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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934. For the fiscal year ended June 30, 1997.
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the transition period from to .
Commission File Number 1-10441
SILICON GRAPHICS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2789662
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
2011 NORTH SHORELINE BOULEVARD, MOUNTAIN VIEW, CALIFORNIA 94043-1389
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (415) 960-1980
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Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED:
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Common Stock, $0.001 par value New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
5 1/4% Senior Convertible Notes New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant, based upon the closing sale price of the
Common Stock on September 2, 1997 on the New York Stock Exchange as reported in
The Wall Street Journal, was approximately $3,638 million. Shares of voting
stock held by each executive officer and director and by each person who owns 5%
or more of any class of registrant's voting stock have been excluded in that
such persons may be deemed to be affiliates. This determination of affiliate
status is not necessarily a conclusive determination for other purposes.
AS OF SEPTEMBER 2, 1997, THE REGISTRANT HAD OUTSTANDING 183,154,820 SHARES OF
COMMON STOCK.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Proxy Statement for registrant's Annual Meeting of Stockholders
to be held October 29, 1997 are incorporated by reference into Part III of this
Form 10-K Report.
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PART I
ITEM 1. BUSINESS
GENERAL
Silicon Graphics is a leader in high-performance computing. The Company's
broad range of workstations and graphics servers deliver advanced 3D graphics
and computing capabilities for engineering and creative professionals. Silicon
Graphics-Registered Trademark- and Cray-Registered Trademark- Research-branded
servers are the market leaders in technical computing applications. The
Company's highly scalable servers also have a growing presence in the enterprise
market, with a particular emphasis on Internet, large corporate data and
telecommunications applications.
The Company's MIPS Group designs and market's the world's highest volume
computer RISC microprocessor. The Company also markets applications software
targeted at engineering and creative professionals in the digital content
creation and manufacturing sectors.
PRODUCTS
The Company's computer systems range from desktop workstations to servers
and supercomputers. Most of these systems are designed around
MIPS-Registered Trademark- RISC microprocessors developed by the Company's MIPS
Group and the IRIX-TM- operating system, which is the Company's enhanced version
of the UNIX operating system.
GRAPHICS PRODUCTS
Silicon Graphics desktop workstations combine key elements of workgroup
collaboration, interactive media and computing at a range of prices and
performance. Systems in this family can be used for tasks as diverse as
manipulating 3D models for computer-aided design (CAD), crunching numbers for
chemistry and geographic information systems applications, or functioning as a
tool for video editing, animation rendering, technical publishing, World Wide
Web and intranet authoring and serving, and software development.
O2 The O2-TM- family of entry-level desktop workstations feature advanced
3D graphics and imaging, real-time video capability and interactive and
professional quality graphics, audio and imaging capabilities. The O2
workstation has significant appeal in markets such as mechanical CAD, chemistry,
color publishing, film and video, software development, education and media
authoring.
OCTANE The Octane-TM- family of single and dual processor workstations is
designed to provide the strongest graphics and computational capability
available in the desktop category, for applications such as 3D solids modeling,
mechanical CAD, digital prototyping, 3D visualization, animation, architectural
design and professional audio and video production.
ONYX2 The Onyx2-TM- family of graphics supercomputers uses multiple
microprocessors and sophisticated graphics subsystems to handle the most
demanding visual computing tasks. Graphics subsystems available with these
servers include the Onyx2Reality-TM- and InfiniteReality-TM- graphics
subsystems. The Onyx2 family is well-suited for applications such as
computational chemistry, oil and gas research, molecular modeling, global
weather modeling, structural dynamics, fluid dynamics, image processing, visual
simulation, medical imaging and chemistry, interactive entertainment and digital
film and video production.
ALIAS--WAVEFRONT The Company's Alias--Wavefront division supplies modeling
and animation application software used by creative professionals in the
entertainment, industrial design and visualization and graphic design markets.
Its industry-leading products include Alias PowerAnimator-TM-, Alias Studio-TM-,
and Wavefront Composer-TM-. Alias--Wavefront has also announced the next
generation Maya-TM- product architecture, which will be incorporated in products
beginning in fiscal 1998. Alias--Wavefront is based in Toronto, Canada with
sales offices across North America, Europe and Asia and worldwide distribution.
COSMO SOFTWARE The Company's Cosmo Software business offers a family of
content creation, browsing and management tools for the World Wide Web and
intranet markets. The Cosmo-TM- products are intended to facilitate the creation
of media-rich 3D environments and especially to take advantage of the power of
the industry standard Virtual Reality Modeling Language (VRML) developed by
Silicon Graphics. Cosmo Software also develops innovative 3D Web environments
under contract for online service customers like Disney Online and Microsoft's
MSN.
SERVERS
ORIGIN200 The Origin200-TM- is a deskside server employing from one to four
processors. The Origin200 server is designed for departmental and other
workgroup serving applications as well as Web serving.
ORIGIN2000 The Origin2000-TM- family of high-performance servers is based
on the Company's innovative non-uniform memory access (NUMA) architecture, which
offers the ability to scale from as few as four to as many as hundreds of
processors in the Cray Origin2000 line while maintaining almost linear
performance per processor. This "pay as you go" flexibility is highly attractive
to customers because it allows them to buy what they need today, add as needed
while protecting their investment, and redeploy when conditions change. Key
applications in the technical and scientific markets include finite element
analysis (to determine the impact of elements like stress and temperature),
quantum chemistry calculation, seismic analysis and computational fluid
dynamics. Key uses in the enterprise market include data mining (to analyze and
organize database information), product data management for manufacturing, and
commercial transaction processing. Origin servers also are used as media
servers, World Wide Web site servers and file servers.
The CRAY T3E-TM- highly scalable supercomputing systems employ a highly
parallel architecture ranging from 16 to as many as 2,048 processors for a broad
range of scientific and industrial applications as diverse as petroleum
exploration, aerospace engineering and defense applications.
VECTOR SYSTEMS The Cray T90-TM- family of supercomputers delivers maximum
performance for vectorized supercomputing applications. The large memory
bandwidth of T90 systems make them ideal for problems involving huge amounts of
data, such as weather and climate modeling and large-scale auto engineering. The
Cray J90-TM- family uses low-cost CMOS technology to deliver affordable
supercomputing for vectorized applications like molecular modeling, ecosystem
simulation, medical imaging and vehicle dynamics simulation.
MIPS RISC MICROPROCESSORS
The Company's system products, except the Cray T3E and vector families, are
based on the MIPS RISC microprocessor architecture. The Company's MIPS RISC
microprocessor designs incorporate a general purpose architecture and
instruction set designed for high performance over a wide range of applications.
The MIPS RISC microprocessor designs make efficient use of instruction
"pipelining" techniques and proprietary compilers, allowing significant
performance gains to be realized by optimizing the tradeoff between compiler and
microprocessor functions. The versatility of the MIPS RISC architecture makes it
suitable for computer applications from entry-level desktop systems up to
supercomputers.
MIPS RISC microprocessors are also used in a wide variety of noncomputer
applications, including disk drives, printers and copiers and, increasingly,
consumer electronics products. Silicon Graphics computers represent only a small
percentage of the worldwide consumption of MIPS RISC microprocessors.
The Company does not manufacture or sell MIPS RISC microprocessors and
related devices. It licenses its designs to "semiconductor partners" who
manufacture and sell the parts. The Company's current licensees are: Integrated
Device Technology, Inc.; LSI Logic Corporation; NEC Corporation; NKK
2
Corporation; Philips Semiconductor; Quantum Effect Design, Inc. and Toshiba
Corporation. The semiconductor partners pay the Company unit royalties based
upon sales.
APPLICATIONS SOFTWARE
Because the Company has historically developed only a very limited set of
applications software, its customers must either develop or license from a third
party the software necessary to address their needs. The Company maintains
active programs to encourage independent software development for its systems,
including training, technology support and cooperative marketing. The Company
believes that there are currently over 2,500 registered application software
programs offered for use on its systems.
MARKETING, SALES AND DISTRIBUTION
The Company sells its system products through its own direct sales force and
through several indirect channels. In fiscal 1997 direct sales accounted for
approximately half of the Company's product revenues. The direct sales and
support organization operates throughout the United States and in all
significant international markets. The Company serves smaller international
markets through distributors.
The principal indirect channels through which the Company operates are the
following:
- VARS, or value added resellers, are software companies that develop or
customize their proprietary software specifically for use with the special
graphics hardware of the Company's workstations. VARs purchase
workstations from the Company or its North American distributor,
incorporate their applications software and resell the systems to
end-users.
- VADS, or value added dealers, are typically direct sales organizations
that sell primarily into a single vertical market and incorporate
appropriate specialized third-party software with the Company's hardware
for sale to their customers.
- SYSTEMS INTEGRATORS include Silicon Graphics systems in much larger
systems customized for use by the federal government and large commercial
clients.
Many of the Company's resellers are served through Access Graphics, an
independent company that functions as a master reseller of the Company's system
products.
Information with respect to international operations and export sales may be
found in Note 14 to the Consolidated Financial Statements included in Part II
below. See also "Risks That Affect Our Business" below. Although no customer
accounted for 10% or more of the Company's total revenues for fiscal 1997, 1996
or 1995, a significant reduction or delay in sales to major customers could
adversely affect the Company's operating results.
CUSTOMER SERVICE AND SUPPORT
The Company believes that the quality and reliability of its system products
and the ongoing support of such products are important elements of its
competitive strategy. The Company's customer service organization includes field
service engineers, field product and applications specialists, product support
engineers, training specialists and administrative support personnel. In
addition, the Company provides customer education through regularly scheduled
courses in system software administration, applications programming and hardware
maintenance. The Company provides local customer support from its regional sales
and service offices located in North America, Western Europe and the Pacific
Rim, with spare parts inventory stored at each location. International
distributors provide training and support for products sold by them.
3
The Company typically provides a standard "return to factory" hardware
warranty against defects in materials and workmanship for periods of up to one
year.
RESEARCH AND DEVELOPMENT
The Company's research and development program is directed principally
toward maintaining and enhancing the Company's competitive position through
incorporating the latest advances in microprocessor, hardware, software and
networking technologies. This effort is focused specifically on developing and
enhancing its computing architectures, MIPS RISC microprocessors, graphics
subsystems, VLSI technology, compiler software, operating system, applications
software and development tools. Simultaneously, the Company seeks to develop new
ways in which to increase product reliability, reduce manufacturing costs and
improve product development lead times.
The Company is currently devoting significant research and development
resources to potential systems based on the Windows NT operating system and
Intel microprocessors. There are no assurances, however, that such systems will
be brought to market, and in any event, the Company does not expect that such
systems would account for any material revenue in fiscal 1998.
During fiscal 1997, 1996 and 1995, the Company spent approximately $479
million, $353 million, and $248 million, respectively, on research and
development. Those amounts represented 13.1%, 12.1% and 11.1%, respectively, of
revenues.
MANUFACTURING
The Company's manufacturing operations primarily involve assembling high
level subassemblies and systems and testing major purchased subassemblies. All
products are subjected to substantial environmental stress and electronic
testing prior to shipment to customers. The Company primarily manufactures and
ships its products from its facilities in Mountain View, California, Chippewa
Falls, Wisconsin and near Neuchatel, Switzerland.
The Company continually evaluates the allocation of manufacturing activities
among the Company's own operations and those of suppliers and subcontractors.
This allocation may be affected by fluctuations in the volume of business,
geopolitical, economic and technological developments and other factors.
Most of the Company's products incorporate components that are available
from only one or limited sources. Key components include application specific
integrated circuits ("ASICs"), storage products, especially RAID-based products,
and certain memory products.
Reliance on single or limited source vendors involves several risks,
including the possibility of a shortage of certain key components that meet the
Company's product specifications. Risks also include long lead times, reduced
control over delivery schedules, and the possibility of charges for excess and
obsolete inventory.
The Company also has single sources for certain peripherals, communications
controllers and power supplies, and the monitors and plastic cabinets used
across the Company's system products. The Company believes that, in most of
these cases, alternative sources of supply could be developed over a period of
time. However, a reduction or interruption in supply or a significant increase
in the price of one or more single or limited source components would, at least
in the short term, adversely affect the Company's operating results.
Many of the Company's suppliers are located outside the United States,
especially in Japan. The prices of parts from these suppliers have been and may
be affected significantly by such factors as protectionist measures and changes
in currency exchange rates between the United States and other countries. In
addition, changes in the availability of certain memory chips (DRAMs, SRAMs and
VRAMs) have caused, and in the future may cause, significant changes in their
prices.
4
COMPETITION
The computer industry is highly competitive and is characterized by rapid
technological advances in both hardware and software development. These advances
result in frequent new product introductions, short product life cycles and
increased new product capabilities, typically representing significant price/
performance improvements. The principal competitive factors in the Company's
market are product features, price/performance, networking capabilities, product
quality and reliability, ease of use, capabilities of the system software,
availability of applications software, customer support, product availability,
corporate reputation and price. The strong competition faced throughout the
Company's product line can result in significant discounting from list price.
The Company's principal competition has historically come from other
workstation and computer system manufacturers and, to a lesser extent, from
graphics subsystem and terminal vendors and graphics integrated circuit
manufacturers. The principal workstation and computer manufacturers that compete
in the Company's markets are Compaq Computers, Digital Equipment, Hewlett
Packard, IBM and Sun Microsystems. The Company is facing increasing competition
at the lowest end of the workstation market from systems based on personal
computer technologies such as the Windows NT operating system, Intel
microprocessors and graphics acceleration cards. The Company has under
development a desktop system that will be based on Intel microprocessors and the
Windows NT operating system. There can be no assurance that this system will be
introduced or gain commercial acceptance.
In the high end of the supercomputer market, the Company faces competition
from IBM as well as from NEC, Hitachi and Fujitsu. In the applications software
market and certain other emerging markets the Company's principal competitor is
Microsoft.
The Company's MIPS RISC microprocessor architecture and technology compete
directly with microprocessor products offered by manufacturers of other
microprocessor designs, in particular those offered by Intel, IBM, Digital, HP,
Motorola and Sun.
PROPRIETARY RIGHTS AND LICENSES
The Company has been granted or has applications pending for a significant
number of U.S. patents, and will continue to seek patent coverage for its
inventions in both the United States and foreign countries. The Company also has
applied for and holds various trademark registrations in the United States and
in selected foreign countries. The Company will continue to seek protection for
its inventions, trademarks, maskworks and copyrights where appropriate.
As is customary in its industry, the Company licenses from third parties a
wide range of software for its internal use and for the use of its customers.
The Company licenses the UNIX operating system on a non-exclusive basis from
Novell, Inc., and sublicenses it to its customers.
The Company's ability to compete may be affected by its ability to protect
proprietary information and to obtain necessary licenses on commercially
reasonable terms. The extent to which U.S. and international intellectual
property laws protect the Company's products, and the enforceability of end-user
license agreements, have not been fully determined, and the computer industry
has seen a substantial increase in litigation with respect to intellectual
property matters. Such litigation or changes in the interpretation of
intellectual property laws could expand or reduce the extent to which the
Company or its competitors are able to protect their intellectual property or
require changes in the design of products which could have an adverse impact on
the Company. The Company has several intellectual property lawsuits pending
against it today. There can be no assurance that the Company will not be made a
party to significant litigation regarding intellectual property matters in the
future. See "Legal Proceedings."
5
EMPLOYEES
As of June 30, 1997, the Company had approximately 10,930 full-time
employees. The Company's future success will depend, in part, on its ability to
continue to attract, retain and motivate highly qualified technical, marketing
and management personnel, who are in great demand. The Company has never had a
work stoppage, and no employees are represented by a labor union. The Company
has workers' councils where required by European Union or other applicable laws.
The Company believes that its employee relations are good.
CORPORATE DATA
The Company was originally incorporated as a California corporation in
November 1981, and reincorporated as a Delaware corporation in January 1990.
ITEM 2. PROPERTIES
The Company believes that, while it currently has or is developing
sufficient facilities to conduct its operations during fiscal 1998, it will
continue to acquire both leased and owned facilities throughout the world as its
business requires. The Company leases sales, service and administrative offices
worldwide and has its principal corporate and manufacturing facilities in the
following locations:
CALIFORNIA The Company's corporate offices and its primary research and
development and manufacturing operations are located in Mountain View,
California, where the Company occupies a total of about 1,832,500 square feet.
These facilities include a ten-building campus facility comprising approximately
726,500 square feet, leased by the Company through the years 2000 to 2005; a
four-building, 500,000 square foot campus facility completed in fiscal 1997 on
22 acres of leased land in the same area; and a sales headquarters building
comprising approximately 112,000 square feet and located on 7.5 acres owned by
the Company near its Mountain View headquarters. The Company also leases ten
other buildings near its Mountain View headquarters, comprising approximately
490,000 square feet.
MINNESOTA AND WISCONSIN The Company also owns manufacturing, research and
development and service facilities comprising approximately 749,000 square feet
in Chippewa Falls, Wisconsin and research and development, sales and
administrative facilities comprising 495,000 square feet in Eagan, Minnesota.
SWITZERLAND The Company's European manufacturing and support center near
Neuchatel, Switzerland is located in a facility owned by the Company, consisting
of approximately 170,000 square feet.
ITEM 3. LEGAL PROCEEDINGS
The Company is defending the lawsuits described below. The Company believes
that it has good defenses to the claims in each of these lawsuits and is
defending each of them vigorously.
The Company is defending a securities class action lawsuit filed in U.S.
District Court for the Northern District of California in January 1996. The suit
alleges that the Company and certain of its officers and directors made material
misrepresentations and omissions during the period from September to December
1995. In May 1996, the District Court dismissed the securities class action with
prejudice. The plaintiffs' appeal to the U.S. Court of Appeals for the Ninth
Circuit is pending.
The Company also is defending securities class action lawsuits involving
MIPS Computer Systems, Inc., which the Company acquired in June 1992, and Alias
Research Inc., which the Company acquired in June 1995. The MIPS case, which was
filed in the U.S. District Court for the Northern District of California in
1992, alleges that MIPS and certain of its officers and directors made material
misrepresentations and omissions during the period from January to October of
1991. In September 1996, the U.S. Court of Appeals for the Ninth Circuit
reversed the summary judgment granted in defendants' favor in
6
June 1994. The Company's petition for review by the U.S. Supreme Court is
pending. The Alias case, which was filed in the U.S. District Court for the
District of Connecticut in 1991, alleges that Alias and certain of its officers
and directors made material misrepresentations and omissions during the period
from May 1991 to April 1992. Alias' motion to dismiss the amended complaint is
pending.
The Company also is defending a patent infringement lawsuit filed by Martin
Marietta Corp. in the U.S. District Court for the Middle District of Florida in
September 1995. The Company has filed a counterclaim seeking to invalidate the
principal patent at issue in the lawsuit, and Martin Marietta has requested the
U.S. Patent and Trademark Office to re-examine the patent. The District Court
has set a trial date for the lawsuit in February 1998.
In July 1996, the Company's Cray Research subsidiary filed a petition with
the U.S. Department of Commerce and the International Trade Commission alleging
that sales of vector supercomputers by Japanese companies violated U.S.
anti-dumping laws. In October 1996, NEC filed a lawsuit in the Court of
International Trade to prevent the Commerce Department from investigating these
anti-dumping claims on the grounds that it was tainted by prejudgment. Cray
Research joined this lawsuit as an interested party. In August 1997, the Court
of International Trade ruled that the Commerce Department investigation was fair
and conducted in compliance with the requirements of the U.S. anti-dumping laws.
The Commerce Department has determined that NEC and Fujitsu are illegally
dumping vector supercomputers in the U.S. market. In September, 1997, the
International Trade Commission ruled that this activity has injured and could
cause further injury to the domestic market. As a result of these findings,
antidumping duties will be imposed on vector supercomputers imported into the
U.S. market by Japanese vendors.
The U.S. Departments of Commerce and Justice are investigating the Company's
compliance with export control laws in connection with sales of its computer
systems, including the sale of certain computer systems to a customer in Russia
in fiscal 1997.
The Company routinely receives communications from third parties asserting
patent or other rights covering the Company's products and technologies. Based
upon the Company's evaluation, it may take no actions or it may seek to obtain a
license. There can be no assurance in any give case that a license will be
available on terms the Company considers reasonable, or that litigation will not
ensue.
Management is not aware of any pending disputes, including those described
above, that would be likely to have a material adverse effect on the Company's
financial condition, results of operations or liquidity. However, management's
evaluation of the likely impact of these pending disputes could change in the
future.
7
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company and their ages are as follows:
EXECUTIVE
OFFICER
NAME AGE POSITION AND PRINCIPAL OCCUPATION SINCE
- ------------------------------- --- ---------------------------------------------------------------- -----------
Edward R. McCracken 53 Chairman, Chief Executive Officer and Director 1984
Robert H. Ewald 49 Executive Vice President, Computer Systems 1996
Gary L. Lauer 44 Executive Vice President, Worldwide Sales and Marketing, Silicon 1988
Graphics, Inc. and President, Silicon Graphics World Trade
Corporation
John E. Bourgoin 51 Senior Vice President, Silicon Graphics, Inc. and President, 1996
MIPS Group
Kenneth L. Coleman 54 Senior Vice President, Customer and Professional Services 1987
William M. Kelly 44 Senior Vice President, Corporate Operations and Secretary 1994
Dennis P. McBride 45 Vice President, Controller 1988
Executive officers of the Company are elected annually by the Board of
Directors and serve at the Board's discretion. There are no family relationships
among any directors, nominees for director or executive officers of the Company.
Except as set forth below, all of the officers have been associated with the
Company in their present positions for more than five years.
Mr. McCracken became Chairman of the Company in 1994.
Mr. Ewald assumed his current responsibilities in 1997. He joined the
Company in 1996 as President of Cray Research and a Senior Vice President of the
Company. Mr. Ewald was the President and Chief Operating Officer of Cray
Research, Inc. from 1994 until 1996, when Cray was acquired by the Company.
Prior to that, he was Chief Operating Officer of Cray's Supercomputer Operations
and in 1993 served as Executive Vice President and General Manager,
Supercomputer Operations. From 1991 through 1993, Mr. Ewald was Cray's Executive
Vice President, Development.
Mr. Lauer joined the Company in 1988 as Vice President, North American
Marketing, became Vice President, North American Field Operations in 1989, was
named Senior Vice President, North American Field Operations in 1991 and became
an Executive Vice President of the Company and the President of Silicon Graphics
World Trade Corporation in 1995.
Mr. Bourgoin joined the Company in 1996 as President of the MIPS Group and a
Senior Vice President of the Company. Prior to joining the Company, Mr. Bourgoin
served as Vice President, Computation Products Group at Advanced Micro Devices,
Inc.
Mr. Coleman assumed his current responsibilities in 1997. From 1987 to 1997
he served as Senior Vice President, Administration of the Company.
Mr. Kelly assumed his current responsibilities in 1997 and has served as
acting Chief Financial Officer since May 1997. He joined the Company in 1994 as
Vice President, Business Development, General Counsel and Secretary. During
1996, Mr. Kelly also served as Senior Vice President, Silicon Interactive Group.
Prior to joining the Company, Mr. Kelly had practiced law since 1978 with the
firm of Shearman & Sterling, most recently as co-managing partner of that firm's
San Francisco office.
Mr. McBride became Vice President, Controller in 1988. In September 1997,
Mr. McBride became Senior Vice President, World Trade Operations.
8
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is traded on the New York Stock Exchange under
the symbol of SGI. The following table sets forth, for the periods indicated,
the high, low, and close prices for the Common Stock as reported on the NYSE.
FISCAL 1997 FISCAL 1996
------------------------------- -------------------------------
LOW HIGH CLOSE LOW HIGH CLOSE
--------- --------- --------- --------- --------- ---------
First Quarter...................... $ 20.00 $ 25.75 $ 22.13 $ 33.00 $ 45.63 $ 34.38
Second Quarter..................... 17.88 27.63 25.50 26.88 38.75 27.50
Third Quarter...................... 19.25 28.38 19.50 21.25 30.38 25.00
Fourth Quarter..................... 12.63 20.25 15.00 23.13 30.13 24.00
The Company had 9,829 stockholders of record as of June 30, 1997. The
Company has not paid any dividends on its common stock. The Company currently
intends to retain earnings for use in its business and does not anticipate
paying cash dividends to common stockholders.
9
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
YEARS ENDED JUNE 30 1997 1996(1) 1995 1994 1993
---------- ---------- ---------- ---------- ----------
Operating Data
(in thousands, except per share amounts):
Total revenue..................................... $3,662,601 $2,921,316 $2,228,268 $1,537,766 $1,132,869
Costs and expenses:
Cost of revenue................................. 2,022,546 1,482,439 1,032,059 735,388 532,213
Research and development........................ 479,101 353,461 247,678 190,796 143,981
Selling, general and administrative............. 1,038,313 807,830 619,259 417,753 336,054
Write-off of acquired in-process technology and
merger-related expenses....................... 10,757 103,193 22,000 -- --
Restructuring costs............................. -- -- -- -- 650
---------- ---------- ---------- ---------- ----------
Operating income from continuing operations....... 111,884 174,393 307,272 193,829 119,971
Interest and other income (expense), net.......... (13,694) 10,413 9,447 4,779 520
Minority interest in net loss of Cray Research.... -- 3,982 -- -- --
---------- ---------- ---------- ---------- ----------
Income from continuing operations before income
taxes........................................... 98,190 188,788 316,719 198,608 120,491
Income from continuing operations................. 78,551 115,037 224,856 141,414 82,803
Net income........................................ 78,551 115,037 224,856 141,814 73,540
Income per share:
Income from continuing operations............... $ 0.43 $ 0.65 $ 1.28 $ 0.86 $ 0.53
Net income...................................... $ 0.43 $ 0.65 $ 1.28 $ 0.86 $ 0.47
Common and common equivalent shares used in the
calculation of income per share................. 182,637 175,790 175,435 165,149 154,887
Balance Sheet Data (in thousands):
Cash, cash equivalents and marketable
investments................................... $ 374,292 $ 456,937 $ 780,012 $ 604,444 $ 208,538
Working capital................................. 1,229,388 994,817 889,371 645,296 398,053
Total assets.................................... 3,344,592 3,158,246 2,206,619 1,567,052 1,048,294
Long-term debt and other........................ 419,144 381,490 287,267 252,645 56,832
Stockholders' equity 1,839,242 1,675,318 1,346,170 937,169 696,649
Statistical Data:
Number of employees............................. 10,930 10,485 6,308 4,707 4,023
Revenue/employee (average; in thousands)........ $ 343 $ 373 $ 400 $ 346 $ 293
Long-term debt and other/total capitalization... 19% 19% 18% 21% 8%
- ------------------------
(1) Amounts reflect the April 2, 1996 acquisition of Cray Research, which was
accounted for as a purchase. See Notes 2 and 3 to the consolidated financial
statements.
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The matters addressed in this discussion, with the exception of the
historical information presented, are forward looking statements involving risks
and uncertainties, including the risks discussed under the heading "Risks That
Affect Our Business" and elsewhere in this report.
INTRODUCTION
The following tables and discussion present certain financial information on
a comparative basis. The Company's fiscal 1996 results reflect the fourth
quarter acquisition of Cray Research in a business combination accounted for
under the purchase method. To provide a meaningful comparison of fiscal 1997 and
fiscal 1996 results, certain items (revenue, gross margin and operating expenses
other than merger-related expense) are presented on a pro forma combined basis
(as if the acquisition had occurred at the beginning of fiscal 1996 and
excluding the results of the Cray Business Systems Division which was disposed
in the first quarter of fiscal 1997) in addition to the actual fiscal 1996
results. Certain fiscal 1996 Cray Research amounts have also been reclassified
to conform to the current year presentation.
FISCAL YEARS ENDED JUNE 30
----------------------------------------
OPERATING ITEMS AS A PERCENTAGE OF TOTAL REVENUE PRO FORMA
(PERCENTAGES MAY NOT ADD DUE TO ROUNDING) 1997 1996 1996 1995
----- --------- ----- -----
Product and other revenue.............................. 84.3% 84.7% 87.4% 89.3%
Service revenue........................................ 15.7 15.3 12.6 10.7
----- --------- ----- -----
Total revenue.......................................... 100.0 100.0 100.0 100.0
Gross margin........................................... 44.8(1) 47.1(1) 49.3(1) 53.7
Research and development expenses...................... 13.1 12.3 12.1 11.1
Selling, general & administrative expenses............. 28.3 26.8 27.7 27.8
Write-off of acquired in-process technology and
merger-related expenses.............................. * 3.0(2) 3.5 1.0
----- --------- ----- -----
Operating margin....................................... 3.1% 4.2% 6.0% 13.8%
- ------------------------
* Less than one percent
(1) Gross margin before Cray Research purchase accounting adjustments would have
been 45.9% for fiscal 1997, 47.6% for fiscal 1996 on a pro forma basis and
49.9% for fiscal 1996.
(2) Excludes $22 million of pre-merger Cray Research restructuring charges.
FISCAL 1997/ FISCAL 1996/
GROWTH RATES PRO FORMA FISCAL 1996 FISCAL 1995
----------------------- ---------------
Product and other revenue...................................... 7% 28%
Service revenue................................................ 10% 55%
Total revenue.................................................. 7% 31%
Gross profit................................................... 2% 20%
Research and development expenses.............................. 14% 43%
Selling, general and administrative expenses................... 13% 30%
11
FISCAL YEAR/YEAR
INCREASE
FISCAL YEARS ENDED JUNE 30 ---------------------
------------------------------------- 1997 VS
REVENUE BY GEOGRAPHY PRO FORMA PRO 1996 VS
($ IN MILLIONS) 1997 1996 1996 1995 FORMA 1996 1995
------ --------- ------ ------ ---------- -------
United States.......................................... $1,927 $1,582 $1,412 $1,093 22% 29%
Europe................................................. 936 1,034 836 635 (9)% 32%
Rest of World(1)....................................... 800 804 673 500 -- % 35%
------ --------- ------ ------ --- -------
Total revenue.......................................... $3,663 $3,420 $2,921 $2,228 7% 31%
------ --------- ------ ------ --- -------
------ --------- ------ ------ --- -------
FISCAL YEARS ENDED JUNE 30
------------------------------------
PRO FORMA
(AS A PERCENTAGE OF TOTAL REVENUE) 1997 1996 1996 1995
---- --------- ---- ----
United States.......................................... 53% 46% 48% 49%
Europe................................................. 25% 30% 29% 29%
Rest of World(1)....................................... 22% 24% 23% 22%
- ------------------------
(1) Includes Japan, other Asia/Pacific countries, Canada and Latin America
FISCAL YEARS ENDED JUNE 30
REVENUE BY PRODUCT LINE ------------------------------------
(AS A PERCENTAGE OF PRODUCT REVENUE, EXCLUDING OTHER PRO FORMA
REVENUE) 1997 1996 1996 1995
---- --------- ---- ----
Servers (primarily from the Cray, Origin POWER
Challenge-TM-, and Challenge-Registered Trademark-
families)............................................ 49% 34% 25% 21%
Graphics Systems (primarily from the
Indy-Registered Trademark-, O2, Octane and Onyx
families)............................................ 51% 66% 75% 79%
REVENUE
Revenue growth in fiscal 1997 compared with pro forma fiscal 1996 reflected
increased shipments of servers as well as increased service revenue supporting a
larger installed base, offsetting a decline in graphics systems shipments. The
revenue growth rate declined substantially from 31% in fiscal 1996 to 7% in
fiscal 1997. However, the 1996 revenue growth rate of 31% includes incremental
Cray Research revenue for the fourth quarter of fiscal 1996. Excluding the
effect of Cray Research revenue for the fourth quarter of fiscal 1996, the
fiscal 1996 growth rate would have been 24%. Factors contributing to the fiscal
1997 decline in the revenue growth rate included the significant product
transitions which were not completed until the fourth quarter, as well as
softness in international business, particularly in Europe.
As illustrated by the Company's fiscal 1997 results, the process of
completing new products and rapidly bringing them into volume production entails
substantial risks. See "Risks That Affect Our Business--Product Development and
Introduction."
The mix of revenue between servers and graphics systems changed
significantly in fiscal 1997, an expected result of the Cray Research
acquisition. While the Company experienced revenue growth in fiscal 1997 across
its server product line, particularly in the high performance segments, graphics
systems revenue was down. Server and graphics systems unit volumes increased in
each of the years presented. Server product revenue per unit increased and
graphics systems revenue per unit decreased in fiscal 1997 compared with pro
forma fiscal 1996, while overall product revenue per unit has remained
substantially unchanged.
Service revenue, which is comprised of hardware and software support and
maintenance, remained fairly constant as a percentage of total revenue in fiscal
1997 compared with pro forma fiscal 1996. The percentage of service revenue to
total revenue in these two periods is higher than that for 1995 due principally
to the additional Cray Research installed base.
12
While the Company's geographic revenue mix had in recent years been shifting
towards its international operations, in fiscal 1997 that trend was reversed,
principally due to weakness in European business as compared to prior periods.
Revenue from Rest of World, principally Japan, represented approximately 22% of
total revenue in fiscal 1997, 24% in pro forma fiscal 1996 and 22% in fiscal
1995. Revenue growth in Japan slowed in fiscal 1997 compared with prior periods
partially as a result of a strengthened U.S. dollar. European revenue was also
somewhat adversely affected by currency changes.
The Company's consolidated backlog at June 30, 1997 was $537 million,
compared with backlog of $572 million at June 30, 1996.
GROSS MARGIN
Cost of product and other revenue includes costs related to product
shipments, including materials, labor, overhead and other direct or allocated
costs involved in their manufacture or delivery. Costs associated with
non-recurring engineering revenue are recognized in research and development
expense. Cost of service revenue includes all costs incurred in the support and
maintenance of the Company's products.
Silicon Graphics' overall gross margin decreased from 47.1% in pro forma
fiscal 1996 to 44.8% in fiscal 1997. The decline was due principally to product
transition costs and relatively higher revenue in the U.S. where margins
typically are lower as compared with international margins.
In fiscal 1996, the overall gross margin decreased to 49.3% from 53.7% in
fiscal 1995. The decrease was due principally to discounting on product sales
resulting from increased competition, as well as the effect of amortization in
the fourth quarter of fiscal 1996 of purchase accounting adjustments made to the
carrying value of acquired inventory and service contracts.
The Company's gross margins are affected by a number of factors, including
geographic and product mix, and will fluctuate from period to period. The
Company expects its gross margins to be higher in fiscal 1998 than in fiscal
1997, following completion of the major product transition in late fiscal 1997.
Furthermore, the Cray Research purchase accounting adjustments to inventory and
service contracts are now fully amortized and thus will have no further
financial statement impact. Gross margins will nonetheless continue to be
affected by competitive pricing programs. See "Risks That Affect Our Business."
OPERATING EXPENSE
Research and development spending in fiscal 1997 increased 14% in absolute
dollars compared with pro forma fiscal 1996, as the Company continued its new
product development programs. Research and development spending also grew as a
percentage of total revenue to 13.1% from 12.3%, largely because the Company
failed to achieve its planned revenue. Research and development spending
increased 43% in absolute dollars (to $353 million from $248 million) and as a
percentage of total revenue (to 12.1% from 11.1%) in fiscal 1996 compared with
fiscal 1995. The increase in the amount of expense resulted in part from the
inclusion of $30 million of Cray Research expenses in the fourth quarter, as
well as spending on projects related to new products introduced in fiscal 1997.
Because of the Company's belief that success in its marketplace requires a
continuous flow of new products, it expects to continue to increase the dollar
amount of research and development spending in fiscal 1998.
Selling, general and administrative expenses increased 13% in absolute
dollars (to $1,038 million from $916 million) and as a percentage of total
revenue (to 28.3% from 26.8%) in fiscal 1997 compared with pro forma fiscal
1996. The increase in the amount of expense resulted from costs of new product
introductions as well as from direct costs related to the increase in sales
personnel during fiscal 1997. Selling, general and administrative expenses
increased 30% in absolute dollars (to $808 million from $619 million) and was
unchanged as a percentage of total revenue in fiscal 1996 compared with fiscal
1995. The increase in the amount of expense resulted in part from the inclusion
of $38 million of Cray Research expenses in the fourth quarter, as well as
continued investments in the Company's sales organization. The Company
13
expects selling, general and administrative expenses as a percentage of
anticipated revenue in fiscal 1998 to be roughly comparable to the fiscal 1997
level.
IMPACT OF CURRENCY
The net effect of currency changes was not significant in any of the past
three fiscal years, although currency fluctuations have had and can have
material impacts on particular quarters.
OTHER OPERATING RESULTS
ACQUIRED IN-PROCESS TECHNOLOGY The Company recognized a one-time, non-tax
deductible charge of $98.2 million in the fourth quarter of fiscal 1996 for
in-process technology acquired in the Cray Research merger that had not yet
reached technological feasibility and that had no alternative future use.
MERGER-RELATED EXPENSES Merger-related expenses in fiscal 1997 relate
primarily to the Cray Research acquisition and consist principally of costs
associated with the integration of Silicon Graphics and Cray Research
information systems, accounting processes and marketing and human resource
activities. The Company expects to incur an additional $3 million of similar
merger-related expenses during fiscal 1998.
INTEREST EXPENSE Consolidated interest expense increased in fiscal 1997 and
in fiscal 1996 principally as a result of borrowings associated with the Cray
Research acquisition. The Company does not expect a significant change in the
level of interest expense in fiscal 1998.
INTEREST INCOME AND OTHER, NET Consolidated interest income and other, net
for fiscal 1997 decreased 66% compared with fiscal 1996, reflecting lower
interest income due to significantly lower average invested cash balances, costs
associated with the expansion of the Company's economic hedging program and the
write-off of an investment in a software company. Consolidated interest income
and other, net for fiscal 1996 increased by 19% over the prior year. This was
primarily the result of higher invested cash balances prior to the closing of
the Cray Research tender offer on April 2, 1996, offset by the Company's $10
million share of losses in a joint venture. The Company expects interest income
and other for fiscal 1998 to increase due to improved cash flows as programs
designed to improve asset management are implemented.
PROVISION FOR INCOME TAXES The consolidated effective tax rate for fiscal
1997 was approximately 20% compared with 39% in fiscal 1996 and 29% in fiscal
1995. The effective tax rate for fiscal 1997 differs from the Federal statutory
rate and is lower than in prior periods primarily as a result of the reinstated
U.S. federal research tax credit, proportionately higher earnings in low tax
jurisdictions, and proportionately higher foreign sales corporation benefits,
offset partially by foreign losses for which no benefit has been recorded. The
1996 rate also reflected the impact of the write-off of acquired in-process
technology for which there was no tax benefit.
The Company does not provide for US federal income taxes on undistributed
earnings of foreign subsidiaries which it intends to permanently reinvest in
those operations. The effective tax rate for fiscal 1998 is expected to increase
over the fiscal 1997 rate primarily due to proportionately lower anticipated
earnings in low tax jurisdictions.
14
FINANCIAL CONDITION
The Company's cash position remained substantially unchanged in fiscal 1997.
At June 30, 1997, cash, cash equivalents and short- and long-term investments
net of short-term borrowings, totaled $330 million, up slightly from $320
million at June 30, 1996.
Operating activities generated $170 million in fiscal 1997, compared with
$212 million in fiscal 1996 and $234 million in fiscal 1995. Fiscal 1997 and
1996 net income was affected by a number of charges that did not use cash: $42
million of reduced gross margin associated with the write-up of acquired Cray
Research inventories and service contracts and a $4 million charge for the
write-off of an investment in a software company in fiscal 1997 and the $98
million write-off of acquired in-process technology and $18 million of reduced
gross margin associated with the write-up of acquired Cray Research inventories
in fiscal 1996. The impact of the fiscal 1997 and 1996 charges was somewhat
offset by increased deferred tax benefit provisions, as well as, in fiscal 1996,
the minority interest in Cray Research loss, which did not provide cash. The
growth in fiscal 1997 receivables reflects higher sales levels and longer
collection cycles. Inventory grew significantly in fiscal 1997 in support of the
product transition as well as to support higher revenue levels. The Company
believes its receivables and inventory levels are higher than its operations
require and it has commenced programs designed to improve its asset management
processes and reduce receivables and inventory levels.
Investing activities, other than changes in the Company's marketable
investments, consumed $301 million in cash during fiscal 1997, compared with
$659 million during fiscal 1996 and $127 million during fiscal 1995. Cash
outlays for capital expenditures were slightly lower as a percentage of total
revenue than in fiscal 1996. Cash outlays for other assets in fiscal 1997 were
higher than in prior years and relate principally to spare parts built to
support the Company's new products introduced during the year. The fiscal 1996
tender offer for Cray Research used approximately $408 million of cash, net of
cash acquired.
In December 1996, the Company's subsidiary in Japan entered into long-term
borrowing arrangements under which it borrowed 6 billion yen ($53 million at the
fiscal year-end exchange rate) for a period of five years. In September 1997,
the Company exchanged $231 million principal amount of new 5 1/4% Senior
Convertible Notes due 2004 (the "Senior Notes") for approximately 98% of its
outstanding Zero Coupon Convertible Debentures due 2013 (the "Zero Coupon
Debentures"). There was no change in the carrying value of the Company's debt.
In each of the past three years the Company's employee stock plans have been an
additional source of cash. In October 1995 the Company announced a program to
repurchase seven million shares of common stock to manage the dilution created
by employee stock plans. Under this program, 2,452,600 shares of common stock
were repurchased for $76 million. The Company has not repurchased any shares
since it entered into its merger agreement with Cray Research in February 1996.
At June 30, 1997, the Company's principal sources of liquidity included
cash, cash equivalents and marketable investments of $374 million ($330 million,
net of short-term borrowings) and up to $250 million available under its
three-year revolving credit facility. At this time the Company expects fiscal
1998 capital expenditures to be comparable as a percentage of total revenue to
fiscal 1997. In connection with the acquisition of Cray Research the Company
also has recorded an accrual of approximately $39 million for exit costs related
to exiting facilities and streamlining duplicate administrative activities.
During fiscal 1997 cash outlays for these activities were approximately $20
million. Future cash outlays related to exit activities are estimated to be
approximately $6 million, most of which are expected to be incurred over the
next two years.
The Company's cash and marketable investments, along with the credit
facility, cash generated from operations and other resources available to the
Company, should be adequate to fund the Company's projected cash flow needs. The
Company believes that the level of financial resources is an important
competitive factor in the computer industry and, accordingly, may elect to raise
additional capital through debt or equity financing in anticipation of future
needs.
15
RISKS THAT AFFECT OUR BUSINESS
Silicon Graphics operates in a rapidly changing environment that involves a
number of risks, some of which are beyond the Company's control. The following
discussion highlights some of these risks.
PERIOD TO PERIOD FLUCTUATIONS The Company's operating results may fluctuate
for a number of reasons. Delivery cycles are typically short, other than for
certain large-scale server products. Well over half of each quarter's revenue
results from orders booked and shipped during the third month, and
disproportionately in the latter half of that month. These factors make the
forecasting of revenue inherently uncertain. Because the Company plans its
operating expenses, many of which are relatively fixed in the short term, on
expected revenue, even a relatively small revenue shortfall may cause a period's
results to be substantially below expectations. Such a revenue shortfall could
arise from any number of factors, including lower than expected demand, supply
constraints, delays in the availability of new products, transit interruptions,
overall economic conditions or natural disasters. The timing of customer
acceptance of certain large-scale server products may also have a significant
effect on periodic operating results. Margins are heavily influenced by mix
considerations, including geographical mix, the mix of service and non-recurring
engineering revenue, the mix of high-end and desktop products and application
software, as well as the mix of configurations within these product categories.
The Company's results have followed a seasonal pattern, with stronger
sequential growth in the second and fourth fiscal quarters, reflecting the
buying patterns of the Company's customers.
The Company's stock price, like that of other technology companies, is
subject to significant volatility. If revenue or earnings in any quarter fail to
meet the investment community's expectations, there could be an immediate impact
on the Company's stock price. The stock price may also be affected by broader
market trends unrelated to the Company's performance.
PRODUCT DEVELOPMENT AND INTRODUCTION The Company's continued success
depends on its ability to develop and rapidly bring to volume production highly
differentiated, technologically complex and innovative products. Product
transitions are a recurring part of the Company's business. During fiscal 1997,
for example, the Company replaced most of its product line, including both
graphics and server systems. A number of risks are inherent in this process.
The development of new technology and products is increasingly complex and
uncertain, which increases the risk of delays. The introduction of a new
computer system requires close collaboration and continued technological
advancement involving multiple hardware and software design and manufacturing
teams within the Company as well as teams at outside suppliers of key components
such as semiconductor and storage products. The failure of any one of these
elements could cause the Company's new products to fail to meet specifications
or to miss the aggressive timetables that the Company establishes. As the
variety and complexity of the Company's product families increase, the process
of planning production and inventory levels also becomes more difficult. In
addition, the extent to which a new product gains rapid acceptance is strongly
affected by the availability of key software applications optimized for the new
systems. There is no assurance that acceptance of the Company's new systems will
not be affected by delays in this process.
Short product life cycles place a premium on the Company's ability to manage
the transition from current products to new products. The Company often
announces new products in the early part of a quarter, while the product is in
the final stages of development, and seeks to manufacture and ship the product
in volume in the same quarter. The Company's results could be adversely affected
by such factors as development delays, the release of products to manufacturing
late in any quarter, quality or yield problems experienced by suppliers,
variations in product costs, delays in customer purchases of existing products
in anticipation of the introduction of new products, and excess inventories of
older products and components.
16
PROCESS RE-ENGINEERING The Company is undertaking a series of programs
aimed at redesigning some of its core business processes, including forecasting,
supply chain management, order fulfillment and collection of accounts
receivable. The goals of these programs include more predictable results of
operations, greater quality and customer satisfaction, and improved asset
management. The Company believes that the success of these programs is critical
to its long-term competitive position. Implementing these changes will require,
among other things, enhanced information systems, substantial training and
disciplined execution. There can be no assurance that these programs will be
implemented successfully, or that disruptions of the Company's operations will
not occur in the process.
COMPETITION The computer industry is highly competitive, with rapid
technological advances and constantly improving price/performance. As most of
the segments in which the Company operates continue to grow faster than the
industry as a whole, the Company is experiencing an increase in competition, and
it expects this trend to continue. This competition comes not only from the
Company's traditional UNIX workstation rivals and traditional supercomputing
competitors, but also from new sources including the personal computer industry.
Many of the Company's competitors have substantially greater technical,
marketing and financial resources and, in some segments, a larger installed base
of customers and a wider range of available applications software. Competition
may result in significant discounting and lower gross margins.
DESKTOP SYSTEM STRATEGY The Company has under development a desktop system
that will be based upon Intel microprocessors and the Windows NT operating
system. There can be no assurance that this system will be introduced, and in
any event the system will not account for any material revenues in fiscal 1998.
Success in this market segment will require that the Company adapt to the very
different requirements of this higher volume, lower margin market, including
lower-cost manufacturing and distribution, marketing to a broader audience in
markets that could extend beyond the Company's traditional markets, and new
approaches to customer interface and support. The Company will also be required
to manage a complex product transition and to support a product line including
multiple operating systems. In particular, although the Company plans to
continue to invest in and support its current line of UNIX/ MIPS-based
workstations, there is a risk that revenue from this business will be materially
reduced by the announcement of the new product. The Company believes that its
future success will depend in significant part on its making the right strategic
choices in this market segment and on executing its strategy effectively.
IMPACT OF GOVERNMENT CUSTOMERS A significant portion of the Company's
revenue is derived from sales to the U.S. government, either directly by the
Company or through system integrators and other resellers. Sales to the
government present risks in addition to those involved in sales to commercial
customers, including potential disruptions due to appropriation and spending
patterns and the government's reservation of the right to cancel contracts for
its convenience.
EXPORT REGULATION The Company's sales to foreign customers are subject to
export regulations. Sales of many of the Company's high-end products require
clearance and export licenses from the U.S. Department of Commerce under these
regulations. The Departments of Commerce and Justice are currently investigating
the Company's compliance with the export regulations in connection with the sale
of several computer systems to a customer in Russia in fiscal 1997. The Company
believes that it has complied in all material respects with all applicable laws
and that this matter will be resolved without a significant adverse effect on
the Company's business. However, there is no assurance that this matter will not
have an unforeseen outcome that could impair the conduct of the Company's
business outside the United States.
The Company's international sales would also be adversely affected if such
regulations were tightened, or if they are not modified over time to reflect the
increasing performance of the Company's products.
DEVELOPMENT AND ACCEPTANCE OF MIPS RISC ARCHITECTURE Most of the Company's
system products incorporate microprocessors based upon the Company's MIPS RISC
microprocessor architecture. The
17
Company licenses the manufacturing and distribution rights to these
microprocessors to selected semiconductor manufacturing companies. The Company
believes that the continued development and broad acceptance of the MIPS
architecture are critical to its future success.
INTELLECTUAL PROPERTY The Company routinely receives communications from
third parties asserting patent or other rights covering the Company's products
and technologies. Based upon the Company's evaluation, it may take no action or
it may seek to obtain a license. In any given case there is a risk that a
license will not be available on terms that the Company considers reasonable, or
that litigation will ensue. The Company currently has patent infringement
lawsuits pending against it. The Company expects that, as the number of hardware
and software patents issued continues to increase, and as the Company's business
grows, the volume of these intellectual property claims will also increase.
EMPLOYEES The Company's future success depends in part on its ability to
continue to attract, retain and motivate highly qualified technical, marketing
and management personnel, who are in great demand.
BUSINESS DISRUPTION The Company's corporate headquarters, including most of
its research and development operations and manufacturing facilities, are
located in the Silicon Valley area of Northern California, a region known for
seismic activity. Operating results could be materially affected by a
significant earthquake. The Company is predominantly self-insured for losses and
business interruptions of this kind.
GLOBAL FINANCIAL MARKET RISKS The Company's business and financial results
are affected by fluctuations in world financial markets, including foreign
currency exchange rates and interest rates. The Company's hedging policy
attempts to reduce some of these risks, based on management's best judgment of
the appropriate tradeoffs among risk, opportunity and expense. The Company
regularly reviews its overall hedging policies, and it continually monitors its
hedging activities to ensure that they are consistent with the Company's policy
and are appropriate and effective in light of changing market conditions.
Management may as part of this review determine at any time to change its
hedging policies. Though the Company intends for its risk management policy to
be comprehensive, there are inherent risks which may be only partially offset by
the Company's program should there be unfavorable movements in either foreign
exchange or interest rates.
Because a significant portion of the Company's revenue is from sales outside
the United States, and many key components are produced outside the United
States, the Company's results can be significantly affected by changes in
foreign currency exchange rates or weak economic conditions in the foreign
markets in which the Company distributes its products. The Company is primarily
exposed to changes in exchange rates on the German mark, British pound, Japanese
yen, French franc, and Korean won. When the U.S. dollar strengthens against
these currencies, the value (as expressed in U.S. dollars) of non-U.S. dollar-
based sales and costs decrease. The opposite happens when the U.S. dollar
weakens. Because the Company is a net receiver of currencies other than the U.S.
dollar, it benefits from a weaker dollar and is adversely affected by a stronger
dollar relative to major currencies worldwide. Accordingly, a strengthening of
the U.S. dollar tends to affect negatively the Company's revenue and gross
margins.
The Company's currency hedging program currently involves hedging (i) net
non-U.S. dollar monetary assets and liabilities and generally all server backlog
where the delivery cycle is expected to exceed three months using currency
forward contracts and (ii) a significant portion of anticipated quarterly
revenue using currency options which expire within each fiscal quarter. The
Company has generally not hedged capital expenditures, investments in
subsidiaries or inventory purchases. However, because the Company procures
inventory and its international operations incur expenses in local currencies,
the financial effects of fluctuations in the U.S. dollar values of non-U.S.
dollar-based transactions frequently mitigate or tend to offset each other on a
consolidated basis.
18
At June 30, 1997, the Company had a notional amount of $296 million in
currency forward contracts related to net non-U.S. dollar monetary assets and
liabilities and server backlog. Approximately $269 million of such currency
forward contracts expire within two months of fiscal year end and all but $8
million expire during fiscal 1998. The currency forward contracts are
principally denominated in German marks ($71 million), British pounds ($38
million) and Japanese yen ($36 million), with the remainder distributed across
over twenty other currencies. At June 30, 1997, the aggregate fair value of the
Company's currency forward agreements was $0.1 million.
The Company also had $55 million in Japanese yen denominated borrowings, $20
million in Swiss franc denominated borrowings and $4 million in other foreign
currency denominated borrowings at June 30, 1997. The aggregate fair value of
these borrowings at June 30, 1997 was $79 million.
The Company's investment securities and substantially all of its debt
instruments carry fixed rates of interest over their respective maturity terms.
The Company does not currently use derivatives, such as swaps, to alter the
interest characteristics of its investment securities or its debt instruments.
The Company's investment securities represented 6% of total assets at June 30,
1997. Investment securities aggregating $110 million mature during fiscal 1998
at fixed rates averaging 5.51%, and investment securities aggregating $87
million mature in fiscal 1999 at fixed rates averaging 5.34%. The aggregate fair
value of the Company's investment securities at June 30, 1997 equaled its
carrying value of $197 million. With respect to its interest bearing liabilities
at June 30, 1997, $41 million of the Company's $45 million in short-term
borrowings were in reverse repurchase agreements (average rate of 6.10%) that
were repaid in July 1997 and all but $20 million of its $380 million in
long-term borrowings are at fixed rates (average rate of 4.45%). The aggregate
future principle cash flow and fair value of the Company's borrowings at June
30, 1997 were $664 million and $414 million, respectively. The differential
between the future cash flow and fair value is primarily attributable to the
Company's Zero Coupon Convertible Subordinated Debentures due 2013 with an
ultimate maturity value of $455 million and a fair value of $223 million.
19
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
QUARTERLY DATA
(UNAUDITED)
FISCAL 1997 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) JUNE 30 MARCH 31 DEC. 31 SEPT. 30
------------ ---------- ---------- ----------
Total revenue.................................................. $ 1,162,317 $ 909,370 $ 825,312 $ 765,602
Costs and expenses:
Cost of revenue.............................................. 597,622 517,292 456,937 450,695
Research and development..................................... 125,196 121,532 124,094 108,279
Selling, general and administrative.......................... 297,712 254,086 254,348 232,167
Merger-related expenses...................................... 3,110 2,482 2,331 2,834
------------ ---------- ---------- ----------
Operating income (loss)........................................ 138,677 13,978 (12,398) (28,373)
Interest and other income (expense), net....................... (9,323) (2,156) (1,397) (818)
------------ ---------- ---------- ----------
Income (loss) before income taxes.............................. 129,354 11,822 (13,795) (29,191)
Net income (loss).............................................. 102,403 10,538 (12,789) (21,601)
Net income (loss) per share.................................... $ 0.56 $ 0.06 $ (0.07) $ (0.13)
Common and common equivalent shares used in the calculation of
income (loss) per share...................................... 183,461 184,555 174,926 172,974
FISCAL 1996 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) JUNE 30(1) MARCH 31 DEC. 31 SEPT. 30
------------ ---------- ---------- ----------
Total revenue.................................................. $ 977,373 $ 676,931 $ 671,733 $ 595,279
Costs and expenses:
Cost of revenue.............................................. 548,395 330,077 331,356 272,611
Research and development..................................... 121,915 78,006 80,797 72,743
Selling, general and administrative.......................... 246,593 195,897 193,151 172,189
Write-off of acquired in-process technology and
merger-related expenses.................................... 101,918 -- 561 714
------------ ---------- ---------- ----------
Operating income (loss)........................................ (41,448) 72,951 65,868 77,022
Interest and other income (expense), net....................... (4,367) 1,740 6,699 6,341
Minority interest in net loss of Cray Research................. 3,982 -- -- --
------------ ---------- ---------- ----------
Income (loss) before income taxes.............................. (41,833) 74,691 72,567 83,363
Net income (loss).............................................. (48,704) 53,031 52,353 58,357
Net income (loss) per share.................................... $ (0.30) $ 0.31 $ 0.30 $ 0.33
Common and common equivalent shares used in the calculation of
income (loss) per share...................................... 164,388 173,545 177,319 179,236
- ------------------------
(1) Amounts reflect the April 2, 1996 acquisition of Cray Research which was
accounted for as a purchase.
See Notes 2 and 3 to the consolidated financial statements.
20
REPORT OF MANAGEMENT
To Our Stockholders:
The Company's management is responsible for the preparation and integrity of
the financial information presented in the accompanying consolidated financial
statements. The financial statements were prepared in conformity with generally
accepted accounting principles and reflect management's estimates and judgments
as required.
The Company's consolidated financial statements have been audited by Ernst &
Young LLP, a firm of independent auditors, whose appointment was approved by the
Company's stockholders. Their accompanying report is based on procedures
performed in accordance with generally accepted auditing standards, including
tests of the accounting records and other auditing procedures as they considered
necessary.
The Company's management maintains a system of internal control and related
policies and procedures designed to provide reasonable assurance that assets are
safeguarded, transactions are properly executed in accordance with management's
authorization, and accounting records may be relied upon for the preparation of
financial statements and other financial information. Limitations exist in any
system of internal control based upon the recognition that the cost of the
systems should not exceed the benefits derived. The system is continuously
monitored by direct management review and by internal auditors who conduct a
program of audits throughout the Company. Ernst & Young LLP, as part of the
audit of the Company's consolidated financial statements, considers that
internal control structure to determine the nature, timing, and extent of its
audit tests. Management believes that the Company's system of internal control
is adequate to accomplish the objectives discussed herein.
The Audit Committee of the Board of Directors, composed solely of directors
who are not officers of the Company, is responsible for monitoring and
overseeing the quality of the Company's accounting and reporting policies,
internal controls and other matters deemed appropriate. Based on the nature of
the matters under review, the independent and internal auditors, as well as
certain officers and employees, attend all or part of the Audit Committee
meetings. The Audit Committee has direct and private access to both internal and
external auditors and reviews the performance of Ernst & Young LLP in their
audit of the Company's financial statements and evaluates their independence and
professional competence.
[SIG] [SIG]
Edward R. McCracken William M. Kelly
CHAIRMAN AND CHIEF EXECUTIVE OFFICER SENIOR VICE PRESIDENT, CORPORATE OPERATIONS
AND ACTING CHIEF FINANCIAL OFFICER
[SIG]
Dennis P. McBride
VICE PRESIDENT, CONTROLLER
21
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To The Board Of Directors And Stockholders Of Silicon Graphics, Inc.
We have audited the accompanying consolidated balance sheets of Silicon
Graphics, Inc. as of June 30, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended June 30, 1997. Our audits also included the
financial statement schedule noted in the index at Item 14(a)(2). 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material aspects, the consolidated financial position of Silicon
Graphics, Inc. at June 30, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
June 30, 1997, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
[SIG]
Palo Alto, California
July 18, 1997
22
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1997 1996(1) 1995
------------ ------------ ------------
Revenue:
Product and other revenue............................................. $ 3,086,791 $ 2,553,128 $ 1,989,969
Service revenue....................................................... 575,810 368,188 238,299
------------ ------------ ------------
Total revenue....................................................... 3,662,601 2,921,316 2,228,268
Costs and Expenses:
Cost of product and other revenue..................................... 1,697,277 1,279,742 908,516
Cost of service revenue............................................... 325,269 202,697 123,543
Research and development.............................................. 479,101 353,461 247,678
Selling, general and administrative................................... 1,038,313 807,830 619,259
Write-off of acquired in-process technology and merger related
expenses............................................................ 10,757 103,193 22,000
------------ ------------ ------------
Total costs and expenses............................................ 3,550,717 2,746,923 1,920,996
------------ ------------ ------------
Operating income........................................................ 111,884 174,393 307,272
Interest expense........................................................ (24,836) (22,365) (18,188)
Interest income and other, net.......................................... 11,142 32,778 27,635
Minority interest in net loss of Cray Research.......................... -- 3,982 --
------------ ------------ ------------
Income before income taxes.............................................. 98,190 188,788 316,719
Provision for income taxes.............................................. 19,639 73,751 91,863
------------ ------------ ------------
Net income.............................................................. $ 78,551 $ 115,037 $ 224,856
------------ ------------ ------------
------------ ------------ ------------
Net income per share.................................................... $ 0.43 $ 0.65 $ 1.28
------------ ------------ ------------
------------ ------------ ------------
Common and common equivalent shares used in the calculation of income
per share............................................................. 182,637 175,790 175,435
- ------------------------
(1) Amounts reflect the April 2, 1996 acquisition of Cray Research, which was
accounted for as a purchase. See Notes 2 and 3 to the consolidated financial
statements.
The accompanying Notes are an integral part of these consolidated financial
statements.
23
CONSOLIDATED BALANCE SHEETS
AT JUNE 30
(DOLLARS IN THOUSANDS) 1997 1996
------------ ------------
ASSETS:
Current assets:
Cash and cash equivalents........................................................... $ 227,222 $ 257,080
Short-term marketable investments................................................... 60,109 38,316
Accounts receivable, net of allowance for doubtful accounts of $24,056 in 1997;
$23,767 in 1996................................................................... 1,131,647 978,874
Inventories......................................................................... 628,064 520,045
Deferred tax assets................................................................. 188,617 198,239
Prepaid expenses and other current assets........................................... 79,935 103,701
------------ ------------
Total current assets.............................................................. 2,315,594 2,096,255
Other marketable investments.......................................................... 86,961 161,541
Property and equipment, net of accumulated depreciation and amortization.............. 525,452 464,879
Other assets.......................................................................... 416,585 435,571
------------ ------------
$ 3,344,592 $ 3,158,246
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Short-term borrowings............................................................... $ 44,763 $ 136,718
Accounts payable.................................................................... 258,884 261,120
Accrued compensation................................................................ 125,076 103,996
Income taxes payable................................................................ 47,480 59,827
Accrued merger liabilities.......................................................... 27,938 56,251
Other current liabilities........................................................... 236,214 204,789
Deferred revenue.................................................................... 337,691 273,549
Current portion of long-term debt................................................... 8,160 5,188
------------ ------------
Total current liabilities......................................................... 1,086,206 1,101,438
Long-term debt and other.............................................................. 419,144 381,490
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value: issuable in series, 2,000,000 shares authorized;
shares issued and outstanding: 17,500............................................. 16,998 16,998
Common stock, $.001 par value, and additional paid-in capital:
500,000,000 shares authorized; shares issued: 179,033,487 in 1997;
172,410,082 in 1996............................................................... 1,263,185 1,172,960
Retained earnings................................................................... 537,238 461,311
Treasury stock, at cost: 28 shares in 1997; 35,614 shares in 1996................... -- (867)
Accumulated translation adjustment and other........................................ 21,821 24,916
------------ ------------
Total stockholders' equity........................................................ 1,839,242 1,675,318
------------ ------------
$ 3,344,592 $ 3,158,246
------------ ------------
------------ ------------
The accompanying Notes are an integral part of these consolidated financial
statements.
24
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
COMMON STOCK
AND ADDITIONAL ACCUMULATED
THREE YEARS ENDED JUNE 30, PREFERRED STOCK PAID-IN CAPITAL TREASURY STOCK TRANSLATION TOTAL
1997 ----------------- -------------------- RETAINED ---------------- ADJUSTMENT STOCKHOLDERS'
(IN THOUSANDS) SHARES AMOUNT SHARES AMOUNT EARNINGS SHARES AMOUNTS AND OTHER EQUITY
------ -------- -------- ---------- -------- ------ -------- ----------- -------------
Balance, June 30, 1994........ 809 $ 37,796 148,450 $ 728,799 $157,619 -- $ -- $ 12,955 $ 937,169
Common stock issued under
employee stock option and
purchase plans including
related tax benefits...... -- -- 7,443 108,509 -- -- -- -- 108,509
Conversion of preferred
stock..................... (476) (19,703) 688 19,703 -- -- -- -- --
Convertible preferred stock,
Series A preferred
dividends................. -- -- -- -- (1,006 ) -- -- -- (1,006)
Currency translation
adjustment................ -- -- -- -- -- -- -- 25,885 25,885
Change in unrealized gains
(losses) on available-
for-sale securities, net
of tax.................... -- -- -- -- -- -- -- 1,157 1,157
Net income.................. -- -- -- -- 224,856 -- -- -- 224,856
Net transactions of Alias
and Wavefront from
February 1, 1994 through
July 31, 1994 and January
1, 1994 through June 30,
1994, respectively........ (316) (1,095) 3,898 46,289 4,446 -- -- (40) 49,600
------ -------- -------- ---------- -------- ------ -------- ----------- -------------
Balance, June 30, 1995........ 17 16,998 160,479 903,300 385,915 -- -- 39,957 1,346,170
Common stock issued under
employee stock option and
purchase plans including
related tax benefits...... -- -- 4,606 72,618 (39,116 ) 2,417 75,147 -- 108,649
Common stock issued for Cray
Research acquisition...... -- -- 7,325 197,042 -- -- -- -- 197,042
Convertible preferred stock,
Series A preferred
dividends................. -- -- -- -- (525 ) -- -- -- (525)
Treasury stock purchased.... -- -- -- -- -- (2,453) (76,014 ) -- (76,014)
Currency translation
adjustment................ -- -- -- -- -- -- -- (12,047) (12,047)
Change in unrealized gains
(losses) on available-
for-sale securities, net
of tax.................... -- -- -- -- -- -- -- (2,994) (2,994)
Net income.................. -- -- -- -- 115,037 -- -- -- 115,037
------ -------- -------- ---------- -------- ------ -------- ----------- -------------
Balance, June 30, 1996(1)..... 17 16,998 172,410 1,172,960 461,311 (36 ) (867 ) 24,916 1,675,318
Common stock issued under
employee stock option and
purchase plans including
related tax benefits...... -- -- 6,623 90,225 (2,099 ) 36 867 -- 88,993
Convertible preferred stock,
Series A preferred
dividends................. -- -- -- -- (525 ) -- -- -- (525)
Currency translation
adjustment................ -- -- -- -- -- -- -- (4,303) (4,303)
Change in unrealized gains
(losses) on available-
for-sale securities, net
of tax.................... -- -- -- -- -- -- -- 1,208 1,208
Net income.................. -- -- -- -- 78,551 -- -- -- 78,551
------ -------- -------- ---------- -------- ------ -------- ----------- -------------
Balance, June 30, 1997........ 17 $ 16,998 179,033 $1,263,185 $537,238 -- $ -- $ 21,821 $1,839,242
------ -------- -------- ---------- -------- ------ -------- ----------- -------------
------ -------- -------- ---------- -------- ------ -------- ----------- -------------
------------------------------------
(1) Amounts reflect the April 2, 1996 acquisition of Cray Research,
which was accounted for as a purchase. See Notes 2 and 3 to the
consolidated financial statements.
The accompanying Notes are an integral part of these consolidated
financial statements.
25
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30
(IN THOUSANDS) 1997 1996(1) 1995
----------- ------------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................... $ 78,551 $ 115,037 $ 224,856
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization.......................................... 354,319 197,836 115,537
Write-off of acquired in-process technology............................ -- 98,208 --
Changes in deferred tax assets and liabilities......................... (18,918) (66,776) 7,912
Other.................................................................. 4,690 (3,050) 34,529
Changes in operating assets and liabilities (net of effects of Cray
Research acquisition):
Accounts receivable.................................................. (152,773) (202,061) (222,482)
Inventories.......................................................... (211,013) (19,632) (115,929)
Accounts payable..................................................... (2,236) 38,109 71,238
Other assets and liabilities......................................... 117,614 54,015 117,983
----------- ------------- -----------
Total adjustments................................................ 91,683 96,649 8,788
----------- ------------- -----------
Net cash provided by operating activities............................ 170,234 211,686 233,644
CASH FLOWS FROM INVESTING ACTIVITIES:
Available-for-sale investments:
Purchases.............................................................. (6,036) (1,006,107) (575,191)
Sales.................................................................. 16,162 1,232,419 178,928
Maturities............................................................. 44,274 52,938 209,873
Acquisition of Cray Research, net of cash acquired....................... -- (408,144) --
Capital expenditures..................................................... (214,989) (188,853) (147,933)
Increase in other assets................................................. (86,359) (62,388) (23,879)
Net increase in cash and cash equivalents of Alias for the period
February 1994 to July 1994, and Wavefront for the period January 1994
to June 1994........................................................... -- -- 44,479
----------- ------------- -----------
Net cash used in investing activities................................ (246,948) (380,135) (313,723)
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of debt......................................................... 123,807 137,509 2,286
Payments of debt principal............................................... (153,730) (24,894) (16,077)
Sale of common stock..................................................... 77,304 81,578 75,334
Repurchase of common stock............................................... -- (76,014) --
Cash dividends-preferred stock........................................... (525) (525) (1,050)
----------- ------------- -----------
Net cash provided by financing activities............................ 46,856 117,654 60,493
----------- ------------- -----------
Net decrease in cash and cash equivalents................................ (29,858) (50,795) (19,586)
Cash and cash equivalents at beginning of year........................... 257,080 307,875 327,461
----------- ------------- -----------
Cash and cash equivalents at end of year................................. $ 227,222 $ 257,080 $ 307,875
----------- ------------- -----------
----------- ------------- -----------
- ------------------------
(1) Amounts reflect the April 2, 1996 acquisition of Cray Research, which was
accounted for as a purchase. See Notes 2 and 3 to the consolidated financial
statements.
The accompanying Notes are an integral part of these consolidated financial
statements.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF OPERATIONS
Silicon Graphics, Inc. ("Silicon Graphics" or the "Company") is a leader in
high-performance computing. The Company's broad range of workstations and
graphics servers deliver advanced 3D graphics and computing capabilities for
engineering and creative professionals. Silicon Graphics and Cray
Research-branded servers are the market leaders in technical computing
applications. The Company's highly scalable servers also have a growing presence
in the enterprise market, with a particular emphasis on Internet, large
corporate data and telecommunications applications. The Company's products are
primarily manufactured in Mountain View, California, Chippewa Falls, Wisconsin
and near Neuchatel, Switzerland. The Company distributes its products through
its direct sales force, as well as through indirect channels including resellers
and distributors. Product and other revenue consists primarily of revenue from
system and software product shipments, as well as the sale of software
distribution rights, system leasing, technology licensing agreements and
non-recurring engineering ("NRE") contracts. Service revenue results primarily
from customer support and maintenance contracts.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include
the accounts of the Company and its wholly-owned subsidiaries after elimination
of significant intercompany transactions and balances. The Company acquired Cray
Research, Inc. in a merger effected in the fourth quarter of fiscal 1996. The
Cray Research operating results were consolidated with those of the Company at
April 2, 1996, and the consolidated results reflect a 25% minority interest in
the Cray Research operating results for the period from April 2, 1996 through
June 30, 1996. The Company acquired Alias Research Inc. ("Alias") and Wavefront
Technologies, Inc. ("Wavefront") in mergers effected in the fourth quarter of
fiscal 1995. These mergers were accounted for as a pooling of interests and as
such, all periods prior to fiscal 1995 were restated. The consolidated financial
statements for fiscal 1995 were not restated to adjust Alias's and Wavefront's
fiscal year-ends to that of the Company. Thus, fiscal 1995 includes the
Company's results of operations and balance sheet data on a June 30 fiscal year
basis, Alias' on a January 31 fiscal year basis, and Wavefront's on a calendar
year basis. Certain amounts for prior years have been reclassified to conform to
current year presentation.
FOREIGN CURRENCY TRANSLATION The Company translates the assets and
liabilities of its foreign subsidiaries stated in local functional currencies to
U.S. dollars at the rates of exchange in effect at the end of the period.
Revenues and expenses are translated using rates of exchange in effect during
the period. Gains and losses from currency translation are included in
stockholders' equity. Currency transaction gains or losses are recognized in
current operations and, net of hedging gains or losses, have not been
significant to the Company's operating results in any period.
USE OF ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results inevitably will differ from those estimates,
and such differences may be material to the financial statements.
CASH EQUIVALENTS AND MARKETABLE INVESTMENTS Cash equivalents consist of
high quality money market instruments with original maturities of 90 days or
less. Short-term marketable investments consist of high quality money market
instruments with original maturities greater than 90 days, but less than one
year, and are stated at fair value. Other marketable investments consist
primarily of high quality debt securities with maturities greater than one year
and less than two years, and are stated at fair value. At June 30, 1997 and
1996, the Company's cash equivalents and marketable investments are all
classified as available-for-sale.
27
The cost of securities when sold is based upon specific identification.
Realized gains and losses and declines in value judged to be
other-than-temporary on available-for-sale securities are included in interest
income and other, net. Unrealized gains and losses (net of tax) on securities
classified as available-for-sale are included in stockholders' equity.
FAIR VALUES OF FINANCIAL INSTRUMENTS Fair values of cash equivalents and
short-term debt approximate cost due to the short period of time to maturity.
Fair values of marketable investments, long-term debt, foreign exchange forward
contracts and interest swaps are based on quoted market prices or pricing models
using current market rates.
DERIVATIVE FINANCIAL INSTRUMENTS Silicon Graphics uses derivatives to
moderate some of its financial market risks including, foreign currency and
interest rate market exposures of certain assets, liabilities and other
obligations. The Company does not hold or issue any derivative instruments for
trading purposes. The Company's accounting policies for these instruments are
based on its designation of such instruments as hedging transactions. The
criteria the Company uses to designate an instrument as a hedge include its
effectiveness in risk reduction and one-to-one matching of derivative
instruments to underlying transactions. Gains and losses on currency forward
contracts that hedge firmly committed customer transactions are deferred and
recognized in revenue in the same period that the underlying transactions are
settled. Gains and losses on currency forward contracts that hedge existing
assets and liabilities are recognized in interest and other income, net, in the
same period as losses and gains on the underlying transactions are recognized
and generally offset. Gains and losses on any derivatives not meeting the above
criteria would be recognized in income in the current period. The differential
between fixed and floating rates to be paid or received on interest rate swaps
is accrued and recognized as an adjustment to interest expense over the life of
the agreements. The related amount payable or receivable is included in other
current assets or accrued liabilities.
INVENTORIES Manufacturing inventories are stated at the lower of cost
(first-in, first-out) or market. Marketing inventories are stated at cost less
depreciation generally based on a two-year life.
PROPERTY AND EQUIPMENT Property and equipment is stated at cost and
depreciation is computed using the straight-line method. Useful lives of two to
seven years are used for machinery and equipment and furniture and fixtures;
leasehold improvements are amortized over the shorter of their useful lives or
the term of the lease. The Company's buildings and improvements are depreciated
over eight to forty years.
OTHER ASSETS Included in other assets are intangible assets related to the
acquisition of Cray Research in fiscal 1996, and goodwill associated with the
acquisition of Silicon Graphics World Trade Corporation in fiscal 1991.
Amortization of these purchased intangibles and goodwill is provided on a
straight-line basis over the respective useful lives of the assets ranging from
four to twenty years. Also included in other assets are purchased technologies
and spare parts that are generally amortized on a straight-line basis over the
course of their respective useful lives ranging from two to ten years, as well
as deferred tax assets.
Effective July 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets
and Long-Lived Assets to Be Disposed Of ("SFAS 121"). The adoption of SFAS 121
has not had a material impact upon the Company's financial position or results
of operations.
REVENUE RECOGNITION Product revenue is generally recognized when the
product is shipped to the customer and the Company has no additional performance
obligations. Sales of certain high performance systems, including most Cray
Research-branded systems, are made on the basis of contracts that include
acceptance criteria. In these instances, revenue (net of trade-in allowances) is
recognized upon acceptance by the customer or independent distributor.
28
Initial software fees are recognized when the product has been shipped,
provided that the Company has no additional performance obligations. Revenue
recognition under technology agreements is dependent on the nature and level of
effort required to deliver and/or support the technology transfer. Generally,
technology revenue is recognized upon the completion of contract requirements or
milestones.
Revenue related to future commitments under service contracts is deferred
and recognized ratably over the related contract term.
PRODUCT WARRANTY The Company provides at the time of sale for the estimated
cost to warrant its products against defects in materials and workmanship for a
period of up to one year.
ADVERTISING COSTS The Company accounts for advertising costs as expense in
the period in which they are incurred. Advertising expense for the years ended
June 30, 1997, 1996 and 1995 was $42.5 million, $37.5 million and $16.9 million,
respectively.
PER SHARE DATA Primary earnings per share are computed using the weighted
average number of shares of common stock and dilutive common stock equivalents
outstanding during the period. Dilutive common share equivalents include stock
options or warrants using the treasury stock or modified treasury stock method
(whichever applies) and, if dilutive, convertible securities on an
as-if-converted basis. For the purpose of calculating earnings per share, the
Company's convertible preferred stock is considered to be a common stock
equivalent. Fully diluted earnings per share are substantially the same as
reported earnings per share.
In March 1997, the Financial Accounting Standards Board issued Statement No.
128, Earnings Per Share ("SFAS 128"), which modifies existing guidance for
computing earnings per share and requires the disclosure of basic and diluted
earnings per share. Under the new standard, basic earnings per share is computed
as earnings available to common stockholders divided by weighted average shares
outstanding excluding the dilutive effects of stock options and other
potentially dilutive securities. Diluted earnings per share includes the
dilutive effect of these securities. The effective date of SFAS 128 is December
15, 1997 and early adoption is not permitted. The Company intends to adopt SFAS
128 during the quarter ended December 31, 1997. Had the provisions of SFAS 128
been applied to the Company's results of operations for each of the three years
in the period ended June 30, 1997, the Company's basic earnings per share would
have been $0.44, $0.70 and $1.44 per share, respectively, and its diluted
earnings per share would have been $0.43, $0.65 and $1.26 per share,
respectively.
STOCK COMPENSATION In fiscal 1997, the Company implemented the disclosure
requirements of the Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation ("SFAS 123"). Under SFAS 123, the
Company will continue to account for stock-based employee compensation
arrangements under the intrinsic value method prescribed by Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB
25"), and will provide pro forma disclosures of net income and earnings per
share as if the fair value basis method prescribed by SFAS 123 had been applied
in measuring employee compensation expense.
RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the Financial Accounting
Standards Board issued Statement No. 130, Reporting Comprehensive Income ("SFAS
130"), and Statement No. 131, Disclosures about Segments of an Enterprise and
Related Information ("SFAS 131"). The Company is required to adopt these
Statements in fiscal 1999. SFAS 130 establishes new standards for reporting and
displaying comprehensive income and its components. SFAS 131 requires disclosure
of certain information regarding operating segments, products and services,
geographic areas of operation and major customers. Adoption of these Statements
is expected to have no impact on the Company's consolidated financial position,
results of operations or cash flows.
NOTE 3. BUSINESS COMBINATIONS
ACQUISITION OF CRAY RESEARCH On April 2, 1996, Silicon Graphics acquired
approximately 75% of the outstanding shares of common stock of Cray Research for
cash. On June 30, 1996, the Company acquired
29
the remaining outstanding Cray Research shares in a merger by exchanging one
share of Silicon Graphics common stock for each remaining share of Cray Research
common stock. Silicon Graphics also assumed the outstanding Cray Research
employee stock options. The aggregate purchase price (including direct
acquisition costs) was approximately $767 million in cash, common stock and the
value associated with options to purchase the Company's common stock. The
Company has accounted for the acquisition using the purchase method.
The following is a summary of the purchase price allocation (in millions):
Inventories and service contracts................................... $ 281.5
Property, plant and equipment....................................... 143.7
Intangible assets................................................... 84.3
Accrual for exit costs.............................................. (39.4)
Other assets/liabilities, net....................................... 198.5
Acquired in-process technology...................................... 98.2
---------
$ 766.8
---------
---------
Intangible assets include $24.5 million of completed technology and an
aggregate of $59.8 million for customer lists, trade name and
workforce-in-place. Completed technology has been assigned a four-year life,
workforce-in-place a five-year life and customer lists and trade name 15-year
lives.
The accrual for exit costs includes only those direct costs related to
exiting facilities and operations acquired from Cray Research and does not
include any costs related to modifications of the previous Silicon Graphics
business. The composition of costs related to the exit activities were as
follows (in millions): non-cancelable lease commitments after closure and
related costs--$16.6; severance and related costs--$20.5; and other costs--$2.3.
Except for approximately $6 million in remaining lease commitments, severance
obligations and other assumed obligations, the activities contemplated in the
$39.4 million accrual for exit costs have been completed at June 30, 1997.
During fiscal 1997, cash outlays related to exit activities were approximately
$20 million. The excess of the original accrual for exit costs over the actual
amounts incurred and currently expected to be incurred will be amortized over
the combined average acquired asset life.
The $98.2 million allocated to acquired in-process technology was expensed
in fiscal 1996 as required under generally accepted accounting principles.
The unaudited pro forma combined condensed results of operations of the
Company for fiscal 1996 and 1995, had the acquisition occurred at the beginning
of each fiscal year presented and which eliminates the non-recurring charges,
are as follows (in thousands, except per share amounts):
1996 1995
------------ ------------
Total revenue..................................................... $ 3,447,480 $ 2,955,991
Net income........................................................ $ 108,044 $ 5,343
Net income per share.............................................. $ 0.59 $ 0.03
The unaudited pro forma combined results for fiscal 1996 and 1995 exclude
the effects of the write-off of acquired in-process technology and other merger
costs of approximately $102 million, as such amounts are non-recurring. In
addition to combining the historical results of operations of the two companies,
the pro forma calculations include the estimated effect on the Company's
historical results of operations from adjustments to the historical carrying
values of Cray Research inventories and property, plant and equipment;
intangible asset amortization; and loss of interest income as a result of making
the acquisition.
The unaudited pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the operating results that would have
occurred had the transaction been completed at the beginning of the periods
indicated, nor is it necessarily indicative of future operating results.
30
MERGERS WITH ALIAS AND WAVEFRONT On June 15, 1995, the Company merged with
Alias and Wavefront. Alias and Wavefront outstanding common stock was converted
to Silicon Graphics common stock at per share rates of .90 and .49,
respectively. Silicon Graphics issued 14,100,577 shares in connection with the
mergers. The mergers were accounted for as a pooling of interests and,
accordingly, the Company's consolidated financial statements and related notes
thereto have been restated to include the results of Alias and Wavefront for all
periods presented. Adjustments to combine these entities, consisting primarily
of intercompany transactions, were not significant.
The Company incurred costs in connection with the mergers and consolidation
of operations. Included in the accompanying consolidated statement of operations
for fiscal 1995 are merger-related expenses totaling approximately $22 million,
consisting primarily of charges for transaction and professional fees, personnel
severance costs, and elimination of duplicate facilities.
NOTE 4. FINANCIAL INSTRUMENTS
CASH EQUIVALENTS AND MARKETABLE INVESTMENTS The Company's cash equivalents
and marketable investments at June 30, 1997 and 1996 are as follows (in
thousands):
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
JUNE 30, 1997 COST GAINS LOSSES FAIR VALUE
---------- ------------- ----------- ----------
U.S. Treasury securities and obligations of U.S. government
agencies....................................................... $ 147,235 $ 6 $ (904) $ 146,337
Repurchase agreements............................................ 35,000 -- -- 35,000
Money market funds............................................... 14,400 -- -- 14,400
Other............................................................ 733 -- -- 733
---------- ----- ----------- ----------
Total............................................................ 197,368 6 (904) 196,470
Less amounts classified as cash equivalents...................... (49,400) -- -- (49,400)
---------- ----- ----------- ----------
Total marketable investments..................................... $ 147,968 $ 6 $ (904) $ 147,070
---------- ----- ----------- ----------
---------- ----- ----------- ----------
JUNE 30, 1996
U.S. Treasury securities and obligations of U.S. government
agencies....................................................... $ 203,975 $ -- $ (2,624) $ 201,351
Repurchase agreements............................................ 55,500 -- -- 55,500
Certificates of deposit and Euro certificates of deposit......... 52,731 -- -- 52,731
U.S. commercial paper............................................ 15,277 -- -- 15,277
Other............................................................ 901 -- -- 901
---------- ----- ----------- ----------
Total............................................................ 328,384 -- (2,624) 325,760
Less amounts classified as cash equivalents...................... (125,903) -- -- (125,903)
---------- ----- ----------- ----------
Total marketable investments..................................... $ 202,481 $ -- $ (2,624) $ 199,857
---------- ----- ----------- ----------
---------- ----- ----------- ----------
Realized gains or losses on sales of available-for-sale securities were not
significant in fiscal 1997 or 1996. In fiscal 1995, the Company recognized a
$7.3 million loss on the sale of its marketable investment in Control Data
Systems, Inc.
The amortized cost and estimated fair value of cash equivalents and
marketable investments at June 30, 1997, by contractual maturity, are as follows
(in thousands):
AMORTIZED ESTIMATED
COST FAIR VALUE
---------- ----------
Due in one year or less............................................... $ 110,168 $ 109,983
Due after one year through two years.................................. 87,200 86,487
---------- ----------
Total................................................................. $ 197,368 $ 196,470
---------- ----------
---------- ----------
31
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The notional principal
amounts of the Company's foreign exchange instruments at June 30, 1997 and 1996
were $296 million and $512 million, respectively. The notional principal amounts
of the interest rate swap agreements at June 30, 1997 and 1996 were $0 and
approximately $200 million, respectively. The notional principal amounts for
off-balance-sheet instruments provide one measure of the transaction volume
outstanding at year end, and do not represent the amount of the Company's
exposure to credit loss or market risk. Credit risk is the Company's gross
exposure to potential accounting loss on these transactions if all
counterparties failed to perform as agreed at the contracted rates and contracts
had to be replaced at rates prevailing at each respective date. The Company
controls credit risk through credit approvals, limits and monitoring procedures.
Credit rating criteria are similar to those for investments.
The Company transacts business in various foreign currencies, including the
major European currencies and the Japanese yen. The Company has established
revenue and balance sheet hedging programs to protect against reductions in
value and volatility of future cash flows caused by changes in foreign exchange
rates. The Company uses derivatives in the form of currency forward contracts
and currency options in its programs. All currency forward contracts related to
recorded transactions expire within two years. All currency forward contracts
related to firmly committed customer transactions expire within two and one-half
years. All currency options open and close within a fiscal quarter. Deferred
gains and losses on contracts related to firm commitments were immaterial at
June 30, 1997 and 1996.
The Company entered into an interest rate swap agreement to reduce the
impact of changes in interest rates on its floating rate long-term debt. This
interest rate swap agreement reflected the gross proceeds of its Zero Coupon
Subordinated Debentures (see Note 9). This agreement expired in November 1996.
FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and estimated fair
values of the Company's financial instruments at June 30, 1997 and 1996 are
summarized as follows (in thousands):
1997 1996
---------------------- ----------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ---------- ---------- ----------
Cash and cash equivalents.................... $ 227,222 $ 227,222 $ 257,080 $ 257,080
Marketable investments....................... 147,070 147,070 199,857 199,857
Debt instruments............................. 424,958 414,547 443,935 452,708
Currency forward contracts................... 1,004 88 2,400 3,225
Interest rate swap........................... -- -- (380) (1,312)
NOTE 5. CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to concentration
of credit risk consist principally of cash investments, currency forward
contracts and trade receivables. The Company places its investments and
transacts its currency forward contracts with high-credit-quality counterparties
and, by policy, limits the amount of credit exposure to any one counterparty.
The Company generally does not require collateral. The credit risk on
receivables due from counterparties related to currency forward contracts is
immaterial at June 30, 1997 and 1996. The Company performs ongoing credit
evaluations of its customers and except in connection with the sales of
supercomputers, generally does not require collateral. The Company maintains
reserves for potential credit losses and such losses have been within
management's expectations.
32
NOTE 6. CONCENTRATIONS OF OTHER RISKS
MATERIALS Most of the Company's products incorporate components that are
available from only one or from a limited number of suppliers. Many of these
components are custom designed and manufactured, with lead times from order to
delivery that can exceed 90 days. Shortages of various essential materials could
occur due to interruption of supply or increased demand in the industry. If the
Company were unable to procure certain such components, it could affect the
Company's ability to meet demand for its products which would have an adverse
effect upon its results.
INTERNATIONAL OPERATIONS Because approximately half of the Company's
revenue is derived from sales outside the United States, and many key components
are produced outside the United States, the Company's results could be
negatively affected by such factors as changes in foreign currency exchange
rates, trade protection measures, longer accounts receivable collection
patterns, and changes in regional or worldwide economic or political conditions.
The risks of its international operations are mitigated in part by the Company's
foreign exchange hedging program and by the extent to which the Company's sales
and manufacturing activities are geographically distributed.
The Company's sales to foreign customers also are subject to export
regulations, with sales of most of the Company's high-end products requiring
clearance and export licenses from the U.S. Department of Commerce. These
regulations are currently under review by the U.S. government. The Company's
export sales would be adversely affected if such regulations were tightened, or
if they are not modified over time to reflect the increasing performance of the
Company's products. The Departments of Commerce and Justice are currently
reviewing the Company's compliance with the export control regulations in
connection with the shipment of several computer systems to a customer in the
Russian Federation in fiscal 1997. The Company believes it has complied in all
material respects with all applicable laws. However, if the Company's export
privileges were limited or denied, the Company's results would be adversely
affected.
NOTE 7. INVENTORIES
Inventories at June 30, 1997 and 1996 are as follows (in thousands):
1997 1996
---------- ----------
Components and subassemblies.......................................... $ 235,492 $ 199,441
Work-in-process....................................................... 235,426 177,744
Finished goods........................................................ 74,519 74,997
Marketing............................................................. 82,627 67,863
---------- ----------
Total inventories..................................................... $ 628,064 $ 520,045
---------- ----------
---------- ----------
NOTE 8. PROPERTY AND EQUIPMENT
Property and equipment at June 30, 1997 and 1996 are as follows (in
thousands):
1997 1996
----------- -----------
Land and buildings.................................................. $ 120,906 $ 115,547
Machinery and equipment............................................. 591,008 507,957
Furniture and fixtures.............................................. 108,183 99,332
Leasehold improvements.............................................. 120,598 102,523
----------- -----------
940,695 825,359
Accumulated depreciation and amortization........................... (415,243) (360,480)
----------- -----------
Net property and equipment.......................................... $ 525,452 $ 464,879
----------- -----------
----------- -----------
33
NOTE 9. BORROWING ARRANGEMENTS
SHORT-TERM BORROWINGS Short-term borrowings at June 30, 1997 and 1996 are
as follows (in thousands):
1997 1996
--------- ----------
Reverse repurchase agreements at 6.10% and 5.37%, respectively,
collateralized by marketable investments............................. $ 40,800 $ 136,700
Other bank borrowings at 10.5% to 16.5%................................ 3,963 --
--------- ----------
Total short-term borrowings............................................ $ 44,763 $ 136,700
--------- ----------
--------- ----------
The Company also has an unsecured $250 million revolving credit facility
that expires in April 1999. There were no cash borrowings under this facility at
June 30, 1997. Interest on borrowings is based upon either a prime rate, LIBOR
rate or competitive bid rate at the Company's option. Under this credit
facility, the Company is subject to certain commitment and utilization fees on
the unused portion of the committed amount. Fees incurred were not material
during the last three fiscal years. Covenants governing the credit facility
require the maintenance of certain financial ratios. At June 30, 1997, the
Company was in compliance with these covenants.
LONG-TERM DEBT Long-term debt at June 30, 1997 and 1996 is as follows (in
thousands):
1997 1996
---------- ----------
Zero Coupon Convertible Subordinated Debentures due 2013 at 4.15%, net of unamortized
discount of $222,370 ($231,731 in 1996)................................................. $ 232,630 $ 223,269
Convertible Subordinated Debentures due 2011 at 6.125%, net of unamortized discount of
$16,897 ($17,529 in 1996)............................................................... 65,103 64,471
Swiss Franc mortgage due 2017 at 3.64%, which resets quarterly............................ 19,619 13,691
Japanese Yen fixed rate loan due 2001 at 2.06%............................................ 52,752 --
Other..................................................................................... 10,090 5,786
---------- ----------
380,194 307,217
Less amounts due within one year (8,160) (5,188)
---------- ----------
Amounts due after one year................................................................ $ 372,034 $ 302,029
---------- ----------
---------- ----------
In November 1993, the Company issued Zero Coupon Convertible Subordinated
Debentures (the "Zero Coupon Debentures") with an ultimate maturity amount of
$455 million. Effective November 2, 1998, the Zero Coupon Debentures will be
redeemable at any time, at the option of the Company, at redemption prices equal
to the issue price ($439.77 per debenture) plus accrued original issue discount
to the date of redemption. At the option of the holder, each Zero Coupon
Debenture is convertible into 16.269 shares of common stock of the Company at
any time. Also at the option of the holder, the Zero Coupon Debentures will be
purchased by the Company on November 2, 1998, November 2, 2003 or November 2,
2008, at purchase prices equal to the issue price plus accrued original issue
discount to such purchase date. The Company, at its option, may elect to pay any
such purchase price in cash or shares of common stock, or any combination
thereof. The Zero Coupon Debentures are redeemable at the option of the holder
in the event of the sale of all, or substantially all, of the Company's common
stock for consideration other than common stock traded on a U.S. exchange or
approved for quotation on the Nasdaq National Market. See Note 20 regarding the
Company's September 1997 exchange of new Senior Convertible Notes for its
outstanding Zero Coupon Debentures.
Related to the Debentures, the Company had a receive fixed, pay floating
interest rate swap agreement on a notional amount of $200.1 million that expired
in November 1996.
In connection with the Cray Research acquisition, the Company assumed the
Cray Research Convertible Subordinated Debentures. These debentures are
convertible into the Company's common stock at a
34
conversion price of $78 per share at any time prior to maturity and may be
redeemed at the Company's option at a price of 100%. In 1994 Cray Research
repurchased a portion of the debentures with a face value of $23.0 million. The
repurchase satisfied the first four required annual sinking fund payments of
$5.8 million originally scheduled for the years 1997 through 2000. Remaining
annual sinking fund payments of $5.8 million each are scheduled from 2001 to
2010 with a final maturity payment of $24.5 million in 2011.
Principal maturities of long-term debt at June 30, 1997, are as follows (in
millions): 1998--$8.2; 1999--$3.9; 2000--$2.7; 2001--$1.9; 2002--$54.4; and
$309.1, thereafter.
NOTE 10. LEASING ARRANGEMENTS AS LESSOR
The Company has entered into certain lease arrangements which are accounted
for as sales. The net investment in sales-type leases at June 30, 1997 and 1996
is summarized as follows (in thousands):
1997 1996
---------- ----------
Total minimum lease payments receivable............................... $ 31,090 $ 43,254
Less unearned interest income......................................... (3,102) (4,927)
Net investment in sales-type leases................................... 27,988 38,327
Less current portion included in current receivables.................. (13,526) (10,443)
---------- ----------
Long-term portion included in other assets............................ $ 14,462 $ 27,884
---------- ----------
---------- ----------
Future minimum lease rents on noncancelable sales-type lease agreements at
June 30, 1997 are as follows (in millions): 1998--$15.3; 1999--$8.3; 2000--$6.3;
and 2001--$1.2.
NOTE 11. LEASING ARRANGEMENTS AS LESSEE
The Company leases certain of its facilities and some of its equipment under
non-cancelable operating lease arrangements.
Future minimum annual lease payments under operating leases, net of
subleases and rental income, at June 30, 1997, were as follows (in millions):
1998--$84.8; 1999--$70.6; 2000--$56.7; 2001--$41.1; 2002-- $32.5; and $218.6,
thereafter. Remaining lease commitments for facilities vacated as a result of
the acquisition of Cray Research are included in the preceding payment amounts.
Future payments associated with these leases were provided for in the Company's
exit cost accrual (see Note 3) and therefore do not represent future operating
expenses.
Aggregate operating lease rent expense was (in millions): $97.7, $76.7 and
$49.6, in fiscal 1997, 1996 and 1995, respectively.
Under one of its lease agreements, the Company is contingently liable for
the residual value of five buildings at the end of their lease terms. The lease
for one of the buildings expires in 2000 and the lease for an additional four
buildings expires in 2002. However, the Company has the option to extend these
leases for an additional 35 years after expiration. If at the end of the final
lease renewal, or upon the Company's option to terminate the lease at any time,
the Company does not purchase the property or arrange a third-party purchase,
then the Company would be obligated to the lessor for a guaranteed payment equal
to a specified percentage of the lessor's purchase price for the properties. The
Company would also be obligated to the lessor for all or some portion of this
amount if the price paid by a third party for the property is below a specified
percentage of the lessor's purchase price. The total amount related to the five
properties, for which the Company would be contingently liable, is approximately
$93.4 million at the end of the lease terms.
35
NOTE 12. STOCKHOLDERS' EQUITY
PREFERRED STOCK TRANSACTIONS NKK Corporation ("NKK") of Japan, through a
wholly-owned U.S. subsidiary, owns 17,500 shares of Series A Convertible
Preferred Stock. The preferred stock pays a 3% cumulative annual dividend, has
preference upon liquidation in the amount of the purchase price and has
aggregate voting rights equivalent to 1,400,000 shares of common stock. The
preferred stock is convertible into the common stock of the Company at certain
times at the then-current price of the common stock. The preferred stock is
perpetual, but is subject to redemption at the option of the Company at certain
times if the market price of the common stock is below $8.75 per share.
STOCK AWARD PLANS The Company has various stock award plans which provide
for the grant of incentive and nonstatutory stock options and the issuance of
restricted stock to employees. Incentive stock options are granted at not less
than the fair market value on the date of grant; the prices of nonstatutory
stock option grants and restricted stock are determined by the board of
directors. Under the plans, options and restricted stock generally vest over a
fifty-month period from the date of grant. Under one of the plans, the number of
shares available for grant or issuance will be automatically increased on July
1, 1997 by a number of shares equal to 3.5% of the total common shares issued
and outstanding on the preceding June 30.
In addition, the Company has a Directors' Stock Option Plan which allows for
the grant of nonstatutory stock options to nonemployee directors at not less
than the fair market value at the date of grant. Eligible directors are granted
an option to purchase 30,000 shares of common stock on the date of their initial
election as a director. On November 1 of each year, each eligible director is
granted an option to purchase an additional 10,000 shares of common stock. These
options generally vest in installments over a four year period. At June 30,
1997, 863,100 shares were available for future option grants under the
Directors' Stock Option Plan.
36
In fiscal 1997, the Company effected an option exchange program to allow
employees (excluding senior executives) to exchange their out-of-the-money stock
options for a smaller number of new options at a more favorable exercise price.
Under the exchange program, one new option could be obtained for every 1.25 to 2
canceled options. The new options, which have an exercise price equal to
$18.875, the fair value on the date of exchange, will vest over the longer of
two years or the original vesting schedule and cannot be exercised prior to May
1998. As a result of the exchange, options to purchase 13,554,514 shares were
exchanged for options to purchase 10,157,554 shares. At June 30, 1997, 1996 and
1995, outstanding options to purchase 18,346,324, 20,442,299 and 20,025,442
shares, respectively, were exercisable and 303,620, 213,855 and no shares of
restricted stock, respectively, were subject to repurchase.
Activity under all of the stock award plans was as follows:
OUTSTANDING OPTIONS
--------------------------
WEIGHTED
SHARES AVERAGE
AVAILABLE NUMBER OF EXERCISE
THREE YEARS ENDED JUNE 30, 1997 FOR GRANT SHARES PRICE
--------------- ------------- -----------
Balance at June 30, 1994.............................................. 3,384,054 31,297,453 $ 10.49
Additional shares authorized for issuance............................. 5,902,569 --
Options granted....................................................... (6,531,385) 6,531,385 $ 28.78
Options exercised..................................................... -- (5,712,687) $ 7.29
Options forfeited..................................................... 928,870 (928,870) $ 17.55
Restricted shares granted............................................. (4,740) --
Plan shares expired................................................... (1,848) --
Net transactions of Alias and Wavefront during eliminated periods from
February 1, 1994 to July 31, 1994 and January 1, 1994 to June 30,
1994, respectively.................................................. (1,185,384) 787,656 $ 13.85
--------------- -------------
Balance at June 30, 1995.............................................. 2,492,136 31,974,937 $ 14.70
Additional shares authorized for issuance............................. 7,116,758 --
Cray Research options assumed......................................... 2,540,543 3,894,570 $ 26.92
Options granted....................................................... (9,305,575) 9,305,575 $ 28.31
Options exercised..................................................... -- (5,283,368) $ 8.65
Options forfeited..................................................... 1,835,013 (1,835,013) $ 26.91
Restricted shares granted............................................. (232,500) --
Restricted shares returned............................................ 20,000 --
Plan shares expired................................................... (160) --
--------------- -------------
Balance at June 30, 1996.............................................. 4,466,215 38,056,701 $ 19.53
Additional shares authorized for issuance............................. 6,833,106 --
Options granted....................................................... (18,817,420) 18,817,420 $ 20.49
Options exercised..................................................... -- (3,703,246) $ 10.47
Options forfeited..................................................... 4,862,813 (4,862,813) $ 26.98
Options canceled...................................................... 13,554,514 (13,554,514) $ 27.37
Restricted shares granted............................................. (209,000) --
Restricted shares returned............................................ 58,900 --
Plan shares expired................................................... -- --
--------------- -------------
Balance at June 30, 1997.............................................. 10,749,128 34,753,548 $ 16.92
--------------- -------------
--------------- -------------
37
The following table summarizes information about options outstanding at June
30, 1997:
OPTIONS OUTSTANDING
------------------------------------------------------
WEIGHTED-AVERAGE
RANGE OF NUMBER OF CONTRACTUAL LIFE WEIGHTED-AVERAGE
EXERCISE PRICES SHARES (IN YEARS) EXERCISE PRICE
- ----------------- ------------ --------------------- -----------------
$ 0.96 - $11.19.. 8,014,374 2.8 $ 5.98
$11.56 - $18.88.. 16,202,084 7.4 $ 16.92
$19.10 - $30.38.. 9,332,594 7.6 $ 24.18
$31.00 - $46.38.. 1,204,496 6.8 $ 33.56
------------
$ 0.96 - $46.38.. 34,753,548 6.3 $ 16.92
------------
------------
OPTIONS OUTSTANDING
-------------------------------
RANGE OF NUMBER OF WEIGHTED-AVERAGE
EXERCISE PRICES SHARES EXERCISE PRICE
- ----------------- ------------ -----------------
$ 0.96 - $11.19.. 7,931,987 $ 5.96
$11.56 - $18.88.. 4,946,634 $ 13.41
$19.10 - $30.38.. 4,744,014 $ 23.98
$31.00 - $46.38.. 723,689 $ 33.76
------------
$ 0.96 - $46.38.. 18,346,324 $ 13.72
------------
------------
STOCK PURCHASE PLAN The Company has an employee stock purchase plan under
which eligible employees may purchase stock at 85% of the lower of the closing
prices for the stock at the beginning of a twenty four-month offering period or
the end of each six-month purchase period. The purchase periods generally begin
in May and November. Purchases are limited to 10% of each employee's
compensation. At June 30, 1997, 14,798,046 shares had been issued under the plan
and 6,261,954 shares were reserved for future issuance.
PRO FORMA INFORMATION The Company has elected to follow APB 25 in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under SFAS 123 requires the use
of option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, no compensation expense is recognized in the
Company's financial statements unless the exercise price of the Company's
employee stock options is less than the market price of the underlying stock on
the date of grant. Total compensation expense recognized in the Company's
financial statements for stock-based awards under APB 25 for fiscal 1997 and
1996 was $5.4 million and $4.0 million, respectively.
Pro forma information regarding net income and earnings per share has been
determined as if the Company had accounted for its employee stock options and
employee stock purchase plan under the fair value method prescribed by SFAS 123.
The fair value of options granted in fiscal 1997 and 1996 reported below has
been estimated at the date of grant using a Black-Scholes option pricing model
with the following weighted average assumptions:
EMPLOYEE STOCK OPTIONS STOCK PURCHASE PLAN
SHARES
------------------------ ------------------------
YEARS ENDED JUNE 30 1997 1996 1997 1996
----------- ----------- ----------- -----------
Expected life (in years)................................ 2.7 3.8 0.5 0.5
Risk-free interestrate.................................. 6.38% 5.18% 5.45% 5.49%
Volatility.............................................. 0.50 0.45 0.57 0.45
Dividend yield.......................................... 0% 0% 0% 0%
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
the Company's options have characteristics significantly different from those of
traded options, and
38
because changes in the subjective input assumptions can materially affect the
fair value estimate, in the opinion of management, the existing models do not
necessarily provide a reliable single measure of the fair value of its options.
The weighted average estimated fair value of employee stock options granted
at grant date market prices during fiscal 1997 and 1996 was $5.94 and $11.48 per
share, respectively. The weighted average exercise price of employee stock
options granted at grant date market prices during fiscal 1997 and 1996 was
$20.56 and $29.24 per share, respectively. The weighted average estimated fair
value of employee stock options granted at below grant date market prices during
fiscal 1997 and 1996 was $13.54 and $16.68 per share, respectively. The weighted
average exercise price of employee stock options granted at below grant date
market prices during fiscal 1997 and 1996 was $12.56 and $13.44 per share,
respectively. The weighted average fair value of restricted stock granted during
fiscal 1997 and 1996 was $18.93 and $27.45 per share, respectively. The weighted
average estimated fair value of shares granted under the Stock Purchase Plan
during fiscal 1997 and 1996 was $7.06 and $15.30 per share, respectively.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows (in thousands, except per share amounts):
YEARS ENDED JUNE 30 1997 1996
--------- ---------
Pro forma net income (loss)................................................. $ (14) $ 73,154
Pro forma earnings per share................................................ $ -- $ 0.42
The effects on pro forma disclosures of applying SFAS 123 are not likely to
be representative of the effects on pro forma disclosures of future years.
Because SFAS 123 is applicable only to options granted subsequent to June 30,
1995, the pro forma effect will not be fully reflected until 1999.
STOCKHOLDER RIGHTS PLAN The Company has a stockholder rights plan (the
"Rights Plan") which provides existing stockholders with the right to purchase
one one-thousandth (0.001) preferred share for each share of common stock held
in the event of certain changes in the Company's ownership. The Rights Plan may
serve as a deterrent to certain abusive takeover tactics which are not in the
best interests of stockholders.
STOCK REPURCHASE PROGRAM On October 19, 1995, the Company announced that
its board of directors had authorized the repurchase of up to 7.0 million shares
of its common stock, either in the open market or in private transactions. The
Company has purchased approximately 2.5 million shares since the commencement of
the repurchase program at an average price of approximately $31.00 per share.
Repurchased shares are available for use under the Company's employee stock
plans and for other corporate purposes. The Company suspended its stock
repurchases when the agreement to acquire Cray Research was announced in
February 1996. Stock repurchases may be resumed at any time.
COMMON SHARES RESERVED The Company has reserved in the aggregate 60,218,307
shares of common stock issuable upon conversion of all convertible subordinated
debentures, as well as shares issuable under its stock award and purchase plans.
39
NOTE 13. INCOME TAXES
The components of income from continuing operations before income taxes are
as follows (in thousands):
YEARS ENDED JUNE 30 1997 1996 1995
--------- ---------- ----------
United States.............................................. $ 84,508 $ 106,176 $ 201,131
International.............................................. 13,682 82,612 115,588
--------- ---------- ----------
$ 98,190 $ 188,788 $ 316,719
--------- ---------- ----------
--------- ---------- ----------
The provision for income taxes consists of the following (in thousands):
YEARS ENDED JUNE 30 1997 1996 1995
---------- ---------- ---------
Federal:
Current.................................................. $ 16,933 $ 111,970 $ 44,781
Deferred................................................. 6,026 (49,246) (733)
State:
Current.................................................. 20,771 13,540 7,761
Deferred................................................. (17,796) (4,299) 4,929
Foreign:
Current.................................................. 853 17,021 31,905
Deferred................................................. (7,148) (15,235) 3,220
---------- ---------- ---------
$ 19,639 $ 73,751 $ 91,863
---------- ---------- ---------
---------- ---------- ---------
The provision for income taxes reconciles to the amounts computed by
applying the statutory federal rate to earnings before taxes as follows (in
thousands):
YEARS ENDED JUNE 30 1997 1996 1995
---------- ---------- ----------
Tax at U.S. federal statutory rate........................ $ 34,366 $ 66,076 $ 110,852
State taxes, net of federal tax benefit................... 1,934 6,006 8,249
Earnings subject to foreign taxes at lower rates.......... (16,599) (33,149) (18,751)
Income of Foreign Sales Corporation not subject to U.S.
tax..................................................... (6,170) (8,355) (9,059)
Nondeductible acquired in-process technology.............. -- 34,373 --
Research and experimentation credits...................... (7,748) -- (4,625)
Net operating loss without tax benefit.................... 9,140 -- --
Nondeductible professional fees........................... -- -- 2,789
Other..................................................... 4,716 8,800 2,408
---------- ---------- ----------
Provision for income taxes................................ $ 19,639 $ 73,751 $ 91,863
---------- ---------- ----------
---------- ---------- ----------
No provision for residual federal taxes has been made on approximately
$241.5 million of accumulated undistributed earnings of the Company's foreign
subsidiaries since it is the Company's intention to permanently invest such
earnings in foreign operations. The Company has been granted exemptions from tax
on income from certain manufacturing operations located outside the U.S. for
years through 2006. The cumulative income tax benefits attributable to the tax
status of this subsidiary are estimated to be $84.5 million at June 30, 1997.
40
The tax effects of temporary differences and carryforwards that give rise to
significant portions of deferred tax assets and liabilities are as follows (in
thousands):
YEARS ENDED JUNE 30
---------------------------------
1997 1996 1995
---------- ---------- ---------
Deferred tax assets:
Net operating loss carryforwards................................... $ 86,360 $ 36,266 $ 4,958
Foreign taxes on unremitted foreign earnings, net of related U.S.
tax liability.................................................... 7,722 23,389 9,418
General business credit carryforwards.............................. 8,970 31,362 16,732
Foreign tax credit carryforwards................................... 28,629 38,561 1,537
Depreciation....................................................... 57,675 55,993 15,793
Inventory valuation................................................ 80,354 59,279 21,586
Nondeductible vacation pay accrual................................. 19,123 14,172 9,382
Intercompany profit elimination.................................... 14,117 10,634 10,690
Merger expenses.................................................... 12,174 51,468 5,456
Other.............................................................. 53,522 43,161 2,895
---------- ---------- ---------
Subtotal......................................................... 368,646 364,285 98,447
Valuation allowance.............................................. (59,907) (60,819) --
---------- ---------- ---------
Total deferred tax assets.......................................... 308,739 303,466 98,447
Deferred tax liabilities:
Intangibles........................................................ 26,703 40,758 --
Other.............................................................. 6,422 6,012 --
---------- ---------- ---------
Total deferred tax liabilities................................... 33,125 46,770 --
---------- ---------- ---------
Total.............................................................. $ 275,614 $ 256,696 $ 98,447
---------- ---------- ---------
---------- ---------- ---------
At June 30, 1997, the Company had federal net operating loss carryforwards
of approximately $215.5 million for United States federal income tax purposes
expiring in the years 2005 through 2011. At June 30, 1997, the Company also had
general business credit carryovers of approximately $5.4 million for United
States federal tax purposes, expiring in the years 1999 through 2010. In
addition, the Company had foreign tax credit carryforwards of approximately
$28.6 million which expire in the years 1998 through 2001, and a capital loss
carryforward of $3.3 million expiring in 2000.
As a result of the acquisition by Silicon Graphics, Cray Research
experienced a "change in ownership" as defined under Section 382 of the Internal
Revenue Code and is subject to certain limitations on the utilization of its
pre-acquisition net operating loss and tax credit carryforwards. The Company has
provided a valuation allowance to offset the deferred tax asset relating to
foreign tax credits that may expire prior to utilization due to this annual
limitation. The valuation allowance for deferred tax assets of approximately
$59.9 million will be applied to reduce the noncurrent intangible assets related
to the acquisition of Cray Research if future tax benefits are subsequently
realized.
41
NOTE 14. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION
The Company, operating in a single industry segment, designs, manufactures
and services high-performance computing systems and software. Information
regarding operations in different geographic areas is as follows (in thousands):
THREE YEARS ENDED JUNE 30 1997 1996 1995
------------ ------------ ------------
Net sales to unaffiliated customers:
United States......................................................... $ 1,927,104 $ 1,412,137 $ 1,093,694
Europe................................................................ 936,184 836,053 635,268
Rest of World......................................................... 799,313 673,126 499,306
------------ ------------ ------------
Total net sales..................................................... $ 3,662,601 $ 2,921,316 $ 2,228,268
------------ ------------ ------------
------------ ------------ ------------
Transfers between geographic areas
(eliminated in consolidation):
United States......................................................... $ 750,098 $ 698,816 $ 485,303
Europe................................................................ 70,731 65,583 --
Rest of World......................................................... -- -- --
------------ ------------ ------------
Total transfers..................................................... $ 820,829 $ 764,399 $ 485,303
------------ ------------ ------------
------------ ------------ ------------
Operating income:
United States......................................................... $ 33,661 $ 67,466 $ 190,725
Europe................................................................ 56,859 121,049 114,837
Rest of World......................................................... 8,614 (12,847) 20,877
Eliminations.......................................................... 12,750 (1,275) (19,167)
Corporate income (loss), net............................................ (13,694) 14,395 9,447
------------ ------------ ------------
Income before income taxes.......................................... $ 98,190 $ 188,788 $ 316,719
------------ ------------ ------------
------------ ------------ ------------
Identifiable assets:
United States......................................................... $ 2,127,957 $ 1,735,411 $ 285,332
Europe................................................................ 332,849 478,129 844,816
Rest of World......................................................... 293,162 280,897 195,296
Eliminations.......................................................... (224,236) (310,815) (113,731)
Corporate assets...................................................... 814,860 974,624 994,906
------------ ------------ ------------
Total assets........................................................ $ 3,334,592 $ 3,158,246 $ 2,206,619
------------ ------------ ------------
------------ ------------ ------------
"Europe" includes Europe and the Middle East. Net revenue from sales to
unaffiliated customers is based on the location of the customer. Intercompany
transfers between geographic areas are accounted for by using the transfer
prices in effect for the respective subsidiaries. Operating income and
identifiable assets are classified based on the location of the Company's
facilities. Corporate assets include cash and cash equivalents, marketable
investments, deferred tax assets and certain other assets. Corporate income
(loss), net, is interest and other income (expense), net.
NOTE 15. BENEFIT PLANS
401(k) RETIREMENT SAVINGS PLAN The Company provides a 401(k) investment
plan covering substantially all of its U.S. employees. The plan provides for a
minimum 25 percent Company match of an employee's contribution up to a specified
limit, but allows for a larger matching subject to certain regulatory
limitations. The Company's matching contributions for fiscal 1997, 1996 and
1995, were $11.0 million, $4.7 million and $13.7 million, respectively.
DEFERRED COMPENSATION PLAN The Company has a Non-Qualified Deferred
Compensation Plan ("The Plan") that allows eligible executives and directors to
defer a portion of their compensation. The deferred
42
compensation, together with Company matching amounts and accumulated earnings,
is accrued but unfunded. Such deferred compensation is distributable in cash and
at June 30, 1997 and 1996, amounted to approximately $5 million and $3 million,
respectively. A participant may elect to receive such deferred amounts in one
payment or in annual installments no sooner than two years following each annual
election. Participant contributions are always 100% vested and Company matching
contributions vest as directed by the board of directors. There have been no
Company matching contributions to date.
NOTE 16. RELATED PARTY TRANSACTIONS
The Company has from time to time engaged in significant transactions with
related parties in the ordinary course of business. Related parties have
included: Northrop Grumman Corporation and Chrysler Corporation, as a director
of both Northrop Grumman and Chrysler became a member of the Company's board of
directors in fiscal 1996; Tandem Computers, Incorporated, as a director of
Tandem is also on the Company's board of directors; Control Data Systems, Inc.
(CDSI) due to the Company's investment in common stock of CDSI through March 31,
1995; and NKK through its indirect ownership of 100% of Series A Convertible
Preferred Stock (see Note 12).
Product and other revenue for the years ended June 30, 1997, 1996 and 1995
included, in the aggregate, sales to related parties in the amount of $77.9
million, $72.9 million and $119.6 million, respectively. Purchases and amounts
receivable from and amounts payable to such related parties were immaterial at
June 30, 1997, 1996 and 1995.
NOTE 17. STATEMENT OF CASH FLOWS
Supplemental disclosures of cash flow information (in thousands):
YEARS ENDED JUNE 30 1997 1996 1995
--------- ---------- ---------
Cash paid during the year for:
Interest............................................................ $ 10,200 $ 9,600 $ 4,600
Income taxes, net of refunds........................................ 29,000 122,000 42,200
Supplemental schedule of noncash investing and financing activities (in
thousands):
YEARS ENDED JUNE 30 1997 1996 1995
--------- ---------- ---------
Tax benefit from stock options........................................ $ 6,300 $ 23,000 $ 31,500
Equipment purchased under capital leases.............................. -- 200 4,300
Conversion of preferred stock......................................... -- -- 20,800
NOTE 18. CONTINGENCIES
The Company is defending the lawsuits described below. The Company believes
that it has good defenses to the claims in each of these lawsuits and is
defending each of them vigorously.
The Company is defending a securities class action lawsuit filed in U.S.
District Court for the Northern District of California in January 1996. The suit
alleges that the Company and certain of its officers and directors made material
misrepresentations and omissions during the period from September to December
1995. In May 1996, the District Court dismissed the securities class action with
prejudice. The plaintiffs' appeal to the U.S. Court of Appeals for the Ninth
Circuit is pending.
The Company also is defending securities class action lawsuits involving
MIPS Computer Systems, Inc.("MIPS"), which the Company acquired in June 1992,
and Alias Research Inc., which the Company acquired in June 1995. The MIPS case,
which was filed in the U.S. District Court for the Northern District of
California in 1992, alleges that MIPS and certain of its officers and directors
made material misrepresentations and omissions during the period from January to
October of 1991. In September 1996, the U.S. Court of Appeals for the Ninth
Circuit reversed the summary judgment granted in defendants' favor in
43
June 1994. The Company's petition for review by the U.S. Supreme Court is
pending. The Alias case, which was filed in the U.S. District Court for the
District of Connecticut in 1991, alleges that Alias and certain of its officers
and directors made material misrepresentations and omissions during the period
from May 1991 to April 1992. Alias' motion to dismiss the amended complaint is
pending.
The Company also is defending a patent infringement lawsuit filed by Martin
Marietta Corp. in the U.S. District Court for the Middle District of Florida in
September 1995. The Company has filed a counterclaim seeking to invalidate the
principal patent at issue in the lawsuit, and Martin Marietta has requested the
U.S. Patent and Trademark Office to re-examine the patent. The District Court
has set a trial date for the lawsuit in February 1998.
The Company routinely receives communications from third parties asserting
patent or other rights covering the Company's products and technologies. Based
upon the Company's evaluation, it may take no action or it may seek to obtain a
license. There can be no assurance in any given case that a license will be
available on terms the Company considers reasonable, or that litigation will not
ensue.
Management is not aware of any pending disputes, including those described
above, that would be likely to have a material adverse effect on the Company's
financial condition, results of operations or liquidity. However, management's
evaluation of the likely impact of these pending disputes could change in the
future.
NOTE 19. PENDING ACQUISITION
In May 1997, the Company entered into an agreement, subject to certain
conditions to closing, to acquire ParaGraph International, Inc. ("ParaGraph"), a
software company, in exchange for cash and shares of the Company's common stock
for an aggregate purchase price of approximately $50 million, including direct
acquisition costs. The Company will account for the acquisition using the
purchase method. Acquired in-process technology is expected to be between $15
million and $20 million. The acquisition is expected to be consummated September
30, 1997.
NOTE 20. DEBT EXCHANGE
On September 11, 1997, the Company exchanged its newly registered Senior
Convertible Notes (the "Senior Notes") due 2004 for approximately 98% of its
existing Zero Coupon Debentures pursuant to an exchange offer initiated in
August. The Senior Notes pay interest semi-annually at a rate of 5.25% and are
convertible into shares of common stock at a conversion price equal to $36.25
per share. The Senior Notes are redeemable at the option of the Company,
beginning in 2002, at varying prices based on the year of redemption. The Senior
Notes are redeemable at the option of the holder in the event of the sale of
all, or substantially all, of the Company's common stock for consideration other
than common stock traded on a U.S. exchange or approved for quotation on the
Nasdaq National Market. The aggregate principal amount of Senior Notes issued in
the exchange was $231 million, equal to the accreted value on the exchange offer
Expiration Date (September 4, 1997) of each $1,000 principal amount at maturity
of the Zero Coupon Debentures tendered in the exchange. Under current generally
accepted accounting principles, the exchange does not constitute an
extinguishment of debt and, accordingly, as a result of the exchange there will
be no change in the carrying value of the Company's debt. The Company recorded a
charge of approximately $2.6 million for the Senior Note issuance costs upon
closing.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
44
PART III
Certain information required by Part III is omitted from this Report in that
the Company has filed its definitive proxy statement pursuant to Regulation 14A
(the "1997 Proxy Statement") not later than 120 days after the end of the fiscal
year covered by this Report, and certain information included therein is
incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the Company's directors required by this Item is
incorporated by reference to the information set forth in the 1997 Proxy
Statement on pages 3 and 4 under the heading "Proposal No. 1--Election of
Directors--Directors and Nominees for Director."
The information concerning executive officers and family relationships
required by this Item is incorporated by reference to the section in Part I
hereof entitled "Executive Officers of the Registrant."
The information concerning compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, required by this Item is incorporated by
reference to information set forth on page 9 of the 1997 Proxy Statement under
the heading "Executive Officer Compensation--Compliance with Section 16(a) of
the Exchange Act."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
information set forth in the 1997 Proxy Statement on page 5 under the headings
"Proposal No. 1--Election of Directors--Compensation Committee Interlocks and
Insider Participation" and "--Director Compensation"; on pages 7 and 8 under the
headings "Executive Officer Compensation--Summary Compensation Table", "--Option
Grants in Fiscal 1997" and "--Option Exercises in Fiscal Year 1997 and Fiscal
Year-End Option Values"; on pages 10 and 11 under the heading "Report of the
Compensation and Human Resources Committee of the Board of Directors"; and on
page 12 under the heading "Company Stock Price Performance Graph".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
information set forth in the 1997 Proxy Statement on pages 1 and 2 under the
headings "Information Concerning Solicitation and Voting--Record Date and
Principal Share Ownership" and "--Voting and Solicitation" and on page 6 under
the heading "Other Information--Security Ownership of Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
information set forth in the 1997 Proxy Statement on pages 9 and 10 under the
heading "Certain Transactions."
45
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
1. FINANCIAL STATEMENTS. The following consolidated financial statements
and supplementary information of Silicon Graphics, Inc., Report of Management
and Report of Independent Auditors are included in Part II of this Report:
PAGE
-----
Report of Management.................................................................................. 21
Report of Ernst & Young LLP, Independent Auditors..................................................... 22
Consolidated Statements of Operations--Years Ended June 30, 1997, 1996 and 1995....................... 23
Consolidated Balance Sheets--June 30, 1997 and 1996................................................... 24
Consolidated Statements of Stockholders' Equity--Years Ended June 30, 1997, 1996
and 1995............................................................................................ 25
Consolidated Statements of Cash Flows--Years Ended June 30, 1997, 1996 and 1995....................... 26
Notes to Consolidated Financial Statements............................................................ 27
SUPPLEMENTARY DATA
Quarterly Data (Unaudited)............................................................................ 20
2. FINANCIAL STATEMENT SCHEDULES. The following financial statement
schedule of Silicon Graphics, Inc. is filed as part of this Report and should be
read in conjunction with the Consolidated Financial Statements of Silicon
Graphics, Inc.
SCHEDULE DESCRIPTION PAGE
- ------------- -------------------------------------------------------------------------------------------- -----
II Valuation and Qualifying Accounts........................................................... S-1
Schedules not listed above have been omitted because they are not applicable
or are not required or the information required to be set forth therein is
included in the consolidated financial statements or notes thereto.
3. EXHIBITS. The following Exhibits are filed as part of, or incorporated
by reference into, this Report:
3.1.1(9) Restated Certificate of Incorporation of the Company.
3.1.2(13) Certificate of Designation of the Series E Preferred Stock filed June 13, 1995.
3.2(16) Bylaws of the Company, as amended.
4.1(5) Amended and Restated Preferred Shares Rights Agreement, dated as of May 6, 1992
between the Company and The First National Bank of Boston, including the
Certificate of Designation of Rights, Preferences and Privileges of Series B
Participating Preferred Stock, the form of Rights Certificate and the Summary of
Rights attached thereto as Exhibits A, B, and C respectively.
4.4(10) First Amendment to Rights Agreement dated as of May 2, 1995 between the Company
and The First National Bank of Boston.
4.3(9) Indenture dated November 1, 1993 between the Company and The First National Bank
of Boston, as Trustee.
4.4(16) Indenture dated February 1, 1986 between Cray Research, Inc. and Manufacturers
Hanover Trust Company, as Trustee.
46
4.5(16) First Supplemental Indenture dated June 30, 1996 between the Company, Cray
Research, Inc., and Chemical Bank (formerly Manufacturers Hanover Trust
Company).
4.6(20) Indenture dated as of September 1, 1997 between the Company and State Street
Bank and Trust Company of California, N.A., as Trustee.
9.1(13) Voting and Exchange Trust Agreement between the Company and Montreal Trust
Company of Canada dated June 15, 1995.
10.1(1) Software Agreement dated as of January 4, 1986, as supplemented June 6, 1986,
and Sublicensing Agreement dated as of June 9, 1986 between the Company and AT&T
Information Systems Inc.
10.2(2) Software License Agreement dated January 24, 1986, between the Company and AT&T
Information Systems Inc.
10.3(3) Stock Purchase Agreement dated March 2, 1990 among the Company, NKK Corporation
and NKK U.S.A. Corporation.
10.4(6) Exchange Agreement dated August 14, 1992 among the Company, NKK Corporation and
NKK U.S.A. Corporation.
10.5(6) Form of Indemnification Agreement entered into between the Company and its
directors, executive officers and certain other agents.
10.6(6) Form of Indemnification Agreement entered into between the Company and its
directors, executive officers and certain other agents. (Revised)
10.7(7)* Form of Employment Continuation Agreement entered into between the Company and
its executive officers, as amended as of October 21, 1993.
10.8* Loan Agreement dated May 25, 1995 between the Company and Gary L. Lauer.
10.9* Promissory Note dated June 18, 1997 issued to the Company by William M. Kelly.
10.10* Letter agreement dated May 22, 1997 between the Company and Robert H. Ewald.
10.11(19)* 1984 Incentive Stock Option Plan, as amended, and amended form of Incentive
Stock Option Agreement.
10.12(9)* Directors' Stock Option Plan and form of Stock Option Agreement as amended as of
October 31, 1994.
10.13(6)* 1985 Stock Incentive Program.
10.14(6)* 1986 Incentive Stock Option Plan, as amended, and amended forms of Incentive
Stock Option Agreement and Nonstatutory Stock Option Agreement.
10.15(4)* 1987 Stock Option Plan and form of Stock Option Agreement.
10.16(15)* Amended and Restated 1989 Employee Benefit Stock Plan and form of stock option
agreement.
10.17(7)* 1993 Long-Term Incentive Stock Plan and form of stock option agreement.
10.18(14)* 1996 Supplemental Non-Executive Equity Incentive Plan and form of stock option
agreement.
10.19(17)* Employee Stock Purchase Plan, as amended as of October 30, 1996.
10.20(8)* Non-Qualified Deferred Compensation Plan dated as of September 9, 1994.
10.21(19)* Addendum to the Non-Qualified Deferred Compensation Plan.
10.22(14) Credit Agreement dated as of April 12, 1996 between the Company and Bank of
America, National Trust and Savings Association.
47
10.23(13) Ground Lease between Silicon Graphics Real Estate Inc. and the City of Mountain
View dated March 7, 1995.
10.24(13) Agreement for Lease between the Company and Virtual Funding, Limited Partnership
dated November 18, 1993.
10.25(13) Amendment No. 1 to Agreement for Lease between the Company and Virtual Funding,
Limited Partnership dated March 15, 1995.
10.26(13) Lease Agreement between the Company and Virtual Funding, Limited Partnership
dated November 18, 1993.
10.27(13) Amendment No. 1 to Lease Agreement between the Company and Virtual Funding,
Limited Partnership dated March 15, 1995.
10.28(18) Guaranty from the Company to Virtual Funding Limited Partnership dated as of
November 18, 1993.
10.29(18) Amendment No. 1 to Guaranty from the Company to Virtual Funding, Limited
Partnership dated as of March 15, 1995.
10.30(18) Amendment No. 2 to Guaranty from the Company to Virtual Funding Limited
Partnership dated as of March 7, 1997.
10.31(11)* Alias Research Inc.'s 1988 Employee Share Ownership Plan Option Agreement.
10.32(11)* Alias Research Inc.'s 1989 Employee Share Ownership Plan Option Agreement.
10.33(11)* Alias Research Inc.'s 1990 Employee Share Ownership Plan and standard forms of
Option Agreements.
10.34(11)* Alias Research Inc.'s 1994 Stock Plan and standard forms of Option Agreements.
10.35(12)* Wavefront Technologies, Inc. 1990 Stock Option Plan with standard form of Option
Agreement.
10.36(15)* Cray Research, Inc. 1989 Non-Employee Directors' Stock Option Plan and form of
stock option agreement.
11.1 Statement of Computation of Per Share Earnings.
21.1 List of Subsidiaries.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
27.1 Financial Data Schedule.
- ------------------------
* This exhibit is a management contract or compensatory plan required to be
filed as an exhibit to this Form 10-K pursuant to Item 14(c).
(1) Incorporated by reference to exhibits to the Company's Registration
Statement on Form S-1 (No. 33-8892), which became effective October 29,
1986.
(2) Incorporated by reference to exhibits to the Company's Registration
Statement on Form S-1 (No. 33-12863), which became effective March 31, 1987.
(3) Incorporated by reference to exhibits to the Company's Current Report on
Form 8-K dated March 16, 1990.
(4) Incorporated by reference to exhibits to the Company's Post-Effective
Amendment to Registration Statement on Form S-8 (No. 33-16529), which became
effective June 18, 1990.
(5) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the period ended March 31, 1992.
48
(6) Incorporated by reference to exhibits to the Company's Annual Report on Form
10-K for the year ended June 30, 1992.
(7) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the period ended September 30, 1993.
(8) Incorporated by reference to exhibits to the Company's Annual Report on Form
10-K for the year ended June 30, 1994.
(9) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the period ended September 30, 1994.
(10) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the period ended March 31, 1995.
(11) Incorporated by reference to exhibits to the Company's Registration
Statement on Form S-8 (No. 33-60215), which became effective June 14, 1995.
(12) Incorporated by reference to exhibits to the Company's Registration
Statement on Form S-8 (No. 33-60213), which became effective June 14, 1995.
(13) Incorporated by reference to exhibits to the Company's Annual Report on
Form 10-K for the year ended June 30, 1995.
(14) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the period ended March 31, 1996.
(15) Incorporated by reference to exhibits to the Company's Registration
Statement on Form S-8 (No. 333-06403), which became effective June 20, 1996.
(16) Incorporated by reference to exhibits to the Company's Annual Report on
Form 10-K for the period ended June 30, 1996, as amended.
(17) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the period ended September 30, 1996.
(18) Incorporated by reference to exhibits to the Company's Quarterly Report on
Form 10-Q for the period ended March 31, 1997.
(19) Incorporated by reference to exhibits to the Company's Annual Report on
Form 10-K for the year ended June 30, 1991.
(20) Incorporated by reference to exhibits to the Company's Registration
Statement on Form S-4 (No. 333-32379), which became effective August 7,
1997.
(b) REPORTS ON FORM 8-K.
No Current Reports on Form 8-K were filed during the quarter ended June 30,
1997.
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SILICON GRAPHICS, INC.
By: /s/ EDWARD R. MCCRACKEN
-----------------------------------------
Edward R. McCracken
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
Dated: September 26, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
Chairman, Chief Executive
/s/ EDWARD R. MCCRACKEN Officer and Director
- ------------------------------ (Principal Executive September 26, 1997
Edward R. McCracken Officer)
/s/ ROBERT R. BISHOP Chairman, Silicon Graphics
- ------------------------------ World Trade Corporation, September 26, 1997
Robert R. Bishop and Director
Senior Vice President,
/s/ WILLIAM M. KELLY Corporate Operations
- ------------------------------ (Principal Financial September 26, 1997
William M. Kelly Officer)
/s/ DENNIS P. MCBRIDE Vice President, Controller
- ------------------------------ (Principal Accounting September 26, 1997
Dennis P. McBride Officer)
/s/ ALLEN F. JACOBSON
- ------------------------------ Director September 26, 1997
Allen F. Jacobson
/s/ C. RICHARD KRAMLICH
- ------------------------------ Director September 26, 1997
C. Richard Kramlich
50
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ ROBERT A. LUTZ
- ------------------------------ Director September 26, 1997
Robert A. Lutz
/s/ JAMES A. MCDIVITT
- ------------------------------ Director September 26, 1997
James A. McDivitt
/s/ LUCILLE SHAPIRO
- ------------------------------ Director September 26, 1997
Lucille Shapiro
/s/ ROBERT B. SHAPIRO
- ------------------------------ Director September 26, 1997
Robert B. Shapiro
/s/ JAMES G. TREYBIG
- ------------------------------ Director September 26, 1997
James G. Treybig
51
SCHEDULE II
SILICON GRAPHICS, INC.
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
ADDITIONS
----------------------
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND DEDUCTIONS END OF
DESCRIPTION OF PERIOD EXPENSES OTHER WRITE-OFFS PERIOD
- ------------------------------------------------------- ----------- ----------- --------- ----------- -----------
Year ended June 30, 1995
Accounts receivable allowances....................... $ 9,492 $ 11,534 $ 0 $ (7,561) $ 13,465
Year ended June 30, 1996
Accounts receivable allowances....................... $ 13,465 $ 4,292 $ 6,383* $ (373) $ 23,767
Year ended June 30, 1997
Accounts receivable allowances....................... $ 23,767 $ 8,427 $ 0 $ (8,138) $ 24,056
- ------------------------
*Acquired Cray Research valuation allowance.
S-1