Filed with the SEC from Mar 27 to Apr 2
Silicon Graphics (SGIC)
Whippoorwill Associates wants the company to consider ways to unlock shareholder value, including the possibility of going private.
Whippoorwill said that it believes that the large concentration of ownership by the company's top shareholders has resulted in a share price that doesn't fully reflect the intrinsic value of Silicon Graphics or the substantial operating progress that the company has achieved over the past year.
Whippoorwill added that the top seven holders of Silicon Graphics own 77% of the company's outstanding shares.
Whippoorwill currently holds about 1.13 million shares (9.8%).
SGI is a leading provider of products and services for use in high-performance computing (â€śHPCâ€ť) and data management. We sell solutions based on a complete range of scalable servers and storage products, from entry-level to high-end, together with associated software products. These integrated solutions enable our customers in the scientific, technical and business communities to solve their most challenging data management and analysis problems providing them with strategic and competitive advantages. Whether studying global climate changes, accelerating the engineering of new automotive designs, providing technologies for homeland security, or gaining â€śbusiness intelligenceâ€ť through data-mining, our solutions are designed to store, manage, access, analyze and transform vast amounts of data to provide insights and intelligence in real time or near-real time. We also offer a range of services, including professional services, customer support, and education that enable fast installation and implementation of our solutions. Our solutions, products and services are used in a range of markets, including defense and intelligence, business, research, and industry, to address scientific, design, and business applications.
For about 25 years, our systems have enabled discovery, innovation and information transformation for scientists, engineers and creative professionals who benefit from systems engineered to meet their specific needs. With our technology and market knowledge we are able to deliver products that have performance and ease-of-use features that enable our customers to achieve their goals more quickly as a result of the benefit of high-performance computing and data management. We are taking the knowledge that we have gained in our traditional markets, coupled with the services our customers rely on and are making them more broadly available across our customersâ€™ organization or enterprise. Our unique shared-memory architecture and the manageability of our server and storage product lines enable enterprise customers with large volumes of data to access, analyze and transform their data to improve their decision-making and their overall competitive advantage. Furthermore, we have expanded our product line to include servers and clusters using both Intel Itanium Â® and Intel Xeon Â® processors which expands our product offerings into a faster growing portion of the market and provides our value add to applications that are well-suited to clusters. Our objective is to maintain and enhance our leadership in high-performance computing and data management. Our strategy to achieve that objective is to incorporate leading-edge technology in solutions that target specific workflow requirements and package the technology in a unified solution that enables customers to efficiently deploy a hybrid server solution to support multi-workflow requirements.
This objective requires that we maintain industry leadership with our products and services and provide highly differentiated solutions to our customers. Accordingly, the core elements of our strategy are as follows:
Leading-Edge Innovation. Being at the forefront of HPC, data management and services is core to our strategy, and accordingly, we invest significantly in product development. We have introduced many important innovations to the world, including the first scalable Non-Uniform Memory Access or NUMA system and work that led to the first storage area networks. Innovations in interoperability, system management software, energy efficiency and hardware density have all contributed to our competitive advantage and access to the market. We also have a rich portfolio of intellectual property in technology areas that align with our core business, and in other non-core areas where we intend to seek ways to monetize the value of our investments.
Support of Industry Standards. We are committed to the support of open standards for core elements of our new generation products, while focusing our proprietary technology development in areas that deliver differentiated features and performance. Commitment to an open system platform is important for several reasons. First, it enables our customers to benefit from the superior price performance of todayâ€™s best-of-breed components, such as commodity dynamic random access memory chips (â€śDRAMsâ€ť) and the Intel Itanium Â® and Intel Xeon Â® processor families. Second, it enables us to leverage the research and development of Intel, Microsoft Â® , and the Linux community, and therefore focus our resources on systems architecture, storage management and solution delivery, all of which we believe are differentiated in important respects in the marketplace. Third, our support of industry standards, such as the Linux and Microsoft operating systems, enables us to assimilate easily into standards-based IT environments.
Contribution to Linux. We are one of the largest computer manufacturers whose new high-performance product platforms are focused on the Linux operating system. We have been one
of the largest contributors to the Linux open source kernel and are leaders in the industry at understanding the requirements of the Linux compute environment. With this extensive Linux experience we are able to envision and build an environment that enables achievement of maximum performance within a Linux environment. The increased adoption of Linux across our target markets has created a significant need for this environment, and we are focused on fulfilling that need.
Direct Engagement with Our Customers. We benefit from a close association with our customers, who are often among the leading experts in their fields. We maintain a program of regular contact and technical discourse with our customers and our ongoing service contracts strengthen that relationship. In addition to participating in and/or sponsoring many industry conferences and forums around the world, our engineers and executives meet regularly with the SGI User Group, an independent entity whose membership includes elite users of our solutions. This direct interaction between the leading edge of the computing world and SGI has influenced our architectural approach. We consider this close association to be a core part of our ongoing strategy.
Market Segment Focus. Leveraging our strengths in scalable high-performance computing, data management and deep domain expertise, we have developed and are continuing to develop solutions that map to customersâ€™ requirements across technical and business applications. We have also aligned our sales and marketing resources to address specific market needs and drive innovation to benefit our target markets.
Offerings aligned with Market growth . According to independent market research, the HPC marketplace has seen strong growth over the past few years, and that growth is expected to continue. The highest growth component of the market has been in clustered compute solutions. With new product introductions that began in July 2006 with the Altix XE Â® , and continuing with the announcement of our latest differentiated product, the Altix ICE Â® , we now have products well positioned to compete in the growing parts of the market. In addition, the database management software marketplace, another key market focus for SGI, is growing significantly, with the Linux Operating System providing the highest growth within that market. We believe our products and market focus are well-aligned to take advantage of these exciting growth opportunities.
Investing in ISV and Reseller Relationships . We depend on strong relationships with a network of software and hardware partners. We maintain and are further investing in a worldwide global developer program for independent software vendors, including porting and benchmarking support, direct interaction with our engineering staff, and sales and marketing engagement. We understand that our success depends on theirs. We also engage in a variety of programs with original equipment manufacturers (â€śOEMâ€ť) and reselling partners, who bring our technologies to a variety of customers not serviced directly by us. Investment in developing reseller channels and in joint marketing with software application partners is important for us, as it supports our ability to deliver more complete, market-driven solutions.
SGIâ€™s server and storage products are developed to enable our customers to overcome the challenges of complex data-intensive workflows, and accelerate breakthrough discoveries, innovation, and information transformation. SGI server systems are primarily based on the Linux operating system and the Intel Itanium 2 and Xeon microprocessor families. We also offer Microsoft Windows Compute Cluster Server (â€śMicrosoft CCSâ€ť) on our Altix XE servers, and continue to offer legacy systems based on the IRIX Â® operating systems and MIPS Â® RISC microprocessors. SGI storage products are based on best-of-breed disk systems and are designed to satisfy customersâ€™ performance and capacity needs through a range of Fibre Channel, Serial Attached SCSI (â€śSASâ€ť), and Serial Advanced Technology Attachment (â€śSATAâ€ť) technologies. These different technologies provide performance, price/ performance and best-in-class pricing for high density storage. These disk systems and other infrastructure hardware (Fibre Channel Switches, Host Bus Adapters (â€śHBAsâ€ť), etc.) are integrated and tested with differentiated SGI software to form a line of Direct-Attached Storage (â€śDASâ€ť), Storage Area Network (â€śSANâ€ť), Network-Attached Storage (â€śNASâ€ť) and Information Lifecycle Management (â€śILMâ€ť) products. SGI addresses specific workflow requirements in scientific, technical, analytic and database environments with our comprehensive family of SGI Â® Altix Â® and SGI InfiniteStorage Â® products, utilizing a unified infrastructure that is based on an industry-standard Linux operating system, a comprehensive data management environment, and common development and administrative toolsets.
Altix Servers. SGI offers a range of scalable servers from our entry level SGI Â® Altix Â® 400 series through the SGI Â® Altix Â® 4000 series of servers and supercomputers. These Altix product families feature Intel Itanium 2 processors, the Linux operating system, and SGI Â® NUMAflexâ„˘. These products are designed to enable customers to configure systems to meet their exact requirements while maintaining flexibility as their needs change over time. Altix 400 series systems combine SGIâ€™s NUMAflex architecture with entry-level pricing and packaging to deliver exceptional value as a scalable solution for small-to-midsize deployments. The Altix 4000 systems are the most scalable systems in the industry, addressing high-end deployments by leveraging the proven NUMAflex approach and the power of up to 1024 Itanium 2 processors running a single operating system. Altix systems can further be expanded via NUMAflex or industry-standard networking interconnects to create supercomputers of 10,240 processors or more that are among the most powerful in the world today.
Altix XE. SGI Altix Â® XE is a line of value-priced, entry-level servers and integrated cluster solutions that complements the Altix scalable server product lines. Altix XE systems are designed to serve the needs of HPC users by combining the advanced Intel Â® Dual-Core Xeon Â® processors with systems focused on superior performance, density and energy efficiency at a low price point. Altix XE clusters combine these systems into clusters using industry-standard interconnects and are delivered in a fully factory integrated and tested cluster solution, backed by SGIâ€™s industry-leading service and support.
Altix ICE. SGI Altix Â® ICE is an integrated HPC system that fits neatly between the Altix XE and the Altix server product lines. It combines the advanced packaging, power, ease-of-use and integrated system benefits of the Altix with the competitive price and price/performance benefits of the Altix XE. The Altix ICE offers superior performance and energy and space efficiency for cluster workloads at a competitive price point. The blade-based architecture and system management tools address many of the complexity issues inherent in traditional cluster offerings.
InfiniteStorage. Customers across HPC and enterprise markets desire ever increasing performance and ease of management in order to harness the massive amounts of data generated by their servers. SGI InfiniteStorage is a line of scalable, high-performance storage solutions built specifically for data-intensive workflow management, and provides faster cycle times and higher levels of manageability, access, availability and security. Within the InfiniteStorage line, SGI offers a broad range of disk systems, ranging from entry-level disk arrays to complex enterprise-class storage systems, in either direct- or fabric-attached configurations.
InfiniteStorage Direct Attached Storage (â€śDASâ€ť). SGI InfiniteStorage DAS products offer a complete line of arrays; from cost effective disks, IOP performance oriented arrays based on SAS and Fibre Channel technologies, to streaming high capacity storage arrays based on SATA technology, to tape systems for near-line and long term archival purposes. SGI offers virtualized data management providing seamless access to file data across n-tiers of storage with our Data Migration Facility (â€śDMFâ€ť) offering. This allows for true ILM by migrating files transparently between different storage types from high-performance arrays, to high density storage, and even to tape systems, all based on a customerâ€™s needs.
InfiniteStorage Storage Area Network (â€śSANâ€ť). SGI InfiniteStorage SAN products offer shared access to high-performance SAN-based storage supporting heterogeneous clients including Linux, Windows and many UNIX variants. These products integrate our CXFSâ„˘ shared file system with disk arrays and industry-standard SAN infrastructure to offer the performance of direct-attached storage with the consolidation/aggregation benefits of a traditional SAN and heterogeneous access benefits of network-attached storage products. In addition, with CXFSâ„˘, SGI InfiniteStorage SAN products allow customers to retain only one copy of the data while enabling shared access, thereby reducing data proliferation, inefficient use of storage and management overhead.
InfiniteStorage Network-Attached Storage (â€śNASâ€ť). The SGI InfiniteStorage NAS line is a complete line of integrated NAS â€śappliancesâ€ť from entry-point configurations for workgroup and departmental file serving, to scalable high-performance NAS systems capable of serving large HPC systems and clusters. InfiniteStorage NAS integrates file management with a â€śsingle paneâ€ť allowing system administrators to deploy their NAS systems in minutes. The InfiniteStorage NAS productsâ€™ intuitive Graphical User Interface (â€śGUIâ€ť) enables users to view utilization and track performance bottlenecks to a specific clientâ€™s machine.
The quality and reliability of our products and our understanding of our customersâ€™ technical and business challenges are critical to our success and a key element of the value we deliver. Our service portfolio offers system solution engineering services, professional and managed services, and traditional customer support and education. We offer our customers service solutions tailored to meet their business objectives and designed to maximize the return on their technology investment. We provide customer support services online, through SGI global support centers, and through authorized local service providers in countries where we do not have a local office. SGIâ€™s support offerings include both hardware and software support and range from on-site and mission critical support to same-day and next-day support with response times based on the needs of the customer.
Support Services. SGI Support Services consist of a core set of offerings that are available worldwide. Our proven support offerings include hardware and software support and range from on-site and mission critical support to same day and next day support with response times based on the needs of the customer. In addition, SGI support customers receive excellent benefits from SGI Electronic Support tools such as Embedded Support Partner (â€śESPâ€ť), SGI Knowledgebase, and Supportfolio.
Managed Services. SGI Managed Services include a broad range of product-focused services to maximize system performance and accelerate productivity. Services include hardware installation, system deployment, implementation, and on-site and remote system management. Specific implementation services include system administration, installation and system configuration, SAN and CXFS implementation, File Server implementation and High-Availability Software implementation.
Professional Services. SGI Professional Services is a total solution provider operating worldwide. We design solutions to help our customers achieve their technology and business goals and overcome their greatest challenges. Our teams of solution architects, project managers, and technical engineers deliver comprehensive solutions as well as specific services that address the solution's life cycle from initial problem assessment to solution architecture, deployment, and integration through follow-on support and service. We deliver solutions focused around HPC, storage and media solutions. Our Professional Services group maps solutions to the customerâ€™s workflow utilizing our technology portfolio, which includes servers, storage, interconnect software, and consulting. We have expertise in a broad range of industries enabling us to address all aspects of typical solutions deployment.
Marketing, Sales, and Distribution
SGI sells system products and solutions through both a direct sales force and indirect channel partners. SGI is engaged in a multi-year program to recruit and develop a stronger reseller channel in order to reach a greater number of customers and introduce our products to new markets . The SGI direct sales and support organization operates throughout the United States and in most significant international markets. We have channel partners in almost all the countries in which we have a presence; in other countries, we work through SGI authorized distributors.
Our indirect channel partners include service providers, systems integrators, value-added resellers, master resellers, and OEMs.
We maintain active programs to encourage independent software development for our systems. Through our Global Developer Program, we provide hardware, software, service, and marketing support benefits to attract and retain software developers and enable these developers to deliver high quality software on both our Linux and IRIX platforms.
Our Solutions Finance organization works with customers to arrange financing options through lease transactions and assists in the remarketing of off-lease systems.
No single end-user customer accounted for 10% or more of our revenues in any of the last three fiscal years. While our sales to the U.S. government sector have represented substantially more than 10% of our revenues in each of the last three fiscal years, these sales are made to and through numerous government agencies and to integrators and resellers that work with those agencies. Information regarding revenue and operating profit by reportable segments and revenue from external customers by geographic region is presented in Note 21 to the consolidated financial statements included in Part II, Item 7 of this Report and in the â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operationsâ€ť in Part II, Item 8 of this Report.
Research and Development
We concentrate our research and development efforts on products and technologies that we believe hold the highest potential, including global shared memory system architectures, space and power-efficient integrated system implementations, the Linux software environment and storage software to streamline access, and use and management of ever-increasing stores of data. We seek to maximize our use of industry-standard components, such as the Intel Itanium and Xeon families of microprocessors and the Linux operating system for all other aspects of our products and technologies.
During fiscal 2007, 2006, and 2005, we spent approximately $60 million, $84 million, and $93 million, respectively, on research and development, representing approximately 13% of total revenue in fiscal 2007, 16% in fiscal 2006, and 13% in fiscal 2005. We are committed to continuing innovation and differentiation, and as a result will most likely continue to make research and development investments consistent with historical levels. However, as total revenue has declined over the last several fiscal years, the absolute dollar level of our investment in research and development has also declined.
Our single point of manufacture and fulfillment is located in Chippewa Falls, Wisconsin. Our manufacturing operations primarily involve the assembly and test of high level subassemblies and subsystems, configured specifically to customer requirements. All finished products are subject to appropriate environmental and functional testing prior to shipment. We regularly evaluate the allocation of manufacturing activities among our own operations and those of suppliers and subcontractors.
We work closely with key suppliers on product introduction plans, strategic inventories, and internal and external manufacturing schedules and levels. Consistent with industry practice, we acquire components through a combination of formal purchase orders, supplier contracts, and open orders based on projected demand information. These purchase commitments typically cover our requirements for periods ranging from 30 to 180 days.
Our focus on and deep domain expertise in HPC provides advantages in being able to develop solutions specifically for these users. However, our competitors such as IBM, Hewlett-Packard, Sun Microsystems and Dell are generally far larger companies with much greater resources. We also compete with systems manufacturers and resellers of systems based on X86 class microprocessors. Because a computer system is a substantial investment requiring multi-year support, our smaller size can have a significant competitive impact. In some instances, the diversified business of our competitors can support very deep discounting to gain market share in the HPC business. We believe growth in the Linux-based systems market may also attract increased competition.
The computer industry is highly competitive and is known for rapid technological advances. These advances result in frequent product introductions, short product life cycles and steadily improving price/performance ratio. Customers make buying decisions based on many factors; including solution completeness, product features, price/performance, total cost of ownership, product quality and reliability, ease of use, capabilities of the system software, availability of third party applications, software, customer support, product availability, existing compute infrastructure, and corporate reputation. Significant discounting from list prices is prevalent in the industry.
Proprietary Rights and Licenses
We currently have issued and have pending more than 750 U.S. patents, and we intend to continue to protect our inventions with patents in the United States and abroad. We also hold various U.S. and foreign trademarks. Although we believe the ownership of patents, copyrights, trademarks, and service marks is an important factor in our business and that our success does depend in part on the ownership thereof, we rely primarily on the innovative skills, technical competence, and marketing abilities of our personnel to differentiate our products and services within the marketplace.
As is customary in our industry, we license from third parties a wide range of software, including the LINUX, Microsoft CCS and UNIX operating systems, for internal use and use by our customers.
Our success will depend in part on our ability to protect our intellectual property portfolio and proprietary information. We are in discussions with several parties regarding the potential use of our patents, which may result in licensing fees, royalties or a one-time settlement. If negotiations are not successful, we may need to litigate. If we were to litigate, we would incur significant costs, litigation may be a significant distraction for our management team, and we might not ultimately prevail. Litigation or changes in the interpretation of intellectual property laws could expand or reduce the extent to which we or our competitors are able to protect intellectual property and could require significant changes in product design. Because of technological changes and the extent of issued patents in our industry, it is possible certain components of our products and business methods may unknowingly infringe existing patents of others. Our industry has seen a substantial increase in litigation with respect to intellectual property matters, and we have been engaged in several intellectual property disputes both as plaintiff and defendant. We are in discussions with several parties whom we believe have infringed upon our patents, and we expect that we will engage in patent infringement litigation from time to time. See â€śRisk Factorsâ€ť.
Seasonality and Backlog
We do not consider our business to be highly seasonal, although in two of the past three years revenues in our second fiscal quarter ending in December have been higher than other quarters in our fiscal year, reflecting in part the buying patterns of calendar year-end customers. Past performance should not be considered a reliable indicator of our future revenues or financial performance.
Our backlog is calculated in accordance with our internal performance measurements, or non-GAAP financial measures, and at June 29, 2007 it was $66 million, down from $127 million at June 30, 2006. The significant decrease in backlog year-over-year is primarily attributable to the completion of two large multi-year transactions during fiscal year 2007. Backlog is comprised of committed purchase orders for products and professional services deliverable within nine months. We generally do not maintain sufficient backlog to meet our quarterly objectives for product revenue without obtaining significant new orders that are booked and shipped within the quarter. In addition, our backlog does not reflect portions of longer delivery-cycle contracts we have been awarded, but which will not be delivered in the next nine months. Although the backlog reflects only orders for which a firm purchase order has been issued or a contract has been made, many orders in backlog are subject to customer cancellation or rescheduling in certain circumstances, and government customers typically have rights of cancellation for convenience. As a result, backlog should not be considered a reliable indicator of our ability to achieve any particular level of revenue or financial performance.
Certain of our products and operations are regulated under various laws in the U.S., Europe and other parts of the world relating to the environment, including laws and regulations that can limit the use of certain substances in our products or require us to recycle our products when they become waste. It is our policy to ensure that our operations and products comply with environmental laws at all times. We track regulatory developments that may impact our business and devote resources toward developing strategies for compliance with new requirements as they are enacted.
We may face significant costs and liabilities in connection with product take-back legislation, such as the European Union Directive on Waste Electrical and Electronic Equipment (â€śWEEEâ€ť), which makes producers of electrical and electronic equipment, including computers, responsible for the collection, recycling, treatment and disposal of past and future covered products. Legislation similar to Restriction of Hazardous Substances (â€śRoHSâ€ť) and WEEE has been or may be enacted in other jurisdictions, including in the United States, Japan and China. These and other environmental laws may become stricter over time and require us to incur substantial compliance costs. RoHS and WEEE are implemented by individual countries in the European Union and each jurisdiction implements, interprets or enforces RoHS and WEEE somewhat differently. Our failure to comply with WEEE and RoHS, contractual obligations relating to WEEE and RoHS or other environmental laws could result in our being directly or indirectly liable for costs, fines or penalties and third-party claims, and could jeopardize our ability to conduct business in countries in the European Union.
As of June 29, 2007 we had 1,588 employees compared with 1,752 at June 30, 2006. Our future success will require that we continue to retain and motivate highly qualified technical, sales, marketing and management personnel. We have never had a work stoppage, and no employees are represented by a labor union. We have workers' councils where required by the European Union or other applicable laws.
Mr. Ewald was named our Chief Executive Officer and appointed as a member of our Board in April 2007. From June 2005 to April 2007, Mr. Ewald served as the Chairman and Chief Executive Officer of Linux Networx, a Linux based networking company. Mr. Ewald served as Executive Vice President and President of Human Resource Solutions of Ceridian Corporation from July 2003 to January 2005. He also served as a director of Ceridian Corporation from March 2001 to January 2005. From October 2002 to 2003, Mr. Ewald was the Chairman and Chief Executive Officer of Scale Eight, Inc., a high-performance network clustered storage company. From March 1999 to October 2002, he served as President and Chief Executive Officer of E-Stamp Corporation, an internet postage company, and as the Executive Chairman of its successor company, Learn2 Corporation. From October 1997 to July 1998, Mr. Ewald was the Executive Vice President and Chief Operating Officer of Silicon Graphics, Inc.
James A. McDivitt became a director of the Company in 1987. Prior to his retirement in March 1995, he was Senior Vice President, Government Operations and International, of Rockwell International Corporation. He has also held executive positions with Consumers Power Company and Pullman, Inc. Mr. McDivitt was selected as an astronaut by NASA in September of 1962. He was the command pilot for the Gemini 4 mission in 1965 and the Commander of the Apollo 9 mission in 1969. He then served as a Program Manager for many Apollo missions until 1972, when he retired from the U.S. Air Force, with the rank of Brigadier General, and from NASA. Mr. McDivitt also serves as a director of Ionatron, Inc.
Anthony Grillo became a director of the Company in October 2006. Since 2005, Mr. Grillo has served as the Chief Executive Officer of American Securities Opportunity Fund, LP, which he founded and which focuses on providing advisory services to and making investments in companies in transition. From January 2005 through September 2005, Mr. Grillo served as Chief Executive Officer of CricketHill Associates, LLC, a boutique advisory firm providing financial advisory services to distressed companies. From March 2001 through December 2004, Mr. Grillo served as the Senior Managing Director of Evercore Partners, an investment banking boutique providing advisory services to multinational corporations on significant mergers, acquisitions, divestitures, restructurings, and other strategic corporate transactions. From 1999 through March 2001, Mr. Grillo was a Senior Managing Director of JLL Partners, a private equity investment firm. Mr. Grillo is also a director of Littelfuse, Inc.
Joanne O. Isham became a director of the Company in January 2007. Since June 2007, Ms. Isham has been the Chief Operating Officer of High Performance Technologies, Inc. Prior to assuming this role, Ms. Isham was the Vice President/Deputy General Manager of Network Systems at BAE Systems (â€śBAEâ€ť). In that capacity, she was directly responsible for identifying strategic opportunities for new mission focus within the intelligence community, Department of Defense, and the Department of Homeland Security. Before joining BAE, Ms. Isham was a member of the Senior Intelligence Service and a career officer at the Central Intelligence Agency (â€śCIAâ€ť). From September 2001 until her retirement, she served as Deputy Director of the National Geospatial-Intelligence Agency. Immediately prior to that assignment, she served as the Deputy Director of Science and Technology at the CIA. In that position, she was the principal executive overseeing the CIAâ€™s scientific and technical program with particular responsibility for clandestine technical activities and CIA-wide research and development. Ms. Isham held several other senior management positions in the CIA and other organizations in the intelligence community.
Kevin D. Katari became a director of the Company on October 17, 2006, and was elected Chairman of our Board on October 18, 2006. Mr. Katari joined Watershed Asset Management, L.L.C., a manager of discretionary capital for institutional investors (â€śWatershedâ€ť), in April 2002 and has served as a Managing Member of Watershed and its affiliate, WS Partners, L.L.C. since March 2004. From 1999 to 2002, Mr. Katari was a co-founder, Vice President, and member of the Board of Directors of Bluefire Systems, Inc., a startup retail consulting and software firm. Mr. Katari is also a member of the Board of Directors of Carmike Cinemas, Inc.
Eugene I. Davis became a director of the Company in October 2006. He is Chairman and Chief Executive Officer of Pirinate Consulting Group, L.L.C., a privately-held consulting firm specializing in crisis and turn-around management, liquidation and sales management, merger and acquisition consulting, hostile and friendly takeovers, proxy contests, and strategic planning advisory services for public and private business entities. Mr. Davis is also a director of Knology, Inc.; Haights Cross Communications, Inc.; PRG-Schultz International, Inc.; Atlas Air Worldwide; Medicor Ltd.; American Commercial Lines, Inc.; and Delta Air Lines, Inc.
Chun Won Yi became a director of the Company in October 2006. He has been serving since May 2003 as a Vice President and Research Analyst of Quadrangle Group LLC, a private investment firm where Mr. Yi is focused on the firmâ€™s distressed debt business. From June 2002 to May 2003, Mr. Yi was an Associate in the Diversified Industries Group at JPMorgan and from June 1999 to June 2002 served as an Analyst for JPMorgan.
Base Salaryâ€” The Compensation Committee believes that it is necessary to set base salaries at levels that allow the Company to secure and retain the services of key executive talent. We annually review the salaries of our executives against basic performance objectives, including absolute performance, performance relative to peers, comparison to external market data and the total reward scenario for each executive. Recommendations for executive salary adjustments are reviewed and approved by the Compensation Committee. In fiscal year 2007, due to the financial condition of the Company, there were no broadly-distributed salary increases for executives as a group, and no specific action was taken to target executive salaries against a specific benchmark.
For fiscal year 2008, the Compensation Committee has targeted executive base salaries at the 75 th percentile of the Compensation Peer Group. In setting the level of executive base salaries, we consider performance, internal equity, external benchmarking data, and related analyses. We generally benchmark our compensation levels against the companies listed above in Benchmarking.
Cash Bonus Planâ€” The Cash Bonus Plan is designed to reward Executives for producing critical, short-term (up to one year) results with emphasis on bookings, revenue, operating results, and personal objectives. In fiscal year 2007, the Compensation Committee established an individual cash bonus target for each executive equal to 40%â€”100% of their base salaries. The average bonus target in fiscal year 2007, as a percentage of base salary, was 44.3% for Vice Presidents and 58% for Senior Vice Presidents. Individual bonus targets were determined through a combination of market benchmarking, internal alignment/segmenting for equity (by job band and reporting relationship), and pay-out modeling to determine cost and affordability. The Compensation Committee has determined that the same general ranges and averages would be used for executive bonus targets in fiscal year 2008.
In selecting objectives for the bonuses of our executives, we identify metrics that are relevant to our business and reflect where we believe the most focus is needed to improve overall financial and operating results. The weighting of each metric suggests the relative level of impact we expect our executives to have on each metric.
For fiscal year 2007, all executives, with the exception of the CEO and those covered by a sales commission plan, were covered by one Cash Bonus Plan design. The table below shows the metrics, weightings, and goal achievement for our executives in the Cash Bonus Plan for fiscal year 2007.
For fiscal year 2008, the total executive population, with the exception of those covered under a sales commission plan, will be segmented into two groups for bonus purposes. These groups are Executive Committee members (including the CEO) and other SVPs & VPs who are not on the Executive Committee. The table below shows the fiscal year 2008 metrics and weightings for each of these groups.
At the end of a given fiscal year, the company's actual performance for each metric is compared to its established target. The goal achievement results for the corporate financial metrics are then applied to a scoring table previously approved by the Compensation Committee. The resulting scores for each metric are applied against the weighting and the executiveâ€™s individual bonus target. The personal objectives (if applicable) are rated and approved by the CEO for each executive and then scored, applied against the weighting, and calculated much like the financial metrics. The calculations for the corporate financial metrics and the personal objectives are then added together. The sum is the actual bonus for the executive. The CEO and Board review and approve the actual calculated bonuses for executives. Any exceptions to the established bonus plan for executives are proposed by the CEO and must be approved by the Compensation Committee.
Equity Plansâ€” We believe that providing a significant portion of our executives' total compensation package in the form of equity awards aligns the incentives of our executives with the interests of our stockholders and with our long-term success. The Compensation Committee determines the form and size of equity awards with a view to each executive's overall compensation package, including prior equity awards. Additional factors considered in determining the form and size of equity awards include performance, impact on the business, future potential, internal fairness, external competitive position, and recommendations from our CEO. Equity awards for our executives include both restricted stock units (RSUs) and stock options. The Compensation Committee typically determines whether to award equity to our executives in the second quarter of each fiscal year, with the grant date being December 1 st . It is the practice of the Compensation Committee to award RSUs and stock options as of the 15 th day (or the applicable following business day) of the month following the start date of all new employees (when equity is part of the new-hire package), including executives. Equity grants resulting from promotions are also awarded on the same timetable as new-hires.
Stock option and RSU grants for Robert Ewald, our CEO, in fiscal year 2007 were given according to his employment contract. The vesting of these stock options and RSUs is in a series of 48 successive and equal monthly installments upon the CEOâ€™s completion of each month of service over the 48 month period, commencing on his hire date.
Post-Termination Compensation and Benefitsâ€” Severance and change in control arrangements for certain of our executives are discussed below under the section Post Employment Compensation and Benefits. The post-termination compensation and benefits for our CEO, Robert Ewald, are explained below in the section entitled Mr. Ewaldâ€™s Compensation. The Compensation Committee believes that these change in control arrangements serve the best interests of stockholders because they help to minimize the distraction of management at a cost that the Compensation Committee believes is appropriate and reasonable.
Other Compensationâ€” During fiscal year 2007, two of our executives received special one-time bonuses outside of the Cash Bonus Plan that were based on metrics established, and later assessed at the end of their defined performance periods, by the then-current CEO and the Compensation Committee. These metrics had urgent and significant impact on the financial restructuring of the Company. The bonus targets for each of these special bonuses were set by the former CEO and the Compensation Committee, based on the magnitude of the potential impact of the metrics on the Company.
All of our executives are eligible to participate in our employee benefit plans, including medical, dental, life insurance, ESPP (if approved by the stockholders and unless prohibited by law), and 401(k) plans. These plans are available to all salaried employees and do not discriminate in favor of executives. It is generally our policy not to extend significant perquisites to our executives that are not available to our employees. We will continue to survey the market and at some point in the future may propose changes to the levels of certain benefits and perquisites provided to our executives.
Executive Compensation During Fiscal Year 2007
On May 8, 2006, SGI and its U.S. subsidiaries filed voluntary petitions under Chapter 11 of the U.S. Bankruptcy Code. We emerged from the bankruptcy process on October 17, 2006, under a plan of reorganization (the â€śPlanâ€ť). In accordance with the Plan, all prior outstanding shares of our common stock were canceled. Most of our executive team, including our former CEO Dennis McKenna, remained in place throughout the reorganization process and managed the operations of the business without daily supervision from the court.
During the Chapter 11 proceedings, we developed and communicated details of a retention strategy that consisted of a cash retention plan for key employees below the executive level. In addition, as a component of the Plan, we outlined a Management Incentive Plan (â€śMIPâ€ť) which included an equity grant incentive program for all executives and for key employees below the executive level. We engaged the Compensation Consultant to assist in the design of these plans. The bankruptcy court approved the cash retention plan, which was implemented in July 2006 shortly after approval. The MIP became effective upon emergence from bankruptcy pursuant to the terms of the confirmed Plan. Additional information on the RSU and stock option grants follows in the paragraph below.
In the ordinary course of business, in August 2006, the Compensation Committee implemented a cash bonus plan for fiscal year 2007, which covered all executives (other than the CEO) and many non-executives who were not on a sales commission plan. In the performance-based cash bonus plan, corporate revenue and operating income goals constituted 70% of the weightings, and personal objectives accounted for the remaining 30% weighting for executives. We assumed the cash bonus plan upon emergence from bankruptcy. Upon review by the Compensation Committee in November of 2006, the average bonus target, as a percentage of base salary, was set at 44.3% for Vice Presidents and 58% for Senior Vice Presidents.
On December 1, 2006, under an overall Management Incentive Plan adopted by our Board, we granted RSUs and stock options as a retention strategy to all executives (other than Mr. McKenna) and to a number of key employees below the executive level. Vice Presidents received RSU grants ranging from 5,859 to 9,206 shares and stock option grants ranging from 17,576 to 27,619 options. Senior Vice Presidents received RSU grants ranging from 9,206 to 12,554 shares and stock option grants ranging from 27,619 to 37,663 options.
On August 28, 2007, the results of the fiscal year 2007 cash bonus plan were formally approved by the Board, and bonuses were paid to participants on September 21, 2007. On average, executives received bonus payments equal to 104% of their individual bonus targets.
Mr. McKennaâ€™s Compensationâ€” During the course of completing the final stages of the plan of reorganization and subsequent emergence from Chapter 11, Mr. McKenna and key bondholders that had been named in the Plan to become members of the new Board came to the mutual conclusion that the Board, when constituted, would begin a search for a new CEO to lead us in our post-bankruptcy growth effort. The Companyâ€™s reconstituted Board initiated the CEO search in the fall of 2006. Due to the desire to keep Mr. McKenna actively engaged in guiding us during the search for a new CEO and to fairly compensate Mr. McKenna for results achieved, our Board approved a bonus agreement for Mr. McKenna, covering the first two quarters of fiscal year 2007, of up to $500,000 based on achievement of certain revenue and EBITDAR targets. We paid $465,122 under this agreement.
On March 30, 2007, the Compensation Committee granted Mr. McKenna an RSU award covering 20,619 shares of common stock. The RSU award was fully vested on the Grant Date and the underlying shares became issuable on May 15, 2007, subject to a six-month deferral under certain specified circumstances. As a condition to the issuance of the RSU award, Mr. McKenna executed a General Release Agreement pursuant to which he released and waived all claims he might have otherwise had against us, including claims relating to the equity compensation awards we previously granted to him.
Also, on March 30, 2007, the Compensation Committee approved a bonus agreement with Mr. McKenna whereby if our revenue and EBITDA for the third quarter of fiscal 2007 met or exceeded specified targets, then we would pay Mr. McKenna a bonus up to $250,000. We paid $197,541 to Mr. McKenna under this agreement.
Previously, on April 6, 2007, we had entered into a Mutual Separation and General Release Agreement with Mr. McKenna. Under the separation agreement, Mr. McKenna executed a general release of all claims against us in exchange for a lump sum severance payment of $500,000 and continued health care coverage at our expense for up to twelve months. The severance payment is payable on the earlier of (i) the date that is six months following his separation from service with the Company and (ii) the date of his death.
Mr. Ewaldâ€™s Compensation â€”On April 6, 2007, Mr. McKenna left his position as our CEO and President and resigned from the Board. On April 9, 2007, we announced that Mr. McKenna had been replaced by Robert Ewald as our CEO. The Board also appointed Mr. Ewald as a Class I Director of the Board.
In negotiating Mr. Ewaldâ€™s compensation, his extensive industry experience, the status of the Companyâ€™s turnaround, and market comparisons for CEOâ€™s of other companies were taken into consideration. As a result of the negotiations and pursuant to the terms of Mr. Ewald's offer letter, Mr. Ewaldâ€™s annual base salary is $600,000, subject to annual adjustment by the Board upon recommendation by the Compensation Committee. Mr. Ewald is also eligible to receive a cash bonus each fiscal year, beginning with fiscal year 2008, of up to 100% of his annual base salary, based upon the achievement of the goals outlined for Executive Committee members under the Annual Variable Incentive Plan. For fiscal year 2007, Mr. Ewald was guaranteed a cash bonus equal to 100% of his annual base salary, prorated for the number of days he was employed by us in fiscal year 2007, provided he remained employed by us through June 29, 2007. Mr. Ewald was paid a fiscal 2007 bonus in the amount of $138,462 on September 21, 2007 . SGI also agreed to reimburse Mr. Ewald for up to $75,000 in relocation expenses pursuant to the Companyâ€™s relocation policy. In addition, the Compensation Committee approved reimbursement of certain personal travel expenses relating to three-destination business and personal travel by Mr. Ewald.
Also, pursuant to the terms of the offer letter, on April 16, 2007, Mr. Ewald was granted an option to purchase 241,142 shares of common stock The options were granted under our Management Incentive Plan (â€śMIPâ€ť) with the stipulation that any shares subject to the option in excess of 147,500 would be subject to stockholder approval of an increase of at least 93,642 shares of common stock available under the MIP within nine months following the option grant date so as to cover those shares. The approval being sought pursuant to Proposal 2 is intended to meet this requirement. The shares are subject to a vesting schedule discussed in the section entitled Equity Plans .
On April 17, 2007, Mr. Ewald received an RSU grant in the amount of 46,358 shares. The number of shares comprising the RSU grant was derived from the difference between 287,500 shares and the 241,142 shares of common stock subject to the stock option grant. The vesting schedule of the RSUs is discussed under the section entitled Equity Plans .
Mr. Ewald is not expected to receive any change in his compensation package for fiscal year 2008. In addition, we do not expect to issue any additional stock option or RSU awards to Mr. Ewald until at least fiscal year 2009.
If the Company terminates Mr. Ewaldâ€™s employment without cause, Mr. Ewald executes a general release of all claims in favor of the Company, and Mr. Ewald agrees not to solicit any of our employees for a 12-month period following his termination date and complies with the terms of his proprietary information agreement with us, Mr. Ewald will receive salary continuation payments for a 12-month period following his termination date at his rate of base salary in effect on his termination date and COBRA premiums paid on his behalf until the earlier of 12 months following his termination or until he is covered by another employerâ€™s health care plan.
MANAGEMENT DISCUSSION FROM LATEST 10K
We are a leading provider of products, services, and solutions for use in HPC and data management. We sell solutions based on a complete range of scalable servers and storage products, from entry-level to high-end, together with associated software products. These solutions enable our customers in the scientific, technical and business communities to solve their most challenging data management and analysis problems providing them with strategic and competitive advantages. Our products are also among the best in the industry in energy efficiency. Whether studying global climate changes, accelerating the engineering of new automotive designs, providing technologies for homeland security, or gaining business â€śintelligenceâ€ť through data-mining, our solutions are designed to store, manage, access, analyze and transform vast amounts of data to provide insights and intelligence in real time or near-real time. We also offer a range of services, including professional services, customer support, and education. Our solutions, products and services are used in a range of markets including defense and intelligence, sciences, engineering analysis, digital content management and both commercial and government enterprise.
The following overview describes key elements of our business strategy and our results achieved during fiscal 2007:
Leadership in High-Performance Computing . During the past several years, we have transitioned our focus from our legacy systems based on our MIPS processors and IRIX operating system to our core systems based on industry-standard processors and the Linux operating system. Our goal is to be the leading provider of Linux Compute platforms, and a leading provider of performance data management and analysis solutions. Our revenue growth prospects, and our ability to return to profitability, depend on our ability to grow our Altix Compute and Data Management Solutions revenues at a rate that will more than offset the expected continued decline of our traditional MIPS/IRIX product and maintenance business. See â€śRisk Factorsâ€ť.
Maintain Gross Margins to Support R&D and Other Investments. Our strategy is to develop differentiated products that provide our customers with strategic and competitive advantages. However, this requires continued substantial investments in research and development. In addition, maintaining acceptable gross margins will require achieving an overall revenue level adequate to absorb our fixed costs, striking the appropriate balance between large lower margin transactions and our more normal sales transactions, and working with suppliers to continue to structure favorable component pricing. It also involves augmenting our hardware sales with revenues from software and services, which generally carry higher gross margins.
Targeting our Product Portfolio on New Business Opportunities. SGI has traditionally focused in technical and scientific computing. We are expanding into targeted areas of the enterprise segment that are well served by our high-performance systems, and are expanding our product portfolio to include X86-based products. We concentrate our development efforts in software and hardware differentiators for our computer systems and storage to better capitalize on requirements of the high-performance compute market. In June 2006, SGI introduced a new line of x86-based cluster products, the Altix XE family, to more effectively address the expanding market for cluster computing. In June 2007, we introduced what we believe is the first high-performance engineered cluster, further enabling our customers to meet their hybrid computing demands.
Focus on Expense Management . Over the past few years, we undertook significant restructuring activities targeted at reducing our expense structure to be more in line with our revenues. We benefited during fiscal year 2007 and will continue to benefit from the lower cost structure achieved through these efforts. While we do not have plans for further comprehensive restructuring activities, we will undertake to continuously improve our cost structure wherever possible, in order to ensure we can continue to invest in the sales, marketing and R&D initiatives that will fuel revenue growth.
On April 9, 2007, the Board of Directors appointed Mr. Robert â€śBoâ€ť Ewald as our new Chief Executive Officer. This leadership change marks a shift from our restructuring phase, to a focus on growth and profitability. Mr. Ewaldâ€™s arrival is part of our business strategy to achieve sustained improvement and growth in our business and financial performance.
Chapter 11 Reorganization
On May 8, 2006, the Predecessor Company and certain of its subsidiaries filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. For further information regarding these petitions, see Note 2 to our Notes to Consolidated Financial Statements in Part II, Item 8 of this Report.
While under bankruptcy protection, we continued to operate our business without interruption as debtor-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code, the Federal Rules of Bankruptcy Procedure, applicable court orders, as well as other applicable laws and rules. In general, a debtor-in-possession is authorized under Chapter 11 to continue to operate as an ongoing business, but may not engage in transactions outside the ordinary course of business without the prior approval of the Court.
In the latter part of fiscal 2006 and through the first half of fiscal 2007, we allocated a substantial amount of resources to bankruptcy restructuring, which included resolving claims disputes and contingencies, determining enterprise value and capital structure, negotiating a Plan of Reorganization with key creditor constituents and evaluating the impact of and implementing fresh-start accounting. On September 19, 2006, the Court entered its Confirmation Order confirming the Plan and we emerged from bankruptcy protection on October 17, 2006 (â€śEmergence Dateâ€ť). Under the Plan, all of the Predecessor Companyâ€™s existing common stock, stock options and restricted stock awards were cancelled upon emergence and the equity holders received no recovery. Accordingly, the Predecessor Companyâ€™s common stock has no value. Our emergence from bankruptcy protection on the Emergence Date resulted in a new reporting entity and new shares of common stock in the Successor Company were issued to the bondholders of the Predecessor Company. These shares began trading on the NASDAQ Global Market under the symbol SGIC on October 23, 2006. We adopted fresh-start accounting in accordance with SOP 90-7 as of September 29, 2006. As required by fresh-start accounting, our assets and liabilities were adjusted to fair value at that date, and certain assets and liabilities not previously recognized in the Predecessor Companyâ€™s financial statements were recognized, at that date under fresh-start accounting. The consolidated financial statements as of June 30, 2006 do not give effect to any adjustments in the carrying values of assets or liabilities that were recorded upon implementation of the Plan and the adoption of fresh-start accounting on September 29, 2006. Accordingly, our financial condition and results of operations as of and after September 29, 2006 are not comparable to the financial condition and results of operations reflected in the historical condensed consolidated financial statements of the Predecessor Company. In addition, the adoption of fresh-start accounting, will have a significant non-cash impact on our future results of operations, has had and will continue to have no impact on the underlying cash, working capital assumptions or the underlying operation of the business. While all amounts reflected in this Form 10-K are reported in accordance with accounting principles generally accepted in the United States, we explain our results of operations excluding the impact of fresh-start accounting in this report and in our other public disclosures of our results of operations and financial condition in order to provide transparency in our financial reporting. We believe that such a presentation is necessary to facilitate period-to-period comparisons of our performance.
Fresh-Start Accounting Adjustments . As more fully described in Note 4 in Notes to the Consolidated Financial Statements included in this Report, as a result of our emergence from bankruptcy, the assets and liabilities of the Successor Company were adjusted to their relative fair values in conformity with SFAS No. 141 as of September 29, 2007, Business Combinations (â€śSFAS 141â€ť). The fresh-start accounting adjustments that had the most significant impact on our financial results for the fiscal year ended June 29, 2007 and will continue to affect our financial results going forward are as follows:
Deferred Revenue valuation . Deferred revenue was revalued to actual cost, which will be incurred to service the liability in the future, plus a reasonable margin. Deferred Revenue is a liability that in the normal course of business would be expected to convert to revenue in the future. Customer support deferred revenue and product and professional services deferred revenue were the two primary components of deferred revenue of the Predecessor Company that were significantly reduced by fresh-start accounting and which will have an unfavorable impact on revenue over the next four years. We concluded that effective as of the beginning of fiscal 2006 certain multiple-element sales transactions, where software was more than incidental to the overall solution, should be recorded under Statement of Position (â€śSOPâ€ť) 97-2, Software Revenue Recognition. Thirty-seven million dollars of deferred revenue and $17 million of deferred cost of sales related to our accounting under SOP 97-2 that had previously been deferred was reduced to zero through the fresh-start accounting adjustments and this impact will have an unfavorable impact on both revenue and gross margin in future periods primarily through at least the remainder of fiscal 2008.
Inventory valuation . SGI has raw materials, work-in-progress, finished goods, delivered systems and demonstration inventory. At September 29, 2006, a write-up of $28 million was required to record these inventories at fair value. The result of the valuation adjustment on our results of operations is that costs of goods sold will increase by the magnitude of the valuation adjustment as the revalued inventory is sold and recorded as cost of goods sold. We expect the impact of the inventory valuation write-up to unfavorably impact cost of sales through the second quarter of fiscal 2008. At June 29, 2007, approximately $5 million of the write-up remains to be recognized to cost of sales.
Intangibles . As a result of fresh-start accounting, new intangibles assets were established. Other Intangible Assets, net of accumulated amortization, were approximately $71 million as of June 29, 2007, and approximately $87 million as of September 29, 2006. We are required to amortize the value of these intangible assets over varying periods up to 17 years impacting both cost of sales and selling, general and administrative expense.
Results of Operations
As discussed above, we emerged from Chapter 11 and adopted fresh-start reporting on September 29, 2006. References to â€śPredecessor Companyâ€ť refer to Silicon Graphics, Inc. prior to September 29, 2006. References to â€śSuccessor Companyâ€ť refer to Silicon Graphics, Inc. on and after September 29, 2006, after giving effect to the cancellation of existing common stock and the issuance of new securities in accordance with the Plan, and application of fresh-start reporting. As a result of the application of fresh-start reporting, the Successor Companyâ€™s financial statements are not comparable with the Predecessor Companyâ€™s financial statements. However, for purposes of discussion of the results of operations, the combined three months ended September 29, 2006 and the nine months ended June 29, 2007 (fiscal 2007) have been compared to the twelve months ended June 30, 2006 as included in our consolidated statements of operations (which are contained in Part II, Item 8 of this Report). In this discussion, we will disclose the fresh-start and other impacts on our results of operations that vary from historical Predecessor Company periods to aid in the understanding of our financial performance.
The following discussion of revenue is based on the results of our reportable segments, as described in Note 21 to our Consolidated Financial Statements in Part II, Item 8 of this Report. Total revenue is principally derived from two reportable segments, Products and Global Services. We have realigned our Products segment into our Core Systems, comprised of our high-performance servers and visualization systems based on Intel Xeon and Intel Itanium 2 microprocessors and the Linux operating system, and storage solutions, and our Legacy Systems, comprised of our high-performance servers and visualization systems based on MIPS microprocessors and the IRIX operating system. This change was made in order to align reportable segments with the process by which our chief operating decision maker makes operating decisions and evaluates performance. Prior year amounts have been reclassified to conform to the current year presentation.
Total revenue decreased $56 million or 11% in fiscal 2007 compared with fiscal 2006, and decreased $211 million or 29% in fiscal 2006 compared with fiscal 2005. The overall decline in revenue from fiscal 2006 to fiscal 2007 was due to declines in sales of Global Services and, to a lesser extent, sales of our Legacy Systems. These declines were partially offset by significant increases in sales of Core Systems. The impact from fresh-start accounting resulted in unfavorable revenue adjustments of $20 million to Products and $25 million to Global Services and was a major factor in the decline in revenue for fiscal 2007 compared with fiscal 2006. In conjunction with the completion of our fiscal 2006 audit, we concluded that certain fiscal 2006 multiple-element sales transactions, where software was more than incidental to the overall solution, should have been more appropriately recorded under Statement of Position (â€śSOPâ€ť) 97-2, Software Revenue Recognition . In conjunction with business turnaround activities initiated during fiscal 2006, we shifted our sales and marketing efforts for certain of our products that include SGI proprietary software to drive a total solution sales approach. We evaluated this shift in strategy against the indicators offered in footnote 2 of SOP 97-2, along with other considerations, in reaching the conclusion that, effective as of the beginning of fiscal 2006, these same products should be accounted for under the provisions of SOP 97-2. This change resulted in revenue adjustments, primarily to product revenue, of approximately $32 million and also contributed to the decline in revenue for fiscal 2006 compared with fiscal 2005. The decline in revenue from fiscal 2005 to fiscal 2006 was also due to declines in sales across all reportable segments, principally declines in sales of both our Core Systems and Legacy Systems and to a lesser extent in sales of Global Services. We expect that our MIPS/IRIX-based and related maintenance revenues will continue to decline. As discussed in Part I Item 1 of this Report, we will continue to develop and implement our business strategies to improve the profitability of our Core Systems revenues. See â€śRisk Factorsâ€ť.
Products. Revenue from our Products segment increased $5 million or 2% in fiscal 2007 compared with fiscal 2006 and declined $184 million or 42% in fiscal 2006 compared with fiscal 2005.
Revenue from Core Systems in fiscal 2007 increased $33 million or 19% compared with fiscal 2006. The increase is primarily a result of higher volumes across all Core systems product lines and greater large dollar transactions for our Altix servers, offset in part by the unfavorable impact from fresh-start accounting, and decreased volume of our Prism family of visualization systems. Storage solutions revenue increased slightly in fiscal 2007 compared with fiscal 2006, offset in part by an increase in revenue adjustments noted above.
Revenue from Core Systems in fiscal 2006 decreased $97 million or 36% compared with fiscal 2005. The decline is primarily a result of reduced volumes and fewer large dollar transactions for our Altix servers, coupled with a fiscal 2006 change in how we account for certain transactions where software was more than incidental to the overall solution, offset in part by increased volume of our Prism family of visualization systems. Storage solutions revenue declined in fiscal 2006 compared with fiscal 2005 despite an increase in average selling prices, primarily due to reduced sales volumes coupled with the accounting change related to SOP 97-2 noted above.
Revenue from Legacy Systems in fiscal 2007 decreased $28 million or 36% compared with fiscal 2006, principally due to a decrease in sales associated with all our MIPS/IRIX-based systems. The continuing long-term decline in the overall UNIX workstation market, an industry-wide trend that we expect will continue as lower-cost personal computers continue to gain market share, also contributed significantly to the revenue decline. The decline in both our MIPS/IRIX-based servers and graphics systems revenue was principally due to reduced volumes due to customers transitioning away from the legacy system technology into Linux based systems. Revenue from our remarketed products decreased compared with fiscal 2006 primarily due to a decrease in sales of our remarketed MIPS/IRIX-based workstation and graphics systems.
Revenue from Legacy Systems in fiscal 2006 decreased $87 million or 53% compared with fiscal 2005, principally due to a decrease in sales associated with all our MIPS/IRIX-based systems. The continuing long-term decline in the overall UNIX workstation market, an industry-wide trend that we expect will continue as lower-cost personal computers continue to gain market share, also contributed significantly to the revenue decline. The decline in both our MIPS/IRIX-based servers and graphics systems revenue was principally due to reduced volumes due to customers transitioning away from the legacy system technology into Linux based systems, and to a lesser extent from the impact of the accounting change related to SOP 97-2 referenced above. Revenue from our remarketed products decreased compared with fiscal 2005 primarily due to a decrease in sales of our remarketed MIPS/IRIX-based server systems.
Global Services. Revenue from our Global Services segment is comprised of hardware and software support, maintenance and professional services. Professional services revenue includes revenue generated from the sale of third party products and SGI consulting and managed services.
Revenue from Global Services in 2007 decreased $61 million or 23% compared with fiscal 2006. The decline was primarily due to the impact from fresh-start accounting resulting in unfavorable revenue adjustments. In addition, our traditional customer support revenue decreased as a result of lower pricing for new contracts compared with existing contracts, coupled with a decline in the overall installed base resulting in fewer contract renewals. To a lesser extent, a decline in revenue generated from professional services contracts also contributed to the overall decline in Global Services revenue.
Revenue from Global Services in 2006 decreased $27 million or 9% compared with fiscal 2005. This decline was largely attributable to the same factors described in the preceding paragraph (except for the impact from fresh-start accounting).
The shift in geographic revenue mix in fiscal 2007 compared with fiscal 2006 is primarily a result of one large transaction, accounting for 9% of total revenue in fiscal 2007, to the Leibniz Computing Center (â€śLRZâ€ť) in Germany. Geographic revenue mix in fiscal 2006 remained relatively unchanged compared with fiscal 2005.
Our backlog is calculated in accordance with our internal performance measurements or non-GAAP financial measures, and at June 29, 2007 our consolidated backlog was $66 million, down from $127 million at June 30, 2006. Backlog is comprised of committed purchase orders for products and professional services deliverable within nine months. Backlog decreased within the Core Systems segment, specifically with regard to our Linux-based Altix servers and storage systems due primarily two large deals in Germany included in the backlog at June 30, 2006, that were recognized as revenue in fiscal 2007. Backlog decreased within the Legacy Systems segment, primarily related to our Origin products. Backlog also decreased in professional services. See â€śBusinessâ€”Seasonality and Backlogâ€ť in Part I, Item 1 of this Report.
We generally do not maintain sufficient backlog to meet our quarterly objectives for product revenue without obtaining significant new orders that are booked and shipped within the quarter. Our backlog reflects only orders for which a firm purchase order has been issued or a contract has been made, although orders in backlog are subject to customer cancellation or rescheduling in certain circumstances, and government customers typically have rights of cancellation for convenience. SGI systems have also been selected for a number of multi-year U.S. government programs, with expected purchases that are not reflected in our current backlog. In addition, we may enter into longer delivery-cycle contracts for which a portion of the value is not reflected in our current backlog, since a portion of such orders may be scheduled to ship outside the time provided in our bookings policy. These types of orders generally also require us and our partners to develop and deliver future products, and are subject to performance guarantees collateralized by letters of credit and additional penalties for delays in delivery or non-performance.
Gross Profit Margin
Cost of product and other revenue includes costs related to product shipments, including materials, labor, overhead and other direct or allocated costs involved in their manufacture and delivery. Costs associated with engineering service revenue are included in cost of service revenue, unless the engineering effort meets the criteria for government funded research, as outlined in SFAS 2, Accounting for Research and Development Costs . If the contract meets the criteria for a government funded research arrangement, the costs to deliver the contract are included in research and development expense. Cost of service revenue includes all costs incurred in the support and maintenance of our products, as well as costs to deliver professional services including the costs associated with third-party products.
Product and other gross profit margin in fiscal 2007 decreased 9.4 percentage points compared with fiscal 2006. The decline in product and other gross profit margin primarily resulted from the unfavorable impact of fresh-start accounting, which accounted for 8.2 percentage points of the decline. Service gross profit margin in fiscal 2007 decreased 6.5 percentage points compared with fiscal 2006. The decline in service gross profit margins primarily resulted from the unfavorable impact of fresh-start accounting. The unfavorable impact of fresh-start accounting resulted in 6.0 percentage points of this decline.
Overall gross profit margin increased to 38.2% in fiscal 2006 from 36.3% in fiscal 2005. Product and other gross profit margin in fiscal 2006 decreased 4.9 percentage points compared with fiscal 2005. As a result of fixed manufacturing costs, cost of sales did not decline in proportion to our lower sales volumes in fiscal 2006 compared with fiscal 2005. Competitive pricing pressures from low cost commodity cluster systems also contributed to the decline in gross profit margin. In addition, we continue to see a shift in revenue mix from our MIPS/IRIX-based systems, which typically carry higher gross margins to our Intel/Linux-based systems, which have lower gross margins. The decline in product and other gross profit margin in fiscal 2006 compared with fiscal 2005 was offset in part by fewer large low margin transactions, which are typically negotiated with high discount rates due to very competitive bidding processes.
Service gross profit margin in fiscal 2006 increased 7.5 percentage points compared with fiscal 2005. The improvements in service gross profit margins primarily resulted from the positive impact of our restructuring actions resulting from headcount reductions and other cost control measures coupled with improved margins on professional services contracts.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations
As discussed above, we emerged from Chapter 11 and adopted fresh-start reporting on September 29, 2006. References to â€śPredecessor Companyâ€ť refer to Silicon Graphics, Inc. prior to September 29, 2006. References to â€śSuccessor Companyâ€ť refer to Silicon Graphics, Inc. on and after September 29, 2006, after giving effect to the cancellation of existing common stock and the issuance of new securities in accordance with the Plan, and application of fresh-start reporting. As a result of the application of fresh-start reporting, the Successor Companyâ€™s financial statements are not comparable with the Predecessor Companyâ€™s financial statements. However, for purposes of discussion of the results of operations, the three and nine months ended March 30, 2007 have been compared to the three and nine months ended March 31, 2006 as included, in part, in our condensed consolidated statements of operations (which are contained in Part I, Item 1 of this report). In this discussion, we will disclose the fresh-start and other impacts on our results of operations that vary from historical predecessor company periods to aid in the understanding of our financial performance.
The following discussion of revenue is based on the results of our reportable segments as described in Note 18 to our notes to the condensed consolidated financial statements in Part I, Item 1 of this report. Total revenue is principally derived from two reportable segments, Products and Global Services. Our Products segment is comprised of our Core Systems , representing our high-performance servers and other products based on Intel Itanium 2 and Intel Xeon microprocessors and the Linux operating system, and storage solutions, and our Legacy Systems , representing our high-performance servers and visualization systems based on MIPS RISC microprocessors and the IRIX operating system.
Revenue for the third quarter of fiscal 2007 increased $5 million or 5% compared with the corresponding period of fiscal 2006 reflecting an increase in sales of our Core Systems, partially offset by a decline in sales in our Global Services. In the third quarter of fiscal 2007, approximately 14% of total revenue was generated by sales to a single customer, comprised of both product and professional services revenue. Included in the overall increase is the unfavorable impact of fresh start accounting adjustments to revenue of $13 million. Excluding the $13 million unfavorable impact to revenue from the fresh start accounting adjustments, revenue for the third quarter of fiscal 2007 increased $19 million or 18% compared with the corresponding period of fiscal 2006. Revenue for the first nine months of fiscal 2007 declined $63 million or 16% compared with the corresponding period of fiscal 2006, principally due to declines in sales of our Global Services and Legacy Systems, partially offset by an increase in sales of our Core Systems. Included in the overall decline is the unfavorable impact of fresh start accounting adjustments to revenue of $35 million. Excluding the $35 million unfavorable impact to revenue from the fresh start accounting adjustments, revenue for the first nine months of fiscal 2007 declined $27 million or 7% compared with the corresponding period of fiscal 2006.
Products. Revenue from our Products segment for the third quarter of fiscal 2007 increased $12 million or 27% compared with the corresponding period in fiscal 2006. In the third quarter of fiscal 2007, approximately 15% of total product revenue was generated by sales to a single customer. The overall increase in product revenue for the third quarter of fiscal 2007 was due to the increase in sales of our Altix server, partially offset by the continuing long-term decline in the overall UNIX-based systems market, an industry-wide trend that we expect will continue as lower-cost personal computers continue to gain market share, the overall decline in volume and the cancellation of our Silicon Graphics Prism and Silicon Graphics Prism deskside products in August 2006. Included in the increase is the unfavorable impact of the fresh start accounting adjustments to product revenue of $6 million. Excluding the impact of the unfavorable fresh start accounting adjustment of $6 million, revenue from our Products segment for the third quarter increased $18 million, or 39%, compared with the corresponding period in fiscal 2006. Revenue from our Products segment for the first nine months of fiscal 2007 decreased $21 million or 10% compared with the corresponding period in fiscal 2006. The overall decline in product revenue for the first nine months of fiscal 2007 was due to the continuing long-term decline in the overall UNIX-based systems market, an industry-wide trend that we expect will continue as lower-cost personal computers continue to gain market share, the overall decline in volume and the cancellation of our Silicon Graphics Prism and Silicon Graphics Prism deskside products in August 2006. Declines in revenue were partially offset by an increase in sales of our Altix servers. Included in the decline is the unfavorable impact of the fresh start accounting adjustments to product revenue of $15 million. Excluding the impact of the unfavorable fresh start accounting adjustment of $15 million, revenue from our Products segment for the first nine months of fiscal 2007 declined $6 million or 3%, compared with the corresponding period in fiscal 2006.
Revenue from Core Systems for the third quarter and first nine months of fiscal 2007 increased $12 million or 38% and $4 million or 3%, respectively, compared with the corresponding periods in fiscal 2006. The increase in Core Systems revenue was primarily due to an increase in sales of SGI Altix servers, partially offset by the overall decline in volume and the cancellation of our Silicon Graphics Prism and Silicon Graphics Prism deskside products in August 2006. Included in the increase for the third quarter and first nine months of fiscal 2007 is the unfavorable impact of the fresh start accounting adjustments to product revenue of $6 million and $13 million, respectively. Despite reduced sales volumes, storage system revenue remained relatively constant for the first nine months of fiscal 2007 compared with the corresponding period in fiscal 2006, primarily due to an increase in average selling prices. Excluding the unfavorable impact of the fresh start accounting adjustments, revenue from our Core Systems for the third quarter of fiscal 2007 increased $18 million, or 56%, and revenue for the first nine months of fiscal 2007 increased $17 million, or 12%, compared with the corresponding period of fiscal 2006.
Revenue from Legacy Systems for the third quarter remained flat compared with the corresponding period in fiscal 2006. Revenue from Legacy Systems for first nine months of fiscal 2007 decreased $25 million, or 39%, compared with the corresponding period in fiscal 2006, principally due to the continuing long-term decline in the overall UNIX workstation market, an industry-wide trend that we expect will continue as lower-cost personal computers continue to gain market share. The decline in revenue for the first nine months of fiscal 2007 compared with the corresponding period in fiscal 2006 was also a result of reduced volumes of our Silicon Graphics Tezro and Fuel visual workstations. The decline in both our MIPS and IRIX based servers and graphics systems revenue was principally due to reduced volumes due to customers transitioning away from the legacy system technology into Linux based systems. Revenue from our remarketed products for the first nine months of fiscal 2007 decreased compared with the corresponding period in fiscal 2006 primarily due to a decrease in sales of our remarketed MIPS and IRIX based server systems, compounded by the impact on our European remanufactured products business due to the implementation of the EUâ€™s Restriction of hazardous Substances, or RoHS, requirements as of July 2006. Included in the decline for the first nine months of fiscal 2007 is the unfavorable impact of the fresh start accounting adjustment to Legacy Systems revenue of $2 million. The impact of the fresh start accounting for the third quarter of fiscal 2007 was immaterial. Excluding the impact of the fresh start accounting adjustments, revenue from our Legacy Systems for the first nine months of fiscal 2007 decreased $23 million or 36% compared with the corresponding period in fiscal 2006.
Global Services. Revenue from our Global Services segment is comprised of hardware and software support, maintenance and professional services. Professional services revenue includes revenue generated from the sale of third party products and our consulting and managed services.
Revenue from Global Services for the third quarter and first nine months of fiscal 2007 decreased $7 million, or 12%, and $41 million, or 21%, respectively, compared with the corresponding periods in 2006. The decline was primarily due to a reduction in our traditional customer support revenue resulting from lower pricing for new contracts compared with existing contracts, coupled with a decline in the overall installed base resulting from fewer contract renewals. The decline in customer support revenue was offset in part by an increase in revenue generated from professional services contracts primarily associated with one customer that accounted for approximately 12% of total Global Services revenue in the third quarter of fiscal 2007. Included in the decline for the third quarter and first nine months of fiscal 2007 is the unfavorable impact of the fresh start accounting adjustment to Global Services revenue of $8 million and $21 million, respectively. Excluding the impact of the fresh start accounting adjustments, revenue from Global Services for the third quarter was relatively flat and for the first nine months of fiscal 2007 decreased $21 million, or 10%, compared with the corresponding periods in fiscal 2006.
Compared with the third quarter of fiscal 2006, revenue in the third quarter of fiscal 2007 increased in Europe due to a large sale that represented approximately 14% of our overall revenue in the quarter and in the Americas primarily attributable to an increase in sales of SGI Altix servers while revenue declined in all other geographies. Revenue for the first nine months of fiscal 2007 declined in all geographic regions. The shift in geographic revenue mix in the third quarter and first nine months of fiscal 2007 compared with the corresponding period in fiscal 2006 is primarily the result of restructuring actions initiated in Europe and Rest of World causing short-term disruption in business operations and therefore lower revenue.
Backlog. Our consolidated backlog at March 30, 2007 was $109 million, down from $131 million at March 31, 2006. Backlog is comprised of committed purchase orders for products and professional services deliverable within nine months. Backlog does not include any customer support maintenance contracts. Backlog decreased within the Core Systems segment, specifically with regard to professional services and the cancellation of our Silicon Graphics Prism and Silicon Graphics Prism deskside products in August 2006, offset in part by an increase in our Linux-based SGI Altix servers and storage systems. Backlog decreased within the Legacy Systems segment, principally due to customers transitioning from the legacy system technology to Linux based systems. Backlog increased slightly in Europe with decreases experienced in all other regions. The increase in backlog in Europe is primarily associated with an overall increase in orders of our Linux-based SGI Altix servers and storage systems, resulting principally from a single order from a European supercomputing center, offset in part by a decline in backlog for professional services. The decline in backlog in the Americas and Rest of World is principally due to a decline in professional services and legacy systems backlog, offset in part by an increase in orders of our Linux-based SGI Altix servers.
We do not maintain sufficient backlog to meet our quarterly objectives for product revenue without obtaining significant new orders that are booked and shipped within the quarter. Our backlog reflects only orders for product and professional services for which a firm purchase order has been issued or a contract has been made, although orders in backlog are subject to customer cancellation or rescheduling in certain circumstances, and government customers typically have rights of cancellation for convenience. SGI systems have also been selected for a number of multi-year U.S. government programs, with expected purchases that are not reflected in our current backlog. In addition, we may enter into longer delivery-cycle contracts for which a portion of the value would not be reflected in our backlog.