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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended June 28, 2002.

For the transition period from                              to                             

Commission File Number 1-10441

SILICON GRAPHICS, INC.
(Exact name of registrant as specified in its charter)

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:

        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 ý    No o

        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." o

        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 August 30, 2002 on the New York Stock Exchange as reported in The Wall Street Journal, was approximately $203 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 August 31, 2002, the registrant had outstanding 199,811,029 shares of Common Stock.

PART I

        This Form 10-K 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, our business turnaround objectives, our expectations for new product introductions and market conditions, headcount reductions and the expected impact on our business of legal proceedings and government regulatory actions. We have based these forward-looking statements on our current expectations about future events. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential" or "continue" or the negative of such terms or other comparable terminology. These statements are only predictions.

        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; ability to achieve profitable operations or limit losses; adverse business conditions; changes in customer order patterns; the impact of employee attrition rates; 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 timely development and successful introduction of strategic products for specific markets; inability to effectively implement our product strategies, including the introduction of a complementary server line based on the Intel processor and the Linux operating system, and the enhancement of our storage offerings through differentiated software offerings; risks related to dependence on our partners and suppliers; risks related to foreign operations (including weak or disrupted economies, unfavorable currency movements and export compliance issues); risks associated with implementation of new business practices, processes and information systems; litigation involving export compliance, 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 business transition 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.

        The following tables and discussion present certain financial information on a comparative basis. During the third and fourth quarters of fiscal 2000, respectively, we sold our Cray® product line and distributed our remaining interest in MIPS Technologies, Inc. ("MTI") through a spin-off. We believe it more relevant if certain fiscal 2001 results (revenue, gross margin and operating expenses other than restructuring activity) are compared with pro forma fiscal 2000. The pro forma results for the twelve-month periods of fiscal 2000 used throughout this discussion are adjusted to exclude the results of operations of the Cray product line and MTI.

ITEM 1. BUSINESS

General

        SGI is a leading provider of products, services and solutions for use in high-performance computing, visualization and the management of large-scale complex data. We sell highly scalable servers, advanced visualization systems, desktop workstations, storage solutions and a range of software products which enable our customers in the scientific, technical and creative communities to solve their

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most challenging problems and provide them with strategic and competitive advantages in their marketplace. We also offer a range of technical solutions, including professional services, Reality Center™ immersive visualization centers, customer support and education. These products and services are targeted primarily towards five market segments: Government and Defense, Science, Manufacturing, Energy, and Media.

Products

        SGI® systems are designed specifically to meet the needs of the scientific, technical and creative marketplaces. SGI systems utilize the IRIX® operating system, which is an enhanced version of UNIX® and feature MIPS® RISC microprocessors. In calendar 2003, SGI will expand the server line to include systems that run on Intel® Itanium 2 processors and the Linux® operating system in addition to those that run on MIPS and IRIX. Both the MIPS/IRIX and Intel/Linux-based product lines feature our innovative SGI NUMA™ architecture and provide unique levels of performance and scalability to our customers.

        Scalable Servers    The SGI Origin™ family of high-performance servers includes the Origin 3000 and Origin 300 series of systems. The Origin family of servers feature the SGI NUMA architecture and IRIX operating system, as well as SGI NUMAflex™, which allows customers to configure systems to meet their unique needs by constructing systems of modular components or "bricks". These bricks can be CPU, storage, and input/output ("I/O") components, which can be configured independently within each system. The modularity of the NUMAflex approach enables the computer system to meet the exact requirements of the customer, while maintaining optimum flexibility in meeting changing needs over time.

        Advanced Graphics Systems    For 20 years, Silicon Graphics has been synonymous with the most powerful and advanced computer graphics capabilities in the industry. Today, the SGI Onyx® family of products continues that tradition, providing the greatest resolution, the most realism and the highest levels of performance in the industry. The Onyx family of systems is built on the same high-bandwidth SGI NUMA architecture as the Origin servers and features our industry-leading InfiniteReality4™ graphics. SGI Onyx 3000 series systems integrate high-performance computing, data management, and high-performance visualization into a single system.

        SGI Reality Center™ environments are powered by SGI Onyx family systems and enable groups of decision makers to visualize complex data in an interactive manner. By immersing decision-makers in high quality, high-resolution and interactive environments, customers around the world have used this technology to increase production from oil reserves, design safer cars, interpret complex scientific data and generally enable real-time decision support.

        Visual Area Networking    In January 2002, SGI introduced a radically new concept called Visual Area Networking that enables customers to access, manipulate and visualize data over a standard network on their client computer using the massive I/O, compute and real-time rendering capabilities of an SGI Onyx. This means that individuals or teams can visualize data using "thin clients" that would not normally be able to access or display such a large amount of data. Visual Area Networking also facilitates collaboration between teams of remote users, since all the data is located at a central point, but multiple users can interactively manipulate and visualize the data. This new technology is particularly applicable to oil and gas discovery, manufacturing and defense applications.

        Desktop Systems    Our Silicon Graphics® O2®, Silicon Graphics Fuel™ and Silicon Graphics Octane® families of MIPS processor and IRIX operating system-based desktop workstations each feature advanced 3D graphics and powerful integrated imaging capabilities. Silicon Graphics O2 workstations are single-processor systems with a unique architecture that is particularly well-suited to image processing applications such as medical imaging and broadcast television graphics, while the

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single-processor Fuel and single- or dual-processor Octane2 systems are targeted at the manufacturing, defense, scientific and energy marketplaces.

        SAN and Data Management    Customers across the high-performance computing ("HPC") markets desire ever increasing performance from their servers, creating a parallel need to manage massive amounts of data generated by these servers. To address the problem of managing such large amounts of complex data, SGI has developed a series of products and solutions to help customers access and utilize their data in a more efficient manner, resulting in better workflow management, faster cycle times, and higher levels of performance, availability, and security.

        SGI offers a broad range of disks and disk subsystems, ranging from entry-level disk arrays to complex enterprise-class storage systems, in either direct- or fabric-attached configurations. As an industry leader in delivering high-bandwidth storage area networks ("SAN") for the HPC market, SGI offers SAN solutions based on tightly integrating our CXFS™ shared filesystem, along with SGI's FailSafe™ high-availability software and Data Migration Facility ("DMF") for hierarchical storage management. SGI also has network attached storage offerings through a range of file-serving solution bundles.

        Alias/Wavefront    Our Alias/Wavefront subsidiary develops award-winning solutions for the film and video, game, interactive media, industrial design, and visualization markets. These solutions-Maya® software for the entertainment industry and Alias Studio™ tools for design-give artists a distinct creative advantage, no matter what their discipline. These industry-leading solutions run on the IRIX, Linux, Windows®, and Macintosh® operating systems. Alias/Wavefront is based in Toronto, Canada, with sales offices and distribution worldwide.

        Applications Software    We maintain active programs to encourage independent software development for our systems. Through our Global Developer Program we provide hardware, software, service, and marketing support benefits to attract and retain software developers and enable these developers to deliver the highest quality software and hardware products on our platform.

Marketing, Sales, and Distribution

        We sell our system products and solutions through both our direct sales force and indirect channel partners. In fiscal year 2002 direct sales accounted for more than half of our product revenues. The direct sales and support organization operates throughout the United States and in all significant international markets. We also have channel partners in almost all the countries in which we have a presence; in others, we work through an SGI authorized distributor.

        Our indirect channel partners include service providers, systems integrators, VARs, ISVs, distributors and master resellers.

        Information with respect to international operations and export sales may be found in Note 9 to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K. See also "Risks That Affect Our Business" included in Part II, Item 7 of this Form 10-K. No single end-user customer accounted for 10% or more of our revenues for each of the last three fiscal years.

Technical Solutions

        The quality and reliability of our products and our understanding of our customer's technical and business challenges is critical to our success. Our SGI Technical Solutions organization includes systems engineers, solution architects, field service engineers, field product and applications specialists, product support engineers, training specialists, and administrative support personnel. We also provide customer education through regularly scheduled courses in system software administration, applications programming, and hardware maintenance. We provide local customer support from offices in North

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America, Western Europe, the Pacific Rim, and certain Latin American countries with spare parts inventories at each location. International distributors provide training and support for products sold by them. We typically provide a standard "return-to-factory" hardware warranty against defects in materials and workmanship for periods of up to three years.

Research and Development

        Our research and development program is directed principally toward maintaining and enhancing our competitive position through incorporating the latest advances in microprocessor, hardware, software and networking technologies. This effort is focused specifically on developing and enhancing our computing architectures, graphics subsystems, MIPS microprocessors, operating system, applications software and development tools. We also are leveraging our work on our MIPS and IRIX systems to introduce systems that incorporate the Intel Itanium family of processors.

        As the evolution to industry-standard instead of proprietary components continues, our ability to focus research and development investments in areas where we have specific competencies for innovation will become increasingly important. There are no assurances that we will be able to sufficiently focus our development efforts or that our investments will yield sufficient differentiation to achieve and sustain a competitive advantage.

        During fiscal 2002, 2001 and 2000, we spent approximately $177 million, $236 million and $301 million, respectively, on research and development that represented approximately 13% of total revenue in each period. Fiscal 2000 includes research and development associated with the Cray product line and MIPS Technologies, Inc. ("MTI"), which were divested in the latter part of fiscal 2000. We are 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. However, declines in total revenue over the last several fiscal years have led us to substantially reduce the absolute level of our investment in research and development.

Manufacturing

        Our 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.

        During fiscal 2002, we closed our manufacturing facility located in Switzerland and consolidated manufacturing activities in our main manufacturing facility located in Chippewa Falls, Wisconsin. We continually evaluate the allocation of manufacturing activities among our own operations and those of suppliers and subcontractors.

        Most of our products incorporate components that are available from only one or limited sources. Key components that are sole-sourced include application specific integrated circuits ("ASICs"), microprocessors, storage products, especially RAID-based products, and certain cable and memory products. We have chosen to deal with sole sources in these cases because of unique technologies, economic advantages or other factors. But reliance on single or limited source vendors involves several risks, including the possibility of shortages of key components. Risks also include long lead times, reduced control over delivery schedules, and the possibility of charges for excess and obsolete inventory.

        We also have single sources for less critical components, such as peripherals, communications controllers and power supplies, and monitors and chassis. We believe that in most cases we could develop alternative sources for these components if necessary. However, unexpected reductions, interruptions or price increases would, at least in the short term, adversely affect our results.

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        Certain of our suppliers are located outside the United States. Pricing from these suppliers can be strongly affected by such factors as trade protection measures and changes in currency exchange rates. In addition, the markets for memory chips (DRAMs, SRAMs and VRAMs), that are a significant component of our overall systems cost, tend to be highly volatile both in terms of pricing and availability.

Competition

        The computer industry is highly competitive and is known for rapid technological advances. 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 for us 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. Significant discounting from list price has been the norm in the industry.

        Our principal competitors are IBM, Hewlett Packard, NEC, Cray and, in some markets, Sun Microsystems. Our unique market focus on technical and creative users provides advantages in being able to design our systems specifically for these users. Our competitors, however, are generally far larger companies with much greater resources.

Proprietary Rights and Licenses

        We own and have applied for a significant number of U.S. patents, and will continue to protect our inventions with patents in the United States and abroad. We also hold various U.S. and foreign trademarks.

        As is customary in our industry, we license from third parties a wide range of software, including the UNIX and Linux operating systems, for internal use and use by our customers.

        Our business will be affected by our success in protecting proprietary information and obtaining necessary licenses. Litigation or changes in the interpretation of intellectual property laws could expand or reduce the extent to which we or our competitors are able to protect intellectual property or could require significant changes in product design. The computer industry has seen a substantial increase in litigation with respect to intellectual property matters, and we have been engaged in several intellectual property lawsuits both as plaintiff and defendant. Although no such proceedings were pending as of June 28, 2002, we expect that litigation of this sort will reoccur from time to time.

Employees

        As of June 28, 2002, we had 4,443 regular employees compared with 5,956 at June 30, 2001. Our future success will depend, in part, on our ability to continue to retain and motivate highly qualified technical, marketing and management personnel. We have never had a work stoppage, and no employees are represented by a labor union. We have workers' councils where required by European Union or other applicable laws. We believe that our employee relations are good.

Corporate Data

        SGI was originally incorporated as a California corporation in November 1981, and reincorporated as a Delaware corporation in January 1990.

ITEM 2. PROPERTIES

        SGI owns and leases sales, service, R&D, and administrative offices worldwide and has its principal facilities in California, Wisconsin and Minnesota. Our corporate headquarters and certain

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R&D operations are located in Mountain View, California, where we lease a total of about 868,000 square feet. Our primary manufacturing facility is located in Chippewa Falls, Wisconsin, where we own and lease about 429,000 square feet for manufacturing, service and R&D activities. We also have leased sales, administrative and R&D facilities of about 241,000 square feet in Eagan, Minnesota.

        As a result of restructuring over the last several years, we also own and lease additional space that we do not currently expect to use in our operations. We own a facility consisting of about 170,000 square feet in Cortaillod, Switzerland that was used until December 2001 as our European manufacturing site. This property is currently being offered for sale or lease. We also lease 3 other buildings near our Mountain View headquarters (about 154,000 square feet) and an additional 50 leased facilities worldwide (about 327,000 square feet), under leases that expire through fiscal 2010. The anticipated costs associated with these facilities, net of estimated sublease income, have been accrued in prior restructuring charges. See Note 3 to Consolidated Financial Statements.

ITEM 3. LEGAL PROCEEDINGS

        Information regarding legal proceedings is set forth in Note 22 to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K, which information is hereby incorporated by reference.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        None.

Executive Officers of the Registrant

        The executive officers of SGI and their ages as of August 31, 2002 are as follows:

        Executive officers of SGI 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 SGI.

        Mr. Bishop was appointed Chairman and Chief Executive Officer of SGI in the fall of 1999. From July 1995 to February 1999, he was the non-executive Chairman of the Board of Silicon Graphics World Trade Corporation.

        Mr. Pratt was appointed Chief Operating Officer of SGI in May 2001. He has held a variety of general and engineering management positions at SGI since 1991 and was made Executive Vice President of Engineering and Manufacturing in July 2000. Prior to that and beginning in 1998, he served as President and General Manager of SGI's Alias/Wavefront subsidiary.

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        Mr. Coggins was appointed Senior Vice President, Europe, the Middle East and Africa, of SGI in July 2001. Prior to joining SGI, he was senior vice president and general manager of Amdahl Europe. He had been employed by Amdahl Corporation, including five years as the marketing director of Amdahl Europe, since 1977.

        Ms. Escher was made Senior Vice President and General Counsel in May 2001. She was appointed Vice President and General Counsel in April 1999. She joined SGI in July 1993 as Securities Counsel and served as the Director of Corporate Legal Services between September 1996 and April 1999.

        Dr. Goh was appointed Senior Vice President and Chief Technology Officer in May 2001. He was made Vice President and Chief Technology Officer in October 2000, Vice President of Global Systems Engineering in October 1999 and a Chief Scientist in 1998. He joined SGI in 1989 and has held a variety of systems engineering positions since that time.

        Ms. Lanterman became Vice President, Corporate Controller in April 2002. She joined SGI in July 2001 as Assistant Controller. Prior to joining SGI, she consulted as a project manager at various high-tech companies including HP, SGI, Fujitsu PC and Logitech. She was a consultant to SGI from April 1999 until she was hired in 2001, working on projects including the implementation of our global ERP system and the Cray divestiture.

        Mr. La Rosa joined SGI in September 2001 as Senior Vice President, Intercontinental (Asia Pacific and Latin America) Field Operations. Prior to joining SGI, he was senior vice president, worldwide sales, of CommVault Systems, Inc. in 2001. Prior to that, Mr. La Rosa held several executive positions in U.S. and international sales and marketing with IBM between 1992 and 2000. Before joining IBM, he was President of American Motion Systems, CEO of Lead Group International and held a number of US- and internationally-based executive management and technical positions at GE from 1967 to 1986.

        Mr. Robbins was made Senior Vice President, North American Field Operations of SGI in July 2001. He was appointed Vice President, U.S. Federal Systems in 1997 and President of SGI's Silicon Graphics Federal subsidiary upon its formation in September 1999. He has held a variety of sales and sales management positions at SGI since 1991.

        Mr. Silverman was appointed Senior Vice President, Marketing in April 2001. He joined SGI in May 1999 as Vice President, Server Marketing. Prior to joining SGI, he was with Hewlett Packard for ten years and held a number of marketing director, business development and product management positions, including the head of marketing for Internet Imaging Operations and Director of Internet Solutions.

        Mr. Zellmer became Senior Vice President and Chief Financial Officer of SGI in July 2001. He was appointed Vice President, Corporate Controller in July 2000. Since 1988, he has held a variety of financial management positions at SGI, and MIPS Computer Systems which was acquired by SGI in 1992.

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PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

        SGI's common stock is traded on the New York Stock Exchange under the symbol 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 for Common Stock

        SGI had 6,451 stockholders of record as of June 28, 2002. We have not paid any cash dividends on our common stock. As a result of our accumulated deficit position and restrictions in certain debt instruments, we do not anticipate paying cash dividends to common stockholders.

ITEM 6. SELECTED FINANCIAL DATA

        The following selected financial information has been derived from the audited consolidated financial statements. The information set forth in the table below is not necessarily indicative of results of future operations, and should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and related footnotes included in Item 8 of this Form 10-K in order to fully understand factors that may affect the comparability of the information presented below. For example, Item 7 presents certain information on a pro forma basis, reflecting adjustments for certain changes in our business operations in fiscal 2000.

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(1)

Fiscal 2002 amounts include net restructuring charges ($33 million) and impairment charges ($12 million). Fiscal 2001 amounts include net restructuring charges ($82 million) and impairment charges ($20 million). Fiscal 2000 amounts include net restructuring charges ($65 million) and impairment charges ($38 million). Fiscal 1999 amount includes a reduction 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).

(2)

Fiscal 2002 amounts include a $64 million gain on sale of 60% interest in SGI Japan and $24 million in class action lawsuit settlement expense. Fiscal 2001 amounts include an $83 million write-off of our investment in a private company and $50 million in gains from the sale of marketable investments. Fiscal 2000 amounts include a loss on the sale of the Cray product line ($8 million). See Note 7 to the Consolidated Financial Statements, "Sale of Cray Product Line". Fiscal 1999 amount includes a $273 million gain on the sale of a portion of SGI's interest in MTI.

(3)

Amounts reflect the March 31, 2000 sale of our Cray product line.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

        SGI has had declining revenue and has been unprofitable on an operating basis for each of the past five fiscal years as we have felt the impact of the slowdown in the economy, strong competition from much larger companies, technologies and product families in transition and management and employee turnover. As part of our plan to restore growth and profitability to SGI, we took several major steps in both fiscal 2002 and 2001 to refocus our operations. We restructured our overall operations, including closing our manufacturing operations in Switzerland and consolidating operations in Wisconsin, reorganizing our services business, discontinuing our Pentium® III-based product line, resulting in noticeable improvements in our gross margins as a percentage of revenues. We also continued to manage significant reductions in operating expenses over the last two fiscal years

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compared with fiscal 2000 levels. These changes substantially reduced the scope of our operating losses in fiscal 2002. To further improve our financial condition during fiscal 2002, we generated more than $150 million in cash from licensing and sales transactions involving assets including real estate, intellectual property, and a majority equity position in SGI Japan. While substantial progress was made in fiscal 2002, we continue to focus on actions intended to restore long-term growth and profitability.

        The following tables and discussion present certain financial information on a comparative basis. During the third and fourth quarters of fiscal 2000, respectively, we sold our Cray product line and distributed our remaining interest in MTI through a spin-off. We believe it more relevant if certain fiscal year 2001 results (revenue, gross margin, interest and other, and operating expenses other than restructuring activity) are compared with pro forma fiscal 2000 results. The pro forma results for the twelve-month period of fiscal 2000 used throughout this discussion are adjusted to exclude the results of operations of the Cray product line and MTI.

Results of Operations

Revenue

        The following discussion of revenue is based on the results of our reportable segments as described in Note 18 to the Consolidated Financial Statements. Total revenue is principally derived from three reportable segments: Servers, Visual Workstations and Global Services, which were determined based on factors including customer base, homogeneity of products, technology, delivery channels and other factors. Effective for fiscal 2002, we reorganized our Global Services segment and removed the remanufactured systems sales from this segment. Revenue from remanufactured systems is included in the servers and visual workstations reportable segments. Prior year amounts have been restated to conform to current year presentation.

        Total revenue in fiscal 2002 decreased $513 million or 28% compared with fiscal 2001, and fiscal 2001 revenue decreased $206 million or 10% compared with pro forma fiscal 2000. Revenue for fiscal 2002 included a one-time receipt of $63 million from Microsoft resulting from an agreement involving a patent cross-license and the transfer of certain of SGI's intellectual property rights. The decline in revenue from fiscal 2001 to fiscal 2002 reflects a general economic slowdown and a significant downturn in IT spending, strong competition from much larger companies and products based on processors with higher peak performance benchmarks, the impact of no longer consolidating the revenue of SGI Japan, the discontinuance of certain visualization workstations based on Pentium III microprocessors, and other factors discussed below that affected particular product families. We expect

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certain of the factors mentioned above to continue to have an adverse impact on our revenue levels going forward. See "Risks That Affect Our Business."

        The following table presents total revenue by reportable segment with prior year segments restated to reflect current year presentation:

        Fiscal 2002 Server revenue (which includes Onyx, Visual Area Network and Storage products) decreased $231 million or 31% compared with fiscal 2001. The decrease primarily reflects declines across all product families within this segment, namely visualization systems, high-performance servers and integrated storage solutions. This decline is primarily attributable to concern about the slowdown in the economy that is causing private sector businesses to delay the acquisition of technology wherever possible. Fiscal 2001 Server revenue decreased $34 million or 4% compared with pro forma fiscal 2000. This decline primarily reflects lower revenue levels within our Origin brand scalable server business and our Onyx graphics system business. Limited availability in the first half of fiscal 2001 of the industry-standard ceramic packaging used in ASICs for our Origin and Onyx 3000 systems as well as a slowdown in the economy affected overall shipping patterns within these businesses. Server revenue levels are also affected by competitive factors, including processor speeds, improvements in commodity graphics performance, the suitability of low-cost cluster solutions for certain application segments, and the timely release of key software applications on the IRIX operating system. See "Risks That Affect Our Business."

        Fiscal 2002 Visual Workstation revenue decreased $160 million or 40% compared with fiscal 2001. The decrease is primarily attributable to the continuing decline in the overall UNIX® workstation market. In addition, during the fourth quarter of fiscal 2001, we announced the discontinuance of certain visualization workstations based upon Intel® 32-bit microprocessors, the impact of which also contributed to the year over year decline in Visual Workstation revenue. Fiscal 2001 Visual Workstation revenue decreased $123 million or 24% compared with pro forma fiscal 2000. The decrease in revenue is primarily attributable to the declining UNIX workstation market, especially within the O2 product family. Fiscal 2000 results were also adversely impacted by the disappointing sales performance of our visual workstations based on the Windows NT® operating system. In light of the disappointing sales performance of our proprietary architecture Silicon Graphics® 320 and Silicon Graphics® 540 visual workstations, we decided to discontinue this product family in favor of products with more industry standard architectures and recorded charges to cost of revenue during fiscal 2000 related to this transition. See "Gross Profit Margin" and "Operating Expenses."

        Global Services revenue is comprised of hardware and software support and maintenance and professional services. Fiscal 2002 Global Services revenue decreased $141 million or 24% compared with fiscal 2001. This decrease is primarily attributable to declines in our professional services revenue as a result of the restructuring of our service organization and in our traditional customer support revenue which is being affected by a lower volume of system sales. Fiscal 2001 Global Services revenue

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decreased $8 million or 1% compared with pro forma fiscal 2000. The slight decrease in revenue is primarily attributable to a decline in our traditional customer support revenue, offset in part by the growth of business within our professional services organization.

        Other revenue is generally comprised of our operating units that are not reportable segments, including the product and service revenue of our application software subsidiary, Alias/Wavefront. Fiscal 2002 other revenue includes a one-time receipt of $63 million from Microsoft resulting from an intellectual property agreement involving a patent cross-license and the transfer of certain of SGI's intellectual property rights. Excluding the revenue associated with the one-time receipt of $63 million from Microsoft, Other revenue decreased $44 million or 40% in fiscal 2002 compared with fiscal 2001, primarily due to a decline in Alias/Wavefront revenue.

        Total revenue by geographic area for fiscal 2002, 2001 and 2000 was as follows (in millions):

        Geographic revenue as a percentage of total revenue for fiscal 2002, 2001 and 2000 was as follows:

        The fluctuation in geographic revenue as a percentage of total revenue between the Americas and Rest of World business in fiscal 2002 compared with fiscal 2001 is primarily due to the impact of no longer consolidating the revenue of SGI Japan. A decrease in sales in the Asia Pacific region in fiscal 2002 compared with fiscal 2001 also contributed to the decline in Rest of World revenue as a percentage of total revenue. The increase in Rest of World business in fiscal 2001 compared with fiscal 2000 primarily reflects increased sales in Japan as a percentage of total revenue.

        Our consolidated backlog at June 28, 2002 was $159 million, down from $209 million at June 30, 2001. Backlog declined across all segments of our business and across all regions. Backlog is comprised of committed purchase orders for products and professional services deliverable within six to nine months, depending on the product family.

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.

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        Our overall gross profit margin increased to 43% in fiscal 2002 compared with 33% in fiscal 2001. Excluding the $63 million in revenue recognized from the Microsoft intellectual property agreement, gross margin was 40% for fiscal 2002. Gross margin improvements in fiscal 2002 are primarily attributable to decreases in manufacturing overhead expense in the second half of fiscal 2002 due to the closure of our manufacturing facility in Switzerland, the completion of the restructuring that was announced in the first quarter of fiscal 2002, and a better product mix. The restructuring included the closure of our manufacturing facility in Switzerland and the reorganization of our services business, which has had a significant impact on the increase in our service margins. Gross margin improvements in fiscal 2002 were offset slightly due to the change in SGI Japan's status during the second quarter of fiscal 2002 to a distribution model, which negatively affects gross margin. See "Impact of SGI Japan Transaction."

        Our overall gross profit margin increased to 33% in fiscal 2001 compared with 32% in pro forma fiscal 2000. Gross profit margin for fiscal 2001 includes a $19 million charge for inventory costs related to the discontinuation of the Pentium III processor-based product line. Without this charge, gross margin for fiscal 2001 would have been 34%. Gross margin for fiscal 2001 was affected by the limited availability of certain components in the first and second quarters of fiscal 2001 which affected shipping patterns and was a factor in causing a higher percentage of revenue to come from lower margin products.

        Fiscal 2000 gross profit margin includes certain adjustments related to our Silicon Graphics 320 and 540 visual workstations, including charges of approximately $46 million for third party manufacturing contract cancellations and purchase commitments and for excess product and demonstration inventory. Also, during fiscal 2000, we charged $21 million to cost of service revenue for future unrecoverable visual workstation support costs. In addition, we recorded a $15 million charge to cost of service revenue for estimated warranty related costs associated with the Cray T90™ supercomputer product line and $18 million for the write-down of excess spares. Without these adjustments, our gross profit margin for fiscal 2000 would have been 37%.

Operating Expenses

        Our total fiscal 2002 operating expenses decreased $383 million or 36% compared with fiscal 2001. Fiscal 2002 operating expenses included $44 million of charges for restructuring and impairment costs. The significant decline in operating expenses year over year is due to an overall expense reduction program aimed at bringing expenses in line with lower revenue levels. Total fiscal 2001 operating expenses decreased $58 million or 5% compared with pro forma fiscal 2000. Fiscal 2001 operating expenses included $102 million of charges for restructuring and impairment and $18 million of charges as a result of the implementation of an Enterprise Resource Planning ("ERP") system and costs associated with a business reorganization. Pro forma fiscal 2000 operating expenses included a net charge of $103 million for estimated restructuring and impairment charges.

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        Research and development    Fiscal 2002 research and development spending decreased $59 million or 25% compared with fiscal 2001. The fiscal 2002 decrease reflects overall reduction in headcount as a result of the continued restructuring of the company to align expenses with lower revenue levels. Research and development spending decreased $17 million or 7% in fiscal 2001 compared with pro forma fiscal 2000. The fiscal 2001 decrease reflects reductions in headcount as well as more concentrated research and development efforts.

        Selling, general and administrative    Fiscal 2002 selling, general and administrative expenses decreased $267 million or 37% compared with fiscal 2001. This decrease in operating expenses resulted primarily from lower headcount as a result of restructuring and personnel attrition, and the impact of our overall expense control measures aimed at bringing operating expenses more in line with revenues. Selling, general and administrative expenses decreased $40 million or 5% in fiscal 2001 compared with pro forma fiscal 2000. The fiscal 2001 decrease reflects reduced headcount as a result of restructuring activities and attrition, significantly reduced commission and outside service expenses and the impact of our overall expense control measures aimed at bringing operating expenses more in line with revenues. The decrease was partially offset by the $18 million of charges as a result of the implementation of an ERP system and costs associated with a business reorganization.

        Other operating expense    Other operating expense for fiscal 2002 represents a charge for estimated restructuring of $46 million and charges of $12 million associated with the impairment of assets, partially offset by adjustments to previously recorded restructuring charges of $13 million. Other operating expense for fiscal 2001 represents a charge for estimated restructuring of $88 million and charges of $20 million associated with the impairment of assets, partially offset by adjustments to previously recorded restructuring charges of $6 million. Other operating expense for fiscal 2000 represents a net charge for estimated restructuring costs of $103 million. As a result of these restructuring actions, we anticipate cash outflows of $11 million through fiscal 2003 for severance and related charges and canceled contracts and $28 million through fiscal 2010 for facilities related expenditures, net of estimated sublease income. See Note 3 to the Consolidated Financial Statements, "Other Operating Expense," for further information regarding these activities.

Interest and Other

        Interest Expense    Interest expense increased 16% in fiscal 2002 compared with fiscal 2001 and increased 4% in fiscal 2001 compared with fiscal 2000. The increase in interest expense in fiscal 2002 is primarily attributable to a full year of interest expense associated with our financing arrangement (see Note 12, "Financing Arrangement") and higher interest associated with the reset interest rate on the restructured Japan debt as compared with fiscal 2001 (see Note 6, "Sale of Interest in SGI Japan").

        Interest Income and Other, Net    Interest income and other, net includes interest income on our cash investments, gains and losses on other investments, and other non-operating items. Interest income and other, net for fiscal 2002 is primarily comprised of a $64 million gain from the sale of 60% of our interest in SGI Japan recognized in the second quarter of fiscal 2002, partially offset by a charge of $24 million for the settlement of a securities class action lawsuit involving a payment of $4 million in cash and the issuance of 8 million shares of common stock, and a $4 million loss on the sale of a building recognized in the first quarter of fiscal 2002. Interest income and other, net for fiscal 2001 includes an $83 million write-off of a private investment, a $50 million gain on the sale of marketable investments, a $24 million gain related to the sale of the Cray product line, and an $8 million gain on the sale of corporate real estate. Significantly lower cash balances in fiscal 2001 compared with fiscal 2000 also contributed to a decrease in interest income.

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Provision for Income Taxes

        Our net benefit for income taxes for fiscal 2002 totaled $36 million and arose principally from a change in the U.S. income tax laws that resulted in additional U.S. income tax refunds related to the operating results of fiscal 2001. Offsetting this federal income tax benefit are various provisions for income taxes payable in state and foreign jurisdictions. We did not recognize a benefit for our fiscal 2002 loss, since the resulting deferred tax asset does not meet the realizability criteria under SFAS No. 109.

        In fiscal 2001, we made a provision for income taxes totaling $27 million, which was comprised of federal, state, and foreign jurisdictional taxes currently payable. We did not recognize a benefit for our fiscal 2001 loss, since the resulting deferred tax asset does not meet the realizability criteria under SFAS No. 109.

        At June 28, 2002, we had gross deferred tax assets arising from deductible temporary differences, tax losses, and tax credits of $782 million. Gross deferred tax assets are offset by a valuation allowance of $700 million and deferred tax liabilities of $84 million. The valuation allowance of $700 million includes $23 million attributable to benefits of stock option deductions, which, if recognized, will be allocated directly to paid-in-capital.

        At June 28, 2002, we had United States federal and foreign jurisdictional net operating loss carryforwards of approximately $1,068 million and $193 million, respectively. The federal losses will begin expiring in fiscal year 2007 and the foreign losses will begin expiring in fiscal year 2003. At June 28, 2002, we also had general business credit carryovers of approximately $37 million for United States federal tax purposes, which will begin expiring in fiscal year 2003.

Impact of SGI Japan Transaction

        During the second quarter of fiscal 2002, we sold a 60% equity interest in SGI Japan to NEC and NEC Soft. This transaction has affected our fiscal 2002 results in several ways. As a minority shareholder, we no longer consolidate the financial results of SGI Japan. We also recognize revenue based on the contractual distribution price of products sold to SGI Japan, which for the initial term of our distribution agreement is based on historical pricing. Gross margins are negatively affected by the shift to distributor pricing, which is lower than the price to ultimate customers, offset to some extent by the amortization of the deferred revenue of $10 million which was allocated to the fair value of the exclusive distribution agreement. This deferred revenue is being recognized as revenue over the three-year period beginning in the third quarter of fiscal 2002.

        The fourth quarter results we announced on July 23, 2002 also reflected the elimination of a $5 million restructuring accrual and a $7 million deferred tax valuation allowance, which were no longer required following our sale of the majority interest in SGI Japan. We have determined that these reversals are more appropriately recognized in our second quarter results, and accordingly, have adjusted Note 24 to the Consolidated Financial Statements, "Selected Quarterly Financial Data (unaudited)." The second quarter results are adjusted to reflect the following changes to our previously reported second quarter results: a $5.5 million decrease in each of other operating expense and operating loss, a $5.5 million increase in income before taxes, a $12.1 million increase in net income, a $0.07 increase in net income per basic share, and $0.05 increase in net income per diluted share. These adjustments have an offsetting impact on the previously announced fourth quarter of fiscal 2002 results. These adjustments did not affect our announced operating results (excluding restructuring) for any quarter, did not have a cash impact and did not change our full fiscal year 2002 results.

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Financial Condition

        At June 28, 2002, cash and cash equivalents and marketable investments totaled $218 million compared with $126 million at June 30, 2001. Also, included in the balance sheet at June 28, 2002 and June 30, 2001 is approximately $45 million and $77 million, respectively, of restricted investments. Restricted investments at June 28, 2002 and June 30, 2001 consist of short and long-term investments pledged as collateral against bank credit facilities. The increase in cash and cash equivalents over prior year is a result of the company's continued focus on cash management, including a focus on account collections and inventory management. Additionally, cash has been supplemented by the sale of assets during the fiscal year, including the sale of a 60% interest in SGI Japan.

        Primarily as a result of net losses, operating activities used $13 million in cash for fiscal 2002, compared with using $282 and $76 million in fiscal 2001 and 2000, respectively. Operating cash flows for fiscal 2002 benefited from $63 million in one-time revenue from the Microsoft intellectual property agreement that was received in the first quarter. To present cash flows from operating activities, net loss for each of the past three years had to be adjusted for certain significant items. Fiscal 2002 net loss is adjusted to remove the impact of a gain of $64 million from the sale of the 60% interest in SGI Japan that is reflected as a cash flow from investing activities. Fiscal 2001 net loss is adjusted to remove the impact of a non-cash charge of $83 million for the write-off of an investment in a private company and a gain of $50 million on the sale of marketable investments that is reflected as a cash flow from investing activity. Included in fiscal 2000 adjustments is an increase of $369 million in our valuation allowance against our remaining deferred tax asset and a tax charge of $93 million related to repatriating accumulated foreign earnings. Partially offsetting these charges is a reduction of $67 million in previously provided income taxes related to certain exposures that were no longer necessary given the increase in the valuation allowance against our deferred tax assets.

        Investing activities, other than changes in our marketable and restricted investments, provided $78 million in cash during fiscal 2002. The principal investing activity during fiscal 2002 was the sale of a 60% interest in SGI Japan for proceeds of $91 million and the sale of corporate real estate and other assets for proceeds of $29 million. These proceeds were offset in part by capital expenditures totaling $28 million. Investing activities, other than changes in our marketable and restricted investments, provided $194 million in cash during fiscal 2001. The principal investing activity during fiscal 2001 was the sale of certain corporate real estate for total cash proceeds of $278 million. These proceeds were partially offset by capital expenditures, including capitalized costs associated with our global ERP system. Investing activities, other than changes in our marketable and restricted investments consumed $349 million in cash during fiscal 2000. The principal investing activity during fiscal 2000 was for the acquisition of capital equipment and our election to exercise an option to purchase five buildings on our Mountain View campus for approximately $125 million that had been held under an off-balance sheet financing arrangement. In addition, cash was reduced by $84 million in fiscal 2000 as result of the spin-off of MTI that is no longer included in our consolidated balance sheet.

        Financing activities over the past three years have included the issuance of common stock under employee stock purchase and option plans, the repurchase of common stock and the repayment of debt. The principal financing activity during fiscal 2002 included the retirement of a $13 million mortgage on our manufacturing facility in Switzerland and the non-cash restructuring of the yen denominated debt from $50 million to $37 million in the second quarter in conjunction with the sale of a majority equity interest in SGI Japan.

        During the fourth quarter of fiscal 2001, we obtained an asset-based credit facility. Available credit is determined monthly based on 85% of eligible accounts receivable, up to a maximum of $75 million. To date, we have used $50 million of this line to secure letters of credit. The credit facility matures in April 2003, and we currently intend to renew or replace this facility at maturity. The facility is currently secured by U.S. accounts receivable and inventory, the pledge of certain intellectual property and a

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$7 million cash deposit. From time to time, we also deposit additional cash, reflected in our restricted cash balances, to secure certain letters of credit or to address fluctuations within the quarter of eligible accounts receivable. The credit facility also contains financial and other covenants. We were not in compliance with the financial covenants in the fourth quarter of fiscal 2001 or the second, third and fourth quarters of fiscal 2002, which were waived by the lenders. In the event we are not able to comply with the financial and other covenants of this facility in the future, or there is a material adverse change impairing our ability to repay the outstanding balance, the facility may be declared to be in default. If a default is declared and not waived, or if the facility matures and is not renewed or replaced it could have a significant impact on our working capital.

        We have incurred net losses and negative cash flows from operations during each of the past three fiscal years. Primarily as a result of substantial business restructuring and expense reductions, we reduced our net loss and cash consumed from operations significantly from fiscal 2001 to fiscal 2002. Through improved operational execution and the sale of non-core assets, we also improved our cash position substantially during fiscal 2002. At June 28, 2002, our principal sources of liquidity included unrestricted cash and marketable investments of $218 million, up from $126 million at June 30, 2001. While a forecast of future events is inherently uncertain, we believe that the combination of our current resources and cash expected to be generated from our fiscal 2003 operating plan will provide sufficient funding to enable the Company to meet its obligations during fiscal 2003. We are committed to the successful execution of our operating plan and business turnaround, and will take steps if necessary to further restructure our business operations to reduce expenses and improve working capital. The failure to achieve our objectives for fiscal 2003 revenue and operating results or significant changes in the terms of our relationships with key suppliers, could result in our not having adequate liquidity to manage our business.

        Future payments due under debt and lease obligations as of June 28, 2002 are as follows (in thousands):

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Critical Accounting Policies and Estimates

        SGI's discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, we evaluate these estimates, including those related to customer programs and incentives, product returns, bad debts, inventories, warranty obligations, impairment of long-lived assets and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

        Management has discussed the development and selection of the following critical accounting policies and estimates with the audit committee of our board of directors and the audit committee has reviewed our disclosures relating to them.

        We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. For all these policies, we caution that future events often do not develop exactly as forecast, and that even the best estimates routinely require adjustment.

        Revenue Recognition    A majority of our revenue is derived from product sales which is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable and collectibility is reasonably assured. Certain of our revenue is generated from high performance systems that may include customer acceptance criteria and for which revenue is deferred until such acceptance is obtained. Our product revenue is derived from product sales that require estimates for sales returns and other allowances at the time of revenue recognition. These estimates are based on historical information, current economic trends and other factors. If the data used to calculate these estimates does not properly anticipate future returns and allowances, revenue could be misstated. To date, actual experience has been consistent with our estimates.

        Product Warranties    We provide for the estimated cost to warrant our products against defects in materials and workmanship at the time revenue is recognized. We estimate our warranty obligation based on factors such as product lifecycle analysis and historical experience, and our estimate is affected by data such as product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required. On a quarterly basis, these estimates are reviewed and adjusted as considered necessary based on the factors noted above.

        Bad Debt    We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. When we become aware of a specific customer's inability to pay their outstanding obligation for reasons such as a deterioration in their operating results or financial position or bankruptcy proceedings, we record a specific reserve for bad debt to reduce their receivable to an amount we reasonably believe is collectible. If the financial condition of specific customers were to change, our estimates of the recoverability of receivables could be further adjusted. We also record allowances for doubtful accounts for all other customers based on a variety of factors including the length of time the receivables are past due and historical experience. On a quarterly basis, these estimates are reviewed and adjusted as considered necessary based on the criteria noted above.

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        Manufacturing and Spares Inventory    We write down our inventory for estimated excess, obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value. At every balance sheet date, we perform an in depth excess and obsolete analysis of all manufacturing inventory parts on order and on hand based upon assumptions about future demand and current market conditions. For all spares inventory on hand, our analysis is based on assumptions about product life cycles, historical usage, current production status and installed base. Additional adjustments to inventory may be required if actual market conditions are less favorable than those projected by us during the analysis.

        Deferred Taxes    We regularly assess the likelihood that our deferred tax assets will be realized from recoverable income taxes or recovered from future taxable income over the next three years, and we record a valuation allowance to reduce our deferred tax assets to the amount that we believe to be more likely than not realizable.

        Restructuring    In recent fiscal years, we have recorded significant accruals in connection with our restructuring programs. These accruals include estimates of employee separation costs and the settlements of contractual obligations including lease terminations resulting from our actions. Accruals associated with vacated facilities and related asset impairments are estimated in accordance with Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies" ("SFAS 5"). Estimates may be adjusted upward or downward upon occurrence of a future triggering event. Triggering events may include, but are not limited to, changes in estimated time to sublease, sublease terms and sublease rates. Due to the extended contractual obligations of certain of these leases and the inherent volatility of commercial real estate markets, we expect to make future adjustments to these vacated facilities accruals.

        Loss Contingencies    We record an obligation for loss contingencies when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Contingent liabilities are often resolved over long time periods and there is a reasonable probability that the ultimate loss will exceed the recorded provision. Estimating probable losses requires analysis of multiple factors that often depend on judgements about the outcome of pending lawsuits and potential actions by third parties including government agencies.

        Long-term Investments    We hold or have held investments in other companies which are accounted for under either the cost method or equity method of accounting and we monitor these investments for impairment on a periodic basis. Some of these companies are publicly traded and have volatile share prices, while many of these companies are not publicly traded and therefore the fair value may be difficult to determine. Many of our investments in non publicly traded companies represent emerging technology companies which are inherently risky because the markets for the technologies or products they have under development are typically in the early stages and may never develop. In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis for the investment is established. Fair values for investments in public companies are determined using quoted market prices. Fair values for investments in privately-held companies are estimated based upon factors such as liquidation values, the values of recent rounds of financing, or quoted market prices of comparable public companies. To determine whether a decline in value is other-than-temporary, we evaluate, among other factors: the duration and extent to which the fair value has been less than the carrying value; the financial health of and specific prospects for the company; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value.

        Other Significant Accounting Policies    Other significant accounting policies not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies regarding financial instruments, stock-based compensation and consolidation require difficult judgements on complex matters that are often subject

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to multiple sources of authoritative guidance. Certain of these matters are among topics currently under reexamination by accounting standards setters and regulators. Although no specific conclusions reached by these standards setters appear likely to cause a material change in our accounting policies, outcomes cannot be predicted with confidence. Also see Note 2 "Summary of Significant Accounting Policies" which discusses accounting policies that must be selected when there are acceptable alternatives.

Recent Accounting Pronouncements

        In June 2001, The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," which eliminates the pooling-of-interest method and provides a single-method approach, the purchase method, for the accounting for all business combinations, as well as new criteria for recognition of intangible assets. SFAS 141 is effective for all business combinations initiated after June 30, 2001. The Company adopted SFAS 141 which had no impact on our results of operations or financial position.

        In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which establishes new standards for goodwill and other intangible assets, including the elimination of goodwill amortization, to be replaced with periodic evaluation of goodwill for impairment. We will adopt SFAS 142 on June 29, 2002 at which time, we are required to evaluate our existing goodwill and intangible assets and make any necessary reclassifications in order to comply with the new criteria in SFAS 142. We will then be required to reassess the useful lives of all intangible assets acquired in purchase business combinations, including those reclassified from goodwill, and make any necessary amortization adjustments by the end of the first interim period after adoption. To the extent that any intangible asset is identified as having an indefinite useful life, SFAS 142 requires us to test the intangible asset for impairment and recognize any impairment losses as a cumulative effect of change in accounting principle in the first interim period. After the identification and assessment of intangible assets discussed above, we are required, under SFAS 142, to identify reporting units and assign all related assets and liabilities and goodwill to the reporting units. We must then complete the two-step transitional goodwill impairment test. The first step, which must be completed within six months of adoption of SFAS 142, requires us to determine the fair value of each reporting unit and compare it to the reporting unit's carrying amount. To the extent that a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired and we are required to complete step two of the transitional goodwill impairment test as soon as possible, but no later than June 27, 2003. Step two requires us to compare the implied fair value of the reporting unit to its carrying amount as of June 29, 2002. Any transitional impairment loss will be recognized as a cumulative change in accounting principle in the first interim period. We have not yet completed our analysis to determine the impact, if any, on our financial results. At June 28, 2002, we had goodwill and intangible assets of $13 million subject to SFAS 142. Amortization expense for goodwill amounted to $1.5 million for the year ended June 28, 2002. The net impact on the 2003 statement of operations from the adoption of SFAS 142 is expected to be a reduction in amortization of approximately $1.5 million.

        In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" or "SFAS 144" that is applicable to financial statements issued for fiscal years beginning after December 15, 2001, with transition provisions for certain matters. The FASB's new rules on asset impairment supersede FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and provides a single accounting model for long-lived assets to be disposed of. Although retaining many of the fundamental recognition and measurement provisions of Statement 121, the new rules significantly change the criteria that would have to be met to classify an asset as held-for-sale. The new rules also will supersede the provisions of APB Opinion 30 with regard to reporting the effects of a

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disposal of a segment of a business and will require expected future operating losses from discontinued operations to be displayed in discontinued operations in the period(s) in which the losses are incurred (rather than as of the measurement date as presently required). We adopted SFAS 144 in the second quarter of fiscal 2002.

        In June 2002 the FASB issued Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The principal difference between Statement 146 and Issue 94-3 relates to Statement 146's requirements for recognition of a liability for a cost associated with an exit or disposal activity. Statement 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as generally defined in Issue 94-3 was recognized at the date of an entity's commitment to an exit plan. A fundamental conclusion reached by the FASB in this Statement is that an entity's commitment to a plan, by itself, does not create an obligation that meets the definition of a liability. Therefore, this Statement eliminates the definition and requirements for recognition of exit costs in Issue 94-3. This Statement also establishes that fair value is the objective for initial measurement of the liability. Severance pay under Statement 146, in many cases, would be recognized over time rather than up front. The FASB decided that if the benefit arrangement requires employees to render future service beyond a "minimum retention period" a liability should be recognized as employees render service over the future service period even if the benefit formula used to calculate an employee's termination benefit is based on length of service. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged.

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.

        Continuing Losses and Impact on Working Capital.    In recent years our continuing net losses, resulting mainly from declining revenues, have consumed cash resources, which we have offset to some extent through improved working capital management and the disposition of non-core assets. Operating activities consumed $13 million in cash during fiscal 2002, and at June 30, 2002 we had unrestricted cash and marketable investments of $218 million. We believe that the combination of our current resources and our planned results for fiscal 2003 will provide sufficient funding to allow us to meet our obligations during fiscal 2003. However, because our cash levels fluctuate significantly during quarters, and especially given the uncertainties of the present business climate, we will continue to focus on expense controls and working capital efficiencies to improve our liquidity. Because we have fewer opportunities than in the past to generate cash through the sales of non-core assets or other nonrecurring transactions, it will be especially important that we achieve our planned-for operating results, which will require that we reverse or at least reduce the rate of the revenue declines experienced in recent years. Failure to achieve our targets could cause significant changes in the terms on which we deal with our suppliers or could otherwise result in our having insufficient liquidity to manage our business.

        Given our credit rating, if we should need to obtain short-term borrowings, there can be no assurance that such borrowings would be available or could be obtained at reasonable rates. The inability to obtain such borrowings could have a material adverse impact on our operations, financial condition and liquidity.

        We have an asset-based credit facility that may be declared to be in default if we fail to meet certain financial and other covenants. The credit facility matures in April 2003 and we currently intend

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to renew or replace this facility at maturity. The facility is currently secured by U.S. accounts receivable and inventory, the pledge of certain intellectual property and a $7 million cash deposit. From time to time, we also deposit additional cash, reflected in our restricted cash balances, to secure certain letters of credit or to address fluctuations within the quarter of eligible accounts receivable. The credit facility also contains financial and other covenants. We were not in compliance with the financial covenants in the fourth quarter of fiscal 2001 or the second, third and fourth quarters of fiscal 2002, which were waived by the lenders. In the event we are not able to comply with the financial and other covenants of this facility in the future, or there is a material adverse change impairing our ability to repay the outstanding balance, the facility may be declared to be in default. If a default is declared and not waived, or if the facility matures and is not renewed or replaced it could have a significant impact on our working capital.

        Period To Period Fluctuations.    Our operating results may fluctuate for a number of reasons. Delivery cycles are typically short, other than for large-scale server products. Over half of each quarter's product 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, military or terrorist actions, 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 desktop product revenue including the mix of configurations within these product categories.

        The present uncertainty in the economy has impacted the timing of buying decisions of our customers. Unless and until the economic environment becomes more positive it will be difficult for us to experience growth in revenue.

        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 adverse impact on our stock price. The stock price may also be affected by broader market trends unrelated to our performance. The listing rules of the NYSE generally require that listed securities trade at a minimum per share price of $1.00 when averaged over a 30 day trading period. If the Common Stock price fails to rise above this minimum threshold and if SGI fails to take action, such as a reverse stock split, to address this issue, the Common Stock could be delisted from the exchange, which would impair the liquidity available to holders of the Common Stock.

        Product Development and Introduction.    Meeting our objectives for fiscal 2003 and beyond will require the timely development and introduction of successful new 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 new computer systems 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. As noted above, our ability to successfully attract and retain key technical, marketing and

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management personnel has a direct impact on our ability to maintain our product development timetables.

        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 testing, 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.

        Most products are upgraded during their product life cycle. The ability to upgrade products in a timely fashion is necessary to compete in the computer industry. Delays in introducing updates and upgrades can adversely affect acceptance and demand for our products.

        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 the addition of scalable servers based on Itanium 2 processors and the Linux operating system in the second half of this fiscal year, will increase our dependence on Intel and other partners, and on our manufacturing partners and other component suppliers. Our business could be adversely affected, for example, if Intel fails to meet product release schedules, if we experience supply constraints, or if we experience any other interruption or delay in the supply chain. The competitiveness of our system products, particularly our servers, is significantly affected by the availability on our platform of third-party software applications that are important to customers in our target markets. Our ability to work with our software partners to ensure porting of these applications to our IRIX operating system and, in the future, to Linux, is a key factor to our business success.

        Impact of Government Customers.    A significant portion of our revenue is derived from sales to the United States 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.

        A portion of our business requires security clearances from the United States government. We have implemented measures to maintain our clearances in light of the fact that our CEO, Robert Bishop, is not a U.S. citizen. However, these arrangements are subject to customer review and approval and periodic review by the Defense Security Service of the Department of Defense. Any disruption or limitation in our ability to do business with the United States government could have an adverse impact on SGI.

        Export Regulation.    Our sales to foreign customers are subject to export regulations. Sales of many of our high-end products require clearance and export licenses from the U.S. Department of Commerce under these regulations. The U.S. Departments of Commerce and Justice are currently conducting civil and criminal investigations into SGI's compliance with the export regulations in connection with several export sales to Tier 3 countries. We have agreed to waivers of the statutes of limitations for these matters and are currently in discussion with the authorities concerning a potential resolution. We believe that these matters will be resolved without a significant adverse effect on our business. There is no assurance, however, that we will reach an acceptable resolution or that the ultimate result would not impair the conduct of our business with the U.S. government or our sales outside the United States.

        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.

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        The Swiss authorities are also investigating compliance with their export regulations in connection with exports from the Swiss manufacturing facility we closed during the second quarter of fiscal 2002. We believe that these matters will be resolved without a significant adverse effect on our business.

        Employees.    Our success depends on our ability to continue to attract, retain and motivate highly qualified technical, sales, marketing and management personnel. The uncertainties surrounding SGI's business prospects have increased the challenges of retaining world-class talent. We implemented further restructuring actions during fiscal 2002. As we continue to work through the turnaround process, there is no guarantee that we will not lose highly qualified employees or that we will be able to hire highly qualified candidates as new skills are needed.

        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. They also generally have a larger installed base of customers, processors that benchmark at higher peak performance and a wider range of available applications software. Competition may result in significant discounting and lower gross margins.

        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.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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.

        Our exposure to interest rate risk relates primarily to our investment portfolio and our convertible subordinated notes. Fixed rate securities and borrowings may have their fair market value adversely impacted due to fluctuations in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates.

        The primary objective of our investment activities is to preserve principal while at the same time maximize yields without significantly increasing risk. To achieve this objective, we invest our excess cash in high quality money market instruments and debt instruments, and, by policy, restrict our exposure to any single corporate issuer by imposing concentration limits. To minimize the exposure due to adverse shifts in interest rates, we maintain investments at an average maturity of generally less than three years.

        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.

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        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 rates in effect at June 28, 2002 and June 30, 2001. We computed the market values for foreign exchange risk based on spot rates in effect at June 28, 2002 and June 30, 2001. The market values that result from these computations are compared to the market values of these financial instruments at June 28, 2002 and June 30, 2001. 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 28, 2002 and June 30, 2001 are as follows:

        Interest Rate Risk: A percentage point decrease in the levels of interest rates with all other variables held constant would result in a decrease in the aggregate fair values of our financial instruments by $6 million and $3 million at June 28, 2002 and June 30, 2001, respectively. A percentage point increase in the levels of interest rates with all other variables held constant would result in an increase in the aggregate fair values of our financial instruments by $6 million and $3 million, respectively.

        Foreign Currency Exchange Rate Risk: A 10% strengthening of foreign currency exchange rates against the U.S. dollar with all other variables held constant would result in a decrease in the fair values of our financial instruments by $10 million and $13 million at June 28, 2002 and June 30, 2001, respectively. A 10% weakening of foreign currency exchange rates 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 $10 million at June 28, 2002 and $9 million at June 30, 2001.

        The financial instruments measured in the foreign currency exchange rate sensitivity analysis are used in our hedging program to reduce our overall corporate exposure to changes in exchange rates.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements

        All other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements and related footnotes.

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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 28, 2002 and June 30, 2001, and the related consolidated statements of operations, stockholders' (deficit) equity, and cash flows for each of the three years in the period ended June 28, 2002. Our audits also included the financial statement schedule listed in the index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

        We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 28, 2002 and June 30, 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 28, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.

                                                                                                                            /s/ ERNST & YOUNG LLP

Palo Alto, California
July 23, 2002

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CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY