<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
- ---
Exchange Act of 1934.
For the quarterly period ended MARCH 31, 1998.
or
Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from _________ to __________.
COMMISSION FILE NUMBER 1-10441
SILICON GRAPHICS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2789662
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2011 N. SHORELINE BOULEVARD, MOUNTAIN VIEW, CALIFORNIA 94043-1389
(Address of principal executive offices) (Zip Code)
(650) 960-1980
(Registrant's telephone number, including area code)
__________________
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X No
--- ---
As of April 30, 1998 there were 188,789,157 shares of Common Stock outstanding.
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<PAGE>
SILICON GRAPHICS, INC.
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE NO.
<S> <C> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets......................................... 3
Condensed Consolidated Statements of Operations............................... 4
Condensed Consolidated Statements of Cash Flows............................... 5
Notes to Condensed Consolidated Financial Statements.......................... 6
Item 2. Management's Discussion and Analysis
of Results of Operations and Financial Condition.............................. 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 17
PART II - OTHER INFORMATION
Item 5. Other Information............................................................. 18
Item 6. Exhibits and Reports on Form 8-K.............................................. 18
Signatures............................................................................... 19
Index to Exhibits........................................................................ 20
</TABLE>
Trademarks used in this Form 10-Q: Silicon Graphics, IRIX and Onyx are
registered trademarks and O2, Octane, Origin and Onyx2 are trademarks of Silicon
Graphics, Inc. in the United States and other countries. MIPS is a registered
trademark of MIPS Technologies, Inc. and CRAY is a registered trademark of Cray
Research, Inc. in the United States and other countries. UNIX is a registered
trademark of The Open Group in the United States and other countries. Windows
NT is either a registered trademark or a trademark of Microsoft Corporation in
the United States and other countries. Other products and company names
mentioned in this report may be the trademarks of their respective owners.
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<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SILICON GRAPHICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
March 31, June 30,
1998 1997(1)
------------ ------------
(unaudited)
<S> <C> <C>
ASSETS
- ------
Current assets:
Cash and cash equivalents.................. $ 514,693 $ 227,222
Short-term marketable investments.......... 265,938 60,109
Accounts receivable, net................... 614,557 1,131,647
Inventories................................ 416,417 628,064
Prepaid expenses and other current assets.. 234,494 268,552
---------- ----------
Total current assets.................... 2,046,099 2,315,594
Other marketable investments................. -- 86,961
Property and equipment, net.................. 527,538 525,452
Other assets................................. 451,277 416,585
---------- ----------
$3,024,914 $3,344,592
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts and notes payable................. $ 199,540 $ 303,647
Other current liabilities.................. 735,354 782,559
---------- ----------
Total current liabilities............... 934,894 1,086,206
Long-term debt and other..................... 406,665 419,144
Total stockholders' equity................... 1,683,355 1,839,242
---------- ----------
$3,024,914 $3,344,592
========== ==========
</TABLE>
(1) The balance sheet at June 30, 1997 has been derived from the audited
financial statements at that date but does not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements.
The accompanying notes are an integral part of these financial statements.
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<PAGE>
SILICON GRAPHICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended March 31, Ended March 31,
----------------------------- ---------------------------
1998 1997 1998 1997
-------------- ------------- ------------- ------------
<S> <C> <C> <C> <C>
Product and other revenue.............................. $ 552,385 $768,673 $1,870,181 $2,074,895
Service revenue........................................ 155,906 140,697 456,868 425,389
--------- -------- ---------- ----------
Total revenue........................................ 708,291 909,370 2,327,049 2,500,284
Costs and expenses:
Cost of product and other revenue.................... 415,222 435,695 1,160,101 1,185,052
Cost of service revenue.............................. 89,060 81,597 261,095 239,872
Research and development............................. 111,975 121,532 345,442 353,905
Selling, general and administrative.................. 250,917 254,086 763,600 740,601
Restructuring charges................................ 43,795 - 96,348 -
Merger-related charges............................... (402) 2,482 18,875 7,647
--------- -------- ---------- ----------
Total costs and expenses.......................... 910,567 895,392 2,645,461 2,527,077
--------- -------- ---------- ----------
Operating (loss) income................................ (202,276) 13,978 (318,412) (26,793)
Interest and other income (expense), net............... (267) (2,156) (1,036) (4,371)
--------- -------- ---------- ----------
(Loss) income before income taxes...................... (202,543) 11,822 (319,448) (31,164)
(Benefit) provision for income taxes................... (49,974) 1,284 (79,862) (7,312)
--------- -------- ---------- ----------
Net (loss) income...................................... (152,569) 10,538 (239,586) (23,852)
Preferred stock dividend requirement................... (131) (131) (394) (394)
--------- -------- ---------- ----------
Net (loss) income available to common stockholders..... $(152,700) $ 10,407 $ (239,980) $ (24,246)
========= ======== ========== ==========
Net (loss) income per common share - basic............. $ (0.81) $ 0.06 $ (1.29) $ (0.14)
========= ======== ========== ==========
Net (loss) income per common share - assuming dilution. $ (0.81) $ 0.06 $ (1.29) $ (0.14)
========= ======== ========== ==========
Common shares outstanding - basic...................... 187,643 176,382 185,892 174,761
========= ======== ========== ==========
Common shares outstanding - assuming dilution.......... 187,643 184,555 185,892 174,761
========= ======== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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<PAGE>
SILICON GRAPHICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended March 31,
-----------------------------
1998 1997
-------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................................... $(239,586) $ (23,852)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization............................................. 230,816 278,103
Write-off of acquired in-process technology............................... 16,900 --
Write-off of goodwill and other........................................... 32,537 (7,730)
Changes in operating assets and liabilities:
Accounts receivable.................................................... 517,918 117,191
Inventories............................................................ 181,059 (219,316)
Accounts payable....................................................... (60,221) 61,566
Other assets and liabilities........................................... (29,752) 27,855
--------- ---------
Total adjustments...................................................... 889,257 257,669
--------- ---------
Net cash provided by operating activities................................. 649,671 233,817
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures........................................................ (148,903) (179,807)
Increase in other assets.................................................... (86,200) (75,644)
Acquisition of ParaGraph, net of cash acquired.............................. 831 --
Available-for-sale investments:
Purchases................................................................. (181,948) (6,023)
Sales..................................................................... 28,000 16,222
Maturities................................................................ 35,222 44,258
--------- ---------
Net cash used in investing activities..................................... (352,998) (200,994)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of debt............................................................ 12,965 63,873
Payments of debt principal.................................................. (61,302) (141,231)
Sale of common stock........................................................ 70,792 53,082
Purchase of common stock.................................................... (31,263) --
Cash dividends - preferred stock............................................ (394) (394)
--------- ---------
Net cash used in financing activities..................................... (9,202) (24,670)
--------- ---------
Net increase in cash and cash equivalents................................... 287,471 8,153
Cash and cash equivalents at beginning of period............................ 227,222 257,080
--------- ---------
Cash and cash equivalents at end of period.................................. $ 514,693 $ 265,233
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest.................................................................. $ 19,000 $ 6,500
Income taxes, net of refunds.............................................. $ 7,400 $ 17,900
</TABLE>
The accompanying notes are an integral part of these financial statements.
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SILICON GRAPHICS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. CONSOLIDATED FINANCIAL STATEMENTS.
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries after elimination of significant intercompany
transactions and balances. The unaudited results of operations for the interim
periods shown herein are not necessarily indicative of operating results for the
entire fiscal year. In the opinion of management, all adjustments (consisting
only of normal recurring accruals) necessary to present fairly the financial
position, results of operations and cash flows for all periods presented have
been made. The unaudited condensed consolidated financial statements included
in this Form 10-Q should be read in conjunction with the audited consolidated
financial statements and notes thereto for the fiscal year ended June 30, 1997.
Certain amounts for the prior year have been reclassified to conform to current
year presentation.
2. BUSINESS COMBINATION.
On September 30, 1997, the Company completed its acquisition of ParaGraph
International, Inc. ("ParaGraph"), a software company, in exchange for cash and
shares of the Company's common stock for an aggregate purchase price of
approximately $50 million, including direct acquisition costs. The Company
accounted for the acquisition using the purchase method. The purchase price was
allocated based on an independent valuation and consisted principally of
acquired in-process technology ($17 million) included in merger-related charges
and goodwill ($34 million). For more information, see Note 5 below.
3. INVENTORIES.
(in thousands)
<TABLE>
<CAPTION>
March 31, 1998 June 30, 1997
-------------- -------------
<S> <C> <C>
Components and subassemblies $ 115,268 $ 235,492
Work-in-process 140,829 235,426
Finished goods 79,663 74,519
Marketing 80,657 82,627
--------- ---------
Total inventories $ 416,417 $ 628,064
========= =========
4. PROPERTY AND EQUIPMENT.
(in thousands)
March 31, 1998 June 30, 1997
-------------- -------------
Property and equipment, at cost $ 945,099 $ 940,695
Accumulated depreciation and amortization (417,561) (415,243)
--------- ---------
Net property and equipment $ 527,538 $ 525,452
========= =========
</TABLE>
5. RESTRUCTURING CHARGES.
In the second quarter of fiscal 1998, the Company announced and began to
implement a restructuring program aimed at bringing operating expenses more in
line with the current environment and restoring profitability to the Company's
operations. The Company's restructuring activity in fiscal 1998 consisted
primarily of eliminating approximately 1,000 positions, writing down certain
operating assets, vacating certain leased facilities and canceling certain
contracts. Through March 31, 1998, these actions have resulted in aggregate
charges of $96 million, of which approximately $51 million have used or will use
cash and $45 million were non-cash charges. The Company expects that the
remaining $30 million accrued balance at March 31, 1998 will result in cash
expenditures of approximately $25 million over the next six months and will be
financed through current
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working capital. The Company anticipates that there will be further
restructuring related charges during the remainder of fiscal 1998.
The following table depicts the fiscal 1998 restructuring activity through March
31, 1998:
<TABLE>
<CAPTION>
Total Spending Balance at
Category Restructuring Charges /Charges March 31, 1998
- -------------------------------------------------------------------------------------------------------------
(in thousands)
<S> <C> <C> <C>
Severance and related charges $46,554 $(28,193) $18,361
Operating asset reserves 36,953 (32,755) 4,198
Canceled contracts 3,967 (2,416) 1,551
Vacated facilities 6,098 (626) 5,472
Other 2,776 (2,610) 166
------- -------- -------
$96,348 $(66,600) $29,748
======= ======== =======
</TABLE>
As a result of strategic business decisions by management in the third quarter
of fiscal 1998, operating asset reserves include a $31 million charge to write-
off purchased intangibles and goodwill associated with the September 1997
acquisition of ParaGraph.
6. EARNINGS PER SHARE.
The following table sets forth the computation of basic and diluted earnings per
share:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------------- -------------------------------
(In thousands, except per share amounts) 1998 1997 1998 1997
NUMERATOR: ---------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
Net (loss) income.......................................... $(152,569) $ 10,538 $(239,586) $(23,852)
Preferred stock dividends.................................. (131) (131) (394) (394)
--------- -------- --------- --------
Numerator for basic and diluted earnings per
share - net (loss) income available to common
shareholders............................................. $(152,700) $ 10,407 $(239,980) $(24,246)
========= ======== ========= ========
DENOMINATOR:
Denominator for basic earnings per
share - weighted-average shares.......................... 187,643 176,382 185,892 174,761
Effect of dilutive securities:
Stock options............................................ -- 8,173 -- --
--------- -------- --------- --------
Denominator for diluted earnings per share -
weighted average shares and assumed conversions.......... 187,643 184,555 185,892 174,761
========= ======== ========= ========
Net (loss) income per common share - basic.................... $ (0.81) $ 0.06 $ (1.29) $ (0.14)
========= ======== ========= ========
Net (loss) income per common share - assuming dilution........ $ (0.81) $ 0.06 $ (1.29) $ (0.14)
========= ======== ========= ========
Potentially dilutive securities excluded from
computations because they are anti-dilutive.................. 10,563 9,142 12,723 17,006
========= ======== ========= ========
</TABLE>
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<PAGE>
7. COMPLIANCE WITH COVENANTS.
At March 31, 1998, the Company was not in compliance with a financial covenant
relating to a $124 million real estate financing arrangement. The Company has
obtained a compliance waiver and is seeking to amend the covenant.
8. STOCK REPURCHASE PROGRAM.
On November 14, 1997, the Company announced that its board of directors had
extended the stock repurchase program originally authorized in October 1995.
The modified plan permits the purchase of up to 12.5 million shares, either in
the open market or in private or option transactions, through June 1999. The
Company has purchased approximately 4.8 million shares since the commencement of
the repurchase program in 1995 at an average price of approximately $22.50 per
share. This includes approximately 2.3 million shares purchased during the nine
months ended March 31, 1998 in open market transactions. The Company also has
the right through call option contracts to purchase up to 3.5 million shares of
its common stock through October 1998. The repurchased shares will be available
for use under the Company's employee stock plans and for other corporate
purposes.
-8-
<PAGE>
9. CONTINGENCIES.
The Company is defending the lawsuits described below. The Company believes
that it has good defenses to the claims in each of these lawsuits and is
defending each of them vigorously.
The Company is defending putative securities class action lawsuits filed in
the U.S. District Court for the Northern District of California (the "Northern
District") and in California Superior Court for the County of Santa Clara in
December 1997 and January 1998 alleging that the Company and certain of its
officers made material misrepresentations and omissions during the period from
July to October 1997.
The Company is also defending a securities class action lawsuit filed in January
1996 in the Northern District alleging that the Company and certain of its
officers and directors made material misrepresentations and omissions during the
period from September to December 1995. The lawsuit was dismissed with prejudice
by the District Court in May 1996. The plaintiff's appeal to the U.S. Court of
Appeals for the Ninth Circuit is pending.
The Company is also defending a securities class action lawsuit involving MIPS
Computer Systems, Inc., which the Company acquired in June 1992. The MIPS
case, which was filed in 1992 in the Northern District, alleges that MIPS and
certain of its officers and directors made material misrepresentations and
omissions during the period from January to October of 1991. In September 1996,
the U.S. Court of Appeals for the Ninth Circuit reversed the summary judgment
granted in defendants' favor in June 1994. In October 1997, the defendants'
petition for review by the U.S. Supreme Court was denied. The case is presently
pending before the District Court.
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 defendant's motion to
dismiss the amended complaint was granted. The plaintiffs' appeal to the U.S.
Court of Appeals for the Second Circuit is pending.
The Company is also defending a patent infringement lawsuit filed by Martin
Marietta Corp. in the U.S. District Court for the Middle District of Florida
in September 1995. The Company has filed a counterclaim seeking to invalidate
the principal patent at issue in the lawsuit and the U.S. Patent and Trademark
Office is re-examining the patent at Martin Marietta's request. The Company's
motion for summary judgment is pending with the District Court. A trial date
for the lawsuit is currently set for August 1998.
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.
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
The matters addressed in this discussion, with the exception of the historical
information presented, are forward-looking statements involving risks and
uncertainties, including the risks discussed under the heading "Risks That
Affect Our Business." The Company's actual results may differ significantly
from the results discussed in the forward-looking statements.
RESULTS OF OPERATIONS
OPERATING ITEMS AS A PERCENTAGE OF TOTAL REVENUE
- --------------------------------------------------------------------------------
(percentages may not add due to rounding)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended March 31, Ended March 31,
------------------------ ----------------------
1998 1997 1998 1997
------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Product and other revenue.............. 78.0% 84.5% 80.4% 83.0%
Service revenue........................ 22.0 15.5 19.6 17.0
------- ------- ------- -------
Total revenue.......................... 100.0% 100.0% 100.0% 100.0%
Gross margin........................... 28.8(1) 43.1(2) 38.9(1) 43.0(2)
Research and development............... 15.8 13.4 14.8 14.2
Selling, general and administrative... 35.4 27.9 32.8 29.6
Restructuring charges.................. 6.2 -- 4.1 --
Merger-related charges................ (0.1) 0.3 0.8 0.3
------- ------- ------- -------
Operating (loss) income................ (28.6) 1.5 (13.7) (1.1)
Interest and other income (expense),
net................................... -- (0.2) -- (0.2)
------- ------- ------- -------
(Loss) income before income taxes...... (28.6) 1.3 (13.7) (1.3)
(Benefit) provision for income taxes... (7.1) 0.1 (3.4) (0.3)
------- ------- ------- -------
Net (loss) income...................... (21.5)% 1.2% (10.3)% (1.0)%
======= ======= ======= =======
</TABLE>
________
(1) 38.7% and 41.9% for the three month and nine month period, respectively,
before a charge related to the Company's refocused supercomputer product
roadmap.
(2) 43.8% and 45.0% for the three month and nine month period, respectively,
before the effects of Cray Research purchase accounting adjustments.
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<PAGE>
REVENUE BY GEOGRAPHY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Three Months Nine Months
Ended March 31, Year Ended March 31, Year
-------------------------- /Year -------------------------- /Year
1998 1997 Change 1998 1997 Change
($ in millions) ------------ ------------ ------------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
United States $ 359 $ 445 (19)% $1,175 $1,292 (9)%
Europe 189 236 (20)% 638 647 (1)%
Rest of World 160 228 (30)% 514 561 (8)%
----- ----- ------ ------
Total revenue $ 708 $ 909 (22)% $2,327 $2,500 (7)%
===== ===== ====== ======
</TABLE>
<TABLE>
<CAPTION>
Three Months Nine Months
Ended March 31, Ended March 31,
------------------------------ ------------------------------
1998 1997 1998 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
United States 51% 49% 51% 52%
Europe 27% 26% 27% 26%
Rest of World 22% 25% 22% 22%
</TABLE>
REVENUE BY PRODUCT LINE
- --------------------------------------------------------------------------------
(as a percentage of product revenue, excluding other revenue)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended March 31, Ended March 31,
---------------------------- ----------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Servers (primarily from the CRAY(R) and Origin(TM)
families) 50% 53% 50% 49%
Graphics systems (primarily from the O2(TM) Octane(TM)
and Onyx2(TM) families) 50% 47% 50% 51%
</TABLE>
REVENUE. The Company's product and other revenue are derived primarily from
shipment of computer system products, with subsystem and software revenue, fees
and royalty payments comprising the remainder. Service revenue is comprised of
hardware and software support and maintenance.
The Company's revenue for the third quarter and first nine months of fiscal 1998
of $708 million and $2,327 million, respectively, declined compared with revenue
of $909 million and $2,500 million, respectively, for the corresponding periods
of fiscal 1997. Revenue declined across all regions, with significant year to
year reductions noted in the Company's business in the United States, as well as
in Japan, Korea and certain Southeast Asian markets primarily resulting from
overall economic weakness in the Asia Pacific region.
Product revenue for the Company's servers and graphics systems for the third
quarter and first nine months of fiscal 1998 declined compared with the same
periods a year ago. This decline reflects the effects of strong competition,
particularly in the shrinking UNIX workstation market, and declining volumes for
Cray supercomputers. The Company believes that the declines in the UNIX
workstation and vector supercomputer markets are long-term trends, and that its
future success will require that a larger proportion of its revenues come from
growing markets. In the near term, the Company's results will be strongly
affected by its ability to accelerate revenue growth from its server products.
Revenue may also be affected by customer perceptions of the Company's longer-
term strategy and its ability to execute the necessary business transitions.
See "Risks That Affect Our Business."
The Company's consolidated backlog at March 31, 1998 was $338 million, down from
backlog of $393 million at December 31, 1997.
GROSS MARGIN. Gross margin of 28.8% and 38.9% for the third quarter and first
nine months of fiscal 1998, respectively, decreased compared with gross margin
of 43.1% and 43.0%, respectively, for the corresponding periods of fiscal 1997.
Gross margin for the third quarter and first nine months of fiscal 1998 would
have been 38.7% and 41.9%, respectively, without non-recurring charges of
approximately $70 million taken in the third quarter related to refocusing the
Company's supercomputer product roadmap. Gross margin for the third quarter
and first nine months of fiscal 1997 would have been 43.8% and 45.0%,
respectively, without purchase accounting adjustments related to acquired Cray
Research inventory and service contracts of approximately $6 million and $39
million, respectively. Excluding the impact of non-recurring charges and
purchase accounting adjustments, gross margins were down
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<PAGE>
primarily due to competitive pricing pressures noted across all product lines
and lower than expected volumes. The Company believes it will continue to
experience margin pressure.
OPERATING EXPENSES (EXCLUDING RESTRUCTURING AND MERGER-RELATED CHARGES).
Operating expenses for the third quarter of fiscal 1998 declined 3% compared
with the same period a year ago but increased from 41.3% to 51.2% as a
percentage of total revenue. The decrease in absolute dollars resulted from
efforts to control spending through more focused project management and a
reduction in selling expenses. As a percent of total revenue, operating expenses
increased principally due to the significant revenue shortfall in the third
quarter of fiscal 1998. Operating expenses for the first nine months of fiscal
1998 increased slightly compared with the same period a year ago and increased
from 43.8% to 47.7% as a percentage of total revenue principally due to the
significant revenue shortfall in fiscal 1998. The Company's operating expenses
as a proportion of total revenue continues to be well above acceptable levels,
and is being addressed through continuing expense management.
RESTRUCTURING CHARGES. The restructuring charges for the third quarter and
first nine months of fiscal 1998 consist principally of severance and related
charges, as well as asset write-downs and lease and other contract cancellation
charges. The Company anticipates that there will be further charges during the
remainder of fiscal 1998. For more information, see Note 5 of the Notes to
Condensed Consolidated Financial Statements (Unaudited) included in Part I of
this Quarterly Report.
MERGER-RELATED CHARGES. Included in merger-related charges for the first nine
months of fiscal 1998 is a $17 million charge for acquired in-process technology
taken in the first quarter in connection with the acquisition of ParaGraph.
Other merger-related expenses in fiscal 1998 and 1997 relate to the acquisitions
of ParaGraph and Cray Research. Expenses related to these mergers are not
expected to be significant for the remainder of fiscal 1998.
OTHER OPERATING RESULTS. Interest and other income (expense), net for the third
quarter and first nine months of fiscal 1998 improved $1.9 million and $3.3
million, respectively. This improvement primarily reflects higher interest
income attributable to much higher invested cash balances in fiscal 1998
compared with fiscal 1997, offset in part by an increase in costs associated
with the Company's currency hedging program and foreign exchange losses on
unhedged currencies. Also included in the fiscal 1998 nine month period are one-
time charges related to fees incurred in connection with the Company's exchange
of its newly issued Senior Convertible Notes for its existing Zero Coupon
Debentures during the first quarter of fiscal 1998, as well as the write-off of
an investment.
TAXES. The Company's effective tax benefit rate for the first nine months of
fiscal 1998 was 28%, excluding the impact of the $17 million non-deductible
write-off of acquired in-process technology in the first quarter of fiscal
1998, and the 25% tax benefit resulting from the $96 million of restructuring
charges taken in the second and third quarters of fiscal 1998. The Company
revised its projected effective tax rate during the third quarter of fiscal
1998 from 20% to 28%, and accordingly, the tax benefits recognized in the
third quarter reflect an adjustment to the first two quarters. The change in
the expected effective tax benefit is primarily attributable to changes in the
forecast of operational results for the year, and the Company's decision to
not permanently reinvest any current year undistributed earnings of the
Company's foreign subsidiaries. No provision for residual federal taxes has
been made on accumulated undistributed earnings through fiscal 1997 of certain
of the Company's foreign subsidiaries since it is the Company's intention to
permanently invest such earnings in foreign operations.
The Company revised its estimated projected effective tax rate in the third
quarter of fiscal 1997 from 20%, resulting in an anticipated 11% effective tax
rate for the third quarter. The reduction in the 1997 projected effective tax
rate was primarily attributable to the reinstatement of the U.S. federal
research credit and to proportionately higher earnings in foreign jurisdictions.
As a result of the acquisition by Silicon Graphics, Cray Research experienced a
"change in ownership" as defined under Section 382 of the Internal Revenue Code
and is subject to certain limitations on the utilization of its pre-acquisition
net operating loss and tax credit carryforward. The Company has provided a
valuation allowance to offset the deferred tax asset relating to foreign tax
credits that may expire prior to utilization due to this annual limitation. The
valuation allowance for deferred tax assets of approximately
-12-
<PAGE>
$59.9 million will be applied to reduce the noncurrent intangible assets related
to the acquisition of Cray Research if future tax benefits are subsequently
realized.
FINANCIAL CONDITION
- -------------------
At March 31, 1998, cash and cash equivalents and marketable investments totaled
$781 million, up from $374 million at June 30, 1997. Operating activities
generated $650 million during the first nine months of fiscal 1998 compared with
$234 million during the first nine months of fiscal 1997. Despite the net loss
for the first nine months of fiscal 1998, cash flow from operating activities
was positive principally due to a significant decrease in accounts receivable
due in part to shorter collection cycles and a reduction in inventory levels, as
well as the effect of charges that did not use cash, including the write-off of
goodwill of $31 million and acquired in-process technology of $17 million
related to the acquisition of ParaGraph. Investing activities, other than
changes in the Company's marketable investments, consumed $234 million in cash
during the first nine months of fiscal 1998, principally for the acquisition of
capital equipment and spare parts. The principal financing activities during the
first nine months of fiscal 1998 included the repayment of $61 million in short-
and long-term borrowings and the use of $31 million to repurchase shares of the
Company's common stock, offset in part by proceeds from employee stock purchase
plan issuances and employee stock option exercises.
In the second quarter of fiscal 1998, the Company announced and began to
implement a restructuring program aimed at bringing operating expenses more in
line with the current environment and restoring profitability to the Company's
operations. For more information, see Note 5 of the Notes to Condensed
Consolidated Financial Statements (Unaudited) included in Part I of this
Quarterly Report. Restructuring charges have been and will be funded through
current working capital.
At March 31, 1998, the Company's principal sources of liquidity included cash
and cash equivalents and marketable investments of $781 million and up to $250
million available under its three-year revolving credit facility. The Company
believes that these principal sources of liquidity along with cash generated
from operations and other resources available to the Company, should be adequate
to fund the Company's projected cash flow needs. The Company believes that the
level of financial resources is an important competitive factor in the computer
industry, and accordingly, may elect to raise additional capital through debt or
equity financing in anticipation of future needs.
RISKS THAT AFFECT OUR BUSINESS
- ------------------------------
Silicon Graphics operates in a rapidly changing environment that involves a
number of risks, some of which are beyond the Company's control. The following
discussion highlights some of these risks.
BUSINESS TRANSITION. Two of the principal market sectors in which the Company
competes -- UNIX workstations and vector supercomputers -- have declined over
the past year, and the Company believes that these declines represent long-term
trends. The Company's goal is to increase its market share in these sectors and
to transition an increasing proportion of its revenues to growing markets,
including Windows NT workstations and UNIX-based scalable servers such as the
Company's Origin server product family. The Company's ability to grow its
revenue over the next several quarters will largely depend on the extent to
which growth in the Origin family and (beginning in fiscal 1999) Windows NT
workstation products compensates for the expected decline in the other market
sectors.
In April 1998 the Company made a series of communications concerning its
strategic plans for the next several years. Key elements of the strategy
include a focus on the technical and technical enterprise markets, a product
roadmap that will over the next several years bring together the Company's
vector supercomputer and scalable server families, and an alliance with Intel
Corporation that will result in the Company's transition to the Intel
microprocessor architecture. While the Company believes that this strategy will
result in its return to growth and profitability, the results will not be
reflected in the Company's results for the next several quarters, and may not be
fully reflected until fiscal 2000.
DESKTOP SYSTEM STRATEGY. The Company has under development a family of desktop
systems that will be based upon Intel microprocessors and the Windows NT
operating system. There can be no assurance that
-13-
<PAGE>
these systems will be introduced as scheduled in the first half of fiscal 1999,
and in any event they will not account for any significant revenues before the
latter half of fiscal 1999. Success in this market segment will require that the
Company adapt to the very different requirements of this higher volume, lower
margin market, including lower-cost manufacturing and distribution, marketing to
a broader audience in markets that could extend beyond the Company's traditional
markets, and new approaches to customer interface and support. The Company will
also be required to maintain and extend its customer franchise through a complex
product transition and to support a product line including multiple operating
systems. In particular, although the Company plans to continue to invest in and
support its current line of UNIX/MIPS-based workstations, there is a risk that
revenue from this business will be materially reduced by the announcement of the
new product. The Company believes that its future success will depend in
significant part on its making the right strategic choices in this market
segment and on executing its strategy effectively.
RESTRUCTURING PROGRAM. In the second quarter of fiscal 1998, the Company
announced and began to implement a restructuring program aimed at bringing
operating expenses more in line with the current environment and restoring long-
term profitability to the Company. The Company is seeking to reduce its fiscal
1999 operating expenses by $200 million below the anticipated level of fiscal
1998 operating expenses. The Company is seeking to reduce its costs in ways that
will not have a material impact on revenue levels, but there can be no assurance
that these goals will be achieved.
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
geographical mix, the mix of service and non-recurring engineering revenue, the
mix of high-end and desktop products and application software, as well as the
mix of configurations within these product categories.
The Company's results have followed a seasonal pattern, with stronger sequential
growth in the second and fourth fiscal quarters, reflecting the buying patterns
of the Company's customers.
The Company's stock price, like that of other technology companies, is subject
to significant volatility. If revenue or earnings in any quarter fail to meet
the investment community's expectations, there could be an immediate impact on
the Company's stock price. The stock price may also be affected by broader
market trends unrelated to the Company's performance.
PROCESS RE-ENGINEERING. The Company is undertaking a series of programs aimed
at redesigning some of its core business processes, including forecasting,
supply chain management, order fulfillment and collection of accounts
receivable. The goals of these programs include more predictable results of
operations, greater quality and customer satisfaction, and improved asset
management. The Company believes that the success of these programs is critical
to its long-term competitive position. Implementing these changes will require,
among other things, enhanced information systems, substantial training and
disciplined execution. There can be no assurance that these programs will be
implemented successfully, or that disruptions of 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 volume production highly
differentiated, technologically complex and innovative products. Product
transitions are a recurring part of the Company's business. During fiscal 1997,
for example, the Company replaced most of its product line, including both
graphics and server systems. A number of risks are inherent in this process.
-14-
<PAGE>
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 and manufacturing
teams within the Company as well as teams at outside suppliers of key components
such as semiconductor and storage products. 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 from current products 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
in 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, delays in customer purchases of existing products in anticipation
of the introduction of new products, and excess inventories of older products
and components.
YEAR 2000 COMPLIANCE. Many computer systems and applications experience
problems handling dates beyond the year 1999 and will need to be modified prior
to the year 2000 in order to remain functional. The Company is assessing the
year 2000 readiness of the systems used in the operation of its business, many
of which are provided by outside suppliers, and the compliance of the computer
products and related software, including operating system software, sold by the
Company to its customers. The Company expects to implement successfully the
systems and programming changes necessary to address year 2000 issues, including
a new release of its IRIX operating system, and does not believe that the cost
of such actions will have a material effect on the Company's results of
operations or financial condition. There can be no assurance, however, that
there will not be a delay in, or increased costs associated with, the
implementation of such changes, or that the new version of the operating system
will be implemented by all of the Company's customers. The Company's inability
to implement such changes could have an adverse effect on future results of
operations.
COMPETITION. The computer industry is highly competitive, with rapid
technological advances and constantly improving price/performance. Most of the
Company's competitors have substantially greater technical, marketing and
financial resources and, in some segments, a larger installed base of customers
and a wider range of available applications software. Competition may result in
significant discounting and lower gross margins.
IMPACT OF GOVERNMENT CUSTOMERS. A significant portion of the Company's revenue
is derived from sales to the U.S. government, either directly by the Company or
through system integrators and other resellers. Sales to the government present
risks in addition to those involved in sales to commercial customers, including
potential disruptions due to appropriation and spending patterns and the
government's reservation of the right to cancel contracts for its convenience.
EXPORT REGULATION. The Company's sales to foreign customers are subject to
export regulations. Sales of many of the Company's high-end products require
clearance and export licenses from the U.S. Department of Commerce under these
regulations. The Department of Commerce is currently investigating the
Company's compliance with the export regulations in connection with the sale of
several computer systems to a customer in Russia in fiscal 1997. The Company
believes that this matter will be resolved without a significant adverse effect
on the Company's business. However, there is no assurance that this matter will
not have an unforeseen outcome that could impair the conduct of the Company's
business outside the United States.
The Company's international sales would also be adversely affected if such
regulations were tightened, or if they are not modified over time to reflect the
increasing performance of the Company's products.
INTELLECTUAL PROPERTY. The Company routinely receives communications from third
parties asserting patent or other rights covering the Company's products and
technologies. Based upon the Company's evaluation, it may take no action or it
may seek to obtain a license. In any given case there is a risk that a license
will not be available on terms that the Company considers reasonable, or that
litigation will ensue. The Company
-15-
<PAGE>
currently has patent infringement lawsuits pending against it. The Company
expects that, as the number of hardware and software patents issued continues to
increase, and as competition in the markets addressed by the Company
intensifies, the volume of these intellectual property claims will also
increase.
EMPLOYEES. The Company's success depends on its ability to continue to attract,
retain and motivate highly qualified technical, marketing and management
personnel, who are in great demand. The current uncertainties surrounding the
Company have increased the challenges of retaining world-class talent.
BUSINESS DISRUPTION. The Company's corporate headquarters, including most of
its research and development operations and manufacturing facilities, are
located in the Silicon Valley area of Northern California, a region known for
seismic activity. Operating results could be materially affected by a
significant earthquake. The Company is not insured for most losses and business
interruptions of this kind.
GLOBAL FINANCIAL MARKET RISKS. The Company's business and financial results are
affected by fluctuations in world financial markets, including foreign currency
exchange rates and interest rates. The Company's hedging policy attempts to
reduce some of these risks, based on management's best judgment of the
appropriate tradeoffs among risk, opportunity and expense. The Company
regularly reviews its overall hedging policies, and it continually monitors its
hedging activities to ensure that they are consistent with the Company's policy
and are appropriate and effective in light of changing market conditions.
Management may as part of this review determine at any time to change its
hedging policies. No such policy can be comprehensive, and the Company remains
subject to risks that cannot be hedged effectively, especially in periods of
high volatility.
Because a significant portion of the Company's revenue is from sales outside the
United States, and many key components are produced outside the United States,
the Company's results can be significantly affected by changes in foreign
currency exchange rates or weak economic conditions in the foreign markets in
which the Company distributes its products. The Company is primarily exposed to
changes in exchange rates on the German mark, British pound, Japanese yen,
French franc, and Korean won. When the U.S. dollar strengthens against these
currencies, the value (as expressed in U.S. dollars) of non-U.S. dollar-based
sales and costs decrease. In the second quarter of fiscal 1998 for example, a
sharp decline in the value of the Korean won adversely affected the Company's
revenues from that country and made hedging prohibitively expensive. The
opposite happens when the U.S. dollar weakens. Because the Company is a net
receiver of currencies other than the U.S. dollar, it benefits from a weaker
dollar and is adversely affected by a stronger dollar relative to major
currencies worldwide. Accordingly, a strengthening of the U.S. dollar tends to
affect negatively the Company's revenue and gross margins.
Countries in the Asia Pacific region, including Japan, which accounts for a
significant proportion of the Company's business in that region, have recently
experienced weaknesses in their currency, banking and equity markets. These
weaknesses could adversely affect demand for the Company's products, the U.S.
dollar value of the Company's foreign currency denominated sales, the
availability and supply of product components to the Company, and ultimately,
the Company's consolidated results of operations.
The Company's currency hedging program currently involves hedging (i) net non-
U.S. dollar monetary assets and liabilities and generally all server backlog
where the delivery cycle is expected to exceed three months using currency
forward contracts and (ii) a significant portion of anticipated quarterly
revenue using currency options which expire within each fiscal quarter. The
Company has generally not hedged capital expenditures, investments in
subsidiaries or inventory purchases. However, because the Company procures
inventory and its international operations incur expenses in local currencies,
the financial effects of fluctuations in the U.S. dollar values of non-U.S.
dollar-based transactions frequently mitigate or tend to offset each other on a
consolidated basis.
-16-
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required under this Item 3 is included in the section above
entitled Global Financial Market Risks.
-17-
<PAGE>
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION
In April 1998, at the request of Richard E. Belluzzo, Chairman and Chief
Executive Officer, the Company entered into an amendment to his employment
agreement dated as of January 22, 1998 to eliminate the provisions for a
supplemental payment in the event that the value of his equity position with the
Company did not achieve certain targets over the vesting period. Mr. Belluzzo
made this request to more closely align his individual interests with those of
the Company's stockholders and employees.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.40 Amendment and Waiver dated as of April 20, 1998 to Agreement
between the Company and Richard E. Belluzzo.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K.
None
-18-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: May 14, 1998 SILICON GRAPHICS, INC.
a Delaware corporation
By: Steven J. Gomo
-----------------------------------------
Steven J. Gomo
Senior Vice President and Chief Financial
Officer (Principal Financial and Accounting
Officer)
-19-
<PAGE>
SILICON GRAPHICS, INC.
INDEX TO EXHIBITS
-----------------
Exhibit Description
- ------- -----------
10.40 Amendment and Waiver dated as of April 20, 1998 to Agreement
between the Company and Richard E. Belluzzo
27.1 Financial Data Schedule
-20-
<PAGE>
EXHIBIT 10.40
AMENDMENT AND WAIVER
SILICON GRAPHICS, INC., a Delaware corporation (the "COMPANY") has
engaged RICHARD E. BELLUZZO (the "EXECUTIVE") as its Chief Executive Officer on
the terms set forth in an offer letter dated as of January 22, 1998 and in an
Agreement, also dated as of January 22, 1998 (the "AGREEMENT"). This Amendment
and Waiver amends certain terms of the Agreement and sets forth the Executive's
irrevocable waiver of certain of his rights thereunder.
1. ELIMINATION OF RIGHT TO SUPPLEMENTAL PAYMENT
(a) The Executive hereby waives any right he may have under the
Agreement to be paid the Supplemental Payment (as such term is defined in the
Agreement) and agrees to the deletion in full of Section 1 of the Agreement.
(b) In connection with the waiver and agreement set forth in
subsection (a), the Executive and the Company agree to the following additional
amendments to the Agreement:
(i) the parenthetical phrase in the last sentence of Section 3(a)(i)
is deleted in its entirety;
(ii) Section 3(b)(ii) is deleted in its entirety;
(iii) the last sentence of Section 3(c) is deleted in its entirety;
(iv) the definitions of "Average Fair Market Value", "Fair Market
Value", "Final Measurement Date", "First Measurement Date", "In-the-Money
Value", "Measurement Date", "Shortfall Amount" and "Unrestricted Stock" set
forth in Section 7 are deleted in their entirety; and
(v) (A) Sections 2, 3, 4, 5, 6 and 7 are renumbered Sections 1, 2,
3, 4, 5 and 6 respectively, and all internal cross-references are
renumbered accordingly; and
(B) subsections (iii), (iv), (v) (vi) and (vii) of former
Section 3(b) (renumbered as Section 2(b) pursuant to clause (A)
above) are renumbered subsections (ii), (iii), (iv), (v) and
(vi), respectively, and all internal cross-references are
renumbered accordingly.
<PAGE>
2. REPRESENTATIONS OF THE EXECUTIVE.
The Executive represents and warrants to the Company that he is
entering into this Agreement and Waiver freely, upon his own initiative and in
consideration of his judgment concerning the best interests of the Company and
its shareholders and his own interests as Chief Executive Officer and a
shareholder of the Company.
3. AGREEMENT REMAINS IN EFFECT.
Except as amended hereby, the Agreement remains in full force and
effect in accordance with its original terms.
4. GOVERNING LAW.
This Amendment and Waiver, together with the Agreement which it
amends, shall be governed by and construed in accordance with the laws of the
State of California (determined without regard to the choice of law provisions
thereof).
IN WITNESS WHEREOF, the parties have executed this Amendment and
Waiver effective as of the 20th day of April, 1998.
SILICON GRAPHICS, INC.
By: /s/ William M. Kelly
------------------------------
Name: William M. Kelly
Title: Senior Vice President,
Corporate Operations
EXECUTIVE
/s/ Richard E. Belluzzo
----------------------------------
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet, consolidated statement of operations and
consolidated statement of cash flows included in the Company's Form 10-Q for the
period ending March 31, 1998, and is qualified in its entirety by reference to
such financial statements and the notes thereto.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> MAR-31-1998
<CASH> 514,693
<SECURITIES> 265,938
<RECEIVABLES> 634,080
<ALLOWANCES> 19,523
<INVENTORY> 416,417
<CURRENT-ASSETS> 2,046,099
<PP&E> 945,099
<DEPRECIATION> 417,561
<TOTAL-ASSETS> 3,024,914
<CURRENT-LIABILITIES> 934,894
<BONDS> 367,396
0
16,998
<COMMON> 168
<OTHER-SE> 1,666,189
<TOTAL-LIABILITY-AND-EQUITY> 3,024,914
<SALES> 1,870,181
<TOTAL-REVENUES> 2,327,049
<CGS> 1,160,101
<TOTAL-COSTS> 1,421,196
<OTHER-EXPENSES> 460,665
<LOSS-PROVISION> 1,949
<INTEREST-EXPENSE> 18,202
<INCOME-PRETAX> (319,448)
<INCOME-TAX> 79,862
<INCOME-CONTINUING> (239,586)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (239,586)
<EPS-PRIMARY> (1.29)
<EPS-DILUTED> (1.29)
</TABLE>
