SGI to restructure (again) after fiscal Q2 loss

Blame Europe, Xeon E5 product transitions

It is becoming more apparent why supercomputer and server maker Silicon Graphics' former president and CEO Mark Barrenechea decided to exit stage left back in December. While the company was growing gear sales, it was heading deeper into the red ink as old machines came off maintenance and new machines await their ramps this year.

In the second quarter of SGI's fiscal year ended in December, SGI's sales rose by 10 per cent, hitting $195.2m. But with all costs on the rise – and, as it turns out, with costs in SGI's European operations rising faster than its sales – the company booked a net loss of $2.3m compared to a profit of $3.7m in the year-ago period when sales were only $177.5m.

It is safe to blame at least some of SGI's woes on delayed shipments by Intel and AMD of their respective "Sandy Bridge-EP" Xeon E5 and "Interlagos" Opteron 6200 processors. While Intel might have been able to ramp up its sales as calendar 2011 came to an end and turn in a banner year in terms of sales and profits, server makers could not get these chips in volume, and everyone knew they were coming.

But SGI clearly has other issues, as Ronald Verdoorn, SGI's chairman and interim CEO, admitted in a conference call with a testy group of Wall Street analysts after the market closed on Tuesday – and as SGI's stock value sank about one-quarter in after-hours trading.

Those moneymen were grumpy – and will continue to be tomorrow and perhaps for the next several months – because when Barrenechea left SGI for Canadian software maker OpenText, Verdoorn reaffirmed reaffirmed SGI's prior fiscal 2012 guidance, which was for sales to be in the range of $740m and $780m (a revenue growth of between 18 and 24 per cent) and earnings per share of between 15 and 30 cents.

Jim Wheat, SGI's CFO, said on the call that the company was raising its revenue guidance to between $770m and $800m, putting on another $20m to $30m in sales, but on a GAAP basis is now expecting for a loss of between 15 and 30 cents. Verdoorn said that SGI "missed the mark" on earnings guidance for fiscal 2012 (pun probably not intended), but tried to appease Wall Street by saying that it had a handle on the issues, and that over the next six to nine months it will be able to scale up its sales and get its costs back into line with revenues to hit its original gross-margin goals.

SGI did not want to elaborate much on the precise nature of the restructuring it has in mind for Europe, but Wheat said that sales in the region were $28.6m with an operating loss of 5.7m. Sales in Europe were essentially flat sequentially, but the operating loss doubled.

The Americas region had a profit of $1.9m, and Asia/Pacific-Japan similarly had a $1.9m profit.

As it turns out, SGI's European business has not been profitable for the past six quarters, according to Wheat. The company had bet that it could grow sales faster than costs, and it now believes that it bet wrong. Presumably there will be layoffs and product line rationalizations – SGI would not say, and added that it has not done any layoffs yet in its European operations, and that such layoffs are not cooked into its projections.

"Our theme is to focus on profitable growth," Verdoorn said when pressed for more details on the plan.

Part of the problem – though SGI would not come out in say this – may be that it had to peddle Rackable servers based on earlier Xeon and Opteron processors to keep revenues rolling in, but had to do so at deeper discounts given the impending Xeon E5 launch sometime this quarter.

The other problem is that its sales are heavily back-ended. In this case, SGI made a lot of its deals in the last two weeks of the quarter – after it had reaffirmed guidance based on the best information it had at the time when Barrenechea said he was taking the CEO job at OpenText.

Two weeks ago, SGI was bragging that it already had $90m in orders for its Xeon E5-based ICE X blade servers, which it showed off a bit at the SC11 supercomputing conference in November. And today, Tony Carrozza executive vice president of field operations at SGI, said that the company was prepping its follow-on UV 1000 shared-memory supercomputers, formerly known as the Altix UV 1000s, which will sport four times the shared memory and twice as many cores as the current 256-socket, 16TB, Xeon E7-based machines. Carrozza added that these machines will be based on Intel's Xeon E5 processors, not the Xeon E7s, and that means they should cost less and perhaps be less complex, as well.

In the quarter, SGI had two customers that represented more than 10 per cent of revenues, statistics that it is required to divulge by the Securities and Exchange Commission. Online retailing giant and cloud computing juggernaut Amazon accounted for 12 per cent of sales, or $23.4m, while the US government accounted for 10 per cent, or around $19.5m. About 63 per cent of its revenues on a global basis went to the public sector, 15 per cent went to cloud service providers, and 10 per cent went to manufacturers. About half of sales were done in the United States and the other half internationally, and only 17 per cent of total revenues in fiscal Q2 were driven by SGI channel partners.

On the new-CEO front, Verdoorn said that SGI's selection committee was in the final stages of candidate selection and would conclude the search and announce the new CEO in the next few months. Wall Street will want a lot more details on what SGI is going to do to right itself on the profit front, but the company can't do that without stepping on the toes of the CEO its board hasn't yet hired.

It's a tricky situation. ®

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