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Rating Action:

MOODY'S LOWERS RATINGS ON SGI AND CRAY RESEARCH CONVERTIBLES; OUTLOOK REMAINS NEGATIVE

02 Jan 2001
MOODY'S LOWERS RATINGS ON SGI AND CRAY RESEARCH CONVERTIBLES; OUTLOOK REMAINS NEGATIVE

Approximately $277 Million of Debt Securities Affected.

New York, January 02, 2001 -- Moody's Investors Service lowered the rating to B3 from B1 on the outstanding $231 million 5-1/4% senior convertible notes, due 2004, of SGI, formerly known as Silicon Graphics, Inc. At the same time, Moody's lowered the rating to Caa2 from B2 on the outstanding $47 million 6-1/8% Cray Research, Inc. convertible subordinated debentures, due 2011. SGI continues to be obligated for the repayment of these debentures in the wake of its March, 2000 sale of Cray Research to Tera Computer Company. SGI's senior implied rating was lowered to B2 from Ba3, and its senior unsecured issuer rating was lowered to B2 from B1. The ratings outlook remains negative.

The ratings downgrade takes into account SGI's continued revenue decline and operating loss in FY2001Q1, ended September 30, 2000, after three years of revenue contraction and substantial losses; the company's mounting leverage, based on total debt of $350 million plus an additional $336 million representing capitalized operating leases, equivalent to 58.7% of total capitalization; and the negative EBITDA recorded over FY2000 and extended through FY2001Q1. The company, known for its three-dimensional visualization capabilities, has experienced a significant erosion in recent years in its share of the server and desktop workstation markets. Moody's is concerned that continued reductions in research and development spending, on both a percentage and an absolute dollar basis, could inhibit the company from maintaining a pace of technological innovation commensurate with the new product releases of its more formidably capitalized competitors, Sun Microsystems, Hewlett-Packard, IBM, Compaq and Dell. SGI's FY2000 introduction of open standards-based products based on Intel microprocessors and the Linux and Windows NT operating systems supplements existing product lines based on its own enhanced version of the UNIX operating system, IRIX, and the SGI-developed RISC (reduced instruction set computing) architecture embedded in chipsets from MIPS Technologies, Inc. (MIPS). While this strategy was adopted by the company in place of pursuing a proprietary visual workstation design based on the Windows operating system, it is not clear whether the company would be able to mobilize the resources required to support both platforms simultaneously.

The ratings additionally reflect the dramatic diminution in SGI's liquidity stemming from the operating losses, the company's implementation of a series of corporate restructurings and divestitures, and adjustments to the company's portfolio of property, plant and equipment. This is most clearly exhibited by the decrease in working capital to $54 million as of September 30, 2000 from $870 million on June 30, 1999. Also as of September 30, 2000, cash, cash equivalents and short-term investments amounted to just over $200 million, down from $688 million at the start of FY2000. An additional $104 million of restricted investments were held as collateral for letters of credit and an equity forward purchase commitment as of the end of FY2001Q1. The company terminated its $250 million senior unsecured credit facility in November, 1998 based on the strong cash position at that time. Operations absorbed just over $75 million in cash in FY2001Q1 after using up nearly $76 million in cash in all of FY2000, some of which was devoted to severance arrangements as the labor complement was pared from 9,200 to 6,700 employees. In addition to the sale of the Cray supercomputing business, in June, 2000 SGI divested its remaining 65% interest in MIPS to shareholders of its common stock. Capital expenditures, consisting largely of the acquisition of equipment and spare parts, consumed $261 million in FY2000 and $41 million in FY2001Q1. During this period, cash was further drawn down by approximately $125 million through the exercise of a purchase option on five buildings on the company's Mountain View campus that the company had formerly leased on an off-balance sheet financing arrangement.

The ratings are supported, however, by SGI's rich portfolio of intellectual property, including patents in the United States and abroad; a sizable installed base of corporate and governmental customers who rely on the graphic performance and realism of the company's visualization systems; a substantially reduced cost structure facilitated by the latest restructuring; and, after the short-lived regime of a much celebrated chief executive officer appointed in early 1998, some stabilization among the company's senior management team. The current CEO, having assumed the reins in late 1999, maintains a significant equity stake in the company. SGI's liquidity position may be enhanced by as much as $400 million in cash which the company believes it could realize from the sale of select assets before FY2001 year end, registering a projected gain of about $200 million. Sale of the company's Alias\Wavefront application software subsidiary as well as administrative office buildings and undeveloped land in Mountain View, a prime Silicon Valley location, have been identified in the past as prospective transactions.

The ratings also take into consideration the favorable customer response to SGI's much awaited third generation of NUMA (non-uniform memory access) products, the 3000 series, introduced in July, 2000. Its Origin™ 3000 servers and Onyx 3000 visualization workstation systems offer the company's proprietary NUMAflex™ modular technology. This system for constructing small to very large systems from a common set of building blocks has been targeted for enterprise segments with high bandwidth and computational requirements, and technical and scientific markets for such activities as quantum chemistry calculation, seismic analysis, computational fluid dynamics, and finite element analysis to determine the impact of stress and temperature on materials. The research imperatives in these fields lead customers to rapidly adopt the newest technology upon availability. This is borne out somewhat by FY2001Q1 orders, which increased 14% over those received in FY2000Q1.

FY2001Q1 revenues declined to $426 million from $514 million year-over-year, or by 17.1%, pro forma for the Cray and MIPS divestitures, following annual revenue declines of 15.2% in FY2000 and 11.3% in FY1999. The company's performance was disappointing in the wake of its new generation of products, the first product launch in two years. Consistent with various computer and communications OEMs, FY2001Q1 production and shipments were constrained by the company's inability to timely source high performance custom ASICs (application specific integrated circuits) from its sole supplier. This resulted in an increase in backlog to $367 million from $298 million at FY2000 year end. FY2001Q1 segment revenues totaled $403 million with $146 million derived from the sale of servers (36.2%, a 32.2% decline in sales from FY2000Q1), $96 million from visual workstations (23.9%, a 40% decline), and $161 million from professional services (40%, a 2.9% decline).

SGI's common stock, reflecting the MIPS spin-off, closed Friday at $4 per share. The 5-1/4% senior convertibles, which are currently subject to redemption at a price of 103, may be converted at any time into shares of common stock at an adjusted price of $18.70 per share. The 6-1/8% Cray convertible subordinated debentures, which are currently subject to redemption at par, may be converted at any time into shares of SGI common stock at an adjusted price of $39.17 per share. In FY2000 and FY1999, the company purchased $11 million and $15 million Cray debentures, respectively, in the open market.

SGI, a provider of scalable, high-performance computing and visualization solutions for technical and creative applications in the manufacturing, sciences, government, telecommunications, and media market segments, is headquartered in Mountain View, California.

New York
Robert N. McCreary
Senior Vice President
Corporate Finance Group
Moody's Investors Service
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New York
Howard Sitzer
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653

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