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Red ink deeper at SGI as sales shrink

Low margin deal hangover

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Jorge Titinger, who was tapped to be the CEO at server and supercomputer maker Silicon Graphics back in February, has his work cut out for him amind slowing sales and mounting losses.

It is a situation that many CEOs at SGI (and at rival Cray) have found themselves in time and time again. But SGI is now in a new fiscal year and has a new product lineup based on the latest processors from Intel and Advanced Micro Devices, and hope is springing again that SGI can boost sales and get back in the black.

In the fourth quarter of fiscal 2012 ended in June, revenues declined by 8.2 per cent to $179.5m. Research and development costs (related in part to the adoption of Intel's Xeon E5 processors in the Rackable and UV2 lines) rose a bit, and despite cutting other costs, the company had a $15.6m loss from operations. After paying taxes and interest, SGI dropped to a net loss of $18.4m, considerably deeper than the $12.1m loss in the year ago period.

For the full twelve months, SGI booked just under $753m in sales, up a very smart 19.6 per cent and far outpacing the server market at large, but the company lost $25.5m for the year, a few million bucks more than it did last year.

About half of that revenue increase came through the acquisition of SGI Japan, a former partner that the company absorbed in March 2011. The revenue hand looks good, but profits are not following suit. SGI has also burned $35m in cash in the past year and now has only $104.9m in the bank.

In the final quarter of the fiscal 2012 year, SGI's product and services revenues were both off. Product revenues dropped 6.2 per cent to $134.5m, but services took a much more severe 13.8 per cent fall, to just under $45m.

Product gross margins fell by 3.8 points to 15.4 per cent, which was caused by a write-down of older product inventories and didn't help the bottom line. Services gross margins rose by 1.8 points to 37.3 per cent. It was not enough to keep the losses at bay.

SGI has an $87m backlog of low-margin deals that it did to boost sales in prior quarters, and this is also weighing down profits at the company. About $15m of those deals booked in fiscal Q4, and another $20m will book in the coming quarter, according to Bob Nikl, the new CFO at SGI who came on board in May and who spoke with Wall Street analysts to go over the numbers.

By the second half of fiscal 2013, SGI will have a better and more profitable mix of business, said Nikl, adding that the goal was to get gross margins in the range of 30 per cent, plus or minus a few points, and operating margins into the mid-to-high single digits. In the short term, Nikl said to expect sales of between $180m and $190m in the September quarter and a GAAP net loss of between 34 and 42 cents per share.

Servers drove 88 per cent of product sales in the June quarter and storage drove 12 percent, unchanged from the March quarter. Servers represented $118.4m of sales and storage represented $16.1m in the June quarter.

Public sector customers – government agencies, research labs, and educational institutions – drove about half of revenues, with hyperscale data center and cloud customers driving 27 per cent of revenues. SGI had two customers who drove more than 10 per cent of revenues, and while they were not mentioned by name, one of them is usually retailing and cloud computing giant Amazon.

SGI has shipped one big UV 2000 shared memory supercomputer, launched in June in the wake of the Xeon E5-4600 processor announcements, to an unnamed US auto maker and has shipped two smaller ones in Europe – one to the UK Computational Cosmology Consortium at Cambridge University that is run by physicist Stephen Hawking.

About 80 per cent of SGI's revenues were driven by direct sales, with the remainder coming from the channel. The United States accounted for 66 per cent of total sales, up a bit in terms of its slice of the pie, while overseas biz accounted for the other 36 per cent.

Like his predecessors, Titinger knows that it is going to take some time to get SGI focused and profitable.

"We recognize that this will be a journey," Titinger said on the call. "There are some immediate opportunities for improvement, which we are addressing and is evidenced by our better working capital management and deal selection discipline."

But the task requires more than that, Titinger said. It requires focus – and calculating where SGI can get the most revenue and profit bang from its development buck.

To that end, Titinger is getting the 1,575 employees at SGI to focus more on vertical markets, not just generic hardware sales; to sell complete stacks of servers, storage, and software; and to get products out faster and at lower cost.

It might also mean selling its interconnect intellectual property to Advanced Micro Devices, Intel, or some other interested party, much as Cray just did selling its "Gemini" and "Aries" interconnects to Intel back in April for $140m.

SGI's stock is up 27 per cent as El Reg goes to press, so Wall Street is clearly happy and it would have been a lot cheaper for Hewlett-Packard or Dell, which need a bigger footprint in supercomputing, to have bought SGI yesterday. But still, at a market capitalization of $274m, it would still be a pretty cheap way to get a three-quarter billion server biz that could be made profitable. ®

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