April 1, 1999 10:55 AM PST

SGI dives after predicting larger loss

Shares of Silicon Graphics plunged more than 20 percent this morning after the company yesterday warned Wall Street that its third quarter net loss will be 20 to 25 cents bigger than analysts' consensus estimates.

The surprise announcement cast a shadow on SGI's earlier plans to have a net profit for the first six months of 1999.

Silicon Graphic stock tumbled 20.75 percent or 3.44 points to 13.13. The issue has traded as high as 20.88 and as low as 7.38 during the past 52 weeks.

The company blamed the shortfall on a revenue slide resulting from a slow ramp-up of its new Visual Workstation 320 computers. Additionally, SGI has encountered a number of problems while transitioning its Origin server line to the new R12000 chip, chief executive Rick Belluzzo said in a statement.

Revenue as a result will be less than expected. The company predicted revenue of about $600 million for the quarter, which ends today.

Analysts were expecting a loss for the quarter of around 7 cents a share, according to a report from First Call. Combined with SGI's warning, it appears that SGI will therefore likely report a loss of 32 to 37 cents a share. Estimates ranged from a loss of 11 cents a share to 4 cents a share. SGI will report its third fiscal quarter results on April 22.

For the fiscal year, analysts had been projecting a loss of 49 cents per share, a figure which included a profit of 12 cents a share for the fourth fiscal quarter.

SGI sells high-powered graphics machines, servers, and supercomputers, known for, among other things, producing the special effects in movies like Jurassic Park. The company is apparently having difficulty switching its business over to new underlying hardware and faces stiff competition from Sun Microsystems, Hewlett-Packard, and others. SGI has added Intel-based systems to its workstation line and plans to do the same with its server line.

At the same time, the company is supplementing the operating systems it offers by adding Microsoft Windows NT and Linux to its stable of Unix machines.

"The transition to a commodity marketplace is hitting them harder than they expected," said Technology Business Research analyst Joe Ferlazzo, adding that SGI is having trouble getting out of the vicious cycle of decreasing revenues and decreasing product shipments. "The problem is they're moving into an entirely new market, and they don't have volume production capabilities," he said.

Merrill Lynch analyst Steve Milunovich wrote in a report that, "[SGI's] turnaround is clearly difficult with changes occurring on multiple fronts." Merrill Lynch maintains an "accumulate" rating on the stock.

"We estimate that revenue will come in between $600-650 million, below our previous estimate of $733 million," Milunovich wrote.

Bill Kelly, senior vice president of SGI's corporate operations, said there have been delays in the company's transition plan to have three quarters of its products instead of one quarter be in growth markets. The company plans "to come out with more definitive guidance on April 22" about whether it will meet its goal of overall profitability for the first six months of 1999.

Although SGI beat earnings estimates by 3 cents a share last quarter, SGI stock has slipped from about $20 per share in early February to its current price of $13.13. Trading was halted after the release.

"Our new 320 Visual Workstation product has received a great critical response, but delays in the initial production ramp and implementing a new operations model adversely affected our third quarter revenue. The product is now in full production, and we are confident that it will be successful," Belluzzo said.

The new Origin servers will be available "without supply constraints" in the June quarter, he added.

Troubled transition
SGI's transition from functioning as a specialized vendor of high-performance workstations to a maker of Intel-Windows NT workstations has been anything but easy. In fact, SGI has chronically reported financial losses during the year-plus period the transition has been taking place.

The transition effectively kicked into gear last January when Belluzzo came over to become SGI's CEO from HP. By April, SGI had laid out internal plans to split off its MIPS processor division into a separate company focusing on chips for game devices and handhelds. The company also pared back the road map on the processors that go in its servers.

Although MIPS began to thrive as an independent company after a shaky start, SGI was feeling the effects of moving from one technology platform to another. The company had to delay its first Intel based workstations from fall 1998 to January 1999 to iron out some technical issues.

The new systems emerged to rave reviews. However, analysts also cautioned that the low price tags on the systems, especially when compared to SGI's traditional boxes, put pressure on the company.

"It's going to reestablish Silicon Graphics in a leadership position in a market category that they have been criticized for arrogantly ignoring," said analyst Jon Peddie of Jon Peddie and Associates in Tiburon, who added, "at $5,000, they have to sell a whole lot of them to become a billion-dollar company. This is just one piece of the Silicon Graphics product strategy."

Ironically, while the first tangible phase of the "Intel" strategy was rolling out, SGI announced that it would extend the life of its own processors, because customers were uncomfortable with delays with Intel's upcoming 64-bit Merced processors.

"It is hard to see how IA-64 could be beaten in the market...[but] the customer feedback has been that they would like to be able to buy a few more rounds of MIPS-based machines while they get their first Merced machines going," said John Mashey, chief scientist at SGI, last month.

 

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