -5- SILICON GRAPHICS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. CONSOLIDATED FINANCIAL STATEMENTS. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and MIPS, a majority-owned subsidiary, after elimination of significant intercompany transactions and balances. The unaudited results of operations for the interim periods shown herein are not necessarily indicative of operating results for the entire fiscal year. In the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position, results of operations and cash flows for all periods presented have been made. The unaudited condensed consolidated financial statements included in this Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 1998. Certain amounts for the prior year have been reclassified to conform to current year presentation. 2. SALE OF INTEREST IN MIPS TECHNOLOGIES, INC. The initial public offering of a 14.8% interest in the Company's subsidiary, MIPS, closed on July 6, 1998. Proceeds, net of issuance costs, to the Company and MIPS were $54 million and $16 million, respectively. The accompanying condensed consolidated financial statements include the operations of MIPS on a fully consolidated basis. The publicly held minority interest in the earnings of MIPS for the third quarter ($1.6 million) and first nine months ($2.7 million) of fiscal 1999 is included in interest and other income (expense), net in the condensed consolidated statement of operations. The publicly held minority interest in the net assets of MIPS ($4.9 million) is included in long-term debt and other in the condensed consolidated balance sheet. In April 1999, the outstanding common stock of MIPS was recapitalized into Class A and Class B Common Stock to permit a multi-step divestiture of the Company's ownership interest in MIPS. On May 13, 1999, the Company and MIPS commenced a public offering of 6,000,000 shares of the Class A Common Stock of MIPS owned by SGI at an offering price to the public of $34.50 per share. SGI has granted the underwriters of the offering a 30-day option to purchase up to 900,000 additional shares of MIPS Class A Common Stock to cover overallotments, if any. After the offering, SGI will own approximately 69% of the total outstanding shares of Class A and Class B Common Stock of MIPS (67% if the undewriters' overallotment option is exercised in full). As previously announced, SGI currently intends to dispose of its remaining interest in MIPS in one or more transactions through public or private offerings, in a dividend or other distribution to SGI stockholders, in an exchange offer for outstanding shares of SGI's Common Stock, or other transactions. The timing and form of any further disposition by SGI of its MIPS stock is subject to the terms of a 90-day lock-up agreement between SGI and the underwriters, as well as market and other conditions. SGI has announced that it expects its divestiture of its interest in MIPS to be completed in the first half of fiscal 2001. See "Risks That Affect Our Business." 3. INVENTORIES. Inventories consist of (in thousands):
March 31, 1999 June 30, 1998 -------------- ------------- Components and subassemblies $ 5,728 $ 114,139 Work-in-process 109,993 74,961 Finished goods 37,124 47,917 Demonstration systems 88,493 85,806 ---------- ---------- $ 241,338 $ 322,823 ---------- ---------- ---------- ----------
4. RESTRICTED INVESTMENTS. Restricted investments consist of long-term investments pledged as collateral against letters of credit and an equity forward purchase arrangement. Restricted investments are held in the Company's name by major financial institutions. -6- 5. PROPERTY AND EQUIPMENT. (in thousands)
March 31, 1999 June 30, 1998 -------------- ------------- Property and equipment, at cost $ 838,103 $ 865,926 Accumulated depreciation and amortization (445,517) (420,506) --------- ---------- Property and equipment, net $ 392,586 $ 445,420 --------- ---------- --------- ----------
6. INVESTMENT IN WAM!NET INC. In March 1999, SGI entered into a series of agreements with WAM!NET Inc. (WNI). WNI is a private company providing digital networking service that integrates high-speed digital file transfer with high-bandwidth data applications intended to improve production workflow in time-sensitive, data-critical industries such as the graphics arts, entertainment and medical imaging. Pursuant to those agreements, SGI acquired a minority interest in WNI preferred stock in exchange for $35 million in cash and title to the Company's campus facility in Eagan, Minnesota valued at $40 million. SGI will account for its investment using the cost method. The two companies also have entered into preferred provider arrangements whereby WNI and SGI each agreed to purchase hardware, software and service from each other over a four-year period beginning January 1, 1999. 7. SHORT-TERM BORROWINGS. In November 1998, the Company terminated its commitment for an unsecured $250 million revolving credit facility. This facility was not used in fiscal 1999 or 1998. 8. RESTRUCTURING CHARGES. 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 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 1,400 of which were eliminated as of March 31, 1999, writing down certain operating assets, vacating certain leased facilities and canceling certain contracts. Through March 31, 1999, these actions have resulted in aggregate charges of $144 million, excluding the adjustment noted below, of which approximately $75 million have used or will use cash, and $69 million were non-cash charges. The Company expects that the remaining $10 million accrued balance at March 31, 1999 will result primarily in cash expenditures and will be financed through working capital. In the second and third quarters of fiscal 1999, the Company revised its estimate of the total costs associated with the program described above. As a result, a cumulative adjustment of approximately $14 million has been recorded in fiscal 1999. The adjustment primarily reflects lower than estimated severance and related charges attributable to higher than expected attrition, as well as lower per person costs. To a lesser extent, estimated costs of contract cancellations, operating asset reserves and exiting certain facilities were also adjusted. The following table depicts the restructuring activity during the first nine months of fiscal 1999: -7-
Balance at Adjustments: Balance at Category June 30, Increase/ Expenditures March 31, 1998 (Decrease) Cash Non-cash 1999 - ----------------------------------------------------------------------------------------------------------------------- (in thousands) Severance and related charges $ 49,403 $ (15,500) $(26,296) $ (184) $ 7,423 Operating asset write-down - 4,216 - (4,216) - Canceled contracts 2,055 (1,916) (139) - - Vacated facilities 7,274 (1,300) (3,541) (203) 2,230 Other 894 500 (611) - 783 -------- --------- -------- ------- ------- $ 59,626 $ (14,000) $(30,587) $(4,603) $10,436 -------- --------- -------- ------- ------- -------- --------- -------- ------- -------
9. EARNINGS PER SHARE. The following table sets forth the computation of basic and diluted loss per share:
Three Months Ended Nine Months Ended March 31, March 31, -------------------------------- ------------------------------- (in thousands, except per share amounts) 1999 1998 1999 1998 - ------------------------------------------------------ ---------------- --------------- --------------- --------------- Net loss $ (39,957) $ (152,569) $ (103,964) $ (239,586) Less preferred stock dividends (131) (131) (394) (394) --------- ---------- ---------- ---------- Net loss available to common stockholders $ (40,088) $ (152,700) $ (104,358) $ (239,980) --------- ---------- ---------- ---------- --------- ---------- ---------- ---------- Weighted average shares outstanding--basic and diluted 186,685 187,643 186,477 185,892 --------- ---------- ---------- ---------- --------- ---------- ---------- ---------- Net loss per share - basic and diluted $ (0.21) $ (0.81) $ (0.56) $ (1.29) --------- ---------- ---------- ---------- --------- ---------- ---------- ---------- Potentially dilutive securities excluded from computations because they are anti-dilutive 15,770 11,115 12,113 13,359 --------- ---------- ---------- ---------- --------- ---------- ---------- ----------
10. COMPREHENSIVE INCOME. The Company has adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS 130") as of the first quarter of fiscal 1999. SFAS 130 establishes new standards for the reporting and display of comprehensive income and its components, however it has no impact on the Company's consolidated financial position or results of operations. The components of comprehensive income, net of tax, are as follows:
Three Months Ended Nine Months Ended March 31, March 31, ------------------------------ ----------------------------- (in thousands) 1999 1998 1999 1998 - -------------------------------------------------- -------------- --------------- -------------- -------------- Net loss $ (39,957) $ (152,569) $ (103,964) $ (239,586) Change in unrealized gain on - available-for-sale investments (93) 120 (6) 546 Foreign currency translation adjustments (6,725) (3,628) 1,023 (14,473) --------- ---------- ---------- ---------- Comprehensive income $ (46,775) $ (156,077) $ (102,947) $ (253,513) --------- ---------- ---------- ---------- --------- ---------- ---------- ----------
-8- The components of accumulated other comprehensive income, net of tax, are as follows:
March 31, June 30, (in thousands) 1999 1998 - -------------------------------------------------------------- ------------------ ------------------ Unrealized gain (loss) on investments $ (75) $ (70) Foreign currency translation adjustments 2,060 1,037 -------- ------- Accumulated other comprehensive income $ 1,985 $ 967 -------- ------- -------- -------
11. STOCK REPURCHASE PROGRAM. The Company's board of directors has authorized a program to repurchase up to 27.5 million shares of its common stock in open market or in private transactions, option or other forward transactions and other potential methods. In the third quarter of fiscal 1999, the Company bought or agreed to buy approximately 6.2 million shares under this program, including shares covered by an equity forward purchase arrangement with an independent counterparty. At March 31, 1999, the Company had outstanding commitments to buy an aggregate of approximately 12.2 million shares of common stock under its equity forward purchase arrangement, including obligations that were transferred from previous put contracts. Under this arrangement, the purchase price will be paid within the next three years at a pre-determined price based on the third-party's acquisition cost. The timing and method of payment (net-share or full physical settlement) is at the discretion of the Company. The purchase commitment under the equity forward is secured in part by collateral, reflected in the Company's financial statements as restricted investments. Repurchased shares are available for use under the Company's employee stock plans and for other corporate purposes. At March 31, 1999, approximately 3.0 million shares remained available for purchase by the Company under this program. 12. 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. The parties to this case reached an agreement to settle the case in December 1998, the terms of which were reflected in a Stipulation of Settlement filed with the Court in January 1999. Under the settlement agreement, the defendants have agreed to establish a $15 million escrow fund that shall be administered to pay the representative plaintiffs' costs and attorney fees, to notify and certify members of the class and to pay the claims of class members. The settlement amount was largely covered by insurance. The settlement agreement provides for release of all parties' claims in connection with the class action and is subject to final approval of the Court. 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 -9- defendants' motion to dismiss the amended complaint was granted. In April 1999, the U.S. Court of Appeals for the Second Circuit reversed the dismissal and remanded the case to the U.S. District Court for the District of Connecticut. The defendants' petition for rehearing en banc with the U.S. Court of Appeals is pending. 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. -10- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION. This Quarterly Report on Form 10-Q includes forward-looking statements regarding the Company's business, objectives, financial condition and future performance. These forward-looking statements include, among others, statements relating to expected levels of revenue, gross margin, operating expense, and future profitability, the benefits expected to result from the transition of our business from declining markets to growth markets, headcount reductions, conversion to the Euro, year 2000 issues and legal proceedings. We have based these forward-looking statements on our current expectations about future events. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in such forward looking statements. Such risks and uncertainties include, among other things: adverse changes in general economic or business conditions; adverse changes in the specific markets for the Company's products, including expected rates of growth and decline in the Company's current markets; adverse business conditions; changes in customer order patterns; heightened competition, reflecting rapid technological advances and constantly improving price/performance, which may result in significant discounting and lower gross margins; continued success in technological advancements and new product introduction, including development and successful introduction of strategic products for specific markets; inability to effectively implement the Company's desktop and server strategy, including the development of appropriate distribution, marketing and customer support models; risks related to dependence on the Company's partners and suppliers; risks related to foreign operations (including the downturn of economic trends, unfavorable currency movements, and export compliance issues); risks associated with year 2000 requirements; risks associated with implementation of the Company's new business practices, processes and information systems; litigation involving intellectual property or other issues; and other factors including those listed under the heading "Risks That Affect Our Business." We undertake no obligation to publicly update or revise any forward looking statements, whether changes occur as a result of new information, future events or otherwise. RESULTS OF OPERATIONS
OPERATING ITEMS AS A PERCENTAGE OF TOTAL REVENUE - ---------------------------------------------------------------------------------------------------------- (PERCENTAGES MAY NOT ADD DUE TO ROUNDING) Three Months Nine Months Ended March 31, Ended March 31, ------------------------ ------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Product and other revenue......................... 73.4% 78.0% 74.3% 80.4% Service revenue................................... 26.6 22.0 25.7 19.6 ------ ------ ------ ------ Total revenue..................................... 100.0% 100.0% 100.0% 100.0% Gross margin...................................... 41.9 28.8 41.0 38.9 Research and development.......................... 15.1 15.8 15.2 14.8 Selling, general and administrative.............. 34.8 35.4 34.9 32.8 Other operating expense........................... (1.0) 6.1 (0.7) 5.0 ------ ------ ------ ------ Operating loss.................................... (7.0) (28.6) (8.4) (13.7) Interest and other income (expense), net.......... (1.2) -- 2.1 -- ------ ------ ------ ------ Loss before income taxes.......................... (8.2) (28.6) (6.3) (13.7) Income tax benefit................................ (1.7) (7.1) (0.9) (3.4) ------ ------ ------ ------ Net loss.......................................... (6.5)% (21.5)% (5.4)% (10.3)% ------ ------ ------ ------ ------ ------ ------ ------ - ----------------------------------------------------------------------------------------------------------
-11-
REVENUE BY GEOGRAPHY - ---------------------------------------------------------------------------------------------------------- Three Months Nine Months Ended March 31, Year Ended March 31, Year --------------------------- /Year ------------------------- /Year ($ in millions) 1999 1998 Change 1999 1998 Change ---- ---- ------ ---- ---- ------ Americas $ 329 $ 382 (14)% $ 1,019 $ 1,252 (19)% Europe 163 190 (14)% 560 639 (12)% Rest of World (1) 127 136 (6)% 341 436 (22)% -------- -------- -------- -------- Total revenue $ 619 $ 708 (13)% $ 1,920 $ 2,327 (17)% -------- -------- -------- -------- -------- -------- -------- --------
REVENUE BY GEOGRAPHY - ---------------------------------------------------------------------------------------------------------- (as a percentage of total revenue) Three Months Nine Months Ended March 31, Ended March 31, --------------------------- --------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Americas 53% 54% 53% 54% Europe 26% 27% 29% 27% Rest of World (1) 21% 19% 18% 19%
(1) "Rest of World" includes principally Japan and the Asia-Pacific region
REVENUE BY PRODUCT LINE - ---------------------------------------------------------------------------------------------------------- (as a percentage of product revenue, excluding other revenue) Three Months Nine Months Ended March 31, Ended March 31, ------------------------- ------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Servers (primarily from the CRAY-Registered Trademark- and Origin-TM- families) 49% 51% 52% 51% Graphics systems (primarily from the O2-Registered Trademark-, Octane-Registered Trademark- and Onyx2-TM-families) 51% 49% 48% 49%
REVENUE. The Company's product and other revenue are derived primarily from shipment of computer system products, with subsystem and software revenue, fees and royalty payments comprising the remainder. Service revenue is comprised of hardware and software support and maintenance and professional services revenue. Revenue for both the third quarter and first nine months of fiscal 1999 declined 13% and 17%, respectively, compared with the corresponding periods of fiscal 1998. Product and other revenue for the third quarter of fiscal 1999 declined compared with the corresponding period of fiscal 1998, primarily due to strong competition in the shrinking UNIX-Registered Trademark- workstation market, a weakening vector supercomputer market and lower than anticipated scalable server product revenue. While sales of the Company's new Silicon Graphics-Registered Trademark- 320 visual workstation systems, which began shipping in the third quarter of fiscal 1999, had a modestly positive effect on the year over year quarterly comparison, they fell short of the Company's expectations, delivering only about half of the revenue the Company had hoped to achieve from this new product line in the third quarter. The Company believes that several factors contributed to the slow ramp of Visual Workstation sales, including yield issues as volume production was initiated and start-up issues with the Company's new build to order process for this product. These factors also affected the delivery of field demo and evaluation units needed to generate product demand. The Company has moderated its revenue expectations for this product line in light of the third quarter performance. Product and other revenue for each product line in the first nine months of fiscal 1999 declined compared with the corresponding period of fiscal 1998 reflecting a decline across all existing product lines and all regions. These year over year declines were sharper in the UNIX workstation and vector supercomputer product revenues than in scalable server product revenue for both the third quarter and first nine months of fiscal 1999. However, revenues from the Company's scalable server systems also fell short of the Company's expectations, due principally to competitive issues and the ongoing transition to an industry-oriented solutions selling model. Service revenue increased for both the third quarter and first nine months of fiscal 1999 compared with the corresponding periods of fiscal 1998, across all regions. The increase in service revenue is primarily due to growth of the Company's -12- professional services business coupled with a slight increase in revenue generated from support and maintenance. The Company believes that the decline in the UNIX workstation and vector supercomputer markets are long-term trends, and that its future success will require that a larger portion of it revenue come from growing markets, including the market for scalable servers and Intel-based workstations and servers. See "Risks That Affect Our Business." The Company's consolidated backlog at March 31, 1999 was $390 million, compared with backlog of $366 million at December 31, 1998. GROSS MARGIN. Cost of product and other revenue includes costs related to product shipments comprising materials, labor, overhead and other direct or allocated costs involved in their manufacture or delivery. Cost of service revenue includes all costs incurred in the support and maintenance of the Company's products, as well as costs to deliver professional services. Gross margin of 41.9% and 41.0 % for the third quarter and first nine months of fiscal 1999, respectively, increased compared with gross margin of 28.8% and 38.9%, respectively, for the corresponding periods of fiscal 1998. Gross margin for the third quarter and first nine months of fiscal 1998 would have been 38.7% and 41.9%, respectively, without non-recurring charges of approximately $70 million taken in the third quarter related to refocusing the Company's supercomputer product roadmap. Excluding the impact of non-recurring charges, gross margin for the third quarter of fiscal 1999 increased 3.2 points compared with the corresponding period of fiscal 1998, primarily due to higher-margin product configurations within both the scalable server and graphics workstation families, offset in part by proportionately higher service revenue. Excluding the impact of non-recurring charges, gross margin for the first nine months of fiscal 1999 declined slightly compared with the corresponding period of fiscal 1998, primarily due to competitive pricing pressures and proportionately higher service revenue. The Company believes it will continue to experience margin pressure, particularly in its supercomputer and desktop product lines. In particular, the Silicon Graphics 320 visual workstation competes 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." OPERATING EXPENSE (EXCLUDING OTHER OPERATING EXPENSE). Compared with the corresponding periods a year ago, operating expense for the third quarter and first nine months of fiscal 1999 declined 15% and 13%, respectively, and declined as a percentage of total revenue from 51.2% to 49.9% for the third quarter of fiscal 1999. The decrease in operating expense resulted from comparatively lower headcount of approximately 1,300 positions and other expense control measures. As a percentage of total revenue, operating expenses increased from 47.7% to 50.2% for the first nine months of fiscal 1999 compared with the same period a year ago primarily due to the decrease in revenue. OTHER OPERATING EXPENSE. Other operating expense for the third quarter and first nine months of fiscal 1999 represents a change in previously estimated restructuring costs. For the third quarter and first nine months of fiscal 1998 other operating expense includes an estimated restructuring charge of $96 million. Also included in the first nine months of fiscal 1998 is a $17 million charge for acquired in-process technology recorded in connection with the acquisition of ParaGraph and $2 million of merger-related expense. For more information regarding the Company's restructuring activity, see Note 7 of the Notes to Condensed Consolidated Financial Statements (Unaudited) included in Part I of this Quarterly Report. INTEREST AND OTHER INCOME (EXPENSE), NET. Interest and other income (expense), net for the third quarter of fiscal 1999 was ($7.4) million compared with ($.3) million for the third quarter of fiscal 1998. The year over year change primarily reflects a partial write-off of an investment and the minority interest in MIPS, offset in part by a reduction in costs associated with the Company's economic hedging program. Interest and other income (expense), net for the first nine months of fiscal 1999 was $40.4 million compared with ($1.0) million for the first nine months of fiscal 1998. The year over year change primarily reflects a $54 million gain on the sale of a portion of the Company's interest in MIPS in the intial public offering and higher interest income attributable to higher invested cash balances. These favorable impacts were partially offset by the write-off of certain of the Company's investments and -13- the settlement of the securities class action lawsuit that SGI was defending as a successor in interest to MIPS Computer Systems, Inc. (MCSI). TAXES. The Company's effective tax benefit rate for the first nine months of fiscal 1999 was 23%, excluding the impact of the $54 million gain on the sale of a portion of its interest in MIPS in the first quarter of fiscal 1999 and a $14 million aggregate change in previously estimated restructuring costs taken in the second and third quarters of fiscal 1999, which were tax effected at 38%. The Company's effective tax benefit rate for the first nine months of fiscal 1998 was 28%, excluding the impact of the $17 million non-deductible write-off of acquired in-process technology in the first quarter of fiscal 1998 and the 25% tax benefit resulting from the $96 million restructuring charges in the second and third quarters of fiscal 1998. The fiscal 1998 and 1999 benefit rates, excluding the impact of the MIPS gain and change in estimated restructuring costs in fiscal 1999 and the in-process technology and restructuring charges in fiscal 1998, differ from the federal statutory rate primarily due to foreign losses for which no benefit has been recognized. At March 31, 1999, the Company had net deferred tax assets of $527 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 taxable 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. FINANCIAL CONDITION At March 31, 1999, cash and cash equivalents and marketable and restricted investments totaled $669 million, down from $737 million at June 30, 1998. Included in the March 31, 1999 balance is approximately $168 million of restricted investments that serve as collateral for letters of credit and an equity forward purchase arrangement. Operating activities generated $107 million during the first nine months of fiscal 1999 compared with $650 million during the first nine months of fiscal 1998. Despite the net loss for the first nine months of fiscal 1999, cash flow from operating activities was positive principally due to a decline in accounts receivable, due in part to shorter collection cycles, and a reduction in inventory levels due to improved inventory management, including outsourcing of certain manufacturing activities. Investing activities, other than changes in the Company's available-for-sale and restricted investments, consumed $148 million in cash during the first nine months of fiscal 1999, principally for the acquisition of capital equipment and spare parts, a portion of the investment in WAM!NET Inc. and an investment in a computer graphics technology company. The use of cash for investing activities was partially offset by proceeds from the sale of a portion of the Company's interest in MIPS. Financing activities used $28 million during the first nine months of fiscal 1999 compared with $9 million during the first nine months of fiscal of 1998. The principal financing activities during the first nine months of fiscal 1999 included the use of $68 million to repurchase shares of the Company's common stock and $22 million in principal payments on outstanding debt. The use of cash for financing activities was partially offset by proceeds from employee stock purchase plan issuances, employee stock option exercises, the issuance of new debt and proceeds from the public offering of MIPS common stock. On May 13, 1999, the Company and MIPS commenced a public offering of 6,000,000 shares of the Class A Common Stock of MIPS owned by SGI at an offering price to the public of $34.50 per share. SGI has granted the underwriters of the offering a 30-day option to purchase up to 900,000 additional shares of MIPS Class A Common Stock to cover overallotments, if any. After the offering, SGI will own approximately 69% of the total outstanding shares of Class A and Class B Common Stock of MIPS (67% if the underwriters' overallotment option is exercised in full). As previously announced, SGI currently intends to dispose of its remaining interest in MIPS in one or more transactions through public or private offerings, in a dividend or other distribution to SGI stockholders, in an exchange offer for outstanding shares of SGI's Common Stock, or other transactions. The timing and form of any further disposition by SGI of its MIPS stock is subject to the terms of a 90-day lock-up agreement between SGI and the underwriters, as well as market and other conditions. SGI has announced that it expects its divestiture of its interest in MIPS to be completed in the first half of fiscal 2001. See "Risks That Affect Our Business." -14- At March 31, 1999, the Company's principal sources of liquidity included cash and cash equivalents and marketable investments of $501 million. The Company believes that these principal sources of liquidity, along with cash generated from operations, the expected proceeds of the MIPS offering, and other resources available to the Company, should be adequate to fund the Company's projected cash flow needs. 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 workstations and servers and UNIX based scalable servers such as the Company's Origin server product family. The Company also has announced a product roadmap that will, over the next several years, merge the Company's vector supercomputer and scalable server families and ultimately transition the Company's products to the Intel microprocessor architecture. This is a long-term transition, and although some benefits are currently being realized it could take until well into fiscal 2000 or beyond before the Company has achieved its desired business model. 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 Windows NT Visual Workstation products compensates for the expected decline in the other market sectors. DESKTOP SYSTEM STRATEGY. The Company has announced a family of desktop systems, the Silicon Graphics 320 and Silicon Graphics 540 visual workstations, based upon Intel microprocessors and the Windows NT operating system. The Silicon Graphics 320 system began commercial shipments in February 1999; the Silicon Graphics 540 system is scheduled for introduction in the June quarter. There is no assurance that these systems will be introduced as scheduled, will achieve the desired levels of market acceptance or will be available in sufficient quantities to meet demand. Revenues in the third quarter for the Silicon Graphics 320 system were below the Company's original expectations due in part to production ramp and other distribution issues, and the Company has modified its revenue expectations accordingly. Although the Silicon Graphics 540 is expected to be introduced in the June quarter, the Company does not expect it to account for significant revenue in fiscal 1999. Success in this market segment requires that the Company adapt to very different requirements: high volume, lower margins; managing an outsourced model for manufacturing, distribution and support; and marketing to higher volume segments in which the Company has not historically participated. The Company will depend on a combination of its existing channels and on newly-established channel relationships to distribute its products in this market segment, with accompanying uncertainty as to how long it will take these new channels to ramp to desired volumes. The Company is also investing in a significant marketing and advertising campaign for the new products, the results of which will not be immediately apparent. 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. 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. The Company is also engaged in a transition from its traditional business of supporting its own proprietary UNIX operating systems, IRIX-Registered Trademark- and UNICOS-Registered Trademark-, to supporting additional operating systems such as Windows NT and Linux. The Company believes that this strategy will position it favorably in growth markets, including the -15- market for 32-bit Intel-based servers. A successful transition to this model will require the Company to make effective resource allocation choices and successfully manage a complex set of support and strategic relationships. 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, additional outsourcing of manufacturing, and establishing significant new distribution channels 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, if new channels do not ramp to desired levels 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 and related information technology. 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. -16- 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 as a user of information systems in the operation of its business, as a supplier of computer systems and related software, including operating system software, to customers, and as a customer of other organizations whose operations may be affected by year 2000 compliance issues. 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 latest update to its IRIX and UNICOS 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. There can be no assurance that the Company's current products do not contain undetected errors or defects associated with year 2000 functions that may result in material costs to the Company. 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 these issues, including potential litigation expenses, 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. These include not just suppliers of components but also the Company's outsourcing partners in manufacturing support and even suppliers of basic utilities. 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. Certain of the costs associated with the Company's internal Year 2000 compliance effort (exclusive of any potential costs related to any customer or other claim) cannot effectively be isolated from other operating expenses, since investing in new systems is both an ordinary cost of doing business and a means to ensure year 2000 compliance. Our current estimates indicate the total costs to insure year 2000 -17- compliance will not be material. 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. The information regarding year 2000 issues provided in this Form 10-Q is based on the Company's current assessment of ongoing activities and is subject to change as the Company continuously monitors these activities. The Company is currently evaluating the need for contingency plans associated with potential year 2000 problems. The Year 2000 disclosure set forth above is a "year 2000 readiness disclosure" as defined in the Year 2000 Information and Readiness Disclosure Act of 1998. INVESTMENT IN MIPS SUBSIDIARY. The value of the Company's interest in its MIPS Technologies, Inc. subsidiary is determined principally by factors outside the Company's control and may fluctuate significantly from time to time. There is no assurance that the Company's interest in MIPS will increase in value or maintain its current level. The Company's ability to realize the value of this interest through a series of divestiture transactions over time is also subject to a number of conditions outside of the Company's control, including the receipt of a favorable ruling from the IRS as to the tax-free status of the ultimate divestiture. There can be no assurance that the Company will be successful in fully realizing the value of the MIPS interest on a tax and market efficient basis. 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 Departments of Commerce and Justice are currently conducting civil and criminal investigations into 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 these matters will be resolved without a significant adverse effect on the Company's business. However, there is no assurance that these matters will not have an unforeseen outcome that could impair the conduct of the Company's business. 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. 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. 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. -18- 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, Silicon Graphics is affected by the conversion of 11 European currencies into the euro beginning in January 1999. 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The information required under this Item 3 is included in the section above entitled Market Risk. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is 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. The parties to this case reached an agreement to settle the case in December 1998, the terms of which were reflected in a Stipulation of Settlement filed with the Court in January 1999. Under the settlement agreement, the defendants have agreed to establish a $15 million escrow fund that shall be administered to pay the representative plaintiffs' costs and attorneys fees, to notify and certify members of the class and to pay the claims of class members. The settlement amount was largely covered by insurance. The settlement agreement provides for release of all parties' claims in connection with the class action and is subject to final approval of the Court. 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. In April 1999, the U.S. Court of Appeals for the Second Circuit reversed the dismissal and remanded the case to the U.S. District Court for the District of Connecticut. The defendants' petition for rehearing en banc with the U.S. Court of Appeals is pending. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.42 (1) 1998 Employee Stock Purchase Plan. 27.1 Financial Data Schedule. - -------------- (1) Incorporated by reference to exhibits to the Company's Registration Statement on Form S-8 (No. 333-76445), which became effective April 16, 1999. -19- (b) Reports on Form 8-K. None -20- SIGNATURES Pursuant to the requirements 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. Dated: May 14, 1999 SILICON GRAPHICS, INC. a Delaware corporation By: Steven J. Gomo ------------------------------ Steven J. Gomo Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) -21- SILICON GRAPHICS, INC. INDEX TO EXHIBITS Exhibit Description - ------- ----------- 27.1 Financial Data Schedule -22- EX-27 2 EX-27
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-Q FOR THE PERIOD ENDING MARCH 31, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND THE NOTES THERETO. 1,000 9-MOS JUN-30-1999 JUL-01-1998 MAR-31-1999 343,967 156,786 507,456 19,357 241,338 1,598,971 838,103 445,517 2,738,391 996,753 361,322 0 16,998 171 1,332,004 2,738,391 1,427,770 1,920,354 833,601 1,133,349 278,648 3,459 17,727 (121,778) 17,814 (103,964) 0 0 0 (103,964) (0.56) (0.56)
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