-----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, LbOPcWkY2YbcLqNUZLcztubo067gKZfGngod/5jCUPnq9NqRFjFnAvMHESdQAYQa lzSI+2V78MKqcjH8IKB3TA== 0001047469-99-037099.txt : 19991227 0001047469-99-037099.hdr.sgml : 19991227 ACCESSION NUMBER: 0001047469-99-037099 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990928 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: 99719021 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, 1999. [___] 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) 1600 Amphitheatre Parkway, Mountain View, California 94043-1351 (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: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ------------------- 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, 1999 on the New York Stock Exchange as reported in The Wall Street Journal, was approximately $1,605 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, 1999, THE REGISTRANT HAD OUTSTANDING 182,872,109 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, 1999 are incorporated by reference into Part III, and parts of the registrant's annual report to stockholders for the fiscal year ended June 30, 1999 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. SGI-TM- servers and 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-Registered Trademark- operating system, which is the Company's enhanced version of the UNIX-Registered Trademark- operating system. Over the next several years, the Company plans to introduce new generations of its products based on the Intel-Registered Trademark- microprocessor architecture and the Linux-TM- and Windows NT-Registered Trademark- operating systems. 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. DESKTOP SYSTEMS The Company offers the 02-Registered Trademark- and Octane-Registered Trademark- families of desktop workstations based on the MIPS microprocessor architecture and the IRIX operating system, and in the second half of fiscal 1999, introduced the Visual Workstation family of desktop workstations based on the Intel microprocessor architecture and the Windows NT operating system. The O2 family of entry-level desktop workstations features 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 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. The Visual Workstation family is designed to provide key functionality for the digital content creation and graphics enthusiast markets. 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-Registered Trademark- 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. ALIAS/WAVEFRONT The Company's Alias/Wavefront subsidiary 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-Registered Trademark- 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, Ontario with sales offices across North America, Europe and Asia and worldwide distribution. SERVERS AND SUPERCOMPUTERS ORIGIN200 The Origin-TM-200 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 Origin-TM-2000 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 Origin2000 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. -2- SGI1000 FAMILY In August 1999, the Company introduced a new family of server products, the SGI-TM-1000 server family. This server family utilizes 32-bit Intel microprocessors and will include projects ranging from a two-microprocessor rack-optimized server, to a four-microprocessor workgroup and applications server, to powerful eight-microprocessor database servers. SGI1400 The SGI-TM-1400M and the SGI-TM-1400L are the first products in the new SGI1000 server family. These servers use four microprocessors and ship with either Microsoft-Registered Trademark- Windows NT or Linux as their operating system. The CRAY T3E-TM- high 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. In August 1999, the Company announced its intention to establish arrangements to transition its Cray-branded line of supercomputers to a strategic partner that will assume the further development and distribution of this product line. MIPS RISC MICROPROCESSORS Many of the Company's system products are based on the MIPS 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 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, and a secondary offering in May 1999, Silicon Graphics now owns about 65% of MTI. Silicon Graphics continues to develop MIPS RISC microprocessors for its own computer systems as part of its computer systems organization. -3- 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 1999 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 16 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 1999, 1998 or 1997, a significant reduction or delay in sales to major customers 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 -4- 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 1999, 1998 and 1997, the Company spent approximately $380 million, $459 million, and $479 million, respectively, on research and development. Those amounts represented 13.8%, 14.8%, and 13.1%, 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. Products are subjected to substantial environmental stress and electronic testing prior to shipment to customers. The Company primarily manufactures and ships its products from its facilities in Chippewa Falls, Wisconsin and near Neuchatel, Switzerland. Both of these facilities 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. -5- 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. The Company is actively outsourcing significant manufacturing activities to companies that are able to manufacture at a lower cost. 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. The Company's present strategy is to move toward components that are readily available from a greater number of sources; however, such a transition may take a period of time to complete. 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 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. -6- 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. One of the principal market sectors in which the Company competes -- supercomputers -- has declined over the past few years, and the Company believes that this decline represents a long-term trend. The Company's goal is to generate an increasing proportion of its revenue from growing markets, including Intel-based servers and UNIX-based scalable servers such as its Origin server product family. The Company has announced a product roadmap that will, over the next five years, shift its products to the Intel microprocessor architecture. To further accelerate this transition, the Company announced in August 1999 its intention to establish arrangements to transition its Visual Workstation line of Windows NT-based workstations and its Cray-branded line of supercomputers to strategic partners who will assume the further development and distribution of these product lines. The result of these alliances and planned restructured operations will be a smaller revenue base and workforce in fiscal 2000, with the goal of returning to sustainable profitability. 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 in fiscal 2000 will largely depend on the successful implementation of these alliances and related restructuring activities in early fiscal 2000 with minimal disruption, and on growth in the server business. There is no assurance that the Company will successfully complete the strategic alliances and related restructuring activities required to achieve its fiscal 2000 objectives. 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 -7- 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 1999, the Company reduced its operating expenses by about $240 million from the level of fiscal 1998 operating expenses. In August 1999, the Company announced and began to implement a restructuring program aimed at bringing its expenses more in line with expected revenue levels resulting from its refocused business operations and restoring long-term profitability. As part of this effort, the Company expects, through the anticipated transfer of businesses to partners, the elimination of positions and managed hiring, to end fiscal 2000 with about 1/3 fewer employees than was the case at the end of fiscal 1999. These steps, and generally tighter operating expense controls, are part of an overall program to reduce the Company's expense structure by approximately $300 million in fiscal 2000. While the objective is to reduce the Company's costs in ways that will not have a material impact on revenue levels, there is 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 longer-term transition to the Intel architecture and additional outsourcing of manufacturing, will increase the Company's dependence on 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 fails to meet product release schedules, or if unanticipated quality issues arise with products from 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 has undertaken 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. In the past year the Company -8- has seen the number of turns of inventory increase significantly and obtained improved efficiencies which have decreased the costs of goods sold. Continued implemention of 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 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 -9- 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. Certain of the costs associated with our 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. The Company's current estimates indicate the total costs to insure year 2000 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 herein is based on the Company's current assessment of ongoing activities and is subject to change as the Company monitors these activities. The Company is currently developing appropriate contingency plans for potential year 2000 problems. The Year 2000 disclosure set forth above is "year 2000 readiness disclosure" as defined in the Year 2000 Information and Readiness Disclosure Act of 1998. 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. A portion of the Company's business requires security clearances from the United States government. The Company is presently discussing appropriate measures to maintain its clearances in light of the fact that Mr. Robert Bishop, who was appointed as Chief Executive Officer in the fall of 1999, is not a United States citizen. Any disruption or limitations in the Company's ability to do business with the United States government could have an adverse impact on the Company. 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 -10- 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 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. 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, 1999 and 1998. The market values for foreign exchange risk are computed based on spot rates in effect at June 30, 1999 and 1998. The market values that result from these computations are compared to the market values of these financial instruments at -11- June 30, 1999 and 1998. 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 30,1999 and 1998 are as follows: Interest Rate Risk:. A percentage point decrease in the level of interest rates with all other variables held constant would result in a decrease in the aggregate fair value of our financial instruments by $14 million at both June 30, 1999 and 1998. A percentage point increase in the level of interest rates with all other variables held constant would result in an increase in the aggregate fair value of our financial instruments by $13 million and $12 million, respectively. Foreign Currency Exchange Rate Risk: A 10% decrease 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 an increase in the fair values of our financial instruments by $8 million at June 30,1999, and a decrease in the fair values of our financial instruments by $14 million at June 30, 1998. A 10% increase in levels of foreign currency exchange rates, 20% for Asian currencies, would result in a decrease in the fair values of our financial instruments by $3 million at June 30, 1999, and an increase in the fair values of our financial instruments by $12 million at June 30, 1998. The change in the relative sensitivity of the fair market value of foreign currency exchange rates in fiscal 1999 compared with fiscal 1998 is primarily driven by the volume of systems shipped and billed in U.S. dollars by our Swiss manufacturing subsidiary which operates in local functional currency. EMPLOYEES As of June 30, 1999, the Company had approximately 9,191 full-time employees, as compared to approximately 10,286 at June 30, 1998. During fiscal 2000, the Company expects the number of employees to be reduced by about 1/3 in order to bring the Company down to the appropriate size for the forecasted revenue and income. 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 operations are located in Mountain View, California, where the Company leases or owns a total of about 1,668,000 square feet. These facilities include a ten-building campus facility of about 727,000 square feet, leased by the Company through the years 2000 to 2005; a four-building, 518,000 square foot campus located on 22 acres of leased land in the same area; and a sales headquarters building comprising approximately 126,000 square feet and located on 7.5 acres owned by the Company near its Mountain View headquarters. The Company also leases six other buildings near its -12- Mountain View headquarters, comprising approximately 306,000 square feet. The Company is currently developing a general purpose office facility of about 400,000 square feet on leased land in the same area; this new facility will replace the ten-building campus facility as those buildings go off lease. MINNESOTA AND WISCONSIN The Company also owns manufacturing, research and development and service facilities of about 595,000 square feet in Chippewa Falls, Wisconsin. In March of 1999, the Company sold its research and development, sales and administrative facilities of about 495,000 square feet in Eagan, Minnesota, to Wam!Net. The sale to Wam!Net included a lease-back of 325,796 square feet of the facility for a period of five years. The sale also included an investment by the Company in Wam!Net and a preferred provider agreement whereby Wam!Net and the Company agreed to purchase hardware, software and service from each other over a four-year period beginning January 1, 1999. 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. On July 2, 1999, the U.S. Court of Appeals for the Ninth Circuit upheld the dismissal. 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 of 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 U.S. Court of Appeals denied defendants' petition for rehearing en banc. The Company has settled 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, alleged 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 the class members. The settlement amount was largely covered by insurance. The settlement agreement -13- provides for release of all parties' claims in connection with the class action and is subject to final approval of the Court. 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. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company and their ages as of September 1999 are as follows:
NAME EXECUTIVE ---- AGE POSITION AND PRINCIPAL OCCUPATION OFFICER --- --------------------------------- SINCE --------- Robert R. Bishop 56 Chairman, Chief Executive Officer and Director 1991 Kurt Akeley 41 Senior Vice President and Chief Technology Officer 1999 Kenneth L. Coleman 56 Senior Vice President, Global Sales, Service & Marketing 1987 Steven J. Gomo 47 Senior Vice President, Chief Financial Officer 1998 William M. Kelly 45 Senior Vice President, Corporate Operations and Secretary 1994 John R. Vrolyk 47 Senior Vice President, Computer Systems Business Unit 1998 Sandra M. Escher 39 Vice President and General Counsel 1999 Betsy Rafael 38 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. Bishop was appointed Chairman and Chief Executive Officer of the Company in the fall of 1999. From July 1995 to February 1999, he was the Chairman of the Board of Silicon Graphics World Trade Corporation. Prior to July 1995, Mr. Bishop served as President of Silicon Graphics World Trade Corporation, a position he had held since July 1986. -14- Mr. Akeley was appointed Senior Vice President, Chief Technology Officer in September 1999. Mr. Akeley co-founded the Company in 1982 and has been Vice President and Chief Engineer since 1990. Mr. Coleman was appointed Senior Vice President, Global Sales, Service and Marketing in June of 1999. Between 1997 and 1999, he was Senior Vice President, Customer and Professional Services 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. 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. Mr. Vrolyk was appointed Senior Vice President, Computer Systems Business Unit in October 1998. He joined the Company in April 1997 as Vice President/General Manager of the Light Client Division and in January 1998 became the Vice President/General Manager of the Server and Supercomputer Business. Prior to joining the Company, he was Vice President/General Manager of the DDS Workgroup and Impact Group at Xerox Corporation. Ms. Escher was appointed Vice President and General Counsel in April 1999. She joined the Company in July 1993 as Securities Counsel and served as the Director of Corporate Legal Services between September 1996 and April 1999. 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. -15- PART II With the exception of the information specifically incorporated by reference from the Company's 1999 Annual Report to Stockholders (the "1999 Annual Report") in Parts I, II and IV of this Form 10-K, the 1999 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 12 of the Company's 1999 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 10 of the Company's 1999 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 13 through 22 of the Company's 1999 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 pages 21 and 22 of the Company's 1999 Annual Report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item is incorporated by reference to the consolidated financial statements and notes thereto and to the section entitled "Quarterly Data" on pages 23 through 44 and 11 of the Company's 1999 Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. -16- 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 "1999 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 1999 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 pages 12 and 13 of the 1999 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 1999 Proxy Statement on pages 5 and 6 under the headings "Proposal No. 1 - Election of Directors - Compensation Committee Interlocks and Insider Participation" and "- Director Compensation"; on pages 11 and 12 under the headings "Executive Officer Compensation - Summary Compensation Table", "- Option Grants in Fiscal 1999" and "Option Exercises in Fiscal Year 1999 and Fiscal Year-End Option Values"; on pages 9 and 10 under the heading "Report of the Compensation and Human Resources Committee of the Board of Directors"; and on page 14 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 1999 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 8 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 1999 Proxy Statement on page 13 under the heading "Certain Transactions." -17- 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 Ernst & Young LLP, Independent Auditors are incorporated by reference to pages 11 and 23 through 45 of the Registrant's 1999 Annual Report: Consolidated Statements of Operations - Years Ended June 30, 19989 1998 and 1997 Consolidated Balance Sheets - June 30, 1999 and 1998 Consolidated Statements of Cash Flows - Years Ended June 30, 1999, 1998 and 1997 Consolidated Statements of Stockholders' Equity - Years Ended June 30, 1999, 1998 and 1997 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.
-18- 4.2(10) First Amendment to Rights Agreement dated as of May 2, 1995 between the Company and The First National Bank of Boston. 4.3(16) Indenture dated February 1, 1986 between Cray Research, Inc. and Manufacturers Hanover Trust Company, as Trustee. 4.4(16) First Supplemental Indenture dated June 30, 1996 between the Company, Cray Research, Inc., and Chemical Bank (formerly Manufacturers Hanover Trust Company). 4.5(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) 10.8(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(19)* 1984 Incentive Stock Option Plan, as amended, and amended form of Incentive Stock Option Agreement. 10.11(9)* Directors' Stock Option Plan and form of Stock Option Agreement as amended as of October 31, 1994. 10.12(6)* 1985 Stock Incentive Program. 10.13(6)* 1986 Incentive Stock Option Plan, as amended, and amended forms of Incentive Stock Option Agreement and Nonstatutory Stock Option Agreement. 10.16(7)* 1993 Long-Term Incentive Stock Plan and form of stock option agreement.
-19- 10.17(14)* 1996 Supplemental Non-Executive Equity Incentive Plan and form of stock option agreement, as amended 10.18(17)* Employee Stock Purchase Plan, as amended as of October 30, 1996. 10.19(23)* 1998 Employee Stock Purchase Plan 10.20(8)* Non-Qualified Deferred Compensation Plan dated as of September 9, 1994. 10.21(19)* Addendum to the Non-Qualified Deferred Compensation Plan. 10.22(11)* Alias Research Inc.'s 1988 Employee Share Ownership Plan Option Agreement. 10.23(11)* Alias Research Inc.'s 1989 Employee Share Ownership Plan Option Agreement. 10.24(11)* Alias Research Inc.'s 1990 Employee Share Ownership Plan and standard forms of Option Agreements. 10.25(11)* Alias Research Inc.'s 1994 Stock Plan and standard forms of Option Agreements. 10.26(12)* Wavefront Technologies, Inc. 1990 Stock Option Plan with standard form of Option Agreement. 10.27(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, 1999. 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.
-20- (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. (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, 1999. (b) REPORTS ON FORM 8-K. No Current Reports on Form 8-K were filed during the quarter ended June 30, 1999.
-21- TRADEMARKS USED IN THE FORM 10-K Silicon Graphics, InfiniteReality, IRIX, O2, Octane and Onyx are registered trademarks, Onyx2, Onyx2Reality, Origin, and SGI are trademarks, of Silicon Graphics, Inc. MIPS is a registered trademark of MIPS Technologies, Inc. used under license by Silicon Graphics, Inc. Cray is a registered trademark and Cray T3E, Cray T90 and Cray SV1 are trademarks of Cray Research, L.L.C. Alias is a registered trademark, and Alias/Wavefront, Alias Studio, Alias StudioPaint 3D and Alias AutoStudio are trademarks, of Alias/Wavefront, a division of Silicon Graphics Limited. Maya is a registered trademark of Silicon Graphics, Inc., and exclusively used by Alias/Wavefront, a division of Silicon Grpahics Limited. UNIX is a registered trademark licensed exclusively through X/Open Company Limited. Microsoft, Windows and Windows NT are registered trademarks of Microsoft Corporation. Intel is a registered trademark of Intel Corp. Linux is a trademark of Linus Torvalds in the U.S. and other countries. -22- 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. Dated: September 27, 1999 SILICON GRAPHICS, INC. By: /S/ ROBERT R. BISHOP ------------------------------ Robert R. Bishop CHAIRMAN AND CHIEF EXECUTIVE OFFICER 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/ ROBERT R. BISHOP Chairman, Chief Executive Officer and September 27, 1999 - -------------------------- Robert R. Bishop Director (Principal Executive Officer) /S/ STEVEN J. GOMO Senior Vice President, Finance and Chief September 27, 1999 - -------------------------- Financial Officer (Principal Financial Steven J. Gomo and Accounting Officer) /S/ C. RICHARD KRAMLICH Director September 27, 1999 - -------------------------- C. Richard Kramlich /S/ ROBERT A. LUTZ Director September 27, 1999 - -------------------------- Robert A. Lutz /S/ JAMES A. MCDIVITT Director September 27, 1999 - -------------------------- James A. McDivitt /S/ LUCILLE SHAPIRO, PH.D. Director September 27 1999 - -------------------------- Lucille Shapiro, Ph.D. /S/ ROBERT B. SHAPIRO Director September 27, 1999 - -------------------------- Robert B. Shapiro
-23- Schedule II SILICON GRAPHICS, INC. Valuation and Qualifying Accounts (in thousands)
Additions Deductions -------------------------- -------------- Balance at Charged to Balance at Beginning Costs and Write-offs/ End of DESCRIPTION of Period Expenses Other Other Period ------------- -------------- ----------- -------------- ------------ Year ended June 30, 1997 Accounts receivable allowance $ 23,767 $ 8,427 $ 0 $ (8,138) $ 24,056 Warranty reserve $ 18,946 $ 26,361 $ 0 $ (27,358) $ 17,949 Deferred tax asset allowance $ 60,819 $ 8,228 $ 0 $ 0 $ 69,047 Year ended June 30, 1998 Accounts receivable allowance $ 24,056 $ 622 $ 0 $ (7,215) $ 17,463 Warranty reserve $ 17,949 $ 42,110 $ 0 $ (27,327) $ 32,732 Deferred tax asset allowance $ 69,047 $ 62,528 $ 10,600(1) $ (51,470)(2) $ 90,705 Year ended June 30, 1999 Accounts receivable allowance $ 17,463 $ 351 $ 0 $ (2,407) $ 15,407 Warranty Reserve $ 32,732 $ 36,111 $ 9,945(3) $ (40,168) $ 38,620 Deferred tax asset allowance $ 90,705 $ 13,511 $ 11,439(1) $ (10,291) $105,364
(1) Reserve of paid-in capital benefits relate to stock option activity (2) Reduction in valuation allowance resulting in an adjustment to purchased intangibles from the Cray acquisition. (3) Reclassification from other accrual accounts EX-13.1 2 EXHIBIT 13.1 SELECTED CONSOLIDATED FINANCIAL DATA
Years Ended June 30 ------------------------------------------------------------------ (in thousands, except per share amounts) 1999 1998 1997 1996(3) 1995 Operating Data: Total revenue $2,748,957 $3,100,610 $3,662,601 $2,921,316 $2,228,268 Costs and expenses: Cost of revenue 1,603,250 1,963,551 2,022,546 1,482,439 1,032,059 Research and development 380,346 459,188 479,101 353,461 247,678 Selling, general and administrative 907,612 1,068,429 1,038,313 807,830 619,259 Other operating expense(1) (15,107) 205,543 10,757 103,193 22,000 ------------------------------------------------------------------ Operating (loss) income (127,144) (596,101) 111,884 174,393 307,272 Interest and other income (expense), net(2) 252,865 (818) (13,694) 14,395 9,447 ------------------------------------------------------------------ Income (loss) before income taxes 125,721 (596,919) 98,190 188,788 316,719 Net income (loss) 53,829 (459,627) 78,551 115,037 224,856 Net income (loss) per share: Basic $ 0.29 $ (2.47) $ 0.44 $ 0.70 $ 1.44 Diluted $ 0.28 $ (2.47) $ 0.43 $ 0.65 $ 1.26 Shares used in the calculation of net income (loss) per share: Basic 186,374 186,149 175,548 162,658 156,437 Diluted 189,427 186,149 182,637 175,790 182,837 Balance Sheet Data: Cash, cash equivalents and marketable and restricted investments $ 782,369 $ 736,720 $ 374,292 $ 456,937 $ 780,012 Working capital 869,980 968,700 1,229,388 994,817 889,371 Total assets 2,788,257 2,964,706 3,344,592 3,158,246 2,206,619 Long-term debt and other 387,005 403,522 419,144 381,490 287,267 Stockholders' equity 1,424,199 1,464,512 1,839,242 1,675,318 1,346,170 Statistical Data: Number of employees 9,191 10,286 10,930 10,485 6,308 Long-term debt and other/ total capitalization 21% 22% 19% 19% 18% ------------------------------------------------------------------
(1) Fiscal 1999 amount includes a change in previously estimated restructuring charges ($14 million). 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. (2) Fiscal 1999 amount includes a $273 million gain on the sale of a portion of SGI's interest in MIPS. (3) Amounts reflect the April 2, 1996 acquisition of Cray which was accounted for as a purchase. 10 QUARTERLY DATA
Fiscal 1999 (unaudited) --------------------------------------------------- (in thousands, except per share amounts) June 30 March 31 Dec. 31 Sept. 30 Total revenue $ 828,603 $ 619,175 $ 684,823 $ 616,356 Costs and expenses: Cost of revenue 469,901 359,636 394,973 378,740 Research and development 87,698 93,331 97,179 102,138 Selling, general and administrative 237,105 215,574 222,005 232,928 Other operating expense(1) (1,107) (6,000) (8,000) -- --------------------------------------------------- Operating income (loss) 35,006 (43,366) (21,334) (97,450) Interest and other income (expense), net(2) 212,493 (7,358) (3,524) 51,254 --------------------------------------------------- Income (loss) before income taxes 247,499 (50,724) (24,858) (46,196) Net income (loss) 157,793 (39,957) (20,341) (43,666) Net income (loss) per share: Basic $ 0.85 $ (0.21) $ (0.11) $ (0.24) Diluted $ 0.81 $ (0.21) $ (0.11) $ (0.24) Shares used in the calculation of net income (loss) per share: Basic 186,197 186,685 186,417 186,329 Diluted 196,839 186,685 186,417 186,329 ---------------------------------------------------
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(3) 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 ---------------------------------------------------
(1) Amounts include a change in previously estimated restructuring charges of $8 million in the second quarter and $6 million in the third quarter. (2) Amounts include a gain on the sale of a portion of SGI's interest in MIPS of $54 million in the first quarter and $219 million in the fourth quarter. (3) 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. 11 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. Price Range of Common Stock
Fiscal 1999 Fiscal 1998 ------------------------------------------------------------------------------------- Low High Close Low High Close First Quarter $ 9.06 $ 15.00 $ 9.38 $ 15.00 $ 30.19 $ 26.25 Second Quarter 7.38 13.94 12.88 11.56 27.50 12.44 Third Quarter 13.13 20.88 16.69 10.94 16.19 13.94 Fourth Quarter 11.69 16.63 16.38 11.06 16.38 12.13 -------------------------------------------------------------------------------------
SGI had 8,445 stockholders of record as of June 30, 1999. We have not paid any dividends on our common stock. We currently intend to retain earnings for use in our business and do not anticipate paying cash dividends to common stockholders. 12 MANAGEMENT'S DISCUSSION AND ANALYSIS THIS ANNUAL REPORT INCLUDES FORWARD-LOOKING STATEMENTS REGARDING OUR 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, 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 OUR PRODUCTS, INCLUDING EXPECTED RATES OF GROWTH AND DECLINE IN OUR 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 PROFIT 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 OUR SERVER STRATEGY; RISKS RELATED TO DEPENDENCE ON OUR 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; 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. 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. OUR 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. Our fiscal 1998 results reflect certain charges attributable to our decision to restructure the business. This decision followed a reevaluation of our core competencies, technology roadmap and business model in an effort to bring our expenses more in line with current revenue levels and restore long-term profitability to SGI. The fiscal 1999 information reflects the results of the restructuring activities we initiated in fiscal 1998. As we exited fiscal 1999, we concluded that the actions we had initiated in fiscal 1998 and continued in fiscal 1999 were not sufficient to deliver the growth and profitability we believe necessary to sustain our business. The discussion that follows is limited to a discussion of the historical results of operations and financial condition. See "Risks That Affect Our Business--Business Transition" for further discussion of our plans for fiscal 2000 and the future. 13 RESULTS OF OPERATIONS
Years ended June 30 ---------------------------------------- $ in millions 1999 1998 1997 Total revenue $ 2,749 $ 3,101 $ 3,663 Cost of revenue 1,603 1,964 2,023 ---------------------------------------- Gross profit 1,146 1,137 1,640 Gross profit margin 41.7% 36.7% 44.8% Total operating expenses 1,273 1,733 1,528 ---------------------------------------- Operating (loss) income (127) (596) 112 Other income (expense) 253 (1) (14) ---------------------------------------- Income (loss) before income taxes 126 (597) 98 ---------------------------------------- Net income (loss) $ 54 $ (460) $ 79 ---------------------------------------- Net income (loss) per share-basic $ 0.29 $ (2.47) $ 0.44 ---------------------------------------- Net income (loss) per share-diluted $ 0.28 $ (2.47) $ 0.43 ---------------------------------------- ----------------------------------------
REVENUE The following discussion of revenue is based on the results of our reportable segments as described in Note 16, "Segment Information." Total revenue is principally derived from three reportable segments: Servers, Visual Workstations and Global Services, which were determined based on factors such as customer base, homogeneity of products, technology, delivery channels and other factors. Total revenue in fiscal 1999 decreased $352 million or 11% compared with fiscal 1998 and fiscal 1998 revenue decreased $562 million or 15% compared with fiscal 1997. These decreases reflect the continuing trends in the declining vector supercomputer and UNIX-Registration Trademark- workstation markets which are part of our Server and Visual Workstation segments, respectively. Decreases were offset in part by growth in our Global Services segment. The following table presents the percentage of total revenue by reportable segment as presented in our performance management system.
Years ended June 30 ------------------------------------------ $ in millions 1999 1998 1997 Servers $ 1,218 $ 1,417 $ 1,795 % of total revenue 44% 46% 49% Visual Workstations $ 647 $ 865 $ 1,112 % of total revenue 24% 28% 30% Global Services $ 682 $ 630 $ 571 % of total revenue 25% 20% 16% Other $ 201 $ 188 $ 184 % of total revenue 7% 6% 5% ------------------------------------------
Fiscal 1999 Server revenue decreased $199 million or 14% compared with fiscal 1998 and fiscal 1998 Server revenue decreased $378 million or 21% compared with fiscal 1997. Although our fiscal 1999 Origin-TM- brand scalable server business returned to growth in fiscal 1999, our vector supercomputer business declined significantly in both fiscal 1999 and 1998. As we exited fiscal 1999, the vector supercomputer product business represented less than 10% of total revenue. Our Onyx-Registration Trademark- supercomputer revenue declined in each of fiscal 1999 and 1998, but the rate of decline slowed in fiscal 1999 to 6% compared with 24% in fiscal 1998. Fiscal 1999 Visual Workstation revenue decreased $218 million or 25% compared with fiscal 1998 and fiscal 1998 Visual Workstation revenue decreased $247 million or 22% compared with fiscal 1997. These decreases reflect the effects of strong competition in the shrinking UNIX workstation market and, in fiscal 1999, the disappointing sales performance of our visual 14 workstations based on the Windows NT-Registration Trademark- operating system introduced in the second half of the fiscal year. See "Risks That Affect Our Business--Business Transition." Global Services revenue is comprised of hardware and software support and maintenance, professional services and remanufactured systems sales. Fiscal 1999 Global Services revenue increased $52 million or 8% compared with fiscal 1998 and fiscal 1998 Global Services revenue increased $59 million or 10% compared with fiscal 1997. Growth in Global Services revenue reflects the impact of our investment in our professional services business, as well as increases in the level of our remanufactured systems business. Other revenue is principally comprised of our operating units that are not reportable segments, including the product and service revenue of our software subsidiary, Alias|Wavefront, and MIPS, our majority-owned subsidiary that develops and markets microprocessors and related intellectual property. Total revenue by geographic area for fiscal 1999, 1998 and 1997 was as follows (in millions):
--------------------------------------- Area 1999 1998 1997 Americas $ 1,536 $ 1,729 $ 2,072 Europe 754 831 936 Rest of World 459 541 655 --------------------------------------- Total revenue $ 2,749 $ 3,101 $ 3,663 --------------------------------------- ---------------------------------------
Geographic revenue as a percentage of total revenue for fiscal 1999, 1998 and 1997 was as follows:
-------------------------------------- Area 1999 1998 1997 Americas 56% 56% 57% Europe 27% 27% 26% Rest of World 17% 17% 17% --------------------------------------
The product revenue decreases we have experienced over the past three years have been widespread as illustrated by the fact that our geographic revenue mix remained relatively consistent during that period. Our consolidated backlog at June 30, 1999 was $376 million, up from $360 million at June 30, 1998, primarily reflecting momentum in our Origin and Onyx businesses. GROSS PROFIT 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 included in research and development expense. Cost of service revenue includes all costs incurred in the support and maintenance of our products, as well as costs to deliver professional services. Our overall gross profit margin increased to 41.7% in fiscal 1999 compared with 36.7% in fiscal 1998 and our fiscal 1998 gross profit margin declined compared with our fiscal 1997 gross profit margin of 44.8%. Gross profit margin for fiscal 1998 included a number of non-recurring charges related to refocusing our supercomputer product roadmap, as well as a write-down of excess spares. Without those charges, our fiscal 1998 gross profit margin would have been 41.3%. Our gross profit margin over the past three years reflects decreased volumes and continuing pricing pressures in both the Server and Visual Workstation segments, as well as in our Global Services business. We have been able to partially mitigate these effects by consolidation and outsourcing of certain manufacturing operations and continued improvements in manufacturing efficiencies and procurement practices. 15 We believe we will continue to experience margin pressure in fiscal 2000, particularly in our Server segment due to competitive pricing pressures as well as our introduction of lower margin products based on industry standard components. See "Risks That Affect Our Business." We expect UNIX workstation margins to remain fairly stable. OPERATING EXPENSES
$ in millions 1999 1998 1997 ------------------------------------------- Research and development $ 380 $ 459 $ 479 % of total revenue 13.8% 14.8% 13.1% Selling, general and administrative $ 908 $ 1,068 $ 1,038 % of total revenue 33.0% 34.5% 28.3% Other $ (15) $ 206 $ 11 % of total revenue (0.5%) 6.6% 0.3% -------------------------------------------
Our total fiscal 1999 operating expenses decreased $460 million compared with fiscal 1998 and fiscal 1998 operating expense increased $205 million compared with fiscal 1997. Fiscal 1998 operating expenses included $206 million of restructuring, long-lived asset impairment and merger-related charges. As we exited fiscal 1998, we expected our restructuring plans would result in the elimination of approximately 1,000 positions in fiscal 1999 and would reduce operating expense by at least $200 million. We believe those actions have reduced our operating expense run rate by approximately $240 million. RESEARCH AND DEVELOPMENT Research and development spending decreased $79 million or 17% in fiscal 1999 compared with fiscal 1998 and $20 million or 4% in fiscal 1998 compared with fiscal 1997. The fiscal 1999 decrease reflects reductions in investments in vector supercomputer and UNIX workstation development. These decreases were offset somewhat by increased investments in scalable server and Windows NT-based visual workstation development. We expect research and development spending in fiscal 2000 to decline compared with fiscal 1999 and to be focused on new scalable server product development. See "Risks That Affect Our Business--Expense Reduction Program." SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses decreased $160 million or 15% compared with fiscal 1998, following a $30 million increase in fiscal 1998 compared with fiscal 1997. The fiscal 1999 decrease reflects the impact of the restructuring actions taken in fiscal 1998, as well as lower selling commissions due to lower revenue, reduced outside consulting and business process re-engineering costs, continued focus on productivity and general expense controls. Marketing expense decreased significantly as well, particularly in corporate and vector supercomputer programs. Fiscal 1999 selling, general and administrative expenses include a number of charges that we do not expect to recur, including a $16 million write-down of certain capitalized internal use-software deemed obsolete as a result of changes in strategic direction. The fiscal 1998 selling, general and administrative expenses increase reflects primarily 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. We expect selling, general and administrative expenses in fiscal 2000 to decline compared with the fiscal 1999 as a result of the actions described in "Risks That Affect Our Business--Expense Reduction Program." OTHER OPERATING EXPENSE Other operating expense for fiscal 1999 includes $14 million of adjustments to the restructuring costs we estimated at the end of fiscal 1998. Other operating expense 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. Other operating expense for fiscal 1997 relates to the Cray acquisition and consists principally of costs associated with the integration of SGI and Cray information systems, accounting processes and human resource activities. INTEREST AND OTHER INTEREST EXPENSE Interest expense has remained relatively flat over the last three years. We do not expect a significant change in the level of interest expense in fiscal 2000. 16 INTEREST INCOME AND OTHER, NET Interest income and other, net includes interest income on our cash investments, gains and losses on other investments, the minority interest in the earnings of MIPS and other non-operating items. Interest income and other, net for fiscal 1999 decreased $21 million from fiscal 1998 and increased $13 million in fiscal 1998 from fiscal 1997. Interest income on our cash investments has increased from $22 million in fiscal 1997 to $37 million in fiscal 1998 and to $40 million in fiscal 1999 due to significantly higher cash balances. The decrease in interest and other income, net in fiscal 1999 was due to the write-down of investments in certain technology companies, the minority interest in MIPS earnings and other non-operating items. We do not expect a significant change in the level of interest income on our cash investments in fiscal 2000. PROVISION FOR (BENEFIT FROM) INCOME TAXES The effective tax benefit rate for fiscal 1999 was 23%, excluding the impact of the MIPS gain and a change in previously estimated restructuring costs, which were tax effected at 38%. The effective tax benefit rate for fiscal 1998 was 23% and the effective tax provision rate for fiscal 1997 was 20%. The fiscal 1999 benefit rate differs from the federal statutory rate primarily due to foreign losses for which no benefit has been recognized. 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 differs from the federal statutory rate primarily due to U.S. Federal research tax credits, earnings in low tax jurisdictions, and foreign sales corporation benefits, offset partially by foreign losses for which no benefit was recorded. At June 30, 1999, we had gross deferred tax assets arising from deductible temporary differences, tax losses and tax credits of $594 million. A valuation allowance of $105 million and deferred tax liability of $38 million offset the gross deferred tax assets. Realization of the net deferred tax assets is dependent on our ability to generate approximately $900 million of future taxable income. We believe that it is more likely than not that the assets will be realized based on forecasted income, including income from the planned divestiture of our interest in MIPS. However, there can be no assurance that we will achieve our expectations of future income. Therefore, on a quarterly basis, we will evaluate the realizability of the deferred tax assets and assess the need for additional valuation allowances. We have not provided for U.S. federal income taxes on undistributed earnings of foreign subsidiaries, which we intend to permanently reinvest in those operations. The cumulative income tax benefit attributable to these permanently reinvested earnings is estimated to be $85 million at June 30, 1999. IMPACT OF CURRENCY Because a significant portion of our revenue is from sales outside the United States, and many key components are produced outside the United States, our financial results can be significantly affected by changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we distribute our products. However, over the most recent three fiscal years, changes in foreign currency exchange rates have not had a material impact on our results of operations. FINANCIAL CONDITION Our financial condition continued to improve during fiscal 1999. This improvement is primarily due to continued focus on asset management, particularly management of inventories and accounts receivable. At June 30, 1999, cash and cash equivalents and marketable and restricted investments totaled $782 million compared with $737 million at June 30, 1998. Included in the June 30, 1999 balance is approximately $94 million of restricted investments that serve as collateral for letters of credit and an equity forward purchase agreement. Operating activities generated $145 million in cash for fiscal 1999, compared with $643 million in fiscal 1998 and $170 million in fiscal 1997. To present cash flows from operating activities, net income (loss) for each of the past three years had to be adjusted for certain significant items that did not either provide or use cash. Fiscal 1999 net income is adjusted to remove the impact of the $273 million gain on the sale of a portion of our interest in MIPS stock that is reflected as a cash flow from investing activities and $27 million in non-cash charges for the write-off of investments in certain technology companies. Fiscal 1998 net loss is adjusted for a $47 million non-cash charge for long-lived asset impairment, a $32 million non-cash charge for the write-off of purchased intangibles and goodwill resulting from the disposal of ParaGraph International Inc. ("ParaGraph"), and a $30 million non-cash charge for the write-down of excess spares. These and other non-deductible 17 charges resulted in significant deferred tax benefit provisions that did not provide cash. Fiscal 1997 net income is adjusted for a $42 million non-cash charge for amortization of the write-up of acquired Cray inventories and service contracts and a $4 million non-cash charge for the write-off of an investment in a software company. Our focus on asset management that resulted in significant reductions in accounts receivable and inventories in fiscal 1998, continued into 1999 generating $195 million in cash. Aside from operations, the most significant transactions affecting our cash position in fiscal 1999 were the initial and secondary public offerings of shares of our subsidiary, MIPS. On a consolidated basis those offerings raised a total of $290 million, of which $273 million represented the proceeds from the sales of portions of our ownership interest in MIPS, and which is presented in investing activities. The remaining $18 million represented the proceeds from newly issued MIPS shares and is included in financing activities. Investing activities, other than changes in our marketable and restricted investments and the MIPS transactions, consumed $261 million in cash during fiscal 1999. We used $35 million to fund a portion of our investment in Wam!Net, Inc., with the remainder used principally for the acquisition of capital equipment and spare parts. Investing activities, other than changes in our marketable investments, consumed $269 million in cash during fiscal 1998 and $301 million during fiscal 1997, principally for capital equipment and spare parts. On August 4, 1999, pursuant to one of our lease agreements, as amended, we exercised our option to purchase five buildings on our Mountain View campus. The purchase is expected to close in September 1999 at a cost of approximately $125 million and will be paid in cash. Financing activities over the past three years have included the issuance of common stock under employee stock purchase and option plans and repurchases of common stock. Our board of directors has authorized the repurchase of up to 27.5 million shares of common stock to mitigate the dilutive effect of the stock plans. Since commencement of this repurchase program we have repurchased 19.3 million shares of common stock at a cost of $311 million. We utilize equity instrument contracts to facilitate the repurchase of common stock and at June 30, 1999, we have outstanding commitments to buy an aggregate of 6.0 million shares of common stock under our equity forward purchase arrangement. At June 30, 1999, approximately 2.2 million shares remain available for purchase under this program. The volume of our borrowing activity has decreased over the past three years corresponding with our strengthened cash position. As a result of our strong cash position, we terminated our $250 million revolving credit facility in November 1998. At June 30, 1999, our principal sources of liquidity included cash, cash equivalents and marketable investments of $688 million. We believe that these principal sources of liquidity, along with cash generated from operations, the expected proceeds from future MIPS offerings, and other resources available to us, should be adequate to fund our projected cash flow needs. At June 30, 1999, we own approximately 67% of the total outstanding shares of Class A and Class B Common Stock of MIPS. We currently intend to dispose of our remaining interest in MIPS in one or more transactions through public or private offerings. We expect our divestiture of MIPS to be completed in the first half of fiscal 2001, subject to market and other conditions. We believe that the level of financial resources is an important competitive factor in the computer industry and, accordingly, we may elect to raise additional capital through debt or equity financing in anticipation of future needs. RISKS THAT AFFECT OUR BUSINESS SGI operates in a rapidly changing environment that involves a number of risks, some of which are beyond our control. This discussion highlights some of these risks. BUSINESS TRANSITION Two of the principal market sectors in which we compete--UNIX workstations and vector supercomputers--have declined over the past few years, and we believe that these declines represent long-term trends. Our goal is to generate an increasing proportion of our revenue from growing markets, including Intel-based servers and UNIX-based scalable servers such as our Origin server product family. We have announced a product roadmap that will, over the next several years, ultimately shift our products to the Intel microprocessor architecture. To further accelerate this transition, we announced in August 1999 our intention to establish arrangements to transition our Visual Workstation line of Windows NT-based workstations and our Cray-Registration Trademark- branded line of vector supercomputers to strategic partners who will assume the further development and distribution of these product lines. The result of these alliances and planned restructured operations will be a smaller revenue base and workforce in fiscal 2000, with the goal of returning to sustainable profitability. This is a long-term 18 transition, and although some benefits are currently being realized, it could take until well into fiscal 2000 or beyond before we have achieved our desired business model. Our ability to achieve our revenue objectives in fiscal 2000 will largely depend on the successful implementation of these alliances and related restructuring activities in early fiscal 2000 with minimal disruption, and on growth in the server business. There is no assurance that we will successfully complete the strategic alliances and related restrucuring activities required to achieve our fiscal 2000 objectives. SERVER STRATEGY Sustained growth in our scalable server business is an important element of our strategic plan 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 we have not traditionally participated, working effectively with independent software providers to ensure that important applications for the market segments targeted by us are available on the SGI platform, and ultimately, managing a successful and timely transition to the Intel architecture. We are also engaged in a transition from our traditional business of supporting IRIX-Registration Trademark-, our own proprietary UNIX operating systems, to supporting operating systems such as Linux-Registration Trademark- and Windows NT. We believe that this strategy will position us favorably in growth markets, including the market for 32-bit Intel-Registration Trademark- processor-based servers and for broadband Internet servers. A successful transition to this model will require us to make effective resource allocation choices and successfully manage a complex set of support and strategic relationships, particularly with respect to open source technologies. DEPENDENCE ON PARTNERS AND SUPPLIERS Our business has always involved close collaboration with partners and suppliers. However, many elements of our current business strategy, including an increasing emphasis on Linux and other open source technologies, a collaborative relationship with NVIDIA for graphics technologies, the introduction of Intel processor-based IA-32 servers and the longer-term transition to the Intel architecture, additional outsourcing of manufacturing and services, and establishing significant new distribution channels will increase our dependence on Microsoft, Intel and other partners, and on our manufacturing partners and other component suppliers. Our 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. EXPENSE REDUCTION PROGRAM During fiscal 1999, we reduced our operating expenses by about $240 million from the level of fiscal 1998 operating expenses. In August 1999, we announced and began to implement a restructuring program aimed at bringing our expenses more in line with expected revenue levels resulting from our refocused business operations and restoring long-term profitability to the Company. As part of this effort, we expect, through the anticipated transfer of businesses to partners, the elimination of positions and managed hiring, to end fiscal 2000 with about 1/3 fewer employees than was the case at the end of fiscal 1999. These steps, and generally tighter operating expense controls, are part of an overall program to reduce our expense structure by approximately $300 million in fiscal 2000. While our objective is to reduce our costs in ways that will not have a material impact on revenue levels, there is no assurance that this will be achieved. PERIOD TO PERIOD FLUCTUATIONS Our 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 we plan our 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 SGI or our 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 visual workstation product revenue including the mix of configurations within these product categories. Our results have followed a seasonal pattern, with stronger sequential growth in the second and fourth fiscal quarters, reflecting the buying patterns of our customers. 19 Our 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 our stock price. The stock price may also be affected by broader market trends unrelated to our performance. PRODUCT DEVELOPMENT AND INTRODUCTION Our continued success depends on our ability to develop and rapidly bring to market highly differentiated, technologically complex and innovative products. Product transitions are a recurring part of our 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 our new products to fail to meet specifications or to miss the aggressive timetables that we establish. There is no assurance that acceptance of our new systems will not be affected by delays in this process. Short product life cycles place a premium on our ability to manage the transition to new products. We often announce new products in the early part of a quarter while the product is in the final stages of development, and seek to manufacture and ship the product in volume during the same quarter. Our 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 SGI 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. We have completed an assessment of our core business information systems, many of which are provided by outside suppliers, for year 2000 readiness and are extending that review to include a wide variety of other information systems and related business processes used in our operations. We plan to have changes to critical systems implemented by the third quarter of calendar 1999 to allow time for testing. Most of our mission critical applications are believed to be year 2000 compliant, including the Oracle information system which was recently upgraded to the most recent version. Although our assessment is ongoing, we currently believe that resolving these matters will not have a material adverse effect on our financial condition or results of operations. We are 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 updates to our IRIX and UNICOS-Registration Trademark- operating systems, which we believe are year 2000 compliant, and additional customer support procedures. We also have made available software upgrades for some earlier releases of the IRIX operating system. We believe that the majority of the hardware systems we expect to support beyond 1999, when running on compliant operating systems, will be year 2000 compliant. Our older products may require upgrade or replacement to become year 2000 compliant. There is no assurance that our current products do not contain undetected errors or defects associated with year 2000 functions that may result in material costs to remediate. We believe that we generally are not legally responsible for costs incurred by customers to achieve their year 2000 compliance. However, we may experience increasing customer satisfaction costs relating to these issues, including potential litigation expenses, over the next few years. We are also assessing the possible effect on our operations of the year 2000 readiness of critical suppliers of products and services. These include not just suppliers of components but also our outsourcing partners in manufacturing support and even suppliers of basic utilities. Our reliance on our 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 us. Certain of the costs associated with our 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 20 costs to insure year 2000 compliance will not be material. We believe that we are unlikely to experience a material adverse impact on our 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 us is not known at this time. The information regarding year 2000 issues provided in this Annual Report is based on our current assessment of ongoing activities and is subject to change as we continuously monitor these activities. We are currently developing appropriate contingency plans for potential year 2000 problems. The Year 2000 disclosure set forth above is "year 2000 readiness disclosure" as defined in the Year 2000 Information and Readiness Disclosure Act of 1998. INVESTMENT IN MIPS SUBSIDIARY The value of our interest in MIPS Technologies, Inc. is determined principally by factors outside our control, including overall equity market conditions and may fluctuate significantly from time to time. There can be no assurance that we will be successful in fully realizing the value of the MIPS interest on a market efficient basis. EXPORT REGULATION Our sales to foreign customers are subject to export regulations. Sales of many of the our 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 SGI's compliance with the export regulations in connection with the sale of several computer systems to a customer in Russia during fiscal 1997. We believe that these matters will be resolved without a significant adverse effect on our business. However, there is no assurance that these matters will not have an unforeseen outcome that could impair the conduct of our business. Our 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 our products. COMPETITION The computer industry is highly competitive, with rapid technological advances and constantly improving price/performance. Most of our 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 our revenue is derived from sales to the U.S. government, either directly by us 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 We routinely receive communications from third parties asserting patent or other rights covering our products and technologies. Based upon our evaluation, we may take no action or may seek to obtain a license. In any given case there is a risk that a license will not be available on terms that we consider reasonable, or that litigation will ensue. We expect that, as the number of hardware and software patents issued continues to increase, and as competition in the markets we address intensifies, the volume of these intellectual property claims will also increase. EMPLOYEES Our success depends on our ability to continue to attract, retain and motivate highly qualified technical, marketing and management personnel, who are in great demand. The current uncertainties surrounding SGI's business prospects have increased the challenges of retaining world-class talent. BUSINESS DISRUPTION Our corporate headquarters, including most of our research and development operations are located in the Silicon Valley area of Northern California, a region known for seismic activity. A significant earthquake could materially affect operating results. We are not insured for most losses and business interruptions of this kind. MARKET RISK In the normal course of business, our financial position 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. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, we do not anticipate material losses in these areas. 21 For purposes of specific risk analysis, we use sensitivity analysis to determine the impact that market risk exposures may have on the fair values of our debt and financial instruments. The financial instruments included in the sensitivity analysis consist of all of our cash and cash equivalents, marketable investments, short-term and long-term debt and all derivative financial instruments. Currency forward contracts and currency options constitute our portfolio of derivative financial instruments. To perform sensitivity analysis, we assess 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. We compute the market values for interest risk based on the present value of future cash flows as impacted by the changes in rates attributable to the market risk being measured. We selected the discount rates used for the present value computations based on market interest exchange rates in effect at June 30, 1999 and 1998. We computed the market values for foreign exchange risk based on spot rates in effect at June 30, 1999 and 1998. The market values that result from these computations are compared to the market values of these financial instruments at June 30, 1999 and 1998. 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, 1999 and 1998 are as follows: Interest Rate Risk: A percentage point decrease in the level of interest rates with all other variables held constant would result in a decrease in the aggregate fair values of our financial instruments by $14 million at both June 30, 1999 and 1998. A percentage point increase in the level of interest rates with all other variables held constant would result in an increase in the aggregate fair values of our financial instruments by $13 million and $12 million, respectively. Foreign Currency Exchange Rate Risk: A 10% decrease 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 an increase in the fair values of our financial instruments by $8 million at June 30, 1999, and a decrease in the fair values of our financial instruments by $14 million at June 30, 1998. A 10% increase in levels of foreign currency exchange rates, 20% for Asian currencies, would result in a decrease in the fair values of our financial instruments by $3 million at June 30, 1999, and an increase in fair values of our financial instruments by $12 million at June 30, 1998. The change in the relative sensitivity of the fair market value of foreign currency exchange rates in fiscal 1999 compared with fiscal 1998 is primarily driven by the volume of systems shipped and billed in U.S. dollars by our Swiss manufacturing subsidiary which operates in local functional currency. 22 CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended June 30 ------------------------------------------- (In thousands, except per share amounts) 1999 1998 1997 Revenue: Product and other revenue $2,090,194 $2,489,983 $3,086,791 Service revenue 658,763 610,627 575,810 ------------------------------------------- Total revenue 2,748,957 3,100,610 3,662,601 Costs and Expenses: Cost of product and other revenue 1,202,562 1,580,647 1,697,277 Cost of service revenue 400,688 382,904 325,269 Research and development 380,346 459,188 479,101 Selling, general and administrative 907,612 1,068,429 1,038,313 Other operating expense (15,107) 205,543 10,757 ------------------------------------------- Total costs and expenses 2,876,101 3,696,711 3,550,717 Operating (loss) income (127,144) (596,101) 111,884 Gain on sale of a portion of SGI interest in MIPS 272,503 -- -- Interest expense (22,562) (24,665) (24,836) Interest income and other, net 2,924 23,847 11,142 ------------------------------------------- Income (loss) before income taxes 125,721 (596,919) 98,190 Provision for (benefit from) income taxes 71,892 (137,292) 19,639 ------------------------------------------- Net income (loss) $ 53,829 $(459,627) $ 78,551 ------------------------------------------- Net income (loss) per share: Basic $ 0.29 $ (2.47) $ 0.44 ------------------------------------------- Diluted $ 0.28 $ (2.47) $ 0.43 ------------------------------------------- Shares used in the calculation of net income (loss) per share: Basic 186,374 186,149 175,548 Diluted 189,427 186,149 182,637 -------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 23 CONSOLIDATED BALANCE SHEETS
At June 30 ------------------------------ (DOLLARS IN THOUSANDS) 1999 1998 Assets: Current assets: Cash and cash equivalents $ 571,117 $ 506,639 Short-term marketable investments 117,026 230,081 Accounts receivable, net of allowance for doubtful accounts of $15,407 in 1999; $17,463 in 1998 582,383 665,420 Inventories 195,181 322,823 Deferred tax assets 243,867 240,838 Prepaid expenses and other current assets 137,459 99,571 ------------------------------ Total current assets 1,847,033 2,065,372 Restricted investments 94,226 -- Property and equipment, net of accumulated depreciation and amortization 380,768 445,420 Net long-term deferred tax assets 126,562 189,806 Other assets 339,668 264,108 ------------------------------ $2,788,257 $2,964,706 ------------------------------ Liabilities and Stockholders' Equity: Current liabilities: Accounts payable 192,974 215,260 Accrued compensation 104,362 160,609 Other current liabilities 365,736 386,477 Deferred revenue 308,281 329,525 Current portion of long-term debt 5,700 4,801 ------------------------------ Total current liabilities 977,053 1,096,672 Long-term debt and other 387,005 403,522 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: 189,555,187 in 1999; 189,519,187 in 1998; 1,421,028 1,407,108 Retained earnings 92,449 65,415 Treasury stock, at cost: 7,010,263 shares in 1999; 1,995,797 shares in 1998 (104,633) (25,976) Accumulated other comprehensive income (1,643) 967 ------------------------------ Total stockholders' equity 1,424,199 1,464,512 ------------------------------ $2,788,257 $2,964,706 ------------------------------ ------------------------------
The accompanying notes are an integral part of these financial statements. 24 CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 30 ---------------------------------------- (In thousands) 1999 1998 1997 Cash Flows From Operating Activities: Net income (loss) $ 53,829 $(459,627) $ 78,551 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 221,508 314,581 354,319 Gain on sale of a portion of SGI interest in MIPS (272,503) -- -- Write-off of acquired in-process technology -- 16,900 -- Changes in deferred tax assets and liabilities 60,067 (162,540) (18,918) Other 54,640 171,608 4,690 Changes in operating assets and liabilities: Accounts receivable 83,036 467,055 (152,773) Inventories 111,908 264,226 (211,013) Accounts payable (22,529) (44,257) (2,236) Other assets and liabilities (144,592) 75,432 117,614 ---------------------------------------- Total adjustments 91,535 1,103,005 91,683 ---------------------------------------- Net cash provided by operating activities 145,364 643,378 170,234 Cash Flows From Investing Activities: Available-for-sale investments: Purchases (396,807) (230,368) (6,036) Sales 207,740 43,000 16,162 Maturities 314,718 104,485 44,274 Purchases of restricted investments (219,579) -- -- Proceeds from the maturities of restricted investments 113,893 -- -- Proceeds from sale of a portion of SGI interest in MIPS 272,503 -- -- Capital expenditures (147,516) (195,137) (214,989) Increase in other assets (113,611) (73,805) (86,359) ---------------------------------------- Net cash provided by (used in) investing activities 31,341 (351,825) (246,948) Cash Flows From Financing Activities: Issuance of debt 7,461 18,735 123,807 Payments of debt principal (25,918) (62,838) (153,730) Sale of SGI common stock 61,527 95,241 77,304 Repurchase of SGI common stock (172,426) (62,749) -- Sale of MIPS common stock 17,654 -- -- Cash dividends-preferred stock (525) (525) (525) ---------------------------------------- Net cash (used in) provided by financing activities (112,227) (12,136) 46,856 ---------------------------------------- Net increase (decrease) in cash and cash equivalents 64,478 279,417 (29,858) Cash and cash equivalents at beginning of year 506,639 227,222 257,080 ---------------------------------------- Cash and cash equivalents at end of year $ 571,117 $ 506,639 $ 227,222 ---------------------------------------- ----------------------------------------
The accompanying notes are an integral part of these financial statements. 25 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Three years ended June 30, 1999 ------------------------------------------ Common Stock Preferred and Additional Retained (In thousands) Stock Paid-In Capital Earnings Balance, June 30, 1996 $ 16,998 $ 1,172,960 $ 461,311 Components of comprehensive income: Net income -- -- 78,551 Currency translation adjustment -- -- -- Change in unrealized loss on available-for-sale investments, net of tax -- -- -- Total comprehensive income Common stock issued under employee plans including related tax benefits (6,623 shares) -- 90,225 -- Convertible preferred stock, Series A preferred dividends -- -- (525) Issuance of treasury stock under employee plans (36 shares) -- -- (2,099) ------------------------------------------ Balance, June 30, 1997 16,998 1,263,185 537,238 Components of comprehensive loss: Net loss -- -- (459,627) Currency translation adjustment -- -- -- Change in unrealized loss on available-for-sale investments, net of tax -- -- -- Total comprehensive loss Common stock issued under employee plans including related tax benefits (7,551 shares) -- 95,194 -- Common stock issued for ParaGraph acquisition (2,935 shares) -- 48,729 -- Convertible preferred stock, Series A preferred dividends -- -- (525) Purchase (4,700 shares) and issuance (2,704 shares) of treasury stock under employee plans--net -- -- (11,671) ------------------------------------------ Balance, June 30, 1998 16,998 1,407,108 65,415 Components of comprehensive income: Net income -- -- 53,829 Currency translation adjustment -- -- -- Change in unrealized loss on available-for-sale investments, net of tax -- -- -- Total comprehensive income Common stock issued under employee plans including related tax benefits (36 shares) -- 794 -- Convertible preferred stock, Series A preferred dividends -- -- (525) Purchase (12,112 shares) and issuance (7,097 shares) of treasury stock under employee plans--net -- -- (29,744) Common stock issued by MIPS -- 16,600 -- Other -- (3,474) 3,474 ------------------------------------------ Balance, June 30, 1999 $ 16,998 $ 1,421,028 $ 92,449 ------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 26
Three years ended June 30, 1999 -------------------------------------------- Accumulated Other Total Treasury Comprehensive Stockholders' (In thousands) Stock Income Equity Balance, June 30, 1996 $ (867) $ 24,916 $ 1,675,318 Components of comprehensive income: Net income -- -- 78,551 Currency translation adjustment -- (4,303) (4,303) Change in unrealized loss on available-for-sale investments, net of tax -- 1,208 1,208 ----------- Total comprehensive income 75,456 Common stock issued under employee plans including related tax benefits (6,623 shares) -- -- 90,225 Convertible preferred stock, Series A preferred dividends -- -- (525) Issuance of treasury stock under employee plans (36 shares) 867 -- (1,232) ----------------------------------------- Balance, June 30, 1997 -- 21,821 1,839,242 Components of comprehensive loss: Net loss -- -- (459,627) Currency translation adjustment -- (21,416) (21,416) Change in unrealized loss on available-for-sale investments, net of tax -- 562 562 ----------- Total comprehensive loss (480,481) Common stock issued under employee plans including related tax benefits (7,551 shares) -- -- 95,194 Common stock issued for ParaGraph acquisition (2,935 shares) -- -- 48,729 Convertible preferred stock, Series A preferred dividends -- -- (525) Purchase (4,700 shares) and issuance (2,704 shares) of treasury stock under employee plans--net (25,976) -- (37,647) ----------------------------------------- Balance, June 30, 1998 (25,976) 967 1,464,512 Components of comprehensive income: Net income -- -- 53,829 Currency translation adjustment -- (2,562) (2,562) Change in unrealized loss on available-for-sale investments, net of tax -- (48) (48) ----------- Total comprehensive income 51,219 Common stock issued under employee plans including related tax benefits (36 shares) -- -- 794 Convertible preferred stock, Series A preferred dividends -- -- (525) Purchase (12,112 shares) and issuance (7,097 shares) of treasury stock under employee plans--net (78,657) -- (108,401) Common stock issued by MIPS -- -- 16,600 Other -- -- -- ----------------------------------------- Balance, June 30, 1999 $(104,633) $ (1,643) $1,424,199 ----------------------------------------- -----------------------------------------
27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. NATURE OF OPERATIONS Silicon Graphics, Inc. ("SGI") is a leader in high-performance computing. SGI's broad range of workstations and graphics servers deliver advanced 3D graphics and computing capabilities for engineering and creative professionals. Our highly scalable servers also have a growing presence in the enterprise market, with a particular emphasis on Internet, large corporate data and telecommunications applications. Our products are manufactured in Wisconsin and Switzerland. We distribute our products through our direct sales force, as well as through indirect channels including resellers and distributors. Product and other revenue consists primarily of revenue from computer system and software product shipments, as well as the sale of software distribution rights, system leasing, technology licensing agreements and non-recurring engineering contracts. Service revenue results from customer support and maintenance contracts, as well as from delivery of professional services. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of SGI and our wholly-and majority-owned subsidiaries. FOREIGN CURRENCY TRANSLATION We translate the assets and liabilities of our 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 our operating results in any period. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires us 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 AND RESTRICTED INVESTMENTS Cash equivalents consist of high quality money market instruments with maturities of 90 days or less at the date of purchase. Short-term marketable investments and restricted 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. At June 30, 1999 and 1998, our cash equivalents and marketable investments are all classified as available-for-sale. At June 30, 1999, our restricted investments are classified as available-for-sale but are pledged as collateral against letters of credit and an equity forward purchase arrangement. Restricted investments are held in SGI's name by major financial institutions. The cost of securities when sold is based upon specific identification. We include realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities in interest income and other, net. We include unrealized gains and losses (net of tax) on securities classified as available-for-sale in stockholders' equity. FAIR VALUES OF FINANCIAL INSTRUMENTS The carrying values of short-term debt and cash equivalents approximate fair value due to the short period of time to maturity. Fair values of marketable and restricted investments, long-term debt, and foreign exchange forward contracts are based on quoted market prices or pricing models using current market rates. DERIVATIVE FINANCIAL INSTRUMENTS We use derivatives to moderate the financial market risks of our business operations. We use derivative products to hedge the foreign currency market exposures underlying certain assets and liabilities and commitments related to customer transactions. Our accounting policies for these instruments are based on our designation of such instruments as hedging transactions. We designate 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. We defer 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 and we recognize them 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. 28 EQUITY INSTRUMENTS INDEXED TO SGI'S COMMON STOCK We record the proceeds received from the sale of equity instruments and amounts paid upon the purchase of equity instruments as a component of stockholders' equity. Subsequent changes in the fair value of the equity instrument contracts are not recognized because we have 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 six 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. Our buildings are depreciated over twenty-five to forty years and improvements over eight to fifteen years. OTHER ASSETS Included in other assets are spare parts that are generally amortized on a straight-line basis over the course of their respective lives ranging from two to five years and investments in certain technology companies that are not publicly traded and are carried at the lower of cost or market value. Also included in other assets is goodwill associated with the fiscal 1991 acquisition of Silicon Graphics World Trade Corporation which is amortized on a straight-line basis over a period of twenty years. REVENUE RECOGNITION We generally recognize product revenue when we ship the product to the customer and we have no additional significant performance obligations. Sales of certain high performance systems may be made on the basis of contracts that include acceptance criteria. In these instances, we recognize revenue 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. We recognize operating system software fees when we ship the product, provided that we have no additional significant performance obligations. We recognize application software fees when we have delivered the product, provided that we have no additional significant performance obligations. We generally recognize royalty revenue, under technology agreements, in the quarter in which we receive a report from a licensee detailing the shipments of products incorporating our intellectual property components. We recognize engineering services, which are generally performed on a best efforts basis, as revenue when we have completed the defined milestones 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 We provide at the time of sale for the estimated cost to warrant our products against defects in materials and workmanship for a period of up to one year on UNIX systems and up to three years on NT systems. ADVERTISING COSTS We account for advertising costs as expense in the period in which they are incurred. Advertising expense for the years ended June 30, 1999, 1998 and 1997 was $49 million, $56 million and $43 million, respectively. PER SHARE DATA 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. STOCK-BASED COMPENSATION We account for stock-based employee compensation arrangements under the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, ("APB 25") and related interpretations. 29 ACCOUNTING CHANGES We implemented new accounting standards in fiscal 1999. The adoption of these standards did not have a material effect on our financial position or results of operations. Beginning with the first quarter of fiscal 1999, we adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS 130"). SFAS 130 establishes new standards for the reporting and display of comprehensive income and its components. The disclosures required by SFAS 130 are presented in the Consolidated Statement of Stockholders' Equity and in Note 14, "Comprehensive Income." Effective June 30, 1999, we adopted Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information ("SFAS 131"). SFAS 131 requires disclosure of certain information regarding operating segments, products and services, geographic areas of operation and major customers. See Note 16, "Segment Information" for further information. Effective July 1, 1998, we adopted the American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, Software Revenue Recognition, which supersedes SOP 91-1. SOP 97-2, as amended by SOP 98-4, and modified by SOP 98-9, provides guidance on revenue recognition for software transactions. It requires deferral of some or all of the revenue related to a specific contract depending on the existence of vendor specific objective evidence of fair value and the ability to allocate the total fee to all elements within the contract. The portion of the fee identified to an element is recognized as revenue when all of the revenue recognition criteria have been met for that element. In June 1998, the Financial Accounting Standards Board issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activity ("SFAS 133"). In June 1999, SFAS 133 was amended by Statement No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 ("SFAS 137"). SFAS 137 is required to be adopted in all fiscal quarters of all fiscal years beginning after June 15, 2000. The Statement will require us 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. We do not expect the adoption to have a material impact on our consolidated financial position, results of operations or cash flows. During fiscal 1998, the American Institute of Certified Public Accountants issued SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. The statement requires the capitalization of internal use computer software costs if certain criteria are met. The capitalized cost will be amortized on a straight-line basis over the useful life of the software. We will adopt the statement as of July 1, 1999. The adoption of the statement is not expected to have a material impact on our financial statements. RECLASSIFICATIONS We have reclassified certain prior year amounts on the Consolidated Balance Sheets, Consolidated Statements of Cash Flows and Notes to Consolidated Financial Statements to conform to the current year presentation. NOTE 3. OTHER OPERATING EXPENSE Other operating expense is as follows (in thousands):
---------------------------------- YEARS ENDED JUNE 30 ---------------------------------- 1999 1998 1997 Write-off of acquired in-process technology and other merger-related expenses $ (1,107) $ 14,905 $10,757 Restructuring (14,000) 143,998 -- Charge for impairment of long-lived assets -- 46,640 -- ---------------------------------- $ (15,107) $ 205,543 $10,757 ---------------------------------- ----------------------------------
30 WRITE-OFF OF ACQUIRED IN-PROCESS TECHNOLOGY AND OTHER MERGER-RELATED EXPENSES The 1999 amount represents an adjustment to previously estimated merger-related expenses. The 1998 amount includes a $17 million charge for acquired in-process technology from the $50 million acquisition of Paragraph, which was accounted for using the purchase method, partially offset by adjustments to previously estimated merger-related expenses. The 1997 amount consists of merger-related expenses. Merger-related expenses consist principally of costs associated with the integration of SGI and Cray information systems, accounting processes and marketing and human resources activities. RESTRUCTURING In the second quarter of fiscal 1998, we announced and began to implement a restructuring program aimed at bringing our expenses more in line with the current revenue levels and restoring long-term profitability to SGI. SGI's restructuring program was broad-based and covered virtually all aspects of our products, operations and processes. The process of developing this program continued during the balance of fiscal 1998 and included a reevaluation of our core competencies, technology roadmap and business model, as well as development of our fiscal 1999 operating plan. Our restructuring activity resulted in the elimination of approximately 1,400 positions, writing down certain operating assets, vacating certain leased facilities and canceling certain contracts. These actions resulted in aggregate charges of $144 million (before the effect of the adjustment noted below), of which approximately $75 million have used or will use cash, and $69 million of which were non-cash charges. The operating asset write-down includes a $32 million charge taken in the third quarter of fiscal 1998 to write down purchased intangibles and goodwill associated with the September 1997 acquisition of ParaGraph which was taken following the evaluation of our core competencies and technology roadmap. We expect that the remaining $8 million accrued balance at June 30, 1999 will result primarily in cash expenditures and will be financed through current working capital. We believe the savings resulting from the restructuring activities, as well as generally tighter operating expense controls, contributed to a reduction in operating expense levels by approximately $240 million in fiscal 1999. During fiscal 1999, we revised downward by $14 million, our estimate of the total costs associated with the program described above. 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, we also adjusted estimated costs of contract cancellations, operating asset write-downs and exiting certain facilities. The following table depicts the restructuring activity in fiscal 1998 and 1999 (in thousands):
----------------------------------------------------------------- Total Fiscal 1999 Fiscal 1998 Adjustments: Restructuring Increase/ Expenditures Balance at Category Charges (Decrease) Cash Non-Cash June 30, 1999 Severance and related charges $ 83,962 $ (15,500) $ (57,188) $ (6,056) $ 5,218 Operating asset write-down 37,780 4,216 -- (41,996) -- Canceled contracts 4,675 (1,916) (324) (2,435) -- Vacated facilities 8,960 (1,300) (6,408) (203) 1,049 Other 8,621 500 (4,104) (2,851) 2,166 ----------------------------------------------------------------- $ 143,998 $ (14,000) $ (68,024) $ (53,541) $ 8,433 ----------------------------------------------------------------- -----------------------------------------------------------------
CHARGE FOR IMPAIRMENT OF LONG-LIVED ASSETS As a result of the processes described above, we also found it necessary to downsize our vector supercomputer business, necessitating an evaluation of the ongoing value of the associated plant and equipment and intangible assets. Based on this evaluation, we 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 estimated exchange and resale value. 31 NOTE 4. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted income (loss) per share (in thousands, except per share amounts):
----------------------------------- Years Ended June 30 ----------------------------------- 1999 1998 1997 Net income (loss) $ 53,829 $(459,627) $ 78,551 Less preferred stock dividends (525) (525) (525) ----------------------------------- Net income (loss) available to common stockholders $ 53,304 $(460,152) $ 78,026 ----------------------------------- Weighted average shares outstanding--basic 186,374 186,149 175,548 Employee stock options and restricted shares 3,053 -- 7,089 ----------------------------------- Weighted average shares outstanding--diluted 189,427 186,149 182,637 ----------------------------------- Net income (loss) per share: Basic $ 0.29 $ (2.47) $ 0.44 ----------------------------------- Diluted $ 0.28 $ (2.47) $ 0.43 ----------------------------------- Potentially dilutive securities excluded from computations because they are anti-dilutive 8,843 12,187 9,144 ----------------------------------- -----------------------------------
NOTE 5. FINANCIAL INSTRUMENTS CASH EQUIVALENTS AND MARKETABLE AND RESTRICTED INVESTMENTS The following table summarizes by major security type the fair value of SGI's cash equivalents and marketable and restricted investments at June 30, 1999 and 1998 (in thousands):
----------------------- 1999 1998 U.S. commercial paper $ 253,227 $ 296,789 Certificates of deposit and time deposits 143,080 93,590 Money market funds 128,600 17,800 Corporate notes and bonds 64,480 -- Repurchase agreements 40,000 36,000 U.S. government securities 26,217 151,933 Money market preferreds -- 40,000 Other 4,323 -- ----------------------- Total 659,927 636,112 Less amounts classified as cash equivalents (448,675) (406,031) ----------------------- Total marketable and restricted investments $ 211,252 $ 230,081 ----------------------- -----------------------
At June 30, 1999 and 1998, the amortized cost of cash equivalents and marketable and restricted investments approximates fair value. Gross unrealized gains and losses were not significant in fiscal 1999 or 1998. Gross realized gains and losses on sales of available-for-sale securities were not significant in fiscal 1999, 1998 or 1997. FINANCIAL INSTRUMENTS WITH DERIVATIVE RISK (OFF-BALANCE SHEET) The notional principal amounts of our currency forward contracts at June 30, 1999 and 1998 were $3 million and $103 million, respectively. There were no currency options outstanding at June 30, 1999. The notional principal amount of our currency options at June 30, 1998 was $79 million. 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 our exposure to credit loss or market risk. Credit risk is our 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. 32 We transact business in various foreign currencies, including the major European currencies and the Japanese yen. We have 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. We use derivatives in the form of currency forward contracts and currency options in our 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 forward contracts related to anticipated transactions expire within six months. Deferred gains and losses on contracts related to firmly committed transactions and anticipated transactions were not significant in fiscal 1999, 1998 or 1997. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and estimated fair values of SGI's financial instruments at June 30, 1999 and 1998 are summarized as follows (in thousands):
------------------------------------------------- 1999 1998 ------------------------------------------------- Carrying Carrying Amount Fair Value Amount Fair Value Cash and cash equivalents $ 571,120 $ 571,120 $ 506,639 $ 506,639 Marketable and restricted investments 211,252 211,252 230,081 230,081 Debt instruments 360,670 329,065 371,261 331,525 Currency forward contracts 2,181 2,790 (3,577) (822) Currency options -- -- 592 163 -------------------------------------------------
NOTE 6. CONCENTRATION OF CREDIT AND OTHER RISKS CREDIT RISK Financial instruments that potentially subject SGI to concentration of credit risk consist principally of cash investments, currency forward contracts and trade receivables. We place our investments and transact our currency forward contracts with high-credit-quality counterparties and, by policy, limit the amount of credit exposure to any one counterparty, and generally do not require collateral. The credit risk on receivables due from counterparties related to currency forward contracts is immaterial at June 30, 1999 and 1998. We perform ongoing credit evaluations of our customers and, except in connection with the sales of supercomputers, generally do not require collateral. We maintain reserves for potential credit losses and such losses have been within our expectations. PRODUCTION Most of our products incorporate certain 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, we increasingly outsource certain aspects of our production, including the entire Windows NT-based workstation product line, to third parties. If we were unable to procure certain such components or sustain our outsourced production capacity, it could affect our ability to meet demand for our products which would have an adverse effect upon our results. INTERNATIONAL OPERATIONS We derive approximately half of our revenue from sales outside the United States. In addition, many key components are produced outside the United States. Therefore, our 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 our international operations are mitigated in part by our foreign exchange hedging program and by the extent to which our sales and manufacturing activities are geographically distributed. Our sales to foreign customers also are subject to export regulations, with sales of most of our high-end products requiring clearance and export licenses from the U.S. Department of Commerce. Our 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 our products. The Departments of Commerce and Justice are currently conducting civil and criminal investigations into SGI's compliance with the export regulations in connection with the sale of several computer systems to a customer in Russia during fiscal 1997. 33 We believe that these matters will be resolved without a significant adverse effect on our business. However, if our export privileges were limited or denied, our results would be adversely affected. NOTE 7. INVENTORIES Inventories at June 30, 1999 and 1998 are as follows (in thousands):
---------------------- 1999 1998 Components and subassemblies $ 19,988 $ 114,139 Work-in-process 71,406 74,961 Finished goods 41,694 47,917 Demonstration systems 62,093 85,806 ---------------------- Total inventories $ 195,181 $ 322,823 ----------------------
NOTE 8. PROPERTY AND EQUIPMENT Property and equipment at June 30, 1999 and 1998 are as follows (in thousands):
------------------------ 1999 1998 Land and buildings $ 94,630 $ 123,437 Machinery and equipment 639,166 644,144 Furniture and fixtures 117,418 118,602 Leasehold improvements 129,605 126,106 ----------- ---------- 980,819 1,012,289 Accumulated depreciation and amortization (600,051) (566,869) ----------- ---------- Net property and equipment $ 380,768 $ 445,420 ----------- ----------
NOTE 9. OTHER ASSETS Other assets at June 30, 1999 and 1998 are as follows (in thousands):
---------------------- 1999 1998 Spare parts $ 157,539 $ 146,024 Investments 82,561 1,418 Software licenses, goodwill and other 99,568 116,666 ---------- --------- $ 339,668 $ 264,108 ---------- ---------
Included in investments at June 30, 1999, is our investment in Wam!Net Inc. (WNI). In March 1999, we entered into a series of agreements with WNI, 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, we acquired a minority interest in WNI preferred stock in exchange for $35 million in cash and title to our campus facility in Eagan, Minnesota, valued at $38 million. We are accounting for this 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. 34 NOTE 10. LONG-TERM DEBT Long-term debt at June 30, 1999 and 1998 is as follows (in thousands):
---------------------- 1999 1998 Senior Convertible Notes due September 2004 at 5.25% $ 230,591 $ 230,591 Zero Coupon Convertible Subordinated Debentures due November 2013 at 4.15%, net of unamortized discount of $3,313 in 1998 -- 3,777 Convertible Subordinated Debentures due February 2011 at 6.125%, net of unamortized discount of $12,651 ($16,154 in 1998) 54,674 65,846 Swiss Franc mortgage due June 2017 at 3.79% (3.77% in 1998), which resets quarterly 18,116 19,893 Japanese Yen fixed rate loan due December 2001 at 2.06% 49,493 42,005 Other 7,797 9,149 ----------- ---------- 360,671 371,261 Less amounts due within one year (5,700) (4,801) ----------- ---------- Amounts due after one year $ 354,971 $ 366,460 ----------- ----------
In November 1993, we issued Zero Coupon Convertible Subordinated Debentures (the "Zero Coupon Debentures") with an ultimate maturity amount of $455 million. In September 1997, we completed an offer to exchange our newly registered Senior Convertible Notes (the "Senior Notes") for up to all of our 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 our option, beginning in 2002, at varying prices based on the year of redemption. The Senior Notes are redeemable at the holder's option in the event of the sale of all, or substantially all, of our common stock for consideration other than common stock traded on a U.S. exchange or approved for quotation on the Nasdaq National Market. We redeemed all remaining unexchanged Zero Coupon Debentures in fiscal 1999. In connection with the Cray acquisition, SGI assumed the Cray Convertible Subordinated Debentures. These debentures are convertible into SGI's common stock at a conversion price of $78 per share at any time prior to maturity and may be redeemed at our option at a price of 100%. Prior to our acquisition of Cray, Cray repurchased a portion of the debentures with a face value of $33 million. The repurchase satisfied the first six required annual sinking fund payments of $6 million originally scheduled for the years 1997 through 2002. In fiscal 1999 we repurchased another portion of the debentures with a face value of $15 million. This repurchase satisfied the next two required annual sinking fund payments of $6 million originally scheduled for the years 2003 through 2004. Remaining annual sinking fund payments of $6 million each are scheduled from 2005 to 2010 with a final maturity payment of $35 million in 2011. Principal maturities of long-term debt at June 30, 1999 are as follows (in millions): 2000 - $6; 2001 - $4; 2002 - $52; 2003 - $1; 2004 - $.3 and $298, thereafter. 35 NOTE 11. LEASING ARRANGEMENTS AS LESSOR We have entered into certain lease arrangements which are accounted for as sales. The net investment in sales-type leases at June 30, 1999 and 1998 is summarized as follows (in thousands):
----------------------- 1999 1998 Total minimum lease payments receivable $ 10,457 $ 1,284 Less unearned interest income (1,091) (47) ---------- ---------- Net investment in sales-type leases 9,366 1,237 Less current portion (2,847) (1,113) ----------- ---------- Long-term portion $ 6,519 $ 124 ----------- ----------
Future minimum lease rents on noncancelable sales-type lease agreements at June 30, 1999 are as follows (in millions): 2000 - $4; 2001 - $3; 2002 - $2 and 2003 - $1. NOTE 12. LEASING ARRANGEMENTS AS LESSEE We lease certain of our facilities and some of our equipment under non-cancelable operating lease arrangements. Future minimum annual lease payments under operating leases, net of subleases and rental income, at June 30, 1999 are as follows (in millions): 2000 - $63; 2001 - $48; 2002 - $38; 2003 - $23; 2004 - $18 and $194, thereafter. Aggregate operating lease rent expense in fiscal 1999, 1998 and 1997 was (in millions): $71, $77 and $71, respectively. NOTE 13. STOCKHOLDERS' EQUITY PREFERRED STOCK TRANSACTIONS NKK Corporation ("NKK") owns 17,500 shares of Series A convertible preferred stock (see Note 18). 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 our common stock at certain times at the then-current price of the common stock. The preferred stock is perpetual, but is subject to redemption at our option at certain times if the market price of the common stock is below $8.75 per share. STOCK AWARD PLANS We have 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 SGI. We grant incentive stock options at not less than the fair market value on the date of grant; the board of directors determines the prices of nonstatutory stock option grants and restricted stock. Under the plans, options and restricted stock generally vest over a fifty-month period from the date of grant. In addition, we have 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, 1999, 876,200 shares were available for future option grants under the Directors' Stock Option Plan. In July 1998, we 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 have an exercise price of $11.125, the fair value on the date the exchange was announced, vest over the longer of two years or the original vesting schedule and could not be exercised prior to January 1999. As a result of the program, options to purchase approximately 12,800,000 shares with a weighted average exercise price of $19.70 were exchanged for new options. At June 30, 1999, 1998 and 1997, there were 18,437,793, 10,832,173, and 10,749,128 unused shares, respectively, available for grant, and there were 820,625, 580,316 and 303,620 shares of restricted stock, respectively, subject to repurchase. 36 Activity under all of the stock award plans was as follows:
1999 1998 1997 ---------------------------------------------------------------------- Number of Weighted Number of Weighted Number of Weighted Shares Average Shares Average Shares Average Under Exercise Under Exercise Under Exercise Option Price Option Price Option Price Balance at July 1 34,394,843 $ 16.59 34,753,548 $ 16.92 38,056,701 $ 19.53 Options granted 20,013,148 $ 12.14 11,536,447 $ 13.18 18,817,420 $ 20.49 Options exercised (3,151,195) $ 8.05 (6,146,202) $ 8.93 (3,703,246) $ 10.47 Options forfeited (12,803,398) $ 19.70 (5,748,950) $ 19.86 (4,862,813) $ 26.98 Options canceled (7,838,056) $ 17.15 -- $ -- (13,554,514) $ 27.37 ----------------------------------------------------------------------- Balance at June 30 30,615,342 $13.15 34,394,843 $ 16.59 34,753,548 $ 16.92 ----------------------------------------------------------------------- Exercisable at June 30 13,286,532 $13.86 17,337,552 $ 17.12 18,346,324 $ 13.72 -----------------------------------------------------------------------
Additional information about options outstanding at June 30, 1999 is as follows:
Options Outstanding Options Exercisable ------------------------------------------------------------------------------------------------ Weighted Weighted Weighted Average Average Average Exercise Number of Exercise Contractual Number of Exercise Price Range Shares Price Life (years) Shares Price $ 0.96 - $ 10.00 2,070,419 $ 7.02 2.5 1,869,276 $ 6.84 $ 10.19 - $ 11.25 14,498,029 $ 11.13 6.7 5,761,399 $11.14 $ 11.31 - $ 15.00 11,071,730 $ 13.74 8.5 3,093,467 $13.25 $ 15.06 - $ 42.50 2,975,164 $ 25.06 6.0 2,562,390 $25.86 ------------------------- ------------------------- 30,615,342 $ 13.15 13,286,532 $13.86 ------------------------- -------------------------
Stock Purchase Plan We have 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, 1999, we had issued 22,174,495 shares under the plan and we have reserved 2,885,505 shares 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 1999, 1998 and 1997 was $5.18, $6.32 and $5.94 per share, respectively. The weighted average exercise price of employee stock options granted at grant date market prices during fiscal 1999, 1998 and 1997 was $12.14, $13.20 and $20.56 per share, respectively. There were no employee stock options granted at below grant date market prices during fiscal 1999. The weighted average estimated fair value of employee stock options granted at below grant date market prices during fiscal 1998 and 1997 was $10.92, and $13.54 per share, respectively. The weighted average exercise price of employee stock options granted at below grant date market prices during fiscal 1998 and 1997 was $8.91 and $12.56 per share, respectively. The weighted average fair value of restricted stock granted during fiscal 1999, 1998 and 1997 was $12.51, $20.79 and $18.93 per share, respectively. The weighted average estimated fair value of shares granted under the Stock Purchase Plan during fiscal 1999, 1998 and 1997 was $4.97, $5.81 and $7.06 per share, respectively. 37 We estimated the weighted average fair value of options granted 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 1999 1998 1997 1999 1998 1997 Expected life (in years) 1.9 2.3 2.7 0.5 0.5 0.5 Risk-free interest rate 5.26% 5.58% 6.38% 4.97% 5.68% 5.45% Volatility 0.71 0.61 0.50 0.56 0.76 0.57 Dividend yield 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% --------------------------------------------------------------------------
PRO FORMA INFORMATION We have elected to follow APB 25 in accounting for our employee stock options. Under APB 25, we recognize no compensation expense in our financial statements except in connection with the grant of restricted stock for nominal consideration and unless the exercise price of our employee stock options is less than the market price of the underlying stock on the grant date. Total compensation expense recognized in our financial statements for stock-based awards under APB 25 for fiscal 1999, 1998 and 1997 was $5 million, $13 million and $5 million, respectively. We determined the following pro forma information regarding net income and earnings per share as if we had accounted for our 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 pro forma information is as follows (in thousands, except per share amounts):
Years ended June 30 ------------------------------------ 1999 1998 1997 Pro forma net loss $ (13,696) $ (538,260) $ (14) Pro forma net loss per share: Basic $ (0.08) $ (2.89) $ -- Diluted $ (0.08) $ (2.89) $ -- ------------------------------------
STOCKHOLDER RIGHTS PLAN We have a stockholder 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 SGI'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 Our board of directors has authorized a program to repurchase up to 27,500,000 shares of our common stock in open market or in private transactions, option or other forward transactions and other potential methods. We have repurchased 19,264,500 shares of common stock at a cost of $311 million since commencement of the repurchase program. We utilize equity instrument contracts to facilitate our repurchase of common stock. At June 30, 1999, we have outstanding commitments to buy an aggregate of 6,000,000 shares of common stock under our equity forward purchase arrangement, including obligations that were transferred from previous sold put contracts. Under this arrangement, the purchase price will be paid within the next two and a half 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 our discretion. The purchase commitment under the equity forward is secured in part by collateral, reflected in our financial statements as restricted investments. Repurchased shares are available for use under our employee stock plans and for other corporate purposes. At June 30, 1999, approximately 2,235,500 shares remained uncommitted and available for our use under this stock repurchase program. COMMON SHARES RESERVED We have reserved in the aggregate 60,328,957 shares of common stock issuable upon conversion of the Senior Notes and Convertible Subordinated Debentures, as well as shares issuable under our stock award and purchase plans. 38 NOTE 14. COMPREHENSIVE INCOME The components of accumulated other comprehensive income (loss), net of tax, are as follows (in thousands):
Years ended June 30 -------------------------------------- 1999 1998 1997 Unrealized loss on available-for-sale investments $ (118) $ (70) $ (632) Foreign currency translation adjustments (1,525) 1,037 22,453 -------------------------------------- Accumulated other comprehensive (loss) income $ (1,643) $ 967 $ 21,821 -------------------------------------- --------------------------------------
NOTE 15. INCOME TAXES The components of income (loss) before income taxes are as follows (in thousands):
Years ended June 30 -------------------------------------- 1999 1998 1997 United States $ 10,699 $(601,962) $ 84,508 International 115,022 5,043 13,682 -------------------------------------- $ 125,721 $(596,919) $ 98,190 -------------------------------------- --------------------------------------
The provision for (benefit from) income taxes consists of the following (in thousands):
Years ended June 30 --------------------------------------- 1999 1998 1997 Federal: Current $ (44,972) $ 26,346 $ 11,153 Deferred 58,618 (185,555) 18,897 State: Current 93 25,488 20,771 Deferred 5,455 (31,762) (17,796) Foreign: Current 38,244 12,727 6,633 Deferred 14,454 15,464 (20,019) --------------------------------------- $ 71,892 $ (137,292) $ 19,639 --------------------------------------- ---------------------------------------
The provision for (benefit from) 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 ---------------------------------------- 1999 1998 1997 Tax at U.S. federal statutory rate $ 44,003 $(208,922) $ 34,366 State taxes, net of federal tax benefit 3,606 (4,078) 1,934 Earnings subject to foreign taxes at lower rates -- -- (16,599) Income of Foreign Sales Corporation not subject to U.S. tax -- -- (6,170) Acquired in-process technology and non-deductible goodwill -- 16,800 -- Research and experimentation credits -- (670) (7,748) Net operating loss with no tax benefit 14,705 43,606 9,140 Foreign tax credits with no tax benefit 4,020 13,355 -- Other 5,558 2,617 4,716 ---------------------------------------- Provision for (benefit from) income taxes $ 71,892 $(137,292) $ 19,639 ---------------------------------------- ----------------------------------------
39 We have made no provision for residual federal taxes on approximately $242 million of accumulated undistributed earnings of certain of our foreign subsidiaries since it is our intention to permanently invest such earnings in foreign operations. We have been granted exemptions from tax on income from certain manufacturing operations located outside the U.S. for years through 2007. We estimate the cumulative income tax benefits attributable to the tax status of this subsidiary to be $85 million at June 30, 1999. The tax effects of temporary differences and carryforwards that give rise to significant portions of deferred tax assets and liabilities at June 30, 1999 and 1998 are as follows (in thousands):
----------------------- 1999 1998 Deferred tax assets: Net operating loss carryforwards $ 191,145 $103,705 General business credit carryforwards 63,000 53,449 Foreign tax credit carryforwards 15,413 33,677 Depreciation 49,226 40,435 Capitalized research expenses 33,661 32,768 Inventory valuation 93,070 143,428 Intercompany profit elimination 18,284 64,283 Reserves not currently deductible 39,441 67,907 Other 90,725 103,655 ----------------------- Subtotal 593,965 643,307 Valuation allowance (105,364) (90,705) ----------------------- Total deferred tax assets 488,601 552,602 Deferred tax liabilities: Foreign taxes on unremitted foreign earnings, net of related U.S. tax liability 38,191 14,784 Other -- 8,881 ----------------------- Total deferred tax liabilities 38,191 23,665 Total $ 450,410 $528,937 ----------------------- -----------------------
At June 30, 1999, we had gross deferred tax assets arising from deductible temporary differences, tax losses, and tax credits of $594 million. The gross deferred tax assets are offset by a valuation allowance of $105 million and deferred tax liabilities of $38 million. The valuation allowance of $105 million includes $22 million attributable to benefits of stock option deductions, which, if recognized, will be allocated directly to paid-in capital. Realization of the majority of the net deferred tax assets is dependent on our ability to generate approximately $900 million of future taxable income. We believe that it is more likely than not that the assets will be realized based on forecasted income, including income from the planned divestiture of our interest in MIPS. However, there can be no assurance that we will meet our expectations of future income. On a quarterly basis, we will evaluate the realizability of the deferred tax assets and assess the need for additional valuation allowances. At June 30, 1999, we had United States federal and foreign jurisdictional net operating loss carryforwards of approximately $382 million and $147 million, respectively. The federal losses will begin expiring in fiscal year 2007 and the foreign losses will begin expiring in fiscal year 2000. At June 30, 1999, we also had general business credit carryovers of approximately $46 million for United States federal tax purposes, which will begin expiring in fiscal year 2000. NOTE 16. SEGMENT INFORMATION SGI is a market leader in technical computing, offering powerful servers, supercomputers and visual workstations. We have three reportable segments: Servers, Visual Workstations and Global Services. Reportable segments are determined based on several factors including customer base, homogeneity of products, technology, delivery channels and other factors. The Visual Workstations segment has two operating units and the Server segment has three operating units. Each operating unit has a vice president or senior vice president that reports directly to the Chief Executive Officer. The CEO evaluates performance and allocates resources to each of these operating units based on profit or loss from operations before interest and taxes. The CEO has been identified as the Chief Operating Decision Maker as defined by SFAS 131. 40 The Server segment's products include the Onyx2-TM- family of graphics supercomputers, the Origin-TM-200 family of servers, the Origin-TM-2000 family of high-performance servers and the Cray supercomputers. Our servers are high-performance multi-purpose computers designed to be the market leaders in technical computing applications, empowering insight in key industries such as manufacturing, government, entertainment, communications, energy, science and education. Our servers also have a growing presence in the commercial market with an emphasis on strategic business analysis, internet applications and digital media serving. In addition, our servers are used as storage management servers for managing very large data repositories that contain company critical information. These products are distributed through our direct sales force, as well as through indirect channels including resellers and distributors. The Visual Workstation segment's products include the Silicon Graphics-R- 320 and Silicon Graphics-R- 540 visual workstations based upon the Intel microprocessor and the Windows NT operating system and the O2-R- and Octane-R- visual workstations based upon the MIPS-R- microprocessor and the IRIX operating system. The Company's visual workstations are used in a variety of applications including computer-aided design, medical imaging, 3D animation, broadcast, modeling and simulation. These products are distributed through the Company's direct sales force, as well as through indirect channels including resellers and distributors. The Global Services segment supports our computer hardware and software products and provides professional services to help customers realize the full value of their information technology investments. Our professional services organization provides technology consulting, education, communication and entertainment services. In addition to the aforementioned reportable segments, the sales and marketing, manufacturing, finance and administration groups also report to the CEO. Expenses of these groups are allocated to the operating units and are included in the results reported. The revenue and related expenses of our wholly-owned software subsidiary Alias|Wavefront and our majority-owned subsidiary MIPS, a designer of high-performance processors and related intellectual property, as well as certain corporate-level operating expenses are not allocated to operating units and are included in "Other" in the reconciliation of reported revenue and operating profit. We do not identify or allocate assets or depreciation by operating segment, nor does the CEO evaluate segments on these criteria. Operating units do not sell product to each other, and accordingly, there is no inter-segment revenue to be reported. The accounting policies for segment reporting are the same as those described in Note 2, "Summary of Significant Accounting Policies." Information on reportable segments is as follows (in thousands):
Years ended June 30 ------------------------------------ Visual Global Servers Workstations Services 1999: Revenue from external customers $1,217,965 $ 647,182 $ 682,362 Segment profit (loss) $ (44,790) $ (235,895) $ 113,915 Significant noncash item: Asset valuation adjustments $ -- $ (16,000) $ -- ------------------------------------ 1998: Revenue from external customers $1,417,487 $ 865,005 $ 630,416 Segment profit (loss) $ (215,562) $ (155,961) $ 39,952 Significant noncash items: Asset valuation adjustments $ -- $ (18,800) $ -- Write-off of excess spares $ -- $ -- $ (30,000) Vector supercomputer inventory and warranty-related charges $ (98,500) $ -- $ (15,700) ------------------------------------ 1997: Revenue from external customers $1,795,206 $ 1,111,810 $ 571,141 Segment profit $ 17,966 $ 63,895 $ 104,613 ------------------------------------
41 Reconciliation to SGI as reported (in thousands):
Years ended June 30 ------------------------------------ 1999 1998 1997 Revenue: Total reportable segments $2,547,509 $2,912,908 $3,478,157 Other 201,448 187,702 184,444 ------------------------------------ Total SGI consolidated $2,748,957 $3,100,610 $3,662,601 ------------------------------------ Operating profit (loss): Total reportable segments $(166,770) $(331,571) $ 186,474 Other 24,519 (58,987) (21,368) Restructuring 14,000 (143,998) -- Write-off of acquired in-process technology and other merger-related expenses 1,107 (14,905) (10,757) Write-down of impaired long-lived assets -- (46,640) -- Amortization of write-up of acquired Cray inventory and service contracts -- -- (42,465) ------------------------------------ Total SGI consolidated $(127,144) $(596,101) $ 111,884 ------------------------------------ ------------------------------------
No single customer represented 10% or more of our total revenue. Geographic revenue for the three years ended June 30, 1999 is based on the location of the customer. Long-lived assets include all non-current assets except long-term restricted and marketable investments and net long-term deferred tax assets. Geographic information is as follows (in thousands):
Revenue Long-lived Assets --------------------------------------------------------------------------- 1999 1998 1997 1999 1998 1997 Americas $1,535,729 $1,728,680 $2,071,709 $ 370,981 $ 376,358 $ 570,652 Europe 753,904 830,819 936,184 301,088 288,995 242,847 Rest of World 459,324 541,111 654,708 48,367 44,175 49,042 --------------------------------------------------------------------------- Total $2,748,957 $3,100,610 $3,662,601 $ 720,436 $ 709,528 $ 862,541 --------------------------------------------------------------------------- ---------------------------------------------------------------------------
NOTE 17. BENEFIT PLANS 401(k) RETIREMENT SAVINGS PLAN We provide a 401(k) investment plan covering substantially all of our 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. Our matching contributions for fiscal 1999, 1998 and 1997, were $6 million, $7 million and $11 million, respectively. DEFERRED COMPENSATION PLAN We have 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, 1999 and 1998, amounted to approximately $5 million and $6 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 our matching contributions vest as directed by the board of directors. There have been no matching contributions to date. NOTE 18. RELATED PARTY TRANSACTIONS We have from time to time engaged in significant transactions with related parties in the ordinary course of business. Related parties include: Northrop Grumman in fiscal 1999, and Northrop Grumman Corporation and Chrysler Corporation in fiscal 1998 and 1997, as a director of both Northrop Grumman and Chrysler became a member of our board of directors in fiscal 1996; and NKK through its indirect ownership of 100% of Series A Convertible Preferred Stock (see Note 13). 42 Total revenue for the years ended June 30, 1999, 1998 and 1997 included, in the aggregate, sales to related parties in the amount of $49 million, $87 million and $60 million, respectively. Purchases and aggregate amounts receivable from and amounts payable to such related parties were immaterial at June 30, 1999, 1998 and 1997. NOTE 19. CONSOLIDATED STATEMENT OF CASH FLOWS Other adjustments to reconcile net income (loss) to net cash provided by operating activities include the write-off of long-lived assets, the write-off of purchased intangibles and goodwill and accruals of compensation expense related to employee stock awards. The effect of exchange rate changes on cash balances is not material for any of the periods presented. Supplemental disclosures of cash flow information (in thousands):
Years ended June 30 --------------------------------- 1999 1998 1997 Cash paid during the year for: Interest $ 21,000 $14,100 $10,200 Income taxes, net of refunds (42,000) 9,200 29,000 ---------------------------------
Supplemental schedule of noncash investing and financing activities (in thousands):
Years ended June 30 --------------------------------- 1999 1998 1997 Tax benefit from stock options $ 906 $ 11,700 $ 6,300 Capital lease financings 2,800 6,300 -- Exchange of property and equipment for minority interest investment in Wam!Net 37,600 -- -- Exchange of Senior Notes for Zero Coupon Debentures -- 230,600 -- ---------------------------------
NOTE 20. CONTINGENCIES We are defending the lawsuits described below. We believe we have good defenses to the claims in each of these lawsuits and we are defending each of them vigorously. We are defending putative securities class action lawsuits filed in the U.S. District Court for the Northern District of California and in California Superior Court for the County of Santa Clara in December 1997 and January 1998 alleging that SGI and certain of its officers made material misrepresentations and omissions during the period from July to October 1997. We are also defending a securities class action lawsuit filed in January 1996 in the Northern District of California alleging that SGI 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. On July 2, 1999, the U.S. Court of Appeals for the Ninth Circuit upheld the dismissal. We are also defending a securities class action lawsuit involving Alias Research Inc., which we 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 U.S. Court of Appeals has denied defendants' petition for rehearing en banc. We have settled a securities class action lawsuit involving MIPS Computer Systems, Inc., ("MCSI") which we acquired in June 1992. The MCSI case, which was filed in 1992 in the Northern District of California, alleged 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 43 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. We routinely receive communications from third parties asserting patent or other rights covering our products and technologies. Based upon our evaluation, we may take no action or we may seek to obtain a license. There can be no assurance in any given case that a license will be available on terms we consider reasonable, or that litigation will not ensue. We are not aware of any pending disputes, including those described above, that would be likely to have a material adverse effect on SGI's financial condition, results of operations or liquidity. However, our evaluation of the likely impact of these pending disputes could change in the future. NOTE 21. SALE OF INTEREST IN MIPS TECHNOLOGIES, INC. On July 6, 1998, we closed an initial public offering of the common stock of our subsidiary, MIPS Technologies, Inc. ("MIPS"), a company formed by SGI 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 SGI's sale of 4,250,000 shares of MIPS common stock for net proceeds of approximately $54 million and MIPS sale of 1,250,000 shares of MIPS common stock for net proceeds to MIPS of approximately $16 million. 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 SGI's ownership interest in MIPS. In May 1999, SGI and MIPS closed a secondary public offering of $6,680,241 shares of the Class A Common Stock of MIPS owned by SGI for net proceeds of approximately $219 million. Following the secondary offering, there were 37,292,286 shares of MIPS common stock outstanding and we retained an approximately 67% ownership interest in MIPS. We have accounted for the MIPS transaction in accordance with APB 18, the Equity Method of Accounting for Investments in Common Stock, and the Securities and Exchange Commission's Staff Accounting Bulletin Topic 5:H. For the offerings of MIPS shares held by us, we included the excess of the net proceeds over the carrying value of those shares, or $273 million, in income in our consolidated statement of operations. For the offering of newly issued MIPS shares, the net proceeds of $16 million are included in additional paid-in capital in our consolidated balance sheet. We will continue to consolidate the results of MIPS' operations for so long as we retain a greater than 50% ownership interest in MIPS. We currently intend to dispose of our remaining interest in MIPS in one or more transactions through public or private offerings. We expect our divestiture of our interest in MIPS to be completed in the first half of fiscal 2001 subject to market and other conditions. NOTE 22. SUBSEQUENT EVENTS (UNAUDITED) On August 4, 1999, pursuant to one of our lease agreements, as amended, we exercised our option to purchase five buildings on our Mountain View campus. The total purchase price will be approximately $125 million. We expect the purchase to close in September 1999. As a result of this transaction, the future minimum lease payments disclosed in Note 12 will be reduced by the following amounts (in millions): 2000 -$7; 2001 - $8 and 2002 - $9. On August 10, 1999, we announced our plans to realign our business through a series of strategic alliances and restructuring actions. In particular, we announced our intentions to establish arrangements to transition our Windows NT-based line of visual workstations and our Cray-branded line of vector supercomputers to strategic partners who will assume the further development and distribution of these products lines. The result of these and other strategic alliances along with related reductions in marketing, sales and administrative personnel will be a smaller revenue base and workforce reduction of 1,000 to 1,500 in fiscal 2000. Further workforce reductions will occur as we transfer businesses to strategic partners. 44 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, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 1999. 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 respects, the consolidated financial position of Silicon Graphics, Inc. at June 30, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 1999, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Palo Alto, California July 20, 1999 45 EX-21.1 3 EXHIBIT 21.1 Exhibit 21.1 SILICON GRAPHICS, INC. SUBSIDIARIES
JURISDICTION OF NAME INCORPORATION ---- --------------- Alias/Wavefront, Inc. California ParaGraph International, Inc. California WTI Developments, Inc. California Cray Research, LLC 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 Cray Research (Canada) Inc. Canada Silicon Graphics 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 Silicon Graphics GmbH Germany Alias/Wavefront GmbH Germany Silicon Graphics A.E. Greece Silicon Graphics Limited Hong Kong Silicon Graphics Kft. Hungary Silicon Graphics Systems (India) Ltd India Cray Research (Israel) Ltd. Israel Silicon Graphics Computer Systems Limited Israel Alias/Wavefront Srl Italy Silicon Graphics S.p.A. Italy Cray Foreign Sales Corporation, Ltd. Jamaica Alias/Wavefront K.K. Japan SGI Japan Limited. Japan JURISDICTION OF NAME INCORPORATION ---- --------------- Korea Silicon Graphics Ltd. South Korea Silicon Graphics 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 of China (China) Co. Ltd. Cray-S.G.-Sistemas Informatico, Sociedada Unipessoal, LDA Portugal Silicon 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 Silicon Graphics Limited United Kingdom Silicon Graphics Manufacturing Finance Limited Jersey Channel Islands Silicon Graphics S.A. Venezuela
-2- EX-23.1 4 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 20, 1999 included in the 1999 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, 33-56017, 33-60213, 33-60215, 333-01211, 333-06403, 333-08651, 333-15977, 333-40849 and 333-76445) pertaining to the Employee Stock Purchase Plan 1982 Stock Option Plan; 1984 Incentive Stock Option Plan, 1985 Stock Incentive Program; 1986 Incentive Stock Option Plan; 1987 Stock Option Plan, 1998 Employee Stock Purchase Plan; 1993 Long-Term Incentive Stock Plan; WaveFront Technologies, Inc. 1990 Stock Option Plan; Alias Research, Inc. 1998 Employee Share Ownership Plan, 1989 Employee Share Ownership Plan, 1990 Employee Share Ownership Plan, 1994 Stock Plan; Amended and Restated 1996 Supplemental Non-Executive Equity Incentive Plan; 1989 Non-Employee Directors' Stock Option Plan; Cray Research, Inc. Amended and Restated 1989 Employee Benefit Stock Plan; Directors' Stock Option Plan of our report dated July 20, 1999 with respect to the consolidated financial statements of Silicon Graphics, Inc. incorporated herein by reference and of our report included in the preceding paragraph with respect to the financial statement schedule included in the Annual Report (Form 10-K) for the year ended June 30, 1999. /s/ Ernst & Young LLP Palo Alto, California September 27, 1999 -24- EX-27.1 5 EXHIBIT 27.1
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 PERIOD ENDING JUNE 30, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND THE NOTES THERETO. 1,000 12-MOS JUN-30-1999 JUL-01-1998 JUN-30-1999 571,117 117,026 597,790 15,407 195,181 1,847,033 980,819 600,051 2,788,257 977,053 354,971 0 16,998 171 1,407,030 2,788,257 2,090,194 2,748,957 1,202,562 1,603,250 365,239 369 22,562 125,721 71,892 53,829 0 0 0 53,829 .29 .28
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