Summary of SILICON GRAPHICS INTERNATIONAL CORP

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements included or incorporated by reference in this Form 10-Q other than statements of historical fact, are forward-looking statements. Investors can identify these and other forward-looking statements by the use of words such as "estimate," "may," "will," "could," "anticipate," "expect," "intend," "believe," "continue" or the negative of such terms, or other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements also include the assumptions underlying or relating to such statements.
Our actual results could differ materially from those projected in the forward-looking statements included herein as a result of a number of factors, risks and uncertainties, including, among others, changes in the anticipated amounts and timing of restructuring charges to be incurred and cost savings expected to be realized from our restructuring actions in Europe, our ability to successfully execute our strategies, the risks discussed in this Part I, Item 2 -"Management's Discussion and Analysis of Financial Condition and Results of Operations," the risk factors set forth in Part II, Item 1A- "Risk Factors" and elsewhere in this Form 10-Q, the risk factors set forth in our Annual Report on Form 10-K for the year ended June 29, 2012 filed with the Securities and Exchange Commission (the "SEC") on September 10, 2012 (our "Annual Report"), and the risks detailed from time to time in our future reports filed with the SEC. The information included herein is as of the filing date of this Form 10-Q with the SEC and future events or circumstances could differ materially from the forward-looking statements included herein. Accordingly, we caution readers not to place undue reliance on these forward-looking statements. Unless required by law, we expressly disclaim any obligation to update or alter our forward-looking statements, whether as a result of new information, future events or otherwise. All subsequent written or oral forward-looking statements attributable to SGI or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Readers are urged to carefully review and consider the various disclosures made in this report and other documents we file from time to time with the SEC to advise interested parties of the risks and factors that may affect our business.
The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto in Part I, Item 1 in this Form 10-Q and with our financial statements and notes thereto for the year ended June 29, 2012 contained in our Annual Report. Overview
We are a global leader in technical computing. We are focused on helping customers solve their most demanding business and technology challenges by delivering large-scale computing and storage, high-performance compute and storage, and data center solutions. We develop, market, and sell a broad line of low cost, mid-range and high-end computing servers and data storage as well as differentiating software. We sell data center infrastructure products purpose-built for large-scale data center deployments. In addition, we provide global customer support and professional services related to our products. We enable enterprises to meet their computing and storage requirements at a lower total cost of ownership and provide them greater flexibility and scalability. We are also a leading developer of enterprise class, high-performance features for the Linux operating system that provide our customers with a standard Linux operating environment combined with our differentiated yet un-intrusive Linux capabilities that are designed to improve performance, simplify system management, and provide a more robust development environment.
Management has implemented a strategic plan which will drive changes in three major areas. First, we are targeting our investments towards the vertical markets where we can provide the highest value to our customers and differentiate our offerings to gain both market share and margin. Second, we are investing and aligning with key partners in order to provide our customers with integrated solutions in Big Data, storage and scale-up computing. Third, management is focusing on initiatives to improve our operational performance and cost structure. We have ongoing efforts to reduce material and other manufacturing costs. We believe that this strategic plan will help create a strong foundation for our business results in the long-term.
Our revenue mix by geography shows that we continue to have strong international presence with 38% of total revenue from sales outside of the U.S. in both the three and six months ended December 28, 2012. In addition, our customer base continues to expand in various sectors, including the public, cloud and manufacturing sectors.

Results of Operations
Summarized below are the results of our operations for the three and six months ended December 28, 2012 as compared to the three and six months ended December 30, 2011.
Financial Highlights

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• Our total revenue for the three months ended December 28, 2012 was $171.2 million, a decrease of $24.0 million or 12%, from the comparable period in fiscal year 2012. In addition, revenue decreased $10.0 million or 3% in the six months ended December 28, 2012 from $374.1 million in the six months ended December 30, 2011. The decrease was due to lower revenue primarily from the decrease in sales in our product revenue in our APJ segment as well as decreased service revenue for all of our geographic segments. In addition, because the six months ended December 30, 2011 was comprised of 27 weeks compared to only 26 weeks for the six months ended December 28, 2012, we recognized revenue for one less week during the current period.

• Our overall gross margin increased by 1.1 percentage points from 26.7% in the three months ended December 30, 2011 to 27.8% in the three months ended December 28, 2012. The favorable change in the overall gross margin in the three months ended December 28, 2012 is due to favorable product margins shifts to higher gross margin which was slightly offset by a decrease in service gross margin. However, our overall gross margin decreased by 3.3 basis points from 28.0% in the six months ended December 28, 2011 to 24.7% in the six months ended December 30, 2012. The decrease for the six months ended December 28, 2012 was due to product mix as well as a result of a few significant low margin product deals that were recognized during the first quarter of fiscal 2013. Our service margins declined by 2.0 basis points and 4.6 basis points for both the three and six months ended December 28, 2012, respectively, largely as a result of lower support services revenue as our new products replace our installed base of older generation products which had higher margin support contracts. Typically our service revenue is recognized ratably over the respective service periods.

• Our research and development and selling, general and administrative expenses were $47.6 million in the three months ended December 28, 2012 compared to $54.2 million in the prior year comparable quarter. Our research and development and selling, general and administrative expenses was $95.3 million for six months ended December 28, 2012, a decrease of $13.7 million compared to $109.0 million for the six months ended December 30, 2011. A primary driver of this decline was the decrease in compensation and related expenses due to reductions in headcount. Total headcount as of December 28, 2012 was 1,442, which reflects a reduction of 121 employees from 1,563 as of December 30, 2011 due to restructuring actions in fiscal 2011 and 2012 and attrition. The savings from the headcount reductions more than offset the increases in salaries and wages due to merit increases. We have also been controlling our costs across all functions in order to streamline our operations and reduce operating expenses and have also benefited from lower charges for the amortization of intangible assets as these assets are nearing full amortization.

• We incurred restructuring expense of $2.9 million and $4.3 million in the three and six months ended December 28, 2012, respectively, as part of the fiscal 2012 restructuring action which is primarily focused on cost reductions in Europe.

• We recognized net income for the three months ended December 28, 2012 of $1.1 million compared to net loss of $2.3 million in the comparable quarter last year. Net loss for the six months ended December 28, 2012 was $7.6 million, compared to a net loss of $4.9 million for the six months ended December 30, 2011. The $3.4 million increase in our net income for the three months ended December 28, 2012 compared to the comparable quarter last year was mainly driven by the income tax benefit recorded as a result of reversals of unrecognized tax benefits as well as our decreased cost structure. The $2.7 million increase in net loss from the six months ended December 30, 2011 was mainly driven by the lower gross margins reflected during the first half of fiscal 2013 as we were unfavorably impacted by a few significant low margin deals and unfavorable product mix which was only partially offset by the income tax benefit and the decrease in our total operating expenses.

Revenue, cost of revenue, gross profit and gross margin Our revenue mix by geography shows that we continue to have a strong international presence with 38% of total revenue attributed to international sales in both the three and six months ended December 28, 2012, respectively. In addition, our customer base continues to expand in various sectors, including the public, cloud and manufacturing sectors.

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The following table presents revenue by operating segment for the three and six months ended December 28, 2012 and December 30, 2011 (in thousands except percentages):

                                   Three Months Ended                        Change                         Six Months Ended                         Change
                        December 28, 2012       December 30, 2011          $           %        December 28, 2012       December 30, 2011          $           %
Total revenue
Americas              $           112,358     $           109,721     $   2,637       2%      $           235,743     $           222,113     $  13,630       6%
APJ                                27,735                  56,873       (29,138 )    (51)%                 72,169                  96,979       (24,810 )    (26)%
EMEA                               31,133                  28,620         2,513       9%                   56,195                  55,017         1,178       2%
Total revenue         $           171,226     $           195,214     $ (23,988 )    (12)%    $           364,107     $           374,109     $ (10,002 )    (3)%

Product revenue
Americas              $            91,698     $            88,429     $   3,269       4%      $           193,340     $           177,485     $  15,855       9%
APJ                                12,605                  34,090       (21,485 )    (63)%                 39,426                  55,891       (16,465 )    (29)%
EMEA                               23,737                  20,524         3,213       16%                  41,589                  38,619         2,970       8%
Total product revenue $           128,040     $           143,043     $ (15,003 )    (10)%    $           274,355     $           271,995     $   2,360       1%

Service revenue
Americas              $            20,660     $            21,292     $    (632 )    (3)%     $            42,403     $            44,628     $  (2,225 )    (5)%
APJ                                15,130                  22,783        (7,653 )    (34)%                 32,743                  41,088        (8,345 )    (20)%
EMEA                                7,396                   8,096          (700 )    (9)%                  14,606                  16,398        (1,792 )    (11)%
Total service revenue $            43,186     $            52,171     $  (8,985 )    (17)%    $            89,752     $           102,114     $ (12,362 )    (12)%

Revenue. We derive revenue from the sale of products and services directly to end-users as well as through resellers and system integrators. Product revenue is derived from the sale of mid-range to high-end computing servers and data storage systems as well as software. We enter into sales contracts to deliver multiple products and/or services. In accordance with our revenue recognition policy, certain sales contracts are deferred and recognized over the service period. Service revenue is generated from the sale of standard maintenance contracts as well as custom maintenance contracts that are tailored to individual customers' needs. We recognize service revenue ratably over the service periods. Maintenance contracts are typically between one to three years in length and we actively pursue renewals of these contracts. We also generate professional services revenue related to implementation of and training on our products.
We continuously make revisions to our product offerings and improvements of our product's performance and data storage capacity. Accordingly, we are unable to directly compare our products from period to period, and are therefore unable to quantify the changes in pricing of our products from period to period. We believe that our on-going revisions to product offerings and product feature improvements help mitigate competitive pricing pressures by shifting the competitive landscape to differentiated value rather than price. Segment Operating Performance
Americas
Revenue from our Americas segment increased $2.6 million or 2.4% to $112.4 million in the three months ended December 28, 2012 from $109.7 million in the three months ended December 30, 2011. The increase in Americas revenue was driven by higher product revenue partially offset by a decrease in service revenue. Product revenue increased by $3.3 million primarily due to the strength in sales of our scale-out compute solutions and third party products. This increase in product revenue was partially offset by a decrease in sales of our storage solutions as well as a decrease in service revenue of $0.6 million as our new products replace our installed base of older generation products with higher margin support contracts. The decrease in service revenue is primarily due to timing of when services were performed on consulting and product integration services. Our service revenue is typically recognized ratably over the respective service periods. The Americas segment represented 65.6% and 56.2% of the total revenue in the three months ended December 28, 2012 and December 30, 2011, respectively. The Americas segment represented a larger portion of total revenue during the three months ended December 28, 2012 primarily due to the significant decrease in the APJ segment.
Revenue from our Americas segment increased $13.6 million or 6.1% to $235.7 million in the six months ended December 28, 2012 from $222.1 million in the six months ended December 30, 2011. The increase in Americas revenue was

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driven by higher product revenue partially offset by a decrease in service revenue. Product revenue increased by $15.9 million primarily due to the strength in sales of our scale-out compute solutions and third party products. This increase in product revenue was partially offset by a decrease in sales of our scale-up compute and storage solutions as well as a decrease in service revenue of $2.2 million as our new products replace our installed base of older generation products with higher margin support contracts. The decrease in service revenue is primarily due to timing of when services were performed on consulting and product integration services. Our service revenue is typically recognized ratably over the respective service periods. Because the six months ended December 30, 2011 was comprised of 27 weeks compared to only 26 weeks for the six months ended December 28, 2012, we recognized revenue for one less week during the current period. The Americas segment represented 64.7% and 59.4% of the total revenue in the six months ended December 28, 2012 and December 30, 2011, respectively.

APJ
Revenue from our APJ segment decreased $29.1 million or 51.2% to $27.7 million in the three months ended December 28, 2012 from $56.9 million in the three months ended December 30, 2011. The revenue decline in APJ is primarily driven by lower product revenue for our scale up products and our third party products which was driven by one significant deal in Japan. Our revenue for the three months ended December 28, 2012 is comprised of $12.6 million from product sales and $15.1 million from services compared to product and service revenue of $34.1 million and $22.8 million, respectively, for the three months ended December 30, 2011. The decrease in service revenue is primarily due to timing of when services were performed on consulting and product integration services as our new products replace our installed base of older generation products. During the three months ended December 30, 2011, we generated a large portion of revenue in Japan for professional services to assist our customers with the implementation of and training of new products. These types of services are typically non-recurring in nature as customers become more accustomed to our next generation products. The APJ segment represented 16.2% and 29.1% of the total revenue in the three months ended December 28, 2012 and December 30, 2011, respectively.
Revenue from our APJ segment decreased $24.8 million or 25.6% to $72.2 million in the six months ended December 28, 2012 from $97.0 million in the six months ended December 30, 2011. The revenue decline in APJ is primarily driven by lower product revenue for our scale up products as well as third party products which was driven by one significant deal in Japan. Our revenue for the six months ended December 28, 2012 is comprised of $39.4 million from product sales and $32.7 million from services compared to product and service revenue of $55.9 million and $41.1 million, respectively, for the six months ended December 30, 2011. The decrease in service revenue is attributable to the timing of professional services provided as discussed above and the fact that the six months ended December 30, 2011 was comprised of 27 weeks compared to only 26 weeks for the six months ended December 28, 2012, thus we recognized revenue for one less week during the current period. The APJ segment represented 19.8% and 25.9% of the total revenue in the six months ended December 28, 2012 and December 30, 2011, respectively.

EMEA
Revenue from our EMEA segment increased $2.5 million or 8.8% to $31.1 million in the three months ended December 28, 2012 from $28.6 million in the three months ended December 30, 2011. The increase in revenue is primarily driven by higher product revenue for our storage and scale out products of $3.2 million offset by a slight decrease in service revenue of $0.7 million. The EMEA segment represented 18.2% and 14.7% of the total revenue in the three months ended December 28, 2012 and December 30, 2011, respectively.
Revenue from our EMEA segment increased $1.2 million or 2.1% to $56.2 million in the six months ended December 28, 2012 from $55.0 million in the six months ended December 30, 2011. The increase in revenue is primarily driven by higher products revenue for our storage and scale out products of $3.2 million offset by a decrease in service revenue of $1.8 million. The decrease in service revenue is primarily attributable to the fact that the six months ended December 30, 2011 was comprised of 27 weeks compared to only 26 weeks for the six months ended December 28, 2012, thus we recognized revenue for one less week during the current period. The EMEA segment represented 15.4% of the total revenue in both the three months ended December 28, 2012 and December 30, 2011, respectively.

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Cost of revenue and gross profit
Cost of revenue and gross profit for the three and six months ended December 28, 2012 and December 30, 2011 were as follows (in thousands except percentages):

                             Three Months Ended                      Change                       Six Months Ended                       Change
                   December 28, 2012     December 30, 2011         $           %       December 28, 2012     December 30, 2011         $           %

Cost of product
revenue           $          97,350     $         112,316     $ (14,966 )    (13)%    $         219,947     $         212,084     $   7,863       4%
Cost of service
revenue                      26,312                30,715        (4,403 )    (14)%               54,386                57,204        (2,818 )    (5)%
Total cost of
revenue           $         123,662     $         143,031     $ (19,369 )    (14)%    $         274,333     $         269,288     $   5,045       2%

Product gross
profit                       30,690                30,727           (37 )     -%                 54,408                59,911        (5,503 )    (9)%
Service gross
profit                       16,874                21,456        (4,582 )    (21)%               35,366                44,910        (9,544 )    (21)%
Total gross
profit            $          47,564     $          52,183     $  (4,619 )    (9)%     $          89,774     $         104,821     $ (15,047 )    (14)%

Product gross
margin                         24.0 %                21.5 %                                        19.8 %                22.0 %
Service gross
margin                         39.1 %                41.1 %                                        39.4 %                44.0 %
Total gross
margin                         27.8 %                26.7 %                                        24.7 %                28.0 %

Cost of revenue consists of costs associated with direct material, labor, manufacturing overhead, shipment of products, inventory write downs and share-based compensation. Cost of revenue also includes personnel costs for providing maintenance and professional services. Our manufacturing overhead and professional services personnel costs are fixed or semi-variable. Our gross margins are impacted by changes in customer and product mix, pricing actions by our competitors and commodity prices that comprise a significant portion of cost of revenue from period to period. In addition, when certain sales contracts are deferred in accordance with our revenue recognition policy, the related cost of revenue is deferred and recognized upon recognition of revenue. Our cost of revenue and gross profit are impacted by price changes, product configuration, revenue mix and product material costs. Our service cost of revenue and gross margin are impacted by timing of support service initiations and renewals, and incremental investments in our customer support infrastructure.
Overall gross profit decreased by $4.6 million to $47.6 million in the three months ended December 28, 2012 from $52.2 million in the three months ended December 30, 2011 primarily due to a decrease in revenue volume in APJ. However, our overall gross margin increased to 27.8% in the three months ended December 28, 2012 from 26.7% in the three months ended December 30, 2011. Our gross margin increased due to lower warranty and excess and obsolete charges, lower material costs, and more favorable product mix shifts due to higher gross margins. This increase was slightly offset by lower service margins. Overall gross profit decreased by $15.0 million to $89.8 million in the six months ended December 28, 2012 from $104.8 million in the six months ended December 30, 2011. Overall gross margin decreased to 24.7% in the six months ended December 28, 2012 from 28.0% in the six months ended December 30, 2011. Our gross margin decreased due to unfavorable product mix shifts primarily as a result of certain low margin deals that occurred in the first quarter of fiscal 2013 in Japan and EMEA, as well as lower service margins.
Product gross profit was flat at $30.7 million in both the three months ended December 28, 2012 and December 30, 2011. Product gross margin increased to 24.0% in the three months ended December 28, 2012 from 21.5% in the three months ended December 30, 2011. Product gross margin increased by 2.5 percentage point on lower product revenue of $15.0 million as a result of favorable product mix and higher margin products primarily in the Americas and EMEA compared to the three month period ended December 30, 2011. Service gross profit decreased $4.6 million or 21.4% to $16.9 million in the three months ended December 28, 2012 from $21.5 million in the three months ended December 30, 2011. Service gross margin decreased to 39.1% in the three months ended December 28, 2012 from 41.1% in the three months ended December 30, 2011 as a result of the lower revenue. Although we have reduced our overall services costs as a result of our restructuring plans and costs savings initiatives, the decrease in these fixed costs was not able to offset the decline in revenue resulting in a lower service gross margin compared to the prior year.

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Product gross profit decreased $5.5 million or 9.2% to $54.4 million in the six months ended December 28, 2012 from $59.9 million in the six months ended December 30, 2011. Product gross margin decreased to 19.8% in the six months ended December 28, 2012 from 22.0% in the six months ended December 30, 2011 as a result of unfavorable product mix shifts to lower margin products primarily in APJ and EMEA as a result of a few low margin product deals that occurred in the first quarter of fiscal 2012 compared to the six month period ended December 30, 2011. Service gross profit decreased $9.5 million or 21.3% to $35.4 million in the six months ended December 28, 2012 from $44.9 million in the six months ended December 30, 2011. Service gross margin decreased to 39.4% in the six months ended December 28, 2012 from 44.0% in the six months ended December 30, 2011 primarily as a result of two significant low margin deals that occurred in the first quarter of fiscal 2013.
Operating Expenses
Operating expenses for the three and six months ended December 28, 2012 and December 30, 2011 were as follows (in thousands except percentages):

                                  Three Months Ended                        Change                          Six Months Ended                          Change
                        December 28, 2012      December 30, 2011         $            %         December 28, 2012       December 30, 2011          $           %

Research and
development           $            15,530     $          16,255     $    (725 )     (4)%      $            29,499     $            32,445     $  (2,946 )     (9)%
Sales and marketing                19,664                23,100        (3,436 )     (15)%                  39,235                  44,898        (5,663 )    (13)%
General and
administrative                     12,383                14,799        (2,416 )     (16)%                  26,572                  31,684        (5,112 )    (16)%
. . .