# Been avoiding talking about SGI … but it looks like a whole slew of events is about to get started

John West at InsideHPC has a brief article on SGI, noting that they have received their second delisting notice. As of now, SGI, a company I spent 6 years at, and really enjoyed my time there (apart from the decisions various company senior management made), which hit a $4B valuation at one point, is currently worth$5.24M.

SGI was once a great company. What made SGI great were the people, some of whom are still there. This was a seriously kick-ass products company.
That badly … badly … lost its way. The blame for this rests squarely with the leadership.
Tomorrow, SGI will no longer trade on the NASDAQ. They will be likely trading on the pink sheets (over the counter).
From the Yahoo financial news site:

SUNNYVALE, Calif., March 9 /PRNewswire-FirstCall/ — Silicon Graphics, Inc. (the “Company”) (Nasdaq: SGIC – News) announced today that it received a notification letter from The Nasdaq Stock Market on March 3, 2009, indicating that trading of the Company’s common stock will be suspended at the opening of business on March 12, 2009 due to a failure to comply with the market value of publicly held shares requirement for continued listing set forth in Marketplace Rule 4310(c)(3)(B).

Not quoted is that in the next sentence, SGI is indicated to have filed a hearing to challenge the rationale behind the delisting. I haven’t seen an update on this, so I am not sure if it will take.
While this is bothersome and destructive of value for most companies, the issue with SGI may be worse. Specifically, SGI has a number of debt instruments that depend upon specific items, possibly including valuation.
From their recent 10Q form

The amendment defers certain near-term cash obligations until the 2011 maturity date but also requires us to comply with new covenants regarding minimum required levels of consolidated EBITDA and liquidity, as described in more detail under “Debt and Equity Facilities” and Note 9, Debt and Other Financing Arrangements, to our notes to the condensed consolidated financial statements in Part I, Item 1 of this report.

Now this isn’t so bad, as long as you are liquid, have good cash flow, lots of backlog and deals. Delisting could be temporary (SGI could apply later). SGI has challenged this delisting now, and they could prevail.
But their 10Q goes on in harsh detail …

The minimum required levels are materially higher than those we have recently achieved and we may not be in compliance with these requirements in the quarter ended March 27, 2009.

That is, they may not be able to achieve, and are higher than they have achieved in the past.
This isn’t, in and of itself, an existential issue.
The next sentence is.

If we do not achieve the required levels then an event of default will occur and the lenders may accelerate the debt and otherwise exercise their rights.

That is, if they can’t achieve specific indicated performance, the people who loaned them money may say “all done.” They will default if they cannot get their earnings up above the levels they agreed to. Which they haven’t been able to in recent history.
This quote doesn’t mean this will happen. An investor has to look at the possibility of SGI paying them back. If their customers slow buying, this is a problem. In this economy, customers have slowed buying.
The 10Q goes on …

We are actively evaluating any further opportunities to restructure the terms of our existing debt arrangements and to raise additional capital in order to meet the working capital requirements of our future business. Such additional capital may not be available on commercially attractive terms or at all.

Ok … we can read this one slowly.
First, they were delisted. This is not a problem …
… unless you have specific valuation, and other covenants tied to your debt, obligations you must maintain, in order to be held in good standing, and not in default.
SGI may not meet these levels of obligation, either from EBITDA or other covenants. They are indicating that they have 15 days to meet those covenants.
Can they do it?
A long while ago (April 2008), I posted a quick financial look at them and asked why were they on a downward trend. This was after Bear Stearns blew up, but well before the rest of the financial meltdown got going in earnest.
In it, I posted a chart, which is a live link against the Yahoo financial chart. Here is the chart.

And here is what I wrote relative to the stock price

The trend of the stock suggests being below 5 by the end of this quarter. Being close to zero within two quarters.

Stock price isn’t everything. But the point about being close to zero was prescient. I was thinking it wouldn’t happen, unless something went very very wrong.
Which did happen.
And the stock price being close to zero could impact covenants on the debt. Which could trigger a default.
Their 8-K form from Sept 2008 has a few interesting elements:

Consolidated EBITDA was amended to be $30 million as of September 25, 2009;$37.5 million as of December 25, 2009; $40 million as of March 26, 2010; and$45 million on June 25, 2010 and for each fiscal quarter-end until and including September 30, 2011. Minimum global liquidity was set at $15 million and fiscal year 2009 capital expenditures are limited to$10 million for fiscal year 2009, and for following fiscal years to $15 million. They have to show earnings of$30M by 25-Sept-2009. They most recently showed -$70M or so. They have$36M in cash, $157M in debt, and are hitting -$60M/year operating cash flow. About -$15M/quarter. Which gives about 2 quarters of cash. And after the Morgan Stanley payment, about 1 quarter of maintaining the global liquidity covenant. More than a year ago, Linux Networx died. It died because it couldn’t maintain its covenants and payment schedule on debt. SGI has a payment due Morgan Stanley coming up soon for their$127.5M term loan. Quarterly payments are about \$4.25M
To the point, I wrote of LNXI then

They got killed (my guess) by going after huge government systems with long drawn out acceptance tests. Which killed their cash flow, and put them into an unsafe business area.
Look, HPC is just like any other business, you have to be able to distinguish good business from bad business. Some business you cannot afford to pursue, the cost of winning is simply too high. Call that business, Pyrrhic business. The wins come at such a huge cost to you, that losing would have been simply better for your business.

So SGI just won 6 of 7 in TI-09. Great. When does this show up on the bottom line? How many months/years out before the revenue can be recognized? And how will SGI rebuild its reseller channel after just losing what is effectively its only educational fulfillment relationship?
And if the bond owners decide they want to protect what little value they have left in the company, force a liquidation, and sell off the pieces to recover a fraction of this debt …
I don’t see a bright or long future for SGI. The writing, as it were, appears to be on the wall, and the clock, in a very real sense, is counting down. Banks and other lenders everywhere are cutting their losses to preserve capital.
As the fable goes, maybe the horse will learn how to sing. Much can happen in 16 days.
But whatever does happen will not be pretty.