FOOL CONFERENCE CALL SYNOPSIS*
By Debora Tidwell (TMF Debit)

Silicon Graphics, Inc.
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2011 North Shoreline Boulevard
Mountain View, CA  94043-1389
(415) 960-1980
http://www.sgi.com

UNION CITY, CA (April 30, 1997)/FOOLWIRE/ --- Silicon Graphics reported their third quarter 1997 earnings on April 17th. Their third quarter revenues were $909 million, up 15% from a year ago when you combine Cray Research revenue with Silicon Graphics revenue on a pro forma basis in the third quarter fiscal 1996. On a reported basis, the growth is 34%. Sequentially, revenue was up 10%.

BOOKINGS. As expected, bookings in the quarter were down over the record bookings last quarter. The results they reported reflect the impact of continued transitions in their desktop business and weakness in business outside the US which was compounded by the strength of the US dollar. Additionally, they experienced significant strength in their server business across the enterprise, file, and compute markets and solid growth for their low-end desktop product, the O2. They completed their product transition in the quarter with the initial appearance of their Octane products. Octane was released to manufacturing late in the quarter on March 22nd. Manufacturing did a good job of ramping production and shipped 1150 units in the last 8 days in the quarter, which was good in the circumstances but less than SGI's plan. There is no doubt that they would have preferred higher revenue growth in the quarter. They had strong demand for the higher performance server business which continued throughout the quarter, but they were unable to turn some of the orders received during the last few days of the quarter into shipments because they ran out of time.

INTERNATIONAL BUSINESS SOFT. The international business was softer than expected, particularly in Germany, France, and Japan. Finally, the stronger dollar against those other currencies lowered their revenue by $15 million or $0.04 per share from the rates that were in effect as of March 31st.

MARGINS. Gross margins were 43.8% in the quarter, down 2.6 points from last quarter on a comparable basis and that is excluding the special charges resulting from the acquisition of Cray Research for the flow through of inventory writeoffs. Although their unit shipments for the quarter were at an all-time high, their plan called for them to be even higher, so they were impacted to some extent by under-absorption of overhead as well as startup costs associated with Octane. These costs which accounted for the decline in gross margins from Q2 are not expected to continue. Gross margins should increase significantly in Q4.

EXPENSES. Expenses, excluding merger-related costs, were down by $3 million sequentially. The number of employees in the company grew 368 during the quarter for an ending headcount of 10,877. Their turnover is down under 10% on an annualized basis versus the average Silicon Valley turnover rate today which is about 25%. The company's third quarter net income was $16 million or $0.09 per share before the charges related to the Cray acquisition. They recorded $9 million in merger-related charges due to the Cray acquisition which has two components. Approximately $6 million or $0.02 represents the purchased accounting effect on gross margin for the inventory writeup of inventory and service contracts at the time of acquisition, as a portion of the inventory is sold to customers. The other merger-related charges in the quarter were $3 million or $0.01 per share. Their tax rate for the quarter was 11% due to the company's performance in the first two quarters of the fiscal year. They expect the rate to also be 11% in the fourth quarter. Their FY 1998 tax rate should be at a more normal level around 26%. Their earnings per share for Q3 was $0.09 prior to the acquisition charges and $0.06 after those charges.

BALANCE SHEET ITEMS. The net change in cash quarter to quarter was a decrease of $33 million. They generated $45 million from operations which was offset by capital expenditures and other assets. They had cash and marketable securities at March 31st of $411 million. Their inventory increased by $74 million over the immediately prior quarter. They had inventory for a higher level of shipments and now that inventory is in place for Q4. Accounts receivable days sales outstanding were 85 days compared to 91 days in the March quarter and 102 days in the year-ago quarter.

BACKLOG AND BOOK-TO-BILL. The book-to-bill ratio was 0.94. The Silicon Graphics product line book-to-bill was above 1.0. Their goal has been to work down the Cray backlog and they were pleased that they were able to build and ship systems to Cray customers who have been waiting for them. The total company backlog at March 31st was $709 million, down from their historical high of $757 million at December 31st. They did ship approximately half of the December backlog as planned but they were unable to take the net backlog down further because bookings came in late in the quarter. They do feel that the current level of backlog is high and will continue to work it down. Of the $709 million of backlog, about half of it is shippable in Q4.

REVENUE BY GEOGRAPHY. North American revenue growth was 27% year over year. European revenue growth was 4% year over year in US dollars, 9% in local currency. In their Pacific region, revenue growth was 8% year over year in US dollars, 17% in local currency. Their US business momentum was strong. The acceptance of their new "O" series products has permeated all markets and geographic sectors across the US. Their European business continued to be softer than they would like and the effect of the strengthening dollar also reduced their growth. In Asia, Japan in particular was adversely affected by currency valuation and reduced government year-end spending. Their business in Asia outside of Japan was good. In Japan, they found several things. The customer set was much less receptive and willing to buy in this quarter than they anticipated. The fiscal year in Japan ends March 31st and that is typically the biggest quarter for companies like SGI. That was exacerbated by the strengthening dollar. They are taking a look at all of their efforts there.

EUROPE. Europe has been soft for the past 6 months for them. Again, they are being very careful about where they invest and how. There are some key market segments for them in Europe that they are enthused about including the server business where they believe there are very significant opportunities and they are pursuing those very aggressively.

SERVER MARKET. The high performance server business is a multi-billion dollar business growing at a very fast rate. They have seen it underway for the past several years with a lot of the right-sizing and downsizing from the older technologies -- the old mainframe and minicomputers. The power of these technologies today allows this whole concept of distributed computing to be a very real thing in a very affordable way. Market research data shows this area growing in excess of 25% and SGI is growing at more than twice that. What they have found is that the high-performance characteristics of their server technologies have got very broad, very strong appeal there.

"O" SERIES PRODUCTS. They have replaced their entire Silicon Graphics product line over the past 6 months. These new products, called the "O" series, which are O2, Octane, Origin 200, Origin 2000, and Onyx 2 are being strongly embraced and accepted by their customers and markets. Today they have the broadest, deepest, and most competitive product line in the industry. Customers do business with Silicon Graphics for very obvious and simple reasons -- power, performance, and technology. This is what their company is about.

PRODUCT LINE DEVELOPMENT STRATEGY. In the past, the term high-performance computing was restricted to the area of supercomputing, a business defined by Cray. Today because of dramatic advances in the areas of microprocessor and other powerful technologies, Silicon Graphics is making high performance computing available to platforms like desktop workstations, servers, and software. In fact, Silicon Graphics is the worldwide leader in high performance supercomputing, high performance servers, high performance workstations, high performance visualization, high performance software, and high performance RISC microprocessors. When customers want high performance desktop capabilities, they buy O2, not Wintel machines. When they need high performance deskside servers, they buy Origin 200 and when they want high performance, highly scalable servers, they buy Origin 2000. When they need the most powerful, high performance computers available in the world, they buy Cray. When customers want to develop the highest performance web sites that can be developed, they buy WebForce and Cosmo. And, when they want to integrate high performance RISC (reduced instruction set chip) microprocessors into their products, they license MIPS. Delivering the highest levels of computing through power, performance, and technology is what Silicon Graphics is all about. High performance computing is what the O series product line is about.

O2 DESKTOP WORKSTATION. The O2 low-price desktop workstation continues to be their fastest selling new product ever. They set a target of shipping 20,000 O2 units by the end of February and they met that goal. They put a demand strategy in place where they set aggressive O2 pricing and the strategy is clearly paying off. Units increased by over 40% from Q2 to Q3. In fact, overall their desktop unit volumes are 65% greater than a year ago. O2 has allowed them to introduce high performance desktop computing to a market space where they haven't previously competed and they are realizing dramatic increases in their desktop unit volumes as a result. For example, they sold 50 systems to NCSA The University of Illinois, 50 systems to Merck for plant design, 24 systems to a company in Canada for CAD work, and 27 systems to Qantas Airlines in Australia. They are gaining marketshare with O2 by offering world leading power, performance, and technology at a price that clearly differentiates O2 from Wintels, PCs, Macs, and all other UNIX workstations. The UNIX workstation business today is an $11 billion plus market, a big portion of which is addressable by Silicon Graphics. They feel that the opportunity for Silicon Graphics with the product lines they have today is outstanding in the workstation marketplace. The strategy today is different from 3-4 years ago in that today they are simply taking marketshare from their competitors. To do that they have to go in with price/performance technology and the right set of applications and they think they have the best formula there. They are seeing more NT presence in the workstation sector. However, their O2 business is growing at a much faster rate in the markets they address. The O2 workstations outperform NT in any available box and have a sticker price around $6,000 for a desktop unit, so they are very competitive.

OCTANE DESKTOP SYSTEM. In February, they completed their O series product line by introducing the world's most powerful desktop workstation, Octane. Octane is the definition of high performance computing on the desktop. During the last 8 days of March, they shipped approximately 1,150 Octanes to customers, the steepest ramp ever in the history of the company. The response to Octane from their applications software partners has been outstanding and benchmarking results show Octane to be a class by itself. They sold 62 Octanes to a telco in India, 40 Octane systems to Square USA, 37 Octane systems to Knowles Atomic Power Labs, 60 Octane systems to a dealer of theirs in Los Angeles, 14 Octane systems to IPT Night Vision Products, and 60 Octane systems to Pixar for work on their next feature film.

CRAY PRODUCT LINE. The Cray line includes the T3E, T90, J90, and Cray Origin 2000. Their Cray business continues to be strong. In the third quarter they sold a T932 to Honda, a T3E to MPG, a T3E to the University of Alaska, a T3E to the Finnish Weather Center, a T932 to the National Institute for Environmental Disaster Prediction in Japan, and several government customers in the US. They also received orders for large supercomputer installations from Nissan, Chrysler, Cirri in Korea, Phillips Petroleum, and Lawrence Livermore Labs. Additionally, and perhaps more importantly, they are gaining significant leverage across the Cray/SGI product lines. A good example would be the DWD which is the German Weather Service where they received a $30 million contract for a T3E, Origin 2000 servers, and O2 workstations. Early in April they held their annual Cray customer executive user group meeting, the most heavily attended Cray customer function ever -- further evidence of the customer enthusiasm of their company's leadership in high performance computer technologies.

ORIGIN SERVER PRODUCTS. SGI's server business is their fastest-growing product area. Their revenue grew almost 50% from Q2 to Q3 in this area, and almost 90% over the year-ago period. Customer demand was high and bookings were strong for the new high performance server families, the Origin 200 and the Origin 2000. The power, performance, architectural design, and scalability of the Origin product families has proven to be very appealing to customers. High performance servers are clearly a new growth opportunity for SGI and they are aggressively pursuing business here. They sold an Origin 2000 16-processor machine to Morgan Stanley for risk analysis, an Origin 2000 64-processor machine to Indiana University for research and technical application use across a variety of departments, an Origin 2000 to NASA Ames, Origin 200 servers to Dreamworks, 10 Origin 200 servers to Forensic Technologies, Lucent Technologies, IPT Night Vision. They received an order from Lockheed Martin for 1,280 Origin 200s totalling $25 million in value that are part of a program for the US Postal Service. SGI servers have broad appeal in both enterprise and technical computing markets.

ONYX INFINITE REALITY SYSTEMS. Their web business continues to grow at a fast rate. Customers who have high performance web site requirements choose Silicon Graphics -- like America Online who purchased over $25 million worth of high performance server technology from SGI in the third quarter, and an Internet service provider in Japan getting their web site started with over $2 million worth of SGI products. Market research firms indicate that the UNIX server market is growing at around 25%. SGI's growth rate is well in excess of twice that. SGI continues to dominate the high-end graphics market with their new world-leading performance Onyx 2 Infinite Reality products, also announced in October. They sold 7 Onyx 2 IR systems to Lockheed Martin for defense satellite imaging, a system to Chrysler for manufacturing design concept and virtual reality work, a system to Texaco for reservoir analysis, and 8 systems to Carlsberg Simulation for visual simulation.

SUMMARY. SGI's US business was strong in Q3. They experienced softness in their business in Europe and Japan. They also saw the effect of a strengthening US dollar. They finished rounding out Silicon Graphics O series product line by announcing and shipping Octane and they continue to see very strong acceptance of the entire O series product line by their customers. From O2 to Cray, Silicon Graphics is delivering the world's highest level of computing performance to their customers and markets worldwide.

OPERATIONAL ISSUES. During the last 6 months they have seen a significant increase in the complexity of their business. Their revenue growth has them approaching a $4 billion run rate. The breadth of their product line has significantly increased and this has been exacerbated by 100% of the Silicon Graphics product lines transitioning in the last quarter. It has been a bumpy process which has been reflected in their results, but it is having a healthy effect which was to force SGI to re-engineer their basic business processes. This focus is consuming a large portion of their management team's efforts. There are many examples underway. One is new product introduction. Their focus there is to increase their ability to drive predictable, seamless, and in volume new product releases to their customers. Quote-to-Collect is another example of a process focus. It defines a broad cross-functional process which includes the functions of quoting an order, configuration management, order entry, order fulfillment, manufacturing, distribution, and receivables collection. This focus will contribute bottom-line returns with reference to improved cycle times, delivery performance, and asset management. Another example is shipment linearity. Their focus here is to increase the percentage of their shipments in the first and second month of each quarter, thus lowering the percentage required to ship in the third month. As an example, they have shipped as much as 80% of their product revenue in the third month of the quarter, last Q4. They have made improvements in shipping a greater percentage in the first two months of the last two quarters and they will continue down that path. This process re-engineering will contribute to increased predictability, lower infrastructure costs and risks, and improved asset management and profit.

PRODUCT TRANSITION. Their business last quarter continued to be affected by their product transition to the O series product line. The transition is at different stages in each of the products. The one product that has clearly made it through the transition is the O2. The Octane, because of electronic issues with some of their parts slipped late into the quarter and, as a result, the number of units was less than they would have liked. And the ramp on the Origin 200 and the Origin 2000 continues to be affected by the issues associated with increasing the ramp. The gross margin was also affected by the product transition. The good part of the story is that all 5 products in the O series are now introduced, shippable in volume, they believe they are at least 95% through the process and the product line looks a lot cleaner going forward.

LOOKING AHEAD. As they look forward, they think there are two ways to win -- increasing growth rates and purely an increase in profit. As their organization is leaner, they have invested heavily in processes and they believe it is possible to produce quite an improvement in profits from the current levels. The growth in the workstation marketplace has declined a little bit in the last few months and the last couple of years. They are very encouraged by the O2 and the fact that the O2 growth rate appears to be much higher than the NT workstation growth rate in the marketplace. Many of their competitors have lost enthusiasm for this market. They find themselves at a point where the time is right to move aggressively for marketshare here and they are doing that and gaining marketshare dramatically. As the Octane gets into the marketplace, they expect to see an increase in momentum in the workstation marketplace. They think the transition and their inability to ship has had some feedback into bookings and they expect that to change as they are truly able to get their demo units in the field and can ship in a more predictable way. Their high performance server market is growing rapidly but the real success story for their company the S2MP architecture is really working for their customers and they are very pleased with the growth rate they are getting. This is an area of increased investment and they will continue to make increases in investments here and reallocation of resources to make sure they are able to continue this penetration of the server marketplace. They are particularly in the Internet operation centers, the large scalable web server that can either be part of ISPs or intranets within large companies or Internet for electronic commerce and other applications. This continues to be a nice area for SGI and the architecture of their server product line seems particularly good here. Another major area of investment for them is their investment in the broadcast television marketplace where high performance is required to deliver streamed content to customers. They think this will be a great growth market for their company and they are unusually well positioned to be a leader in this market. The supercomputer market has been good to them this year, in part because of their own product cycles. The microprocessor activity at MIPS is paying off for them, not only in terms of their systems level contribution in architecture like the S2MP server architecture, but also in terms of royalties. Their relationship with Nintendo has been particularly successful. The Nintendo product is generating some royalty income that is allowing them to have a possible future as well.

IMPROVING PROFITABILITY. They have taken steps to improve on the process side, are trying to build a stronger foundation for the future. They are redeploying resources throughout their organization to better match market conditions. They are clearly focused on increasing stockholder value and think there are two ways to win there.

EXPECTATIONS. They are committed at the company to improve the profitability and the revenue growth. Their results in each of the quarters in 1996 reflect that they are consistently making progress. For the fourth quarter 1997, they are planning expenses to increase only slightly over Q3 and expect revenue growth to be in the range of 10% or so over Q3 1997. Manufacturing startup costs and production constraints for their new products are behind them. They expect their operating profit margin will increase in Q4 but they don't think they will quite make it into their operating profit model.

They will give more details on expectations for FY 1998 in their next conference call when they have completed the planning process. They are currently reviewing their investment resources to align them behind their growth markets as part of the FY 1998 planning process. They hope that they will exit FY 1997 on a path to increasingly strong revenue growth. In FY 1998, most of their efforts will be focused on profitable growth. The management team is committed to achieving profit growth substantially greater than revenue. They are also committed to greatly improving asset management, processes, and the infrastructure to enable consistently predictable and increasingly profitable results.

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