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SGI losses widen, but revenue bumps up

Still disposing of 'LMDs of profit destruction'

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Hyperscale server and supercomputer maker Silicon Graphics is still chewing through a pile of ICE X cluster low-margin deals – what company top brass call LMDs, a weapon of profit destruction that their predecessors allowed – which whacked profits in the quarter ended in September.

That September quarter is the first quarter of SGI's fiscal 2013 year, and during it the company brought in $192.9m total revenues, up 7.8 per cent compared to the prior year's period.

But thanks to the recognition of two of those LMDs – one in Europe, one in the US – worth a total of $15m, cost of revenue was up 19.3 per cent to $150.7m, smacking down gross profits by almost the same per cent to $42.2m. Even with belt tightening across the board, the low margin deals plus $1.5m in costs due to a restructuring announced in February pushed SGI to post a net loss of $8.7m, significantly larger than the $2.7m loss it had in the year-ago quarter.

If you ignore the restructuring and the two LMD deals recognized in the quarter, the underlying SGI biz was at break-even. But, of course, you can't ignore those bad deals any more than you can your crazy uncle.

The ICE X machines are innovative, dense-packed machines based on Intel's Xeon E5 processors, launched last fall at the SC11 supercomputing extravaganza in Seattle. In early 2012, as then-CEO Mark Barrenechea was stepping down to go run OpenText, SGI bragged that it had booked $90m in early ICE X orders.

A month later, however, when SGI announced a restructuring plan as it was searching for a new CEO, and after Jorge Titinger was named president and CEO at SGI in February, he and outgoing CFO Jim Wheat identified nine low-margin deals worth $87m that SGI had done that it could not walk away from.

The company recognized revenues of five of those deals, accounting for $15m, in Q4 of fiscal 2012 ended in June, and recognized two more deals worth $15m in Q1 fiscal 2013 – about $5m less than it was expected. In a conference call with Wall Street analysts going over the numbers on Tuesday, new CFO Bob Nikl, hired in April, said that the deals booked in fiscal Q4 had low single-digit margins at the gross margin level, but that the two recognized in the quarter just ended were not profitable even at that level.

The bad news is that there is $57m in two deals left to burn through. The good news is that gross margins will be lower than the first wave of deals, but not negative like the two deals booked in fiscal Q1.

Titinger said on the call that SGI hopes to book some of those two LMDs in the December quarter, but it looks increasingly likely that this revenue recognition would be pushed out to the March quarter of next calendar year, which will be SGI's third quarter of fiscal 2013, meaning that profit margins will get a haircut then.

In the September quarter, SGI booked $146.3m in product revenues, up 13.5 per cent. Within this, compute products accounted for $131.7m and $14.6m coming from storage products, about the same 90-10 split as in the prior quarter.

Services, including professional services and maintenance, brought in $46.6m in revenues. Hyperscale cloud operators snarfed up $44.4m in products and services, or 23 per cent of the SGI pie, while the public sector accounted for $98.4m, or a 51 per cent slice. SGI had one customer who accounted for more than 10 per cent of its revenues, but it did not disclose who it was or how much revenue that customer drove – although it's usually e-tailing giant Amazon or the US government in those quarters in which SGI has such a big wheel driving deals.

SGI exited the quarter with $111m in cash and paid down $5m on its credit line, which still has $10.3m. Of the various incarnations of SGI that have occurred throughout history, there are quite a few that have been in a weaker position than this one.

Titinger said that SGI is gearing up to make some enhancements to its Xeon E5-based UV 2 "big brain" supercomputer at the SC12 event in Salt Lake City next week. The UV 2 system uses the NUMALink 5 interconnect to lash together up to 4,096 cores and up to 16TB of main memory into the largest shared memory system on the planet.

Titinger said that the ramp for the UV 2 system was slower than for the UV 1 announced three years ago, mostly because there was so much pent-up demand for a giant Xeon-based shared memory system that could run either Windows or Linux. The prior Itanium-based machines were a harder sell – and more expensive, as well.

That said, Titinger added that the company is working with software partners to round out the offering on the UV 2 machines, and that the "deal potential" is up 50 per cent from where it was last quarter.

Looking ahead, SGI expects for revenues of between $180m and $195m in the fiscal second quarter ending in December, with a net loss of somewhere between 14 and 22 cents per share – not quite as bad as the 27 cents per share it lost this time around. ®

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