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SGI > SEC Filings for SGI > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for SILICON GRAPHICS INTERNATIONAL CORP

Form 10-Q for SILICON GRAPHICS INTERNATIONAL CORP


7-Nov-2012

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements included or incorporated by reference in this Form 10-Q other than statements of historical fact, are forward-looking statements. Investors can identify these and other forward-looking statements by the use of words such as "estimate," "may," "will," "could," "anticipate," "expect," "intend," "believe," "continue" or the negative of such terms, or other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements also include the assumptions underlying or relating to such statements.
Our actual results could differ materially from those projected in the forward-looking statements included herein as a result of a number of factors, risks and uncertainties, including, among others, changes in the anticipated amounts and timing of restructuring charges to be incurred and cost savings expected to be realized from our restructuring actions in Europe, our ability to successfully execute our strategies, the sufficiency of our cash, cash equivalents and short-term investments and cash generated from operations, and our future liquidity requirements, the risks discussed in this Part I, Item 2 -"Management's Discussion and Analysis of Financial Condition and Results of Operations," the risk factors set forth in Part II, Item 1A- "Risk Factors" and elsewhere in this Form 10-Q, the risk factors set forth in our Annual Report on Form 10-K for the year ended June 29, 2012 filed with the Securities and Exchange Commission (the "SEC") on September 10, 2012 (our "Annual Report"), and the risks detailed from time to time in our future reports filed with the SEC. The information included herein is as of the filing date of this Form 10-Q with the SEC and future events or circumstances could differ materially from the forward-looking statements included herein. Accordingly, we caution readers not to place undue reliance on these forward-looking statements. Unless required by law, we expressly disclaim any obligation to update or alter our forward-looking statements, whether as a result of new information, future events or otherwise. All subsequent written or oral forward-looking statements attributable to SGI or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Readers are urged to carefully review and consider the various disclosures made in this report and other documents we file from time to time with the SEC to advise interested parties of the risks and factors that may affect our business.
The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto in Item 1 in this Form 10-Q and with our financial statements and notes thereto for the year ended June 29, 2012 contained in our Annual Report.
"Silicon Graphics," "SGI," "Eco-Logical," "RapidScale," "Roamer," "CloudRack," "ICE Cube," "MobiRack," "Rackable," "Altix," "CXFS," "NUMAlink," "Octane," "Origin," "REACT," "SGI FullCare," "SGI FullExpress," "SGI Global Developer Program," "SGI Tempo," "OpenFOAM," "SGI ArcFiniti," "SGI Accelerate," "COPAN" and the "Silicon Graphics" logo are trademarks or registered trademarks of Silicon Graphics International Corp. or its subsidiaries in the U.S. and/or other countries. Other trademarks or service marks appearing in this report may be trademarks or service marks of other owners. Overview
We are a global leader in technical computing. We are focused on helping customers solve their most demanding business and technology challenges by delivering large-scale computing and storage, high-performance compute and storage, and data center solutions. We develop, market, and sell a broad line of low cost, mid-range and high-end computing servers and data storage as well as differentiating software. We sell data center infrastructure products purpose-built for large-scale data center deployments. In addition, we provide global customer support and professional services related to our products. We enable enterprises to meet their computing and storage requirements at a lower total cost of ownership and provide them greater flexibility and scalability. We are also a leading developer of enterprise class, high-performance features for the Linux operating system that provide our customers with a standard Linux operating environment combined with our differentiated yet un-intrusive Linux capabilities that are designed to improve performance, simplify system management, and provide a more robust development environment.
Management has implemented a strategic plan which will drive changes in three major areas. First, we are targeting our investments towards the vertical markets where we can provide the highest value to our customers and differentiate our offerings to gain both market share and margin. Second, we are investing and aligning with key partners in order to provide our customers with integrated solutions in Big Data, storage and scale-up computing. Third, management is focusing on initiatives to improve our operational performance and cost structure. We have ongoing efforts to reduce material and other manufacturing costs. We believe that this strategic plan will help create a strong foundation for our business results in the long-term.
Our revenue mix by geography shows that we continue to have strong international presence with 38% of total international revenue in the three months ended September 28, 2012. In addition, our customer base continues to expand in various sectors, including the public, cloud and manufacturing sectors.


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Results of Operations
Summarized below are the results of our operations for the three months ended September 28, 2012 as compared to the three months ended September 30, 2011. Financial Highlights
Our total revenue for the three months ended September 28, 2012 was $192.9 million, up $14.0 million or 8%, from the comparable period in fiscal year 2011. The increase was primarily due to higher revenue from the increase in sales in our product revenue in our Americas and APJ segments offset by decreases in the service revenue for all of our geographic segments.

Our overall gross margin decreased by 7.5 percentage points from 29.4% in the three months ended September 30, 2011 to 21.9% in the three months ended September 28, 2012. This change in overall gross margin is due to decreases in both product and service gross margin. The decline in our product gross margin was due to product mix as well as a result of a two significant low margin product deals that were recognized during the quarter. The decline in our service gross margins was largely as a result of lower support services revenue as our new products replace our installed base of older generation products which had higher margin support contracts. Typically our service revenue is recognized ratably over the respective service periods. Because the three months ended September 30, 2011 was comprised of 14 weeks compared to only 13 weeks for the three months ended September 28, 2012, we recognized revenue for one less week for our service contracts during the current quarter.

Our research and development and selling, general and administrative expenses was $47.7 million in the three months ended September 28, 2012, a decrease of $7.1 million compared to $54.9 million for the three months ended September 30, 2011. A primary driver of this decline was the decrease in compensation and related expenses due to reductions in headcount. Headcount as of September 28, 2012 was 1,495, which reflects a reduction of 57 employees from 1,552 as of September 30, 2011 due to the fiscal 2011 and 2012 restructuring actions and attrition. We have also been controlling our costs across all functions in order to streamline our operations and reduce operating expenses and have also benefited from lower charges for the amortization of intangible assets as these assets are nearing full amortization.

We incurred restructuring expense of $1.5 million in the three months ended September 28, 2012 as part of the fiscal 2012 restructuring action which is primarily focused on cost reductions in Europe.

Net loss for the three months ended September 28, 2012 was $8.7 million compared to net loss of $2.7 million for the three months ended September 30, 2011. The $6.0 million increase in net loss from the three months ended September 30, 2011 was mainly driven by the lower gross margins reflected during the quarter as we were unfavorably impacted by a few significant low margin deals and unfavorable product mix as well as an unfavorable change in income tax expense which was only partially offset by the decrease in our total operating expenses.

Revenue, cost of revenue, gross profit and gross margin Our revenue mix by geography shows that we continue to have a strong international presence with 38% of total international revenue in the three months ended September 28, 2012. In addition, our customer base continues to expand in various sectors, including the public, cloud and manufacturing sectors.


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The following table presents revenue by operating segment for the three months ended September 28, 2012 and September 30, 2011 (in thousands except percentages):

                                   Three Months Ended                      Change
                       September 28, 2012     September 30, 2011         $          %
Total revenue
Americas              $           123,385    $            112,392    $ 10,993      10%
APJ                                44,434                  40,106       4,328      11%
EMEA                               25,062                  26,397      (1,335 )   (5)%
Total revenue         $           192,881    $            178,895    $ 13,986      8%

Product revenue
Americas              $           101,642    $             89,056    $ 12,586      14%
APJ                                26,821                  21,801       5,020      23%
EMEA                               17,852                  18,095        (243 )   (1)%
Total product revenue $           146,315    $            128,952    $ 17,363      13%

Service revenue
Americas              $            21,743    $             23,336    $ (1,593 )   (7)%
APJ                                17,613                  18,305        (692 )   (4)%
EMEA                                7,210                   8,302      (1,092 )   (13)%
Total service revenue $            46,566    $             49,943    $ (3,377 )   (7)%

Revenue. We derive revenue from the sale of products and services directly to end-users as well as through resellers and system integrators. Product revenue is derived from the sale of mid-range to high-end computing servers and data storage systems as well as software. We enter into sales contracts to deliver multiple products and/or services. In accordance with our revenue recognition policy, certain sales contracts are deferred and recognized over the service period. Service revenue is generated from the sale of standard maintenance contracts as well as custom maintenance contracts that are tailored to individual customers' needs. We recognize service revenue ratably over the service periods. Maintenance contracts are typically between one to three years in length and we actively pursue renewals of these contracts. We also generate professional services revenue related to implementation of and training on our products.
Our continuous introduction of new products and improvements of our product's performance and data storage capacity means that we are unable to directly compare our products from period to period, and therefore, we are unable to quantify the changes in pricing of our products from period to period. We believe that our on-going introduction of new products and product features help mitigate competitive pricing pressures by shifting the competitive landscape to differentiated value rather than price.
Segment Operating Performance
Americas
Revenue increased $11.0 million or 10% to $123.4 million in the three months ended September 28, 2012 from $112.4 million in the three months ended September 30, 2011. The increase in Americas revenue was driven by higher product revenue partially offset by a decrease in service revenue. Product revenue increased by $12.6 million due primarily to the strength in sales of our scale-out compute solutions. This increase in product revenue was partially offset by a decrease in sales of our scale-up compute solutions as well as a decrease in service revenue of $1.6 million as our new products replace our installed base of older generation products with higher margin support contracts. The decrease in service revenue is primarily due to timing of when services were performed on consulting and product integration services. Our service revenue is typically recognized ratably over the respective service periods. Because the three months ended September 30, 2011 was comprised of 14 weeks compared to only 13 weeks for the three months ended September 28, 2012, we recognized revenue for one less week for our service contracts during the current quarter. The Americas segment represented 64% and 63% of the total revenue in the three months ended September 28, 2012 and September 30, 2011, respectively.


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APJ
Revenue increased $4.3 million or 11% to $44.4 million in the three months ended September 28, 2012 from $40.1 million in the three months ended September 30, 2011. Our higher revenue in APJ is primarily driven by higher product revenue for our scale out products which was driven by one significant deal in Japan. Our revenue for the three months ended September 28, 2012 is comprised of $26.8 million from product sales and $17.6 million from services compared to product and service revenue of $21.8 million and $18.3 million, respectively, for the three months ended September 30, 2011. The decrease in service revenue is attributable to the fact that the three months ended September 30, 2011 was comprised of 14 weeks compared to only 13 weeks for the three months ended September 28, 2012, thus we recognized revenue for one less week for our service contracts during the current quarter. The APJ segment represented 23% and 22% of the total revenue in the three months ended September 28, 2012 and September 30, 2011, respectively.
EMEA
Revenue decreased $1.3 million or 5% to $25.1 million in the three months ended September 28, 2012 from $26.4 million in the three months ended September 30, 2011. The decrease in revenue is primarily attributable to a decrease in service revenue of $1.1 million primarily attributable to the fact that the three months ended September 30, 2011 was comprised of 14 weeks compared to only 13 weeks for the three months ended September 28, 2012, thus we recognized revenue for one less week for our service contracts during the current quarter. In addition, we also experienced a decrease in product revenue of $0.2 million. The EMEA segment represented 13% and 15% of the total revenue in the three months ended September 28, 2012 and September 30, 2011, respectively.

Cost of revenue and gross profit
Cost of revenue and gross profit for the three months ended September 28, 2012 and September 30, 2011 were as follows (in thousands except percentages):

                                      Three Months Ended                      Change
                           September 28, 2012     September 30, 2011         $          %

Cost of product revenue   $         122,597      $          99,767      $  22,830      23%
Cost of service revenue              28,074                 26,489          1,585      6%
Total cost of revenue     $         150,671      $         126,256      $  24,415      19%

Product gross profit                 23,718                 29,185         (5,467 )   (19)%
Service gross profit                 18,492                 23,454         (4,962 )   (21)%
Total gross profit        $          42,210      $          52,639      $ (10,429 )   (20)%

Product gross margin                   16.2 %                 22.6 %
Service gross margin                   39.7 %                 47.0 %
Total gross margin                     21.9 %                 29.4 %

Cost of revenue consists of costs associated with direct material, labor, manufacturing overhead, shipment of products, inventory write downs and share-based compensation. Cost of revenue also includes personnel costs for providing maintenance and professional services. Our manufacturing overhead and professional services personnel costs are fixed or semi-variable. Our gross margins are impacted by changes in customer and product mix, pricing actions by our competitors and commodity prices that comprise a significant portion of cost of revenue from period to period. Further when certain sales contracts are deferred in accordance with our revenue recognition policy, the related cost of revenue is deferred and recognized upon recognition of revenue. Our cost of revenue and gross profit are impacted by price changes, product configuration, revenue mix and product material costs. Our service cost of revenue and gross margin are impacted by timing of support service initiations and renewals, and incremental investments in our customer support infrastructure.
Overall gross profit decreased by $10.4 million to $42.2 million in the three months ended September 28, 2012 from $52.6 million in the three months ended September 30, 2011. Overall gross margin decreased to 21.9% in the three months


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ended September 28, 2012 from 29.4% in the three months ended September 30, 2011. Our gross margin decreased due to unfavorable product mix shifts and competitive product pricing pressures in EMEA, as well as lower service margins. Product gross profit decreased $5.5 million or 19% to $23.7 million in the three months ended September 28, 2012 from $29.2 million in the three months ended September 30, 2011. Product gross margin decreased to 16.2% in the three months ended September 28, 2012 from 22.6% in the three months ended September 30, 2011 as a result of unfavorable product mix shifts to lower margin products primarily in APJ and EMEA as a result of a few low margin product deals compared to the three month period ended September 30, 2011. Service gross profit decreased $5.0 million or 21% to $18.5 million in the three months ended September 28, 2012 from $23.5 million in the three months ended September 30, 2011. Service gross margin decreased to 39.7% in the three months ended September 28, 2012 from 47% in the three months ended September 30, 2011 as a result of two significant low margin deals as well as higher service costs. Operating Expenses
Operating expenses for the three months ended September 28, 2012 and September 30, 2011 were as follows (in thousands except percentages):

                                                               Three Months Ended                        Change
                                                   September 28, 2012       September 30, 2011         $          %

Research and development                         $             13,969     $             16,190     $ (2,221 )   (14)%
Sales and marketing                                            19,571                   21,798       (2,227 )   (10)%
General and administrative                                     14,189                   16,885       (2,696 )   (16)%
Restructuring                                                   1,474                      133        1,341     1,008%
Total operating expense                          $             49,203     $             55,006     $ (5,803 )   (11)%

Research and development. Research and development expense consists primarily of personnel and related costs, contractor fees, new component testing and evaluation, test equipment, new product design and testing, other product development activities, share-based compensation, and facilities and information technology costs.
Research and development expense decreased $2.2 million or 14% to $14.0 million in the three months ended September 28, 2012 from $16.2 million in the three months ended September 30, 2011. The decrease in research and development expense is primarily due to a reduction in third party provider and non-recurring engineering costs as we were ramping up for new product introductions that were introduced in fiscal 2012 of approximately $1.4 million. As a result of decreased headcount, compensation and related expenses decreased by $0.7 million during the three months ended September 28, 2012.
Sales and marketing. Sales and marketing expense consists primarily of salaries, bonuses and commissions paid to our sales and marketing employees, amortization of intangible assets, share-based compensation, and facilities and information technology costs. We also incur marketing expenses for activities such as trade shows, direct mail and advertising.
Sales and marketing expense decreased $2.2 million or 10% to $19.6 million in the three months ended September 28, 2012 from $21.8 million in the three months ended September 30, 2011. This decrease was primarily due to an decrease in our compensation and related expenses as well as lower commissions and bonus expense reflecting achievement of sales commission targets and performance metrics. We are actively managing our costs and reduced our travel and marketing related expenses by $0.4 million. In addition, we also benefited from a decrease in intangible amortization expense of $0.5 million as some of our intangible assets become fully depreciated, resulting in lower intangible amortization expense. General and administrative. General and administrative expense consists primarily of personnel costs, legal and professional service costs, depreciation, bad debt expense, share-based compensation, and facilities and information technology costs.
General and administrative expense decreased $2.7 million or 16% to $14.2 million in the three months ended September 28, 2012 from $16.9 million in the three months ended September 30, 2011. We are controlling our costs and have reduced our professional fees, including legal related expenses and recruiting fees by approximately $1.8 million. We have also reduced costs for travel related expenses by $0.2 million, purchases of small equipment by $0.2 million and bad debt expenses by $0.3 million. This is partially offset by an increase in share-based compensation expense of $0.2 million.


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Restructuring. Total restructuring expense related to the Fiscal 2012 Restructuring Action and the restructuring actions we undertook in prior years was $1.5 million for the three months ended September 28, 2012 and was $0.1 million for the three months ended September 30, 2011 for charges related to the Fiscal 2011 Restructuring Action. As a result of the Fiscal 2012 Restructuring Action, we anticipate future cash outflow of between $14.0 million to $17.0 million, of which we expect to recognize a substantial portion in fiscal year 2013.
Total other income (expense), net
Total other income (expense), net for the three months ended September 28, 2012 and September 30, 2011 were as follows (in thousands except percentages):

                                                             Three Months Ended                      Change
                                                 September 28, 2012      September 30, 2011        $          %

Interest income (expense), net                  $              (155 )   $            (98 )     $    (57 )    58%
Other income (expense), net                                  (1,107 )               (858 )         (249 )    29%
Total other income (expense), net               $            (1,262 )   $           (956 )     $   (306 )    32%

Interest income (expense), net. Interest income (expense), net primarily consists of interest earned on our interest-bearing investment accounts which include money market funds and U.S. treasury bills, as well as interest expense relating to our credit facility and to certain tax payments.
Other income (expense), net. Other income (expense), net during the three months ended September 28, 2012 consisted primarily of foreign exchange losses of $0.8 million primarily as a result of the strengthening of the Euro, British Pound and Canadian dollar against the U.S. Dollar compared to foreign exchange losses of $1.0 million during the three months ended September 30, 2011 as a result of the exchange rates in effect during that period. Income tax provision (benefit)
Income tax provision (benefit) for the three months ended September 28, 2012 and September 30, 2011 were as follows (in thousands except percentages):

Three Months Ended Change
September 28,
2012 September 30, 2011 $ %

Income tax provision (benefit) $ 425 $ (667 ) $ 1,092 (164)%

We recorded a tax expense of $0.4 million for the three months ended September 28, 2012. The net tax benefit was primarily comprised of tax liability computed based on the Company's foreign projected financial results for the year ending June 29, 2013 offset by the reversals of unrecognized tax benefits including related interest. The effective tax rate differed from the combined federal and net state statutory income tax rate for the three months ended September 28, 2012 primarily due to tax expense incurred by the Company's foreign subsidiaries with operating income, offset by the release of the unrecognized tax benefits due to lapse of statute of limitations, benefits from reversals of previously accrued taxes in foreign jurisdictions and benefit from utilization of net operating losses not previously recognized. We recorded a tax benefit of $0.7 million for the three months ended September 30, 2011. Our tax benefit for the three months ended September 30, 2011 included $0.9 million primarily from the reversal of unrecognized tax benefits and related interest. The effective tax rate used to record the tax expense differed from the combined federal and net state statutory income tax rate for fiscal 2012 primarily due to domestic operating losses generated during the period from which the Company does not benefit, tax expense incurred by the Company's foreign subsidiaries with operating income, and tax expense associated with our unrecognized tax benefits and related interest.
As of September 28, 2012, we have provided a partial valuation allowance against our net deferred tax assets. Based on all available evidence, on a jurisdictional basis, including our historical operating results, and the uncertainty of predicting our future income, the valuation allowance reduces the majority of our deferred tax assets to an amount that is more likely than not to be realized. The amount of the valuation allowance is attributable to U.S. federal, state and certain foreign deferred tax assets primarily consisting of net operating loss carryovers, tax credit carryovers, accrued expenses, and . . .

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