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Insult and injury piling on SGI

SGI's $10-million chip recall campaign is only the latest blow to the company, troubled by short-term financial pressures and market encroachment from vendors that once competed at arm's length.

Silicon Graphics' (SGI) $10-million recall campaign of the R10000 microprocessors announced yesterday is only the latest blow to a company troubled by short-term financial pressures and a gradual encroachment on its market from vendors that once competed at arm's length.

SGI is now planning to replace all 10,000 of the R10000 microprocessors that shipped between March and July and are used inside most SGI models from the low to high end of its lineup. The company found that its chip supplier, NEC had given it chips damaged by a manufacturing error that would shut down a computer without warning.

The problem was fixed during the summer and the company has already replaced the chips in many of the machines originally shipped with the faulty chip, but SGI will still take a one-time charge of several million dollars in the second quarter to pay for the recall campaign.

But that will only add insult to injury. SGI earnings for the first quarter are also expected to come in substantially below analysts' expectations of 29 cents per share, due partially to slipping sales as well as the manufacturing problems that temporarily halted delivery of many of its systems.

Financial analysts who follow SGI say the company is also getting squeezed by new competitors in the low-end workstation market.

SGI is number three in the workstation market, with 13 percent of the market behind Sun Microsystems which holds 31 percent and Hewlett-Packard which has 23 percent, according to market research firm International Data Corporation.

But SGI has traditionally enjoyed a largely uncontested market for users of animation and mechanical design applications, but low-end workstations from HP and others running Intel's high-powered Pentium Pro chips and Microsoft's Windows NT operating system are beginning to erode that niche, according to IDC analyst Tom Copeland.

He added that such machines were on display at a conspicuous number of booths at August's Siggraph, the leading graphics trade show, an event that SGI could be said to have dominated until now.

This trend may only accelerate if more developers start supporting two new 3D technologies from Intel: the Accelerated Graphics Port, and its MMX multimedia processing technology built into Pentium chips. The two technologies are designed to work in conjunction to increase computers' 3D graphics performance by as much as a factor of four at a lower cost than existing offerings.

The company's historically high profit margins have also been shrinking, according to George Elling, an analyst with Merrill Lynch and the company needs those profit margins to fuel its expensive research and development efforts.

But while SGI's problems are clear, Elling for one thinks the company still has time to compensate. "They will have to fend off the competitors and that will be a challenge. My bet, however, is that the company is still strong and will do well over time if they build on their strengths and diversify," he said.