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Struggles seen in SGI spin-off

SGI plans to spin off its embedded products chip-design business, but the new company already faces a struggle to retain a major contract with Nintendo.

Silicon Graphics (SGI) today announced plans to spin off its embedded products chip-design business, but the new company already faces several large financial challenges, including an apparent struggle to retain a major contract for supplying chip technology to Nintendo's next-generation game system, sources said.

As previously reported, workstation maker SGI will spin off the group that develops and licenses MIPS processor designs to chip manufacturers in the embedded market, which includes handheld devices, video games, and television set-top boxes.

Under the plan, SGI will hold an 80 percent stake in the new company, while MIPS will hold 20 percent. The goal is take the MIPS company public by the end of June.

SGI will keep the high-end portion of the MIPS processor business, which designs the chips that are used in its Unix-based workstations and servers.

The move comes as Richard Belluzzo, a highly regarded industry veteran who was named SGI's chairman and chief executive last January, looks for ways to propel the company forward. SGI, which plans to announce third-quarter results April 21, has already warned it expects a loss for the period, which would mark a third consecutive quarter of losses.

SGI Unix workstations, instrumental in creating special effects for scores of movies including hits such as Jurassic Park and Terminator 2, have established a strong reputation in the entertainment industry as the crème de la crème of graphics computers. But declining sales in this business and stalled marketing efforts on the server side are expected to contribute to weak third-quarter results, the company said.

SGI's spin-off too seems to face hard times. Sources close to the company say it is struggling to retain a major contract for the next-generation Nintendo gaming machine. In the past, SGI MIPS processors have been the main silicon engine for Nintendo game boxes.

Constance Sweeney, an SGI spokeswoman, declined to comment on SGI's MIPS plans or the company's contract with Nintendo. In 1993, SGI won a joint development and licensing agreement to supply the microprocessor technology, the 64-bit MIPS RISC chip, for Nintendo's 64-bit platform.

In an an interview with NEWS.COM today, Belluzo said he could not comment on the Nintendo issue. He noted, however, that the spin-off company will not be relying on a single customer, like Nintendo, for its success.

He pointed to the MIPS processors being used by WebTV and in devices loaded with the Windows CE operating system.

Formerly pleased with its relationship with SGI, Nintendo became nervous last year after SGI announced that long-standing chairman and CEO Edward McCracken would step down, former employees said. Last winter, Nintendo decided to explore other options because it was concerned about the level of commitment that the new, as yet unnamed, SGI CEO would give to its product, sources added. As a result, Nintendo did not renew its contract within an deadline established by SGI.

Royalties from Nintendo 64's hardware and software sales make up a sizable portion of the MIPS Group revenue, contributing about $45 million annually, according to former employees. One source noted that the revenue stream from Nintendo royalties will remain "quite healthy" for the next three to four years. But once the next version of the Nintendo video game console is released, royalties from the Nintendo 64 will decline.

Jim Turley, senior editor of the Microprocessor Report, noted that chips bought by Nintendo and Sony's PlayStation represent about 66 to 75 percent of units shipped by the MIPS Group.

Although the MIPS Group is the only designer for the Nintendo 64, it faces several large competitors as it turns its attention to chip designs for embedded devices in the Windows CE market, Turley said. Rivals include Hitachi and Advanced Risc Machines (ARM).

"If MIPS lost Nintendo, they would have to at least double their Windows CE business," Turley said, pointing out that MIPS already does virtually half of the chip designing business for Windows CE, and Hitachi the other half.

But a former employee noted it would be difficult to do both the chips for Nintendo's next-generation game console and the rapidly expanding embedded device market.

Elsewhere, MIPS is faring well in the TV set-top box business. General Instrument announced last month that MIPS licensee Quantum Effect Design will supply processors for General Instrument's DCT-5000+ advanced interactive digital cable box. This could result in chip sales well into the millions.

The new MIPS company is also likely to find it needs to ramp up its investment in research and development.

Peter ffoulkes, a workstation analyst at Dataquest, conjectured that questions surrounding the future viability of the MIPS platform at the high end of SGI's server and workstation offerings may also affect the new company's future as a leader in embedded systems.

SGI's high-end MIPS designs eventually migrate down for use in embedded devices, currently savings the MIPS group a lot of additional research and development expense.

"You can pop them [low-end embedded chips] out like peas," ffoulkes said. But, to do that, "you need top-down development."

Therefore, if chip designs for the high-end machines go, the future of the low-end becomes a question mark.

"If you look at things they are selling into the Nintendo systems, Sony PlayStation, etc., they are basically selling into areas that want reasonable performance. They are selling low-cost 64-bit chips. They're selling essentially the designs that went into their high-end workstations a few years ago, things like the R2000, R3000. Those had to come from somewhere," ffoulkes said.

But one former employee contended the migration from the high-end chips is not all that easy. Said the source: "This is pretty much the conventional wisdom, but it doesn't really apply anymore because present-day high-end designs are too complicated and carry too much baggage to be competitive in the embedded market."

Meanwhile, last week, SGI filed a trade secret violation lawsuit against Artx, a graphic design company believe by many analysts to be an SGI competitor in the Nintendo arena. Also named in the suit were Artx chief executive Wei Yen and the company's technology guru, Tim Van Hook. Yen, who founded Artx in September, is a former SGI senior vice president who guided the company's Nintendo operation. Van Hook, also a former SGI employee, was a key architect for the Nintendo 64 platform.

"I not only want to get the company performing to where it needs to, but we will also be protecting our intellectual property and we intend to reinforce this," Belluzzo said.

The lawsuit, which is under seal in Santa Clara County Superior Court, alleges that Artx, Yen, and Van Hook put their SGI knowledge to use over the past several months, said John Sullivan, vice president and general counsel for SGI. He declined to comment on whether those projects included developing Nintendo's next-generation gaming platform.

Van Hook declined to comment and Yen did not return phone calls.