10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the fiscal year ended June 30, 2006.

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period              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 Incorporation or Organization)	(I.R.S. Employer Identification No.)

1200 Crittenden Lane, Mountain View, California 94043-1351

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (650) 960-1980

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Title of each class

Common Stock, $0.001 par value

6.50% Senior Secured Convertible Notes

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.    Yes  ¨    No  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”).    Yes  ¨    No  x

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  ¨    No  x

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  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 December 30, 2005 on the Over-the-Counter Bulletin Board, was approximately $74 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 15, 2006, the registrant had 274,247,196 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Part III of this Form 10-K will be filed with the Securities and Exchange Commission as an amendment to this Form 10-K in accordance with General Instruction G(3).

SILICON GRAPHICS, INC.

FORM 10-K

FOR FISCAL YEAR ENDED JUNE 30, 2006

TABLE OF CONTENTS

		Page
PART I
Item 1.	Business	3
Item 1A.	Risk Factors	12
Item 1B.	Unresolved Staff Comments	21
Item 2.	Properties	21
Item 3.	Legal Proceedings	22
Item 4.	Submission of Matters to a Vote of Security Holders	22
PART II
Item 5.	Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities	23
Item 6.	Selected Financial Data	24
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 8.	Financial Statements and Supplementary Data	48
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	101
Item 9A.	Controls and Procedures	101
Item 9B.	Other Information	102
PART III
Item 10.	Directors and Executive Officers of the Registrant	103
Item 11.	Executive Compensation	103
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	103
Item 13.	Certain Relationships and Related Transactions	103
Item 14.	Principal Accountant Fees and Services	103
PART IV
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	104
	Signatures	108

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PART I

Cautionary Statement Regarding Forward-Looking Information

The Business section and other parts of this Annual Report on Form 10-K contain forward-looking statements about our business, objectives, financial condition, and future performance that involve risks and uncertainties. These forward-looking statements include, among others, statements relating to the following: expected emergence from Chapter 11, expected levels of revenue, gross margin, operating expense, future profitability, our expectations for new product introductions and market conditions, our assessment of the adequacy of our liquidity and capital resources, our belief regarding capital levels required for fiscal 2007, headcount reductions, and the expected impact on our business of restructuring actions, legal proceedings, and government actions. We have based these forward-looking statements on our current expectations about future events. In some cases, you can identify forward-looking statements by terminology such as “may”, “will”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “potential”, or “continue” or the negative of such terms and similar terms. These forward-looking statements are only predictions and are subject to risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in such statements. Factors that might cause such a difference in results include, but are not limited to: the effects of our Chapter 11 filing; our ability to maintain adequate liquidity; our ability to obtain and maintain normal terms with customers, suppliers and service providers; our ability to continue as a going concern; our ability to operate pursuant to the terms of our credit agreement; our ability to consummate our plan of reorganization with respect to our Chapter 11 Cases; our ability to maintain contracts that are critical to our operations; risks associated with the volatility of our stock price; risks associated with the timely development, production and acceptance of new products and services; increased competition; dependence on third party partners and suppliers; the failure to achieve expected product mix and revenue levels; failure to manage costs and generate improved operating results and cash flows; failure to maintain compliance with debt covenants; and failure to maintain adequate cash resources for the operation of our business. Additional risks and uncertainties include the following: risks related to liquidity and the adequacy of our capital resources; risks related to our ability to achieve profitable operations or limit losses; risks related to the impact on our business of the restructuring effected in fiscal 2005 and the significant restructuring effected in fiscal 2006 and to be effected in fiscal 2007; risks related to our compliance with debt covenants; changes in customer order patterns; the impact of employee attrition and our ability to hire certain key professionals in areas such as sales, marketing, finance, engineering and product management in order to execute our business strategies; adverse changes in general economic or business conditions; adverse changes in the markets for our products, including expected rates of growth and decline in our current markets; heightened competition, reflecting rapid technological advances and constantly improving price/performance, which may result in significant discounting and lower gross profit margins; continued success in technological advancements and the acceptance of new product introductions; risks related to dependence on our partners and suppliers; risks related to foreign operations (including weak or disrupted economies, unfavorable currency movements, and export compliance issues); risks associated with intellectual property disputes and other claims and litigation; and other factors, including, but not limited to, those discussed below under the heading “Risk Factors” in Item IA of this Form 10-K. We undertake no obligation to publicly update or revise any forward-looking statements, whether changes occur as a result of new information, future events, changed assumptions, or otherwise.

ITEM 1. BUSINESS

General

SGI is a leading provider of products, services, and solutions for use in high-performance computing and storage. We sell highly scalable servers, storage solutions, and associated software products that enable our customers in the scientific, technical and business communities to solve their most challenging problems and provide them with strategic and competitive advantages. Whether analyzing images to aid in brain surgery, studying global climate changes, accelerating the engineering of new automotive designs, providing technologies for homeland security, or gaining business “intelligence” from mining a company’s databases, SGI’s systems are designed to compute vast amounts of data, translate data into high-resolution images in a realistic timeframe and scale, and provide high-speed storage. We also offer a range of services and solutions, including professional services, customer support, and education. These products and services are used in a range of application segments including defense and intelligence, sciences, engineering analysis, and enterprise data management.

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Chapter 11 Reorganization

On May 8, 2006 (the “Petition Date”), Silicon Graphics, Inc. (“the Company” or “SGI”) and certain of its subsidiaries (collectively, the “Debtors”), filed voluntary petitions for reorganization under chapter 11 of Title 11 (“Chapter 11”) of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Court”) (Case Nos. 06-10977BRL through 06-10990BRL) (the “Chapter 11 Cases”). Certain subsidiaries of SGI, consisting principally of international subsidiaries, are not debtors (collectively, the “Non-Debtors”) in this bankruptcy proceeding. The Debtors remain in possession of their assets and properties as debtors-in-possession (“DIP”) under the jurisdiction of the Court and in accordance with the provisions of the Bankruptcy Code. In general, as debtors-in-possession, each of the Debtors is authorized 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. For further information regarding these petitions, see Note 1 to the consolidated financial statements in Part II, Item 8 of this Form 10-K.

On May 10, 2006, SGI, Silicon Graphics Federal, Inc. and Silicon Graphics World Trade Corporation (collectively, the “Borrowers”) entered into a Post-Petition Loan and Security Agreement (the “Interim DIP Agreement”) dated as of May 8, 2006 with Quadrangle Master Funding Ltd., Watershed Technology Holdings, LLC and Encore Fund, L.P. (collectively, the “Interim DIP Lenders”). The Interim DIP Agreement provided $70 million of DIP financing (the “$70 million DIP Financing”) to the Borrowers secured by certain of the Borrowers’ assets.

In June 2006, the Debtors entered into a replacement Post-Petition Loan and Security Agreement (the “DIP Agreement”) with Morgan Stanley Senior Funding, Inc. (the “Administrative Agent”), Wells Fargo Foothill, Inc., the Interim DIP Lenders and certain other lenders party thereto (collectively, the “DIP Lenders”), providing up to $130 million of debtor-in-possession financing (the “$130 million DIP Financing”). This $130 million DIP Financing was approved by the Court on June 26, 2006 and we borrowed $100 million against this facility, of which a portion of the funds were used to repay our outstanding borrowings against the $70 million Interim DIP Financing and our pre-petition asset-backed credit facility.

At a hearing held on July 27, 2006, the Court approved the Company’s Disclosure Statement, ruling that it contained adequate information for soliciting creditor approval of the Company’s Plan of Reorganization. At a hearing held on September 19, 2006, the Court confirmed the Company’s Plan of Reorganization as amended (the “Plan”). This Confirmation Order became a Final Order on October 2, 2006. We expect to emerge in October 2006 subject to the remaining conditions precedent to emergence:

• The conditions precedent to the effectiveness of the Exit Facility and the Backstop Commitment Agreement are satisfied or waived by the parties thereto and the Reorganized Debtors have access to funding under the Exit Facility;

• Allowed General Unsecured SGI Federal Claims and Allowed General Unsecured SGI World Trade Claims shall not aggregate more than $1 million;

• All actions, agreements, instruments or other documents necessary to implement the terms and provisions of the Plan are effected or executed and delivered, as applicable; and

• All authorizations, consents and regulatory approvals, if any, required by the Debtors in connection with the consummation of the Plan are obtained and not revoked.

Under Chapter 11, we are continuing to operate our business without interruption as a debtor-in-possession under the jurisdiction of the 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.

Although we cannot currently estimate the impact of the Chapter 11 filings on our future financial statements, we have determined that we will be required to review certain assumptions used in determining the fair values of our long-lived assets and other intangibles, deferred revenue and the realizability of our accounts receivable among other items. These charges will have a significant non-cash impact on our future results of operations, but will have no impact on the underlying cash, working capital assumptions or the underlying operation of the business.

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Proposed Business Plan

In connection with our Chapter 11 proceeding, we prepared a proposed business plan that was presented to our Court appointed Creditors’ Committee on June 30, 2006 and is described in our Disclosure Statement. Certain highlights of the business plan are provided below. The projections underlying the business plan were not prepared to conform to the guidelines established by the American Institute of Certified Public Accountants regarding financial forecasts, and were not audited, reviewed, or compiled by our independent registered public accounting firm. It should also be noted that the following highlights are forward looking and based on certain forecasts, market assumptions and many other factors and, as such, are inherently inaccurate and should not be relied upon. Further, our proposed business plan described in the Disclosure Statement and the assumptions utilized therein were determined prior to the finalization of our consolidated financial statements for fiscal 2006. A change in these assumptions or factors could significantly affect the projections contained in the business plan. Additionally, you should carefully read the “Cautionary Statement Regarding Forward-Looking Information” section of this Form 10-K for a list of some of the items that could affect our business and actual financial results.

The business plan projects pro forma year-over-year consolidated revenue growth of between approximately 2.5% to 5.0% given our strategies regarding new product development, penetration of new markets and the stabilization of our current core of revenue sources. Accordingly, the business plan projects consolidated revenue of $532 million in fiscal 2006 to increase to approximately $671 million in fiscal 2011. The business plan projects gross profit of between 38% and 40% with slight changes as the mix of products changes and as revenue increases while fixed costs of goods sold remains static. The business plan projects that we will continue to implement further restructuring actions to reduce costs in fiscal 2008 and as such, operating expenses, excluding restructuring, will continue to decline through fiscal 2008. For fiscal 2009 and beyond, the projections assume that operating expenses will increase for modest annual increases in employee compensation. The business plan projects an operating loss of approximately $22 million in fiscal 2007 as we continue to implement restructuring actions to achieve profitability in fiscal 2008 and beyond.

The business plan projects that, at emergence, we will obtain a term loan for approximately $70 million and will repay the outstanding debtor-in-possession (“DIP”) facility with part of the $50 million proceeds from the rights offering and the $70 million exit facility. Post-emergence projected interest expense represents interest expense associated with the $70 million exit facility.

Upon emergence, the business plan projects that our new common stock will consist of 25,000,000 authorized shares of the reorganized company with distributions including approximately 10,000,000 shares issued and distributed to holders of Allowed Secured Note Claims and Allowed Cray Unsecured Debenture Claims, 1,125,000 shares distributed as Overallotment Shares pursuant to the Backstop Purchasers pursuant to the Backstop Purchase Agreement, and a certain number of shares not to exceed 10% of the new common stock to be distributed pursuant to the terms of the New Management Incentive Plan.

In preparing the business plan, we made many assumptions, which, if changed, could significantly affect the results of operations against the business plan. Some of the major assumptions include: current and projected market conditions in each of our respective markets; successful implementation of our top-line growth strategies; successful execution of operational improvements including cost savings opportunities in our manufacturing operations and in administrative departments; and the ability to maintain sufficient working capital to self-fund our operations or gain access to financing sources to fund any deficiencies. We undertake no obligation to publicly update or revise any of the projections or information discussed in the business plan, whether changes occur as a result of new information, future events, changed assumptions, or otherwise.

Business Strategy

For more than 20 years, SGI systems have enabled discovery, innovation and information transformation for scientists, engineers and creative professionals who benefit from systems engineered to meet their specific needs. We are taking the knowledge that we have gained in our traditional markets, coupled with the services our customers rely on and are making that more broadly available across our customers’ organization or enterprise. The unique shared-memory architecture of our server product line enables enterprise customers dealing with bigger data sets 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 with Intel Xeon processors and clusters. SGI’s strategy, to incorporate

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leading-edge technology in point-solutions that target specific workflow requirements and package the technology in a unified solution, enables all customers to efficiently deploy a “blended” server solution to support multi-workflow requirements.

This strategy 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 high-performance computing, data management and services is core to our strategy, and accordingly we invest significantly in product development. SGI has introduced many important innovations to the world, including the first scalable NUMA (“Non-Uniform Memory Access”) system and work that led to the first storage area networks. Recent innovations in interoperability have brought to SGI a range of product lines that operate well together in customer environments, enabling SGI to solve a broader range of customer problems.

• Support of Industry Standards. SGI is committed to the support of open standards for core elements of its new generation products, while focusing its proprietary component technology development to 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 today’s best-of-breed components, such as commodity DRAMs and the Intel Itanium and Xeon families of processors. Second, it enables SGI to leverage the research and development of Intel and the Linux community and therefore to focus our resources on systems architecture, storage management and solution delivery, all of which we believe is differentiated in important respects in the marketplace. Third, our support of industry standards, such as the Linux operating system, enables SGI to assimilate easily into standards-based IT environments.

• Direct Engagement with Our Customers. SGI benefits greatly from its close association with its customers, who are often among the leading experts in their fields. We maintain a program of regular contact and technical discourse with our customers. In addition to sponsoring many industry conferences and forums around the world, SGI engineers and executives meet regularly with the SGI User Group, an independent entity whose membership includes elite users of SGI solutions. This direct interaction between the leading edge of the computing world and SGI has influenced our architectural approach, and we consider this close association to be a core part of our ongoing strategy.

• Market Focus. Leveraging our strengths in scalable high-performance computing, data management and deep domain expertise, we are developing solutions that map to customers’ enterprise and workflow environments. We have also aligned our marketing resources to address specific market needs and drive innovation to benefit our target markets.

• Investing in ISV and Reseller Relationships. SGI depends on a strong ecosystem of software, hardware and partners. We are 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 resources. We understand that our success depends on theirs. We also engage in a variety of programs with OEM and reselling partners, who bring our technologies to a variety of customers not serviced directly by SGI. Investment in developing reseller channels and in software application partners joint marketing continues to be a key strategy for us, as it supports our ability to deliver a complete market-driven solution.

Products

SGI systems are developed to enable our customers to overcome the challenges of complex data-intensive workflows, and accelerate breakthrough discoveries, innovation, and information transformation. SGI systems are primarily based on the Linux operating system and Intel Itanium 2 and Xeon microprocessors; although we continue to offer systems based on the IRIX® operating system and MIPS® RISC microprocessors. The SGI server platform addresses specific workflow requirements with its Linux-based comprehensive family of SGI® Altix® products in a unified infrastructure that is based on industry-standard Linux operating system, a comprehensive storage offering, and common development and administrative toolsets across the platform.

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Scalable Servers. SGI offers a full range of scalable servers from our entry level SGI® Altix® 400 series of servers and clusters through the SGI® Altix® 4000 series of servers and supercomputers. These Altix product families feature Intel Itanium 2 processors, the Linux operating system, and SGI® NUMAflex™, which enables customers to configure systems to meet their exact requirements, while maintaining optimum flexibility in meeting their changing needs over time. Altix 400 series systems combine SGI’s NUMAflex architecture with entry-level pricing to deliver exceptional value as a scalable solution for departmental, database and cluster applications. The Altix 4000 systems are the most scalable systems in the industry and achieve this performance through the combination of the proven NUMAflex approach and the power of up to 1024 Itanium 2 processors running a single operating system. Altix systems can further be brought together in clusters to create supercomputers of 10,240 processors or more that are among the most powerful in the world today.

Altix XE. SGI Altix® XE is a value-priced entry-level server and integrated cluster solution that complements the Altix scalable server product lines. It offers superior performance and energy efficiency at a lower price point. The combination of the advanced Intel® Dual-Core Xeon® processor architecture delivered in a fully factory integrated cluster solution, backed by SGI’s industry-leading service and support provides customers with exceptional value in the SGI Altix XE platform.

Storage Solutions. Customers across high-performance computing and enterprise markets desire ever increasing performance from their servers, creating a parallel need to manage the massive amounts of data generated by these servers. SGI InfiniteStorage is a line of scalable, high-performance storage solutions built specifically for data-intensive workflow management, faster cycle times, and higher levels of access, availability and security.

Within the InfiniteStorage line, SGI offers a broad range of disks and disk subsystems, ranging from entry-level disk arrays to complex enterprise-class storage systems, in either direct- or fabric-attached configurations. SGI offers industry-leading scalable network-attached storage (“NAS”) through a range of file-serving solutions bundles. SGI also offers storage area network (“SAN”) solutions based on tightly integrating our CXFS™ shared file system, along with SGI’s FailSafe^® high-availability software and Data Migration Facility (“DMF”) for hierarchical storage management. InfiniteStorage systems can be attached to SGI systems and a variety of platforms from other vendors. This approach is intended to allow these solutions to scale across storage architectures and operating systems in addition to scaling from megabytes to exabytes and from hundreds to millions of files in a single system.

Global Services

The quality and reliability of our products and our understanding of SGI customers’ technical and business challenges is critical to our success. SGI’s Technology Solutions service portfolio offers system solution engineering services, professional and managed services, and traditional customer support and education. Through our Technology Solutions, we offer our customers service solutions tailored to meet their business objectives and 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 SGI does not have a local office. SGI’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 (“ESP”), 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 configuration of SGI systems, SAN and CXFS Implementation, File Server Implementation and High-Availability Software Implementation.

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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. SGI delivers solutions focused around High Performance Computing (“HPC”), Storage and Media Solutions. Our Professional Services group maps solutions to the customer’s workflow utilizing our extremely rich technology portfolio with a complete spectrum of industry best-in-class technology including servers, storage, interconnect, software and consulting. SGI has expertise in a broad range of industries for complete solution stacks including development, deployment and management.

Marketing, Sales, and Distribution

SGI sells system products and solutions through both a direct sales force and indirect channel partners. In fiscal 2006, SGI initiated a 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 the highest quality software on both our Linux and IRIX platforms.

Our Solutions Finance organization works with customers to arrange third party financing for sales-type lease transactions and assists in the remarketing of off-lease systems.

Information with respect to international operations and export sales is presented in Note 10 to the consolidated financial statements included in Part II, Item 8 of this Form 10-K. See also “Risk Factors” included in Item IA of this Form 10-K.

No single end-user customer accounted for 10% or more of our revenues in any of the last three fiscal years. While our sales in the U.S. government sector represent substantially more than that level, these sales are made to and through numerous government agencies and to integrators and resellers who 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 18 to the consolidated financial statements included in Part II, Item 8 of this Form 10-K and in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of this Form 10-K.

Research and Development

SGI is concentrating its research and development efforts on products and technologies that it believes hold the highest potential, including global shared memory system architectures and storage. Our strategy is to derive maximum leverage from these efforts by using a foundation of industry-standard components, such as the Intel Itanium family of microprocessors and the Linux operating system. As a result, we have sharply reduced our investment in visualization technology and graphics as well as MIPS microprocessors and the IRIX operating system. There can be no assurance that we will maintain or create sufficient differentiation to achieve and sustain a competitive advantage.

During fiscal 2006, fiscal 2005 and fiscal 2004, SGI spent approximately $84 million, $93 million, and $109 million, respectively, on research and development, representing approximately 16% of total revenue in fiscal 2006 and 13% of total revenue in each of fiscal 2005 and fiscal 2004. 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, declines in total revenue over the last several fiscal years have led us to reduce the absolute dollar level of our investment in research and development.

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Manufacturing

SGI’s 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 continually evaluate the allocation of manufacturing activities among our own operations and those of suppliers and subcontractors.

Most of our products incorporate components that are available from only one or limited sources. Key components that are sole-sourced include application specific integrated circuits (“ASICs”), microprocessors and certain cable, power and memory products. We have chosen to deal with sole sources in these cases because of unique technologies, economic advantages, or other factors. But reliance on single or limited source vendors involves several risks, including the possibility of shortages of key components. Continued availability of these components could be affected if producers were to discontinue supplying, or to change the payment terms for, components customized to meet our requirements. Risks also include limited bargaining flexibility, long lead times, reduced control over delivery schedules, and the possibility of charges for excess and obsolete inventory. We attempt to mitigate these potential risks by working closely with these and other 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.

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

Several of our suppliers are located outside the United States. Pricing from these suppliers can be strongly affected by such factors as trade protection measures and changes in currency exchange rates. In addition, the markets for memory modules, which are a significant component of our overall systems cost, can be volatile both in terms of pricing and availability.

Competition

The computer industry is highly competitive and is known for rapid technological advances. These advances result in frequent product introductions, short product life cycles and steadily improving price/performance. 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, and corporate reputation. Significant discounting from list prices is prevalent in the industry.

Our focus on addressing a large portion of the workflow with high performance offerings in our key application segments 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, concerns as to our continued viability 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 high-performance computing business. We believe growth in the Linux-based systems market may also attract increased competition. An important competitive development in our market has been the emergence of networked clusters and commodity computers from suppliers like Dell Computer as an alternative to our midrange products. These clusters have grown at a faster than anticipated rate and are taking an increasing share of the high-performance computing market.

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Proprietary Rights and Licenses

We currently own and have applied for more than 700 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 and UNIX operating systems, for internal use and use by our customers.

Our business will be affected by our success in protecting proprietary information and obtaining necessary licenses. 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 could incur significant costs and we might not prevail in our case. Litigation or changes in the interpretation of intellectual property laws could expand or reduce the extent to which we or our competitors are able to protect intellectual property or could require significant changes in product design. Because of technological changes in the computer industry, current extensive patent coverage, and the rapid rate of issuance of new patents, it is possible certain components of our products and business methods may unknowingly infringe existing patents of others. The computer industry has seen a substantial increase in litigation with respect to intellectual property matters, and we have been engaged in several intellectual property disputes both as plaintiff and defendant. We are in discussions with several parties that have asserted intellectual property infringement claims, and we expect that litigation of this sort will reoccur from time to time. See “Risk Factors”.

Seasonality and Backlog

We do not consider our business to be highly seasonal, although in two of the past three years revenues in the second fiscal quarter ending in December have been higher than other quarters in our fiscal year, reflecting in part buying patterns of calendar year-end customers. Past performance should not be considered a reliable indicator of our future revenues or financial performance.

Our consolidated backlog at June 30, 2006 was $127 million, up from $120 million at June 24, 2005. Backlog is comprised of committed purchase orders for products and 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, we have not yet reflected in our backlog portions of longer delivery-cycle contracts we have been awarded, but which will not be delivered in the next nine months. The deliveries associated with these contracts are currently scheduled to ship outside the time frame provided in our bookings policy and will not be recognized as revenue in fiscal 2007. 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. 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.

Environmental Laws

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. While it is our policy to ensure that our operations and products comply with environmental laws at all times any failure to so comply with environmental laws or customer requirements relating to such laws could require us to stop producing or selling certain products, recall noncompliant products, or otherwise incur substantial costs in order to acquire costly material or to make other operational changes in order to achieve compliance. Although environmental costs and liabilities have not materially

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affected us to date, due to the nature of our operations and legal developments affecting our products and operations, environmental costs and liabilities could have a material adverse affect on our business and financial position in the future.

From time to time new regulations are enacted, and it is difficult to anticipate how such regulations will be implemented and enforced. We cannot estimate the possible loss exposure; therefore, no accrual for the costs to comply with these regulations has been recorded. We track regulatory developments that may impact our business and devote resources toward developing strategies for compliance with new requirements as they are enacted.

For example, we face increasing complexity in our product design and procurement operations as we adjust to new and anticipated requirements relating to the materials composition of our products, including the European Union Directive on the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”), which regulates the use of lead and other hazardous substances in electrical and electronic equipment put on the market in the European Union on or after July 1, 2006. Due to these restrictions, we have decided not to ship our remarketed products to Europe after July 1, 2006, and we are completing our work with our suppliers to assure RoHS compliance with respect to our other products. If a regulatory authority determines that one of our products is not RoHS-compliant, we may have to redesign and re-qualify certain components to meet RoHS requirements, which could subject us to increased engineering expenses in this process, and could face shipment delays, penalties and possible product detentions or seizures.

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 (“WEEE”), 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 RoHS 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 being implemented by individual countries in the European Union and it is likely that each jurisdiction will implement, interpret or enforce RoHS and WEEE somewhat differently. In addition, final guidance from individual jurisdictions may impose different or additional responsibilities on us. 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.

Employees

As of June 30, 2006, we had 1,738 regular employees compared with 2,423 at June 24, 2005. 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 European Union or other applicable laws.

Corporate Data

SGI was originally incorporated as a California corporation in November 1981, and reincorporated as a Delaware corporation in January 1990. SGI’s website address is www.sgi.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports are available, without charge, on the investor relations page of our website, www.sgi.com, as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Our Corporate Governance Guidelines, Code of Business Conduct and Ethics and the charters of the Audit Committee, Compensation and Human Resources Committee and Corporate Governance and Nominating Committee of our Board of Directors are also posted on our website at www.sgi.com/company_info/. Copies are also available, without charge, from the Corporate Secretary, Silicon Graphics, Inc., 1200 Crittenden Lane, Mountain View, CA 94043.

Trademarks Used in the Form 10-K

Silicon Graphics, SGI, Octane, Onyx, Origin, Tezro, Fuel, FailSafe, IRIX, and Altix are registered trademarks, and CXFS, NUMAflex and Prism are trademarks of Silicon Graphics, Inc. in the U.S. and/or other countries worldwide.

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MIPS is a registered trademark of MIPS Technologies, Inc. used under license by Silicon Graphics, Inc. UNIX is a registered trademark of The Open Group. Intel, Xeon and Itanium are registered trademarks of Intel Corporation or its subsidiaries in the United States and other countries. Linux is a registered trademark of Linus Torvalds.

EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of SGI and their ages as of September 15, 2006 are as follows:

Name	Age	Position and Principal Occupation	Executive Officer Since
Dennis McKenna	57	Chairman of the Board, Chief Executive Officer and President	2006
Kathy Lanterman	46	Senior Vice President, Chief Financial Officer and Corporate Controller	2002
Eng Lim Goh, PhD	46	Senior Vice President and Chief Technology Officer	2000
Barry Weinert	52	Vice President, General Counsel and Corporate Secretary	2006

Executive officers of SGI are elected annually by the Board of Directors and serve at the Board’s discretion. There are no family relationships among any directors, nominees for director, or executive officers of SGI.

Mr. McKenna was appointed as the President and Chief Executive Officer of the Company in January 2006. On February 1, 2006, the Board of Directors appointed Mr. McKenna as a director and Chairman of the Board. Prior to joining the Company, Mr. McKenna served as the President and Chief Executive Officer of SCP Global Technologies, a private company that is a supplier of semiconductor capital equipment, from March to August 2005. From October 1997 to August 2004, Mr. McKenna served initially as President and Chief Executive Officer, and subsequently as President and Chief Executive Officer and Chairman, of ChipPAC, Inc., a public global semiconductor manufacturing and services company.

Ms. Lanterman became Senior Vice President, Chief Financial Officer and Corporate Controller in February 2006. She served as Vice President, Corporate Controller from April 2002 through February 2006 after joining SGI in July 2001 as Assistant Controller. She was a consultant to SGI from April 1999 until she was hired in 2001, working on projects including the implementation of our global Enterprise Resource Planning system.

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

Mr. Weinert became Vice President and General Counsel in January 2006. He joined SGI in May 1995 as Commercial Counsel and served as the Associate General Counsel from March 2001 until January 2006.

ITEM 1A. RISK FACTORS

SGI operates in a rapidly changing environment that involves a number of risks, some of which are beyond our control.

We have been incurring losses and consuming cash in our operations and must reverse these trends. We have incurred net losses and negative cash flows from operations resulting from year over year declines in revenue during

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each of the past several fiscal years. At June 30, 2006, our principal source of liquidity was unrestricted cash and marketable investments of $55 million, down from $64 million at June 24, 2005. Currently, we expect to continue consuming cash from operations through at least the first half of fiscal 2007. We also experience significant intra-quarter fluctuations in our cash levels, with the result that our cash balances are generally at their highest point at the end of each quarter and significantly lower at other times. These intra-quarter fluctuations reflect our business cycle, with significant requirements for inventory purchases in the early part of the quarter and most sales closing in the last few weeks of the quarter. To maintain adequate levels of unrestricted cash within each quarter, we offer certain customers discounted terms for early payment and hold certain vendor payments to the beginning of the following quarter. We also continue to focus on expense controls, margin improvement initiatives and working capital efficiencies. However, it is essential to our operating plans for fiscal 2007 that our restructuring plan yields its anticipated savings and we meet the goals of our financing arrangements for both fiscal years. See“—Financial Condition”.

To seek to improve our liquidity, we are continuing to implement restructuring actions aimed at substantial expense reductions and a revenue generation initiative aimed at reversing the decline in our revenues. In addition, our operating goals require us to maintain stable year-over-year revenue levels while realizing our targeted expense savings and margin improvements. If we fail to achieve these targets, we will likely consume further cash in our operations, which would further impair our liquidity. See “—Financial Condition”.

Our future financial results will be affected by the adoption of fresh start accounting and may not reflect historical trends. The Company’s emergence from Chapter 11 proceedings will result in a new reporting entity and adoption of fresh-start reporting in accordance with SOP 90-7. As required by fresh-start accounting, our assets and liabilities will be adjusted to fair value, and certain assets and liabilities not previously recognized in the Company’s financial statements will be recognized under fresh-start accounting. Because we have not yet completed our reorganization and adopted fresh start accounting, the condensed consolidated financial statements as of June 30, 2006 do not give effect to any adjustments in the carrying values of assets or liabilities that will be recorded upon implementation of the Company’s Plan. Accordingly, our financial condition and results of operations from and after the effective date will not be comparable to the financial condition and results of operations reflected in our historical consolidated financial statements. For further information about fresh start accounting, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, “Fresh Start Reporting”.

We face significant challenges in connection with our bankruptcy reorganization. On May 8, 2006, we and certain of our subsidiaries filed voluntary petitions for relief under chapter 11 of the Bankruptcy Code. See Note 1 to the consolidated financial statements in Part II, Item 8 of this Form 10-K for further information. Our ability, both during and after the Chapter 11 Cases, to continue as a going-concern is dependent upon, among other things, (i) our ability to successfully achieve required cost savings to complete our restructuring; (ii) our ability to maintain adequate cash on hand; (iii) our ability to generate cash from operations; (iv) the consummation of a plan of reorganization under the Bankruptcy Code; and (v) our ability to achieve profitability. There can be no assurance that we will be able to successfully achieve these objectives in order to continue as a going-concern. The accompanying consolidated financial statements do not include any adjustments that might result should we be unable to continue as a going-concern.

There is a risk of non-occurrence of the effective date. At a hearing held on September 19, 2006, the Court confirmed our Plan (the “Confirmation Date”). While the Plan has been confirmed by the Court, it has not yet been consummated. Although we believe that the effective date of the Plan (the “Effective Date”) will occur soon after the Confirmation Date, there can be no assurance as to such timing. Under the Plan, the Effective Date must occur within 30 days of the date of the Court’s order confirming the Plan. Moreover, if each of the conditions to consummation and the occurrence of the Effective Date has not been satisfied or duly waived on or before October 20, 2006, or such later date as may be consented to by the parties, the Court may vacate the Confirmation Order, in which event the Plan would be deemed null and void. The failure of the Effective Date to occur on or before October 20, 2006, would (unless duly waived) constitute a termination event under the Restructuring Agreement that could allow parties to terminate their obligations to support the Plan. This, in turn, could cause an event of default under the Company’s post-petition financing agreement and the post-petition financing order that could give rise to termination of the post-petition credit facility and the Debtors’ ability to use cash collateral as well as the exercise of remedies by the agent thereunder with respect to some or all of the Debtors’ assets.

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We may not achieve our operating goals and may not be in compliance with debt covenants. In June 2006, the Debtors entered into a replacement Post-Petition Loan and Security Agreement with Morgan Stanley Senior Funding, Inc., Wells Fargo Foothill, Inc., and certain other lenders party thereto, providing up to $130 million of debtor-in-possession financing. See Note 13 to the consolidated financial statements in Part II, Item 8 of this Form 10-K. Under the terms of the $130 million DIP Financing, we are required to comply with various terms and conditions. Although to date we have been in compliance, there can be no assurance that we will be able to comply with such terms and conditions in the future. In the event that we default under the DIP Agreement and the DIP Agreement is terminated, there can be no assurance that sufficient alternative financing arrangements will be available. Furthermore, in the event that cash flows, together with available borrowings under the $130 million DIP Financing or alternative financing arrangements, are not sufficient to meet the Company’s cash requirements, we may be required to reduce planned capital expenditures, sell additional assets and seek other sources of capital. We can provide no assurance that such actions will be sufficient to cover any cash shortfalls. The need to comply with the terms of our debt obligations may also limit our ability to obtain additional financing and our flexibility in planning for or reacting to changes in our business and the industry. In addition, if we are unable to achieve the goals of our going-forward business plan and operational restructuring strategy, we may be forced to sell all or parts of our business, develop and implement further restructuring plans or become subject to further insolvency proceedings.

We may not be successful in closing our exit financing. We have received a commitment and paid a commitment fee to Morgan Stanley Senior Funding, Inc. and General Electric Capital Corporation to provide the Company with a credit facility adequate to meet our forecasted cash requirements. The commitment for financing is dependent on completing a definitive loan agreement, and other closing conditions. While we believe that we will be able to successfully meet these requirements, we cannot guarantee that the funds will be made available to us until all such conditions are met.

Our bankruptcy reorganization may negatively impact our future operations and the operations of our subsidiaries. As part of the first day relief requested in the Chapter 11 Cases, the Court entered orders allowing us to pay certain pre-petition key vendor trade claims in the ordinary course of business. However, we were not permitted to pay all of our vendors in full. As a result, while we have not yet experienced any significant disruption in our relationships with our suppliers or vendors, we may have difficulty maintaining existing relationships, or creating new relationships with suppliers or vendors. Our suppliers and vendors could stop providing supplies or services to us or provide such supplies or services only on terms such as ‘cash on delivery,’ ‘cash on order,’ or other terms that could have an adverse impact on our short-term cash flows. In addition, the filing of the Chapter 11 Cases may adversely affect our ability to retain existing customers, attract new customers and maintain contracts that are critical to our operations.

The filing of the Chapter 11 Cases and the publicity surrounding the filing might also adversely affect the businesses of our non-debtor subsidiaries. Because our business is closely related to the businesses of all of our subsidiaries, any downturn in the business of our subsidiaries could also affect our prospects. It remains uncertain whether the commencement of the Chapter 11 Cases and the associated risks will adversely affect the businesses of any of our subsidiaries. In addition, our non-debtor subsidiaries do not have the benefit of the automatic stay and other protections afforded by the Bankruptcy Code.

Upon consummation of the Plan, our existing common stock will be cancelled and have no value. Under the Plan, all of our existing common stock will be cancelled upon consummation of the Plan and the holders of such securities will receive no recovery. This has caused a significant negative reaction from our stockholders and may adversely affect our ability to attract new stockholders in the future.

The conduct of our business may be restricted under the Bankruptcy Code. The Debtors are operating their businesses as debtors-in-possession pursuant to the Bankruptcy Code. Under applicable bankruptcy law, during the pendency of the Chapter 11 Cases, the Debtors are required to obtain the approval of the Court prior to engaging in any transaction outside the ordinary course of business for the debtor entities. In connection with any such approval, creditors and other parties in interest may raise objections to such approval and may appear and be heard at any hearing with respect to any such approval. Accordingly, although the Debtors may seek the approval of the Court to sell assets and settle liabilities (including for amounts other than those reflected on the Company’s consolidated financial statements), there can be no assurance that the Court will grant such approvals. The Court also has the authority to oversee and exert control over the Debtors’ ordinary course operations.

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As a result of the restrictions described above, prior to the Effective Date, our ability to respond timely to changing business and economic conditions may be significantly restricted, and we may be prevented from engaging in transactions that might otherwise be considered beneficial.

Our on-going restructuring activities may not reduce our losses and cash consumption. We have implemented several expense-related restructurings in recent years. In addition, in September 2005, March 2006, and June 2006 we began to implement restructuring plans aimed at further substantial expense reductions and continue to execute on these plans. See “—Overview—Further Restructurings to Reduce Expenses”. Although we will seek to implement these actions in a manner that does not materially reduce revenue or impair our ability to compete successfully, we cannot be certain that these outcomes will not occur or that these actions will accomplish their intended objective of reducing our losses and cash consumption. Substantially all of the restructuring charges have required or will require the outlay of cash.

We are operating under new leadership that will cause strategic and operational changes in our business. On January 27, 2006, the Board of Directors appointed Mr. Dennis McKenna as our new President and Chief Executive Officer in order to effectuate the turnaround of our business. In addition, our Board of Directors appointed Mr. McKenna as a director and Chairman of the Board on February 1, 2006. Also on February 27, 2006 Mr. Jeffery Zellmer, the Company’s Senior Vice President and Chief Financial Officer and Mr. Warren Pratt, the Company’s Executive Vice President and Chief Operating Officer, resigned. Ms. Kathy Lanterman, the Company’s Vice President and Controller, was appointed the new Senior Vice President and Chief Financial Officer of the Company.

We are currently in a transition period as a result of these leadership changes. We may continue to have strategic, operational or leadership changes to our business in the future and we cannot assure you that such strategic, operational or leadership changes, if any, will lead to an improvement of our business and financial condition. There can also be no assurance that any such strategic, operational or leadership changes will not lead to a further deterioration of our business or financial condition.

We may not be able to raise additional capital in the future. In the future, we may need to obtain additional financing to fund our business or repay our debt, and we cannot assure you that financing will be available in amounts or on terms acceptable to us. In addition, if funds are raised by incurring further debt, our operations and finances may become subject to further restrictions and we may be required to limit our service or product development activities or other operations, or otherwise modify our business strategy. If we fail to comply with financial or other covenants required in connection with such a financing, our creditors may be able to exercise remedies that could substantially impair our ability to operate. In addition, if we obtain additional funds by selling any of our equity securities or if we issue equity derivative securities in connection with obtaining debt financing, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution, or the equity securities may have rights, preferences or privileges senior to the common stock.

Our success is dependent on continued revenue growth from newer product families. The SGI Altix family of servers and superclusters based on the Intel Itanium 2 processor and the Linux operating system was introduced in January 2003 and additional products in this line were added during fiscal 2004. In addition, our SGI Altix XE family of cluster products was introduced in June 2006. Our Linux-based systems sales declined by 40% in fiscal 2006 compared with fiscal 2005. Risks associated with these newer product families include dependence on Intel in terms of price, supply, dependability, performance, product roadmaps and timely access to design specifications, and continued support for and development of the Itanium 2 and Xeon processor families; the availability of Linux applications optimized for the 64-bit Itanium platform or our scalable systems architecture; acceptance of the Linux operating system in demanding environments; and competition from other suppliers of Intel-based servers, including clusters of low-end servers. These clusters are rapidly increasing as an important competitive factor in the high performance server market and have had a negative effect on our revenues and our gross margins.

Future revenue growth from our newer product families is especially important because revenues from our

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traditional MIPS and IRIX products and maintenance business are expected to continue to decline. Our ability to achieve future revenue growth will depend significantly on the market success of these newer product families in servers and storage as well as our ability to generate sales to match or replace revenues generated from large sales transactions in prior periods. If one or more of the product lines were to fail in the market, it could have an adverse effect on our business and liquidity.

Our product strategy and business would be adversely affected by any delay, discontinuance or decreased competitiveness of the microprocessors we use. Our core products are based on system architectures that have been developed by working closely with partners for optimization on our products. Our product strategy and business depend on the continued availability and competitiveness of the microprocessors that we use and would be adversely affected by any further delays and/or discontinuance of these processor families. In addition, we may incur penalties under long-term contracts that require the delivery of future products. It is also important to our competitive position that our chosen microprocessors be competitive as to performance as well as price. Microprocessor technology changes rapidly, and in order to be competitive we must keep pace with those changes. Although we have taken steps with the introduction of new products to mitigate our dependence on a single microprocessor, the transition will take some time, and the migration may be expensive and time consuming.

Our results of operations would be adversely affected if the carrying value of our long-lived assets became impaired. We evaluate our long-lived assets, including property and equipment and goodwill, whenever events or circumstances occur that indicate that the carrying amount of a long-lived asset may not be recoverable. Such events or circumstances may include the discontinuation of a product or product line, a sudden or consistent decline in the forecast for a product, changes in technology or in the way an asset is being used, a history of operating or cash flow losses or an adverse change in legal factors or in the business climate. Our long-lived asset impairment review would be based on a cash flow analysis and would require judgment with respect to many factors, including future cash flows, changes in technology, the continued success of product lines and future volume and revenue and expense growth rates. It is possible that our estimates of cash flows may change within the next twelve months resulting in the need to reassess the carrying value of our long-lived assets for impairment. The process of evaluating the potential impairment of goodwill is subjective and requires significant estimates and assumptions at many points during the analysis. Our estimated future cash flows are based on assumptions that are consistent with our annual planning process and include estimates for revenue and operating margins and future economic and market conditions. We base our fair value estimates on assumptions we believe to be reasonable at the time, but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates. As a result, we may incur substantial non-cash impairment charges, which could adversely affect our results of operations. For example, in the third quarter of fiscal 2006 our operating results were adversely impacted by an $8 million charge for the impairment of goodwill associated with our Products reporting unit. See Note 11 to the consolidated financial statements in Part II, Item 8 of this Form 10-K for further information on our goodwill impairment assessment.

Our financial reporting controls and procedures may be impaired by our restructuring activities and attrition. The uncertainties surrounding our business prospects, the Chapter 11 filing, and our continuing restructuring actions have increased the challenges of attracting and retaining qualified employees. Our annualized attrition rates have increased significantly in fiscal 2006 compared with fiscal 2005. There is no guarantee that we can retain highly qualified employees, or that we will be able to hire highly qualified candidates, as new skills are needed. In addition, while we will strive to ensure that material weaknesses do not develop in our internal controls due to headcount reductions or other factors, there is no guarantee that our internal controls will be unaffected by the restructuring actions or increasing attrition. If material weaknesses develop and we are unable to efficiently and effectively address these matters, investors could lose confidence in the reliability of our internal controls over financial reporting.

We are increasingly dependent on our key suppliers. Our strategy of developing system products based on industry-standard technologies has increased our technical dependence on Intel and other key suppliers. It is therefore important that we receive appropriate development cooperation from our suppliers, and that the products from these suppliers continue to evolve in ways that support the differentiation that we seek to bring to our products. In particular, our Altix family depends on continued component availability, dependability, quality, performance and price/performance. Our financial performance and business prospects would be adversely affected if our suppliers were to reduce their support, including to supply components on terms that enable us to compete effectively for sales with substantial price sensitivity.

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The competitiveness of our system products, particularly our servers, is also significantly affected by the availability on our platform of third-party software applications that are important to customers in our target markets. The success of our Linux-based products and services depends on, among other things, the growth of the Linux market, the acceptance of Linux solutions by customers in demanding environments, the availability of Linux applications optimized for the 64-bit Itanium 2 platform or our scalable systems architecture and our dependence on acceptance of SGI-developed code by the open source community and by Linux distributors with whom we partner.

Our dependence on key suppliers, including sole source suppliers, may prevent us from delivering an acceptable product on a timely basis. We rely on both single source and sole source suppliers for many of the components we use in our products. For example, we currently utilize microprocessors from a sole source supplier in our Altix family of servers and superclusters and have designed our system architecture to optimize performance using their processors. If we were to utilize an alternative microprocessor, the transition would require an alternative design, which would be costly and cause significant delays in the development of future products, adversely affecting our business and operating results.

Our business is dependent on our ability to anticipate our needs for components and products and our suppliers’ ability to deliver such components and products in time to meet critical manufacturing and distribution schedules. In addition, we have benefited from favorable discounts on certain components from key suppliers for selected transactions. Our business could be adversely affected, for example, if suppliers fail to meet product release schedules, if we experience supply constraints, if we fail to negotiate favorable pricing or if we experience any other interruption or delay in the supply chain that interferes with our ability to manufacture our products or manage our inventory levels. Risks also include limited bargaining flexibility, the possibility of charges for excess and obsolete inventory and risks involved with end of life buys from single source and sole source suppliers. We are currently focused on maximizing our working capital by working closely with our suppliers and tightly managing our overall supply chain.

In addition, we are in the process of transitioning to an alternate supplier to act as our foundry for certain key integrated circuits for new products planned for 2008 and later. There can be no assurance that we will be able to complete the transition without significant incremental cash impact.

We may not be able to retain and attract qualified employees. Our success depends on our ability to continue to attract, retain and motivate highly qualified technical, sales and marketing and management personnel. The uncertainties surrounding our business prospects, the Chapter 11 Cases and our continuing restructuring actions have increased the challenges of retaining world-class talent. Our annualized attrition rates have increased significantly in fiscal 2006 compared with fiscal 2005. Although we have put programs in place to encourage employee retention, there is no guarantee that we can retain highly qualified employees or that we will be able to hire highly qualified candidates as new skills are needed.

We are dependent on sales to the U.S. government. A significant portion of our revenue is derived from sales to the U.S. government, either directly by us or through system integrators and other resellers. Sales to the government present risks in addition to those involved in sales to commercial customers, including potential disruptions due to changes in appropriation and spending patterns. Our U.S. government business is also highly sensitive to changes in the U.S. government’s national and international priorities and budgeting. Events like Operation Iraqi Freedom and the continuing war on terrorism may affect funding for our programs or result in changes in government programs or spending priorities that may adversely affect our business. In addition, the U.S. government can typically terminate or modify its contracts with us at any time for its convenience. Our government business is also subject to specific procurement regulations and a variety of other requirements. Failure to comply with these or other applicable regulations and requirements could lead to suspension or debarment from government contracting or subcontracting for a period of time. Any disruption or limitation in our ability to do business with the U.S. government could have an adverse impact on us.

A portion of our business requires security clearances from the U.S. government. These arrangements are subject to periodic review by customer agencies and the Defense Security Service of the Department of Defense.

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We expect our operating results to fluctuate for a variety of reasons. Our revenue and operating results may fluctuate for a number of reasons from period to period, and we have consistently fallen short of our forecasts in recent years. Decreases in revenue can arise from any number of factors, including decreased demand, supply constraints, delays in the availability of new products, transit interruptions, overall economic conditions, competitive factors, military or terrorist actions, or natural disasters. Demand can also be adversely affected by concerns specifically associated with our financial health and by product and technology transition announcements by us or our competitors. The timing of customer acceptance of certain large-scale server products may also have a significant effect on periodic operating results. Margins are heavily influenced by revenue levels, mix considerations, including geographic concentrations, the mix of product and service revenue, industry price trends, competitive pricing pressures (particularly for high visibility accounts) and the mix of server and desktop product revenue as well as the mix of configurations within these product categories. As a result of the concentration of sales in the third month of each quarter, developments late in a quarter can have a significant impact on that period’s results.

We operate in a highly competitive industry. The computer industry is highly competitive, with rapid technological advances and constantly improving price/performance. Most of our competitors have substantially greater technical, marketing and financial resources. They also generally have a larger installed base of customers and a wider range of available applications software. Competition may result in significant discounting and lower gross margins. In addition, as our Linux-based systems business grows, the number of our competitors may grow commensurate with the increased market opportunity. An important competitive development in our market has been the emergence of networked clusters of commodity computers from suppliers like Dell Computer as an alternative to our midrange products. These clusters have grown at a faster than anticipated rate and are taking an increasing share of the high-performance computing market. These clustered systems may not be subject to U.S. export regulations, which may make them more attractive to certain international customers. See “—Many of our international sales require export licenses”. Although we have introduced a cluster product, we face significant competition in this market.

Our typical concentration of sales at the end of our fiscal quarters makes period-to-period financial results less predictable. Over half of each quarter’s product revenue results from orders booked and shipped during the third month, and disproportionately in the latter half of that month. This makes the forecasting of revenue inherently uncertain and can produce pressure on our internal infrastructure during the third month of a quarter. Because we plan our operating expenses, many of which are relatively fixed in the short term, on expected revenue, even a relatively small revenue shortfall may cause a period’s results to be substantially below expectations.

We are subject to the risks of international operations. We generate a large portion of our revenue outside the United States, and as a result, our business is subject to the risks associated with doing business internationally. International transactions frequently involve increased financial and legal risks arising from stringent contractual terms and conditions and the widely differing legal systems and customs in foreign countries. War, terrorism or public health issues in the regions of the world in which we do business have caused and may continue to cause damage or disruption to commerce by creating economic and political uncertainties. Such events could adversely affect our business in any number of ways, such as decreasing demand for our products, increasing our costs of operations, making it difficult to deliver products to customers, and causing delays and other problems in our supply chain. Our future revenue, gross margin, expenses and financial condition could also suffer due to other international factors, including but not limited to: changes in a country’s economic and labor conditions; currency fluctuations; compliance with a variety of foreign laws, as well as U.S. laws affecting the activities of U.S. companies abroad; changes in tax laws; changes in the regulatory or legal environment; difficulties associated with repatriating cash generated abroad; fluctuations in transportation costs; natural and medical disasters; and trade protection measures.

Many of our international sales require export licenses. Our sales to customers outside the United States are subject to U.S. export regulations. Sales of many of our high-end products require clearance and export licenses from the U.S. Department of Commerce under these regulations. Our international sales would be adversely affected if such regulations were tightened, or if they are not modified over time to reflect the increasing performance of our products. Delay or denial in the granting of any required licenses could make it more difficult to make sales to foreign customers. In addition, we could be subject to regulations, fines and penalties for violations of import and export regulations such as our products being shipped directly or through a third-party to certain countries. Such violations could result in penalties, including prohibiting us from exporting our products to one or more countries, and could materially and adversely affect our business.

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We may not be able to develop and introduce new products on a timely basis. Meeting our objectives for the future will require that our recently introduced products achieve success in the marketplace and that we succeed in the timely development and introduction of more successful new products. Product transitions are a recurring part of our business. A number of risks are inherent in this process.

The development of new technology and products is increasingly complex and uncertain, which increases the risk of delays. The introduction of new computer systems requires close collaboration and continued technological advancement involving multiple hardware and software design teams, internal manufacturing teams, outside suppliers of key components such as semiconductors and outsource manufacturing partners. The failure of any one of these elements could cause our products under development to fail to meet specifications or to miss the aggressive timetables that we establish. There is no assurance that development or acceptance of our new systems will not be affected by delays in this process. In addition, from time to time we receive co-funding for certain development efforts and reduction or elimination of such funding could adversely affect the development and introduction of new systems.

Our product strategy and business depend on the continued availability and competitiveness of the Itanium 2 processor family and would be adversely affected by any delays and/or discontinuance of this processor family. See “—Our product strategy and business would be adversely affected by any delay, discontinuance or decreased competitiveness of the microprocessors we use”. In addition, we may incur penalties under long-term contracts that require the delivery of future products.

Short product life cycles place a premium on our ability to manage the transition to new products. We often announce new products in the early part of a quarter while the product is in the final stages of development and testing, and seek to manufacture and ship the product in volume during the same quarter. Our results could be adversely affected by such factors as development delays, the release of products to manufacturing late in any quarter, quality or yield problems experienced by suppliers, variations in product costs and excess inventories of older products and components. In addition, some customers may delay purchasing existing products in anticipation of new product introductions.

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

We may become involved in intellectual property disputes. We routinely receive communications from third parties asserting patent or other rights covering our products and technologies. Based upon our evaluation, we may take no action or may seek to obtain a license. 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 could incur significant costs and we might not prevail in our case. We are in discussions with several parties that have asserted intellectual property infringement claims. In any given case there is a risk that a license will not be available on terms that we consider reasonable, or that litigation will ensue. We expect that, as the number of hardware and software patents issued continues to increase, and as competition in the markets we address intensifies, the volume of these intellectual property claims will also increase.

In addition, our growing visibility as a supplier of Linux-based systems and as a participant in the open source software community increases our risk of becoming embroiled in the intellectual property disputes concerning these subjects, such as the current widely reported litigations between SCO Group on the one hand and IBM and Red Hat on the other. We received a notice from SCO Group purporting to terminate, as of October 14, 2003, our fully paid license to certain UNIX operating system-related code, under which we distribute our IRIX operating system, on the basis that we have breached the terms of such license. We believe that the SCO Group’s allegations are without merit and that our fully paid license is non-terminable. Nonetheless, there can be no assurance that this dispute with SCO Group will not escalate into litigation, which could have a material adverse effect on us, or that SCO Group’s intellectual property claims will not impair the market acceptance of the Linux operating system.

On August 3, 2006, LG Electronics, Inc. (“LGE”) filed a motion (the “LGE Motion”) in the Chapter 11 Cases of

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the Debtors seeking relief from the automatic stay pursuant to section 362(d)(1) of the Bankruptcy Code so that LGE may proceed with certain patent infringement claims against the Company in the appropriate district court and seek damages for alleged pre- and post-petition infringements of certain of LGE’s patents. The LGE Motion also requests that the Court determine that the automatic stay does not apply to LGE’s ability to commence a proceeding against us in respect of our alleged continuing, post-petition infringement of LGE’s patents. LGE also filed proofs of claims in the Chapter 11 Cases against each of the Debtors in connection with the alleged patent infringement. On August 25, 2006, the Debtors objected to LGE’s proofs of claim. The Debtors and LGE resolved the LGE Motion by stipulation dated September 8, 2006, and entered by the Court on September 8, 2006. In the stipulation, LGE agreed to withdraw the LGE Motion, agreed not to file any objection to confirmation of the Debtors’ plan of reorganization, and agreed to withdraw all proofs of claim asserting pre-petition infringement except the one filed against the Company. The Debtors agreed that LGE claims alleging patent infringement first arising after the commencement of the Chapter 11 Cases could be adjudicated in a court of competent jurisdiction other than the Court after confirmation of the plan of reorganization. On September 26, 2006, we filed a motion to estimate the LGE claims at $0.00 for purposes of allowance and distribution under the Plan. A hearing on this motion is scheduled for November 1, 2006. We do not believe that LGE’s claims of patent infringement are meritorious and we intend to oppose them. See “Legal Proceedings”.

On April 27, 2004, SGI received a letter from counsel for Patriot Scientific Corporation listing six patents purportedly owned by Patriot concerning various microprocessor technologies. The letter did not name any specific products of SGI but noted that Patriot had commenced litigation against six companies in two separate litigations, including Intel. On September 23, 2005, SGI received a follow up letter from Alliacense, which purported to be a successor entity to Patriot. The September 2005 letter stated that Alliacense had reached agreement with several companies, including Intel and AMD, for licenses to the subject patents. The letter did not identify any specific products of SGI that Alliacense believed to infringe any of the subject patents; however, the letter states Alliacense’s belief that “virtually every product manufactured today utilizing microprocessors or embedded microprocessors” will require a portfolio license from Alliacense. We believe that Alliancense’s assertions are without merit. See “Legal Proceedings”.

We will not be able to utilize a significant portion of our net operating loss and credit carryforwards. We currently have over $1 billion in U.S. net operating loss carryforwards due to prior period losses. Most of these net operating loss carryforwards were incurred prior to SGI’s Chapter 11 reorganization and therefore are subject to limitation under U.S. and state income tax laws. Pursuant to these loss limitation rules, the utilization of net operating loss and credit carryforwards of a loss corporation are limited if during a testing period (usually three years) there is greater than a 50% cumulative shift in the ownership of its stock. As a result of the bankruptcy reorganization, SGI exchanged some of its debt for common stock. This exchange resulted in more than a 50% cumulative shift in the stock ownership of SGI. Accordingly, SGI’s ability to utilize its net operating losses will be significantly limited as provided under section 382 of the Internal Revenue Code. This limitation would reduce our income after taxes, thereby affecting our cash balances and liquidity, if in any given future fiscal period taxable profits are in excess of the restricted losses available for offset.

Compliance or the failure to comply with environmental laws could impact our future net earnings. 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 limit the use of certain substances in our products or require us to recycle our products when they become waste. While it is our policy to ensure that our operations and products comply with environmental laws at all times, any failure to so comply with environmental laws or customer requirements relating to such laws could require us to stop producing or selling certain products, recall noncompliant products, or otherwise incur substantial costs in order to acquire costly equipment to make other operational changes in order to achieve compliance. Although environmental costs and liabilities have not materially affected us to date, due to the nature of our operations and legal developments affecting our products and operations, environmental costs and liabilities could have a material adverse affect on our business and financial position in the future.

From time to time new regulations are enacted, and it is difficult to anticipate how such regulations will be implemented and enforced. We track regulatory developments that may impact our business and devote substantial resources toward developing strategies for compliance with new requirements as they are enacted.

For example, we face increasing complexity in our product design and procurement operations as we adjust to new and anticipated requirements relating to the materials composition of our products, including RoHS, which regulates

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the use of lead and other hazardous substances in electrical and electronic equipment put on the market in the European Union on or after July 1, 2006. Due to these restrictions, we have decided not to ship our remarketed products from the United States to Europe after July 1, 2006, and we are completing our work with our suppliers to assure RoHS compliance with respect to our other products. If a regulatory authority determines that one of our products is not RoHS-compliant, we may have to redesign and re-qualify certain components to meet RoHS requirements, which could subject us to increased engineering expenses in this process, and could face shipment delays, penalties and possible product detentions or seizures.

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 (“WEEE”), 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 RoHS 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 being implemented by individual countries in the European Union and it is likely that each jurisdiction will implement, interpret or enforce RoHS and WEEE somewhat differently. In addition, final guidance from individual jurisdictions may impose different or additional responsibilities on us. 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.

Our business is subject to market risk. In the normal course of business, our financial position is routinely subject to a variety of risks, including market risk associated with interest rate movements and currency rate movements on non-U.S. dollar denominated assets and liabilities, as well as collectibility of accounts receivable. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, we do not anticipate material losses in these areas.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

We own and lease sales, service, research and development and administrative offices worldwide and have our principal facilities in California, Wisconsin, Minnesota, and Maryland, United States and in Reading, United Kingdom. At June 30, 2006, our worldwide facilities represented aggregate floor space of approximately 1.0 million square feet, of which 0.9 million square feet is used in our operations, less than 0.1 million square feet is subleased to other tenants and 0.1 million square feet is currently vacant. We have two reportable segments: Products and Global Services. Because of the relationship between these segments, substantially all of our properties are used at least in part by both of these segments and we have the flexibility to use each of the properties in whole or in part for each of the segments.

Information about our leased and owned facilities at June 30, 2006 is as follows:

	Square Feet		Lease Terms End	Square Feet Not Used in Operations	Primary Uses
	Leased	Owned
Mountain View, California	175,000	—	2006	—	Research and development, sales, administration
Chippewa Falls, Wisconsin	125,000	324,000	2008	55,000	Manufacturing, service, research and development
Eagan, Minnesota	85,000	—	2010	15,000	Research and development, sales, administration
Reading, United Kingdom	20,000	—	2009	—	Research and development, sales, service, administration
Silver Springs, Maryland	18,000	—	2009	—	Research and development, sales, administration
Other international	219,000	—	—	56,000	Sales
Other domestic	41,000	—	—	13,000	Sales
	683,000	324,000		139,000

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Our leased facilities in Mountain View, California include our corporate headquarters. See Note 14 in the consolidated financial statements in Part II, Item 8 of this Form 10-K for additional information about these leases.

As a result of restructuring over the last several years, we own and lease space that we do not currently expect to use in our operations. See Note 5 to the consolidated financial statements in Part II, Item 8 of this Form 10-K for further information about lease payments for properties vacated under our restructuring actions.

ITEM 3. LEGAL PROCEEDINGS

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

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

None.

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PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is presently being quoted on the Pink Sheets Electronic Quotation Service (“Pink Sheets”) maintained by Pink Sheets LLC for the National Quotation Bureau, Inc. under the ticker symbol SGID.PK. Prior to November 7, 2005, our common stock was listed under, and traded on, the New York Stock Exchange (“NYSE”) under the trading symbol SGI. As a result of shares of our common stock not meeting the minimum per share price of $1.00 averaged over a thirty day trading period our common stock was suspended from trading by the NYSE and, thereafter, delisted by the NYSE.

As a result of our bankruptcy proceedings, certain restrictions in trading are imposed under a Court order that requires certain direct and indirect holders of claims, preferred securities and common stock to provide at least ten days advance notice of their intent to buy or sell claims against the Debtors or shares in SGI. In addition, as a result of the confirmation of our Plan by the Court on September 19, 2006, all of our existing common stock, stock options and restricted stock awards will be canceled upon emergence from Chapter 11, and the holders of such securities will receive no recovery.

As of September 15, 2006, we had 8,016 holders of record. This number does not include beneficial owners of the Company’s common stock whose shares are held in the names of various dealers, clearing agencies, banks, brokers and other fiduciaries. We have not paid any cash dividends on our common stock. As a result of our accumulated deficit position and restrictions in certain debt instruments, we do not anticipate paying cash dividends to common stockholders.

The following table sets forth (1) the high and low close price on any given day within the quarter and the close price on the last day of the quarter for our common stock as reported on the NYSE for fiscal 2005 and for the first quarter and a portion of the second quarter of fiscal 2006, and (2) the high and low bid quotation on any given day within the quarter and the close bid quotation on the last day of the quarter for our common stock as reported on the Over-the-Counter Bulletin Board (“OTCBB”) and Pink Sheets for a portion of the second quarter and the third and fourth quarters of fiscal 2006. These quotations reflect inter-dealer prices, without retail markup, markdown or commissions, and may not necessarily represent actual transactions.

Price Range for Common Stock

	Fiscal 2006						Fiscal 2005
	Low		High		Close		Low		High		Close
First Quarter	$	0.56	$	0.97	$	0.78	$	1.37	$	2.26	$	1.43
Second Quarter	$	0.35	$	0.77	$	0.35	$	1.26	$	1.98	$	1.79
Third Quarter	$	0.32	$	0.49	$	0.44	$	1.11	$	1.78	$	1.17
Fourth Quarter	$	0.04	$	0.44	$	0.05	$	0.68	$	1.19	$	0.73

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ITEM 6. SELECTED FINANCIAL DATA

The following selected financial information has been derived from our audited consolidated financial statements (except statistical data). The information set forth in the table below is not necessarily indicative of results of future operations, and should be read in conjunction with Part II, Item 7 of this Form 10-K, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and our consolidated financial statements and related footnotes included in Part II, Item 8 of this Form 10-K in order to fully understand factors that may affect the comparability of the information presented below. Results of continuing operations for all years presented in this Form 10-K exclude the operating results of our Alias application software business which is classified as discontinued operations (see Note 8 to the consolidated financial statements in Part II, Item 8 of this Form 10-K) (in thousands, except per share amounts and employee data):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004			June 27, 2003			June 28, 2002
Operating Data:
Total revenue	$	518,805		$	729,965		$	842,002		$	896,605		$	1,277,274
Costs and expenses:
Cost of revenue		320,433			465,076			492,845			563,480			760,319
Research and development		83,677			92,705			108,763			157,924			163,725
Selling, general, and administrative		211,731			244,568			257,742			282,359			409,561
Impairment of goodwill ating expense (1)		8,386			—			—			—			—
Other operating expense (1)		21,155			24,083			47,825			30,046			44,476
Operating loss		(126,577	)		(96,467	)		(65,173	)		(137,204	)		(100,807	)
Interest and other income (expense), net (2)		(15,437	)		12,721			(44,600	)		(24,664	)		18,701
Loss from continuing operations before reorganization items and income taxes	$	(142,014	)	$	(83,746	)	$	(109,773	)	$	(161,868	)	$	(82,106	)
Net loss from continuing operations	$	(146,194	)	$	(75,732	)	$	(100,246	)	$	(135,203	)	$	(49,436	)
Net loss	$	(146,194	)	$	(76,008	)	$	(45,770	)	$	(129,704	)	$	(46,323	)
Net loss per share basic and diluted:
From continuing operations	$	(0.54	)	$	(0.29	)	$	(0.44	)	$	(0.67	)	$	(0.25	)
Net loss	$	(0.54	)	$	(0.29	)	$	(0.20	)	$	(0.64	)	$	(0.24	)
Shares used in the calculation of net loss per share–basic and diluted		269,367			263,430			227,837			201,424			194,974
Balance Sheet Data:
Cash, cash equivalents and unrestricted investments	$	54,876		$	64,286		$	156,865		$	136,468		$	208,240
Restricted investments		48,498			40,170			24,494			36,728			44,689
Total assets		380,058			452,145			569,924			649,854			910,119
Long-term debt and other		73,616			375,852			372,048			400,124			455,312
Stockholders’ deficit		(330,454	)		(191,188	)		(122,678	)		(164,891	)		(54,641	)
Statistical Data:
Number of employees		1,738			2,423			2,655			3,714			4,443

(1) Fiscal 2006 amount represents net restructuring charges ($10 million) and asset impairment charges ($11 million). Fiscal 2005 amount represents net restructuring charges. Fiscal 2004 amounts include net restructuring charges ($45 million) and asset impairment charges ($3 million). Fiscal 2003 amounts include net restructuring charges ($26 million) and asset impairment charges ($4 million). Fiscal 2002 amounts include net restructuring charges ($33 million) and asset impairment charges ($12 million).

(2) Fiscal 2006 amounts include net interest expense of $16 million. Fiscal 2005 amounts include a gain of $21 million on the sale of a portion of our equity investment in SGI Japan, Ltd. (“SGI Japan”). Fiscal 2004 amounts include a $31 million non-cash loss resulting from the extinguishment of the exchanged 5.25% Senior Convertible Notes due in 2004. Fiscal 2003 amounts include net interest expense of $23 million and a $3 million other than temporary decline in the value of an investment. Fiscal 2002 amounts include a $64 million gain on the sale of a 60% interest in SGI Japan and $24 million in class action lawsuit settlement expense.

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

Chapter 11 Reorganization

On May 8, 2006, we and certain of our subsidiaries filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. For further information regarding these petitions, see Note 1 to the consolidated financial statements in Part II, Item 8 of this Form 10-K.

Under Chapter 11, we are continuing to operate our business without interruption as debtor-in-possession under the jurisdiction of the 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 have allocated or will allocate a substantial amount of resources to bankruptcy restructuring, which includes 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. In addition to financial restructuring activities, we are preparing to operate after our emergence from Chapter 11 protection. At a hearing held on September 19, 2006, the Court confirmed the Company’s Plan. Under the Plan, all of SGI’s existing common stock, stock options and restricted stock awards will be cancelled upon our exit from Chapter 11, and holders of such securities will receive no recovery. Accordingly, our existing common stock will have no value. We currently plan to emerge from Chapter 11 in October 2006.

Overview

SGI is a leading provider of products, services, and solutions for use in high-performance computing and storage. We sell highly scalable servers, storage solutions, and associated software products that enable our customers in the scientific, technical and business communities to solve their most challenging problems and provide them with strategic and competitive advantages. Whether analyzing images to aid in brain surgery, studying global climate changes, accelerating the engineering of new automotive designs, providing technologies for homeland security, or gaining business “intelligence” from mining a company’s databases, SGI’s systems are designed to compute vast amounts of data, translate data into high-resolution images in a realistic timeframe and scale, and provide high-speed storage. We also offer a range of services and solutions, including professional services, customer support, and education. These products and services are used in a range of application segments including defense and intelligence, sciences, engineering analysis, and enterprise data management.

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Business Strategy

The following overview describes key elements of our business strategy and our results achieved during fiscal 2006:

Leadership in High-Performance Standards-Based Computer Systems. 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. However, competition is putting pressure on the growth rates and gross margins for our Linux (or core systems) product families. These pressures include increasing acceptance of commodity clusters (large groups of low cost, small computers including connected PCs) in the high-performance computing market. Our revenue growth prospects, and our ability to return to profitability, depend on our ability to grow the server and storage (or core system) product families at a rate that will more than offset the expected continued decline of our traditional MIPS/IRIX product and maintenance business. In addition, our product strategy and business depend on the continued availability and competitiveness of our microprocessors and could be adversely affected by any delays and/or discontinuance of these microprocessors. See “—Risk Factors”.

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.

Targeting our Product Portfolio on New Business Opportunities. While SGI has traditionally focused in technical and scientific computing, in addition we are expanding into targeted areas of the enterprise segment that are well served by SGI’s high performance systems and expanding our product portfolio to include X86-based products. At the same time, we have made changes in our product strategy by ceasing development of future generations of differentiated visualization products and concentrating our development efforts in computer systems and storage to better capitalize on these trends. In June 2006, SGI introduced a new line of x86-based products, the Altix XE family, to more effectively address the expanding market for cluster computing.

Further Restructurings to Reduce Expenses. We continue to reduce our total operating cost structure, principally from headcount reductions and geographic consolidation of functions and facilities. Costs for fiscal 2006 for manufacturing and service, research and development, sales, marketing and administration declined 23% from the comparable prior year period. However, our revenue has continued to decline at a faster rate than anticipated, resulting in continued operating losses and cash consumption. In the fourth quarter of fiscal 2005, we retained the turnaround firm AlixPartners LLC to advise us regarding further expense reductions, increasing revenue, improving liquidity and our intentions to initiate restructuring actions in the first quarter of fiscal 2006.

During fiscal 2006, we implemented restructuring activities under three fiscal 2006 restructuring plans. These actions included headcount reductions; initiatives to reduce costs in other areas, including procurement costs for goods and services; consolidation and reorganization of operations in several locations; focusing marketing spending on the highest priority activities; renegotiated services contracts with vendors to improve terms and other spending controls. The original goal of our fiscal 2006 restructuring actions was to achieve $80 to $100 million in annualized cost savings when fully realized. In the third quarter of fiscal 2006, we increased our goal of $100 million in annualized savings to $150 million in annualized savings. We have taken actions during fiscal 2006 that we believe will achieve $150 million in annualized savings. We have seen considerable cost savings benefit during fiscal 2006 from these initiatives and expect to realize the remaining saving during fiscal 2007.

Leadership Transition

On January 27, 2006, the Board of Directors appointed Mr. Dennis McKenna as our new President and Chief Executive Officer in order to effectuate the turnaround of our business. In addition, our Board of Directors appointed Mr. McKenna as a director and Chairman of the Board on February 1, 2006. We are currently in a transition period as a result of this leadership change. Although we have announced changes to our overall business strategy, operations and leadership and we expect to have strategic, operational or leadership changes to our business in the future, we cannot assure you that such strategic, operational or leadership changes, if any, will lead to an improvement of our business and financial condition.

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Results of Operations

The financial information and the discussion below should be read in conjunction with the accompanying consolidated financial statements and notes thereto. The following tables and discussion present certain financial information on a comparative basis. We sold our Alias application software business in June 2004 (see Note 8 to our consolidated financial statements in Part II, Item 8 of this Form 10-K) and have excluded its operating results from continuing operations and reflected them as discontinued operations for all periods presented in this Form 10-K (dollars in millions, except per share amounts; amounts may not add due to rounding):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Total revenue	$	519		$	730		$	842
Cost of revenue		320			465			493
Gross profit		198			265			349
Gross profit margin		38.2	%		36.3	%		41.5	%
Total operating expenses (1)		325			361			414
Operating loss		(127	)		(96	)		(65	)
Interest and other income (expense), net		(15	)		13			(45	)
Loss from continuing operations before reorganization items and income taxes	$	(142	)	$	(84	)	$	(110	)
Net loss from continuing operations (2)	$	(146	)	$	(76	)	$	(100	)
Net income from discontinued operations		—			—			54
Net loss	$	(146	)	$	(76	)	$	(46	)
Net income (loss) per share–basic and diluted:
Continuing operations	$	(0.54	)	$	(0.29	)	$	(0.44	)
Discontinued operations		(0.00	)		(0.00	)		0.24
Net loss per share–basic and diluted	$	(0.54	)	$	(0.29	)	$	(0.20	)

(1) Total fiscal 2006 operating expenses include: (i) charges of approximately $9 million for the acceleration of depreciation associated with changes in the estimated useful lives of certain leasehold improvements and furniture and fixtures associated with two of our buildings at our U.S. corporate headquarters that were vacated in fiscal 2006; (ii) approximately $2 million of operating asset write downs for fixed assets and demonstration units associated with the end of production of existing Silicon Graphics Prism^™ and Prism Deskside products and the cancellation of future Prism products; and (iii) approximately $8 million for the impairment of goodwill. These charges represent increases in net loss per share – basic and diluted of $0.04 in fiscal 2006.

(2) Net loss from continuing operations includes $8 million of reorganization expense.

Revenue

The following discussion of revenue is based on the results of our reportable segments, as described in Note 18 to our consolidated financial statements in Part II, Item 8 of this Form 10-K. 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 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.

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Total revenue decreased $211 million or 29% in fiscal 2006 compared with fiscal 2005, and decreased $112 million or 13% in fiscal 2005 compared with fiscal 2004. The overall decline in revenue from fiscal 2005 to fiscal 2006 was 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. 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 (“SOP”) 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 for fiscal 2006, these same products need to 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. Excluding any impairment impact from Fresh Start Accounting, this revenue reduction in fiscal 2006 would be expected to amortize into revenue in future periods. The decline in revenue from fiscal 2004 to fiscal 2005 was due to declines in sales of our proprietary MIPS/IRIX-based products that more than offset growth in sales of our Intel/Linux-based Altix servers and Prism visualization systems, coupled with declines in our storage solutions and global services revenue. We expect that our MIPS/IRIX-based and related maintenance revenues will continue to decline. As discussed in Part I Item 1 of this Form 10-K, we will continue to develop and implement our business strategies to improve the profitability of our Core Systems revenues. See “Risk Factors”.

The following table presents total revenue by reportable segment (dollars in millions; numbers may not add due to rounding):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Core Systems	$	173		$	270		$	200
Legacy Systems		78			165			296
Total Products	$	251		$	435		$	496
% of total revenue		48	%		60	%		59	%
Global Services	$	268		$	295		$	346
% of total revenue		52	%		40	%		41	%

Products. Revenue from our Products segment decreased $184 million or 42% in fiscal 2006 compared with fiscal 2005 and declined $61 million or 12% in fiscal 2005 compared with fiscal 2004.

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 noted above.

Revenue from Core Systems in fiscal 2005 increased $70 million or 35% compared with fiscal 2004. The increase is primarily due to the increase in Altix sales and to a lesser extent, to the increase in Prism sales, offset in part by declines in Storage solutions revenues. Altix server volumes increased while average selling prices for Altix servers declined due to competitive pressures from commodity cluster systems. The lower average selling prices of the entry level Altix product, introduced in the latter half of fiscal 2004, also contributed to the decline in the aggregate average selling prices for the Altix server product family in fiscal 2005. The Storage solutions revenue decline in fiscal 2005 was primarily due to relatively flat volume coupled with lower average selling prices.

Revenue from Legacy Systems in fiscal 2006 decreased $87 million or 52% 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

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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 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.

Revenue from Legacy Systems in fiscal 2005 decreased $131 million or 44% compared with fiscal 2004, primarily 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. Our workstations revenue has declined steadily over the past few years as we discontinued several product families and as our medical OEM business deteriorated. Reduced volumes of our Silicon Graphics® Octane® family of visual workstations, as we completed its end of life, and reduced volumes of both our Silicon Graphics® Fuel® and Silicon Graphics® Tezro® visual workstations were the primary contributors to the decline in workstation revenue in fiscal 2005. Also contributing to this decline was a higher mix of Fuel visual workstations which carry a lower average selling price than Tezro workstations. The decline in our MIPS/IRIX-based graphics systems revenue in fiscal 2005 was principally due to reduced volumes despite an increase in the overall average selling prices. Both volume and average selling prices for SGI® Origin® servers declined. During the second quarter of fiscal 2005, we expanded our graphics systems product family with the introduction of Silicon Graphics Prism, our graphics system based on Linux, Itanium 2, and SGI’s scalable graphics technology. However, the decline in MIPS/IRIX-based graphics systems revenue in fiscal 2005 compared with fiscal 2004 exceeded the revenue generated by the Prism graphics 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 2006 decreased $27 million or 9% compared with fiscal 2005. The decline was primarily due to a reduction in our traditional customer support revenue 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 2005 decreased $50 million or 15% compared with fiscal 2004. This decline was largely attributable to the same factors described in the preceding paragraph.

Total revenue by geographic area for fiscal 2006, 2005 and 2004 was as follows (dollars in millions):

	Years ended
Area	June 30, 2006				June 24, 2005				June 25, 2004
Americas	$	306	59	%	$	448	61	%	$	548	65	%
Europe		131	25	%		177	24	%		211	25	%
Rest of World		82	16	%		105	15	%		83	10	%
Total revenue	$	519			$	730			$	842

Geographic revenue mix in fiscal 2006 remained relatively unchanged compared with fiscal 2005. The shift in geographic revenue mix in fiscal 2005 compared with fiscal 2004 is primarily a result of two large transactions, accounting for 4% of total revenue in fiscal 2005, to SGI Japan, a related party that is also our exclusive distributor in Japan.

Our consolidated backlog at June 30, 2006 was $127 million, up from $120 million at June 24, 2005. Backlog is comprised of committed purchase orders for products and professional services deliverable within nine months. Backlog

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increased within the Core Systems segment, specifically with regard to our Linux-based Altix servers and storage systems, offset in part by a decrease in professional services. Backlog decreased within the Legacy Systems segment, primarily related to our Origin products. See “Business - Seasonality and Backlog” in Part I, Item 1 of this Form 10-K.

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 such as a current order from a European supercomputing center for which a portion of the value is not reflected in our current backlog. A portion of this order is currently scheduled to ship outside the time provided in our bookings policy and the contract is not expected to be recognized as revenue until fiscal 2008. 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.

As described in the paragraphs below, overall gross profit margin increased to 38.2% in fiscal 2006 from 36.3% in fiscal 2005. This increase was primarily due to an improvement in service gross profit margin, offset in part by a decline in product and other gross profit margin.

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.

Overall gross profit margin declined to 36.3% in fiscal 2005 from 41.5% in fiscal 2004. Product and other gross profit margin in fiscal 2005 decreased 6.8 percentage points compared with fiscal 2004. As a result of fixed manufacturing costs, cost of sales did not decline in proportion to our lower sales volumes in fiscal 2005 compared with fiscal 2004. Also, we continued to see a shift in mix from our MIPS/IRIX-based systems which typically carry a higher gross margin to our Intel/Linux-based systems which have lower gross margins. These negative impacts on gross margin were offset slightly by favorable manufacturing variances resulting from manufacturing efficiencies and procurement cost controls. Our results in fiscal 2005 also reflected a higher percentage of revenue from a relatively small number of large transactions, especially in the Altix product family. In particular, approximately 9% of our fiscal 2005 revenue resulted from two individual large transactions. These transactions typically are negotiated with high discount rates due to very competitive bidding processes, resulting in lower gross margins, offset to some extent by favorable component pricing

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provided to us by certain vendors for these transactions. Increasing competitive pricing pressures from low cost commodity cluster systems also contributed to the decline in gross profit margin. We expect to continue to generate a portion of our revenue from large, high visibility transactions which are typically very complex, tend to have lower gross margins and represent unpredictable sales cycles. We also plan to continue to work with suppliers such as Intel to structure favorable component pricing to support these types of anticipated sales. However, there is no assurance that we will be able to moderate the gross margin impact of larger, low margin transactions in any particular period.

Service gross profit margin in fiscal 2005 decreased 2.7 percentage points compared with fiscal 2004 as service costs did not decline in proportion to revenue due to fixed cost elements. Fixed costs associated with professional services coupled with lower margins on sales of third party product were the primary causes for the decline. Also contributing to the margin decline was a large sales transaction involving a significant portion of professional services at lower than average gross margin.

Operating Expenses

Operating expenses were as follows (dollars in millions):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Research and development	$	84		$	93		$	109
% of total revenue		16	%		13	%		13	%
Selling, general and administrative	$	212		$	245		$	258
% of total revenue		41	%		34	%		31	%
Impairment of goodwill	$	8		$	—		$	—
% of total revenue		2	%		—			—
Other operating expenses	$	21		$	24		$	48
% of total revenue		4	%		3	%		6	%

Operating Expenses (excluding Other Operating Expenses). Fiscal 2006 operating expenses (excluding other operating expenses) decreased $34 million or 10% compared with fiscal 2005, but increased as a percentage of total revenue from 46% to 59%. Fiscal 2005 operating expenses (excluding other operating expenses) decreased $29 million or 8% compared with fiscal 2004, but increased as a percentage of total revenue from 44% to 46%. The significant decline in operating expenses (excluding other operating expenses) in both years was primarily attributable to lower headcount resulting from our restructuring activities, employee attrition, and the impact of our overall expense control measures aimed at bringing expenses in line with revenue. Although we expect to realize significant long-term cost savings resulting from our restructuring actions, the savings reflected in our operating expenses (excluding other operating expenses) in fiscal 2006 were partially offset by $13 million in outside services incurred primarily in connection with our cost reduction and strategic planning initiatives. Additionally we recorded an $8 million non-cash charge for the impairment of goodwill in the third quarter of fiscal 2006, which also offset our cost savings from our restructuring actions. The decrease in our 2006 operating expenses (excluding other operating expenses) was also offset slightly by the fact that our accounting calendar had 53 weeks during fiscal 2006 compared with 52 weeks during fiscal 2005.

Adoption of SFAS 123(R)

We have three share-based compensation plans: two stock option programs and an employee stock purchase plan (“ESPP”). Our accounting for our current stock-based compensation plans will continue to be recorded in our results of operations during our bankruptcy proceedings. Under the Plan, all of our existing common stock, stock options, and restricted stock awards will be cancelled upon consummation of the Plan by the Court and our exit from Chapter 11, and the holders of such securities will receive no recovery.

Prior to fiscal 2006, we accounted for these plans under the recognition and measurement provisions of APB Opinion No. (“APB”) 25, Accounting for Stock Issued to Employees, and related guidance, as permitted by SFAS 123,

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Accounting for Stock-Based Compensation. Accordingly, we did not recognize any significant amounts of share-based employee compensation expense in our statements of operations prior to fiscal 2006; instead, we provided footnote disclosure of our pro forma results of operations as if we had recognized compensation expense in accordance with SFAS 123.

Beginning in the first quarter of fiscal 2006, we adopted the fair value recognition provisions of SFAS 123(R), Share-Based Payment, using the modified-prospective transition method. Under that transition method, compensation cost recognized in fiscal 2006 includes the following: (a) compensation cost related to any share-based payments granted through, but not yet vested as of June 24, 2005, and (b) compensation cost for any share-based payments granted subsequent to June 24, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R).

As a result of adopting SFAS 123(R), we recognized share-based employee compensation expense of $2.2 million during fiscal 2006, which primarily affected our reported research and development and selling, general, and administrative expenses. We calculated this expense based on the fair values of the share-based compensation awards as estimated using the Black-Scholes-Merton closed-form option valuation model. Use of this model requires us to make assumptions about expected future volatility of our stock price and the expected term of the options that we grant. Calculating share-based compensation expense under SFAS 123(R) also requires us to make assumptions about expected future forfeiture rates for our option awards. As of June 30, 2006, total unrecognized compensation expense related to unvested share-based compensation arrangements already granted under our various plans was $4.1 million, which we expect will be recognized over a weighted-average period of 2.3 years. However, it is difficult to predict the actual amount of share-based compensation expense that we will recognize in future periods because that expense can be affected by changes in the amount or terms of our share-based compensation awards issued in the future, changes in the assumptions used in our model to value those future awards, including estimated forfeiture rates, changes in our stock price, and changes in interest rates, among other factors.

Research and Development. Fiscal 2006 research and development spending decreased $9 million or 10% compared with fiscal 2005. The fiscal 2006 decrease resulted primarily from a 15% reduction in headcount and lower facilities and information technology-related costs, offset in part by increased outside services costs. The decline in headcount related primarily to the discontinuation of our custom visualization efforts, although attrition also contributed to the decline. Fiscal 2005 research and development spending decreased $16 million or 15% compared with fiscal 2004. The fiscal 2005 decrease reflected similar factors as the fiscal 2006 decrease, including a 14% reduction in headcount. We will continue to focus our research and development investments toward potential growth areas, including investments in our Altix family of servers while leveraging the research and development efforts of our industry partners, as we continue to move to product lines that incorporate industry standard technologies.

Selling, General and Administrative. Fiscal 2006 selling, general and administrative expenses decreased $33 million or 13% compared with fiscal 2005. The decrease was primarily due to a 22% reduction in headcount and other cost savings measures, offset in part by an increase of $8 million in outside consulting expenses driven primarily by professional advisory fees incurred in connection with our cost reduction and strategic planning initiatives and an increase of $5 million for legal expenses that occurred prior to our filing for bankruptcy under Chapter 11. Fiscal 2005 selling, general and administrative expenses decreased $13 million or 5% compared with fiscal 2004. The fiscal 2005 decrease resulted primarily from a 16% decline in headcount as a result of restructuring and personnel attrition, and the impact of our overall expense control measures.

Impairment of Goodwill. We review goodwill for impairment in the fourth quarter of each year, or more frequently if events or circumstances indicate the carrying value of an asset may not be recoverable in accordance with SFAS 142. We perform this test separately for each of our two reporting units. Our reporting units are consistent with the reportable segments identified in Note 18 to our consolidated financial statements in Part II, Item 8 of this Form 10-K. At the end of the third quarter of fiscal 2006, based on a combination of factors, we concluded there were sufficient indicators to require us to assess whether any portion of our recorded goodwill balance was impaired. Based on our estimates of forecasted discounted cash flows as well as our market capitalization, at that time, we concluded that the goodwill in our Products reporting unit was impaired. As a result, we concluded that all of the recorded goodwill in the Products reporting unit ($8 million) was impaired and expensed as a non-cash charge to continuing operations during the third quarter of 2006. See Note 11 to our consolidated financial statements in Part II, Item 8 of this Form 10-K for further information regarding our goodwill impairment assessment.

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Other Operating Expenses. Over the past several years in response to declining revenues, we have initiated a number of restructuring actions, under various plans, aimed at reducing the level of cash consumed in operations and restoring long-term profitability to SGI. These actions have resulted in both headcount reductions and facility closures. Other operating expense for fiscal 2006 consisted mainly of a $20 million charge for severance and related costs, $2 million in costs associated with the cancellation of our Prism and Prism Deskside products offset in part by a net credit of $1 million related to our vacated leased facilities. In addition, on June 27, 2006 we reached an agreement with our landlord, including $25 million in settlement costs, that terminated our lease obligations at Amphitheatre Technology Center (“ATC”) and terminated our lease obligations for two buildings at Crittenden Technology Center (“CTC”). We also amended the lease obligations for a third building at CTC. Upon execution of the settlement for the termination of the lease obligations at ATC and CTC, we recorded a reversal of liabilities of $41 million representing the net present value of future rental payments for the ATC and CTC buildings in the fourth quarter of fiscal 2006 which largely offset previous charges to this category during the year. Other operating expense for fiscal 2005 represented a charge of $18 million for estimated restructuring costs and charges of $10 million for accretion expense on vacated properties still under lease to us. These charges were partially offset by $4 million of adjustments to previously recorded restructuring charges. Other operating expense for fiscal 2004 represented a charge for estimated restructuring costs of $49 million and charges of $3 million related to the impairment of assets. These charges were partially offset by $4 million of adjustments to previously recorded restructuring charges. As of June 30, 2006, as a result of the restructuring actions we have undertaken through June 30, 2006, we anticipate operating cash outflows of $6 million in fiscal 2007 for both severance and related charges and facility-related charges, with the remainder of our restructuring obligations to be paid through fiscal 2011. See Note 5 to our consolidated financial statements in Part II, Item 8 of this Form 10-K for further information regarding our restructuring activities.

Reorganization Items, Net. Reorganization items, net represents amounts incurred as a direct result of the Company’s Chapter 11 filing and are presented separately in our Consolidated Statements of Operations. Such items consist of the following (dollars in thousands):

	2006
Professional fees	$	13,285
Pre-petition liability claim adjustments		755
Write-off of unamortized debt premium and discount, net		(9,381	)
Write-off of unamortized debt issuance costs		3,167
	$	7,826

Interest and Other

Interest and other income (expense) were as follows (in thousands):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Interest expense	$	(16,445	)	$	(16,052	)	$	(19,234	)
Investment gain (loss)	$	(227	)	$	20,703		$	194
Foreign exchange gain (loss)		(197	)		2,774			2,402
Miscellaneous income (expense)		(1,780	)		876			1,807
Interest income		2,357			1,908			1,664
Interest and other income (expense), net	$	153		$	26,261		$	6,067
Loss on extinguishment of tendered debt	$	—		$	—		$	(30,915	)
Earnings (loss) from equity investment	$	855		$	2,512		$	(518	)

Interest Expense. Interest expense increased 2% in fiscal 2006 primarily due to an increase in our outstanding debt associated with a term loan that was part of a new two-year asset-backed credit facility completed in the second quarter of fiscal 2006 coupled with a higher rate of interest on this term loan than interest rates on our existing debt, offset in part by

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interest expense incurred on various non-debt transactions in the ordinary course of business in fiscal 2005. Interest expense decreased 17% in fiscal 2005 primarily due to a reduction in outstanding debt and a $4 million credit to interest expense related to premium amortization on our 6.50% Senior Secured Convertible Notes. Interest expense decreased 25% in fiscal 2004 primarily due to a $7 million credit to interest expense related to premium amortization on our 6.50% Senior Secured Convertible Notes, offset in part by $3 million in interest expense associated with the induced conversion of a portion of these same convertible notes.

Interest Income and Other, Net. Interest income and other, net includes interest income on our cash investments, gains and losses on other investments, and other non-operating items. The Miscellaneous income (expense) component of Interest and other income, net for fiscal 2006 includes $3 million in bank charges primarily associated with our pre-petition credit facility that remained outstanding through June 27, 2006. Interest income and other, net for fiscal 2005 is primarily composed of a $21 million gain on the sale of a portion of our 40% interest in SGI Japan, which after this transaction, reduced our remaining interest to 24% in fiscal 2005. Interest income and other, net for fiscal 2004, excluding the loss on extinguishment of tendered debt, primarily includes the receipt of $2 million in settlement for the termination of a contractual arrangement.

Loss on Extinguishment of Tendered Debt. During the second quarter of fiscal 2004, we successfully completed an exchange offer for 98% of our 5.25% Senior Convertible Notes due to mature in September 2004. We accounted for the exchange offer as a debt extinguishment, resulting in a non-cash loss of approximately $31 million, primarily representing the difference between the fair value of the new debt instruments and the net carrying value of the extinguished debt. The difference was treated as a premium on the new Senior Secured Convertible Notes and was expected to be amortized as an offset to interest expense over the term of the notes. The remaining balance was written off as a reorganization item in the fourth quarter of fiscal 2006 as a result of our bankruptcy proceeding under Chapter 11. See Note 4 to the consolidated financial statements in Part II, Item 8 of this Form 10-K for information related to reorganization items.

Earnings (Loss) from Equity Investment. Earnings (loss) from equity investment represents our share of the earnings of SGI Japan. As noted above, we sold a portion of this investment during fiscal 2005. In fiscal 2006, our ownership percentage was diluted by approximately 4% as a result of new shares issued by SGI Japan.

Provision for Income Taxes

Our net benefit for income taxes from continuing operations for fiscal 2006, fiscal 2005, and fiscal 2004 totaled $4 million, $8 million, and $10 million, respectively. The net tax benefit provision in these years arose principally from the reassessment of our global tax exposures, and refunds associated with certain U.S. Federal, state, and foreign income taxes paid in prior years, partially offset by net income tax expense incurred in foreign jurisdictions. We did not recognize a tax benefit for our fiscal 2006, fiscal 2005, and fiscal 2004 losses, since the resulting deferred tax asset does not meet the criteria for realization under SFAS 109.

At June 30, 2006, we had gross deferred tax assets arising from deductible temporary differences, tax losses, and tax credits of $877 million. The gross deferred tax assets are offset by a valuation allowance of $791 million and deferred tax liabilities of $87 million. The valuation allowance of $791 million included $35 million attributable to tax benefits from stock option deductions, which, if recognized, will be allocated directly to paid-in-capital.

At June 30, 2006, we had U.S. federal, state, and foreign jurisdictional net operating loss carryforwards of $1.4 billion, $386 million, and $171 million, respectively. The federal losses will begin expiring in fiscal 2010, the state losses will begin expiring in fiscal 2007, and the foreign losses will begin to expire in fiscal 2007. At June 30, 2006, we also had general business credit carryovers of $38 million for United States federal tax purposes, which will begin to expire in fiscal 2007, and alternative minimum tax credits of 5 million, which do not have fixed expirations dates. We had state research and development credits of $29 million, which do not have fixed expiration dates, and state manufacturing investment tax credits of $4 million which will begin to expire in fiscal year 2007. As a result of the bankruptcy reorganization, there is expected to be a greater than 50% cumulative shift in SGI’s stock ownership and thus we will not be able to utilize a significant portion of our net operating loss and credit carryforwards to offset income tax liabilities from future profits. See “Risk Factors”.

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We have submitted a claim for a significant refund of U.S. federal income tax relating to the years 1986 through 1988. The recognition of the refund was deferred pending the settlement of two Tax Court cases that were decided in November 2003. Since then we have been in negotiations with the Internal Revenue Service to settle the refund and these negotiations continue. It is unclear what amount of refund, if any, will be obtained and in accordance with SFAS 5, Accounting for Contingencies, as of June 30, 2006, we have not recognized a gain contingency for this refund claim in our consolidated statement of operations or consolidated balance sheet.

Discontinued Operations

On June 15, 2004, we completed the sale of our Alias application software business to a technology-focused private equity firm. As a result of this transaction, we have presented the operating results of Alias as a discontinued operation for all periods presented. We received $58.4 million in gross proceeds from the sale and recorded a net gain of $50.5 million. SGI transferred approximately 430 employees to the buyer as a result of the sale and has no remaining liability related to Alias that would impact our results of operations or liquidity. See Note 8 to the consolidated financial statements in Part II, Item 8 of this Form 10-K for further information.

Off-Balance Sheet Arrangements

In the ordinary course of business, we enter into off-balance sheet arrangements as defined by the SEC Final Rule 67 (“FR-67”), Disclosure in Management’s Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations, including certain guarantees. None of these off-balance sheet arrangements either has, or is reasonably likely to have, a material current or future effect on our financial condition, results of operations, liquidity, or capital resources. See Note 12 to the consolidated financial statements in Part II, Item 8 of this Form 10-K for further information regarding these guarantees.

Contractual Obligations

The following table summarizes our significant contractual obligations at June 30, 2006, and the effect these obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

	Payments Due by Period
	Total		Less than 1 Year		1-3 Years		3-5 Years		More than 5 Years
Long-term debt obligations (1):
$130 Million Debtor In Possession Financing due 2007	$	103,706	$	103,706	$	—	$	—	$	—
Other		913		735		178		—		—
Capital lease obligation		775		300		475		—		—
Operating lease obligations (2)		27,142		10,516		12,165		4,410		51
Purchase obligations (3)		14,165		12,559		1,606		—		—
Restructuring-related obligations (4)		4,845		4,845		—		—		—
Total	$	151,546	$	132,661	$	14,424	$	4,410	$	51

Except for long-term debt, capital lease, and certain restructuring-related obligations, this table does not include contractual obligations that have been recorded on our balance sheet as liabilities or amounts we are financing under our DIP Agreement to support $5 million in letters of credit for rent deposits for our corporate headquarters building in the Crittenden Technology Center campus in Mountain View, California. For further information regarding our DIP Agreement, see “Financial Condition” included in Part II, Item 7, and Note 13 to the consolidated financial statements in Part II, Item 8 of this Form 10-K.

(1) Includes estimated interest payments. Assumes that no additional conversions or early redemptions occur.

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(2) Operating lease obligations consist primarily of non-cancelable operating leases, including facilities vacated as part of our restructuring activities, and do not include the offsetting effect of projected or contractual sublease income. The significant decrease in our operating lease obligations compared with fiscal 2005 was primarily due to the settlement with our landlord to restructure our lease obligations at Amphitheatre Technology Center (“ATC”) and Crittenden Technology Center (“CTC”) campuses in Mountain View, California.

(3) Purchase obligations, as presented in this table, are defined as off-balance sheet agreements to purchase goods or services that are enforceable and legally binding on us and that specify all significant terms, which include the following: fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction. As a result, purchase obligations include all commitments to purchase goods or services of either a fixed or minimum quantity that are non-cancelable, that would cause us to incur a penalty if the agreement was cancelled, or that require us to make specified minimum payments even if we do not take delivery of the contracted goods or services (“take-or-pay” contracts). If the obligation to purchase goods or services is non-cancelable, we consider the entire value of the contract to be the amount of the purchase obligation. If the obligation is cancelable, but we would incur a penalty upon cancellation, we consider the amount of the penalty to be the amount of the purchase obligation. We consider the contracted minimum amounts of take-or-pay contracts to be the amount of the purchase obligation, since that represents the portion of the contract that is a firm commitment. We have estimated the expected timing and amounts of payment of the purchase obligations based on current information; the actual timing and amounts paid may be different due to timing of the receipt of the goods or services or changes to the agreed-upon amounts for obligations.

(4) As a result of our approved restructuring plans, we expect to make these future cash payments, which are primarily for employee severance and all of which have been recorded as liabilities on our consolidated balance sheet at June 30, 2006. This amount excludes obligations related to non-cancelable operating leases for facilities vacated as part of our restructuring activities, which are included in the “operating lease obligations” amount disclosed above.

On August, 30 2006, SGI entered into a commitment letter with Morgan Stanley Senior Funding, Inc. and General Electric Capital Corporation to provide exit liquidity financing as part of the Company’s plan to emerge from bankruptcy in fiscal 2007. The exit financing facility consists of an $85 million term loan from Morgan Stanley Senior Funding, Inc. and a $30 million line of credit from General Electric Capital Corp. that will be used to pay off the existing $130 million DIP Financing, make distributions pursuant to the Plan, and provide working capital for the Company’s ongoing operations. The exit financing facility is expected to mature in five years after the final credit agreement is executed. The estimated annual payments, including estimated interest, over the next five years is as follows (in thousands): fiscal 2007 — $11,269; fiscal 2008 — $12,179; fiscal 2009 — $23,991; fiscal 2010 — $26,727; fiscal 2011 — $24,086 and $39,609 thereafter.

On September 7, 2006 we entered into a Lease Agreement with Christensen Holdings, L.P. for a replacement headquarters facility in Sunnyvale, California. The lease is for approximately 128,154 square feet with an initial five year lease term at $0.977 per square foot in the first year, increasing to $1.137 per square foot by the fifth year. We expect to occupy the new facility by the end of calendar 2006.

Financial Condition

To the extent the matters described below relate to future events or expectations, they may be significantly affected by the Chapter 11 filings. The Chapter 11 filings will involve, or may result in, various restrictions on the Company’s activities, limitations on financing, the need to obtain Court approval for various matters, the discharge of certain obligations and uncertainty as to relationships with vendors, suppliers, customers and others with whom the Company may conduct or seek to conduct business.

Cash Balances. At June 30, 2006, our unrestricted cash and cash equivalents and marketable investments totaled $55 million compared with $64 million at June 24, 2005. At June 30, 2006 and June 24, 2005, we also held approximately $48 million and $40 million, respectively, of restricted investments. Restricted investments at June 30, 2006 and June 24, 2005 consisted of short- and long-term investments pledged as collateral against bank credit facilities or held under a security agreement. The decrease in our cash and cash equivalents compared with the prior year is primarily the result of cash used in our operations and investment activities during fiscal 2006, offset in part by cash provided by our borrowings.

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Cash Consumption Trends. Primarily as a result of net losses, operating activities from continuing operations used $93 million during fiscal 2006, compared with using $98 million during fiscal 2005. The negative operating cash flows from continuing operations in fiscal 2006 were primarily due to our net losses and low revenue levels. We generated $35 million from our accounts receivable during fiscal 2006, an increase from the $21 million that was generated during the same period of fiscal 2005. During fiscal 2006, inventory increased $3 million compared to the $20 million increase in inventory reported in fiscal 2005 resulting from lower revenue levels coupled with continued focus on inventory management. Our accounts payable decreased $49 million in fiscal 2006 compared with a decrease of $7 million in the same period of fiscal 2005 primarily due to $55 million in pre-petition liabilities reclassified to liabilities subject to compromise as a result of our filing for bankruptcy under Chapter 11. During fiscal 2006 deferred revenue increased $34 million compared with a decrease of $4 million in the same period of fiscal 2005, primarily resulting from the timing of revenue recognition of sales transactions. During fiscal 2006, our accrued compensation decreased $5 million compared with the $3 million decrease in accrued compensation in the same period of fiscal 2005 primarily due to headcount reductions. During fiscal 2006, we reduced our days sales outstanding from 49 days at June 24, 2005 to 45 days at June 30, 2006.

Cash used in our operating activities from continuing operations increased by $36 million from fiscal 2004 to fiscal 2005, which is primarily due to our revenue decreasing more rapidly than we were able to adjust our operating expenses. This increase was not reflected in our net loss from continuing operations, which decreased by $25 million, because some items included in the computation of our fiscal 2005 and fiscal 2004 net losses do not affect operating cash flow. The most significant of these items are as follows: the inclusion in the fiscal 2004 net loss of a $31 million loss on the early extinguishment of debt, which does not affect operating cash flow; the reduction of the fiscal 2005 net loss by a $21 million gain on the sale of an equity investment, which does not affect operating cash flow; and the benefit to the fiscal 2005 net loss from a $17 million reduction in depreciation and amortization charges, which are non-cash expenses. Our operating cash flow did benefit from a $14 million increase from fiscal 2004 to fiscal 2005 for prepayments we have received from our customers for customer support contracts and longer delivery-cycle contracts, for which revenue recognition is deferred. During fiscal 2005, we maintained our focus on customer cash collections, as our days sales outstanding were 49 days at both June 24, 2005 and June 25, 2004.

Included in our cash used in operating activities from continuing operations are cash payments related to our past restructuring actions. Cash payments for severance and contractual and facilities obligations related to these actions totaled approximately $57 million, $40 million, and $53 million in fiscal 2006, fiscal 2005, and fiscal 2004, respectively. We expect these past restructuring actions to result in cash outlays of approximately $10 million subsequent to June 30, 2006, of which approximately $6 million are projected to occur in fiscal 2007.

Investing activities, other than changes in our marketable and restricted investments, used $11 million in cash during fiscal 2006. Our principal investing activity during fiscal 2006 was the purchase of $7 million of property and equipment. Investing activities, other than changes in our marketable and restricted investments, generated $14 million in cash during fiscal 2005. Our principal investing activity during fiscal 2005 was the sale of 40% of our investment in SGI Japan, which generated $29 million of cash. This was partially offset by purchases of property and equipment of $12 million. Investing activities, other than changes in our marketable and restricted investments, provided $42 million in cash during fiscal 2004. Our principal investing activity was the sale of our manufacturing facility in Cortaillod, Switzerland for proceeds of $11 million. These proceeds were partially offset by $18 million in purchases of property and equipment and a $9 million increase in other assets, including $4 million in debenture issuance costs. Additionally, we had net cash provided by discontinued operations investing and operating activities of $58 million in 2004 as a result of the sale of our Alias application software business, including proceeds from the sale.

Financing activities over the past three years have included the repayment of debt and the issuance of common stock in a private placement transaction and under employee stock purchase and option plans. Financing activities provided $103 million and $28 million during fiscal 2006 and fiscal 2004, respectively, and used $10 million during fiscal 2005. During fiscal 2006, we repaid debt principal of $78 million and received proceeds of $178 million from DIP funding issued while under Chapter 11. We also received proceeds of $3 million from stock issued under our employee stock plans. During fiscal 2005, we repaid debt principal of $18 million and received proceeds of $4 million from stock issued under our employee stock plans and $4 million from lease financing of customer support contracts and other financing. Our principal financing activity during fiscal 2004 was the sale of 18 million shares of our common stock to certain institutional investors in a private placement transaction. This transaction had an aggregate sale price of $50 million and provided us with net

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proceeds of $47 million. During fiscal 2004, we also completed an exchange offer under which we issued $226 million principal amount of 6.50% Senior Secured Convertible Notes and 11.75% Senior Secured Notes, both due 2009, in exchange for notes that would otherwise have matured in September 2004. In connection with this transaction, we repaid $18 million of our debt and paid approximately $4 million in debt issuance costs.

We have incurred net losses and negative cash flows from operations during each of the past several fiscal years. At June 30, 2006, our principal sources of liquidity included unrestricted cash and marketable investments of $55 million, down from $64 million at June 24, 2005. Currently, we expect to continue consuming cash from operations through at least the first half of fiscal 2007. We also experience significant intra-quarter fluctuations in our cash levels, with the result that our cash balances are generally at their highest point at the end of each quarter and significantly lower at other times. These intra-quarter fluctuations reflect our business cycle, with significant requirements for inventory purchases in the early part of the quarter and most sales closing in the last few weeks of the quarter. To maintain adequate levels of unrestricted cash within each quarter, we offer certain customers discounted terms for early payment and hold certain vendor payments to the beginning of the following quarter. We also continue to focus on expense controls, margin improvement initiatives and working capital efficiencies. However, it is essential to our operating plan for fiscal 2007 that we complete the execution of the definitive agreements associated with our exit financing. See “Restructuring Activities and Additional Capital”.

Credit Arrangements. On October 25, 2005, we announced the completion of a new two-year asset-backed credit facility with Wells Fargo Foothill, Inc. and Ableco Finance LLC. The new facility provided for credit of up to $100 million, consisting of a $50 million revolving line of credit and a $50 million term loan. The borrowing base under our credit facility was determined weekly based on the value of working capital items, real estate and intellectual property. Our facility was secured by substantially all of the assets of SGI and our domestic subsidiaries (the “Borrowers”) and, together with the indentures governing our Senior Secured Notes, included covenants for minimum levels of EBITDA, minimum levels of cash and cash equivalents, and limits on capital expenditures. Subject to certain specified exceptions, the facility and the indentures governing our Senior Secured Notes also limited our ability to incur additional indebtedness, create liens on our assets, enter into certain transactions (including mergers, consolidations and reorganizations), dispose of certain assets, pay dividends or other distributions on capital stock, repurchase capital stock, or prepay or repurchase debt obligations. Our credit facility was subject to acceleration upon various events of default and failure to comply with these covenants could entitle the lender to accelerate the underlying obligations. On several occasions during the past three fiscal years, we were in violation of financial and administrative covenants in the predecessor credit facility. In each case, we received a waiver of compliance from the lender.

At June 27, 2006, we had an outstanding balance of $30 million against the term loan. Through June 27, 2006 we were using our revolving line of credit under this facility to support letters of credit, including letters of credit required under our lease obligations for the Crittenden and Amphitheatre Technology Center campuses in Mountain View, California and to support our current operations. This facility was paid in full on June 28, 2006 with funds from our $130 million DIP Financing described below.

On May 26, 2006, we reached a settlement with our landlord to restructure our lease obligations at Amphitheatre Technology Center (“ATC”) and Crittenden Technology Center (“CTC”) and received Court approval of the settlement on June 15, 2006. This settlement terminated our lease obligations at ATC and terminated our lease obligations for two buildings at CTC as of June 30, 2006. It also amended our lease obligations for a third building at CTC. Pursuant to the agreement, we vacated the two buildings at CTC by June 30, 2006 and plan to vacate our third building by December 31, 2006.

At June 24, 2005, we had outstanding $191 million, in aggregate principal amount of senior secured convertible notes and senior secured notes, both due in 2009, and $57 million in aggregate principal amount of convertible subordinated debentures, due in 2011. As a result of filing for bankruptcy under Chapter 11 and in accordance with SOP 90-7, the Senior Secured Convertible Notes, the Senior Secured Notes and the 6.125% Convertible Subordinated Debentures were considered subject to compromise at June 30, 2006. Our Senior Secured Notes contain a covenant that limits our ability to incur indebtedness to banks and other institutional lenders in excess of $100 million, including any indebtedness under our credit facility unless such condition is waived.

During the fourth quarter of fiscal 2005, we received a notice of default from an investor claiming to own more than 25% of our outstanding 2011 convertible subordinated debentures. We assumed these debentures when we acquired Cray Research in 1996. The notice alleges that in 2000 we violated the indenture for the 2011 Debentures when we sold certain assets relating to the former Cray Research vector computing business to Tera Computer (now known as Cray, Inc.) without having them assume the indenture. We strongly disagree with the claims made in the notice and intend to vigorously challenge any claim of an event of default. There is currently $57 million outstanding principal amount of 2011 Debentures. The 2011 Debentures are unsecured and subordinated. Upon the effective date of the Plan, all of the claims of the 2011 Debentures will have been addressed in accordance with the terms of the Plan and all claims relating to defaults will be discharged.

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DIP Financing. On May 10, 2006, we entered into an Interim DIP Agreement with the Interim DIP Lenders. The Interim DIP Agreement provided a $70 million term loan to the Borrowers secured by certain of the Borrowers’ assets for which we borrowed $28 million through June 27, 2006. In June 2006, the Debtors entered into the DIP Agreement with the DIP Lenders providing up to $130 million of debtor-in-possession financing. This DIP Agreement was approved by the Court on June 26, 2006 and we borrowed $100 million against this facility, of which a portion of the funds were used to repay our outstanding borrowings against the $70 million Interim DIP Financing and our pre-petition asset-backed credit facility.

Restructuring Activities and Additional Capital. In the fourth quarter of fiscal 2005 we retained the turnaround firm AlixPartners LLC to advise us regarding further expense reductions, increasing revenue, improving liquidity and our intentions to initiate restructuring actions in the first quarter of fiscal 2006. During fiscal 2006, we implemented restructuring activities under three fiscal 2006 restructuring plans. These actions included headcount reductions, initiatives to reduce costs in other areas, including procurement costs for goods and services, consolidation and reorganization of operations in several locations, focusing marketing spending on the highest priority activities, and benefits and other spending controls. The original goal of our fiscal 2006 restructuring actions was to achieve $80 to $100 million in annualized cost savings when fully realized. In the third quarter of fiscal 2006, we increased our goal of $100 million in annualized savings to $150 million in annualized savings. We have taken actions during fiscal 2006 that we believe achieve the anticipated $150 million in annualized savings. We have seen considerable cost savings benefit during fiscal 2006 from these initiatives and expect to realize the remaining saving during fiscal 2007.

Forecasts of future events are inherently uncertain, and there are significant risks associated with the achievement of our goals for fiscal 2007. While we are implementing initiatives aimed at improving revenue and margins for our core systems products, we expect to continue consuming cash from operations through at least the first half of fiscal 2007. We expect the $130 million DIP Financing to provide adequate liquidity to meet our operating needs through our expected emergence from bankruptcy. On August, 30 2006, SGI signed a commitment letter with Morgan Stanley Senior Funding, Inc. and General Electric Capital Corporation to provide exit financing as part of our plan to emerge from bankruptcy in fiscal 2007. The exit financing facility consists of an $85 million term loan from Morgan Stanley Senior Funding, Inc. and a $30 million line of credit from General Electric Capital Corp. that will be used to pay off the existing $130 million DIP Financing, make distributions pursuant to the Plan, and provide working capital for our ongoing operations. The exit financing facility is expected to mature in five years after the final credit agreement is executed. The new financing is subject to the execution of definitive agreements and customary closing conditions and is expected to be completed in October 2006 to coincide with our emergence from bankruptcy. We cannot be certain however, that arrangements for this or other additional financing will be successfully completed, that we will be able to maintain compliance with all of the covenants contained in any additional financing, or that the additional financing would be adequate to achieve our objectives. If we are unable to achieve the goals of our going-forward business plan and operational restructuring strategy, we may be forced to sell all or parts of our business or develop and implement further restructuring plans.

Fresh-Start Reporting

The Company’s emergence from Chapter 11 proceedings will result in a new reporting entity and adoption of fresh-start reporting in accordance with SOP 90-7. The condensed consolidated financial statements as of June 30, 2006 do not give effect to any adjustments in the carrying values of assets or liabilities that will be recorded upon implementation of the Company’s Plan of Reorganization.

The following unaudited pro forma financial information reflects implementation of the Plan of Reorganization as if it had been effective on June 30, 2006. Reorganization adjustments have been estimated in the pro forma financial information to reflect the discharge of certain pre-petition liabilities and the adoption of fresh-start reporting in accordance with SOP 90-7. The pro forma fair value allocated to the assets and liabilities of the Company is in conformity with SFAS No. 141 “Business Combinations” (“SFAS 141”).

Estimated reorganization adjustments in the following pro forma balance sheet result primarily from the:

i. changes in the carrying values of assets and liabilities to reflect fair values including the establishment of certain intangible assets;

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ii. discharge of the Company’s pre-petition liabilities in accordance with the Plan of Reorganization;

iii. addition of new financing;

iv. issuance of New Silicon Graphics, Inc. Common Stock and cancellations of old common stock;

These adjustments are based upon the preliminary work of the Company and its financial consultants to determine the relative fair value of the Company’s assets and liabilities. The allocation of the reorganization enterprise value to individual assets and liabilities will change based upon completion of the fair valuation process and will result in differences to the fresh-start adjustments and allocated values estimated in this pro forma information. In accordance with SFAS 141, the fair value adjustments will be finalized within twelve months from the effective date of the Plan of Reorganization.

In addition, in accordance with SOP 90-7, upon implementation of fresh-start reporting New Silicon Graphics will be required to adopt pending changes in accounting principles required by new pronouncements. We have not yet completed our assessment of the impact of adopting such new pronouncements and the following unaudited pro forma financial information does not include the impact, if any, of such new pronouncements.

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SILICON GRAPHICS, INC.

CONDENSED CONSOLIDATED PRO FORMA BALANCE SHEET ^(a)

(In thousands, except shares and par value, unaudited)

	Historical June 30, 2006			Plan Reorganization Adjustments			Fresh-Start Valuation Adjustments			Pro Forma June 30, 2006
Assets
Cash & Cash Equivalents	$	54,673		$	38,529	(b), (i)		—		$	93,202
Short term marketable investments		203			—			—			203
Short term restricted investments		32,539			—			—			32,539
Accounts receivable, net of allowance for doubtful accounts of $3,117		58,417			—			—			58,417
Inventories, net		49,997			—			14,203	(g)		64,200
Prepaid Expenses		10,457			—			—			10,457
Other Current Assets		54,723			—			—			54,723
Total current assets		261,009			38,529			14,203			313,740
Restricted Investments		15,959			—			—			15,959
Property and equipment, net of accumulated depreciation and amortization		27,873			—			15,037	(g)		42,910
Goodwill		4,515			—			(4,515	)(g)		—
Other non-current assets, net		70,703			2,000	(c)		110,497	(g)		183,200
Unallocated excess of (deficiency of) reorganization value		—			—			44,866	(g)		44,866
Total assets	$	380,058		$	40,529		$	180,088		$	600,675
Liabilities and shareholders’ equity (deficit)
Current Liabilities:
Accounts Payable		8,951			39,074	(d), (i)		—			48,025
Accrued compensation		29,224			—			—			29,224
Income Taxes Payable		1,596			—			—			1,596
Other current liabilities		43,325			6,500	(d), (i)		—			49,825
Current portion of long term debt		103,124			(100,000	)(f)		(2,420	)(g)		703
Current portion of deferred revenue		124,379			—			—	(g)		124,379
Current portion of restructuring liability		6,067			—			—			6,067
Total current liabilities		316,667			(54,426	)		(2,420	)		259,820
Noncurrent Liabilities:
Long-term Debt		397			85,000	(b)		(221	)(g)		85,176
Non-current portion of deferred revenue		45,538			—			—	(g)		45,538
Other non-current liabilities		27,681			—			(3,265	)(g)		24,416
Total liabilities not subject to compromise		390,282			30,574			(5,906	)		414,951
Liabilities subject to compromise		320,230			(320,230	)(d)		—			—
Total liabilities		710,512			(289,657	)		(5,906	)		414,951
Stockholders’ Equity (Deficit):
Common stock		1,564,504			178,964	(e)		(1,557,744	)(h)		185,725
Accumulated Deficit		(1,868,202	)		144,461	(e)		1,723,741	(h)		—
Treasury stock, at cost		(6,760	)		6,760	(e)		—			—
Accumulated other comprehensive loss		(19,997	)		—			19,997	(h)		—
Total shareholders’ equity (deficit)		(330,454	)		330,185			185,994			185,725
Total liabilities and stockholders’ equity (deficit)	$	380,058		$	40,529		$	180,088		$	600,675

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a. The Condensed Consolidated Pro Forma Balance Sheet estimates the effect of implementing the Plan and fresh-start reporting which will be required for financial reporting upon emergence. Under fresh-start reporting, which is required by SOP 90-7, reorganization enterprise value of $242.5 million based on the Disclosure Statement (see Note 1 of our consolidated financial statements), which, after reduction for the New Debt and remaining non-Debtor interest bearing liabilities, results in a reorganization equity value of $183.1 million.

The adjustments in the condensed consolidated projected pro forma balance sheet are based on estimates. Actual adjustments will be based on the final valuation and may be materially different than those presented herein.

b. Reflects repayment of the DIP facility of $100 million, the new term loan of $85 million, which the Company has secured for exit financing, the issuance of 7.5 million shares issued through the Rights offering for $48 million, net of backstop and rights offering fees, 1.125 million overallotment shares for $7.5 million, and payment of $2 million for exit financing fees.

c. Reflects the capitalization of the Exit Financing fees associated with the acquisition of the new term loan of $85 million and the new working capital facility of $30 million. The Condensed Consolidated Pro Forma Balance Sheet does not include any borrowings against the working capital facility.

d. Reflects the discharge of SGI’s pre-petition liabilities in accordance with the Plan of Reorganization and the reclassification of remaining liabilities subject to compromise to the appropriate liability accounts in accordance with the Plan of Reorganization. Discharge of SGI’s pre-petition liabilities is summarized as follows (in thousands):

To be exchanged for stock	$	190,964
To be paid in cash		114,001
	$	304,965

Additionally, in accordance with the Plan, holders of the Cray Unsecured Notes received the right to purchase shares 700,000 shares of New SGI stock for $6.67 per share, and holders of the SGI Senior Secured Notes and Senior Secured Convertible Notes received the right to purchase an additional 6.8 million shares of New SGI stock for $6.67 per share.

e. Reflects the issuance of New SGI Common stock to pre-petition creditors and the gain on the discharge of liabilities subject to compromise.

f. Reflects the repayment of the $100 million DIP facility.

g. Reflects changes to the carrying values of assets and liabilities to reflect fair values. The unallocated excess of reorganization value will be determined upon the finalization of fresh start accounting. It is likely that the deferred revenue balances will be significantly reduced by the valuation adjustments, but we are unable to allocate the amount at this time.

h. Reflects the elimination of historical retained deficit and other equity accounts and an adjustment to shareholder’s equity to result in the estimated reorganized equity value in accordance with SOP 90-7 (see note a above).

i. The Condensed Consolidated Pro Forma Balance Sheet does not give effect to cash payments estimated at $47.6 million to unsecured creditors and for taxes, interest and other costs pursuant to the Plan of Reorganization.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, we evaluate these estimates, including: those related to customer programs and incentives; bad debts; inventory; lease residual values; warranty obligations; restructuring; incomes taxes and contingencies. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.

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

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

Revenue Recognition. We recognize revenue from sales when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectibility is reasonably assured. Certain revenue is generated from contracts where we are obligated to deliver multiple products and/or services. In these instances, we must assess the arrangement to determine whether the elements of the arrangement should be treated as separate units of accounting for revenue recognition purposes and if so, how the total contract price should be allocated among the elements and when revenue should be recognized for each element. We recognize revenue for delivered elements only when there is objective and reliable evidence of the fair value of the undelivered items and customer acceptance, if applicable, has been obtained. Allocation of the total contract price between each element of the arrangement may impact the timing of revenue recognition, but will not change the total revenue recognized on the contract. For revenue arrangements that include or represent software products and services as well as any non-software deliverables for which a software deliverable is more than incidental to its functionality, we apply the accounting guidance in SOP 97-2, “Software Revenue Recognition” in determining the timing of revenue recognition.

Occasionally, we enter into arrangements in which substantial modification of software is required. Percentage of completion revenue recognition is applied when we can reasonably estimate costs and progress toward completion. We recognize revenue in accordance with SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” as work progresses based on the percentage that incurred costs to date bear to estimated total costs.

Product Warranties. We provide for the estimated cost to warrant our products against defects in materials and workmanship at the time revenue is recognized. We estimate our warranty obligation based on factors such as product life cycle analysis and historical experience, and our estimate is affected by data such as product failure rates, material usage and service delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required. On a quarterly basis, these estimates are reviewed and adjusted as considered necessary based on the factors noted above. Changes in product warranty estimates decreased our product warranty liability by approximately $1 million in both fiscal 2006 and fiscal 2004 and increased our product warranty liability by approximately $1 million in fiscal 2005.

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

Lease Residual Values. We retain an estimated unguaranteed residual value interest in the products sold under certain sales-type lease arrangements, representing the estimated fair market value of the equipment at the end of the lease

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term. The residual value is derived for each significant product family based upon the following factors: historical data regarding recovery of residual values; current assessment of market conditions for used equipment; and any forward-looking projections deemed significant, particularly those relating to upcoming technology or changing market conditions. Residual values are evaluated periodically to determine if other-than-temporary declines in estimated residual values are indicated. Any anticipated increase in future residual values is not recognized until the used equipment is remarketed. Factors that could cause actual results to differ materially from the estimates include severe changes in the used equipment market and unforeseen changes in technology.

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

Valuation of Goodwill. We review goodwill for impairment in the fourth quarter of each year, or more frequently if events or circumstances indicate the carrying value of an asset may not be recoverable in accordance with SFAS 142, Goodwill and Other Intangible Assets. The provisions of SFAS 142 require that a two-step impairment test be performed on goodwill. In the first step, we compare the fair value of each reporting unit to its carrying value. Our reporting units are consistent with the reportable segments identified in Note 18 of the consolidated financial statements in Part II, Item 8 of this Form 10-K. We determine the fair value of our reporting units using both an income approach and market approach. Under the income approach, we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. Under the market approach, we estimate fair value based on what investors are paying for similar interests in comparable companies through the development of ratios of market prices to various earnings indications of comparable companies taking into consideration adjustments for growth prospects, debt levels and overall size. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. We recorded an $8 million non-cash charge for the impairment of goodwill in the third quarter of fiscal 2006.

The process of evaluating the potential impairment of goodwill is subjective and requires significant estimates and assumptions at many points during the analysis. In determining the fair value of a reporting unit we make estimates and assumptions about these reporting units. Our estimated future cash flows are based on assumptions that are consistent with our annual planning process and include estimates for revenue and operating margins and future economic and market conditions. We base our fair value estimates on assumptions we believe to be reasonable at the time, but that are unpredictable and inherently uncertain. In addition, we make certain judgments and assumptions in allocating shared assets and liabilities to determine the carrying values for each of our reporting units. Actual future results may differ from those estimates.

Impairment of Long-Lived Assets. Carrying values for our long-lived tangible assets are assessed for possible impairment in accordance with the requirements of SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Impairment tests are conducted when our management team identifies events or when it believes that changes in circumstances that indicate that the carrying amount of a long-lived asset may not be recoverable. Such events or changes in circumstances may include the discontinuation of a product or product line, a sudden or consistent decline in the forecast for a product, changes in technology or in the way an asset is being used, a history of operating or cash flow losses or an adverse change in legal factors or in the business climate. Our impairment review to determine if a potential impairment charge is required is based on an undiscounted cash flow analysis. This analysis requires judgment with respect to many factors, including future cash flows, changes in technology, the continued success of product lines and future volume and revenue and expense growth rates. It is possible that our estimates of undiscounted cash flows may change in the future resulting in the need to reassess the carrying value of our long-lived assets for impairment.

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Stock-Based Compensation Expense. We account for stock-based compensation in accordance with the provisions of SFAS 123(R). Under the fair value recognition provisions of SFAS 123(R), stock-based compensation cost is estimated at the grant date based on the value of the award and is recognized as expense ratably over the requisite service period of the award. Determining the appropriate fair value model and calculating the fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rates and expected option life. The actual results may differ from the estimates which could cause future operating results to differ from expectations.

Restructuring. In recent fiscal years, we have recorded significant accruals in connection with our restructuring programs. These accruals include estimates of employee separation costs and the settlements of contractual obligations, including lease terminations resulting from our actions. Accruals associated with vacated facilities and related asset impairments are estimated in accordance with SFAS 5, Accounting for Contingencies, and SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, respectively. Estimates may be adjusted upward or downward upon occurrence of a future triggering event. Triggering events may include, but are not limited to, changes in estimated time to sublease, sublease terms and sublease rates. Due to the extended contractual obligations of certain of these leases and the inherent volatility of commercial real estate markets, we expect to make future adjustments to these vacated facilities accruals. Over the past three years, various triggering events have caused our estimates to increase by $1 million in fiscal 2006 and to decrease by $5 million and $4 million in fiscal 2005 and 2004, respectively.

Income Taxes. Estimates and judgments occur in the calculation of certain tax liabilities and in the determination of the recoverability of certain deferred tax assets, which arise from temporary differences and carryforwards. We regularly assess the likelihood that our deferred tax assets will be realized from recoverable income taxes or recovered from future taxable income based on the realization criteria set forth under SFAS 109, Accounting for Income Taxes, and we record a valuation allowance to reduce our deferred tax assets to the amount that we believe to be probable of realization. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will probably be due. If payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer probable. If our estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.

Loss Contingencies. We record an obligation for loss contingencies when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Contingent liabilities are often resolved over long time periods and there is a reasonable probability that the ultimate loss will differ from and perhaps exceed the recorded provision. Estimating probable losses requires analysis of multiple factors that often depend on judgments about the outcome of pending lawsuits and potential actions by third parties including government agencies. Over the past two years, we have resolved lawsuits whereby the ultimate outcome caused us to partially reverse previously recorded contingent liabilities in the amount of $0.5 million and $5 million in fiscal 2005, and 2004, respectively. No such adjustments were recorded in fiscal 2006.

Other Significant Accounting Policies. Other significant accounting policies not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies regarding financial instruments and consolidation require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. Certain of these matters are among topics currently under reexamination by accounting standards setters and regulators. Specific conclusions reached by these standards setters may cause a material change in our accounting policies.

Recent Accounting Pronouncements

See Note 2 to our consolidated financial statements in Part II, Item 8 of this Form 10-K for a description of recent accounting pronouncements, including our expected adoption dates and estimated effects on our results of operations, financial condition, and cash flows.

45

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the normal course of business, our financial position is routinely subject to a variety of risks, including market risk associated with interest rate movements, market risk associated with currency rate movements on non-U.S. dollar denominated assets and liabilities, and credit risk related to the collectibility of accounts receivable. We regularly assess these risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. As a result, we do not anticipate material losses in these areas.

Our exposure to interest rate risk relates primarily to our investment portfolio and our debt portfolio. However, as a result of our filing for bankruptcy under Chapter 11, the Senior Secured Convertible Notes, the Senior Secured Notes and the 6.125% Convertible Subordinated Debentures are considered subject to compromise and interest is no longer accrued on these instruments. Fixed rate securities may have their fair market value adversely impacted due to fluctuations in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. The interest expense on our current debt portfolio would be adversely impacted due to an increase in interest rates and favorably impacted due to a decrease in interest rates.

Our exposure to foreign currency exchange rate risk relates to sales commitments, anticipated sales, purchases and other expenses, and assets and liabilities denominated in foreign currencies. For most currencies, we are a net receiver of the foreign currency and are adversely affected by a stronger U.S. dollar relative to the foreign currency. To protect against reductions in value caused by adverse changes in currency exchange rates, we have established balance sheet and forecasted transaction risk management programs.

We primarily use forward contracts to hedge our foreign currency balance sheet exposures. We recognize the gains and losses on foreign currency forward contracts in the same period as the re-measurement losses and gains of the related foreign currency-denominated exposures.

We use a combination of forward contracts and options designated as cash flow hedges to protect against the foreign currency exchange rate risks inherent in our forecasted net revenue denominated in currencies other than the U.S. dollar. We record the portion of the gain or loss in the fair value of our cash flow hedges that is determined to be an effective hedge as a component of other comprehensive loss, and we recognize this amount in our earnings as revenue in the same period or periods in which the hedged transaction affects earnings. We recognize in other income (expense), net on our statement of operations any remaining, ineffective portion of the gain or loss on a hedging instrument during the period of the change.

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

For purposes of specific risk analysis, we use sensitivity analysis to determine the impact that market risk exposures may have on the fair values of our debt and financial instruments. The financial instruments included in the sensitivity analysis consist of all of our cash and cash equivalents, marketable investments, short-term and long-term debt, and all derivative financial instruments. Currency forward contracts and currency options constitute our portfolio of derivative financial instruments.

To perform sensitivity analysis, we assess the risk of loss in fair values from the impact of hypothetical changes in interest rates and foreign currency exchange rates on market sensitive instruments. We compute the market values for interest risk based on the present value of future cash flows as impacted by the changes in rates attributable to the market risk being measured. We selected the discount rates used for the present value computations based on market interest rates in effect at June 30, 2006 and June 24, 2005. We computed the market values for foreign exchange risk based on spot rates in effect at June 30, 2006 and June 24, 2005. The market values that result from these computations are compared to the market values of these financial instruments at June 30, 2006 and June 24, 2005. The differences in this comparison are the hypothetical gains or losses associated with each type of risk.

46

The results of the sensitivity analyses at June 30, 2006 and June 24, 2005 were as follows:

Interest Rate Risk: A percentage point decrease in the levels of interest rates with all other variables held constant would have resulted in no increase in the aggregate fair value of our financial instruments at June 30, 2006 and an increase in the aggregate fair value of our financial instruments of $8 million at June 24, 2005. A percentage point increase in the levels of interest rates with all other variables held constant would have resulted in no decrease in the aggregate fair value of our financial instruments at June 30, 2006 and a decrease in the aggregate fair value of our financial instruments of $8 million at June 24, 2005.

Foreign Currency Exchange Rate Risk: A 10% strengthening of foreign currency exchange rates against the U.S. dollar with all other variables held constant would have resulted in a decrease in the aggregate fair value of our financial instruments of $5 million at June 30, 2006 and $8 million at June 24, 2005. A 10% weakening of foreign currency exchange rates against the U.S. dollar with all other variables held constant would have resulted in an increase in the aggregate fair value of our financial instruments of $5 million at June 30, 2006 and $9 million at June 24, 2005.

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

47

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements

	Page
Financial Statements:
Report of Independent Registered Public Accounting Firm	49
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting	50
Consolidated Statements of Operations	52
Consolidated Balance Sheets	53
Consolidated Statements of Cash Flows	54
Consolidated Statements of Stockholders’ Deficit	55
Notes to Consolidated Financial Statements	56
Financial Statement Schedule:
Schedule II—Valuation and Qualifying Accounts	104

48

Report of KPMG LLP, Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Silicon Graphics, Inc.

We have audited the accompanying consolidated balance sheet of Silicon Graphics, Inc. and subsidiaries (Debtors-in-Possesion) as of June 30, 2006, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for the year ended June 30, 2006. In connection with our audit of the consolidated financial statements, we also have audited the financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of June 30, 2006 and the results of their operations and their cash flows for the year ended June 30, 2006, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

The accompanying consolidated financial statements and financial statement schedule have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company has incurred recurring operating losses and negative cash flows, has a stockholders’ deficit and has filed a voluntary petition seeking to reorganize under Chapter 11 of the United States Bankruptcy Code all, of which raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The accompanying financial statements and financial statement schedule do not include any adjustments that might result from the outcome of this uncertainty.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of June 30, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated October 13, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

Mountain View, California

October 13, 2006

49

Report of KPMG LLP, Independent Registered Public Accounting Firm on Internal Control over Financial Reporting

To the Board of Directors and Stockholders of Silicon Graphics, Inc.

We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that Silicon Graphics, Inc. and subsidiaries (Debtors-in-Possession) maintained effective internal control over financial reporting as of June 30, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Silicon Graphics, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Silicon Graphics, Inc. maintained effective internal control over financial reporting as of June 30, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Silicon Graphics, Inc. maintained, in all material respects, effective internal control over financial reporting as of June 30, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Silicon Graphics, Inc. as of June 30, 2006, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for the year ended June 30, 2006, and the related financial statement schedule, and our report dated October 13, 2006 expressed an unqualified opinion on those consolidated financial statements and financial statement schedule.

/s/ KPMG LLP

Mountain View, California

October 13, 2006

50

Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Silicon Graphics, Inc.

We have audited the accompanying consolidated balance sheet of Silicon Graphics, Inc. as of June 24, 2005, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for each of the two years in the period ended June 24, 2005. Our audits also included the financial statement schedule listed in the index at Item 15(a) as of June 24, 2005 and June 25, 2004. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Silicon Graphics, Inc. at June 24, 2005, and the consolidated results of its operations and its cash flows for each of the two years in the period ended June 24, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule at June 24, 2005 and June 25, 2004, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

The accompanying financial statements and schedule have been prepared assuming that Silicon Graphics, Inc. will continue as a going concern. As more fully described in Note 1, Silicon Graphics, Inc. has incurred recurring operating losses, negative cash flows and has a stockholders’ deficit. These conditions raise substantial doubt about Silicon Graphics, Inc.’s ability to continue as a going concern. (Management’s plans in regard to these matters are also described in Note 1.) The financial statements and schedule do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

/s/ Ernst & Young LLP

San Jose, California

September 15, 2005

51

SILICON GRAPHICS, INC.

(Debtors-in-Possession)

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Revenue:
Product and other revenue	$	223,259		$	391,322		$	473,154
Product revenue from related party		28,836			44,658			25,990
Service revenue		266,710			293,985			342,858
Total revenue		518,805			729,965			842,002
Costs and expenses:
Cost of product and other revenue		177,328			285,428			292,628
Cost of service revenue		143,105			179,648			200,217
Research and development		83,677			92,705			108,763
Selling, general, and administrative		211,731			244,568			257,742
Impairment of goodwill		8,386			—			—
Other operating expenses		21,155			24,083			47,825
Total costs and expenses		645,382			826,432			907,175
Operating loss		(126,577	)		(96,467	)		(65,173	)
Interest expense (contractual interest of $18,735 in 2006)		(16,445	)		(16,052	)		(19,234	)
Interest and other income (expense), net		153			26,261			(24,848	)
Earnings (loss) from equity investment		855			2,512			(518	)
Loss from continuing operations before reorganization items and income taxes		(142,014	)		(83,746	)		(109,773	)
Reorganization items, net		(7,826	)		—			—
Loss from continuing operations before income taxes		(149,840	)		(83,746	)		(109,773	)
Income tax benefit		3,646			8,014			9,527
Net loss from continuing operations		(146,194	)		(75,732	)		(100,246	)
Discontinued operations:
Net income from discontinued operations, net of tax		—			—			3,975
(Loss) gain on disposition of discontinued operations, net of tax		—			(276	)		50,501
Net loss	$	(146,194	)	$	(76,008	)	$	(45,770	)
Net (loss) income per common share – basic and diluted:
Continuing operations	$	(0.54	)	$	(0.29	)	$	(0.44	)
Discontinued operations		—			(0.00	)		0.24
Net loss per share - basic and diluted	$	(0.54	)	$	(0.29	)	$	(0.20	)
Weighted-average shares used to compute net loss per share – basic and diluted		269,367			263,430			227,837

See accompanying notes to consolidated financial statements.

52

SILICON GRAPHICS, INC.

(Debtors-in-Possession)

CONSOLIDATED BALANCE SHEETS

(In thousands, except shares and par value)

	June 30, 2006			June 24, 2005
Assets:
Current assets:
Cash and cash equivalents	$	54,673		$	64,247
Short-term marketable investments		203			39
Short-term restricted investments		32,539			39,757
Accounts receivable, net of allowance for doubtful accounts of $3,117 in 2006 and $2,227 in 2005		58,417			93,335
Inventories		49,997			75,662
Prepaid expenses		10,457			5,666
Other current assets		54,723			37,765
Total current assets		261,009			316,471
Restricted investments		15,959			413
Property and equipment, net of accumulated depreciation and amortization		27,873			56,257
Goodwill		4,515			12,901
Other non-current assets, net		70,702			66,103
	$	380,058		$	452,145
Liabilities and Stockholders’ Deficit:
Current liabilities:
Accounts payable	$	8,951		$	58,075
Accrued compensation		29,224			34,062
Income taxes payable		1,596			2,689
Other current liabilities		43,325			56,260
Current portion of long-term debt		103,124			1,820
Current portion of deferred revenue		124,379			98,305
Current portion of restructuring liability		6,067			16,270
Total current liabilities		316,666			267,481
Long-term debt		397			261,992
Non-current portion of deferred revenue		45,538			36,188
Other non-current liabilities		27,681			77,672
Total liabilities not subject to compromise		390,282			643,333
Liabilities subject to compromise		320,230			—
Total liabilities		710,512			643,333
Commitments and contingencies
Stockholders’ deficit:
Common stock, $.001 par value, and additional paid-in capital; 750,000,000 shares authorized; shares issued: 2006 - 274,887,761; 2005 - 265,845,397; shares outstanding: 2006 - 274,247,196; 2005 - 265,192,795		1,564,504			1,555,033
Accumulated deficit		(1,868,201	)		(1,721,981	)
Treasury stock, at cost: 640,565 shares in 2006 and 652,602 shares in 2005		(6,760	)		(6,792	)
Accumulated other comprehensive loss		(19,997	)		(17,448	)
Total stockholders’ deficit		(330,454	)		(191,188	)
	$	380,058		$	452,145

See accompanying notes to consolidated financial statements.

53

SILICON GRAPHICS, INC.

(Debtors-in-Possession)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Cash Flows From Operating Activities of Continuing Operations:
Net loss	$	(146,194	)	$	(76,008	)	$	(45,770	)
Income from discontinued operations		—			—			(3,975	)
Loss (gain) on disposition of discontinued operations		—			276			(50,501	)
Net loss from continuing operations		(146,194	)		(75,732	)		(100,246	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		48,343			59,062			79,461
Amortization of premium and discount on long-term debt, net		(3,147	)		(3,441	)		(6,446	)
Non-cash recovery for reorganization items		(6,214	)		—			—
Impairment of goodwill		8,386			—			—
Share-based compensation expense		2,184			—			—
Loss on early extinguishment of debt		—			—			30,915
Non-cash interest expense on induced debt conversion		—			—			3,089
Gain on sale of equity investment		—			(20,541	)		—
Non-cash restructuring charges (recoveries)		(1,587	)		(1,479	)		3,062
Other		(110	)		(2,692	)		1,858
Changes in operating assets and liabilities:
Accounts receivable		34,917			20,566			3,029
Inventories		(3,324	)		(20,408	)		(7,907	)
Accounts payable		(49,123	)		(7,167	)		(10,710	)
Accrued compensation		(4,838	)		(2,734	)		517
Deferred revenue		34,125			(4,233	)		(18,350	)
Accounts payable and accrued liabilities subject to compromise		72,490			—			—
Other assets and liabilities		(78,697	)		(39,399	)		(40,521	)
Total adjustments		53,405			(22,466	)		37,997
Net cash used in operating activities of continuing operations		(92,789	)		(98,198	)		(62,249	)
Cash Flows From Investing Activities of Continuing Operations:
Marketable investments:
Purchases		(666	)		(185	)		(1,608	)
Maturities		503			2,156			38
Restricted investments:
Purchases		(43,524	)		(53,900	)		(87,706	)
Maturities		35,278			55,119			100,165
Proceeds from the sale of equity investment		—			29,085			—
Proceeds from the sale of corporate real estate and other assets		—			—			10,615
Purchases of property and equipment		(7,028	)		(12,444	)		(17,866	)
Increase in other assets		(4,102	)		(2,458	)		(9,138	)
Net cash provided by (used in) investing activities of continuing operations		(19,539	)		17,373			(5,500	)
Cash Flows From Financing Activities of Continuing Operations:
Payments of debt principal		(78,678	)		(17,684	)		(18,056	)
Proceeds from debt principal		178,000			1,677			—
Payments of debt issuance costs		—			—			(3,618	)
Net proceeds from financing arrangements		559			2,210			—
Proceeds from employee stock plans		2,873			4,014			2,579
Net proceeds from sale of SGI common stock through private placement		—			—			47,270
Net cash provided by (used in) financing activities of continuing operations		102,754			(9,783	)		28,175
Cash Flows from Discontinued Operations:
Net cash provided by operating and investing activities		—			—			58,401
Net cash provided by discontinued operations		0			0			58,401
Net (decrease) increase in cash and cash equivalents		(9,574	)		(90,608	)		18,827
Cash and cash equivalents at beginning of year - continuing operations		64,247			154,855			136,028
Cash and cash equivalents at end of year - continuing operations	$	54,673		$	64,247		$	154,855

See accompanying notes to consolidated financial statements.

54

SILICON GRAPHICS, INC.

(Debtors-in-Possession)

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT

(In thousands, except shares)

	Common Stock and Additional Paid-in Capital			Accumulated Deficit			Treasury Stock			Accumulated Other Comprehensive Loss			Total Stockholders’ Deficit
Balance at June 27, 2003	$	1,467,798		$	(1,606,049	)	$	(6,715	)	$	(19,925	)	$	(164,891	)
Components of comprehensive loss:
Net loss		—			(45,770	)		—			—			(45,770	)
Currency translation adjustments		—			—			—			928			928
Currency translation adjustment included in net income of discontinued operations											(1,598	)		(1,598	)
Change in unrealized loss on derivative instruments designated and qualifying as cash flow hedges		—			—			—			236			236
Total comprehensive loss														(46,204	)
Adjustment to stock issued for settlement of securities class action lawsuit		(5,849	)		5,849			—			—			—
Issuance of common stock (18,181,818 shares) under private placement net of issuance costs		47,270			—			—			—			47,270
Issuance of common stock (27,260,480 shares) through debt conversions		35,274			—			—			—			35,274
Issuance of common stock (959,520 shares) through induced conversion incentive		3,090			—									3,090
Issuance of common stock (3,645,761 shares) under employee stock plans—net		2,842			—			(59	)		—			2,783
Balance at June 25, 2004		1,550,425			(1,645,970	)		(6,774	)		(20,359	)		(122,678	)
Components of comprehensive loss:
Net loss		—			(76,008	)		—			—			(76,008	)
Currency translation adjustments		—			—			—			1,047			1,047
Change in unrealized loss on derivative instruments designated and qualifying as cash flow hedges		—			—			—			1,864			1,864
Total comprehensive loss														(73,097	)
Issuance of common stock (402,400 shares) through debt conversions		503			—			—			—			503
Issuance of common stock (3,611,119 shares) and treasury stock (2,257 shares) net of treasury stock purchases (18,557 shares) under employee stock plans—net		4,105			(3	)		(18	)		—			4,084
Balance at June 24, 2005		1,555,033			(1,721,981	)		(6,792	)		(17,448	)		(191,188	)
Components of comprehensive loss:
Net loss		—			(146,194	)		—			—			(146,194	)
Currency translation adjustments		—			—			—			(982	)		(982	)
Change in unrealized gain on derivative instruments designated and qualifying as cash flow hedges		—			—			—			(1,567	)		(1,567	)
Total comprehensive loss														(148,743	)
Issuance of common stock (9,054,401 shares) and treasury stock (12,037 shares) under employee stock plans—net		2,942			(26	)		32			—			2,948
Stock-based compensation		2,184			—			—			—			2,184
Increase in interest in equity investment		4,345			—			—			—			4,345
Balance at June 30, 2006	$	1,564,504		$	(1,868,201	)	$	(6,760	)	$	(19,997	)	$	(330,454	)

See accompanying notes to consolidated financial statements.

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SILICON GRAPHICS, INC., et al.

(Debtors-in-Possession)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Operations

SGI is a leading provider of products, services, and solutions for use in high-performance computing and storage. We sell highly scalable servers, storage solutions, and associated software products that enable our customers in the scientific, technical and business communities to solve their most challenging problems and provide them with strategic and competitive advantages. Whether analyzing images to aid in brain surgery, studying global climate changes, accelerating the engineering of new automotive designs, providing technologies for homeland security, or gaining business “intelligence” from mining a company’s databases, SGI’s systems are designed to compute vast amounts of data, translate data into high-resolution images in a realistic time-frame and scale, and provide high-speed storage. We also offer a range of services and solutions, including professional services, customer support, and education. These products and services are used in a range of application segments including defense and intelligence, sciences, engineering analysis, and enterprise data management.

Our products are manufactured in Chippewa Falls, Wisconsin. We distribute our products through our direct sales force and through indirect channels including resellers, distributors and system integrators. Product and other revenue consist primarily of revenue from computer system and software product shipments and from system leasing, technology licensing agreements, and non-recurring engineering contracts. Service revenue results from customer support and maintenance contracts and from delivery of professional services.

The accompanying audited consolidated financial statements have been prepared assuming we will continue as a going concern, which assumes continuity of operations and realization of assets and satisfaction of liabilities in the ordinary course of business. The consolidated financial statements do not include any adjustments that might be required should we be unable to continue to operate as a going concern.

We have incurred operating losses and negative cash flows from operations during each of the past several fiscal years. Our working capital deficit at June 30, 2006 was $56 million, down from working capital of $49 million at June 24, 2005. Additionally, we had a stockholders’ deficit of $330 million at June 30, 2006. Our unrestricted cash and marketable investments at June 30, 2006 were $55 million, down from $64 million at June 24, 2005.

Our ability, both during and after the Chapter 11 Cases, to continue as a going-concern is dependent upon, among other things, (i) our ability to successfully achieve required cost savings to complete our restructuring; (ii) our ability to maintain adequate cash on hand; (iii) our ability to generate cash from operations; (iv) the consummation of a plan of reorganization under the Bankruptcy Code; and (v) our ability to achieve profitability. There can be no assurance that we will be able to successfully achieve these objectives in order to continue as a going-concern. The accompanying consolidated financial statements do not include any adjustments that might result should we be unable to continue as a going-concern.

Proceedings Under Chapter 11 of the Bankruptcy Code

Chapter 11 Reorganization

On May 8, 2006 (the “Petition Date”), Silicon Graphics, Inc. (“the Company” or “SGI”) and certain of its subsidiaries (collectively, the “Debtors”), filed voluntary petitions for reorganization under chapter 11 of Title 11 (“Chapter 11”) of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Court”) (Case Nos. 06-10977BRL through 06-10990BRL) (the “Chapter 11 Cases”). The Company filed jointly with the following direct and indirect subsidiaries: Silicon Graphics Federal, Inc., Cray Research, LLC, Silicon Graphics Real Estate, Inc., Silicon Graphics World Trade Corporation, Silicon Studio, Inc., Cray Research America Latina Ltd., Cray Research Eastern Europe Ltd., Cray Research India Ltd., Cray Research International, Inc., Cray Financial Corporation, Cray Asia Pacific, Inc., ParaGraph International, Inc., and WTI-Development, Inc. Certain subsidiaries of SGI, consisting principally of international subsidiaries, are not debtors (collectively, the “Non-Debtors”) in this bankruptcy proceeding. The Debtors remain in possession of their assets and properties as debtors-in-possession (“DIP”) under the jurisdiction of the Court and in accordance with the provisions of the Bankruptcy Code. In general, as debtors-in-possession, each of the Debtors is authorized 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.

We have sought and obtained Court approval through our “first day” and subsequent motions to pay certain foreign vendors, meet our pre- and post-petition payroll obligations, maintain our cash management systems, pay our taxes, continue to provide employee benefits, honor certain pre-petition customer programs, and maintain our insurance programs. In addition, the Court has approved certain trading notification and transfer procedures designed to allow restrictions in the trading of our common stock (and related securities) which could negatively impact our accrued net operating losses and other tax attributes.

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On May 10, 2006, SGI, Silicon Graphics Federal, Inc. and Silicon Graphics World Trade Corporation (collectively, the “Borrowers”) entered into a Post-Petition Loan and Security Agreement (the “Interim DIP Agreement”) dated as of May 8, 2006 with Quadrangle Master Funding Ltd., Watershed Technology Holdings, LLC and Encore Fund, L.P. (collectively, the “Interim DIP Lenders”). The Interim DIP Agreement provided $70 million of DIP financing (the “$70 million DIP Financing”) to the Borrowers secured by certain of the Borrowers’ assets. The interest rate under the Interim DIP Agreement was the per annum rate equal to the greater of (i) the rate of interest published in the Wall Street Journal from time to time as the “Prime Rate” plus seven percentage points or (ii) 250 basis points higher than the rate at which cash interest was then payable under the Company’s pre-petition credit agreement, provided that upon an event of default, the then current interest rate under the Interim DIP Agreement would be increased by two percentage points.

In June 2006, the Debtors entered into a replacement Post-Petition Loan and Security Agreement (the “DIP Agreement”) with Morgan Stanley Senior Funding, Inc., (the “Administrative Agent”), Wells Fargo Foothill, Inc., the Interim DIP Lenders and certain other lenders party thereto (collectively, the “DIP Lenders”), providing up to $130 million of debtor-in-possession financing (the “$130 million DIP Financing”). The $130 million DIP Financing was approved by the Court on June 26, 2006. The Order approving the $130 million DIP Financing (i) authorized the Debtors to incur post-petition secured indebtedness in the amount of up to $130 million while granting to the Administrative Agent and lenders thereunder, subject to specified “permitted” prior liens, and a “carve-out” for specified professional fees and other costs and expenses, superpriority administrative expense claims and first priority priming liens against, and security interests in, substantially all of the Debtors’ then-owned and after-acquired property, (ii) authorized the Debtors to repay amounts owed under their pre-petition credit agreement, which was repaid on June 28, 2006, (iii) authorized the Debtors to repay amounts borrowed under the Interim DIP Agreement, and (iv) authorized the Debtors’ use of cash collateral of their secured notes and granted to the secured noteholders certain adequate protection of their interests therein.

At a hearing held on July 27, 2006, the Court approved the Company’s Disclosure Statement, ruling that it contained adequate information for soliciting creditor approval of the Company’s Plan as amended (the “Plan”). At a hearing held on September 19, 2006, the Court confirmed the Company’s Plan. This Confirmation Order became a Final Order on October 2, 2006. We expect to emerge in October subject to the remaining conditions precedent to emergence:

• The conditions precedent to the effectiveness of the Exit Facility and the Backstop Commitment Agreement are satisfied or waived by the parties thereto and the Reorganized Debtors have access to funding under the Exit Facility;

• Allowed General Unsecured SGI Federal Claims and Allowed General Unsecured SGI World Trade Claims shall not aggregate more than $1 million;

• All actions, agreements, instruments or other documents necessary to implement the terms and provisions of the Plan are effected or executed and delivered, as applicable; and

• All authorizations, consents and regulatory approvals, if any, required by the Debtors in connection with the consummation of the Plan are obtained and not revoked.

Subject to certain exceptions in the Bankruptcy Code, the Chapter 11 filings automatically stayed the initiation or continuation of most actions against the Debtors, including most actions to collect pre-petition indebtedness or to exercise control over the property of the bankruptcy estates. As a result, absent an order of the Court, creditors are precluded from collecting pre-petition debts and substantially all pre-petition liabilities are subject to compromise under the Plan.

Under the Bankruptcy Code, the Debtors also have the right to assume, assume and assign, or reject certain executory contracts and unexpired leases, subject to the approval of the Court and certain other conditions. Generally, the assumption of an executory contract or unexpired lease requires a debtor to cure certain existing defaults under the contract, including the payment of accrued but unpaid pre-petition liabilities. Rejection of an executory contract or unexpired lease is typically treated as a breach of the contract or lease, immediately prior to the Chapter 11 filing. Subject to certain exceptions, this rejection relieves the debtor from performing its future obligations under that contract but entitles the counterparty to assert a pre-petition general unsecured claim for damages. Parties to executory contracts or unexpired leases rejected by a debtor may file proofs of claim against that debtor’s estate for damages.

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For the duration of the Chapter 11 Cases, our business is subject to the risks and uncertainties of bankruptcy. For example, the Chapter 11 Cases could adversely affect our relationships with customers, suppliers and employees which in turn could adversely affect the going concern value of our businesses and of our assets. Also, transactions outside of the ordinary course of business are subject to the prior approval of the Court which may limit our ability to respond to certain market events or take advantage of certain market opportunities, and, as a result, our operations could be materially adversely affected.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation. The accompanying audited consolidated financial statements have been prepared assuming we will continue as a going concern, which assumes continuity of operations and realization of assets and satisfaction of liabilities in the ordinary course of business. The consolidated financial statements do not include any adjustments that might be required should we be unable to continue to operate as a going concern. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The accompanying consolidated financial statements include the accounts of SGI and our wholly- and majority-owned subsidiaries (both Debtor and Non-Debtor). All significant intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the financial position, results of operations, and cash flows for all periods presented have been made.

Accounting for Reorganization. The accompanying consolidated financial statements of SGI have been prepared in accordance with Statement of Position 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,” and on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. However, as a result of the bankruptcy filings, such realization of assets and satisfaction of liabilities are subject to a significant number of uncertainties. SGI’s consolidated financial statements do not reflect adjustments that might be required if SGI (or any of the Debtors) is unable to continue as a going concern.

Reclassifications. Certain revisions have been made to all periods presented in the consolidated financial statements to conform to current year presentation. As described in Note 8, we have classified the financial results of our Alias application software business as discontinued operations for all periods presented. Included in the statement of cash flows is a fiscal 2004 revision to separately disclose the investing activities from discontinued operations. These notes to our consolidated financial statements relate to continuing operations only, unless otherwise indicated.

Foreign Currency Translation. We translate the assets and liabilities of our foreign subsidiaries stated in local functional currencies to U.S. dollars at the rates of exchange in effect at the end of the period, except for inventory, property, plant and equipment and certain other assets, which we remeasure at their historical exchange rates. We translate revenues and expenses using rates of exchange in effect during the period, except for those expenses related to the previously noted balance sheet amounts, which are remeasured at historical exchange rates. We are a U.S. dollar functional currency company. As such, translation adjustments resulting from remeasuring the financial statements of subsidiaries into the U.S. dollar are included in our results of operations. For fiscal 2006, fiscal 2005, and fiscal 2004, currency transaction gains or losses net of hedging gains or losses, were not significant to our results of operations. Investments accounted for using the equity method in an investee that reports in a foreign currency are translated in conformity with Statement of Financial Accounting Standards No. (“SFAS”) 52, Foreign Currency Translation, at the rate of exchange in effect at the end of the period with the resulting translation adjustment recorded directly to accumulated other comprehensive loss, a separate component of stockholders’ deficit.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses as presented in our consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.

Cash Equivalents and Marketable and Restricted Investments. Cash equivalents consist of high credit quality money market instruments with maturities of 90 days or less at the date of purchase. Short-term marketable investments and restricted investments consist of both high credit quality money market instruments and high credit quality debt securities with maturities of one year or less, and are stated at fair value.

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At June 30, 2006 and June 24, 2005, our restricted investments consist of short- and long-term investments that are pledged as collateral against letters of credit or held under a security agreement. The majority of our restricted investments is currently pledged as collateral against letters of credit and are primarily associated with two specific customer arrangements for significant multi-year contracts with long-term delivery and installation commitments. Restricted investments are held in SGI’s name by major financial institutions (see Note 7).

The cost of securities when sold is based upon specific identification. We include realized gains and losses and declines in value of available-for-sale securities that we judge to be other-than-temporary in interest income and other, net. We include unrealized gains and losses, net of tax, on securities classified as available-for-sale in accumulated other comprehensive loss, a component of stockholders’ deficit.

Fair Values of Financial Instruments. The carrying values of short-term debt and cash equivalents approximate fair value due to the short period of time to maturity. The fair values of marketable investments, long-term debt, foreign exchange forward contracts, and currency options are based on quoted market prices or pricing models.

Derivative Financial Instruments. We use derivative financial instruments to moderate the financial market risks of our business operations by hedging the foreign currency market exposures underlying certain assets and liabilities and certain commitments related to customer transactions. We do not invest in derivative financial instruments for speculative or trading purposes. See Note 7 for more information about our derivative financial instruments and the accounting policies that we apply to them.

Accounts Receivable and Allowance for Doubtful Accounts. Our accounts receivable consists of short-term, non-interest-bearing trade receivables, which we record at the amounts due to us from our customers, less an allowance for doubtful accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. When we become aware of a specific customer’s inability to pay their outstanding obligation, for reasons such as deterioration in their operating results or financial position or bankruptcy proceedings, we record a specific reserve to reduce their receivable to the amount that we reasonably believe is collectible. We also record general allowances for doubtful accounts for our entire customer population based on a variety of factors, including the length of time the receivables are past due and historical experience.

Inventories. Manufacturing inventories are stated at the lower of cost (first-in, first-out) or market. Demonstration systems are stated at cost less depreciation, generally based on a fifteen-month life. Costs include material, labor and manufacturing overhead.

Property and Equipment. We state property and equipment at cost and compute depreciation expense using the straight-line method. We depreciate machinery and equipment and furniture and fixtures over useful lives of two to five years, and we amortize leasehold improvements over the shorter of their useful lives or the term of the lease. We depreciate our buildings over twenty-five to forty-five years and improvements over the remaining life of the building.

Capitalized Software. In accordance with SOP 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” we capitalize certain costs incurred to acquire or create internal use software, principally related to software coding, designing system interfaces, and installation and testing of the software. Capitalized costs are included in property and equipment (see Note 11) and are amortized over periods ranging from 3 to 5 years.

Long-Lived Assets. We account for our long-lived tangible assets and definite-lived intangible assets in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. As a result, we assess long-lived assets classified as “held and used”, including property and equipment, assets under capital leases, spares inventory and long term prepaid assets subject to amortization, for impairment whenever events or changes in business circumstances arise that may indicate that the carrying amount of a long-lived asset may not be recoverable, such as a significant current period operating or cash flow loss combined with a history of such losses. Under SFAS 144, an impairment loss would be calculated when the sum of the estimated future undiscounted cash flows expected to result from the use of an asset and its eventual disposition is less than the carrying amount of the asset. Because of our fiscal 2006 operating and cash flow losses and our history of such losses, we evaluated our long-lived assets for impairment during fiscal 2006; based on the results of this evaluation, the carrying value of these assets were determined to be

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recoverable. Nonetheless, it is possible that our estimates of undiscounted cash flows may change in the future resulting in the need to reassess the carrying value of our long-lived assets for impairment. As required by SFAS 144, we classify long-lived assets as “held for sale” only when all of the criteria for a qualifying plan of sale are met, and we reassess the “fair value less cost to sell” of such assets each reporting period. We continue to classify long-lived assets to be disposed of other than by sale as “held and used” until they are actually disposed of.

Other Assets. Included in other assets are spare parts that are generally depreciated on a straight-line basis over an estimated useful life of five years and equity investments in certain technology companies that are carried at either market value or the lower of cost or market. Our investment in SGI Japan comprised the majority of our total equity investments for fiscal 2006 and fiscal 2005. Goodwill of $5 million is also included in other assets.

Goodwill. Our goodwill resulted from the acquisition of Silicon Graphics World Trade Corporation in fiscal 1991. As required by SFAS 142, we ceased amortizing goodwill and began annually testing goodwill for impairment. We perform this test separately for each of our two reporting units, which correspond to our two reportable segments. In prior years, we performed our annual impairment test as of the last day of our fiscal year. For fiscal 2005 and forward, we have changed the measurement date to the first day of our fourth fiscal quarter in order to provide additional time to quantify the fair value of our reporting units and to evaluate the results of the impairment testing. This change did not have a material effect on our financial position, results of operations, or cash flows. We would also test goodwill for impairment if an event occurs or a circumstance changes that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

We perform the goodwill impairment test using a two-step approach. First, we compare the carrying amount of each reporting unit to its fair value, which we estimate using a present value technique. If the carrying value of a reporting unit exceeds its fair value, we perform the second step of the impairment test. In this step, we recognize an impairment loss for the excess, if any, of the carrying amount of the reporting unit’s goodwill over the implied fair value of the goodwill. The implied fair value of a reporting unit’s goodwill is the amount by which the fair value of the entire reporting unit exceeds the sum of the individual fair values of its assets, except goodwill, less the sum of the individual fair values of its liabilities.

Income taxes. We estimate our income tax provision or benefit in each of the jurisdictions in which we operate, including estimating exposures related to examinations by taxing authorities. We must also make judgments regarding the realizability of deferred tax assets. The carrying value of our net deferred tax asset is based on our belief that it is more likely than not that we will generate sufficient future taxable income in certain jurisdictions to realize these deferred tax assets. A valuation allowance has been established for deferred tax assets which we do not believe meet the more likely than not criteria established by SFAS No. 109, “Accounting for Income Taxes.” Our judgments regarding future taxable income may change due to changes in market conditions, changes in tax laws, tax planning strategies or other factors. If our assumptions and consequently our estimates change in the future, the valuation allowances we have established may be increased or decreased, impacting future income tax expense. The effective tax rate is highly dependent upon the geographic distribution of our worldwide earnings or loss, tax regulations in each geographic region, the availability of tax credits and carryforwards, and the effectiveness of our tax planning strategies. We regularly monitor the assumptions used in estimating our annual effective tax rate and adjust our estimates accordingly. If actual results differ from our estimates, future income tax expense could be materially affected.

Revenue Recognition. SGI enters into revenue arrangements to sell products and services for which we are obligated to deliver multiple products and/or services. A typical multiple-element arrangement includes SGI product, third party product or services, SGI consulting services and SGI maintenance services.

In the first quarter of fiscal 2004, we adopted Emerging Issues Task Force Issue No. (“EITF”) 00-21, Revenue Arrangements with Multiple Deliverables. Under EITF 00-21, multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting. In performing the assessment, we first apply the separation criteria within FTB 90-1 Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts to separate the deliverables falling within the scope of FTB 90-1. Multiple-element arrangements are separated into more than one element if all of the following are met:

• The delivered item(s) has value to the customer on a standalone basis.

• There is objective and reliable evidence of the fair value of the undelivered item(s).

• If the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially within our control.

If all of the above criteria are not met, revenue associated with the arrangement is deferred until the criteria are met on all undelivered elements, or the entire arrangement has been delivered. If objective and reliable evidence of fair value is

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available for all elements of the arrangement, revenue is allocated to each element based upon the relative fair value of each element to the total arrangement value. The price charged when an element is sold separately generally determines fair value. In the absence of fair value for a delivered element, we allocate revenue first to the fair value of the undelivered elements and then allocate the residual value to the delivered elements. In the absence of fair value for an undelivered element, the entire arrangement is accounted for as a single unit of accounting and revenue for the delivered elements is deferred until the undelivered elements have been delivered.

In multiple element revenue arrangements that include software that is more than incidental to the products or services as a whole, software and software-related elements are accounted for in accordance with AICPA Statement of Position (“SOP”) No. 97- 2, “Software Revenue Recognition”, as amended by SOP 98-9. Software-related elements include software products and services, as well as any non-software deliverable for which a software deliverable is essential to its functionality. We allocate revenue to each element based upon vendor-specific objective evidence (“VSOE”) of the fair value of the element or, if VSOE is not available, by application of the residual method. VSOE of fair value for an element is based upon the price charged when the element is sold separately.

Effective for fiscal 2006, and for certain of our storage solution arrangements whereby software is essential to the functionality, we are applying the accounting guidance in SOP 97-2, in determining the timing of 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 for fiscal 2006, these same products should be accounted for under the provisions of SOP 97-2. In fiscal 2006 we were not able to establish VSOE on our post-contract customer support (“PCS”) services. Accordingly, when PCS is an element of the sale arrangement, revenue and the related costs (product and third-party consulting) on the entire arrangement will generally be deferred and recognized over the initial customer support period.

Occasionally, we enter into a multiple-element arrangement in which substantial modification of software is one element of the arrangement and that software does not provide separate value to the customer. In this instance, the entire arrangement is accounted for in accordance with SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts”. Percentage of completion revenue recognition is applied when we can reasonably estimate costs and progress toward completion. We recognize revenue as work progresses based on the percentage that incurred costs to date bear to estimated total costs. If we are unable to reasonably estimate costs and progress toward completion, we utilize the completed contract method of revenue recognition. Notwithstanding the recognition of revenue using this method, the contracts are reviewed on a regular basis to determine whether a loss contract exists. A loss will be accrued in the period in which estimated contract revenue is less than the current estimate of total contract costs. Revenue recognized under these arrangements are not significant for any periods presented.

After application of the appropriate accounting guidance to our multiple element arrangements, the revenue policies described below are then applied to each unit of accounting.

Product (hardware and software) Revenue. We recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable and collectibility is reasonably assured. The product is considered delivered to the customer (including distributors, channel partners and resellers) once it has been shipped, and title and risk of loss have transferred. Sales of certain high performance systems may be made on the basis of contracts that include acceptance criteria. In these instances, we recognize revenue upon acceptance by the customer or independent distributor. We defer the fair value of products that have been shipped to the customer but for which the appropriate revenue recognition criteria (e.g. customer acceptance) have not yet been met. We reduce product revenue for certain stock rotation and price protection rights that may occur under contractual arrangements we have with certain resellers. Estimated sales returns are also provided for as a reduction to product revenue and were not material for any period presented in the consolidated financial statements.

Certain of our customers prefer to acquire our products under a sales type lease arrangement. We recognize revenue on these arrangements when the criteria under both SFAS 13, Lease Accounting, and SAB 104 have been met. The resulting receivables generated under these arrangements are generally sold to unrelated financing companies and are accounted for in accordance with SFAS 140, Accounting for the Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. In accordance with the criteria set forth in SFAS 140, transfers of such receivables are recorded as a sale of assets. We do maintain an unguaranteed residual value in the products sold under sales-type lease arrangements. We record this unguaranteed residual value as an asset in our balance sheet and measure it on an ongoing basis at the estimated fair market value of the equipment at the end of the lease term. We separately estimate this residual value for each significant product family considering the following factors: historical data regarding recovery of residual values, our current assessment of market conditions for used equipment, and any forward-looking projections we deem significant, particularly those relating to upcoming technology or changing market conditions. We periodically evaluate the residual values for indicators of other-than-temporary decline, in which case we would adjust the recorded residual values; we would not recognize any increase in residual values until the used equipment is resold. The estimated amounts of our unguaranteed residual value interests in leases sold was $5 million at both June 30, 2006 and June 24, 2005.

Service Revenue. We recognize service revenue when persuasive evidence of an arrangement exists, the service has been rendered, the price is fixed or determinable, and collectibility is reasonably assured. Revenue related to future commitments under service contracts is deferred and recognized ratably over the related contract term. Consulting and installation revenue is generally recognized when the service has been performed. Service revenue includes third-party product and is subject to the revenue policies that apply to product revenue.

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Royalty Revenue. We recognize royalty revenue under fixed fee arrangements the quarter in which the revenue is earned in accordance with the contractual terms and conditions. Under volume-based technology agreements, where we are unable to reliably estimate licenses volume, we recognize revenue in the quarter in which we receive reports from licensees detailing the shipments of products incorporating our intellectual property components. The reports are generally received on a one-quarter lag basis from when the royalty revenues were earned.

Engineering Service Revenue. We recognize engineering services revenue when services are rendered, or when an identifiable portion of the contract is completed, no significant post-delivery obligations exist, and collectibility is reasonably assured.

Royalty and engineering service revenues were not significant for any periods presented.

Shipping and Handling Costs. Shipping and handling costs are classified as a component of cost of sales. Customer payments of shipping and handling costs are recorded as product and other revenue.

Product Warranty. At the time of sale, we provide for an estimated cost to warrant our products against defects in materials and workmanship for a period of up to one year on UNIX and Linux systems and up to three years on storage systems.

Advertising Costs. We record advertising costs as expense of the period in which they are incurred. Advertising expense from continuing operations for fiscal 2006, fiscal 2005, and fiscal 2004 was $1.6 million, $0.5 million, and $2 million, respectively.

Per Share Data. Basic earnings per share is based on the weighted effect of all common shares issued and outstanding, and is calculated by dividing net loss by the weighted average shares outstanding during the period. Diluted earnings per share is calculated by dividing net income, adjusted for the effect, if any, from assumed conversion of all

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potentially dilutive common shares outstanding, by the weighted average number of common shares used in the basic earnings per share calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive common shares outstanding.

Recent Accounting Pronouncements. In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections, which supersedes APB 20, Accounting Changes, and SFAS 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 changes the method for reporting an accounting change. Under SFAS 154, accounting changes must be retrospectively applied to all prior periods whose financial statements are presented, unless the change in accounting principle is due to a new pronouncement that provides other transition guidance or unless application of the retrospective method is impracticable. Under the retrospective method, companies will no longer present the cumulative effect of a change in accounting principle in their statement of operations for the period of the change. SFAS 154 carries forward unchanged APB 20’s guidance for reporting corrections of errors in previously issued financial statements and for reporting changes in accounting estimates. SFAS 154 will be effective for our fiscal year 2007. We do not expect the adoption of SFAS 154 to have a material effect on our financial position, results of operations, or cash flows.

In June 2005, the FASB issued FASB Staff Position No. (“FSP”) FAS 143-1, Accounting for Electronic Equipment Waste Obligations. FSP FAS 143-1 addresses the accounting for obligations associated with Directive 2002/96/EC on Electrical and Electronic Equipment (the “Directive”) adopted by the European Union (“EU”). FSP FAS 143-1 will be effective the later of our fiscal 2006 or the date that an EU member country in which we might have an obligation adopts the Directive. To date, the adoption of FSP FAS 143-1 in those countries which have already adopted the Directive has not had a material effect on our financial position, results of operations, or cash flows and we do not expect the adoption of FSP FAS 143-1 by countries in the future to have a material effect on our financial position, results of operations, or cash flows.

In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 provides the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Recognition occurs when a company concludes that a tax position is more likely than not to be sustained upon examination. Measurement is only addressed if recognition has been satisfied. The tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, that is more likely than not to be realized upon ultimate settlement. FIN 48 will be effective for our fiscal year 2008. We have not determined what effect, if any, the adoption of FIN 48 will have on our financial statements.

In July 2006, the FASB issued FASB Staff Position No. (“FSP”) APB 18-1, Accounting by an Investor for Its Proportionate share of Accumulated Other Comprehensive Income of an Investee Accounted for under the Equity Method in Accordance with APB Opinion No. 18 upon a Loss of Significant Influence. FSP APB 18-1 requires companies to offset their proportionate share of an investee’s equity adjustments for other comprehensive income against the carrying value of the investment at the time significant influence is lost. To the extent that the offset results in a carrying value of the investment that is less than zero, a company should reduce the carrying value of the investment to zero and record the remaining balance in income. FSP APB 18-1 will be effective for our second quarter of fiscal year 2007. We do not expect the adoption of FSP APB 18-1 to have a material effect on our financial position, results of operations, or cash flows.

Note 3. Share-Based Compensation

During fiscal 2006, fiscal 2005 and fiscal 2004, we had three active share-based compensation plans, and two Board approved share-based agreements as described below. Our accounting for our current stock-based compensation plans will continue to be recorded in our results of operations during our bankruptcy proceedings. Under the Plan, all of our existing common stock, stock options, and restricted stock awards will be cancelled upon consummation of the Plan by the Court and our exit from Chapter 11, and the holders of such securities will receive no recovery.

Our Amended and Restated 1993 Long-Term Incentive Stock Plan (the “1993 Plan”) permits the grant to our employees of up to 3,800,000 restricted shares of our common stock and up to 30,938,808 of share options on our common stock. The 1993 Plan also permits the issuance of stock appreciation rights (“SARs”). Option awards are generally granted with an exercise price equal to the market price of our common stock at the date of grant; those awards

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generally vest based on four years of continuous service and have seven-year contractual terms. Restricted share awards generally vest in four annual installments. Vesting may be accelerated if there is a change in control of SGI and the successor corporation does not assume or issue an equivalent share right. Currently, there are no shares of restricted stock subject to repurchase under this plan.

Our Amended and Restated 1996 Supplemental Non-Executive Equity Incentive Plan (the “1996 Plan”) permits the grant of shares of our common stock or equivalent instruments to our employees (which may be subject to conditions and restrictions) and/or of share options on up to a total of 22,500,000 shares of our common stock. Option awards are generally granted with an exercise price equal to the market price of our common stock at the date of grant; those awards generally vest based on four years of continuous service and have seven-year contractual terms. Restricted share awards generally vest in four annual installments. Vesting may be accelerated if there is a change in control of SGI and the successor corporation does not assume or issue an equivalent share right. Currently, there are no shares of restricted stock subject to repurchase under this plan.

Our Amended and Restated 1998 Employee Stock Purchase Plan (“ESPP”) allows eligible employees to purchase our stock through payroll deductions at 85% of the lower of the closing price for the stock at the beginning or the end of the six-month purchase period. Purchases are limited to 10% of each employee’s compensation and cannot exceed an amount set by the Board of Directors. On January 26, 2006, the Board of Directors suspended new offering periods under the ESPP until otherwise determined by the Board.

On January 26, 2006, the Board approved certain minor amendments to the 1993 Plan, 1996 Plan and ESPP program required to qualify the grant of options and issuance of shares under the plans under applicable state securities laws.

On February 1, 2006, the Company entered into an agreement to issue 5,368,044 non-qualified stock options to Dennis McKenna, President, Chief Executive Officer, and Chairman of the Board. These options will cliff vest 25% on February 1, 2007 and then in equal quarterly installments over the remaining 36 months. The exercise price is $0.35 per share and it will expire in seven years from the date of grant. The terms of this option are similar to the 1993 Plan described above and vesting of these options may be accelerated on the conditions set forth in the employment agreement dated January 27, 2006. Currently, all 5,368,044 shares will be cancelled upon emergence from bankruptcy and will receive no recovery.

On February 1, 2006, the Company entered into an agreement to issue 2,684,022 shares of restricted common stock to Dennis McKenna, President, Chief Executive Officer, and Chairman of the Board. Under the terms of this agreement, the shares will be vested and non-forfeitable over a two-year period ending February 1, 2008. Three-eighths of the shares will vest on December 31, 2006, with the remaining five-eighths to vest in quarterly installments beginning February 1, 2007. During the vesting period, ownership of the shares cannot be transferred. The unvested shares have voting rights as other common stock and have been reported as currently issued and outstanding. Currently, all 2,684,022 shares are subject to repurchase under this agreement.

Adoption of SFAS 123(R)

Effective June 25, 2005, we adopted the fair value recognition provisions of SFAS 123(R), Share-Based Payment, using the modified-prospective transition method and therefore we have not restated our financial results for prior periods. Under that transition method, compensation cost recognized during fiscal 2006 includes the following: (a) compensation cost related to any share-based payments granted through, but not yet vested as of June 24, 2005, and (b) compensation cost for any share-based payments granted subsequent to June 24, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). We recognize compensation expense for the fair values of these options and awards, which have graded vesting, on a straight-line basis over the requisite service period of each of these options and awards.

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Compensation Costs

The compensation costs that have been included in our results of operations and the total income tax benefit, if any, that we recognized on our statement of operations for these share-based compensation arrangements during fiscal 2006 were as follows (in thousands):

	Year Ended June 30, 2006
Share-based compensation cost included in:
Cost of product and other revenue	$	88
Cost of service revenue		242
Research and development		611
Selling, general, and administrative		1,243
Total share-based compensation cost		2,184
Income tax benefit recognized		—
	$	2,184

Because the amount of share-based compensation associated with our cost of production is not significant, we did not capitalize any share-based compensation cost as part of inventory and fixed assets during fiscal 2006. Net cash proceeds from the exercise of stock options were $0.4 million, $4.0 million, and $2.6 million during fiscal 2006, fiscal 2005, and fiscal 2004, respectively. No income tax benefit was realized from stock option exercises during fiscal 2006. In accordance with SFAS 123(R), we present excess tax benefits from the exercise of stock options, if any, as financing cash flows rather than operating cash flows. The incremental share-based compensation expense associated with the adoption of SFAS 123(R) in fiscal 2006 was $2 million.

Prior to June 25, 2005, we accounted for our share-based compensation plans under the recognition and measurement provisions of APB Opinion No. (APB) 25, Accounting for Stock Issued to Employees, and related guidance, as permitted by SFAS 123, amended by SFAS 148, Accounting for Stock-Based Compensation-Transition and Disclosure (SFAS 148). We did not recognize any significant share-based employee compensation costs in our statements of operations prior to fiscal 2006, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. As required by SFAS 148 prior to the adoption of SFAS 123(R), we provided pro forma net loss and pro forma net loss per common share disclosures for stock-based awards, as if the fair-value-based method defined in SFAS 123 had been applied.

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The following table presents the pro forma effect on net loss from continuing operations and net loss per share if we had applied the fair value recognition provisions of SFAS 123 to options granted under our share-based compensation arrangements during fiscal 2005 and fiscal 2004 (in thousands, except per share amounts):

	Years Ended
	June 24, 2005			June 25, 2004
Net loss from continuing operations, as reported	$	(75,732	)	$	(100,246	)
Add:
Share-based employee compensation expense included in net income/(loss) from continuing operations		49			201
Deduct:
Share-based employee compensation expense determined under fair value method		(6,222	)		(4,949	)
Net income/(loss) from continuing operations, pro forma	$	(81,905	)	$	(104,994	)
Net income/(loss) per share from continuing operations — basic and diluted:
As reported	$	(0.29	)	$	(0.44	)
Pro forma	$	(0.31	)	$	(0.46	)

For purposes of this pro forma disclosure, we estimated the value of the options using a Black-Scholes-Merton closed-form option pricing formula and amortized that value to expense over the options’ vesting periods. We allocated this fair value to the pro forma compensation expense of our fiscal periods using the accelerated expense attribution method specified in FASB Interpretation No. (“FIN”) 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.

Valuation of Stock Options

The fair value of each option is estimated on the date of grant using the Black-Scholes-Merton closed-form option valuation model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of our stock. We use historical data to estimate the options’ expected term, which represents the period of time that options granted are expected to be outstanding. For purposes of performing our valuation, we separated our employees into two groups, within which the employees have similar historical exercise behavior; the ranges given below result from certain groups of employees exhibiting different behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

	Years Ended
	June 30, 2006	June 24, 2005		June 25, 2004
Expected volatility	1.10 – 1.26	1.00		1.10
Expected term (in years)	2.34-3.67	5.37		2.77
Risk-free rate	3.96%-4.90%	3.89	%	1.30	%
Expected dividends	0%	0	%	0	%

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Summary of Stock Options

A summary of options under all of our share-based compensation plans as of June 30, 2006 and changes during fiscal 2006, fiscal 2005, and fiscal 2004 are as follows (in thousands, except exercise price and contractual term):

	Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in Years)	Aggregate Intrinsic Value
Options outstanding at June 27, 2003	38,173		$	3.02	7.38	$	4,642
Options granted	6,818		$	1.16
Options exercised	(3,609	)	$	0.79
Options forfeited or expired	(6,761	)	$	3.50
Options outstanding at June 25, 2004	34,621		$	2.80	6.92	$	21,338
Options granted	5,355		$	1.63
Options exercised	(641	)	$	0.80
Options forfeited or expired	(3,894	)	$	3.53
Options outstanding at June 24, 2005	35,441		$	2.58	6.10	$	841
Options granted	5,788		$	0.37
Options exercised	(746	)	$	0.54
Options forfeited or expired	(9,492	)	$	2.40
Options outstanding at June 30, 2006	30,991		$	2.27	5.33	$	—
Options vested and exercisable at June 30, 2006	22,334		$	2.85	4.92	$	—
Options expected to vest at June 30, 2006	28,071		$	2.42	0.26	$	—

Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of fiscal 2006, which was $0.046, and the exercise price, multiplied by the number of “in the money” options that would have been received by the option holders had all option holders exercised their options on June 30, 2006. The weighted-average grant-date fair value of options granted during fiscal 2006 and fiscal 2005 was $0.27 and $1.26, respectively. The total intrinsic value of options exercised during fiscal 2006 was $0.2 million.

As of June 30, 2006, $4.1 million of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under our various option plans is expected to be recognized over a weighted-average period of 2.3 years.

Summary of Restricted Stock Awards

Restricted stock awards are independent of option grants and are generally subject to forfeiture if employment terminates prior to the release of the restrictions. The Company expenses the cost of the restricted stock awards, which is determined to be the fair market value of the shares at the date of grant, ratably over the period during which the restrictions lapse.

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Nonvested restricted stock awards as of June 30, 2006 and changes during fiscal 2006, fiscal 2005 and fiscal 2004 were as follows (in thousands, except weighted average grant date fair value):

	Number of Shares		Weighted- Average Grant Date Fair Value
Nonvested at June 27, 2003	98		$	4.77
Granted	—
Vested	—
Forfeited	(49	)	$	4.77
Nonvested at June 25, 2004	49		$	4.77
Granted	—
Vested	—
Forfeited	(49	)	$	4.77
Nonvested at June 24, 2005	—		$	—
Granted	2,684		$	0.35
Vested	—		$	—
Forfeited	—		$	—
Nonvested at June 30, 2006	2,684		$	0.35

As of June 30, 2006, there was $0.8 million of unrecognized share-based compensation expense related to nonvested restricted stock awards. That cost is expected to be recognized over a weighted-average period of 2 years.

Employee Stock Purchase Plan

The fair value of each option element of our ESPP is estimated on the date of grant using the Black-Scholes-Merton closed-form option valuation model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of our stock. Expected term represents the six-month offering period for our ESPP. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

	Years Ended
	June 30, 2006		June 24, 2005		June 25, 2004
Expected volatility	.72		.83		1.10
Expected term	6 months		6 months		6 months
Risk-free rate	3.79	%	2.10	%	1.01	%
Expected dividends	0	%	0	%	0	%

As of June 30, 2006, we had issued 49,238,398 shares over the life of the ESPP and its predecessor plans. 5,615,464 and 2,985,583 shares were issued during fiscal 2006 and fiscal 2005, respectively. As of June 30, 2006, we had 3,399,545 shares in reserve for future issuance under the plan; however, on January 26, 2006, the Board of Directors suspended new offering periods under the ESPP until otherwise determined by the Board.

Disclosures Pertaining to All Share-Based Compensation Plans

Cash received from option exercises and ESPP contributions under all share-based payment arrangements during fiscal 2006 and fiscal 2005 was $2.9 million and $4.0 million, respectively. Because of our net operating losses, we did not realize any tax benefits for the tax deductions from share-based payment arrangements during fiscal 2006 and fiscal 2005.

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Equity Issuances. During fiscal 2005, holders converted $0.5 million principal amount of our 6.50% Senior Secured Convertible Notes, resulting in the issuance of 402,400 shares of common stock.

On February 19, 2004, we sold 18,181,818 shares of our common stock for an aggregate purchase price of $50 million ($2.75 per share) to certain institutional investors in a private placement transaction.

On February 19, 2004, we also issued 959,520 shares of our common stock to certain of these institutional investors in connection with their conversion of $24 million aggregate principal amount of our 6.50% Senior Secured Convertible Notes due June 2009 into 19,190,400 common shares. In accordance with SFAS 84, Induced Conversion of Convertible Debt, we recorded a $3 million non-cash charge to interest expense representing the fair market value of the additional 959,520 shares of common stock issued. In addition to the aforementioned conversions, during fiscal 2004, holders converted $11 million principal amount of our 6.50% Senior Secured Convertible Notes, resulting in the issuance of 9,029,600 shares of common stock.

Note 4. Bankruptcy Related Disclosures

Accounting for Reorganization

The accompanying consolidated financial statements have been prepared in accordance with AICPA Statement of Position (SOP) 90-7 Financial Reporting by Entities in Reorganization Under the Bankruptcy Code. In accordance with SOP 90-7, all pre-petition liabilities subject to compromise have been segregated in the condensed consolidated balance sheet and classified as “liabilities subject to compromise” at the estimated amount of allowable claims. Liabilities not subject to compromise are separately classified as current or non-current. Our consolidated statement of operations for fiscal 2006 portrays the results of operations during Chapter 11 proceedings. As such, any revenues, expenses and gains and losses realized or incurred that are directly related to the bankruptcy case are reported separately as reorganization items due to bankruptcy.

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Condensed consolidating financial statements of the Debtors and Non-Debtors are set forth below. “Debtors” include all entities that filed for protection from creditors in fiscal 2006. “Non-Debtors” include the Company’s businesses that are generally not affected by the bankruptcy filings.

SILICON GRAPHICS, INC.

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

(In thousands)

For the Year Ended June 30, 2006

	Debtors			Non-Debtors			Eliminations (1)			Consolidated
Total revenue	$	401,674		$	120,297		$	(3,166	)	$	518,805
Costs and expenses:
Cost of revenue		262,911			60,983			(3,461	)		320,433
Research and development		79,480			4,197			—			83,677
Selling, general and administrative		151,511			60,220			—			211,731
Impairment of goodwill		8,386			—			—			8,386
Other operating, net (1)		16,721			4,434			—			21,155
Total costs and expenses		519,009			129,834			(3,461	)		645,382
Operating (loss) income		(117,335	)		(9,537	)		295			(126,577	)
Interest expense		(16,073	)		(372	)		—			(16,445	)
Interest and other income (expense), net		(5,059	)		6,419			(352	)		1,008
Loss before reorganization items and income taxes		(138,467	)		(3,490	)		(57	)		(142,014	)
Reorganization items, net		(7,826	)		—			—			(7,826	)
Loss before income taxes		(146,293	)		(3,490	)		(57	)		(149,840	)
Income tax provision (benefit)		(12,579	)		8,933			—			(3,646	)
Net loss	$	(133,714	)	$	(12,423	)	$	(57	)	$	(146,194	)

(1) Consolidated financial results are comprised of Debtor and Non-Debtor entities that have affiliated transactions with other Debtor and Non-Debtor entities. Amounts included under the heading “Eliminations” represent entries required to properly eliminate transactions between affiliated entities for consolidated financial statement presentation purposes.

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SILICON GRAPHICS, INC.

CONDENSED CONSOLIDATING BALANCE SHEET

(In thousands)

June 30, 2006

	Debtors			Non-Debtors			Eliminations (1)			Consolidated
Assets:
Current assets:
Cash and cash equivalents	$	24,096		$	30,577		$	—		$	54,673
Short-term marketable investments		—			203			—			203
Short-term restricted investments		6,036			26,503			—			32,539
Accounts receivable, net		26,737			31,680			—			58,417
Inventories		49,578			445			(26	)		49,997
Prepaid expenses and other current assets		958,232			56,554			(949,606	)		65,180
Total current assets		1,064,679			145,962			(949,632	)		261,009
Property and equipment, net of accumulated depreciation and amortization		25,407			2,466			—			27,873
Other non-current assets		174,331			246,660			(329,815	)		91,176
	$	1,264,417		$	395,088		$	(1,279,447	)	$	380,058
Liabilities and Stockholders’ Equity (deficit):
Liabilities not subject to compromise:
Current liabilities:
Accounts payable	$	3,784		$	5,167		$	—		$	8,951
Accrued compensation		12,871			16,353			—			29,224
Current portion of long-term debt		102,420			704			—			103,124
Current portion of deferred revenue		87,266			37,113			—			124,379
Other current liabilities		1,001,667			(6,006	)		(944,673	)		50,988
Total current liabilities		1,208,008			53,331			(944,673	)		316,666
Non-current portion of deferred revenue		17,985			27,553			—			45,538
Other non-current liabilities		10,513			17,565			—			28,078
Total liabilities not subject to compromise		1,236,506			98,449			(944,673	)		390,282
Liabilities subject to compromise		320,230			—			—			320,230
Total liabilities		1,556,736			98,449			(944,673	)		710,512
Total stockholders’ Equity (deficit)		(292,319	)		296,639			(334,774	)		(330,454	)
	$	1,264,417		$	395,088		$	(1,279,447	)	$	380,058

(1) Consolidated financial results are comprised of Debtor and Non-Debtor entities that have affiliated transactions with other Debtor and Non-Debtor entities. Amounts included under the heading “Eliminations” represent entries required to properly eliminate transactions between affiliated entities for consolidated financial statement presentation purposes.

Interest expense

The Debtors have discontinued recording interest on liabilities subject to compromise. Contractual interest on liabilities subject to compromise in excess of reported interest was approximately $2 million for fiscal 2006.

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Reorganization items

Reorganization items, net represents expense or income amounts that were recorded as a direct result of our Chapter 11 filing and are presented separately in our Consolidated Statements of Operations. Such items consist of the following (dollars in thousands):

	2006
Professional fees	$	13,285
Pre-petition liability claim adjustments		755
Write-off of unamortized debt premium and discount, net		(9,381	)
Write-off of unamortized debt issuance costs		3,167
	$	7,826

Professional fees relate to legal, accounting and other professional costs directly associated with the reorganization process.

Liabilities Subject to Compromise.

Liabilities subject to compromise refer to liabilities incurred prior to the Petition Date. The amounts of the various categories of liabilities that are subject to compromise are set forth below. These amounts represent our estimates of known or potential pre-petition date claims that are likely to be resolved in connection with the bankruptcy filings. Such claims remain subject to future adjustments. Adjustments may result from negotiations, actions of the Court, rejection of executory contracts and unexpired leases, the determination as to the value of any collateral securing claims, proofs of claim or other events. There can be no assurance that the liabilities of the Debtors will not be found to exceed the fair value of their assets. This could result in claims being paid at less than 100% of their face value and the equity or SGI’s stockholders could be diluted or eliminated entirely.

Liabilities subject to compromise consist of the following (in thousands):

	June 30, 2006
6.50% Senior Secured Convertible Notes due June 1, 2009	$	188,578
6.125% Convertible Subordinated Debentures due February 1, 2011		56,776
11.75% Senior Secured Notes due June 1, 2009		2,386
Accounts payable		55,447
Accrued liabilities		17,043
	$	320,230

In accordance with SOP 90-7, we ceased to accrue and recognize interest expense on liabilities subject to compromise as noted above. In addition, debt discounts and premiums, as well as capitalized debt issue costs associated with the above debt have been adjusted to reflect the debt at its probable allowed claim amount, resulting in a credit adjustment of approximately $6 million to reorganization items resulting from the write-off of unamortized debt premium, discount and loan cost as shown in the reorganization items table above. Accounts payable and accrued liabilities subject to compromise represent our best estimates of known or potential pre-petition liabilities that are probable of resulting in an allowed claim against us in connection with the bankruptcy filings and are recorded at the estimated amount of the allowed claim, which may differ from the amount for which the liability will be settled.

Liabilities not subject to compromise include: (1) liabilities held by Non-Debtor entities; (2) liabilities incurred after the Petition Date; (3) pre-petition date liabilities that the Debtors expect to pay in full, even though certain of these amounts may not be paid until a plan of reorganization is approved; (4) liabilities related to pre-petition contracts that have not been rejected; and (5) pre-petition date liabilities that have been approved for payment by the Court and that the Debtors expect to pay (in advance of a plan of reorganization) in the ordinary course of business, including certain employee related items (salaries, vacation and medical benefits).

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The classification of liabilities “not subject to compromise” versus liabilities “subject to compromise” is based on currently available information and analysis. As the bankruptcy filing proceeds and additional information and analysis is completed or, as the Court rules on relevant matters, the classification of amounts between these two categories may change. The amount of any such changes could be significant.

Note 5. Other Operating Expense

Other operating expense was as follows (in thousands):

	Years ended
	June 30, 2006		June 24, 2005		June 25, 2004
Restructuring and impairment charges, net	$	21,155	$	24,083	$	47,825

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Restructuring – Fiscal 2006

Other operating expenses, net represents the costs associated with our restructuring and impairment activities. These activities, by plan or action, were as follows during fiscal 2006 (in thousands, numbers may not add due to rounding):

	Balance at June 24, 2005		Costs Incurred		Adjust- ments			Non-cash Settlements and Other			Cash Payments			Balance at June 30, 2006
Fiscal 2000 plan:
Vacated facilities	$	1,282	$	—	$	(13	)	$	—		$	(1,269	)	$	—
Fiscal 2001 plan:
Vacated facilities		1,404		—		(83	)		—			(1,321	)		—
Fiscal 2002 plan:
Severance and related charges		142		—		(23	)		—			(20	)		99
Vacated facilities		329		—		49			(141	)		(237	)		—
		471		—		26			(141	)		(257	)		99
Fiscal 2003 plan:
Severance and related charges		114		—		(59	)		—			(36	)		19
Vacated facilities		127		—		99			—			(226	)		—
		241		—		40			—			(262	)		19
Fiscal 2004 plan:
Severance and related charges		258		—		(243	)		—			(15	)		—
Vacated facilities		33,489		7,025		(31,713	)		(23	)		(8,762	)		16
		33,747		7,025		(31,956	)		(23	)		(8,777	)		16
Fiscal 2005 plan:
Severance and related charges		1,891		289		(47	)		—			(2,093	)		40
Vacated facilities		6,482		1,105		(4,856	)		—			(2,731	)		—
Accelerated depreciation		—		—		—			—			—			—
		8,373		1,394		(4,903	)		—			(4,824	)		40
Fiscal 2006 plan 1:
Severance and related charges		—		9,194		757			—			(9,440	)		511
Vacated facilities		—		1,336		(5,415	)		6,776			(1,734	)		963
Accelerated depreciation		—		4,654		408			(5,062	)		—			—
		—		15,184		(4,250	)		1,714			(11,174	)		1,474
Fiscal 2006 plan 2:
Severance and related charges		—		7,938		79			(1,778	)		(4,146	)		2,093
Vacated facilities		—		392		—			(222	)		(63	)		107
Other		—		1,900		—			(1,900	)		—			—
		—		10,230		79			(3,900	)		(4,209	)		2,200
Fiscal 2006 plan 3:
Severance and related charges		—		2,154		—			—			(71	)		2,083
Vacated facilities		—		21,794		—			3,555			(24,598	)		751
Accelerated depreciation		—		4,432		—			(4,432	)		—			—
		—		28,380		—			(877	)		(24,669	)		2,834
All restructuring plans:
Severance and related charges		2,405		19,575		466			(1,778	)		(15,821	)		4,845
Vacated facilities		43,113		31,652		(41,932	)		9,945			(40,941	)		1,837
Accelerated depreciation		—		9,086		408			(9,494	)		—			—
Other		—		1,900		—			(1,900	)		—			—
Total of all restructuring plans	$	45,518	$	62,213	$	(41,058	)	$	(3,227	)	$	(56,762	)	$	6,682

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During fiscal 2006, we made $57 million in payments related to all of our restructuring plans and actions, $16 million of which was for severance and related charges and $41 million of which was for vacated facilities obligations, including $25 million in settlement costs for the termination of our lease obligations at Amphitheatre Technology Center (“ATC”) and Crittenden Technology Center (“CTC”). The $25 million cost was due to a June 27, 2006 settlement with our landlord which terminated our lease obligations at ATC and terminated our lease obligations for two buildings at CTC. It also amended our lease obligations for a third building at CTC. Pursuant to the agreement, we vacated the two buildings at CTC by June 30, 2006 and plan to vacate our third building by December 31, 2006.

During fiscal 2006, we recognized costs of $21 million, of which $20 million was for severance and related charges and $2 million was for operating asset write downs for fixed assets and demonstration units and release of purchase commitments, both of which are associated with the end of production of existing Prism and Prism Deskside products. Total vacated facilities and accelerated depreciation cost was a net $1 million credit to other operating expense. Costs related to our vacated leased facilities included a $28 million charge for the ATC and CTC settlement costs including termination fees, commissions and legal expenses, a $7 million accretion expense associated with our fiscal 2004 Mountain View, California headquarters (ATC) relocation, a $1 million accretion expense associated with one building at CTC which we partially vacated in fiscal 2005 and fully vacated in fiscal 2006, a $5 million charge for the fair value of future remaining obligations and accretion expense associated with one building at CTC fully vacated in fiscal 2006, and a $2 million charge related to the vacating of other leased facilities throughout the world in fiscal 2006. In addition we recognized $15 million of credits related to the write off of deferred rent and tenant improvement allowances on these vacated facilities, $10 million in charges for the acceleration of depreciation associated with changes in the estimated lives of certain leasehold improvements and furniture and fixtures and $2 million in write offs for prepaid rent. Upon execution of the settlement for the termination of our lease obligations at ATC and CTC, we recorded a reversal of liabilities of $41 million of future rental payments for the ATC and CTC buildings. These included $32 million, $5 million and $4 million related to fiscal 2004, fiscal 2005 and fiscal 2006, respectively.

The restructuring liability balance of $7 million at June 30, 2006 includes $5 million in severance obligations and $2 million of facility-related liabilities. The facility-related liabilities of $2 million represent $4 million in future non-cancelable rental payments due, less estimated sublease income of $2 million, $1 million of which is under contract, and less than $1 million in accretion expense that will be recognized through fiscal 2011. We expect to pay all the accrued severance and related charges and $4 million of facility-related charges during fiscal 2007, with the remainder of our restructuring obligations to be paid through fiscal 2011.

In an effort to further reduce our operating expenses, we implemented restructuring activities under three fiscal 2006 restructuring plans during fiscal 2006. Under these restructuring plans, we recognized costs of $20 million for the elimination of approximately 500 positions across all levels and functions. We expect to eliminate more positions under the fiscal 2006 restructuring plans in the first half of fiscal 2007 and expect to complete these actions and make the remaining payments related to these fiscal 2006 actions by approximately the end of fiscal 2007. In addition to the ATC and CTC settlement, under the fiscal 2006 restructuring plans, we also recorded a charge of $3 million for costs related to vacating approximately 51,000 square feet of sales and administrative facilities throughout the world, with lease terms expiring through fiscal 2011. We completed substantially all facilities related actions under the fiscal 2006 restructuring plans by the end of fiscal 2006, but we will continue to make payments on the associated leases through the end of their lease terms. As required by SFAS 146, we calculated and accrued the fair value of our future contractual obligations under these operating leases using our credit-adjusted risk-free interest rate as of the date we ceased to use the leased properties. As of June 30, 2006, the fair value of our future remaining obligations for the leased properties was $2 million. On a quarterly basis over the periods from the respective cease-use dates to the end of the lease terms, we are required to accrete these discounted future obligations for the leased property up to their contractually obligated amount of $4 million using the effective interest method. In fiscal 2006, we began to record restructuring accretion expense, which we expect to be less than $1 million annually through fiscal 2011. Our obligation associated with the fiscal 2006 restructuring plans as of June 30, 2006 included $5 million in severance and related charges and the aforementioned $4 million of vacated leased facility obligations, net of estimated sublease income of $2 million.

As of June 30, 2006, we have substantially completed the execution of our fiscal 2000 through fiscal 2005 restructuring plans, with the exception of certain severance obligations of our international subsidiaries.

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The restructuring and relocation costs incurred during fiscal 2006, the cumulative amount incurred through June 30, 2006, and the total amount expected to be incurred for each major type of cost associated with our restructuring plans accounted for in accordance with SFAS 146 (our fiscal 2004, fiscal 2005, and fiscal 2006 plans) were as follows (in thousands):

	Products			Global Services			Total
Fiscal 2004 restructuring plan:
Costs incurred and adjustments during fiscal 2006:
Severance and related charges	$	(118	)	$	(125	)	$	(243	)
Vacated facilities		(9,786	)		(14,902	)		(24,688	)
Total	$	(9,904	)	$	(15,027	)	$	(24,931	)
Cumulative costs incurred as of June 30, 2006:
Severance and related charges	$	10,648		$	8,444		$	19,092
Canceled contracts		366			275			641
Vacated facilities		6,731			(2,123	)		4,608
Other		3,119			2,471			5,590
Impairment charges		1,714			1,348			3,062
Total	$	22,578		$	10,415		$	32,993
Fiscal 2005 restructuring plan:
Costs incurred and adjustments during fiscal 2006:
Severance and related charges	$	132		$	109		$	241
Vacated facilities		(1,494	)		(2,256	)		(3,750	)
Total	$	(1,362	)	$	(2,147	)	$	(3,509	)
Cumulative costs incurred as of June 30, 2006:
Severance and related charges	$	5,656		$	4,351		$	10,007
Vacated facilities		3,398			1,313			4,711
Total	$	9,054		$	5,664		$	14,718
Fiscal 2006 restructuring plan 1:
Costs incurred and adjustments during fiscal 2006 (which are also the cumulative costs incurred as of June 30, 2006):
Severance and related charges	$	5,169		$	4,781		$	9,950
Vacated facilities		(1,639	)		(2,438	)		(4,077	)
Accelerated depreciation		2,400			2,662			5,062
Total	$	5,930		$	5,005		$	10,935
Total amount expected to be incurred:
Severance and related charges	$	5,169		$	4,781		$	9,950
Vacated facilities		(1,492	)		(2,230	)		(3,722	)
Accelerated depreciation		2,400			2,662			5,062
Total	$	6,077		$	5,213		$	11,290
Fiscal 2006 restructuring plan 2:
Costs incurred and adjustments during fiscal 2006 (which are also the cumulative costs incurred as of June 30, 2006):
Severance and related charges	$	3,439		$	4,576		$	8,015
Canceled contracts		43			55			98
Vacated facilities		170			223			393
Other		778			1,025			1,803
Total	$	4,430		$	5,879		$	10,309
Total amount expected to be incurred:
Severance and related charges	$	3,439		$	4,576		$	8,015
Canceled contracts		43			55			98
Vacated facilities		174			229			403
Other		778			1,025			1,803
Total	$	4,434		$	5,885		$	10,319
Fiscal 2006 restructuring plan 3:
Costs incurred and adjustments during fiscal 2006 (which are also the cumulative costs incurred as of June 30, 2006):
Severance and related charges	$	892		$	1,262		$	2,154
Vacated facilities		9,025			12,769			21,794
Accelerated depreciation		1,835			2,597			4,432
Total	$	11,752		$	16,628		$	28,380
Total amount expected to be incurred:
Severance and related charges	$	2,398		$	3,392		$	5,790
Vacated facilities		9,025			12,769			21,794
Accelerated depreciation		1,835			2,597			4,432
Total	$	13,258		$	18,758		$	32,016

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Restructuring – Fiscal 2005

Our restructuring and impairment activities, by plan or action, were as follows during fiscal 2005 (in thousands):

	Balance at June 25, 2004		Costs Incurred		Adjust- ments			Non-cash Settlements and Other		Cash Payments			Balance at June 24, 2005
Fiscal 2000 plan:
Vacated facilities	$	5,898	$	—	$	(367	)	$	—	$	(4,249	)	$	1,282
Fiscal 2001 plan:
Vacated facilities		4,225		—		(342	)		—		(2,479	)		1,404
Fiscal 2002 plan:
Severance and related charges		52		61		(436	)		533		(68	)		142
Vacated facilities		450		—		229			—		(350	)		329
		502		61		(207	)		533		(418	)		471
Fiscal 2003 plan:
Severance and related charges		288		104		(317	)		52		(13	)		114
Vacated facilities		959		—		286			—		(1,118	)		127
		1,247		104		(31	)		52		(1,131	)		241
Fiscal 2004 plan:
Severance and related charges		1,086		193		—			—		(1,021	)		258
Vacated facilities		46,966		9,867		(3,422	)		—		(19,922	)		33,489
		48,052		10,060		(3,422	)		—		(20,943	)		33,747
Fiscal 2005 plan:
Severance and related charges		—		9,766		—			—		(7,875	)		1,891
Vacated facilities		—		8,461		—			1,221		(3,200	)		6,482
		—		18,227		—			1,221		(11,075	)		8,373
All restructuring plans:
Severance and related charges		1,426		10,124		(753	)		585		(8,977	)		2,405
Vacated facilities		58,498		18,328		(3,616	)		1,221		(31,318	)		43,113
Total of all restructuring plans	$	59,924	$	28,452	$	(4,369	)	$	1,806	$	(40,295	)	$	45,518

During fiscal 2005, we made payments of $9 million for severance and related charges and $31 million for our vacated facilities obligations, primarily rent.

We recognized restructuring and asset impairment costs of $28 million during fiscal 2005. These costs included $10 million for severance, primarily associated with our fiscal 2005 restructuring plan, and $18 million related to accretion and other costs related to our vacated leased facilities. The vacated facilities costs included $8 million in expenses related to vacating approximately 198,000 square feet of sales and administrative facilities throughout the world, with lease terms expiring through fiscal 2014. Also included in vacated facilities costs were $10 million in restructuring accretion expense for the ATC, which is part of the fiscal 2004 restructuring plan. In fiscal 2005 we recorded a $3 million adjustment to reduce our estimate of future vacated facilities costs for our fiscal 2004 restructuring plan based on a reduction in the base rent we received for a facility vacated as part of that restructuring plan.

Restructuring – Fiscal 2004

Our restructuring and impairment activities were as follows during fiscal 2004 (in thousands):

Category	Severance and Related Charges			Canceled Contracts			Vacated Facilities			Other Charges			Impairment Charges			Total
Balance at June 27, 2003	$	7,191		$	13		$	24,648		$	—		$	—		$	31,852
Additions—fiscal 2004 restructuring and impairment		19,646			641			23,284			5,590			3,062			52,223
Adjustments:
Increase		—			—			—			—			—			—
(Decrease)		(1,207	)		—			(3,191	)		—			—			(4,398	)
Reclassification:
Cash		—			—			—			—			—			—
Non-cash		—			—			36,461			—			—			36,461
Expenditures:
Cash		(24,204	)		(654	)		(22,704	)		(5,590	)		—			(53,152	)
Non-cash		—			—			—			—			(3,062	)		(3,062	)
Balance at June 25, 2004	$	1,426		$	—		$	58,498		$	—		$	—		$	59,924

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Note 6. Loss per Share

Set forth below is a reconciliation of basic and diluted loss per share from continuing operations (in thousands, except per share amounts):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Net loss from continuing operations	$	(146,194	)	$	(75,732	)	$	(100,246	)
Weighted average shares outstanding – basic and diluted		269,367			263,430			227,837
Net loss per share from continuing operations – basic and diluted	$	(0.54	)	$	(0.29	)	$	(0.44	)
Potentially dilutive weighted securities excluded from computations because they are anti-dilutive		153,710			155,848			87,737

Potentially dilutive weighted securities include the assumed exercise of stock options and the assumed vesting of restricted stock awards as well as the assumed conversion of debt using the if-converted method.

Note 7. Financial Instruments

Cash Equivalents and Marketable and Restricted Investments

The following table summarizes by major security type the fair value of our cash equivalents and marketable and restricted investments at June 30, 2006 and June 24, 2005 (in thousands):

	2006			2005
Money market funds	$	2,060		$	2,183
Time deposits		51,024			43,836
Total		53,084			46,019
Less amounts classified as cash equivalents		(4,383	)		(5,810	)
Total marketable and restricted investments	$	48,701		$	40,209

Gross realized gains and losses on sales and unrealized gains and losses on our securities were not significant in any one fiscal period presented.

Derivative Instruments and Hedging Activities

Risk Management. In the normal course of business, our financial position is exposed to a variety of risks, including market risk associated with interest rate movements and currency rate movements on non-U.S. dollar denominated assets and liabilities. We regularly assess risks and have established policies and business practices to protect against the adverse effects of these and other potential exposures. We use derivative financial instruments to moderate the financial market risks of our business operations by hedging the foreign currency market exposures underlying certain assets and liabilities and certain commitments related to customer transactions. We do not invest in derivative financial instruments for speculative or trading purposes.

Accounting Policies. We report our derivative financial instruments at their fair value in the other current assets and other current liabilities lines of our consolidated balance sheet. Our accounting for changes in the fair values of the derivative financial instruments depends on whether they qualify for accounting as a hedging instrument and, if so, whether they are fair value hedges or cash flow hedges.

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We designate derivative financial instruments as hedges based in part on their effectiveness in risk reduction and one-to-one matching of the instruments to the hedged transactions. We test the hedging effectiveness of currency forward contracts using a forward-to-forward rate comparison, which makes same-currency hedges perfectly effective. We test the hedging effectiveness of currency option contracts using changes in the option’s intrinsic value and the effect of discounting. As a result, we exclude the change in the volatility value of the option contract from the assessment and immediately recognize that amount in interest and other income (expense), net on our statement of operations. We will designate derivative financial instruments as fair value hedges or cash flow hedges based on the type of risk that they are hedging. At June 30, 2006 and June 24, 2005, we did not have any derivative financial instruments designated as fair value hedges.

Cash Flow Hedges. A cash flow hedge is a derivative financial instrument that hedges the exposure to variability in expected future cash flows attributable to a particular risk. This exposure may be associated with an existing recognized asset or liability or a forecasted transaction. Our cash flow hedging instruments are primarily currency options and currency forward contracts, generally expiring within one year, purchased as hedges of anticipated sales that are denominated in foreign currencies. These contracts are entered into to mitigate the risk that the eventual cash flows resulting from the transactions will be adversely affected by changes in exchange rates.

We record the portion of the gain or loss in the fair value of our cash flow hedges that is determined to be an effective hedge as a component of other comprehensive loss, and we recognize this amount in our earnings as revenue in the same period or periods in which the hedged transaction affects earnings. We recognize in other income (expense), net on our statement of operations any remaining, ineffective portion of the gain or loss on a hedging instrument during the period of the change. The amount in accumulated other comprehensive loss at June 30, 2006 will generally be recognized in earnings within the next twelve months. During fiscal 2006, fiscal 2005, and fiscal 2004, we did not identify any material ineffectiveness in our cash flow hedges, and we did not exclude any gains or losses related to our cash flow hedges from our assessments of hedge effectiveness

Other Derivative Financial Instruments. We also use derivative financial instruments to hedge the foreign currency market exposures underlying certain of our assets and liabilities that are denominated in foreign currencies. These derivative financial instruments are not designated as fair value or cash flow hedges. As a result, we recognize in other income (expense), net on our statement of operations any change in the fair value of these instruments, and we also recognize in other income (expense), net any changes in the value of the hedged assets or liabilities resulting from fluctuations in foreign currency exchange rates.

Accumulated Derivative Gains or Losses. The following table summarizes activity in other comprehensive loss related to derivative financial instruments held by us and classified as cash flow hedges (in thousands):

	Years ended
	June 30, 2006			June 24, 2005
Opening balance	$	1,719		$	(145	)
Reclassified into earnings from other comprehensive loss, net		1,047			54
Changes in fair value of derivatives, net		(2,614	)		1,810
Unrealized gain (loss) on derivative instruments included in other comprehensive loss	$	152		$	1,719

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Fair Value of Financial Instruments

The carrying amounts and estimated fair values of our financial instruments were as follows (in thousands):

	June 30, 2006				June 24, 2005
	Carrying Amounts		Fair Value		Carrying Amounts		Fair Value
Cash and cash equivalents	$	54,673	$	54,673	$	64,247	$	64,247
Marketable investments		48,701		48,701		40,209		40,209
Debt instruments		103,521		103,521		263,812		175,536
Currency forward contracts		132		132		1,885		1,885
Currency options		—		—		138		138

We estimated these fair values using quoted market prices. These estimated fair values may not be representative of the actual values of the financial instruments that could have been realized as of our fiscal year end or that will be realized in the future.

Note 8. Discontinued Operations

On June 15, 2004, we received $58.4 million in gross proceeds for the sale of our Alias application software business (Alias) to Accel-KKR, a technology-focused private equity investment firm, and recorded a net gain of $50.5 million on the transaction. As a result of this transaction, we have shown the operating results of Alias as a discontinued operation.

The financial results of Alias included in discontinued operations were as follows (in thousands):

	Years ended
	June 24, 2005			June 25, 2004
Revenue	$	—		$	66,425
Income from discontinued operations before income taxes	$	—		$	4,975
Income tax provision		—			1,000
Net income from discontinued operations		—			3,975
Gain (loss) on disposition of discontinued operations before income taxes		(276	)		52,010
Income tax provision		—			1,509
Net gain (loss) on disposition of discontinued operations		(276	)		50,501
Net income (loss) from discontinued operations	$	(276	)	$	54,476

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Total assets sold to and liabilities assumed by Accel-KKR on June 15, 2004 were as follows (in thousands):

Cash and cash equivalents	$	9,468
Accounts receivable, net		12,133
Other current assets		2,198
Property and equipment, net		3,711
Other assets		658
Total assets	$	28,168
Short-term deferred revenue	$	15,035
Other liabilities		8,544
Total liabilities	$	23,579

Note 9. Sale of Interest in SGI Japan

On March 30, 2005, we completed the sale of a portion of our equity investment in SGI Japan, Ltd. (“SGI Japan”) to Canon Sales Co., Inc., NIWS Co., Ltd., and SOFTBANK Media & Marketing Corp. We received net cash proceeds of $29 million and recorded a net gain of $21 million, included as a component of interest and other income (expense), net, in the fourth quarter of fiscal 2005. No tax liability was incurred as a result of this transaction. For further information regarding our related party relationship with SGI Japan, see Note 20.

Note10. Concentration of Credit and Other Risks

Credit Risk. Financial instruments that potentially subject SGI to concentration of credit risk consist principally of cash equivalents, investments, currency forward and option contracts, and trade receivables. We place our investments and transact our currency forward and option contracts with high-credit-quality counterparties and, by policy, limit the amount of credit exposure to any single counterparty. The credit risk on receivables due from counter-parties related to currency forward contracts was immaterial at June 30, 2006 and June 24, 2005. We perform ongoing credit evaluations of our customers and generally do not require collateral. We maintain reserves for potential credit losses and such losses have been within our expectations.

Production. Most of our products incorporate 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 we were unable to procure critical components or sustain our outsourced production capacity, our ability to meet demand for our products may be affected, which would have an adverse effect on our financial results.

International Operations. We derive just over 40% of our revenue from sales outside the United States. Therefore, our results could be affected by events such 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. However, the risks of our international operations are mitigated in part by our foreign exchange hedging program and by the extent to which our sales are geographically distributed.

Government Sales. A significant portion of our revenue is derived from sales to the U.S. government, either directly by us or through system integrators and other resellers. Any disruption or limitation in our ability to do business with the U.S. government could have an adverse impact on us.

Export Compliance. Our sales to foreign customers are subject to export regulations. Sales of many of our products require clearance and export licenses from the U.S. Department of Commerce under these regulations. Our international sales could be adversely affected if such regulations were tightened, or if they are not modified over time to reflect the increasing performance of our products.

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Note 11. Consolidated Financial Statement Details

Inventories

Inventories at June 30, 2006 and June 24, 2005 were as follows (in thousands):

	2006		2005
Components and subassemblies	$	22,308	$	25,526
Work-in-process		17,187		23,076
Finished goods		3,783		13,093
Demonstration systems		6,719		13,967
Total inventories	$	49,997	$	75,662

Other Current Assets

Other current assets at June 30, 2006 and June 24, 2005 were as follows (in thousands):

	2006		2005
Deferred cost of goods sold	$	29,081	$	15,241
Value-added tax receivable		7,569		14,381
Other		18,073		8,143
Total other current assets	$	54,723	$	37,765

Property and Equipment

Property and equipment at June 30, 2006 and June 24, 2005 were as follows (in thousands):

	2006			2005
Land and buildings	$	42,266		$	42,214
Machinery and equipment (including capitalized software)		242,410			267,595
Furniture and fixtures		20,609			26,435
Leasehold improvements		34,370			40,696
		339,655			376,940
Accumulated depreciation and amortization		(311,781	)		(320,683	)
Net property and equipment	$	27,873		$	56,257

Other Non-Current Assets, net

Other non-current assets at June 30, 2006 and June 24, 2005 were as follows (in thousands):

	2006		2005
Spare parts, net of accumulated depreciation of $53,586 in 2006 and $57,570 in 2005	$	19,876	$	25,913
Equity Investment, principally SGI Japan, a related party		18,604		16,213
Software licenses and other, net of accumulated amortization of $2,834 in 2006 and $2,134 in 2005		32,222		23,977
Total other non-current assets, net	$	70,702	$	66,103

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Goodwill

We review goodwill for impairment in the fourth quarter of each year, or more frequently if events or circumstances indicate the carrying value of an asset may not be recoverable in accordance with SFAS 142, Goodwill and Other Intangible Assets. We perform this test separately for each of our two reporting units. Our reporting units are consistent with the reportable segments identified in Note 18. Our goodwill resulted from the acquisition of Silicon Graphics World Trade Corporation in fiscal 1991.

At the end of the third quarter of fiscal 2006, based on a combination of factors, particularly: (1) the shortfall in our operating results through the third quarter of fiscal 2006; (2) the delisting of our common stock from the NYSE effective January 13, 2006; (3) our then current market capitalization; (4) delays in key technology refreshes of our micro processor family; (5) projected operating results; and (6) the increasing likelihood of filing for bankruptcy under Chapter 11, we concluded there were sufficient indicators to require us to assess whether any portion of our recorded goodwill balance was impaired.

Based on our estimates of forecasted discounted cash flows as well as our market capitalization, at that time, we concluded that the goodwill in our Products reporting unit was impaired. The lower discounted cash flows attributable to our Products reporting unit in fiscal 2006 were primarily due to a decrease in revenue as well as reduced expectations for our products. In measuring the amount of goodwill impairment, we did not make a hypothetical allocation of the estimated fair value of this reporting unit to the assets (other than goodwill) within the reporting unit (as required by SFAS 142). We did not make such a hypothetical allocation for the following reasons: (1) the estimated fair value of the reporting unit based on our estimates of forecasted discounted cash flows was negative; and (2) any allocation of such negative fair value would have resulted in no implied value of the existing goodwill. As a result, we concluded that all of the recorded goodwill in the Products reporting unit ($8 million) was impaired and expensed as a non-cash charge to continuing operations during the third quarter of 2006.

Note 12. Guarantees

Financial Guarantees

Financial guarantees include contracts that contingently require us to make payments to the beneficiary of the guarantee based on changes in an underlying variable (for example, a specified interest rate, security price, or other variable) that is related to an asset, liability, or equity security of the guaranteed party. Currently, we have issued financial guarantees to cover rent on leased facilities and equipment, in favor of government authorities and certain other parties to cover liabilities associated with the importation of goods and to support payments in advance of future delivery on our goods and services. The majority of our financial guarantees have terms of one year or less. Our maximum potential obligation under financial guarantees at June 30, 2006 was $49 million for which we had $48 million of assets held as collateral.

Assets held as collateral closely approximate fair value. At June 30, 2006, we did not have any obligations associated with our guarantees that met the criteria to be recorded as liabilities on our statement of financial position.

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Product Warranty

The product warranty activity during fiscal 2006 and fiscal 2005 was as follows (in thousands):

	2006			2005
Product warranty beginning balance	$	6,442		$	5,203
New warranties issued		7,359			10,469
Warranties paid		(8,049	)		(9,503	)
Changes in warranty rate estimates		(271	)		273
Product warranty ending balance	$	5,481		$	6,442

Note 13. Debt and Other Financing Arrangements

Debt at June 30, 2006 and June 24, 2005 was as follows (in thousands):

	2006			2005
Debtor-in-Possession Financing due November 10, 2006	$	100,000		$	—
6.50% Senior Secured Convertible Notes due June 1, 2009, including unamortized premium of $0 at June 30, 2006 and $18,970 at June 24, 2005		—			207,548
6.125% Convertible Subordinated Debentures due February 1, 2011, net of unamortized discount of $0 at June 30, 2006 and $6,442 at June 24, 2005		—			50,334
11.75% Senior Secured Notes due June 1, 2009		—			2,386
Other		3,521			3,544
		103,521			263,812
Less amounts due within one year		(103,124	)		(1,820	)
Amounts due after one year	$	397		$	261,992

DIP Financing

On May 8, 2006, the Borrowers entered into the Interim DIP Agreement with the Interim DIP Lenders. The Interim DIP Agreement provides a $70 million term loan to the Borrowers secured by certain of the Borrowers’ assets. The interest rate under the Interim DIP Agreement is the per annum rate equal to the greater of (i) the rate of interest published in the Wall Street Journal from time to time as the “Prime Rate” plus seven percentage points or (ii) 250 basis points higher than the rate at which cash interest is then payable under the Company’s pre-petition credit agreement, provided that upon an event of default, the then current interest rate under the Interim DIP Agreement is increased by two percentage points. We borrowed $23 million against this facility in May 2006 and borrowed an additional $5 million in June 2006. In the latter part of June 2006, this $70 million interim facility was replaced by the $130 million DIP Agreement noted below.

In June 2006, the Debtors entered into the DIP Agreement with the DIP Lenders, providing up to $130 million of debtor-in-possession financing. This DIP Agreement was approved by the Court on June 26, 2006. The Order approving the DIP Agreement (i) authorized the Debtors to incur post-petition secured indebtedness in the amount of $130 million while granting to the Administrative Agent and lenders thereunder, subject to specified “permitted” prior liens, and a “carve-out” for specified professional fees and other costs and expenses, super priority administrative expense claims and first priority priming liens against, and security interests in, substantially all of the Debtors’ then-owned and after-acquired property, (ii) authorized the Debtors to repay amounts owed under their pre-petition credit agreement, which was repaid on June 28, 2006, (iii) authorized the Debtors to repay amounts borrowed under the Interim DIP Agreement, and (iv) authorized the Debtors’ use of cash collateral of their secured notes and granted to the secured noteholders certain adequate protection of their interests therein. During June 2006, we borrowed $100 million against this facility.

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Notes and Debentures

As a result of filing for bankruptcy under Chapter 11 and in accordance with SOP 90-7, the Senior Secured Convertible Notes, the Senior Secured Notes and the 6.125% Convertible Subordinated Debentures were considered subject to compromise as of May 8, 2006.

In December 2003, we exchanged $224 million of newly issued 6.50% Senior Secured Convertible Notes (the “Senior Secured Convertible Notes”) and $2 million of 11.75% Senior Secured Notes (the “Senior Secured Notes”) for 98% of our existing 5.25% Senior Convertible Notes (the “2004 Senior Notes”). The Senior Secured Convertible Notes are convertible at the holders’ option into shares of common stock at a conversion price equal to $1.25 per share, and they were redeemable at our option beginning in December 2005. During the ensuing twelve months, the Senior Secured Convertible Notes may only be redeemed at our option at 100% of the principal amount if the closing price of our common stock has been at least 150% of the conversion price for the 20 consecutive trading days ending two trading days prior to the notice of redemption. Beginning in December 2006, the Senior Secured Convertible Notes may be redeemed at our option at 100% of the principal amount. The Senior Secured Notes are not convertible and are redeemable at our option at varying prices based on the year of redemption, beginning in June 2004 at 104% of the principal amount. Both the Senior Secured Convertible Notes and the Senior Secured Notes are redeemable at the option of the holder in the event of the sale of all, or substantially all, of our common stock for consideration other than common stock traded on a U.S. exchange or approved for quotation on the NASDAQ National Market. In addition, the indentures governing the Senior Secured Convertible Notes and the Senior Secured Notes contain covenants that, among other things, limit our ability to incur additional indebtedness, issue capital stock, pay dividends on and redeem or repurchase our capital stock, and prepay or repurchase subordinated debt. Both the Senior Secured Convertible Notes and the Senior Secured Notes are also secured by a junior priority security interest in certain of those assets in which the lenders under our secured credit facility currently hold a senior priority security interest.

The debt exchange was accounted for as an extinguishment of the tendered debt and resulted in a non-cash loss of approximately $31 million recorded in the second quarter of fiscal 2004, primarily representing the difference between the fair value of the new debt instruments and the net carrying value of the extinguished debt. The difference is treated as a premium on the new Senior Secured Convertible Notes and is being amortized as an offset to interest expense over the term of the notes. None of our Senior Secured Convertible Notes were converted during fiscal 2006. The unamortized premium on our Senior Secured Convertible Notes was reduced by $4 million during fiscal 2006 due to regular amortization and, as a result of filing for bankruptcy under Chapter 11, the remaining unamortized premium was written off to reorganization items.

During fiscal 2004, $35 million principal amount of our Senior Secured Convertible Notes were converted, resulting in the issuance of 28,220,000 shares of common stock, including 19,190,400 shares related to our induced conversion transaction described in Note 3. The unamortized premium on our Senior Secured Convertible Notes was also reduced by $7 million, of which approximately $2 million was due to regular amortization and $5 million resulted from debt conversions. During fiscal 2005, $0.5 million principal amount was converted, resulting in the issuance of 402,400 shares of common stock. During fiscal 2005, the unamortized premium was reduced by $4 million due to regular amortization and the effects of the conversions.

The remaining 2004 Senior Notes which were not tendered for exchange as noted above, with an aggregate principal amount of $4 million, were paid in full on September 1, 2004. Also during fiscal 2005, we repaid in full the remaining $14 million principal balance of our yen-denominated loan.

In connection with the fiscal 1996 acquisition of Cray Research, Inc. (“Cray Research”), we assumed the 6.125% Convertible Subordinated Debentures due in 2011. These debentures are convertible into shares of our common stock at a conversion price of $39.17 per share at any time prior to maturity and may be redeemed at our option at a price of 100% of the principal amount. Prior to our acquisition of Cray Research, Cray Research repurchased a portion of the debentures with a face value of $33 million. The repurchase satisfied the first nine required annual sinking fund payments of $6 million originally scheduled for fiscal years 1997 through 2002. In fiscal 2000 and fiscal 1999, we repurchased additional portions of the debentures with a face value of $11 million and $15 million, respectively. These repurchases satisfied the next four required annual sinking fund payments of $6 million originally scheduled for fiscal 2003 through fiscal 2006. Remaining annual sinking fund payments of $5 million in fiscal 2007 and $6 million each in fiscal 2008 to

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2010 are scheduled, with a final maturity payment of $35 million in 2011. During the fourth quarter of fiscal 2005, we received a notice of default from a purported holder of more than 25% of these debentures. For further information regarding this allegation, see Note 22 to our consolidated financial statements.

Asset-backed Credit Facility

On October 24, 2005, we entered into a two-year asset-backed credit facility with Wells Fargo Foothill, Inc. and Ableco Finance LLC. The facility provided for credit of up to $100 million, consisting of a $50 million revolving line of credit and a $50 million term loan. The borrowing base under this credit facility was determined weekly based on the value of working capital items, real estate and intellectual property. The revolving line of credit bears interest payable monthly at the prime rate plus 0.75% for cash advances up to $30 million. We were using this revolving line to secure letters of credit, principally the rent deposits required under our leases for the Amphitheatre and Crittenden Technology Center campuses in Mountain View, California. We deposited additional cash collateral when the eligible accounts receivable and other collateral, which fluctuate within the quarter, were below the level needed to secure our letters of credit. The term loan and cash advances greater than $30 million bear interest payable monthly at the prime rate plus 4.5% or 10.0%, whichever was greater. Letters of credit bear interest payable monthly up to a maximum rate of 3.0%. The facility did not require the permanent deposit of cash collateral. The facility was secured by substantially all of the assets of SGI and its domestic subsidiaries (the “Borrowers”) and included covenants for, among other things, minimum levels of EBITDA, minimum levels of cash and cash equivalents, and limits on capital expenditures. Subject to certain specified exceptions, the credit facility also limited the ability of the Borrowers to incur additional indebtedness, create liens on their assets, enter into certain transactions (including mergers, consolidations and reorganizations), dispose of certain assets, pay dividends or other distributions on capital stock, repurchase capital stock or prepay or repurchase debt obligations. The credit facility was subject to acceleration upon various events of default, including nonpayment of principal, interest, fees or other amounts when due, violation of covenants, commencement of insolvency proceedings against any Borrower or any of its U.S. subsidiaries or material foreign subsidiaries, the entry of certain judgments against any Borrower or any of its subsidiaries, cross default to indebtedness of any Borrower or any of its subsidiaries, and invalidity of loan documents or security interests. During the second quarter of fiscal 2006, we borrowed an initial $35 million against the term loan and on February 3, 2006, borrowed the remaining $15 million. We were in violation of the EBITDA covenant under this facility as of March 31, 2006 and we received a Default and Forbearance Letter from the lenders resulting from this violation. We accepted the terms of the Default and Forbearance Letter and applied $20 million of cash collateral against the outstanding term loan and reduced our obligation to $30 million. This facility was paid in full on June 28, 2006 with funds from our $130 million DIP Financing.

The filing of the Debtors’ Chapter 11 Cases described in Note 1 constituted an event of default under the Company’s 6.50% Senior Secured Convertible Notes due June 1, 2009 and the Company’s 11.75% Senior Secured Notes due June 1, 2009 and the Company’s pre-petition credit facility with Wells Fargo Foothill, Inc. and Ableco Finance LLC. The Debtors believe that any remedies that may exist related to this event of default under such indentures and agreements are stayed under the Bankruptcy Code.

Other debt at June 30, 2006 includes $3 million of proceeds received in connection with products sold under certain sales-type lease arrangements, after which we sold the lease receivables to certain financial institutions. These debt amounts represent future revenue streams for customer support contracts on those leased products that we are required under EITF 88-18, Sales of Future Revenue, to classify as debt. These future revenue streams will be amortized into revenue over the life of the contracts and will have no future cash-flow impact. Other debt at June 30, 2006 also included a $1 million loan secured by a receivable. The loan bears interest at a fixed annual rate of 5.22% and is repayable in quarterly installments ending in fiscal 2008.

On August, 30 2006, SGI entered into a commitment letter with Morgan Stanley Senior Funding, Inc. and General Electric Capital Corporation to provide exit liquidity financing as part of the Company’s plan to emerge from bankruptcy in fiscal 2007. The exit financing facility consists of an $85 million term loan from Morgan Stanley Senior Funding, Inc. and a $30 million line of credit from General Electric Capital Corp. that will be used to pay off the existing $130 million DIP Financing, make distributions pursuant to the Plan, and provide working capital for the Company’s ongoing operations. The exit financing facility is expected to mature in five years after the final credit agreement is executed. The estimated annual payments, including estimated interest, over the next five years is as follows (in millions): fiscal 2007 — $11; fiscal 2008 — $12; fiscal 2009 — $24; fiscal 2010 — $27; fiscal 2011 — $24 and $40 thereafter.

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Principal maturities of long-term debt as of June 30, 2006 were as follows (in millions): fiscal 2007 — $101.

Note 14. Leasing Arrangements as Lessee

We lease certain of our facilities and equipment under non-cancelable operating lease arrangements. Some of these leases include rental escalation clauses, renewal options, and, in certain cases, purchase options. Some of the facilities leases also require us to make additional payments to the landlords for common costs of operating and maintaining the facilities.

Future minimum annual lease payments under non-cancelable operating leases and contractual receipts from non-cancelable subleases, substantially all of which relate to facilities in restructuring, are as follows at June 30, 2006 (in thousands):

	Non-cancelable Operating Leases
	Facilities and Equipment Not in Restructuring		Facilities in Restructuring		Total		Non-cancelable Subleases			Net Payments
Fiscal 2007	$	9,697	$	818	$	10,515	$	(294	)	$	10,221
Fiscal 2008		6,183		682		6,865		(190	)		6,675
Fiscal 2009		4,792		509		5,301		(117	)		5,184
Fiscal 2010		3,045		218		3,263		—			3,263
Fiscal 2011		1,074		73		1,147		—			1,147
Thereafter		52		—		52		—			52
	$	24,843	$	2,300	$	27,143	$	(601	)	$	26,542

Aggregate operating lease rent expense in fiscal 2006, fiscal 2005, and fiscal 2004, was $14 million, $20 million, and $28 million, respectively. Included in fiscal 2004 rent expense was an offset of $3 million, which relates to recognition of a portion of our deferred gain on a sale leaseback transaction completed in December 2000 involving our ATC and CTC campuses in Mountain View, California. Amortization of this deferred gain during fiscal 2006 was not significant. During fiscal 2004, we entered into an agreement to sublease our ATC campus and relocated our corporate headquarters to the CTC campus, which entailed leasing additional space at this facility. Therefore, during fiscal 2004, we reclassified $30 million of the liability associated with the deferred gain from other liabilities to accrued restructuring. For additional information regarding this sublease agreement, see Note 5. As of June 30, 2006, we have a remaining deferred gain of $3 million on the sale leaseback transaction, which we will continue to amortize as an offset to rent expense. Pursuant to the May 26, 2006 settlement with our landlord to restructure our lease obligations at ATC) and CTC, we plan to vacate our remaining building at CTC by December 31, 2006. We will write off the remaining deferred gain at that time as a credit to restructuring expense.

Our lease of our corporate headquarters at the CTC campus requires us to deposit a letter of credit in an aggregate amount equal to $5 million with the landlord of this facility. This letter of credit is supported by our $130 million DIP Financing arrangement. If our obligations under our credit facility or long-term debt arrangements are accelerated due to an event of default, our landlords under these leases may have the right to exercise various remedies under the related leases, including without limitation, eviction, lease termination, assertion of claims for accelerated rents, and draws against outstanding letters of credit (which may include recovery of free rent for prior periods).

On September 7, 2006 we entered into a Lease Agreement with Christensen Holdings, L.P. for a replacement headquarters facility in Sunnyvale, California. The lease is for approximately 128,154 square feet with an initial five year lease term at $0.977 per square foot in the first year, increasing to $1.137 per square foot by the fifth year. We expect to occupy the new facility by the end of calendar 2006. Obligations under this new arrangement are not included in the tables above.

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Note 15. Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss, net of tax of $0, were as follows (in thousands):

	June 30, 2006			June 24, 2005
Unrealized gain (loss) on derivative instruments designated and qualifying as cash flow hedges	$	152		$	1,719
Foreign currency translation adjustments		(20,149	)		(19,167	)
Accumulated other comprehensive loss	$	(19,997	)	$	(17,448	)

As a result of reductions in our investments in foreign entities, we transferred $2 million of net accumulated foreign currency translation gains to income during fiscal 2005. We did not have any similar transactions during fiscal 2006.

Note 16. Income Taxes

The components of loss from continuing operations before income taxes were as follows (in thousands):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
United States	$	(137,912	)	$	(109,009	)	$	(111,310	)
International		(11,928	)		25,263			1,537
	$	(149,840	)	$	(83,746	)	$	(109,773	)

The (benefit) provision for income taxes consisted of the following (in thousands):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Federal:
Current	$	388		$	(4,113	)	$	(3,963	)
Deferred		—			—			—
State:
Current		(758	)		246			(2,571	)
Deferred		—			—			—
Foreign:
Current		(3,016	)		(4,059	)		(2,868	)
Deferred		(260	)		(88	)		(125	)
	$	(3,646	)	$	(8,014	)	$	(9,527	)

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The benefit for income taxes reconciles to the amounts computed by applying the statutory federal tax rate to our loss from continuing operations before income taxes as follows (in thousands):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Tax at U.S. federal statutory rate	$	(52,444	)	$	(29,311	)	$	(38,420	)
State taxes, net of federal tax benefit		(493	)		160			(1,670	)
Net operating loss with no tax benefit		55,772			27,598			38,100
Net foreign tax benefit with no U.S. tax cost		(3,276	)		(4,147	)		(1,734	)
Earnings subject to foreign taxes at lower rates		—			(4,057	)		(6,092	)
Goodwill impairment		(2,935	)		—			—
Other		(270	)		1,743			289
Benefit for income taxes	$	(3,646	)	$	(8,014	)	$	(9,527	)

The tax effects of temporary differences and carryforwards that give rise to significant portions of deferred tax assets and liabilities at June 30, 2006 and June 24, 2005 (in thousands):

	2006			2005
Deferred tax assets:
Net operating loss carryforwards	$	586,240		$	507,877
General business credit carryforwards		59,716			61,589
Capitalized research expenses		80,909			76,628
Inventory valuation		20,507			23,981
Reserves not currently deductible		20,418			41,407
Other		109,117			103,095
Subtotal		876,907			814,577
Valuation allowance		(791,426	)		(730,616	)
Total deferred tax assets		85,481			83,961
Deferred tax liabilities:
U.S. residual taxes on unremitted foreign earnings		83,822			82,300
Other		3,665			3,927
Total deferred tax liabilities		87,487			86,227
Total	$	(2,006	)	$	(2,266	)

At June 30, 2006, we had gross deferred tax assets arising from deductible temporary differences, tax losses, and tax credits of $877 million. The gross deferred tax assets were offset by a valuation allowance of $791 million and deferred tax liabilities of $87 million. The valuation allowance of $791 million included $35 million attributable to tax benefits of stock option deductions, which, if recognized, would be allocated directly to paid-in capital. The total valuation allowance increased $61 million in fiscal 2006. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of deferred tax assets will not be realized. The realization is based on several factors, including the Company’s past earnings and the scheduling of deferred tax liabilities and projected income operating activities. As of June 30, 2006, management does not believe it is more likely than not that the deferred tax assets relating to U.S. federal, state, and foreign operations are realizable. Deferred income taxes have been provided on the undistributed earnings of foreign subsidiaries.

At June 30, 2006, we had United States federal, state, and foreign jurisdictional net operating loss carryforwards of $1.4 billion, $386 million, and $171 million, respectively. The federal losses will begin expiring in fiscal 2010, the state losses will begin expiring in fiscal 2007, and the foreign losses will begin to expire in fiscal 2007. At June 30, 2006, we also had general business credit carryovers of $38 million for United States federal tax purposes, which will begin to expire in fiscal 2007, and alternative minimum tax credits of $5 million, which do not have fixed expirations dates. We had state research and development credits of $29 million, which do not have expiration dates, and state manufacturing investment tax credits of $4 million which will begin to expire in fiscal 2007.

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Most of these net operating loss carryforwards were incurred prior to SGI’s Chapter 11 reorganization and therefore are subject to limitation under U.S. and state income tax laws. Pursuant to these loss limitation rules, the utilization of net operating loss and credit carryforwards are limited if, during a testing period (usually three years), there is greater than a 50% cumulative shift in the ownership of its stock. As a result of the bankruptcy reorganization, SGI will exchange some of its debt for common stock. This exchange is expected to result in more than a 50% cumulative shift in the stock ownership of SGI. Accordingly, SGI’s ability to utilize its net operating losses will be significantly limited as provided under section 382 of the Internal Revenue Code.

Note 17. Research and Development Arrangements

Beginning in fiscal 2004, we entered into research and development arrangements with external government and commercial entities, varying in contract duration from 1 to 4 years. Currently, the value of these arrangements totals $9 million and covers periods through fiscal 2008. The objective of these arrangements is to fund the development of technologies or products that meet specific operational needs for our business partners and lead towards the commercialization of new products that can be sold for incremental revenue. In fiscal 2006, we earned Product and Other revenue of approximately $2 million in compensation and incurred $2 million in cost of Product and Other revenue under such contracts. In fiscal 2005, we earned approximately $3 million in compensation and incurred $3 million in costs under such contracts.

Note 18. Segment Information

SGI has two reportable segments, Products and Global Services. Our reportable segments are determined after assessment of factors such as quantitative thresholds of business components to be included into reportable segments, customer base, economic characteristics, homogeneity of products, technology, delivery channels, and other factors, and are aligned with the process by which executive management makes operating decisions and evaluates performance.

Products

Our Products segment is comprised of our Core Systems based on the Intel Itanium 2 microprocessor and Linux operating system as well as our storage solutions and our Legacy Systems based on the MIPS RISC microprocessor and IRIX operating system including the remarketed versions of these workstations, graphics systems, high-performance servers and storage solutions. Our Products are distributed through our direct sales force and through indirect channels, including resellers, distributors, and systems integrators.

Our Core Systems are comprised of our high-performance servers and visualization systems based on Intel Itanium 2 microprocessors and the Linux operating system and storage solutions. Our Core Systems include the SGI Altix family of high-performance servers and the SGI InfiniteStorage line of storage solutions. These are high-performance supercomputing systems designed for technical computing applications, and they are also used as storage management servers for managing very large data repositories that contain critical information and media servers for broadcast television applications. Our Core Systems also include the Silicon Graphics Prism family of visualization systems. These visualization systems are used in a variety of applications, including computer-aided design, medical imaging, 2D and 3D animation, broadcast, modeling, and simulation. Our graphics systems integrate high-performance computing, data management, and high-performance visualization into a single system. The Prism family of visualization systems has recently been discontinued but will continue to ship through the second quarter of fiscal 2007.

Our Legacy Systems are comprised of our high-performance servers and visualization systems based on MIPS RISC microprocessors and the IRIX operating system. Our Legacy Systems include the SGI Origin family of high-performance servers. These are high-performance supercomputing systems designed for technical computing applications, and they are also used as storage management servers for managing very large data repositories that contain critical information and media servers for broadcast television applications. Our Legacy Systems also include the Silicon

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Graphics Tezro and Silicon Graphics Fuel workstations and the SGI Onyx family of graphics systems. These workstations are used in a variety of applications, including computer-aided design, medical imaging, 2D and 3D animation, broadcast, modeling, and simulation. Our graphics systems integrate high-performance computing, data management, and high-performance visualization into a single system. Our Legacy Systems also include the remarketed versions of the MIPS/IRIX-based workstations, graphics systems and high-performance servers as well as remarketed versions of our storage solutions.

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Global Services

Our Global Services segment supports our computer hardware and software products and provides professional services to help customers realize the full value of their information technology investments. Our professional services organization provides technology consulting, education, managed services, and third-party products.

Revenue from external customers for similar classes of products and services was as follows (in thousands):

	Years ended
	June 30, 2006		June 24, 2005		June 25, 2004
Core Systems:
Computer systems products	$	122,741	$	205,685	$	120,225
Data management products		49,933		64,279		80,034
Total Core Systems		172,674		269,964		200,258
Legacy Systems:
Computer systems products		73,843		160,152		292,381
Data management products		4,492		4,554		3,666
Total Legacy Systems		78,335		164,705		296,047
Total Products revenue	$	251,009	$	434,670	$	496,306
Support services	$	215,329	$	237,434	$	281,363
Professional services and solutions		52,467		57,861		64,333
Total Global Services revenue	$	267,796	$	295,295	$	345,696

Segment Results

We evaluate our segments based on the direct revenues, costs of sale and expenses that we can directly attribute to those segments. We do not routinely manage our business by identifying or allocating assets, corporate administrative costs, or depreciation by operating segment, nor do we evaluate segments on these criteria. On a quarterly basis, we utilize a robust set of assumptions to allocate indirect costs, which contribute to overall company profit and loss, to our segments. Operating segments do not sell products to each other, and accordingly, there is no inter-segment revenue to be reported.

Operating results for our reportable segments were as follows (in thousands):

	Years ended
	June 30, 2006			June 24, 2005			June 25, 2004
Revenue from external customers:
Products	$	251,009		$	434,670		$	496,306
Global services		267,796			295,295			345,696
Total consolidated	$	518,805		$	729,965		$	842,002
Operating income (loss):
Products	$	(142,792	)	$	(86,282	)	$	(119,016	)
Global services		37,370			13,896			101,668
Total reportable segments		(105,422	)		(72,386	)		(17,348	)
Restructuring		(21,155	)		(24,083	)		(47,825	)
Total consolidated	$	(126,577	)	$	(96,467	)	$	(65,173	)

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Our revenue by geographic region, based on the location of the customer, was as follows (in thousands):

	Years ended
	June 30, 2006		June 24, 2005		June 25, 2004
Americas	$	306,156	$	447,974	$	547,530
Europe		130,831		176,641		211,200
Rest of world		81,818		105,350		83,272
Total	$	518,805	$	729,965	$	842,002

Our long-lived assets, except long-term restricted investments, other long-term investments, and net long-term deferred tax assets, were located in geographic regions as follows (in thousands):

	June 30, 2006		June 24, 2005
Americas	$	71,907	$	98,323
Europe		6,634		14,756
Rest of world		5,946		5,969
Total	$	84,487	$	119,048

No single customer represented 10% or more of our total revenue in any period presented.

Note 19. Benefit Plans

401(k) Retirement Savings Plan. We provide a 401(k) investment plan covering substantially all of our U.S. employees. The plan provides for a minimum 25% Company match of an employee’s contribution up to a specified limit, but allows for a larger matching subject to certain regulatory limitations. Our matching contributions for fiscal 2006 were approximately $1 million, and were approximately $2 million in both fiscal 2005 and 2004.

Deferred Compensation Plan. We have a Non-Qualified Deferred Compensation Plan that allows eligible executives and directors to defer a portion of their compensation. The deferred compensation, together with Company matching amounts and accumulated earnings, is accrued but unfunded. Such deferred compensation is distributable in cash and amounted to approximately $2 million as of June 30, 2006 and $2 million as of June 24, 2005. A participant may elect to receive such deferred amounts in one payment or in annual installments no sooner than two years following each annual election. Participant contributions are always 100% vested and our matching contributions vest as directed by the board of directors. There have been no matching contributions to date. The plan has been closed to both new participants and contributions. As a result of the bankruptcy, the Non-Qualified Deferred Compensation Plan is considered subject to compromise.

Note 20. Related Party Transactions

We record our proportionate share of SGI Japan’s financial results as non-operating income or loss in accordance with APB 18, The Equity Method of Accounting for Investments in Common Stock. We record product revenue sold to SGI Japan under SEC Staff Accounting Bulletin No. (SAB) 104, Revenue Recognition. However, because of our related party relationship with SGI Japan, we reduce our proportionate share of their financial results for any SGI product sold to SGI Japan that has not been sold through to their customer, by the amount of profit on those transactions. Due to the timing of receipt of financial reporting information from SGI Japan, these entries are recorded on a one quarter lag, unless the amount of profit on product not yet sold through to SGI Japan’s customers during the quarter is materially different than previous quarters. When materially different, we reduce our proportionate share of SGI Japan’s financial results by the amount of the profit on those specific transactions in the current quarter.

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Revenue and standard cost of revenue associated with sales to SGI Japan, which represent substantially all of our sales to related parties, were as follows (in thousands):

	Years ended
	June 30, 2006		June 24, 2005		June 25, 2004
Product revenue	$	28,836	$	44,658	$	25,990
Standard cost of product revenue	$	17,613	$	25,616	$	14,194

During fiscal 2006 SGI Japan issued new shares of their common stock and as a result, our ownership percentage was diluted from 24% to 20%. In accordance with SEC Staff Accounting Bulletin No. (“SAB”) 51, Accounting for Sales of Stock by a Subsidiary, we increased the value of our equity investment in SGI Japan by approximately $4 million which was recorded as a component of stockholders’ deficit.

We did not make any purchases from related parties during fiscal 2006 and 2005. Total purchases from related parties were $0.2 million for fiscal 2004. Aggregate amounts receivable from these related parties were $0.2 million at June 30, 2006 and $1 million at June 24, 2005. Aggregate amounts payable to these related parties were immaterial at each of June 30, 2006 and June 24, 2005.

During fiscal 2001 and fiscal 2002 we extended loans to several executive officers. At June 24, 2005, loans receivable from executives were $25 thousand. In fiscal 2006, these loans were paid in full.

Note 21. Supplemental Cash Flow Information

Supplemental disclosures of cash flow information (in thousands):

	Years ended
	June 30, 2006		June 24, 2005			June 25, 2004
Cash paid during the year for:
Interest	$	13,453	$	16,830		$	22,679
Income taxes, net of refunds		2,302		(9,267	)		(3,014	)

Supplemental schedule of non-cash investing and financing activities (in thousands):

	Years ended
	June 30, 2006		June 24, 2005		June 25, 2004
Exchange of 6.5% Senior Secured Convertible Notes and 11.75% Senior Secured Notes for 98% of our 5.25% Senior Convertible Notes	$	—	$	—	$	226,742
Conversion of 6.50% Senior Secured Convertible Notes into common stock		—		503		32,185
Interest expense incurred with the induced conversion of a portion of our 6.50% Senior Secured Convertible Notes		—		—		3,090

Note 22. Contingencies

The Company may, from time to time, be involved in lawsuits, claims, investigations and proceedings that arise in the ordinary course of its business. In accordance with SFAS No. 5, “Accounting for Contingencies,” we record a provision for a liability when management believes that it is both probable that a liability has been incurred and we can reasonably estimate the amount of the loss. We believe we have adequate provisions for any such matters. We review these provisions at least quarterly and adjust these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case.

Our U.S. income tax returns for fiscal years 2003 to 2005 are open, and to date, we have not been notified of any pending audits or of any proposed adjustments to those returns. We are also negotiating the settlement of tax issues relating to our investment in Cray Research that affect the years 1984 through 1988. The current settlement proposals may result in a significant tax credit. We are currently being audited for state sales and use tax matters for the years 2000 through 2006 in Wisconsin, Minnesota and California. In addition, we have open income tax, VAT, and sales tax audits for years 1995 through 2005 in various foreign jurisdictions. The most significant of these audits surrounds proposed adjustments we made in April 2005 to our prior year Canadian federal tax returns for fiscal years 1996 through 2004. The adjustments are currently being reviewed by the Canadian Revenue Authorities and if accepted, will result in a significant

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tax credit. Our tax reserves associated with these historic Canadian federal tax returns have been prepared on the basis of issued assessments for fiscal years 1996 through 2002 and submitted tax returns for fiscal years 2003 and 2004. The outcome of any tax audits cannot be predicted with certainty, but we believe that any resulting audit adjustments to any of our open tax returns will not result in a material adverse impact on our financial condition, results of operations, or cash flows.

As described in Note 1, on the Petition Date, May 8, 2006, the Debtors filed voluntary petitions for relief under Chapter 11. As debtors-in-possession, we are 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. As of the Petition Date, most pending litigation (including some of the actions described below) is stayed, and absent further order of the Court, no party, subject to certain exceptions, may take any action, again subject to certain exceptions, to recover on pre-petition claims against us.

SCO Group, the successor to AT&T as the owner of certain UNIX system V intellectual property and as our licensor, has publicly claimed that certain elements of the Linux operating system infringe SCO Group’s intellectual property rights. In August 2003, we received a letter from SCO Group alleging that, as a result of our activities related to the Linux operating system, we are in breach of the fully paid license under which we distribute our IRIX operating system. The letter purported to terminate our UNIX System V license effective October 14, 2003. We have not received any communication from SCO with regard to this purported termination since that time. We believe that the SCO Group’s allegations are without merit and that our fully paid license is non-terminable. There can be no assurance that this dispute with SCO Group will not escalate into litigation, which could have a material adverse effect upon SGI, or that SCO Group’s intellectual property claims, which include a widely publicized litigation against IBM Corporation, will not impair market acceptance of the Linux operating system.

On August 10, 2005, our German subsidiary, which is not a party to the Chapter 11 Cases, filed a lawsuit with the LG Munich, a Higher Regional Court in Germany, against T-Systems International GmbH (“TSI”), a systems integrator, relating to a dispute regarding whether acceptance criteria were met with regard to an SGI system delivered in the spring of 2003. We are seeking full payment for the system in an amount equal to €4.6 million ($5.8 million based on the conversion rate as of June 30, 2006). On September 21, 2005, TSI filed a counterclaim contesting our claim and alleging damages of €9 million plus interest since April 2004 ($11.3 million based on the conversion rate as of June 30, 2006), which exceeds our contractual limit of liability of €2 million ($2.5 million based on the conversion rate as of June 30, 2006). On December 7, 2005, we responded to TSI’s counterclaim and filed a motion seeking an additional €3.8 million ($4.8 million based on the conversion rate as of June 30, 2006) for lost profit relating to maintenance services. We cannot currently predict the outcome of this dispute.

The filing of the Debtors’ Chapter 11 Cases described in Note 1 constituted an event of default under the Company’s 6.50% Senior Secured Convertible Notes due June 1, 2009 and the Company’s 11.75% Senior Secured Notes due June 1, 2009 and the Company’s pre-petition credit facility with Wells Fargo Foothill, Inc. and Ableco Finance LLC. The Debtors believe that any remedies that may exist related to this event of default under such indentures and agreements are stayed under the Bankruptcy Code. Upon the Effective Date of the Plan, all of the claims of the 2009 Notes will have been addressed in accordance with the terms of the Plan and all claims relating to defaults will be discharged.

On July 12, 2005, we disclosed that we had received a notice of default from a purported holder of more than 25% of our 6.125% Convertible Subordinated Debentures due 2011 (the “2011 Debentures”), which we assumed when we acquired Cray Research in 1996 (see Note 13). The notice alleged that the indenture for the 2011 Debentures was breached in 2000 when we sold assets relating to certain former Cray Research product lines to Tera Computer Company (now known as Cray, Inc.) without causing Tera to assume the indenture. As a result of the notice and the expiration of the applicable cure period, such holder may now seek to accelerate the maturity of the 2011 Debentures. We strongly disagree with the claims made in the notice and intend to vigorously challenge any claim of an event of default. There are currently $57 million outstanding principal amount of 2011 Debentures. The 2011 Debentures are unsecured and subordinated. Upon the Effective Date of the Plan, all of the claims of the 2011 Debentures will have been addressed in accordance with the terms of the Plan and all claims relating to defaults will be discharged.

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On July 29, 2005, Syntegra (USA), Inc., a computer repair services vendor, filed a complaint against SGI in the U.S. District Court, Northern District of California, in connection with SGI’s termination of its contract with Syntegra and transition of its business to an alternate vendor alleging, among other things, breach of contract, unfair competition and misappropriation of trade secrets. This complaint was dismissed from the federal court as improperly filed and on September 20, 2005, Syntegra re-filed a substantively similar complaint in the Superior Court of California, Santa Clara County. On November 7, 2005, SGI filed its answer to Syntegra’s complaint and, additionally, filed a cross complaint against Syntegra for, among other things, declaratory relief and breach of contract. We intend to vigorously defend against Syntegra’s allegations and pursue our claims.

On August 3, 2006, LG Electronics, Inc. (“LGE”) filed a motion (the “LGE Motion”) in the Chapter 11 Cases of the Debtors seeking relief from the automatic stay pursuant to section 362(d)(1) of the Bankruptcy Code so that LGE may proceed with certain patent infringement claims against the Company in the appropriate district court and seek damages for alleged pre- and post-petition infringements of certain of LGE’s patents. The LGE Motion also requests that the Court determine that the automatic stay does not apply to LGE’s ability to commence a proceeding against the Company in respect of the Company’s alleged continuing, post-petition infringement of LGE’s patents. LGE also filed proofs of claims in the Chapter 11 Cases against each of the Debtors in connection with the alleged patent infringement. On August 25, 2006, the Debtors objected to LGE’s proofs of claims. The Debtors and LGE resolved the LGE Motion by stipulation dated September 8, 2006, and entered by the Court on September 8, 2006. In the stipulation, LGE agreed to withdraw the LGE Motion, agreed not to file any objection to confirmation of the Debtors’ Plan, and agreed to withdraw all proofs of claim asserting pre-petition infringement except the one filed against SGI. The Debtors agreed that LGE claims alleging patent infringement first arising after the commencement of the Chapter 11 Cases could be adjudicated in a court of competent jurisdiction other than the Court after confirmation of the Plan. On September 26, 2006, we filed a motion to estimate the LGE claims at $0.00 for purposes of allowance and distribution under the Plan. A hearing on this motion is scheduled for November 1, 2006.

The Company first learned of LGE’s claims in December 2000 when it received a letter stating LGE’s belief that the Company was infringing eight patents owned by LGE. During the past several years, the parties have exchanged correspondence and held numerous meetings in an effort to resolve the claims. Although LGE has made a demand for a monetary settlement to its claims, no formal action was filed prior to bankruptcy. LGE is currently in the process of litigating similar patent claims with several other system manufacturers and has indicated to the Company that it is reserving all rights concerning its claims pending the resolution of that litigation. Until the LGE Motion, SGI had not received any further correspondence from LGE since an April 5, 2004 letter indicating that the lawsuits against the other companies were still pending and that LGE would continue licensing discussions at any time.

The Company does not believe LGE’s claims of patent infringement are meritorious and intends to oppose them.

As a result of anonymous allegations and allegations by an ex-employee we conducted an internal investigation into whether certain systems were delivered to an entity in China in possible violation of U.S. export laws. We have voluntarily shared information with respect to the investigation with the U.S. Department of Commerce. We cannot assure that the Department or other agencies of the US government will not institute any proceedings against the Company in the future. In addition, from time to time, we receive inquiries from regulatory agencies informally requesting information or documentation. There can be no assurance in any given case that such informal review will not lead to further proceedings involving the Company in the future.

We also routinely receive communications from third parties asserting patent or other rights covering our products and technologies. Based upon our evaluation, we may take no action or we may seek to obtain a license. We are in discussions with several parties that have asserted intellectual property infringement claims. There can be no assurance in any given case that a license will be available on terms we consider reasonable, or that litigation will not ensue.

On April 27, 2004, SGI received a letter from counsel for Patriot Scientific Corporation listing six patents purportedly owned by Patriot concerning various microprocessor technologies. The letter did not name any specific products of SGI but noted that Patriot had commenced litigation against six companies in two separate litigations, including Intel. On September 23, 2005, SGI received a follow up letter from Alliacense, which purported to be a successor entity to Patriot. The September 2005 letter stated that Alliacense had reached agreement with several companies, including Intel and AMD, for licenses to the subject patents. The letter did not identify any specific products of SGI that Alliacense believed to infringe any of the subject patents; however, the letter states Alliacense’s belief that “virtually every product manufactured today utilizing microprocessors or embedded microprocessors” will require a portfolio license from Alliacense. We believe that Alliancense’s assertions are without merit.

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We are not aware of any pending disputes, including those disputes and settlements described above, that would be likely to have a material adverse effect on our financial condition, results of operations, or liquidity. However, litigation is subject to inherent uncertainties and costs, including costs of litigation, and unfavorable outcomes could occur. An unfavorable outcome could include the payment of monetary damages, cash or other settlement, or an injunction prohibiting us from selling one or more products. If an unfavorable resolution were to occur, there exists the possibility of a material adverse impact on our financial condition, results of operations, or cash flows of the period in which the resolution occurs or on future periods.

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Note 23. Selected Quarterly Financial Data (Unaudited)

(In thousands, except per share amounts; numbers may not add due to rounding)

	Fiscal 2006
	June 30			March 31			December 30 (1)			September 30 (1)
Total revenue	$	115,708		$	105,562		$	136,796		$	160,739
Costs and expenses:
Cost of revenue		70,532			68,227			80,952			100,722
Research and development		18,220			20,838			21,254			23,365
Selling, general and administrative		42,903			51,336			57,627			59,865
Impairment of goodwill		—			8,386			—			—
Other operating expense (2)		(7,694	)		11,550			10,114			7,185
Operating income (loss)		(8,253	)		(54,775	)		(33,151	)		(30,398	)
Interest and other income (expense) , net		(3,615	)		(4,292	)		(2,226	)		(5,304	)
Reorganization items (3)		(7,826	)		—			—			—
Loss from continuing operations before income taxes	$	(19,694	)	$	(59,067	)	$	(35,377	)	$	(35,702	)
Net loss from continuing operations	$	(20,376	)	$	(53,955	)	$	(35,664	)	$	(36,199	)
Net loss from discontinued operations, net of tax		—			—			—			—
Net loss	$	(20,376	)	$	(53,955	)	$	(35,664	)	$	(36,199	)
Net loss per common share – basic and diluted:
Continuing operations	$	(0.08	)	$	(0.20	)	$	(0.13	)	$	(0.14	)
Discontinued operations		—			—			—			—
Net income (loss) per common share – basic	$	(0.08	)	$	(0.20	)	$	(0.13	)	$	(0.14	)
Shares used in the calculation of net income (loss) per common share:
Basic		271,563			270,452			268,383			267,036
Diluted		271,563			270,452			268,383			267,036

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	Fiscal 2005
	June 24 (4)			March 25			December 24			September 24
Total revenue	$	172,216		$	159,240		$	223,102		$	175,407
Costs and expenses:
Cost of revenue		108,958			104,283			139,358			112,477
Research and development		20,234			24,342			24,823			23,306
Selling, general and administrative		57,956			61,025			62,870			62,717
Other operating expense (2)		1,424			14,294			5,199			3,166
Operating loss		(16,356	)		(44,704	)		(9,148	)		(26,259	)
Interest and other income (expense) , net		23,208			(1,361	)		(3,724	)		(5,402	)
Income (loss) from continuing operations before income taxes	$	6,852		$	(46,065	)	$	(12,872	)	$	(31,661	)
Net income (loss) from continuing operations	$	7,847		$	(44,501	)	$	(11,149	)	$	(27,929	)
Net loss from discontinued operations, net of tax		—			—			—			(276	)
Net income (loss)	$	7,847		$	(44,501	)	$	(11,149	)	$	(28,205	)
Net income (loss) per common share – basic:
Continuing operations	$	0.03		$	(0.17	)	$	(0.04	)	$	(0.11	)
Discontinued operations		—			—			—			(0.00	)
Net income (loss) per common share – basic	$	0.03		$	(0.17	)	$	(0.04	)	$	(0.11	)
Net income (loss) per common share – diluted:
Continuing operations	$	0.02		$	(0.17	)	$	(0.04	)	$	(0.11	)
Discontinued operations		—			—			—			(0.00	)
Net income (loss) per common share – diluted	$	0.02		$	(0.17	)	$	(0.04	)	$	(0.11	)
Shares used in the calculation of net income (loss) per common share:
Basic		265,149			264,043			262,487			262,039
Diluted		417,845			264,043			262,487			262,039

(1) In conjunction with the preparation of our year-end financial statements and the completion of our audit for fiscal 2006, we concluded that certain of our sales transactions where software was more than incidental to the overall solution should more appropriately have been recorded under SOP 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 for fiscal 2006, these same products should be accounted for under the provisions of SOP 97-2. This change resulted in adjustments to revenue, cost of revenue, and operating loss for the first and second quarters of fiscal 2006, as compared to the results previously reported. We believe the adjustments to the results previously reported are immaterial. The impacts of these adjustments on our reported results of operations for the first and second quarters were as follows ( (decrease) to income; in thousands, except per share amounts):

	Quarters Ended
	Dec 30, 2005			Sept 30, 2005
Total revenue (decrease)	$	(7,597	)	$	(8,938	)
Operating loss (increase)	$	(4,231	)	$	(4,128	)
Net loss from continuing operations (increase)	$	(4,231	)	$	(4,128	)
Net loss per common share (increase)	$	(0.02	)	$	(0.02	)

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(2) Other operating expense is composed of restructuring and asset impairment charges.

(3) Reorganization items represent expenses for professional fees and adjustments to debt carrying values for amounts in excess of allowed claims as a result of the reorganization of our business under Chapter 11.

(4) In the fourth quarter of fiscal 2005, we recorded adjustments for a number of individually immaterial items that related to events or transactions in earlier quarters. The impacts of these adjustments on our reported results of operations for the fourth quarters were as follows (increase (decrease) to income; in thousands, except per share amounts):

	Quarter Ended June 24, 2005
Total revenue	$	(2,625	)
Operating loss	$	2,728
Net income/loss from continuing operations	$	3,275
Net income/loss per common share – diluted	$	0.01

24. Subsequent Event (Unaudited)

In August 2006, we completed the sale of a portion of our equity investment in SGI Japan to SGI Japan, Ltd. We received net cash proceeds of approximately $17 million and will record a net gain of approximately $8 million in the first quarter of fiscal 2007. As a result of the sale, our ownership interest will be reduced to approximately 10%. See Note 20 further information on our related party relationship with SGI Japan.

On September 7, 2006 we entered into a Lease Agreement with Christensen Holdings, L.P. for a replacement headquarters facility in Sunnyvale, California. The lease is for approximately 128,154 square feet with an initial five year lease term at $0.977 per square foot in the first year, increasing to $1.137 per square foot by the fifth year. We expect to occupy the new facility by the end of calendar 2006.

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

An evaluation was performed under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of June 30, 2006. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2006 based on the framework set forth in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of June 30, 2006.

Management’s assessment of the effectiveness of our internal control over financial reporting as of June 30, 2006 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included in Part II, Item 8 of this Form 10-K.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting.

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ITEM 9B. OTHER INFORMATION

On September 18, 2006, each officer of the Company who is a party to an Employment Continuation Agreement with the Company entered into an agreement with the Company acknowledging that no change of control will occur in connection with the Company’s emergence from Bankruptcy.

Pursuant to a lease agreement dated as of September 7, 2006 between the Company, as tenant, and Christensen Holdings, L.P., as landlord, we leased approximately 128,154 rentable square feet of space located at 1140-1154 East Arques Avenue in Sunnyvale, California to be used as the Company’s new headquarters. The lease was approved by the Bankruptcy Court on September 19, 2006 and became effective on September 29, 2006. The lease term is approximately sixty (60) months and provides for one 5-year extension at our option. The lease provides for the payment by the Company of “Base Rent” and “Additional Rent” and further provides that all utility and other building services furnished to the Company be paid directly by the Company.

Pursuant to the lease, “Base Rent” is payable monthly at a rate commencing at $125,206 per month during the first year and escalating to $145,711 per month during the fifth year of the lease. “Additional Rent” is also payable on a monthly basis (based upon an estimated annual aggregate amount determined by the landlord and subject to an annual adjustment upon determination of actual costs) and includes the Company’s proportionate share of certain costs and expenses attributable to the leased premises including taxes and assessments, insurance costs, outside area expenses, maintenance and repair costs, and management costs. We have deposited the sum of $920,400 as a security deposit with the landlord which amount may be reduced to $460,200 on the third anniversary of the commencement date of the lease provided that certain conditions are satisfied as set forth in the lease.

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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item will be filed with the Securities and Exchange Commission as an amendment to this Form 10-K in accordance with General Instruction G(3).

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item will be filed with the Securities and Exchange Commission as an amendment to this Form 10-K in accordance with General Instruction G(3).

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item will be filed with the Securities and Exchange Commission as an amendment to this Form 10-K in accordance with General Instruction G(3).

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item will be filed with the Securities and Exchange Commission as an amendment to this Form 10-K in accordance with General Instruction G(3).

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this Item will be filed with the Securities and Exchange Commission as an amendment to this Form 10-K in accordance with General Instruction G(3).

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PART IV

ITEM 15. 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: See “Index to Consolidated Financial Statements” under Item 8 on page 48 of this Annual Report

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. Schedules not listed have been omitted because they are not applicable or are not included in the consolidated financial statements or notes thereto.

Schedule II

Valuation and Qualifying Accounts

(in thousands)

Description	Balance at Beginning of Period		Charged to Costs and Expenses		Other			(Write-offs)/ Recoveries			Balance at End of Period
Year ended June 25, 2004:
Accounts receivable allowance	$	8,421	$	212	$	(2,332	)(2)	$	(1,726	)	$	4,575
Deferred tax asset allowance	$	724,610	$	17,053	$	1,861	(1)	$	—		$	743,524
Year ended June 24, 2005:
Accounts receivable allowance	$	4,575	$	280	$	(1,120	)(2)	$	(1,508	)	$	2,227
Deferred tax asset allowance	$	743,524	$	21,673	$	8,504	(1)	$	(43,085	)	$	730,616
Year ended June 30, 2006:
Accounts receivable allowance	$	2,227	$	877	$	(132	)	$	145		$	3,117
Deferred tax asset allowance	$	730,616	$	59,795	$	1,015	(1)	$	—		$	791,426

(1) Reserve of paid-in capital benefits related to stock option activity.

(2) In addition to the items noted in (1), includes approximately $1 million of accounts receivable allowance for discontinued operations and approximately $1 million of MCSI reserve reclassification to long term accounts receivable.

3. EXHIBITS. The following Exhibits are filed as part of, or incorporated by reference into, this Report

2.1	Debtors’ First Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code, as Modified, dated September 15, 2006 (incorporated by reference to Exhibit 2.1 of Registrant’s Form 8-K filed on September 19, 2006).
2.2	Disclosure Statement for Debtors’ First Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code dated July 27, 2006 (incorporated by reference to Exhibit 2.2 of Registrant’s Form 8-K filed on September 19, 2006).
3.1.1	Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1.1 of Registrant’s Form 10-K for the year ended June 25, 2004).

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3.1.2	Amendment to the Restated Certificate of Incorporation of the Company, dated December 16, 2003 (incorporated by reference to Exhibit 3.1 of Registrant’s Form 8-K filed on December 17, 2003).
3.2	Bylaws of the Company, as amended (incorporated by reference to Exhibit 3.2 of Registrant’s Form 8-K filed on December 17, 2003).
4.1	Indenture dated February 1, 1986 between Cray Research, Inc. and Manufacturers Hanover Trust Company, as Trustee (incorporated by reference to Exhibit 4.5 of Registrant’s Amended Form 10-K for the year ended June 30, 1996).
4.2	First Supplemental Indenture dated June 30, 1996 between the Company, Cray Research, Inc., and Chemical Bank (formerly Manufacturers Hanover Trust Company) (incorporated by reference to Exhibit 4.6 of Registrant’s Amended Form 10-K for the year ended June 30, 1996).
4.3	Indenture dated as of December 24, 2003 between SGI and U.S. Bank National Association, as Trustee (incorporated by reference to Exhibit 4.4 of Registrant’s Form 10-K for the year ended June 24, 2005).
4.4	Form of 6.50% Senior Secured Convertible Note (incorporated by reference to Exhibit 4.5 of Registrant’s Form 10-K for the year ended June 24, 2005).
4.5	Indenture dated as of December 24, 2003 between SGI and U.S. Bank National Association, as Trustee (incorporated by reference to Exhibit 4.6 of Registrant’s Form 10-K for the year ended June 24, 2005).
4.6	Form of 11.75% Senior Secured Note (incorporated by reference to Exhibit 4.7 of Registrant’s Form 10-K for the year ended June 24, 2005).
4.7	Intercreditor Agreement dated December 24, 2003 among SGI, Wells Fargo Foothill, Inc. and U.S. Bank National Association (incorporated by reference to Exhibit 4.8 of Registrant’s Form 10-K for the year ended June 24, 2005).
4.8	Security Agreement dated December 24, 2003 between SGI and U.S. Bank National Association, as Trustee (incorporated by reference to Exhibit 4.9 of Registrant’s Form 10-K for the year ended June 24, 2005).
4.9	Intellectual Property Security Agreement dated December 24, 2003 between the Company and U.S. Bank National Association, as Trustee (incorporated by reference to Exhibit 4.2 of Registrant’s Form 8 K filed on April 25, 2006).
4.10	First Supplemental Indenture, dated September 18, 2006, between SGI and U.S. Bank National Association, as Trustee.
4.11	Second Supplemental Indenture, dated September 18, 2006, between SGI and U.S. Bank National Association, as Trustee.
10.1	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. (incorporated by reference to exhibits of Registrant’s Registration Statement on Form S-1 (No. 33-8892), which became effective October 29, 1986).
10.2	Software License Agreement dated January 24, 1986, between the Company and AT&T Information Systems Inc. (incorporated by reference to exhibits of Registrant’s Registration Statement on Form S-1 (No. 33-12863), which became effective March 31, 1987).
10.3	Form of Indemnification Agreement entered into between the Company and its executive officers and certain other agents. (Revised) (incorporated by reference to exhibits of Registrant’s Annual Report on Form 10-K for the year ended June 30, 1992).
10.4*	Form of Employment Continuation Agreement entered into between the Company and its executive officers, as amended and restated as of April 25, 2001 (incorporated by reference to Exhibit 10.4 of Registrant’s Quarterly Report on Form 10-Q for the period ended March 25, 2005).
10.5*	Form of Agreement dated September 15, 2006, requiring acknowledgment by executive officers that no change of control will occur in connection with emergence from Bankruptcy.
10.6*	1985 Stock Incentive Program, as amended and restated (incorporated by reference to Exhibit 10.1 of Registrant’s Quarterly Report on Form 10-Q for the period ended December 24, 2004).
10.7*	Forms of stock option agreement to the 1985 Stock Incentive Program (incorporated by reference to Exhibit 10.6 of Registrant’s Annual Report on Form 10-K for the period ended June 24, 2005).
10.8*	Amended and Restated 1993 Long-Term Incentive Stock Plan (incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended December 30, 2005).
10.9*	Forms of stock option agreement to Amended and Restated 1993 Long-Term Incentive Stock Plan (incorporated by reference to Exhibit 10.1 of Registrant’s Form 10-Q for the quarter ended September 30, 2005)

105

10.10*	Amended and Restated 1996 Supplemental Non-Executive Equity Incentive Plan (incorporated by reference to Exhibit 10.3 of Registrant’s Form 10-Q for the quarter ended December 30, 2005).
10.11*	Forms of stock option agreement to Amended and Restated 1996 Supplemental Non-Executive Equity Incentive Plan (incorporated by reference to Exhibit 10.2 of Registrant’s Form 10-Q for the quarter ended September 30, 2005).
10.12*	Amended and Restated 1998 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.4 of Registrant’s Form 10-Q for the quarter ended December 30, 2005).
10.13*	Non-Qualified Deferred Compensation Plan dated as of September 9, 1994 (incorporated by reference to Exhibit 10.68 of Registrant’s Annual Report on Form 10-K for the year ended June 30, 1994).
10.14*	Addendum to the Non-Qualified Deferred Compensation Plan (incorporated by reference to Exhibit 10.19 of Registrant’s Annual Report on Form 10-K for the year ended June 30, 1995).
10.15*	Executive Incentive Plan Description and Summary Forms of Notice (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed on November 8, 2005).
10.16*	Sales Executive Compensation Plan Description and Summary Form of Notice (incorporated by reference to Exhibit 10.2 of Registrant’s Form 8-K filed on November 8, 2005).
10.17*	Letter Agreement between Warren Pratt and the Company, as amended as of November 2001 (incorporated by reference to Exhibit 10.18 of Registrant’s Annual Report on Form 10-K for the year ended June 28, 2002).
10.18*	Amended and Restated Promissory Note in the principal amount of $250,000 as of April 2001 (incorporated by reference to Exhibit 10.19 of Registrant’s Annual Report on Form 10-K for the year ended June 28, 2002).
10.19*	Pledge Agreement between Warren Pratt and the Company dated September 27, 2000 (incorporated by reference to Exhibit 10.20 of Registrant’s Annual Report on Form 10-K for the year ended June 28, 2002).
10.20*	Amended and Restated Promissory Note in the principal amount of $500,000 as of April 2001 (incorporated by reference to Exhibit 10.21 of Registrant’s Annual Report on Form 10-K for the year ended June 28, 2002).
10.21	Purchase Agreement between Silicon Graphics Inc. and certain institutional investors dated as of February 16, 2004 (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K as filed on February 20, 2004).
10.22	Purchase Agreement dated as of April 14, 2004 among Alias Systems (US) Holding Company, Alias Systems Corp., Alias Holding IP Limited Partnership, Alias Worldwide IP Limited Partnership, Alias US IP Limited Partnership, Accel-KKR Company, LLC, Silicon Graphics, Inc., Silicon Graphics Limited and Silicon Graphics World Trade BV (incorporated by reference to Exhibit 5.1 of Registrant’s Form 8-K filed on April 15, 2004).
10.23	Restructuring Agreement dated May 7, 2006 (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed on May 9, 2006).
10.24	Post-Petition Loan and Security Agreement dated June 28, 2006 (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed on June 29, 2006).
10.25	Global Settlement Agreement dated June 23, 2006 (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed on June 27, 2006).
10.26*	Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.5 of Registrant’s Form 10-Q for the quarter ended December 30, 2005).
10.27*	Employment Agreement between Silicon Graphics, Inc. and Dennis McKenna dated January 27, 2006 (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed on February 2, 2006).
10.28*	Amended Employment Agreement between Silicon Graphics, Inc. and Dennis McKenna dated April 17, 2006 (incorporated by reference to Exhibit 10.3 of Registrant’s Form 8-K filed on April 20, 2006).
10.29*	Amended Restricted Stock Agreement between Silicon Graphics, Inc. and Dennis McKenna dated April 17, 2006 (incorporated by reference to Exhibit 10.4 of Registrant’s Form 8-K filed on April 20, 2006).
10.30*	Termination Agreement between Silicon Graphics, Inc. and Robert R. Bishop dated April 14, 2006 (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed on April 20, 2006).
10.31*	Severance Letter from Silicon Graphics, Inc. to Robert R. Bishop dated April 14, 2006 (incorporated by reference to Exhibit 10.2 of Registrant’s Form 8-K filed on April 20, 2006).
10.32*	Vice President Severance Benefits Plan, effective August 11, 2003 (incorporated by reference to Exhibit 10.5 of Registrant’s Form 10-Q for the quarter ended March 31, 2006).

106

10.33	Amended and Restated Commercial Lease dated as of July 9, 2003 between WXIII/Crittenden Realty A/B, L.L.C. and Silicon Graphics, Inc. (incorporated by reference to Exhibit 10.5 of Registrant’s Form 8-K filed on July 7, 2005).
10.34	Lease Modification and Termination Agreement dated June 15, 2006 (incorporated by reference to Exhibit 10.2 of Registrant’s Form 8-K filed on June 29, 2006).
10.35*	Letter Agreement between Warren Pratt and the Company dated May 16, 2005 (incorporated by reference to Exhibit 10.1 of Registrant’s Form 8-K filed on May 16, 2005).
10.36	Lease Agreement dated as of September 7, 2006, between Christensen Holdings, L.P. and Silicon Graphics, Inc. relating to the property at 1140 - 1154 East Arques Avenue, Sunnyvale, California.
21.1	List of Subsidiaries.
23.1	Consent of KPMG LLP, Independent Registered Public Accounting Firm.
23.2	Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Dennis McKenna and Kathy Lanterman.

* 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).

107

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/ Dennis P. McKenna
Dated: October 16, 2006		Dennis P. McKenna Chairman and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ DENNIS P. MCKENNA	Chairman, Chief Executive Officer and Director (Principal Executive Officer)	October 16, 2006
Dennis P. McKenna
/s/ KATHY A. LANTERMAN	Chief Financial Officer and Corporate Controller (Principal Financial Officer)	October 16, 2006
Kathy A. Lanterman
/s/ ROBERT R. BISHOP	Vice Chairman and Director	October 16, 2006
Robert R. Bishop
/s/ LEWIS S. EDELHEIT	Director	October 16, 2006
Lewis S. Edelheit
/s/ JAMES A. McDIVITT	Director	October 16, 2006
James A. McDivitt
/s/ ANTHONY R. MULLER	Director	October 16, 2006
Anthony R. Muller
/s/ ROBERT M. WHITE	Director	October 16, 2006
Robert M. White

108

EX-4.10

Exhibit 4.10

SILICON GRAPHICS, INC.

6.50% Senior Secured Convertible Notes Due 2009

FIRST SUPPLEMENTAL INDENTURE

Dated September 18, 2006

U.S. BANK NATIONAL ASSOCIATION,

TRUSTEE

FIRST SUPPLEMENTAL INDENTURE, dated September 18, 2006, by and between SILICON GRAPHICS, INC., a Delaware corporation (the “Company”), and U.S. BANK NATIONAL ASSOCIATION, a national banking association organized and existing under the laws of the United States of America, not in its individual capacity but solely as Trustee (the “Trustee”) under the Indenture (as defined herein).

RECITALS

WHEREAS, the Company and the Trustee entered into an Indenture, dated as of December 24, 2003 (the “Indenture”), pursuant to which the Company issued $224,356,000 aggregate principal amount of 6.50% Senior Secured Convertible Notes Due 2009 (the “Securities”);

WHEREAS, as of the Effective Date (as defined herein) of this First Supplemental Indenture $188,578,000 aggregate principal amount of the Securities were outstanding;

WHEREAS, Section 9.02 of the Indenture provides that the Company and the Trustee may amend the Indenture or the Securities with the written consent of the Holders (as defined in the Indenture) of at least a majority of the aggregate principal amount of the Securities outstanding;

WHEREAS, the Company has sought to obtain debtor in possession financing from Quadrangle Master Funding Ltd., Watershed Technology Holdings, L.L.C., and Encore Fund, L.P. (collectively, the “DIP Lenders”) in the form of term loans pursuant to the terms and on the conditions set forth in the $70,000,000 Post-Petition Loan and Security Agreement, dated as of May 8, 2006 (the “DIP Agreement”), by and among Silicon Graphics, Inc., Silicon Graphics Federal, Inc., and Silicon Graphics World Trade Corporation, on the one hand, and Quadrangle Master Funding Ltd., Watershed Technology Holdings, L.L.C., and Encore Fund, L.P., on the other hand, and the proposed order approving such financing attached hereto as Exhibit A which shall be secured by a lien senior to the lien on the Collateral granted to the Securityholders under the Security Agreement;

WHEREAS, holders or beneficial owners or investment managers or advisers for the beneficial owners of not less than $94,482,087 in aggregate principal amount of the Securities outstanding, constituting not less than 50.1 perscent (50.1%) of the outstanding Securities, have consented to the amendments set forth in this First Supplemental Indenture, subject to the closing of the DIP Agreement;

WHEREAS, all acts and things prescribed by the Indenture to make this First Supplemental Indenture a valid instrument legally binding on the Company and the Trustee, in accordance with its terms, have been duly done and performed; and

WHEREAS, capitalized terms used herein but not otherwise defined herein shall have the meanings ascribed to such terms in the Indenture.

NOW, THEREFORE, to comply with the provisions of the Indenture and in consideration of the above premises, the Company and the Trustee covenant and agree for the equal and proportionate benefit of the respective Holders of the Securities as follows:

2

ARTICLE I

Section 1.01. This First Supplemental Indenture is supplemental to the Indenture and does and shall be deemed to form a part of, and shall be construed in connection with and as part of, the Indenture for any and all purposes.

Section 1.02. Notwithstanding anything herein to the contrary, this First Supplemental Indenture is deemed effective as of May 10, 2006 (the “Effective Date”).

ARTICLE II

Section 2.01. Upon the Effective Date of this First Supplemental Indenture pursuant to Section 1.02 above, the text of Section 4.06(e) of the Indenture shall be deemed deleted in its entirety and replaced with the following:

“(e) (i) other indebtedness to banks or other institutional lenders in the form of revolving credit loans or term loans or the issuance of letters of credit or bankers’ acceptances or the like, including the Secured Credit Facility as it may be extended, refinanced, renewed or replaced, provided that the aggregate principal amount of such other indebtedness at any time outstanding does not exceed $100 million, provided further that the amount set forth in this clause (e)may be increased to permit as necessary the term loans under the $70,000,000 Post-Petition Loan and Security Agreement, dated as of May 8, 2006, by and among Silicon Graphics, Inc., Silicon Graphics Federal, Inc., and Silicon Graphics World Trade Corporation, on the one hand, and Quadrangle Master Funding Ltd., Watershed Technology Holdings, LLC, and Encore Fund, L.P., on the other hand; or “.

Section 2.02. Upon the Effective Date of this First Supplemental Indenture pursuant to Section 1.02 above, the text of the defined term “Senior Priority Lien” of Section 1.01 of the Indenture shall be deemed deleted in its entirety and replaced with the following:

““Senior Priority Lien” means any lien on the Collateral created by the Company that is senior to the lien granted to the Securityholders under the Security Agreement and that secures debt permitted under section 4.06(e) of this Indenture, including, but not limited to the liens created under the Secured Credit Facility and under the $70,000,000 Post-Petition Loan and Security Agreement, dated as of May 8, 2006, by and among Silicon Graphics, Inc., Silicon Graphics Federal, Inc., and Silicon Graphics World Trade Corporation, on the one hand, and Quadrangle Master Funding Ltd., Watershed Technology Holdings, LLC, and Encore Fund, L.P., on the other hand.”

ARTICLE III

Section 3.01. Except as specifically modified herein, the Indenture and the Securities are in all respects ratified and confirmed (mutatis mutandis) and shall remain in full force and effect in accordance with their terms.

Section 3.02. Except as otherwise expressly provided herein, no duties, responsibilities or liabilities are assumed, or shall be construed to be assumed, by the Trustee by reason of this First Supplemental Indenture. This First Supplemental Indenture is executed and accepted by the Trustee subject to all of the terms and conditions set forth in the Indenture with the same force and effect as if those terms and conditions were repeated at length herein and made applicable to the Trustee with respect hereto.

3

Section 3.03. THIS FIRST SUPPLEMENTAL INDENTURE SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK BUT WITHOUT GIVING EFFECT TO APPLICABLE PRINCIPLES OF CONFLICTS OF LAW TO THE EXTENT THAT THE APPLICATION OF THE LAWS OF ANOTHER JURISDICTION WOULD BE REQUIRED THEREBY. This First Supplemental Indenture shall be governed and construed in accordance with the applicable terms and provisions of the Indenture as supplemented hereby, which terms and provisions are incorporated herein by reference, as if this First Supplemental Indenture were the “Indenture” referred to therein.

Section 3.04. The parties may sign any number of copies of this First Supplemental Indenture. Each signed copy shall be an original, but all of such executed copies together shall represent the same agreement.

Section 3.05. Upon the Effective Date, this First Supplemental Indenture shall form a part of the Indenture for all purposes replacing in all respects (a) Section 4.06(e) of the Indenture with the language set forth in Section 2.01 hereof and (b) the defined term “Senior Priority Lien” of Section 1.01 of the Indenture with the language set forth in Section 2.02 hereof. Every holder of Senior Secured Notes heretofore or hereafter authenticated and delivered shall be bound hereby. Any and all references, whether within the Indenture or in any notice, certificate or other instrument or document, shall be deemed to include a reference to this First Supplemental Indenture (whether or not made), unless the context shall otherwise require.

[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK.]

4

IN WITNESS WHEREOF, the parties hereto have caused this First Supplemental Indenture to be duly executed as of the date first written above.

COMPANY
SILICON GRAPHICS, INC.
By:	/s/ Kathy Lanterman
Name:	Kathy Lanterman
Title:	Senior Vice President and Chief Financial Officer
TRUSTEE
U.S. BANK NATIONAL ASSOCIATION
By:	/s/ James E. Murphy
Name:	James E. Murphy
Title:	Vice President

SIGNATURE PAGE TO FIRST SUPPLEMENTAL INDENTURE

(6.50% SENIOR SECURED CONVERTIBLE NOTES DUE 2009)

EX-4.11

Exhibit 4.11

SILICON GRAPHICS, INC.

6.50% Senior Secured Convertible Notes Due 2009

SECOND SUPPLEMENTAL INDENTURE

Dated September 18, 2006

U.S. BANK NATIONAL ASSOCIATION

TRUSTEE

SECOND SUPPLEMENTAL INDENTURE, dated September 18, 2006, by and between SILICON GRAPHICS, INC., a Delaware corporation (the “Company”), and U.S. BANK NATIONAL ASSOCIATION, a national banking association organized and existing under the laws of the United States of America, not in its individual capacity but solely as Trustee (the “Trustee”) under the Indenture (as defined herein).

RECITALS

WHEREAS, the Company and the Trustee entered into an Indenture, dated as of December 24, 2003 (the “Indenture”), pursuant to which the Company issued $224,356,000 aggregate principal amount of 6.50% Senior Secured Convertible Notes Due 2009 (the “Securities”);

WHEREAS, as of the Effective Date (as defined herein) of this Second Supplemental Indenture $188,587,000 aggregate principal amount of the Securities were outstanding;

WHEREAS, Section 9.02 of the Indenture provides that the Company and the Trustee may amend the Indenture or the Securities with the written consent of the Holders (as defined in the Indenture) of at least a majority of the aggregate principal amount of the Securities outstanding;

WHEREAS, the Company and certain of its subsidiaries have sought to obtain debtor in possession financing from Morgan Stanley Senior Funding, Inc., Wells Fargo Foothill, Inc., Quadrangle Master Funding Ltd., Watershed Technology Holdings, LLC, and Encore Fund, L.P. (collectively, the “DIP Lenders”) in the form of revolving and term loans pursuant to the terms and on the conditions set forth in the $130,000,000 Post-Petition Loan and Security Agreement, dated as of June 28, 2006 (the “DIP Agreement”), by and among Silicon Graphics, Inc., Silicon Graphics Federal, Inc., and Silicon Graphics World Trade Corporation, on the one hand, and Morgan Stanley Senior Funding, Inc., Wells Fargo Foothill, Inc., Quadrangle Master Funding Ltd., Watershed Technology Holdings, LLC, and Encore Fund, L.P., on the other hand, and the proposed order approving such financing attached hereto as Exhibit A which shall be secured by a lien senior to the lien on the Collateral granted to the Securityholders under the Security Agreement;

WHEREAS, holders or beneficial owners or investment managers or advisers for the beneficial owners of not less than $94,482,087 in aggregate principal amount of the Securities outstanding, constituting not less than 50.1 percent (50.1%) of the outstanding Securities, have consented to the amendments set forth in this Second Supplemental Indenture, subject to the closing of the DIP Agreement;

WHEREAS, all acts and things prescribed by the Indenture to make this Second Supplemental Indenture a valid instrument legally binding on the Company and the Trustee, in accordance with its terms, have been duly done and performed; and

WHEREAS, capitalized terms used herein but not otherwise defined herein shall have the meanings ascribed to such terms in the Indenture.

NOW, THEREFORE, to comply with the provisions of the Indenture and in consideration of the above premises, the Company and the Trustee covenant and agree for the equal and proportionate benefit of the respective Holders of the Securities as follows:

2

ARTICLE I

Section 1.01. This Second Supplemental Indenture is supplemental to the Indenture and does and shall be deemed to form a part of, and shall be construed in connection with and as part of, the Indenture for any and all purposes.

Section 1.02. Notwithstanding anything herein to the contrary, this Second Supplemental Indenture shall be deemed effective as of June 26, 2006 (the “Effective Date”).

ARTICLE II

Section 2.01. Upon the Effective Date of this Second Supplemental Indenture pursuant to Section 1.02 above, the text of Section 4.06(e) of the Indenture shall be deemed deleted in its entirety and replaced with the following:

“(e) (i) other indebtedness to banks or other institutional lenders in the form of revolving credit loans or term loans or the issuance of letters of credit or bankers’ acceptances or the like, including the Secured Credit Facility as it may be extended, refinanced, renewed or replaced, provided that the aggregate principal amount of such other indebtedness at any time outstanding does not exceed $100 million, provided further that the amount set forth in this clause (e) may be increased to permit as necessary the term loans under the $130,000,000 Post-Petition Loan and Security Agreement, dated as of June 28, 2006, by and among Silicon Graphics, Inc., Silicon Graphics Federal, Inc., and Silicon Graphics World Trade Corporation, on the one hand, and Morgan Stanley Senior Funding, Inc., Wells Fargo Foothill, Inc., Quadrangle Master Funding Ltd., Watershed Technology Holdings, LLC, and Encore Fund, L.P., on the other hand; or”.

Section 2.02. Upon the Effective Date of this Second Supplemental Indenture pursuant to Section 1.02 above, the text of the defined term “Senior Priority Lien” of Section 1.01 of the Indenture shall be deemed deleted in its entirety and replaced with the following:

““Senior Priority Lien” means any lien on the Collateral created by the Company that is senior to the lien granted to the Securityholders under the Security Agreement and that secures debt permitted under section 4.06(e) of this Indenture, including, but not limited to the liens created under the Secured Credit Facility and under the $130,000,000 Post-Petition Loan and Security Agreement, dated as of June 28, 2006, by and among Silicon Graphics, Inc., Silicon Graphics Federal, Inc., and Silicon Graphics World Trade Corporation, on the one hand, and Morgan Stanley Senior Funding, Inc., Wells Fargo Foothill, Inc., Quadrangle Master Funding Ltd., Watershed Technology Holdings, LLC, and Encore Fund, L.P., on the other hand.”

ARTICLE III

Section 3.01. Except as specifically modified herein, the Indenture and the Securities are in all respects ratified and confirmed (mutatis mutandis) and shall remain in full force and effect in accordance with their terms.

Section 3.02. Except as otherwise expressly provided herein, no duties, responsibilities or liabilities are assumed, or shall be construed to be assumed, by the Trustee by reason of this Second Supplemental Indenture. This Second Supplemental Indenture is executed and accepted by the Trustee subject to all of the terms and conditions set forth in the Indenture with the same force and effect as if those terms and conditions were repeated at length herein and made applicable to the Trustee with respect hereto.

3

Section 3.03. THIS SECOND SUPPLEMENTAL INDENTURE SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK BUT WITHOUT GIVING EFFECT TO APPLICABLE PRINCIPLES OF CONFLICTS OF LAW TO THE EXTENT THAT THE APPLICATION OF THE LAWS OF ANOTHER JURISDICTION WOULD BE REQUIRED THEREBY. This Second Supplemental Indenture shall be governed and construed in accordance with the applicable terms and provisions of the Indenture as supplemented hereby, which terms and provisions are incorporated herein by reference, as if this Second Supplemental Indenture were the “Indenture” referred to therein.

Section 3.04. The parties may sign any number of copies of this Second Supplemental Indenture. Each signed copy shall be an original, but all of such executed copies together shall represent the same agreement.

Section 3.05. Upon the Effective Date, this Second Supplemental Indenture shall form a part of the Indenture for all purposes replacing in all respects (a) Section 4.06(e) of the Indenture with the language set forth in Section 2.01 hereof and (b) the defined term “Senior Priority Lien” of Section 1.01 of the Indenture with the language set forth in Section 2.02 hereof. Every holder of Securities heretofore or hereafter authenticated and delivered shall be bound hereby. Any and all references, whether within the Indenture or in any notice, certificate or other instrument or document, shall be deemed to include a reference to this Second Supplemental Indenture (whether or not made), unless the context shall otherwise require.

[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK.]

4

IN WITNESS WHEREOF, the parties hereto have caused this Second Supplemental Indenture to be duly executed as of the date first written above.

COMPANY
SILICON GRAPHICS, INC.
By:	/s/ Kathy Lanterman
Name:	Kathy Lanterman
Title:	Senior Vice President and Chief Financial Officer
TRUSTEE
U.S. BANK NATIONAL ASSOCIATION
By:	/s/ James E. Murphy
Name:	James E. Murphy
Title:	Vice President

SIGNATURE PAGE TO SECOND SUPPLEMENTAL INDENTURE

(6.50% SENIOR SECURED CONVERTIBLE NOTES DUE 2009)

EX-10.5

EXHIBIT 10.5

SILICON GRAPHICS, INC.

FORM OF AGREEMENT

This Agreement, dated as of September 15, 2006 (this “Agreement”), is entered into by and between the undersigned employee (the “Employee”) and Silicon Graphics, Inc., a Delaware corporation (the “Company”).

WHEREAS, on May 8, 2006, the Company and certain of its subsidiaries (collectively, the “Debtors”) filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code in the United States Bankruptcy Court for the Southern District of New York (Case Nos. 06-10977 (BRL) through 06-10990 (BRL)) (the “Chapter 11 Cases”);

WHEREAS, the Company and the Employee have entered into a change in control agreement, dated as of [                          ], 2006 (the “Change Agreement”); and

WHEREAS, the Employee, recognizing that the Company will rely on this Agreement in connection with the Debtors’ exit from the Chapter 11 Cases (the “Chapter 11 Exit”), agrees as follows:

1. The Employee agrees that the Chapter 11 Exit shall not constitute a Change in Control (as defined under the Change Agreement).

2. This Agreement shall be interpreted and enforced in accordance with the laws of the State of California.

3. This Agreement will be binding upon and inure to the benefit of (i) the heirs, executors and legal representatives of the Employee upon the Employee’s death and (ii) any successor of the Company. Any such successor of the Company will be deemed substituted for the Company under the terms of this Agreement for purposes of enforcing the Company’s rights hereunder.

4. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together will constitute one and the same instrument.

IN WITNESS WHEREOF, the parties hereto hereby execute this Agreement as of the date first above written.

EMPLOYEE

By:

Name:

SILICON GRAPHICS, INC.

By:

Name:

Title:

2

EX-10.36

Exhibit 10.36

LEASE AGREEMENT

This Lease Agreement (“Lease”), dated as of September 7, 2006, is made and entered into by Christensen Holdings, L.P., a California limited partnership (“Landlord”), and Silicon Graphics, Inc., a Delaware corporation (“Tenant”).

1. Demise. In consideration of the rents and all other charges and payments payable by Tenant, and for the agreements, terms and conditions to be performed by Tenant in this Lease, LANDLORD DOES HEREBY LEASE TO TENANT, AND TENANT DOES HEREBY LEASE FROM LANDLORD, the Premises described below (the “Premises”), upon and subject to the agreements, terms and conditions of this Lease for the Term hereinafter stated.

2. Premises. The Premises demised by this Lease are approximately 128,154 rentable square feet of space, as shown on Exhibit A attached hereto, in that certain single-story building (“Building”) at 1140 - 1154 East Arques Avenue, Sunnyvale, California, together with the non-exclusive right to use (i) the Outside Areas (as defined below) of the Property (as defined below) to the extent set forth in Paragraph 43 below, and (ii) parking set forth in Paragraph 44 below in common with other tenants and occupants of the Property. The Building and the adjacent buildings commonly known as 1130, 1188 and 1198 East Arques Avenue (the “Adjacent Buildings”) constitute part of a larger office/research and development park commonly known as 1130-1198 East Arques, as more particularly shown on Exhibit B attached hereto, with a total building area of approximately 305,846 rentable square feet (collectively, the “Property”). The parties agree to the square footage figures set forth in this Paragraph 2 notwithstanding that the actual rentable square footage of the Premises (and the portions thereof) may be more or less than that specified.

3. Term.

(a) Commencement Date. The term of this Lease (“Term”) shall be sixty (60) months commencing on the Commencement Date (as defined below), unless sooner terminated and subject to any extensions granted hereunder. The “Commencement Date” of this Lease shall be the earlier of (i) substantial completion of the Tenant Improvements (as defined below) and the Additional Work (as defined below), and (ii) the date that Tenant commences occupancy and use of the Premises for the purpose of conducting Tenant’s business operations therein (the commencement of such occupancy and use shall be deemed to constitute “possession” for purposes of this Lease and Tenant shall not be deemed to be “in possession” of the Premises prior to the commencement of such occupancy and use). For purposes of this Lease, the date of “substantial completion” of the Tenant Improvements and Additional Work shall be the date that all of the following has occurred: (i) the Tenant Improvements and Additional Work are complete except for minor items of adjustment or repair of the type commonly found on an architect’s punchlist which would not materially interfere with Tenant’s use and enjoyment of the Premises for their intended purpose; (ii) the City of Sunnyvale has approved the Tenant Improvements and Additional Work in accordance with its building code, evidenced by its completion of a final inspection and written approval of such improvements as so completed in accordance with the building permit(s) issued for the Tenant Improvements and/or Additional Work. If the Commencement Date is other than the first day of a calendar month and/or if the expiration date of this Lease is other than the last day of a calendar month,

Rent (as defined below) shall be prorated for the month in which the Commencement Date or expiration date, as applicable, occurs on the basis of the number of days that Tenant had possession of the Premises during such calendar month.

(b) Commencement Date Memorandum. When the actual Commencement Date is determined, the parties shall execute a Commencement Date Memorandum setting forth the Commencement Date and the expiration date of this Lease (which expiration date shall be sixty (60) months following the Commencement Date) in the form shown in Exhibit C.

(c) Tenant Delays. If the Commencement Date has not occurred on or before January 1, 2007 due to Tenant’s failure to complete the Tenant Improvements (provided that, at such time, the Additional Work shall have been completed as required hereunder, and provided further that such failure is not otherwise caused by Landlord’s breach of any of its obligations under this Lease (and with respect to which Tenant shall have given Landlord written notice within ten (10) days after Tenant becomes aware of such breach) or by the negligence or willful misconduct of Landlord or its Agents) then, beginning on January 1, 2007 and continuing on the first day of each calendar month thereafter until the Commencement Date, Tenant shall pay to Landlord the Base Rent set forth in Paragraph 4(a) and the Additional Rent set forth in Paragraph 4(b).

(d) Early Access.

(1) Upon execution and delivery of this Lease (and prior to the Effective Date (as defined below) and the Commencement Date), Tenant shall be permitted to enter the Premises for the purpose of commencing (and after the Effective Date, completing) the Tenant Improvements (following approval of the same by Landlord) and installing Tenant’s furniture, fixtures (including, without limitation, cable installation) and equipment and otherwise preparing the Premises for Tenant’s occupancy. For purposes of this Paragraph 3(d), the period prior to the Effective Date shall be referred to as the “Early Access Period.” Such entry onto the Premises prior to the Commencement Date shall be at Tenant’s sole risk and subject to all the terms and provisions hereof, except for the payment of Rent which shall not commence until the Commencement Date; provided, however, that Tenant’s entry onto the Premises during the Early Access Period shall be subject only to those provisions in this Lease relating to the construction and installation of the Tenant Improvements and to the other provisions set forth in this Paragraph 3(d). Notwithstanding the foregoing, Tenant shall pay prior to delinquency the cost of any utility services provided to Tenant during the Early Access Period and at any time prior to the Commencement Date, which payment shall be made directly to the utility service provider. Landlord shall have the right to impose such additional reasonable conditions on Tenant’s early entry as Landlord shall deem appropriate.

(2) During the Early Access Period, (i) Landlord shall maintain the insurance required to be maintained by Landlord pursuant to Paragraph 13 and Tenant shall maintain commercial liability insurance in such form and in such amount as required under Paragraph 14(a), (ii) Tenant shall indemnify, defend and hold harmless Landlord and its Agents (as defined below) against and from any and all claims, liabilities, judgments, costs, demands, causes of action and expenses (including, without limitation, reasonable attorneys’ fees) (collectively, “Claims”) arising from the construction and installation of the Tenant Improvements by Tenant or any other activity done, permitted or suffered by Tenant, its Agents

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or independent contractors in and about the Premises, the Building or the Property and/or with respect to any action or proceeding brought on account of the foregoing, and (iii) Landlord shall indemnify, defend and hold harmless Tenant and its Agents against and from any and all Claims arising from the negligence or willful misconduct of Landlord or its Agents and/or with respect to any action or proceeding brought on account of the foregoing. If any action or proceeding is brought against Landlord or Tenant, as the case may be, by reason of any Claim against such party, upon written notice from the party against whom any such Claim is brought, the other party shall defend the same at its expense by counsel reasonably satisfactory to the party against whom any such Claim is brought. The foregoing indemnity shall not relieve any insurance carrier of its obligations under any policies required to be carried by either party to the extent that such policies cover the peril or occurrence that results in the Claim that is subject to the foregoing indemnity. The foregoing indemnity shall be effective only during the Early Access Period and shall survive the termination of the parties’ obligations pursuant to subparagraph (3) below.

(3) Notwithstanding the terms and provisions of Paragraph 47, the terms and provisions of this Paragraph 3(d) shall be effective and otherwise binding upon the Landlord and Tenant immediately upon execution and delivery of this Lease by Landlord and Tenant; provided, that, if the Effective Date has not occurred on or prior to September 20, 2006 and, as a result, either party shall have elected to terminate this Lease pursuant to Paragraph 47, Tenant shall cease all work with respect to the Tenant Improvements and, upon Landlord’s request, remove any Tenant Improvements installed by Tenant and repair any damage and perform any restoration work caused by such removal within ten (10) days following the cessation of such work (the “Early Access Restoration”). Upon completion by the Tenant of the Early Access Restoration (and subject to the survival of the indemnities as provided in subparagraph (2) above), the parties hereto shall have no further obligations under this Paragraph 3(d).

(4) Upon execution and delivery of this Lease, Tenant shall remit to Landlord a deposit in the amount of $153,400 (the “Early Access Deposit”) which shall constitute a security deposit for the performance by Tenant of any Early Access Restoration which it may be obligated to perform pursuant to subparagraph (3) above. If Early Access Restoration is required hereunder and Tenant fails to complete and pay for the cost of such Early Access Restoration as required under subparagraph (3) above, then Landlord shall be entitled to apply all or any portion of the Early Access Deposit to the payment of any costs or expenses incurred by Landlord to complete any Early Access Restoration which has not been completed and/or paid for by Tenant. Notwithstanding the foregoing, Tenant’s obligation to perform any Early Access Restoration and pay for the cost of same shall not be limited to the amount of the Early Access Deposit. If the Effective Date shall have occurred and as a result, no Early Access Restoration shall be required hereunder, then the Early Access Deposit shall be applied to or credited against the payment of Base Rent and Additional Rent for the first month of the Term which is due and payable by Tenant pursuant to Paragraph 4(a).

4. Rent.

(a) Base Rent. Tenant shall pay to Landlord, in advance on or before the first day of each calendar month of the Term, without further notice or demand and without offset or deduction, the monthly installments of rent specified below (“Base Rent”):

Months of Term	Base Rent
1 through 12	$125,206/month ($.977 prsf)
13 through 24	$130,333/month ($1.017 prsf)
25 through 36	$135,459/month ($1.057 prsf)
37 through 48	$140,585/month ($1.097 prsf)
49 through 60	$145,711/month ($1.137 prsf)

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Within five (5) calendar days after the Effective Date, Tenant shall pay to Landlord the Base Rent and Additional Rent for the first month of the Term (such Additional Rent to be estimated on the assumption that the Term will commence on or about December 1, 2006). If the Commencement Date is other than the first day of a calendar month, Landlord will prorate the first month’s Base Rent and Additional Rent paid to Landlord and apply any credit to which Tenant may be entitled to the Base Rent and Additional Rent due on the first day of the following calendar month. Rent shall be paid to Landlord at its address noted herein, or at any other place Landlord may from time to time designate by written notice to Tenant pursuant to Paragraph 32.

(b) Additional Rent. In addition to the Base Rent, Tenant shall pay to Landlord, in accordance with this paragraph and without duplication, Tenant’s proportionate share as specified below of the following items (collectively, “Additional Rent”). Tenant’s share shall be adjusted if at any time during the term of this Lease, including any Option Period, if applicable, Tenant is leasing more or less than the original Premises leased by Tenant as of the date of this Lease.

(1) Taxes and Assessments. All real estate taxes and assessments applicable to the Property during the Term of this Lease (“Taxes and Assessments”). Taxes and Assessments shall mean any form of assessment, license, fee, levy, penalty (but only if a result of Tenant’s delinquency in payment of Additional Rent), or tax (other than net income, estate, succession, inheritance, transfer or franchise taxes) imposed by any authority having the direct or indirect power to tax or by any city, county, state or federal government or any improvement or other district or division thereof, whether such tax is (i) determined by the area of the Premises, the Building or the Property, or any part thereof or the Rent and other sums payable hereunder by Tenant, including, but not limited to, any gross income or excise tax levied by any of the foregoing authorities with respect to receipt of any Rent due under this Lease; (ii) upon any legal or equitable interest of Landlord in the Premises, the Building or the Property, or any part thereof; (iii) upon this transaction or any document to which Tenant is a party creating or transferring any interest in the Premises, the Building or the Property; (iv) levied or assessed in lieu of, in substitution for, or in addition to, existing or additional taxes against the Premises, the Building or the Property, whether or not now customary or within the contemplation of the parties; or (v) a surcharge against the parking area. Tenant and Landlord acknowledge that Proposition 13 was adopted by the voters of the State of California in the June, 1978 election and that assessments, taxes, fees, levies and charges may be imposed by governmental agencies for such purposes as fire protection, street, sidewalk, road, utility construction and maintenance, refuse removal and for other governmental services which may formerly have been provided without charge to property owners or occupants. It is the intention of the parties that all new and increased assessments, taxes, fees, levies and charges due to Proposition 13 or any other cause are to be included within the definition of real property taxes for purposes of this Lease.

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Tenant acknowledges that the Building and other buildings within the Property constitute a single tax parcel. Accordingly, the Building shall be allocated a portion of the Taxes and Assessments for the Property based upon:

(A) the assessed value of the Building as indicated by the tax assessor’s records plus

(B) 52.181% of the assessed value of the land plus

(C) its proportionate share of special assessments based on the total of the assessed value of the Building under clause (A) above and the assessed value of the land allocated to the Building under clause (B) above compared to the total assessed value of the Property.

These determinations shall be made by Landlord from the respective valuations assigned in the assessor’s work sheet or such other information as may be reasonably available. Landlord’s reasonable determination thereof, in good faith, shall be conclusive (absent manifest error). If the assessed value of the Building and/or the Property is increased by the inclusion therein of a value placed upon the personal property or improvements of the Tenant, and if Landlord pays the taxes based on such increased assessment, then Tenant shall, upon demand, repay to Landlord the portion of such taxes resulting from such increase in assessment. In the event the Premises and any improvements installed therein by Tenant or Landlord, for the benefit of Tenant, are valued by the assessor disproportionately higher or lower than those of other tenants in the Building or the Property, Tenant’s percentage share shall be readjusted upwards or downwards accordingly, and Tenant agrees to such readjusted percentage share. Such determination shall be made by Landlord from the respective valuations assigned in the assessor’s work sheet or such other information as may be reasonably available. Landlord’s reasonable determination thereof, in good faith, shall be conclusive (absent manifest error).

(2) Insurance Costs. All insurance premiums payable with respect to the Building, including premiums for special form coverage for the Building (including the cost of any earthquake insurance, if Landlord elects to maintain such coverage, such cost, however, not to exceed 150% of the cost of special form coverage for the Building during the same policy period), commercial general liability insurance, other insurance as Landlord deems reasonably necessary and any deductibles paid under policies of any such insurance (collectively, the “Insurance Costs”). To the extent that Landlord maintains insurance under one or more master policies, Landlord shall provide Tenant with satisfactory evidence of its allocation (and the methodology therefor) of the cost of any such master policies and/or deductibles paid thereunder to Tenant.

Tenant’s share of the Insurance Costs shall be the percentage determined by dividing the rentable area of the Premises by the total rentable area of the Building plus the rentable area of the building at 1130 East Arques Avenue, which the parties agree shall be 78.28%. In the event the Premises and any improvements installed therein by Tenant or

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Landlord, for the benefit of Tenant, are valued disproportionately higher or lower than those of tenants in the building at 1130 East Arques Avenue, Tenant’s share shall be readjusted upwards or downwards accordingly, and Tenant agrees to such readjusted share. Such determination shall be made by Landlord from information as may be reasonably available. Landlord’s reasonable determination thereof, in good faith, shall be conclusive (absent manifest error).

(3) Outside Area Expenses. All costs to operate, manage, maintain, repair, replace, supervise, insure (including provision of general liability insurance) and administer the Outside Area including, but not limited to, watering, fertilizing, landscaping, tree work, spraying, plant and tree replacement, lighting, signage (other than signage specific to any particular tenant of any portion of the Property), repair and replacement of paving and sidewalks, drainage, fossil filters, P.I.V.’s, trash pickup and disposal, clean-up and sweeping; fire line and water therefor; and any parking charges or other costs levied, assessed or imposed by, or at the direction of, or resulting from statutes or regulations, or interpretations thereof, promulgated by any governmental authority or insurer in connection with the use or occupancy of the Outside Area and/or the Property (collectively, “Outside Area Expenses”).

Tenant’s share of the Outside Area Expenses shall be that percentage determined by dividing the rentable area of the Premises by the total rentable area of all buildings on the Property which the parties agree shall be 41.90% as of the date of this Lease.

(4) Maintenance and Repair of Building. Except as provided otherwise below, all costs to maintain, repair, and replace the Building including but not limited to the roof coverings, the floor slabs, the exterior glass and the exterior walls (including the painting and crack sealing thereof) of the Building, all utility and plumbing systems, and fixtures and equipment located on the outside of the Building and all costs associated with the maintenance, repair, installation, and replacement of Building alarm systems (if any) and fire detection systems, back flow systems and testing, fire line monitoring, washing and cleaning of exterior window and wall surfaces of the Building, and any alterations or improvements to the Building which are required to be made in order to comply with laws effective after the Commencement Date, and any parking charges or other costs levied, assessed or imposed by, or at the direction of, or resulting from statutes or regulations, or interpretations thereof, promulgated by any governmental authority or insurer in connection with the use or occupancy of the Building (collectively, the “Maintenance and Repair Costs”). Notwithstanding said provisions, Tenant’s share of the cost of any improvement or replacement to the Building having a useful life of more than five years, which exceeds $25,000, shall be amortized on a straight-line basis over its useful life together with interest thereon at the rate of 10% per annum, and only the amortized portion of such cost and interest shall be included in costs recoverable by Landlord from Tenant hereunder. Also, notwithstanding anything to the contrary, Landlord shall not recover from Tenant hereunder the costs of any repair or replacement incurred in maintaining, repairing or replacing, for structural integrity, the load-bearing part of any of the exterior walls (other than for painting or crack sealing), the foundation, or the structural components of the roof, unless such repair or replacement was necessitated solely by the acts of Tenant.

(5) Management and Administration. Tenant’s share of the costs for management and administration of the Building and the Property, including a property

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management fee, accounting, auditing, billing, postage, employee benefits, and payroll taxes which share shall be in an amount equal to 3% of Tenant’s annual Base Rent (collectively, the “Management Costs”).

(c) Payment of Additional Rent.

(1) Upon execution and delivery of this Lease, Landlord shall submit to Tenant an estimate of Tenant’s applicable share of monthly Taxes and Assessments, Insurance Costs, Outside Area Expenses, Maintenance and Repairs Costs and Management Costs (collectively, the “Costs”) for the period between the estimated Commencement Date (which, for purposes of this provision, shall be estimated to be on or about December 1, 2006) and the following December 31 and Tenant shall pay its applicable share of such estimated Costs (which amount shall constitute Additional Rent) in advance on a monthly basis concurrently with the payment of the Base Rent. Attached hereto as Exhibit D and solely for informational purposes is a calculation of Additional Rent that would be payable for the period from January 1, 2007 to December 31, 2007. Tenant shall continue to make said monthly payments until notified by Landlord of a change therein. By April 1 of each calendar year, Landlord shall provide to Tenant a statement showing the actual Costs due to Landlord for the prior calendar year (both the total of each of such Costs and Tenant’s share thereof as provided for herein), prorated from the Commencement Date during the first year. If the total of the monthly payments of Additional Rent made by Tenant for the prior calendar year (or portion thereof during which this Lease was in effect) is less than the actual Costs chargeable to Tenant for such prior calendar year in accordance with the terms hereof, then Tenant shall pay the difference in a lump sum within thirty (30) days after receipt of such statement from Landlord. Any overpayment by Tenant of Additional Rent for the prior calendar year shall be credited to the payment of the next due monthly installment(s) of Additional Rent.

(2) The actual Costs for the prior calendar year shall be used as the basis for the calculation of Tenant’s monthly payment of estimated Additional Rent for the current year, subject to adjustment as provided above and known to Landlord, except that in any year in which resurfacing of the parking area, exterior painting, or material roof repairs or other work are planned to be undertaken and paid for in such year, Landlord may include the estimated cost of such planned work (to the extent that such estimated cost is expected to be paid for in such year) in the estimated monthly Costs for purposes of determining Additional Rent payable hereunder.

Landlord shall make a final determination of Costs for the year in which this Lease terminates as soon as possible after termination. Tenant shall remain liable for payment of any Additional Rent due to Landlord in excess of the Additional Rent previously paid by Tenant, and, conversely, Landlord shall promptly return to Tenant any overpayment of Additional Rent, even though the Term has expired and Tenant has vacated the Premises. Failure of Landlord to submit statements as called for herein shall not be deemed a waiver of Tenant’s obligation to pay Additional Rent as herein provided.

(d) General Payment Terms. The Base Rent, Additional Rent and all other sums payable by Tenant to Landlord under this Lease are referred to as the “Rent.” All Rent shall be paid without deduction, offset or abatement in lawful money of the United States of America. Rent for any partial month during the Term shall be prorated for the portion thereof falling due within the Term.

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5. Late Charge. Notwithstanding any other provision of this Lease, Tenant hereby acknowledges that late payment to Landlord of Rent due hereunder will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. If any Rent due from Tenant is not received by Landlord or by Landlord’s designated agent within five (5) days after the date such Rent is due, then Tenant shall pay to Landlord a late charge equal to six percent (6%) of such overdue amount, plus any attorneys’ fees incurred by Landlord by reason of Tenant’s failure to pay Rent when due hereunder. Landlord and Tenant hereby agree that such late charges represent a fair and reasonable estimate of the cost that Landlord will incur by reason of Tenant’s late payment. Landlord’s acceptance of such late charges shall not constitute a waiver of Tenant’s default with respect to such overdue amount or estop Landlord from exercising any of the other rights and remedies granted under this Lease.

Initials:

Landlord     HC                    Tenant     DM        

6. Security Deposit.

(a) On or prior to October 5, 2006, Tenant shall deposit with Landlord a security deposit in the amount of Nine Hundred Twenty Thousand Four Hundred Dollars ($920,400) (the “Security Deposit”) as security for the full and faithful performance of each and every term, covenant and condition of this Lease. The Security Deposit may be in the form of an unconditional, irrevocable, letter of credit issued by a national bank or other credit provider reasonably acceptable to Landlord (the “LOC Provider”) and in form reasonably acceptable to Landlord providing for payment in whole or in part at a location in San Mateo County against presentation of Landlord’s drafts at site without conditions, except as stated below, for the benefit of Landlord (the “Security LOC”). The Security LOC shall provide, among other things, that (i) Landlord shall have a right to draw down an amount up to the stated amount of the Security LOC upon presentation to the LOC Provider of Landlord’s statement that (i) either (1) an Event of Default has occurred under the Lease or (2) Tenant has failed to pay Base Rent or Additional Rent within three (3) calendar days after the due date thereof, and that, in either case, such amount is due and payable to Landlord under the terms and conditions of this Lease, and (ii) the Security LOC will be honored by the LOC Provider without inquiry as to the accuracy thereof. The Security LOC shall be maintained in effect in the amount required hereunder, whether through replacement, renewal or extension, through the date that is thirty (30) days after the expiration of the term of this Lease. If Tenant obtains a Security LOC with an expiration date earlier than the date set forth in the preceding sentence, Tenant shall deliver a new Security LOC in the amount required hereunder or a certificate of renewal or extension to Landlord at least thirty (30) days prior to the expiration of the Security LOC. Failure to timely deliver such new Security LOC or certificate of renewal or extension to Landlord shall entitle Landlord to draw upon the Security LOC in full, and to retain the cash proceeds thereof as a cash security deposit for the performance of Tenant’s obligations under this Lease and in accordance with the provisions hereof applicable to a cash Security Deposit. In the event that Tenant has provided the Security Deposit in cash, it may at any time thereafter substitute a Security LOC therefor in a stated amount equal to the cash deposit (in which event, the cash deposit shall be returned to

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Tenant upon delivery to Landlord of the Security LOC), and in the event that Tenant has provided the Security Deposit in the form of a Security LOC, it may at any time thereafter substitute cash therefor in an amount equal to the then required stated amount of the Security LOC (in which event, the Security LOC shall be returned to Tenant for cancellation upon delivery of the cash deposit).

(b) Landlord shall be permitted to make partial draws on the Security LOC and may use and apply the whole or any part of the Security Deposit as may be reasonably necessary (a) to remedy Tenant’s default in the payment of any Rent, (b) to repair damage to the Premises caused by Tenant and which damage is not otherwise repaired by Tenant as required under the terms of this Lease, (c) to clean the Premises upon termination of this Lease if Tenant has otherwise failed to do so as required pursuant to the terms of this Lease, (d) to reimburse Landlord for the payment of any amount which Landlord may reasonably spend or be required to spend by reason of Tenant’s default hereunder, or (e) to compensate Landlord for any other loss or damage which Landlord may suffer by reason of Tenant’s default hereunder and for which Tenant is liable hereunder including, without limitation, those damages provided for in California Civil Code Section 1951.2 and any successor statutes providing for damages in the event of the termination of a lease due to a default by the tenant thereunder, and those damages provided by any other provision of applicable law now or hereafter in force or provided for in equity. If Landlord draws upon all or any portion of the Security LOC for the foregoing purposes, Tenant shall, within five (5) days after written demand therefor, deliver a Security LOC in the full amount required hereunder (or an amendment to the existing Security LOC so that the stated amount of the Security LOC is equal to the amount of the Security Deposit required to be maintained hereunder). Tenant’s failure to timely deliver such new Security LOC (or amendment to the existing Security LOC) shall be a material default under this Lease and shall entitle Landlord to draw upon the balance of the Security LOC in full and retain the cash proceeds thereof as collateral for the performance of Tenant’s obligations under this Lease.

(c) As a material part of the consideration given by Tenant to Landlord to induce Landlord to enter into this Lease, Tenant waives the provisions of California Civil Code Section 1950.7, and all other provisions of law now in force or that become in force after the date of the execution of this Lease, that provide that Landlord may claim from a security deposit only those sums reasonably necessary to remedy defaults in the payment of Rent, to repair damage caused by Tenant to the Premises, or to clean the Premises. Landlord and Tenant agree that Landlord may, in addition, claim those sums reasonably necessary to compensate Landlord for any other foreseeable or unforeseeable loss or damage caused by the acts or omissions of Tenant or Tenant’s officers, agents, employees, independent contractors or invitees.

(d) Provided that all Rent due hereunder has been fully paid to Landlord, then within thirty (30) days following the later of (i) the expiration of the Term, and (ii) the date Tenant surrenders possession of the Premises to Landlord in the condition required by the terms of this Lease, the Security Deposit or any balance thereof shall be returned to Tenant or, at the option of Landlord, to the last assignee of Tenant’s interest in this Lease. If Landlord uses or applies all or any portion of the Security Deposit in accordance with the terms of this Lease, within ten (10) days after written demand from Landlord, Tenant shall restore the Security Deposit to the amount of the Security Deposit immediately preceding any such use or application, and Tenant’s failure to do so shall be a default under this Lease. No part of the

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Security Deposit shall be considered to be held in trust, to bear interest or another increment for its use, or to be prepayment for any moneys to be paid by Tenant under this Lease. In the event Landlord transfers its interest in this Lease, Landlord shall transfer the then remaining amount of the Security Deposit to Landlord’s successor in interest, and thereafter Landlord shall have no further liability to Tenant with respect to such Security Deposit.

(e) Notwithstanding the foregoing or anything to the contrary contained herein, the amount of the Security Deposit held by Landlord shall be reduced to Four Hundred Sixty Thousand Two Hundred Dollars ($460,200) (the “Reduced Amount”) on and as of the third anniversary of the Commencement Date (the “Reduction Date”), provided that (i) as of the Reduction Date, no Event of Default then exists and is continuing, (ii) Tenant’s audited year-end financial statements for the most recent fiscal year ending prior to the Reduction Date reflect Revenues (as defined below) of at least $300,000,000 and Profit Margin (as defined below) of ten percent (10%) or more, calculated according to generally accepted accounting principles, consistently applied (“GAAP”); (iii) Tenant’s balance sheet for the most recent calendar month ending at least thirty (30) days prior to the Reduction Date (the “Applicable Month”) shows cash or equivalent assets of at least $70,000,000, (iv) Tenant’s current ratio (current assets to current liabilities) for the Applicable Month is greater than 1.5, and (v) Tenant has delivered to Landlord the financial statements of Tenant for the immediately preceding fiscal year and for the Applicable Month, and, if necessary, detailed calculations, demonstrating to Landlord’s reasonable satisfaction that the conditions described in clauses (iii) and (iv) above have been satisfied (the foregoing conditions described in clauses (i) through (v), inclusive being referred to collectively as the “Reduction Conditions”). As used herein, the term “Revenues” shall mean all revenue from the operations of Tenant’s business, including, but not limited to, fee income, lease income, net equipment sales, fixed assets rolling stock sales, intercompany management fees and other income or other operating revenues derived by Tenant in accordance with GAAP accounting. The term “Profit Margin” shall mean operating earnings (earnings before income taxes) divided by Revenues, all calculated in accordance with GAAP. Upon reduction of the Security Deposit to the Reduced Amount as provided above, the balance of the Security Deposit (if in the form of a cash deposit) then held by Landlord shall be returned to Tenant or, if the Security Deposit is in the form of a Security LOC, the stated amount of the Security LOC shall be reduced (by an amendment to the Security LOC which shall be approved by Landlord) to the Reduced Amount; provided, that, at Tenant’s election, Tenant may substitute the existing Security LOC with a replacement Security LOC in a stated amount equal to the Reduced Amount and upon receipt of such replacement Security LOC, Landlord shall return the original Security LOC to Tenant. Upon reduction of the Security Deposit as provided above, Landlord shall return to Tenant that portion of any cash Security Deposit held by Landlord in excess of the Reduced Amount within fifteen (15) days following the later of (x) the Reduction Date or (y) the date on which the Reduction Conditions have been satisfied, failing which Landlord shall pay interest at the Interest Rate (as defined below) on any cash amount to be returned until such cash amount has been returned to Tenant. Notwithstanding the foregoing or anything to the contrary contained herein, upon satisfaction of the Reduction Conditions, the Security Deposit shall automatically be deemed to have been reduced to the Reduction Amount regardless of whether or not the actual amount of the Security Deposit then held by Landlord (whether in the form of cash or a Security LOC) is in excess of the Reduction Amount.

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7. Intentionally Omitted.

8. Use of Premises.

(a) Permitted Uses. The Premises shall be used only for general office, customer training and/or engineering research, including engineering labs for hardware engineering and software development, and a portion of the Premises (not to exceed the usable area of the Premises currently allocated for such use) may be used as a cafe (the “Intended Use”) and for any other legally permitted uses as reasonably approved by Landlord, all to the extent permitted by governmental regulations. No printed circuit board manufacture or wafer fabrication shall be permitted, or any activities involving Hazardous Materials (as defined below), except that Tenant shall be permitted to use customary office products and cleansers and minor quantities of cleaners and solvents in connection with its business so long as such office products, cleansers, cleaners and solvents are used, stored and disposed of in compliance with all applicable laws.

(b) Compliance with Governmental Regulations. Tenant shall, at Tenant’s expense, faithfully observe and comply with all local, state and federal statutes, rules, regulations, ordinances, requirements, and orders, now in force or which may hereafter be in force pertaining to the Premises or Tenant’s use thereof, including without limitation, any statutes, rules, regulations, ordinances, requirements, or orders requiring installation of fire sprinkler systems or removal of asbestos placed on the Premises by Tenant, whether substantial in cost or otherwise, and all recorded covenants, conditions and restrictions affecting the Property (collectively, “Private Restrictions”) now in force or which may hereafter be in force; provided that no such future Private Restrictions shall materially affect Tenant’s use and enjoyment of the Premises or Property for the Intended Use and provided, that Tenant shall not be required to make any structural changes to the Premises or the Building not otherwise contemplated to be made by Tenant in connection with its Intended Use of the Premises unless the requirement for such changes is imposed solely as a result of any improvements or additions made or proposed to be made at Tenant’s request. The final unappealable judgment of any court of competent jurisdiction, or the admission of Tenant in any action or proceeding against Tenant, whether Landlord be a party thereto or not, that Tenant has violated any such rule, regulation, ordinance, statute or Private Restriction, shall be conclusive of that fact as between Landlord and Tenant. Landlord represents that there are no Private Restrictions currently in effect with respect to the Premises that limit, restrict, impair or otherwise adversely affect Tenant’s use and enjoyment of the Premises for the Intended Use or otherwise preclude, restrict or limit Tenant’s ability to construct and install any of the Tenant Improvements.

9. Acceptance of Premises. Tenant acknowledges having inspected the Premises prior to the execution and delivery of this Lease. Subject to the completion of the Additional Work by Landlord as provided herein, by execution hereof, Tenant accepts the Premises as suitable for Tenant’s Intended Use and as being in good and sanitary operating order, condition and repair, AS IS, and without representation or warranty by Landlord as to the condition of the Premises or as to the suitability or fitness of the Premises for the conduct of Tenant’s business or for any other purpose. Any damage to the Premises caused by Tenant’s move-in shall be repaired or corrected by Tenant, at its expense.

10. Surrender. Upon the expiration or earlier termination of the Term, Tenant shall surrender the Premises to Landlord in its condition existing as of the Commencement Date, normal wear and tear and fire or other casualty excepted, with all interior walls repaired and

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repainted if damaged, all carpets shampooed and cleaned, all broken, marred or nonconforming acoustical ceiling tiles replaced with matching tiles, all interior sides of windows washed, the plumbing and electrical systems and lighting in good order and repair, including replacement of any burned out or broken light bulbs or ballasts, the HVAC equipment serviced and repaired by a reputable and licensed service firm (if Tenant is at any time, pursuant to the terms of this Lease, required to maintain the HVAC system serving the premises), and all floors cleaned, all to the reasonable satisfaction of Landlord. Tenant shall not be required to remove from the Premises any of the Tenant Improvements (other than data or telecommunications cabling, which Landlord may require Tenant to remove). Notwithstanding the foregoing, Tenant shall have the right, at its option, to remove those particular Tenant Improvements more particularly described on Exhibit F attached hereto (collectively, the “Specialized Tenant Improvements”) and Landlord shall have the right, as a condition to its approval of any Specialized Tenant Improvements, to require Tenant to remove some or all of such Specialized Tenant Improvements from the Premises upon the expiration or sooner termination of this Lease. Landlord shall specify in writing to Tenant at the time of its approval of the Final Plans and Specifications (as defined below) which, if any, Specialized Tenant Improvements Tenant will be required to remove at the expiration or sooner termination of this Lease and whether or not Tenant will be required, at the expiration or sooner termination of this Lease, to remove any data or telecommunications cabling. To the extent that Tenant elects to remove, or is required to remove, any Specialized Tenant Improvements, it shall repair any damage and perform any restoration work caused by such removal. Tenant shall remove from the Premises Tenant’s personal property and if Tenant fails to do so and such failure continues after the termination of this Lease, Landlord may retain such personal property and all rights of Tenant with respect to it shall cease, or Landlord may place all or any portion of such personal property in public storage for Tenant’s account. Tenant shall be liable to Landlord for costs of removal of any such personal property and storage and transportation costs of same. If the Premises are not so surrendered at the termination of this Lease, Tenant shall indemnify Landlord and its Agents against all loss or liability, including reasonable attorneys’ fees and costs, resulting from delay by Tenant in so surrendering the Premises.

Normal wear and tear, for the purposes of this Lease, shall be construed to mean wear and tear caused to the Premises by a natural aging process which occurs in spite of prudent application of the best standards for maintenance, repair and janitorial practices to the extent the same are Tenant’s obligations under this Lease. It is not intended, nor shall it be construed, to include items of neglected or deferred maintenance which would have or should have been attended to during the Term of the Lease if the best standards had been applied to properly maintain and keep the Premises at all times in good condition and repair.

In the event of surrender of this Lease, Landlord shall have the option of terminating all existing subleases or accepting any sublease(s) as a direct lease or leases.

11. Alterations and Additions; Tenant Improvements; Additional Work.

(a) Other than the Tenant Improvements, Tenant shall not make, or permit to be made, any alteration or addition to the Premises, or any part thereof, without the prior written consent of Landlord, such consent not to be unreasonably withheld, conditioned or delayed. Normal repair and maintenance work (including painting and re-carpeting) shall not be deemed to be an alteration or addition to the Premises. Any alteration or addition to the Premises shall be

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at Tenant’s sole cost and expense, in compliance with all applicable laws and requirements requested by Landlord, and in accordance with plans and specifications submitted in writing to Landlord and approved in writing. Tenant agrees not to proceed to make such alterations or additions, notwithstanding consent from Landlord to do so, until ten (10) days after Tenant’s receipt of such written consent.

(b) Subject to Tenant’s right to remove, or Landlord’s right to require Tenant to remove, any or all of the Specialized Tenant Improvements, all additions, alterations or improvements (including Tenant Improvements), including, but not limited to, heating, lighting, electrical, air conditioning, fire extinguishers, lighting fixtures, ballasts, light globes, and tubes, hot water heaters, fixed partitioning, drapery, wall covering and paneling, built-in cabinet work and carpeting installations made by Tenant, together with all property that has become an integral part of the Building, shall at once be and become the property of Landlord, and shall not be deemed trade fixtures; provided, however, that Tenant shall remove from the Premises (i) any alterations or additions that were made by or on behalf of Tenant without Landlord’s approval, and (ii) any alterations or additions that were made by or on behalf of Tenant with Landlord’s approval if, as a condition of such approval, Landlord indicated to Tenant in writing that Tenant would be required to remove such alterations and/or additions from the Premises at the expiration or sooner termination of the Lease.

(c) Landlord acknowledges that Tenant will need to make or cause to be made certain improvements to the Premises as more particularly described on Exhibit E attached hereto (collectively, the “Tenant Improvements”) in order to enable Tenant to utilize the Premises for the Intended Use. Landlord acknowledges receipt of the preliminary plans and specifications for the Tenant Improvements (the “Preliminary TI Plans”) and hereby consents to the Preliminary TI Plans, subject to its right to approve the Final Plans and Specifications. Prior to commencing construction of the Tenant Improvements, Tenant shall submit to Landlord complete final working drawings and specifications prepared by a licensed architect based upon the Preliminary TI Plans (the “Final Plans and Specifications”) for Landlord’s approval, which approval shall not be unreasonably withheld, conditioned or delayed. Within five (5) business days after Landlord’s receipt of the Final Plans and Specifications, Landlord shall notify Tenant of Landlord’s approval or disapproval thereof, specifying in reasonable detail the basis for Landlord’s disapproval, if applicable. No material revisions shall be made to the approved Final Plans and Specifications unless approved in writing by Landlord (which approval shall not be unreasonably withheld, conditioned or delayed). Landlord’s review of the Final Plans and Specifications shall be for Landlord’s sole purpose and shall not imply Landlord’s review of the same, nor obligate Landlord to review the same, for quality, design, compliance with laws or other like matters. Accordingly, notwithstanding that any Final Plans and Specifications are reviewed by Landlord or its space planner, architect, engineers or consultants, Landlord shall have no liability whatsoever in connection therewith and shall not be responsible for any errors or omissions contained in the Final Plans and Specifications.

(d) Landlord will provide Tenant with an improvement allowance in an amount not to exceed One Million Eight Hundred Thousand Dollars ($1,800,000) (the “TI Allowance”). The proceeds of the TI Allowance shall be used by Tenant solely for payment of the costs of the Tenant Improvements, including space planning fees, architectural and engineering fees, all costs of obtaining building permits and other necessary governmental

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approvals, and all direct and indirect costs of procuring, constructing and installing the Tenant Improvements, including the general contractor’s fee for overhead and profit. In no event, however, will the TI Allowance be used for any costs of procuring, moving, constructing or installing any of Tenant’s personal property in the Premises. Subject to the application of the TI Allowance thereto, all Tenant Improvements will be constructed and/or performed by Tenant at its sole cost and expense. The TI Allowance shall be paid to Tenant on a progress payment basis within fifteen (15) days after Landlord’s receipt of (i) itemized invoices for the Tenant Improvement costs to be paid, and (ii) a conditional waiver and release upon progress payment from the general contractor and applicable subcontractors. Landlord shall pay its pro rata share of each progress payment based upon the ratio of the TI Allowance to the total Tenant Improvements costs, as such ratio may be adjusted from time to time to account for any increase in the total Tenant Improvements costs. Tenant shall be responsible for the balance of each payment due to the general contractor. A ten percent (10%) retainage shall be withheld from each progress payment. Landlord shall pay Landlord’s pro rata share of such retainage within fifteen (15) days after a “Notice of Completion” (or the equivalent) has been recorded for the Tenant Improvements and Landlord has received (i) the original certificate of occupancy or other equivalent certificate covering the Premises; (ii) an endorsed copy of the recorded “Notice of Completion” (or the equivalent); (iii) an unconditional release and waiver upon final payment from the general contractor and each subcontractor and supplier engaged in connection with the Tenant Improvements; (iv) copies of all building permits, indicating inspection an approval by the issuer of the permits; (v) an architect’s certification that the Tenant Improvements have been completed in accordance with the Final Plans and Specifications; and (vi) two (2) sets of “as built” drawings for the Tenant Improvements. Landlord may, at its option, issue any check in payment of Tenant Improvement costs as a joint check payable to Tenant and Tenant’s general contractor.

(e) On or prior to the Commencement Date, Landlord shall replace or cause to be replaced certain rooftop HVAC mechanical equipment as more particularly described on Exhibit G attached hereto (the “Additional Work”). Landlord shall cause the Additional Work to be completed in a good and workmanlike manner in accordance with the specifications developed by Devcon Construction Inc. and pursuant to all of the standards and subject to all of the requirements applicable to the Tenant Improvements. The Additional Work shall be competitively bid by at least three (3) subcontractors based on specifications developed by Devcon Construction Inc. and approved by Landlord and Tenant. Landlord shall have the right to select two (2) of the subcontractors for the bidding process. The final selection of the subcontractor to perform the Additional Work shall be based on the results of the bidding process and shall be subject to the approval of Landlord and Tenant. Landlord shall solicit competitive bids (subject to the foregoing) and enter into a contract with Devcon Construction Inc., as the general contractor who will in turn enter into a subcontract with the selected subcontractor and who will supervise the completion of the Additional Work. Tenant shall have the right to participate in the bidding process and to attend all construction meetings regarding the Additional Work. Landlord shall make every effort to notify Tenant of any such meetings at least one (1) day in advance thereof but its failure to do so shall not constitute a default hereunder

(f) Landlord shall have the right to approve all construction contracts with respect to the Tenant Improvements, which consent shall not be unreasonably withheld or

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delayed; notwithstanding the foregoing, Landlord acknowledges that Tenant has entered into a contract with Devcon Construction Inc. as general contractor for the completion of the Tenant Improvements (the “Devcon Agreement”) and hereby approves the Devcon Agreement. Landlord shall not be entitled to receive any fees or be reimbursed for any costs incurred in connection with its review or approval of the Devcon Agreement, any other construction contracts, the Preliminary TI Plans, the Final Plans and Specifications or any other plans with respect to the Tenant Improvements or Additional Work (including any engineering, mechanical, architectural plans or any legal review), or with respect to any supervision by the Landlord of the construction by Tenant of any Tenant Improvements.

(g) The Tenant Improvements shall be constructed by Tenant in a good and workmanlike manner, in accordance with the Final Plans and Specifications approved by Landlord (subject to any non-material changes which are not required to be approved by Landlord hereunder), and in compliance with all applicable laws, pursuant to the Devcon Agreement. Tenant shall keep Landlord fully informed of all progress and shall allow representatives of Landlord to observe, inspect and monitor the construction of the Tenant Improvements. Tenant shall arrange for the Tenant Improvements to be fully warranted (labor and materials) by the general contractor, sub-contractor or appropriate supplier, as the case may be, for period of one(1) year from the completion thereof. Tenant shall be responsible for obtaining all necessary permits and approvals (including building and occupancy permits) and other authorizations from the City of Sunnyvale or other governmental agencies in connection with construction of the Tenant Improvements; provided, that Landlord shall cooperate with Tenant in obtaining such permits, approvals and/or authorizations and shall, upon request by Tenant, execute such documents as may be necessary or required in connection therewith. Tenant shall provide Landlord with copies of all required permits and approvals within thirty (30) days after completion of the Tenant Improvements.

(h) During construction of the Tenant Improvements, each of Tenant’s contractors and subcontractors shall carry workers’ compensation insurance in the statutory limits covering all of their respective employees, and commercial general liability insurance, with limits, in form, and with companies as are required under Paragraph 14 of the Lease. Tenant shall carry, or cause its general contractor to carry, builder’s special form insurance in an amount sufficient to cover the construction of the Tenant Improvements, which shall name Landlord as an additional insured. Landlord shall also be named as an additional insured on Tenant’s general contractor’s policy of commercial general liability insurance. Certificates for all insurance carried pursuant to this paragraph shall be delivered to Landlord prior to commencement of construction of the Tenant Improvements. Any such liability insurance shall provide that it is primary with respect to Landlord and that any other insurance maintained by Landlord is excess and noncontributing with the insurance required hereunder.

12. Maintenance of Premises.

(a) Maintenance by Tenant. Subject to the provisions of Paragraph 12(c), throughout the Term Tenant shall, at its sole expense and at all times (whether or not such portion of the Premises requiring repairs, or the means of repairing the same, are reasonably or readily accessible to Tenant, and whether or not the need for such repairs occurs as a result of Tenant’s use, any prior use, the elements, or the age of such portion of the Premises), (1) keep and maintain in good order, condition, and repair, and to repair and to replace the Premises, and

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every part thereof, including but not limited to glass, windows, window frames, door closers, locks, storefronts, interior and exterior doors and door frames, and the interior of the Premises, (excepting only those portions of the Building to be maintained by Landlord, as provided in Paragraph 12(c)), (2) keep and maintain in good order and condition, repair, and replace all utility lighting, and plumbing systems, fixtures and equipment, including without limitation, electricity, gas, fire sprinkler and stand pipes, fire alarms, smoke detection, HVAC, water, and sewer, located in or on the Premises, and furnish all expendables, including fluorescent tubes, ballasts, light bulbs, paper goods and soaps, used in the Premises, (3) subject to Paragraph 16 hereof, repair all damage to the Building or the Outside Area caused by the negligence or willful misconduct of Tenant or its agents, employees, contractors or invitees. Tenant shall not do anything to cause any damage, deterioration or unsightliness to the Building or the Outside Area. Tenant agrees to maintain and pay for a service contract which meets the manufacturer’s recommendations for the air conditioning, heating and ventilating systems installed in the Premises and which is approved by Landlord (the “HVAC Contract”). Landlord reserves the right to hire a licensed HVAC contractor to inspect annually the air conditioning, heating, and ventilating system. If this contractor finds deficiencies in the condition of this system, Tenant agrees to make all repairs and corrections within a reasonable period of time at Tenant’s expense, and after thirty (30) days notice pay the cost of the inspections by Landlord’s contractor. If no deficiencies are found, Landlord shall pay for the cost of the inspections. Notwithstanding the foregoing, during the first twelve (12) months of the Term of this Lease, Landlord shall pay to Tenant the amount of $2,635 per month (which amount represents the cost differential between an Airco standard HVAC service contract and an Airco “Guaranteed Lifetime Program” HVAC service contract) to cover a portion of the cost of any HVAC Contract required to be maintained by Tenant hereunder; provided, that, in lieu of Landlord making such payments to Tenant in cash each month during such 12-month period, an amount equal to $2,635 shall be credited against each monthly Additional Rent payment due and payable by Tenant during such 12-month period.

(b) Landlord’s Right to Maintain and Repair at Tenant’s Expense. Notwithstanding the foregoing, Landlord shall have the right, but not the obligation, at Tenant’s expense, to enter the Premises and perform Tenant’s maintenance, repair and replacement work. Within thirty (30) days after invoice therefor from Landlord, Tenant shall pay all reasonable costs and expenses incurred by Landlord in connection with such maintenance, repair and replacement work. Landlord shall have the right to perform Tenant’s maintenance, repair and replacement work only if Tenant fails to take appropriate remedial action within ten (10) days after receiving written notice from Landlord specifying the nature of Tenant’s failure to comply with Paragraph 12(a) of this Lease. Notwithstanding the foregoing, if Tenant’s failure to maintain, repair or replace as required by Paragraph 12(a) of this Lease creates an immediate danger of material further damage to the Premises, Landlord shall not be required to give the notice to Tenant set forth in the previous sentence.

(c) Maintenance by Landlord. Subject to the provisions of Paragraphs 12(a), 21 and 22, and further subject to Tenant’s obligation under Paragraph 4 to reimburse Landlord, in the form of Additional Rent, for Tenant’s share of the cost and expense of the following items (other than the Structural Items (as defined below) for which Landlord shall be solely liable and with respect to which no Additional Rent shall be paid by Tenant), Landlord agrees to repair and maintain the following items: the roof coverings (provided that Tenant installs no additional air conditioning or other equipment on the roof that damages the roof coverings), the floor slabs,

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and the exterior walls (including any glass therein and including the painting thereof) of the Building; the utility and plumbing systems (including fountain and sewer lines), fixtures and equipment located outside the Building; and the parking areas, landscaping, sprinkler systems, alarm system, sidewalks, driveways, curbs, and lighting systems in the Outside Area. Subject to the provisions of Paragraphs 21 and 22, Landlord shall maintain, repair, or replace for structural integrity the load bearing part of exterior walls, the foundation, and the structural components of the roof (collectively, the “Structural Items”) (providing that Tenant installs no additional air conditioning or other equipment on the roof that damages these components). Notwithstanding the foregoing or anything to the contrary contained herein, Landlord shall be solely responsible for the cost of maintaining, repairing and replacing the Structural Items and the cost thereof shall not be included as a Maintenance and Repair Cost or otherwise paid by Tenant as Additional Rent hereunder. Landlord shall not be obligated to repair minor settlement cracks on walls or floor of the Premises. Landlord shall not be responsible for minor leaking of any walls of the Building due to minor settlement cracks or porosity due thereto or as a result of porosity thereof. Landlord shall not be required to repair or maintain conditions due to any act, negligence or omission of Tenant or its agents, contractors, employees or invitees. Landlord’s obligation hereunder to repair and maintain is subject to the condition precedent that Landlord shall have received written notice of the need for such repairs and maintenance. Tenant shall promptly report in writing to Landlord any defective condition known to Tenant that Landlord is required to repair. All work by and for Landlord shall be performed during normal working hours and not on weekends, holidays, or after normal working hours at overtime, holiday, or premium pay unless Tenant agrees to pay any overtime or additional costs incurred as a result thereof.

(d) Tenant’s Waiver of Rights. Tenant hereby expressly waives all rights to make repairs at the expense of Landlord or to terminate this Lease, as provided for in California Civil Code Sections 1941 and 1942, and 1932 (l), respectively, and any similar or successor statute or law in effect or any amendment thereof during the Term.

13. Landlord’s Insurance. Landlord shall maintain in force during the Term of this Lease special form insurance covering the Building for the full replacement cost thereof and, at Landlord’s option (and subject to the qualification with respect to the cost thereof set forth in Paragraph 4(b)(2)), earthquake coverage, with a deductible provision, if any, that does not materially exceed that which prudent, efficient operators of similar buildings in comparable business parks in Santa Clara County would carry from time to time in the exercise of reasonable business judgment. Tenant shall, at its sole cost and expense, comply with any and all reasonable requirements pertaining to the Premises of any insurer necessary for the maintenance of reasonable fire and public liability insurance, covering the Building and appurtenances. Landlord may maintain “loss of rents” insurance, insuring that the Rent will be paid in a timely manner to Landlord for a period of at least twelve (12) months if the Premises are destroyed or rendered unusable or inaccessible by any cause insured against under this Lease. The premium for such loss of rents insurance shall be Additional Rent as set forth in Paragraph 4(b) (2).

14. Tenant’s Insurance.

(a) Liability Insurance. Tenant shall, at Tenant’s expense, secure and keep in force a policy of commercial general liability insurance covering the Premises, insuring Tenant, and naming Landlord and its lenders (if any) as additional insureds, against any liability arising out of the use, occupancy or maintenance of the Premises. The minimum limit of coverage of

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such policy shall be in the amount of not less than Two Million Dollars ($2,000,000.00) per occurrence, shall include an extended liability endorsement providing contractual liability coverage (which shall include coverage for Tenant’s indemnification obligations in this Lease), and shall contain a severability of interest clause or a cross liability endorsement. The limit of any insurance shall not limit the liability of Tenant hereunder. No policy shall be cancelable or subject to reduction of coverage, without at least thirty (30) days prior written notice to Landlord, and loss payable clauses shall be subject to Landlord’s approval. Such policies of insurance shall be issued as primary policies and not contributing with or in excess of coverage that Landlord may carry, by an insurance company authorized to do business in the State of California for the issuance of such type of insurance coverage and rate A:X or better in Best’s Key Rating Guide. A copy of said policy or a certificate evidencing to Landlord’s reasonable satisfaction that such insurance is in effect shall be delivered to Landlord upon commencement of the Term, and thereafter whenever said policies are renewed or modified, and also whenever Landlord shall reasonably request.

(b) Personal Property Insurance. Tenant shall maintain in full force and effect on all of its fixtures and equipment on the Premises, a policy or policies of special form insurance with standard coverage endorsement to the extent of the full replacement cost thereof. During the Term of this Lease, the proceeds from any such policy or policies of insurance shall be used for the repair or replacement of the fixtures and equipment so insured. Landlord shall have no interest in the insurance upon Tenant’s equipment and fixtures and will sign all documents reasonably necessary in connection with the settlement of any claim or loss by Tenant. Landlord will not carry insurance on Tenant’s possessions. Tenant shall furnish Landlord with a certificate evidencing to Landlord’s reasonable satisfaction that such insurance is currently in effect, and whenever required, shall satisfy Landlord that such policy is in full force and effect.

15. Indemnification.

Tenant shall indemnify, defend and hold harmless Landlord and its agents, employees, partners, members, shareholders, officers and directors (collectively “Agents”) against and from any and all claims, liabilities, judgments, costs, demands, causes of action and expenses (including, without limitation, reasonable attorneys’ fees) arising from (1) Tenant’s use of the Premises or the Building or from any activity done, permitted or suffered by Tenant, its Agents or independent contractors in and about the Premises, the Building or the Property, and (2) any act, neglect, fault, willful misconduct or omission of Tenant, or Tenant’s Agents and invitees or from any breach or default in the terms of this Lease by Tenant, and (3) any action or proceeding brought on account of any matter in items (1) or (2). If any action or proceeding is brought against Landlord or any of its Agents by reason of any such claim, upon written notice from Landlord, Tenant shall defend the same at Tenant’s expense by counsel reasonably satisfactory to Landlord. As a material part of the consideration to Landlord, Tenant hereby assumes all risk of damage to property or injury to persons in or about the Premises from any cause whatsoever (except that which is caused by the sole active negligence or willful misconduct by Landlord or its Agents or by the failure of Landlord to observe any of the terms and conditions of this Lease, if such failure has persisted for an unreasonable period of time after written notice to Landlord of such failure), and Tenant hereby waives all claims in respect thereof against Landlord. Landlord shall indemnify, defend and hold harmless Tenant and its

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Agents against and from any and all claims, liabilities, judgments, costs, demands, causes of action and expenses (including, without limitation, reasonable attorneys’ fees) arising from (1) the negligence or willful misconduct of Landlord, or Landlord’s Agents or from any breach or default in the terms of this Lease by Landlord, and (2) any action or proceeding brought on account of any matter in item (1). If any action or proceeding is brought against Tenant or any of its Agents by reason of any such claim, upon written notice from Tenant, Landlord shall defend the same at Landlord’s expense by counsel reasonably satisfactory to Tenant. The obligations of Landlord and Tenant under this Paragraph 15 shall survive any termination of this Lease.

The foregoing indemnity shall not relieve any insurance carrier of its obligations under any policies required to be carried by either party pursuant to this Lease, to the extent that such policies cover the peril or occurrence that results in the claim that is subject to the foregoing indemnity.

16. Subrogation. Landlord and Tenant hereby mutually waive any claim against the other during the Term for any loss or damage to any of their property located on or about the Premises, the Building or the Property (and including the Premises, Building and Property) that is caused by or results from perils covered by insurance carried (or required to be carried pursuant to the terms of this Lease) by the respective parties, to the extent of the proceeds of such insurance actually received with respect to such loss or damage, whether or not due to the negligence of the other party or its Agents. Nothing in this Paragraph 16 shall relieve a party of liability to the other for failure to carry insurance required by this Lease.

17. Free from Liens. Tenant shall keep the Premises and the Property free from any liens arising out of any work performed, materials furnished, or obligations incurred by or for Tenant and Tenant hereby indemnifies and holds Landlord and its Agents harmless from all liability and cost, including reasonable attorneys’ fees and costs, in connection with or arising out of any such lien or claim of lien. Tenant shall cause any such lien imposed to be released of record by payment or posting of a proper bond acceptable to Landlord within ten (10) days after written request by Landlord. Tenant shall give Landlord written notice of Tenant’s intention to perform work on the Premises which might result in any claim of lien at least ten (10) days prior to the commencement of such work to enable Landlord to post and record a “Notice of Nonresponsibility”. If Tenant fails to so remove any such lien within the prescribed ten (10) day period, then Landlord may do so at Tenant’s expense and Tenant shall reimburse Landlord as Additional Rent for such amounts upon demand. Such reimbursement shall include all costs incurred by Landlord including Landlord’s reasonable attorneys’ fees with interest thereon from the date advanced or paid by Landlord at the Interest Rate.

18. Advertisements and Signs. Subject to Tenant’s receipt of all necessary governmental approvals, Tenant shall be permitted to install and maintain, at Tenant’s sole cost and expense, (i) identification signage at each of the entry areas on the exterior of the Building pursuant to the Building’s master signage program with the City of Sunnyvale, and (ii) Tenant identification signage on the two monument signs in the Outside Area provided for tenants of the Building and the Adjacent Buildings, all as depicted on Exhibit H attached hereto. Tenant shall be entitled to use its pro rata share of the monument signs. The size, design, materials and exact location of Tenant’s signage shall be subject to Landlord’s prior approval, which shall not be unreasonably withheld. Tenant shall not place or permit to be placed in, upon, or about the Premises or the Property any other signs, advertisements or notices without obtaining Landlord’s

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prior written consent or without complying with applicable law, and will not conduct, or permit to be conducted, any sale by auction on the Premises or otherwise on the Property. Tenant shall remove any sign, advertisement or notice placed on the Premises by Tenant upon the expiration of the Term or sooner termination of this Lease, and Tenant shall repair any damage or injury to the Premises, the Building or the Property caused thereby, all at Tenant’s expense. If any signs are not removed, or necessary repairs not made, Landlord shall have the right to remove the signs and repair any damage or injury to the Premises, the Building or the Property at Tenant’s sole cost and expense.

19. Utilities. Tenant shall contract directly with the appropriate utility provider for all water, gas, electricity, sewer, and refuse pickup for the Building and Landlord shall have no responsibility therefor. Tenant shall also be responsible for all telephone services, janitorial service and any other utilities and services furnished directly to and used by Tenant in, on or about the Premises during the Term, together with any taxes thereon, and shall promptly pay all charges for any utilities and services furnished to the Premises as and when due. Landlord shall not be liable in damages or otherwise for any failure or interruption of any utility service or other service furnished to the Premises, except that resulting from the gross negligence or willful misconduct of Landlord. In addition, Tenant shall not be entitled to any abatement or reduction of Rent by reason of such failure or interruption, no eviction of Tenant shall result from such failure or interruption, and Tenant shall not be relieved from the performance of any covenant or agreement in this Lease because of such failure or interruption.

20. Entry by Landlord. Tenant shall permit Landlord and its Agents to enter into and upon the Premises at all reasonable times, upon reasonable notice of no less than twenty-four (24) hours, (except in the case of an emergency, for which only as much notice as can reasonably be given under the circumstances shall be required), and subject to Tenant’s reasonable security arrangements, for the purpose of inspecting the same or showing the Premises to prospective purchasers, lenders or tenants or to alter, improve, maintain and repair the Premises as required or permitted of Landlord under the terms hereof. Landlord and its Agents shall also be permitted to access the roof of the Building to maintain and repair the roof of the Building and any Building equipment located on the roof, including HVAC equipment, and no prior notice to Tenant shall be required for any such access. In each instance, such entry or access by Landlord or its Agents shall be without any liability to Tenant for any loss of occupation or quiet enjoyment of the Premises thereby occasioned (except for actual damages resulting from the gross negligence or willful misconduct of Landlord or its Agents). Tenant shall permit Landlord to post notices of non-responsibility and ordinary “for sale” or “for lease” signs, provided that Landlord may post such “for lease” signs and exhibit the Premises to prospective tenants only during the six (6) months prior to the expiration of this Lease. No such entry shall be construed to be a forcible or unlawful entry into, or a detainer of, the Premises, or an eviction of Tenant from the Premises.

21. Destruction and Damage.

(a) If the Building is damaged by fire or other perils covered by extended coverage insurance, Landlord shall, at Landlord’s option:

(i) In the event of total destruction of the Building (which shall mean destruction or damage in excess of fifty percent (50%) of the full insurable value thereof), to

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elect either to commence promptly to repair and restore the Building and prosecute the same diligently to completion, in which event this Lease shall remain in full force and effect; or not to repair or restore the Building, in which event this Lease shall terminate. Landlord shall give Tenant written notice of its intention within sixty (60) days after the occurrence of such destruction. If Landlord elects not to restore the Building, this Lease shall be deemed to have terminated as of the date of such total destruction.

(ii) In the event of a partial destruction of the Building (which shall mean destruction or damage to an extent not exceeding fifty percent (50%) of the full insurable value thereof) for which Landlord will receive insurance proceeds sufficient to cover the cost to repair and restore such partial destruction (subject to any applicable deductible) and, if the damage thereto is such that the Building may be substantially repaired or restored to its condition existing immediately prior to such damage or destruction within one hundred eighty (180) days from the date of such destruction, Landlord shall commence and proceed diligently with the work of repair and restoration, in which event the Lease shall continue in full force and effect. If such repair and restoration requires longer than one hundred eighty (180) days or if the insurance proceeds therefor (plus the amount of any applicable deductible and any amounts Tenant may elect or may be obligated to contribute) are not sufficient to cover the cost of such repair and restoration, Landlord may elect either to so repair and restore, in which event the Lease shall continue in full force and effect, or not to repair or restore, in which event the Lease shall terminate. In either case, Landlord shall give written notice to Tenant of its intention within sixty (60) days after the destruction occurs. If Landlord elects not to restore the Building, this Lease shall be deemed to have terminated as of the date of such partial destruction.

(b) If the Building is damaged by any peril not covered by extended coverage insurance, and the cost to repair such damage exceeds any amount Tenant may agree to contribute (at its sole election and without any obligation to do so), Landlord may elect either to commence promptly to repair and restore the Building and prosecute the same diligently to completion, in which event this Lease shall remain in full force and effect; or not to repair or restore the Building, in which event this Lease shall terminate. Landlord shall give Tenant written notice of its intention within sixty (60) days after the occurrence of such damage. If Landlord elects not to restore the Building, this Lease shall be deemed to have terminated as of the date on which Tenant surrenders possession of the Premises to Landlord, except that if the damage to the Premises materially impairs Tenant’s ability to continue its business operations in the Premises, then this Lease shall be deemed to have terminated as of the date such damage occurred.

(c) In the event of repair and restoration as herein provided, the monthly installments of Base Rent shall be abated proportionately in the ratio which Tenant’s use of the Premises is impaired during the period of such repair or restoration, unless the damage was caused by the negligent or willful acts of omissions of Tenant, in which event there shall be abatement of Base Rent only to the extent of rental abatement insurance proceeds received by Landlord. Tenant shall not be entitled to any compensation or damages for loss of use of the whole or any part of the Premises and/or any inconvenience or annoyance occasioned by such damage, repair or restoration.

(d) If Landlord is obligated to or elects to repair or restore as herein provided, Landlord shall promptly repair or restore only those portions of the Building and Premises which

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were originally provided at Landlord’s expense, substantially to their condition existing immediately prior to the occurrence of the damage or destruction; and Tenant shall promptly repair and restore, at Tenant’s expense, Tenant’s fixtures, improvements, alterations and additions in and to the Premises or Building which were not provided at Landlord’s expense.

(e) Notwithstanding anything to the contrary contained in this Paragraph 21, Tenant shall have the right, at its sole option, to terminate this Lease upon a total destruction of the Building as described in Paragraph 21(a)(i), if the Premises cannot be restored within two hundred ten (210) days from the date of such destruction, by delivering written notice of such election to Landlord within sixty (60) days of the occurrence of such total destruction. Subject to the foregoing, Tenant hereby waives the provisions of California Civil Code Section 1932(2) and Section 1933(4) which permit termination of a lease upon destruction of the leased premises, and the provisions of any similar law now or hereinafter in effect, and the provisions of this Paragraph 21 shall govern exclusively in case of such destruction.

22. Condemnation. If twenty-five percent (25%) or more of the Building or the parking area for the Premises is taken for any public or quasipublic purpose by any lawful governmental power or authority, by exercise of the right of appropriation, inverse condemnation, condemnation or eminent domain, or sold to prevent such taking (each such event being referred to as a “Condemnation”), Landlord or Tenant may, at its option, terminate this Lease as of the date title vests in the condemning party. If the Building after any Condemnation and any repairs by Landlord would be untenantable for the conduct of Tenant’s business operations, Tenant shall have the right to terminate this Lease as of the date title vests in the condemning party. If either party elects to terminate this Lease as provided herein, such election shall be made by written notice to the other party given within thirty (30) days after the nature and extent of such Condemnation have been finally determined. Tenant shall not, because of such taking, assert any claim against Landlord. Landlord shall be entitled to receive the proceeds of all Condemnation awards (except separate awards for trade fixtures, the then unamortized cost of the Specialized Tenant Improvements, and relocation expenses), and Tenant hereby assigns to Landlord all of its interest in such awards. If less than twenty-five percent (25%) of the Building or the parking area is taken, Landlord, at its option, may terminate this Lease unless (i) Tenant shall agree, at its sole option, to continue the Lease in effect as to the portion of the Premises which is not subject to the Condemnation (in which case Rent shall be adjusted to reflect the decreased square footage of the Premises), (ii) the parking available to Tenant following the condemnation is legally sufficient to permit Tenant to conduct business at the Premises, and (iii) the Condemnation awards received by Landlord (together with any additional amounts which Tenant agrees to contribute, in its sole discretion and without any obligation to make any such contribution) are sufficient to restore the Premises and/or the Property to a condition which will permit Tenant to utilize the remaining Premises for the Intended Use, in which case, Landlord shall complete the restoration of the Premises and/or Property as provided below and this Lease shall continue in effect, subject to adjustment of Base Rent as provided below. If neither Landlord nor Tenant elects to terminate this Lease to the extent permitted above, Landlord shall promptly proceed to restore the Premises and/or the Property, to the extent of any Condemnation award received by Landlord, to substantially the same condition as existed prior to such Condemnation, allowing for the reasonable effects of such Condemnation, and a proportionate abatement shall be made to the Base Rent corresponding to the time during which, and to the portion of the floor area of the Building (adjusted for any increase thereto resulting from any

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reconstruction) of which, Tenant is deprived on account of such Condemnation and restoration. The provisions of California Code of Civil Procedure Section 1265.130, which allows either party to petition the Superior Court to terminate the Lease in the event of a partial taking of the Premises, and any other applicable law now or hereafter enacted, are hereby waived by Landlord and Tenant.

23. Assignment and Subletting.

(a) Subject to Paragraph 23(d), Tenant shall not voluntarily or by operation of law, (1) mortgage, pledge, hypothecate or encumber this Lease or any interest herein, (2) assign or transfer this Lease or any interest herein, sublet the Premises or any part thereof, or any right or privilege appurtenant thereto, or allow any other person (the employees, agents and invitees of Tenant excepted) to occupy or use the Premises, or any portion thereof, without first obtaining the written consent of Landlord, which consent shall not be unreasonably withheld, conditioned or delayed. A change in control of Tenant shall constitute an assignment requiring Landlord’s consent. A transfer, on a cumulative basis, of more than fifty percent of the voting control of Tenant shall constitute a change in control for this purpose. When Tenant requests Landlord’s consent to such assignment or subletting, it shall notify Landlord in writing of the name and address of the proposed assignee or subtenant and the nature and character of the business of the proposed assignee or subtenant and shall provide current financial statements for the proposed assignee or subtenant prepared in accordance with generally accepted accounting principles or other accounting method reasonably acceptable to Landlord. Tenant shall also provide Landlord with a copy of the proposed sublet or assignment agreement, including all material terms and conditions thereof. Landlord shall then have the option, to be exercised within ten (10) days of receipt of the foregoing, to (1) cancel this Lease as of the commencement date stated in the proposed sublease or assignment but, with respect to any proposed sublease, only with respect to that portion of the Premises being sublet pursuant to such proposed sublease, (2) acquire from Tenant the interest, or any portion thereof, in this Lease and/or the Premises that Tenant proposes to assign or sublease, on the same terms and conditions as stated in the proposed sublet or assignment agreement, (3) consent to the proposed assignment or sublease, or (4) refuse its consent to the proposed assignment or sublease, providing that such consent shall not be unreasonably withheld, conditioned or delayed.

(b) Without otherwise limiting the criteria upon which Landlord may withhold its consent, Landlord may take into account the reputation and creditworthiness of the proposed assignee or subtenant, the character of the business proposed to be conducted in the Premises or portion thereof sought to be subleased, and the potential impact of the proposed assignment or sublease on the economic value of the Premises. In any event, Landlord may withhold its consent to any assignment or sublease if (1) the actual use proposed to be conducted in the Premises or portion thereof conflicts with the provisions of Paragraph 8(a) or (b) above or with any other lease which restricts the use to which any space in the Building may be put, or (2) the proposed assignment or sublease contemplates alterations, improvements or additions to the Premises or portions thereof for which Landlord’s consent is required pursuant to the terms of this Lease and, because of the nature of such alterations, improvements or additions, Landlord would not be unreasonable in withholding its consent pursuant to Paragraph 11.

(c) If Landlord approves an assignment or subletting as herein provided, Tenant shall pay to Landlord, as Additional Rent, fifty percent (50%) of the difference, if any,

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between (1) the Base Rent plus Additional Rent allocable to that part of the Premises affected by such assignment or sublease pursuant to the provisions of this Lease, and (2) the rent and any additional rent paid by the assignee or sublessee to Tenant, after deducting customary real estate commissions and reasonable attorneys’ fees, if any, incurred by Tenant in connection with any such assignment or sublease. The assignment or sublease agreement, as the case may be, after approval by Landlord, shall not be amended without Landlord’s prior written consent (which consent shall not be unreasonably withheld, conditioned or delayed), and shall contain a provision directing the assignee or subtenant to pay the rent and other sums due thereunder directly to Landlord upon receiving written notice from Landlord that Tenant is in default under this Lease with respect to the payment of Rent. Landlord’s collection of such rent and other sums shall not constitute an acceptance by Landlord of attornment by such assignee or subtenant. A consent to one assignment, subletting, occupation or use, shall not constitute consent to any subsequent assignment, subletting, occupation or use, and consent to any assignment or subletting shall in no way relieve Tenant of any liability under this Lease. Any assignment or subletting without Landlord’s consent (to the extent such consent is expressly required hereunder) shall be void, and shall, at the option of Landlord, constitute an Event of Default under this Lease.

(d) Notwithstanding the provisions of this Paragraph 23 to the contrary, Landlord’s prior written consent shall not be required for, and Landlord shall not have the right to terminate this Lease pursuant to Paragraph 23(a) with respect to, an assignment or sublease to (i) an entity which controls, is controlled by, or is under common control with, Tenant, (ii) any entity resulting from a merger or consolidation with Tenant, or (iii) any person or entity which acquires substantially all of the assets of Tenant as a going concern of the business that is conducted at the Premises, provided that in each such instance, Tenant gives Landlord written notice of any such assignment or sublease and, in the event of an assignment, the assignee has a net worth which is equal to or greater than the Tenant’s net worth at the time of the assignment and assumes, in writing, for the benefit of Landlord, all of Tenant’s obligations under the Lease (any assignee described in clauses (i), (ii) or (iii) above being referred to herein as a “Permitted Assignee”).

(e) Tenant shall pay Landlord’s reasonable fees, including a reasonable administration fee, not to exceed One Thousand Dollars ($1,000.00) per transaction, incurred in connection with Landlord’s review and processing of documents regarding any proposed assignment or sublease.

(f) Tenant acknowledges and agrees that the restrictions, conditions and limitations imposed by this Paragraph 23 on Tenant’s ability to assign or transfer this Lease or any interest herein, to sublet the Premises or any part thereof, to transfer or assign any right or privilege appurtenant to the Premises, or to allow any other person to occupy or use the Premises or any portion thereof, are, for the purposes of California Civil Code Section 1951.4, as amended from time to time, and for all other purposes, reasonable at the time that the Lease was entered into, and shall be deemed to be reasonable at the time that Tenant seeks to assign or transfer this Lease or any interest herein, to sublet the Premises or any part thereof, to transfer or assign any right or privilege appurtenant to the Premises, or to allow any other person to occupy or use the Premises or any portion thereof.

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24. Tenant’s Default. The occurrence of any one of the following events shall constitute an event of default on the part of Tenant (each, an “Event of Default”):

(a) The abandonment of the Premises by Tenant (provided, that, Tenant shall not be deemed to have abandoned the Premises if Tenant shall have vacated all or any portion of the Premises but is continuing to pay Rent in accordance with the terms of this Lease);

(b) Failure to pay any installment of Base Rent or Additional Rent due and payable hereunder, said failure continuing for a period of three (3) calendar days after written notice from Landlord of such failure;

(c) Failure to pay any Rent, other than Base Rent or Additional Rent, due and payable hereunder, said failure continuing for a period of ten (10) calendar days after written notice from Landlord of such failure;

(d) A general assignment by Tenant for the benefit of creditors;

(e) Other than the Existing Bankruptcy Case, the filing of a voluntary petition in bankruptcy by Tenant, the filing of a voluntary petition for an arrangement, the filing of a petition, voluntary or involuntary, for reorganization, or the filing of an involuntary petition by Tenant’s creditors, said involuntary petition remaining undischarged for a period of sixty (60) days;

(f) Receivership, attachment, or other judicial seizure of substantially all of Tenant’s assets on the Premises, such attachment or other seizure remaining undismissed or undischarged for a period of sixty (60) days after the levy thereof;

(g) Failure of Tenant to execute and deliver to Landlord any estoppel certificate, subordination agreement, or lease amendment within the time periods and in the manner required by Paragraphs 29, 30 or 39; provided, that the occurrence of any event described in this clause (g) shall not constitute an Event of Default unless Landlord has elected to treat such event as an Event of Default pursuant to a written notice given to Tenant;

(h) The execution by Tenant of an assignment or sublease with respect to this Lease or the Premises by Tenant contrary to the provision of Paragraph 23, unless such assignment or sublease is expressly conditioned upon Tenant having received Landlord’s consent thereto; provided, that the occurrence of any event described in this clause (h) shall not constitute an Event of Default unless Landlord has elected to treat such event as an Event of Default pursuant to a written notice given to Tenant;

(i) Failure of Tenant to restore the Security Deposit to the amount and within the time period provided in Paragraph 6 above;

(j) Failure in the performance of any of Tenant’s covenants, agreements or obligations hereunder (except those failures specified as Events of Default in other Paragraphs or elsewhere in this Paragraph 24, which shall be governed by such other Paragraphs), which failure continues for thirty (30) calendar days after written notice thereof from Landlord to Tenant provided that, if Tenant has exercised reasonable diligence to cure such failure and such failure

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cannot be cured within such thirty (30) day period despite reasonable diligence, Tenant shall not be in default under this subparagraph unless Tenant fails thereafter diligently and continuously to prosecute the cure to completion; and

(k) Chronic delinquency by Tenant in the payment of Base Rent of Additional Rent, or any other periodic payments required to be paid by Tenant under this Lease. “Chronic delinquency” shall mean failure by Tenant to pay Base Rent or Additional Rent, or any other periodic payments required to be paid by Tenant under this Lease within (5) calendar days after written notice thereof for any three (3) months (consecutive or nonconsecutive) during any twelve (12) month period. In the event of a Chronic Delinquency, in addition to Landlord’s other remedies for an Event of Default provided in this Lease, at Landlord’s option, Landlord shall have the right to require that Base Rent and Additional Rent be paid by Tenant quarterly, in advance.

Tenant agrees that any written notice given by Landlord pursuant to Paragraph 24(b), (c), (j) or (k) above shall satisfy the requirements for notice under California Code of Civil Procedure Section 1161, and Landlord shall not be required to give any additional notice in order to be entitled to commence an unlawful detainer proceeding.

25. Landlord’s Remedies.

(a) Termination. In the event of the occurrence of an Event of Default by Tenant, then in addition to any other remedies available to Landlord at law or in equity and under this Lease, Landlord shall have the immediate option to terminate this Lease and all rights of Tenant hereunder by giving written notice to Tenant of such intention to terminate. In the event that Landlord shall elect to so terminate this Lease, then Landlord may recover from Tenant:

(1) the worth at the time of award of any unpaid Rent which has been earned at the time of such termination; plus

(2) the worth at the time of award of the amount by which the unpaid Rent which would have been earned after termination until the time of award exceeds the amount of such rental loss Tenant proves could have been reasonably avoided; plus

(3) the worth at the time of award of the amount by which the unpaid Rent for the balance of the Term of this Lease after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided; plus

(4) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant’s failure to perform its obligations under this Lease or which in the ordinary course would be likely to result therefrom, including, without limitation, any costs or expenses reasonably and necessarily incurred by Landlord (i) in retaking possession of the Premises; (ii) in maintaining, repairing, preserving, restoring, replacing, cleaning, altering or rehabilitating the Premises or any portion thereof, including such acts for reletting to a new tenant or tenants; (iii) for leasing commissions; or (iv) for any other costs necessary or appropriate to relet the Premises; plus

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(5) such reasonable attorneys’ fees incurred by Landlord as a result of an Event of Default, and costs in the event suit is filed by Landlord to enforce such remedy; and plus

(6) at Landlord’s election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by applicable law.

As used in subparagraphs (1) and (2) above, the “worth at the time of award” is computed by allowing interest at an annual rate equal to ten percent (10%) per annum or the maximum rate permitted by law, whichever is less. As used in subparagraph (3) above, the “worth at the time of award” is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award, plus one percent (1%). Tenant waives redemption of relief from forfeiture under California Code of Civil Procedure Sections 1174 and 1179, or under any other present or future law, in the event Tenant is evicted or Landlord takes possession of the Premises by reason of any Event of Default by Tenant hereunder.

(b) Continuation of Lease. In the event of the occurrence of an Event of Default, then in addition to any other remedies available to Landlord at law or in equity and under this Lease, Landlord shall have the remedy described in California Civil Code Section 1951.4 (Landlord may continue this Lease in effect after the occurrence of an Event of Default and abandonment and recover Rent as it becomes due, provided Tenant has the right to sublet or assign, subject only to reasonable limitations).

(c) Re-entry. In the event of the occurrence of an Event of Default, Landlord shall also have the right, with or without terminating this Lease, in compliance with applicable law, to re-enter the Premises and remove all persons and property from the Premises; such property may be removed and stored in a public warehouse or elsewhere at the cost of and for the account of Tenant.

(d) Reletting. In the event of the abandonment of the Premises by Tenant or in the event that Landlord shall elect to re-enter as provided in Paragraph 25(c) or shall take possession of the Premises pursuant to legal proceedings or pursuant to any notice provided by law, then if Landlord does not elect to terminate this Lease as provided in Paragraph 25(a), Landlord may from time to time, without terminating this Lease, relet the Premises or any part thereof for such term or terms and at such rental or rentals and upon such other terms and conditions as Landlord in its sole discretion may deem advisable with the right to make alterations and repairs to the Premises. In the event that Landlord shall elect to so relet, then rent and other sums received by Landlord from such reletting shall be applied in the following order: (1) to reasonable attorneys’ fees incurred by Landlord as a result of the occurrence of an Event of Default and costs in the event suit is filed by Landlord to enforce such remedies; (2) to the payment of any Rent other than Base Rent or Additional Rent due hereunder from Tenant to Landlord; (3) to the payment of any reasonable costs of such reletting; (4) to the payment of the costs of any reasonable alterations and repairs to the Premises required to be made at Landlord’s expense in connection with any such reletting; (5) to the payment of Rent due and unpaid hereunder; and (6) the residue, if any, shall be held by Landlord and applied in payment of future Rent payable by Tenant hereunder as the same may become due and payable hereunder. Should that portion of such rent and other sums received from such reletting during any month, which is applied to the payment of Rent hereunder, be less than the Rent payable during the month by

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Tenant hereunder, then Tenant shall pay such deficiency to Landlord. Such deficiency shall be calculated and paid monthly. Tenant shall also pay to Landlord, as soon as ascertained, any costs and expenses reasonably and necessarily incurred by Landlord in such reletting (and not otherwise reimbursed to Landlord) or in making such alterations and repairs not covered by the rent and other sums received from such reletting.

(e) No Termination Implied. No re-entry or taking of possession of the Premises by Landlord pursuant to this Paragraph 25 shall be construed as an election to terminate this Lease unless a written notice of such intention is given to Tenant or unless the termination thereof is decreed by a court of competent jurisdiction. Notwithstanding any reletting without termination by Landlord because of the occurrence of an Event of Default, Landlord may at any time after such reletting elect to terminate this Lease as a result of such Event of Default.

(f) Cumulative Remedies. The remedies herein provided are not exclusive and Landlord shall have any and all other remedies provided herein or by law or in equity.

(g) No Surrender. No act or conduct of Landlord, whether consisting of the acceptance of the keys to the Premises, or otherwise, shall be deemed to be or constitute an acceptance of the surrender of the Premises by Tenant prior to the expiration of the Term, and such acceptance by Landlord of surrender by Tenant shall only flow from and must be evidenced by a written acknowledgment of acceptance of surrender signed by Landlord. The surrender of this Lease by Tenant, voluntarily or otherwise, shall not work a merger unless Landlord elects in writing that such merger takes place, but shall operate as an assignment to Landlord of any and all existing subleases, or Landlord may, at its option, elect in writing to treat such surrender as a merger terminating Tenant’s estate under this Lease, and thereupon Landlord may terminate any or all such subleases by notifying the sublessee of its election so to do within (5) days after such surrender.

26. Attorney’s Fees. In the event any legal action or proceeding, including arbitration and declaratory relief, is commenced for the purpose of enforcing any rights or remedies pursuant to this Lease, the prevailing party shall be entitled to recover from the non-prevailing party reasonable attorneys’ fees, as well as costs or suit, in said action or proceeding, whether or not such action is prosecuted to judgment.

27. Taxes. Tenant shall be liable for and shall pay, prior to delinquency, all taxes levied against personal property and trade or business fixtures of Tenant. If any alteration, addition or improvement installed by Tenant pursuant to Paragraph 11, or any personal property, trade fixture or other property of Tenant, is assessed and taxed with the Property, Tenant shall pay such taxes to Landlord within fifteen (15) days after delivery to Tenant of a statement therefor.

28. Effect of Conveyance. The term “Landlord” as used in this Lease, means only the owner for the time being of the Property containing the Building, so that, in the event of any sale of the Property or the Building, Landlord shall be and hereby is entirely freed and relieved of all covenants and obligations of Landlord hereunder accruing from and after the transfer, and it shall be deemed and construed, without further agreement between the parties and the purchaser at any such sale, that the purchaser of the Property or the Building has assumed and agreed to carry out any and all covenants and obligations of Landlord hereunder.

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29. Tenant’s Estoppel Certificate. From time to time, upon written request of Landlord, Tenant shall execute, acknowledge and deliver to Landlord or its designee, a written certificate stating (a) the date this Lease was executed, the Commencement Date of the Term and the date the Term expires; (b) the date Tenant entered into possession of the Premises for purposes of the Commencement Date; (c) the current amount of Base Rent and Additional Rent payable by Tenant hereunder and the date to which such Rent has been paid; (d) that this Lease is in full force and effect and has not been assigned, modified, supplemented or amended in any way (or, if assigned, modified, supplemented or amended, specifying the date and terms of any agreement so affecting this Lease); (e) that this Lease represents the entire agreement between the parties with respect to Tenant’s right to use and occupy the Premises (or specifying such other agreements, if any): (f) that all obligations under this Lease to be performed by Landlord as of the date of such certificate have been satisfied (or specifying those as to which Tenant claims that Landlord has yet to perform); (g) that all required contributions by Landlord to Tenant on account of the Tenant Improvements or other improvements, alterations or additions to the Premises have been received (or stating exceptions thereto); (h) to the best of Tenant’s knowledge that on such date there exist no defenses or offsets that Tenant has against the enforcement of this Lease by Landlord (or stating exceptions thereto); (i) that no Base Rent or Additional Rent payable by Tenant hereunder has been paid more than one (1) month in advance (or stating exceptions thereto); (j) that if a security deposit has been made with Landlord, stating the amount thereof; and (k) any other matters evidencing the status of this Lease that may be reasonably required either by a lender making a loan to Landlord to be secured by a deed of trust covering the Premises or by a purchaser of the Premises. Any such certificate delivered pursuant to this Paragraph 29 may be relied upon by a prospective purchaser of Landlord’s interest or a mortgagee of Landlord’s interest or assignee of any mortgage upon Landlord’s interest in the Premises. If Tenant shall fail to provide such certificate within ten (10) days of receipt by Tenant of a written request by Landlord as herein provided, such failure shall, at Landlord’s election, constitute an Event of Default under this Lease.

30. Subordination. Landlord shall have the right to cause this Lease to be and remain subject and subordinate to any and all mortgages or deeds of trust that may hereafter be executed covering the Premises (“Encumbrances”), or any renewals, modifications, consolidations, replacements or extensions thereof, for the full amount of all advances made or to be made thereunder and without regard to the time or character of such advances, together with interest thereon and subject to all the terms and provisions thereof, provided, that, in the event of the foreclosure of any such Encumbrance, so long as Tenant is not in default hereunder, the holder thereof (“Holder”) shall agree to recognize Tenant’s rights under this Lease as long as Tenant shall pay the Rent as and when due pursuant to the terms of this Lease and observe and perform all the provisions of this Lease to be observed and performed by Tenant. Within ten (10) days after Landlord’s written request, Tenant shall execute, acknowledge and deliver any and all reasonable documents required by Landlord or the Holder to effectuate such subordination and non-disturbance. If Tenant fails to do so, such failure shall, at Landlord’s option, constitute an Event of Default under this Lease. Notwithstanding anything to the contrary set forth in this Paragraph 30, Tenant hereby agrees to attorn to any person or entity purchasing or otherwise acquiring the Premises at any sale or other proceeding or pursuant to the exercise of any other rights, powers or remedies under an Encumbrance provided that such person or entity has granted a non-disturbance to Tenant as described above. Landlord hereby represents to Tenant that there are no Encumbrances as of the date of execution of this Lease. As a condition to the

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subordination of this Lease to any future Encumbrances, Tenant shall receive a non-disturbance agreement from the Holder of such Encumbrance, in recordable form and otherwise reasonably acceptable to Tenant, providing that, so long as no Event of Default has occurred and is continuing under this Lease, the Holder thereof shall recognize Tenant’s rights under this Lease, and this Lease shall continue in full force and effect as a direct lease between such Holder and Tenant notwithstanding any such foreclosure or enforcement proceeding.

31. Environmental Covenants.

(a) As used herein, the term “Hazardous Material” shall mean any substance or material which has been determined by any state, federal or local governmental authority to be capable of posing a risk of injury to health, safety or property, including all of those materials and substances designated as hazardous or toxic by the city in which the Premises are located, the U.S. Environmental Protection Agency, the Consumer Product Safety Commissions, the Food and Drug Administration, the California Water Resources Control Board, the Regional Water Quality Control Board, San Francisco Bay Region, the California Air Resources Board, CAL/OSHA Standards Board, Division of Occupational Safety and Health, the California Department of Food and Agriculture, the California Department of Health Services, and any federal agencies that have overlapping jurisdiction with such California agencies, or any other governmental agency now or hereafter authorized to regulate materials and substances in the environment. Without limiting the generality of the foregoing, the term “Hazardous Material” shall include all of those materials and substances defined as “hazardous materials” or “hazardous waste” in Sections 66680 through 66685 of Title 22 of the California Administrative Code, Division 4, Chapter 30, as the same products, fractions, constituents and sub-constituents of petroleum or petroleum-related substances, asbestos, and any other materials requiring remediation now or in the future under federal, state or local statutes, ordinances, regulations or policies.

(b) Tenant represents, warrants and covenants (i) that subject to the provisions of Paragraph 8(a) it will use and store in, on or about the Premises, only those Hazardous Materials that are necessary for Tenant to conduct its business activities on the Premises, (ii) that, with respect to any such Hazardous Materials, Tenant shall comply with all applicable federal, state and local laws, rules, regulations, policies and authorities relating to the storage, use, disposal or cleanup of Hazardous Materials, including, but not limited to, the obtaining of proper permits, and (iii) that it will not dispose of any Hazardous Materials in, on or about the Premises under any circumstances.

(c) Tenant shall immediately notify Landlord of any inquiry, test, investigation or enforcement proceeding by or against Tenant, Landlord or the Premises concerning a Hazardous Material and affecting the Premises or the Property. Tenant acknowledges that Landlord, as the owner of the Premises, shall have the right to negotiate, defend, approve and appeal, any action taken or order issued with regard to a Hazardous Material by an applicable governmental authority. Landlord shall immediately notify Tenant of any inquiry, test, investigation or enforcement proceeding against the Premises concerning a Hazardous Material on the Premises. Tenant shall pay Landlord’s cost of negotiating, defending or appealing any action or order issued with regard to any Hazardous Material by an applicable governmental authority if Tenant caused, permitted or suffered such Hazardous Material to come onto the Premises.

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(d) If Tenant’s storage, use or disposal of any Hazardous Material in, on or adjacent to the Premises results in any contamination of the Premises, the Building or the Property (or the soil or surface, or groundwater under the property) (1) requiring remediation under federal, state or local statutes, ordinances, regulations, or policies, or (2) at levels which are unacceptable to Landlord, in Landlord’s reasonable judgment, Tenant agrees to clean up said contamination. Tenant further agrees to indemnify, defend and hold Landlord harmless from and against any claims, liabilities, suits, causes of action, costs, expenses or fees, including reasonable attorneys’ fees and costs, which Landlord may incur arising out of or in connection with any remediation, cleanup work, inquiry or enforcement proceeding in connection therewith, and any Hazardous Materials currently or hereafter used, stored or disposed of by Tenant or its agents, employees, contractors or invitees in, on or adjacent to the Premises.

(e) Notwithstanding any other right of entry granted to Landlord under this Lease, Landlord shall have the right upon reasonable prior written notice (except in an emergency or in a situation where there is a danger of immediate further contamination, in which case only such prior notice as may reasonably be given will be required) to enter the Premises or to have consultants enter the Premises throughout the Term of this Lease for the purpose of (1) determining whether the Premises are in conformity with federal, state and local statues, regulations, ordinances, and policies including those pertaining to the environmental condition of the Premises, (2) conducting an environmental audit or investigation of the Premises for purposes of sale, transfer, conveyance or financing, (3) determining whether Tenant has complied with this Paragraph 31, and (4) determining the corrective measures, if any, required of Tenant to ensure the safe use, storage and disposal of Hazardous Materials, or to remove Hazardous Materials (except to the extent used, stored or disposed of by Tenant or its agents, employees, contractors or invitees in compliance with applicable law). Tenant agrees to provide access and reasonable assistance for such inspections. Such inspections may include, but are not limited to, entering the Premises or adjacent property with drill rigs or other machinery for the purpose of obtaining laboratory samples. Landlord shall not be limited in the number of such inspections during the term of this Lease but shall not perform such inspections more than once in any twelve-month period unless Landlord has reason to suspect or believe that Tenant is in violation of the provisions of this Paragraph 31. To the extent such inspection discloses the presence of Hazardous Materials used, stored or disposed of other than in accordance with subparagraph (b)(ii) above, Tenant shall reimburse Landlord for the reasonable cost of such inspections within ten (10) days of receipt of a written statement thereof. If the consultants conducting such inspections determine that the Premises is contaminated with Hazardous Materials used, stored or disposed of by Tenant or its agents, employees, contractors or invitees in violation of Paragraph 31(b), Tenant shall, in a timely manner, at its expense, remove such Hazardous Materials or otherwise comply with the recommendations of such consultants to the reasonable satisfaction of Landlord and any applicable governmental agencies. The right granted to Landlord herein to inspect the Premises shall not create a duty on Landlord’s part to inspect the Premises, or liability of Landlord for Tenant’s use, storage or disposal of Hazardous Materials, it being understood that Tenant shall be solely responsible for all liability in connection therewith. Landlord shall be liable for the gross negligence or willful misconduct of Landlord or its agents, employees or consultants in conducting the aforementioned inspections.

(f) Tenant shall surrender the Premises to Landlord upon the expiration or earlier termination of this Lease free of debris, waste and Hazardous Materials used, stored or

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disposed of by Tenant or its agents, employees, contractors or invitees, and in a condition which complies with all governmental statutes, ordinances, regulations and policies and the provisions of this Paragraph 31.

(g) Tenant’s obligations under this Paragraph 31 shall survive termination of this Lease, and Tenant waives the statute of limitations, as to Landlord, applicable to any action brought hereunder.

(h) Landlord hereby discloses to Tenant that the Premises and the Property are in an area in which contamination of soils or groundwater by Hazardous Materials may exist as a result of the actions of a third party. If Tenant desires more definite information regarding the existence or possible existence of contamination by Hazardous Materials of soils or groundwater of or beneath the Premises, the Property, or other real property in the general area of the Property, then Tenant shall investigate such matters. Notwithstanding the foregoing, Landlord shall use commercially reasonable efforts to obtain written confirmation from the California Regional Water Quality Control Board that no action will be taken against a tenant of the Premises, in form similar to that certain letter attached hereto as Exhibit I.

32. Notices. All notices, demands, requests, consents, approvals, submittals or communications which may or are to be required or permitted to be given to either party by the other hereunder shall be in writing and shall be sent by United States mail, postage prepaid, certified, or by personal delivery or overnight courier, addressed to the addressee at the address for such addressee as specified below, or to such other place as such party may from time to time designate in a notice to the other party given as provided herein. Notice shall be deemed given and effective upon actual receipt (in the case of personal service or overnight courier) or two days after deposit in the United States mail, to the following addresses:

To the Landlord:	Christensen Holdings, L.P.
	801 American Street
	San Carlos, CA 94070
	Attention: Gavin Christensen
To the Tenant:	Silicon Graphics, Inc.
	1140 East Arques Avenue
	Sunnyvale, CA 94085
	Attention: Mary Clifford
	and
	Silicon Graphics, Inc.
	1140 East Arques Avenue
	Sunnyvale, CA 94085
	Attention: Vice President of Facilities
with copies to:	Silicon Graphics, Inc.
	1200 Crittenden Lane
	Mountain View, CA 94043
	Attention: Mary Clifford/Vice President of Facilities

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(Prior to Commencement Date)

and

United Properties

3500 American Boulevard W — #200

Bloomington, MN 55431

Attention: Jill Campbell/Lease Administrator

33. Waiver. The waiver of any breach of any term, covenant or condition of this Lease shall not be deemed to be a waiver of such term, covenant or condition or any subsequent breach of the same or any other term, covenant or condition herein contained. The subsequent acceptance of Rent by Landlord shall not be deemed to be a waiver of any preceding breach by Tenant, other than the failure of Tenant to pay the particular rental so accepted, regardless of Landlord’s knowledge of such preceding breach at the time of acceptance of such Rent. No delay or omission in the exercise of any right or remedy of Landlord following the occurrence of an Event of Default shall impair such a right or remedy or be construed as a waiver. Any waiver by landlord of any Event of Default must be in writing and shall not be a waiver of any other Event of Default concerning the same or any other provisions of this Lease.

34. Holding Over. Any holding over after the expiration of the Term, without the express written consent of Landlord, shall constitute an Event of Default and, without limiting Landlord’s remedies provided in this Lease, such holding over shall be construed to be a tenancy at sufferance, at a rental rate of one hundred fifty percent (150%) of the Base Rent last due in this Lease, plus Additional Rent, and shall otherwise be on the terms and conditions herein specified, so far as applicable.

35. Successors and Assigns. The terms, covenants and conditions of this Lease shall, subject to the provisions as to assignment, apply to and bind the heirs, successors, executors, administrators and assigns of all of the parties hereto. If Tenant shall consist of more than one entity or person, the obligations of Tenant under this Lease shall be joint and several.

36. Time. Time is of the essence of this Lease and each and every term, condition and provision herein.

37. Brokers. Landlord represents and warrants to Tenant that neither it nor its officers or agents nor anyone acting on its behalf has dealt with any real estate broker except CPS and Holcomb Realty (“Landlord’s Brokers”) and Tenant represents to Landlord that Liberty-Greenfield/California, Inc. (“Tenant’s Broker”) is its sole real estate broker in such negotiations, and each party agrees to indemnify and hold harmless the other from any claim or claims, and costs and expenses, including attorney’s fees, incurred by the indemnified party in conjunction with any such claim or claims of any other broker or brokers to a commission in connection with this Lease as a result of the actions of the indemnifying party. Landlord shall pay a commission to Landlord’s Brokers in accordance with a separate agreement among Landlord and Landlord’s Brokers. In addition, Landlord shall pay a commission to Tenant’s Broker in the aggregate amount of $487,652, such amount to be paid one-half ($243,826) on October 5, 2006 and one-half ($243,826) on the Commencement Date. Landlord hereby indemnifies and agrees to hold Tenant harmless from any claims, costs or expenses made by

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Tenant’s Broker or Landlord’s Broker against Tenant for any commissions due and payable to them by Landlord hereunder. Tenant hereby indemnifies and agrees to hold Landlord harmless from any claims, costs or expenses made by Tenant’s Broker against Landlord in connection with any dispute between Tenant and Tenant’s Broker (other than a dispute regarding or arising from Landlord’s failure to pay, at the times and in the amounts provided above, any commissions which Landlord is obligated to pay hereunder to Tenant’s Broker). No brokerage fee or commission shall be paid by Landlord on any renewal of this Lease, or the exercise of any option to extend the term under this Lease.

38. Rules and Regulations. Tenant agrees to comply with such reasonable rules and regulations as Landlord may adopt from time to time for the orderly and proper operating of the Building and parking and other common areas provided that similar rules and regulations are also applicable to other tenants of the Property. Such rules may include but shall not be limited to the following: (a) restriction of employee parking to a limited, designated area or areas; and (b) regulation of the removal, storage and disposal of Tenant’s refuse and other rubbish at the sole cost and expense of Tenant. The rules and regulations shall be binding upon Tenant upon delivery of a copy of them to Tenant. Landlord shall not be responsible to Tenant for the failure of any other person to observe and abide by any of said rules and regulations. In the event of any conflict between the rules and regulations and this Lease, this Lease shall control.

39. Mortgagee Protection.

(a) Modifications for Lender. If, in connection with obtaining financing for the Premises or any portion thereof, Landlord’s lender shall request reasonable modifications to this Lease as a condition to such financing, Tenant shall not unreasonably withhold, delay or defer its consent to such modifications, provided such modifications do not impact any Rent or other payments to be made by Tenant hereunder or otherwise adversely affect Tenant’s rights or increase Tenant’s obligations under this Lease.

(b) Rights to Cure. Tenant agrees to give to any Holder, by registered mail, at the same time as it is given to Landlord, a copy of any notice of default given to Landlord, provided that prior to such notice Tenant has been notified, in writing, (by way of notice of assignment of rents and leases, or otherwise) of the address of such Holder. Tenant further agrees that if Landlord shall have failed to cure such default within the time provided for in this Lease, then the Holder shall have an additional twenty (20) days after expiration of such period, or after receipt of such notice from Tenant (if such notice to the Holder is required by this Paragraph 39(b), whichever shall last occur, within which to cure such default or if such default cannot be cured within that time, then such additional time as may be necessary if within such twenty (20) days, any Holder has commenced and is diligently pursuing the remedies necessary to cure such default (including but not limited to commencement of foreclosure proceedings, if necessary to effect such cure), in which event this Lease shall not be terminated.

40. Entire Agreement. This Lease, including the exhibits, schedules and any addenda attached hereto, which are hereby incorporated herein by this reference, contains the entire agreement of the parties hereto, and no representations, inducements, promises or agreements, oral or otherwise, between the parties, not embodied herein or therein, shall be of any force and effect.

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41. Construction. This Lease shall be construed and interpreted in accordance with the laws of the State of California. The parties acknowledge and agree that no rule of construction to the effect that any ambiguities are to be resolved against the drafting party shall be employed in the interpretation of this Lease, including the exhibits, schedules and any addenda attached hereto. All captions in this Lease are for reference only and shall not be used in the interpretation of this Lease. Whenever required by the context of this Lease, the singular shall include the plural, the masculine shall include the feminine, and vice versa. If any provision of this Lease shall be determined to be illegal or unenforceable, such determination shall not affect any other provision of this Lease and all such other provisions shall remain in full force and effect.

42. Representations and Warranties of Tenant. Tenant hereby makes the following representations and warranties, each of which is material and being relied upon by Landlord, is true in all respects as of the date of this Lease, and shall survive the expiration or termination of the Lease.

(a) Tenant is duly organized, validly existing and in good standing under the laws of the state of its organization and the persons executing this Lease on behalf of Tenant have the full right and authority to execute this Lease on behalf of Tenant and to bind Tenant without the consent or approval of any other person or entity. Subject to the satisfaction of the Effectiveness Condition (as defined below), Tenant has full power, capacity, authority and legal right to execute and deliver this Lease and to perform all of its obligations hereunder. Upon the effectiveness of this Lease on the Effective Date, this Lease will constitute the legal, valid and binding obligation of Tenant, enforceable in accordance with its terms.

(b) Other than the Existing Bankruptcy Case and in connection with any proceedings arising therefrom or therein, Tenant has not (1) made a general assignment for the benefit of creditors, (2) filed any voluntary petition in bankruptcy or suffered the filing of an involuntary petition by any creditors, (3) suffered the appointment of a receiver to take possession of all or substantially all of its assets, (4) suffered the attachment or other judicial seizure of all or substantially all of its assets, (5) admitted in writing its inability to pay its debts as they come due, or (6) made an offer of settlement, extension or composition to its creditors generally.

43. Outside Areas.

(a) Subject to the terms and conditions of this Lease and such rules and regulations as Landlord may from time to time prescribe, Tenant and Tenant’s employees, invitees, guests and customers shall have the nonexclusive right to use the access roads, parking areas, and facilities within the Property, exclusive of the Building and the other buildings on the Property, provided and designated by Landlord for the general use and convenience of all occupants of the Property, which areas and facilities are referred to herein collectively as the “Outside Area.” This right shall terminate upon the termination of this Lease. Landlord reserves the right from time to time to make changes in the shape, size, location, amount and extent of the Outside Area. Landlord further reserves the right to promulgate such reasonable rules and regulations relating to the use of the Outside Area and any part or parts thereof, as Landlord may deem appropriate for the best interests of the occupants of the Property. The rules and regulations shall be binding upon Tenant upon delivery of a copy of them to Tenant and

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Tenant shall abide by them and cooperate in their observance. Such rules and regulations may be amended by Landlord from time to time, with or without advance notice, and all amendments shall be effective upon delivery of a copy to Tenant. Tenant agrees to require its employees, executives, invitees, guests and customers to abide by such rules and regulations including parking regulations.

(b) Landlord shall operate, manage and maintain the Outside Area, and landscaping and the surface of the exterior walls. The manner in which the Outside Area shall be maintained and the expenditures for such maintenance shall be at the discretion of Landlord.

(c) No materials, supplies, equipment, finished products or semi-finished products, raw materials or articles of any nature shall be stored upon or permitted to remain outside of the Building, except with the prior written consent of the Landlord. No waste materials or refuse shall be dumped upon or permitted to remain upon any part of the Property outside of the Building, unless approved by Landlord.

(d) Tenant shall not use solid hard tires on any fork lifts or dollies on paved parking, truck loading or driveway areas, and in the event Tenant violates this provision, Tenant shall be responsible for the cost of resurfacing the entire damaged area.

44. Parking. Motor vehicle parking shall be non-exclusive, subject to reallocation by Landlord from time to time. Landlord reserves the right to designate from time to time the parking spaces for vehicles of Tenant and its employees, guests and invitees provided that in such instance Landlord shall make every effort to allocate the parking spaces closest to the Building for the use of Tenant and its employees, guests and invitees. Tenant shall have the right to a total parking allocation equal to 3.62 parking spaces for every 1,000 rentable square feet of the Premises and no additional fees or charges shall be paid by Tenant for the use of such parking spaces (except that any governmentally imposed charges or fees for parking may be included in the Outside Area Expenses payable by Tenant). Tenant agrees that Landlord shall have no responsibility for policing these parking spaces or seeing that they are used exclusively by Tenant’s employees, guests, or invitees. Tenant shall not at any time park or permit the parking of Tenant’s trucks or other vehicles, or the trucks or other vehicles of others, in driveways or adjacent to loading areas as to interfere in any way with the use of such areas, nor shall Tenant at any time park or permit the parking of Tenant vehicles or trucks, or the vehicles or trucks of Tenant’s suppliers or invitees, in any portion of the parking areas not designated by Landlord for such use by Tenant. Tenant shall not park or permit to be parked inoperative vehicles or equipment on any portion of the Outside Area and agrees that no vehicle will be parked on the Outside Area for longer than eighteen (18) hours in any twenty-four (24) hour period.

45. Calculation of Rentable Square Feet. The square footage of building area referred to in this Lease is calculated by utilizing measurements from either the outer extent (drip line) of roofed areas or from the outside of exterior walls.

46. Roof Rights.

(a) Tenant’s Equipment. Subject to the terms and conditions set forth in this Paragraph 46, and Tenant’s receipt of all necessary governmental approvals, Tenant shall have

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the right to install and operate a satellite dish or dishes on the roof of the Building, and related cabling within the Building risers (collectively, “Tenant’s Equipment”), at no charge to Tenant for the use of the roof and the risers, for the purpose of transmitting and/or receiving microwave or radio signals, in a manner consistent with Tenant’s business. Tenant shall, however, be responsible for all costs associated with the installation, maintenance and repair of Tenant’s Equipment as well as any utility costs associated with the operation of Tenant’s Equipment. The number, size, location and method of installing or affixing Tenant’s Equipment on the roof shall subject to the prior approval of Landlord, which approval shall not be unreasonably withheld, delayed or conditioned so long as Tenant’s Equipment can be installed and operated on the roof of the Building without damaging the Building structure. Installation shall be designed and supervised by a duly registered and qualified professional engineer or architect approved by the Landlord. The installation shall be actually fastened (bolted, welded or otherwise positively anchored, not ballasted) to the structure and properly flashed to the roof membrane with all necessary work to preserve the roof integrity and any warranties. Any future installations or changes in Tenant’s Equipment shall be subject to all the conditions and restrictions for original installation of Tenant’s Equipment as set forth herein, and shall be subject to Landlord’s prior approval. For any transmitting device, the Tenant shall submit data to the Landlord detailing necessary safety precautions that will be used on the installation, including EMF output, in keeping with accepted operating and safety standards. Tenant shall not be permitted to assign or sublet the Tenant’s Equipment installation and operation rights to any other party. The right to operate Tenant’s Equipment shall expire upon the expiration or sooner termination of this Lease, at which time Tenant shall remove all of Tenant’s Equipment, including all cabling, from the Building and repair any damage to the Building caused by the installation, operation or removal of Tenant’s Equipment. Landlord shall have the right to do maintenance, repairs and remodeling to the Building and roof space at any time without Tenant’s prior approval provided that none of such maintenance, repairs or remodeling interferes with the use of the Premises by Tenant or the conduct of Tenant’s business in the Building.

(b) Cabling. In the event that Tenant desires to run any cable through the Building in connection with the installation and maintenance of Tenant’s Equipment, Tenant agrees to submit working drawings to the Landlord specifying the following: (i) the locations throughout the Building where the cable will be located; (ii) the manner in which the cabling will be run through the Building; (iii) the communications closets, if any, which will be utilized in installing and maintaining such cabling; (iv) the amount of cable which will be required to be utilized; and (v) the type of cable which will be utilized. Such working drawings are subject to Landlord’s approval (which approval shall not be unreasonably withheld, conditioned or delayed) and Tenant shall not install any cabling or perform any work until such working drawings have been approved by the Landlord. Additionally, Tenant agrees that all cable shall be shielded cable, that the cable coating shall comply with all applicable fire codes and is properly labeled so that it can be identified by the Landlord, Landlord’s agents or third parties. Tenant further agrees to provide Landlord reasonable notice prior to installing any cable, and such notice shall set forth the times at which Tenant expects to be installing or working on such cables.

47. Effectiveness of Lease. Landlord acknowledges that, as of the date of execution and delivery of this Lease, Tenant is a debtor-in-possession under that certain chapter 11 case styled In re Silicon Graphics, Inc. et al., Case No. 06-10977 (BRL) (the “Existing Bankruptcy

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Case”) pending in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). Notwithstanding anything to the contrary contained in this Lease and except as otherwise provided in Paragraph 3(d), this Lease shall become effective only upon Tenant having been authorized to enter into this Lease by order of the Bankruptcy Court and such order shall have not been reversed, vacated or stayed and the time to appeal, petition for certiorari, or move for a new trial, reargument or rehearing shall have expired, and no appeal, petition for certiorari or other proceedings for a new trial or rehearing shall then be pending (such condition to the effectiveness of this Lease being referred to herein as the “Effectiveness Condition”). The date on which the Effectiveness Condition is satisfied is referred to herein as the “Effective Date.” If the Effectiveness Condition has not been satisfied on or prior to September 20, 2006, then either party shall have the right, by written notice given to the other party, to terminate this Lease, whereupon neither party hereto shall have any further rights or obligations hereunder except as otherwise provided in Paragraph 3(d).

48. Option to Extend.

(a) Option Term. Provided that an Event of Default shall not have occurred and be continuing, either at the time of exercise or at the time the extended Term commences, Tenant shall have the option to extend the initial Term of this Lease for an additional period of five (5) years (the “Option Period”) with respect to all of the Premises, on the same terms, covenants and conditions provided herein, except that the Base Rent payable hereunder during the Option Period shall be ninety-five percent (95%) of the then fair market rental value of the Premises, as determined pursuant to Paragraph 48(b). Tenant shall exercise its option, if at all, by giving Landlord written notice (the “Option Notice”) at least six (6) months but not more than twelve (12) months prior to the expiration of the initial Term of this Lease.

(b) Option Period Rent.

(1) The “then fair market rental value of the Premises” shall be defined to mean the fair market rental value of the Premises as of the commencement of the Option Period, taking into consideration the uses permitted under this Lease, the quality, size, design and location of the Premises, and the rent for comparable buildings located in Sunnyvale, and shall be determined as provided in this Paragraph 48(b)(1). The parties shall have thirty (30) days after Landlord receives the Option Notice within which to agree on the then fair market rental value of the Premises. If the parties so agree within said period, they shall immediately execute an amendment to this Lease stating the Base Rent for the Option Period based upon ninety-five percent (95%) of the then fair market rental value of the Premises. If the parties are unable to so agree within said period then the then fair market rental value of the Premises shall be determined in accordance with Paragraph 48(b)(2).

(2) Within seven (7) days after the expiration of the thirty (30) day period set forth in Paragraph 48(b)(i), each party, at its sole cost and by giving notice to the other party, shall appoint an independent real estate appraiser with at least five (5) years’ full-time commercial appraisal experience in the area in which the Premises are located to determine the then fair market rental value of the Premises for the Option Period. If a party does not appoint an appraiser within ten (10) days after the other party has given notice of the name of its appraiser, the single appraiser appointed shall be the sole appraiser and shall determine the then fair market rental value of the Premises. If the two (2) appraisers are appointed by the parties as stated in

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this paragraph, they shall meet promptly and attempt to determine the then fair market rental value of the Premises. If they are unable to agree within thirty (30) days after the second appraiser has been appointed, they shall attempt to elect a third appraiser meeting the qualifications stated in this paragraph within ten (10) days after the last day the two (2) appraisers are given to determine the then fair market rental value of the Premises. If they are unable to agree on the third appraiser, either of the parties to this Lease, by giving ten (10) days’ notice to the other party, can apply to the Santa Clara County Superior Court, for the selection of a third appraiser who meets the qualifications stated in this paragraph. Each of the parties shall bear one-half (1/2) of the cost of appointing the third appraiser and of paying the third appraiser’s fee. The third appraiser, however selected, shall be a person who has not previously acted in any capacity for either party.

(3) Within thirty (30) days after the selection of the third appraiser, a majority of the appraisers shall determine the then fair market rental value of the Premises for the Option Period. If a majority of the appraisers are unable to do so within said period of time, the three (3) appraisals shall be added together and their total divided by three (3); the resulting quotient shall be deemed to be the then fair market rental value of the Premises. If, however, the low appraisal and/or the high appraisal are/is more than ten percent (10%) lower or higher, respectively, than the middle appraisal, then the low appraisal and/or the high appraisal, respectively, shall be disregarded. If only one appraisal is disregarded, the remaining two (2) appraisals shall be added together and their total divided by two (2); the resulting quotient shall be deemed to be the then fair market rental value of the Premises. If both the low appraisal and the high appraisal are disregarded as stated in this paragraph, then only the middle appraisal shall be used as the result of the appraisal. After the fair market rental value of the Premises has been determined, the appraisers shall immediately notify the parties and the parties shall amend this Lease to set forth the Base Rent for the Option Period based upon ninety-five percent (95%) of the then fair market rental value of the Premises.

(c ) Rights Personal to Tenant. The option to extend the Term set forth herein is personal to Silicon Graphics, Inc. and to any Permitted Assignee and shall not be transferred or assigned to any other third party; provided, however, that if the net worth of an assignee (other than a Permitted Assignee) then in possession of the Premises is equal to or greater than the net worth of Silicon Graphics, Inc. as of the date of exercise of the option to extend the Term pursuant to Paragraph 48, then the option may be assigned to such assignee.

49. Interest on Past Due Obligations. Any Base Rent or Additional Rent due Landlord hereunder, other than late charges, not received by Landlord within thirty (30) days following the date on which it was due, shall bear interest from the thirty-first (31st) day after it was due at the rate of 10% per annum, but not exceeding the maximum rate allowed by law (the “Interest Rate”), in addition to the late charge provided for in Paragraph 5.

50. Confidentiality. Except as required by applicable law (including, without limitation, in connection with the Existing Bankruptcy Case), the Securities and Exchange Commission regulations, or any securities listing agency rules or requirements, Landlord and Tenant each agree to keep the terms and conditions of this Lease confidential and neither party shall disclose any such terms to a third party without the prior written consent of the other, provided, however, that the foregoing shall not prohibit Tenant from presenting a copy of this

39

Lease to a prospective assignee, sublessee, lender or purchaser nor shall it prohibit Landlord from presenting a copy of this Lease to a prospective lender or purchaser of the Building or the Property.

51. Tenant’s Remedy. If, as a consequence of a default by Landlord under this Lease, Tenant recovers a money judgment against Landlord, such judgment shall be satisfied only out of the proceeds of sale received upon execution of such judgment and levied thereon against the right, title and interest of Landlord in the Property and out of Rent or other income received by Landlord from the Property or out of consideration received by Landlord from the sale or other disposition of all or any part of Landlord’s right, title or interest in the Property or out of insurance proceeds received by Landlord from any damage to or destruction of the Property, and Landlord’s Agents shall have no personal liability for any deficiency.

52. Counterparts. This Lease may be executed in one or more counterparts, and may be signed by each party on a separate counterpart, each of which, taken together, shall be an original, and all of which shall constitute one and same instrument.

[THE REMAINDER OF THIS PAGE IS LEFT BLANK]

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Landlord and Tenant have executed and delivered this Lease as of the date first hereinabove set forth.

LANDLORD:			TENANT:
Christensen Holdings, L.P., a California limited partnership			Silicon Graphics Inc., a Delaware corporation
By:	The Christensen Company, LLC, a California limited liability company, General Partner		By:	/s/ Dennis McKenna
			Its:	CEO and President
	By:	/s/ Herman Christensen, Jr.
		Herman Christensen, Jr., its Manager

EXHIBIT A

Premises

[See Attached]

EXHIBIT B

Property

Legal Description

All that certain real property situated in the City of Sunnyvale, County of Santa Clara, State of California, described as follows:

ALL OF PARCEL 2, as shown upon that certain Map entitled, Parcel Map lying within the City of Sunnyvale, being a resubdivision of Parcels A & B as shown upon that Record of Survey recorded in Book 285 of Maps, at page 3, City of Sunnyvale, Santa Clara County, California, which Map was filed for record in the office of the Recorder of the County of Santa Clara, State of California, on May 10, 1977 in Book 395 of Maps, at page 23.

Site Plan

[See Attached]

EXHIBIT C

Commencement Date Memorandum

The undersigned parties agree that the Commencement Date under and as defined in the Lease Agreement dated as of September 7, 2006, entered into between the parties is                         , 200   and the expiration date of the Lease Agreement is                         , 200  .

LANDLORD:			TENANT:
Christensen Holdings, L.P., a California limited partnership			Silicon Graphics, Inc., a Delaware corporation
By:	The Christensen Company, LLC, a California limited liability company, General Partner		By:
			Its:
	By:
		Herman Christensen, Jr., Manager

EXHIBIT D

Additional Rent Calculation (Example)

[See Attached]

EXHIBIT E

Tenant Improvements

• Build–out a central customer lobby area for the space

• Demo 20% of existing rooms (including specialized lab areas) to create an open office environment throughout the floor

• Install the SGI standard Herman Miller Ethospace furniture systems

• Re-use existing closed door spaces as either employee offices or phone/focus rooms

• Build-out break rooms and service areas (copy/ printer) as necessary; aesthetic upgrade on existing rooms for conference rooms and hard wall offices.

• Install new CAT5E data cabling for network infrastructure throughout the entire space

• Build-out a Fitness Center

• Build out Customer Training Room and Lab.

• Re-use existing warehouse and docks for Shipping & Receiving functions

• Install a new security system utilizing card access and cameras

• General cosmetic upgrade – paint, repair/replacement of flooring, walls and ceiling

• Paint and flooring upgrade in existing cafe

[See Attached Schematic]

EXHIBIT F

Specialized Tenant Improvements

• Build-out 14000 sq feet of Engineering R&D labs converting existing rooms and open office space to a consolidated full computer environment.

• Chilled water plant for lab HVAC.

• Upgrade/re routing of electrical systems to accommodate systems requirements in the labs

• Installation of all new CAT5E data cabling for network infrastructure.

[See Attached Schematic]

EXHIBIT G

Additional Work

1. Replacement of eight Trane roof top air conditioning package units; AC-1, AC-2, AC-3 (40 tons each), AC-4 (50 tons), AC-5, AC-6 (55 tons each) , AC-7 and AC-8 (50 tons each) and replacement of nine roof top duct furnaces and the rooftop pneumatic control compressor.

2. Includes disconnect and reconnect of all gas and plumbing piping, and electrical connections.

3. Replace missing condensate piping on all rooftop equipment either being replaced or re-used.

4. Include new Ductwork and supports as required to tie new equipment into existing duct mains.

5. Reclaim refrigerant on all units prior to removal.

6. Include required permits.

7. Include factory start-up, and test.

8. Include one year warranty

9. Replace equipment with like units, matching size, capacity, weight, etc.

10. Include HVAC design drawings and as-builts in CAD format.

11. Provide T-24 calculations as required for acquisition of applicable permits.

12. Include structural modifications, if required, to support new equipment.

EXHIBIT H

Signage Locations

EXHIBIT I

See Attached

EX-21.1

Exhibit 21.1

SILICON GRAPHICS, INC. SUBSIDIARIES

Name	Jurisdiction of Incorporation
Silicon Graphics Federal, Inc.	Delaware
Silicon Graphics World Trade Corporation	Delaware
Cray Research, L.L.C.	Delaware
Cray Financial Corporation	Delaware
Cray Research America Latina Ltd.	Delaware
Cray Research Eastern Europe Ltd.	Delaware
Cray Research India Ltd.	Delaware
Cray Research Asia/Pacific, Inc.	Delaware
Cray Research International, Inc.	Delaware
Silicon Studio, Inc.	Delaware
Silicon Graphics Real Estate, Inc.	Delaware
MIPS Computer Systems Federal, Inc.	Delaware
MIPS HR Systems, Inc.	Delaware
ParaGraph International, Inc.	California
WTI Developments, Inc.	California
Silicon Graphics World Trade B.V.	Netherlands
Silicon Graphics Computer Systems GmbH	Austria
Silicon Graphics S.A./N. V.	Belgium
Silicon Graphics s.r.o.	Czech Republic
Silicon Graphics A/S	Denmark
Silicon Graphics Oy	Finland
Silicon Graphics SA	France
Silicon Graphics GmbH	Germany
Silicon Graphics AE	Greece
Silicon Graphics Kft	Hungary
Silicon Graphics S.p.A.	Italy
Silicon Graphics B.V.	Netherlands
Silicon Graphics Europe Trade BV	Netherlands
Silicon Graphics Trading Sarl	Switzerland
Silicon Graphics A/S	Norway
Silicon Graphics Sp.z.o.o.	Poland
Silicon Graphics, S.A.	Spain
Silicon Graphics AB	Sweden
Silicon Graphics Finance S.A.	Switzerland
Silicon Graphics Manufacturing Finance Ltd.	Jersey, Channel Islands, U.K.
Silicon Graphics Limited	Canada
Silicon Graphics S.A.	Switzerland

Silicon Graphics Computer Systems GmbH	Austria
Silicon Graphics Bilgisayar Sistemleri Anonim Siket	Turkey
Silicon Graphics Limited	United Kingdom
Cray Research Limited	United Kingdom
Silicon Graphics (Pty) Limited	Republic of South Africa
Silicon Graphics S.A.	Argentina
Silicon Graphics SA	Chile
Silicon Graphics S.A. de C.V.	Mexico
Silicon Graphics S.A.	Venezuela
Silicon Graphics Pty Ltd.	Australia
Silicon Graphics Comercio e Servicos Ltda	Brazil
Silicon Graphics Computer Engineering & Technology	China
Silicon Graphics Limited	Hong Kong
Silicon Graphics Systems (India) Limited	India
Silicon Graphics Limited	New Zealand
Silicon Graphics Pte Ltd	Singapore
Korea Silicon Graphics Ltd.	South Korea
Silicon Graphics Limited	Taiwan
Silicon Graphics Computer Systems Limited	Israel
Silicon Graphics Biomedical (1995) Ltd	Israel
Alias Systems NV	Belgium
Cray Research (Canada) Inc.	Canada
Cray Research (Israel), Ltd.	Israel
Silicon Graphics Sdn Bhd	Malaysia

EX-23.1

Exhibit 23.1

CONSENT OF KPMG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Registration Statements (Form S-3 File No. 333-113116, Form S-4 File No. 333-110683, and Form S-8 File Nos. 33-48890, 33-51275, 33-56017, 33-58017, 333-01211, 333-08651, 333-40849, 333-76445, 333-48780, 333-71628, 333-90263, 333-100124 and 333-112346) of Silicon Graphics, Inc. and subsidiaries (Debtors-in-Possession) of our report dated October 13, 2006, with respect to the consolidated balance sheet of Silicon Graphics, Inc. as of June 30, 2006 and the related consolidated statement of operations, stockholders’ deficit, and cash flows for the year ended June 30, 2006, and the related financial statement schedule, management’s assessment of the effectiveness of internal control over financial reporting as of June 30, 2006, and the effectiveness of internal control over financial reporting as of June 30, 2006, which reports appear in the June 30, 2006 annual report on Form 10-K of Silicon Graphics, Inc.

Our report dated October 13, 2006 contains an explanatory paragraph that states that Silicon Graphics, Inc. has incurred recurring operating losses and negative cash flows, has a stockholders’ deficit and has filed a voluntary petition seeking to reorganize under Chapter 11 of the United States Bankruptcy Code, all of which raise substantial doubt about its ability to continue as a going concern. The consolidated financial statements and financial statement schedule do not include any adjustments that might result from the outcome of this uncertainty.

/s/ KPMG LLP

Mountain View, California

October 13, 2006

EX-23.2

Exhibit 23.2

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Registration Statements (Form S-3 File No. 333-113116, Form S-4 File No. 333-110683, and Form S-8 File Nos. 33-48890, 33-51275, 33-56017, 33-58017, 333-01211, 333-08651, 333-40849, 333-76445, 333-48780, 333-71628, 333-90263, 333-100124 and 333-112346) of Silicon Graphics, Inc. of our reports dated September 15, 2005, with respect to the consolidated financial statements and schedule of Silicon Graphics, Inc., for each of the two years in the period ended June 24, 2005 included in this Annual Report (Form 10-K) for the year ended June 30, 2006.

/s/ Ernst & Young LLP

San Jose, California

October 13, 2006

EX-31.1

Exhibit 31.1

FORM OF 302 CERTIFICATION

I, Dennis McKenna, certify that:

1. I have reviewed this annual report on Form 10-K of Silicon Graphics, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;

4. The company’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the company and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the company’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; and

5. The company’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: October 16, 2006

/s/ Dennis McKenna

Dennis McKenna

Chief Executive Officer

EX-31.2

Exhibit 31.2

FORM OF 302 CERTIFICATION

I, Kathy Lanterman, certify that:

1. I have reviewed this annual report on Form 10-K of Silicon Graphics, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;

4. The company’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the company and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the company’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting; and

5. The company’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: October 16, 2006

/s/ Kathy Lanterman

Kathy Lanterman

Chief Financial Officer

EX-32.1

Exhibit 32.1

FORM OF 906 CERTIFICATION

The certification set forth below is being submitted to the Securities and Exchange Commission in connection with the Report on Form 10-K (the “Report”) for the purpose of complying with Rule 13a-14(b) or Rule 15d-14(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Section 1350 of Chapter 63 of Title 18 of the United States Code.

Dennis McKenna, the Chief Executive Officer and Kathy Lanterman, the Chief Financial Officer of Silicon Graphics, Inc., each certifies that, to the best of his/her knowledge:

1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and

2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Silicon Graphics, Inc.

Date: October 16, 2006

/s/ Dennis McKenna
Name:	Dennis McKenna
	Chief Executive Officer
/s/ Kathy Lanterman
Name:	Kathy Lanterman
	Chief Financial Officer