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SGI > SEC Filings for SGI > Form 10-Q on 3-May-2013All Recent SEC Filings

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Form 10-Q for SILICON GRAPHICS INTERNATIONAL CORP


3-May-2013

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 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 Part I, 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.


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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 41.4% and 39.6% of total revenue from sales outside of the U.S. in the three and nine months ended March 29, 2013, respectively. In addition, our customer base continues to expand in various sectors, including the public, cloud and manufacturing sectors.

Results of Operations
Summarized below are the results of our operations for the three and nine months ended March 29, 2013 as compared to the three and nine months ended March 30, 2012.
Financial Highlights
Our total revenue for the three months ended March 29, 2013 was $232.6 million, an increase of $33.2 million or 16.6%, from the comparable period in fiscal year 2012. In addition, revenue increased $23.2 million or 4.0% to $596.7 million in the nine months ended March 29, 2013 from $573.5 million in the nine months ended March 30, 2012. The increase was due primarily as a result of increased product sales n our product sales in our EMEA and Americas segments, where we recognized a number of significant large deals during the quarter. This was slightly offset by decreased service revenue in our EMEA and APJ geographic segments.

Our overall gross margin decreased by 3.2 percentage points from 25.8% in the three months ended March 30, 2012 to 22.6% in the three months ended March 29, 2013. The unfavorable change in the overall gross margin in the three months ended March 29, 2013 was due to unfavorable margins resulting from two significant low margin deals recognized during the third quarter of fiscal 2013. Our overall gross margin decreased by 3.5 percentage points from 27.3% in the nine months ended March 30, 2012 to 23.8% in the nine months ended March 29, 2013. The decrease for the nine months ended March 29, 2013 was also a result of the low margin deals previously discussed as well as a number of similar deals recognized during the first quarter of fiscal 2013 in Japan and EMEA. In addition, we also experienced higher excess and obsolete inventory charges during the first nine months of fiscal 2013. Our service margins declined by 6.5 percentage points and 5.2 percentage points for both the three and nine months ended March 29, 2013, respectively, 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.

Our research and development and selling, general and administrative expenses were $50.3 million in the three months ended March 29, 2013 compared to $53.0 million in the prior year comparable quarter. Our research and development and selling, general and administrative expenses was $145.6 million for nine months ended March 29, 2013, a decrease of $16.4 million compared to $162.0 million for the nine months ended March 30, 2012. A primary driver of this decline was the decrease in compensation and related expenses due to reductions in headcount. Total headcount as of March 29, 2013 was 1,437, which reflects a reduction of 125 employees from 1,562 as of March 30, 2012 due to restructuring actions in fiscal 2012 and 2011 attrition. The savings from the headcount reductions more than offset the increases in salaries and wages due to merit increases. 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.


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We incurred restructuring expense of $0.7 million and $5.1 million in the three and nine months ended March 29, 2013, respectively, as part of the fiscal 2012 restructuring action primarily focused on cost reductions in Europe.

We recognized net income for the three months ended March 29, 2013 of $9.2 million compared to net loss of $1.2 million in the comparable quarter last year. Net income for the nine months ended March 29, 2013 was $1.6 million, compared to a net loss of $6.1 million for the nine months ended March 30, 2012. The $10.4 million increase in our net income for the three months ended March 29, 2013 compared to the comparable quarter last year was mainly driven by the income tax benefit recorded as a result of reversals of unrecognized tax benefits as well as our decreased cost structure. This was partially offset by two significant low margin deals that were recognized during the quarter. The $7.7 million increase in net income from the nine months ended March 30, 2012 was mainly driven by income tax benefit recorded as a result of unrecognized tax benefits, the decrease in our total operating expenses, which was partially offset by low margin deals that were recognized during the first and third quarters of fiscal 2013.

We are continuing to streamline our operations and have tight controls over our spending in order to help achieve our long-term operating target goals.

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 41.4% and 39.6% of total revenue attributed to international sales in the three and nine months ended March 29, 2013, respectively. In addition, our customer base continues to expand in various sectors, including the public, cloud and manufacturing sectors.
The following table presents revenue by operating segment for the three and nine months ended March 29, 2013 and March 30, 2012 (in thousands except percentages):

                     Three Months Ended                  Change               Nine Months Ended               Change
                                    March 30,                             March 29,      March 30,
                March 29, 2013         2012           $           %          2013           2012            $           %
Total revenue
Americas      $        142,215     $  128,321     $ 13,894      10.8%    $  377,958     $  350,434     $  27,524      7.9%
APJ                     36,314         44,660       (8,346 )   (18.7)%      108,483        141,639       (33,156 )   (23.4)%
EMEA                    54,059         26,409       27,650     104.7%       110,254         81,426        28,828      35.4%
Total revenue $        232,588     $  199,390     $ 33,198      16.6%    $  596,695     $  573,499     $  23,196      4.0%

Product
revenue
Americas      $        119,341     $  107,580     $ 11,761      10.9%    $  312,681     $  285,065     $  27,616      9.7%
APJ                     19,854         25,253       (5,399 )   (21.4)%       59,280         81,144       (21,864 )   (26.9)%
EMEA                    47,945         17,406       30,539     175.5%        89,534         56,025        33,509      59.8%
Total product
revenue       $        187,140     $  150,239     $ 36,901      24.6%    $  461,495     $  422,234     $  39,261      9.3%

Service
revenue
Americas      $         22,874     $   20,741     $  2,133      10.3%    $   65,277     $   65,369     $     (92 )   (0.1)%
APJ                     16,460         19,407       (2,947 )   (15.2)%       49,203         60,495       (11,292 )   (18.7)%
EMEA                     6,114          9,003       (2,889 )   (32.1)%       20,720         25,401        (4,681 )   (18.4)%
Total service
revenue       $         45,448     $   49,151     $ (3,703 )   (7.5)%    $  135,200     $  151,265     $ (16,065 )   (10.6)%

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.
We continuously make revisions to our product offerings and improvements of our product's performance and data storage capacity. Accordingly, we are unable to directly compare our products from period to period, and are therefore unable


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to quantify the changes in pricing of our products from period to period. We believe that our on-going revisions to product offerings and product feature improvements help mitigate competitive pricing pressures by shifting the competitive landscape to differentiated value rather than price. Segment Operating Performance
Americas
Revenue from our Americas segment increased $13.9 million or 10.8% to $142.2 million in the three months ended March 29, 2013 from $128.3 million in the three months ended March 30, 2012. The increase in Americas revenue was driven by higher product revenue as well as an increase in service revenue. Product revenue increased by $11.8 million primarily due to the strength in sales of our scale-out compute solutions, software and third party products. This increase in product revenue was partially offset by a decrease in sales of our scale-up solutions. We also experienced an increase in service revenue of $2.1 million primarily as a result of the sale of standard maintenance contracts as well as custom maintenance contracts that are associated with our customers using new products or replacing their existing installed base of older generation products. The increase 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. The Americas segment represented 61.1% and 64.4% of the total revenue in the three months ended March 29, 2013 and March 30, 2012, respectively. The Americas segment represented a lower portion of total revenue during the three months ended March 29, 2013, primarily due to the significant increase in the EMEA segment.
Revenue from our Americas segment increased $27.5 million or 7.9% to $378.0 million in the nine months ended March 29, 2013 from $350.4 million in the nine months ended March 30, 2012. The increase in Americas revenue was driven primarily by higher product revenue as well as a decrease in service revenue of $0.1 million. Product revenue increased by $27.6 million primarily due to the strength in sales of our scale-out compute solutions, software and third party products. This increase in product revenue was partially offset by a decrease in sales of our scale-up compute and storage solutions. Our service revenue was $65.3 million in the nine months ended March 29, 2013, or about flat compared to comparable quarter last year. Service revenue will typically fluctuate 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. The Americas segment represented 63.3% and 61.1% of the total revenue in the nine months ended March 29, 2013 and March 30, 2012, respectively.

APJ
Revenue from our APJ segment decreased $8.3 million or 18.7% to $36.3 million in the three months ended March 29, 2013 from $44.7 million in the three months ended March 30, 2012. The revenue decline in APJ is primarily driven by lower product revenue for our scale-up and scale-out solutions and our third party products which was driven primarily in Japan. Our revenue for the three months ended March 29, 2013 is comprised of $19.9 million from product sales and $16.5 million from services compared to product and service revenue of $25.3 million and $19.4 million, respectively, for the three months ended March 30, 2012. The decrease in service revenue is primarily due to timing of when services were performed on consulting and product integration services as our new products replace our installed base of older generation products. During the three months ended March 30, 2012, we generated a large portion of revenue in Japan for professional services to assist our customers with the implementation of and training of new products. These types of services are typically non-recurring in nature as customers become more accustomed to our next generation products. We are also experiencing a slight deterioration in customer service contracts as existing maintenance contracts are lapsing at a faster rate than we are able to renew or enter into new contracts. The APJ segment represented 15.6% and 22.4% of the total revenue in the three months ended March 29, 2013 and March 30, 2012, respectively.
Revenue from our APJ segment decreased $33.2 million or 23.4% to $108.5 million in the nine months ended March 29, 2013 from $141.6 million in the nine months ended March 30, 2012. The revenue decline in APJ is primarily driven by lower product revenue for our scale-up and software solutions as well as third party products, partially offset by higher revenue generated in our scale-out solutions. Our revenue for the nine months ended March 29, 2013 is comprised of $59.3 million from product sales and $49.2 million from services compared to product and service revenue of $81.1 million and $60.5 million, respectively, for the nine months ended March 30, 2012. The decrease in service revenue is attributable to the timing of professional services provided as well as a slight deterioration in customer service maintenance contracts as discussed above. The APJ segment represented 18.2% and 24.7% of the total revenue in the nine months ended March 29, 2013 and March 30, 2012, respectively.


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EMEA
Revenue from our EMEA segment increased $27.7 million or 104.7% to $54.1 million in the three months ended March 29, 2013 from $26.4 million in the three months ended March 30, 2012. The increase in product revenue of $30.5 million is primarily driven by higher product revenue for our scale-out products as well as increases in our storage and scale-up solutions. This was offset by a slight decrease in service revenue of $2.9 million. The decrease in service revenue is attributable to the timing of professional services provided. We are also experiencing a slight deterioration in our customer service maintenance contracts as existing maintenance contracts are lapsing at a faster rate than we are able to renew or enter into new contracts. These types of services are typically non-recurring in nature as customers become more accustomed to our next generation products. The EMEA segment represented 23.2% and 13.2% of the total revenue in the three months ended March 29, 2013 and March 30, 2012, respectively.
Revenue from our EMEA segment increased $28.8 million or 35.4% to $110.3 million in the nine months ended March 29, 2013 from $81.4 million in the nine months ended March 30, 2012. The increase in revenue is primarily driven by higher products revenue for scale out products of $30.5 million as well as our storage solutions. This was offset by a decrease in service revenue of $4.7 million. The decrease in service revenue is attributable to the timing of professional services provided as well as a slight deterioration in customer service maintenance contracts as discussed above. The EMEA segment represented 18.5% of the total revenue in the nine months ended March 29, 2013 and 14.2% in the nine months ended March 30, 2012, respectively.

Cost of revenue and gross profit
Cost of revenue and gross profit for the three and nine months ended March 29, 2013 and March 30, 2012 were as follows (in thousands except percentages):

                        Three Months Ended                   Change                   Nine Months Ended                   Change
                 March 29, 2013     March 30, 2012        $           %       March 29, 2013     March 30, 2012         $           %

Cost of
product
revenue         $      152,523     $      121,263     $ 31,260      25.8%    $      372,470     $      333,347     $  39,123      11.7%
Cost of
service
revenue                 27,573             26,617          956      3.6%             81,959             83,821        (1,862 )   (2.2)%
Total cost of
revenue         $      180,096     $      147,880     $ 32,216      21.8%    $      454,429     $      417,168     $  37,261      8.9%

Product gross
profit                  34,617             28,976        5,641      19.5%            89,025             88,887           138      0.2%
Service gross
profit                  17,875             22,534       (4,659 )   (20.7)%           53,241             67,444       (14,203 )   (21.1)%
Total gross
profit          $       52,492     $       51,510     $    982      1.9%     $      142,266     $      156,331     $ (14,065 )   (9.0)%

Product gross
margin                    18.5 %             19.3 %                                    19.3 %             21.1 %
Service gross
margin                    39.3 %             45.8 %                                    39.4 %             44.6 %
Total gross
margin                    22.6 %             25.8 %                                    23.8 %             27.3 %

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. In addition, 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 increased by $1.0 million to $52.5 million in the three months ended March 29, 2013 from $51.5 million in the three months ended March 30, 2012 primarily due to an increase in revenue volume in the Americas segment. However, our overall gross margin decreased to 22.6% in the three months ended March 29, 2013 from 25.8% in the three months ended March 30, 2012. Our gross margin decreased primarily as a result of the low margin deals that occurred in the


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third quarter of fiscal 2013 in EMEA and Americas, impacting both our product and service margins. We also recorded higher excess and obsolete inventory charges during the three months ended March 29, 2013 compared to the three months ended March 30, 2012 which also contributed to the lower gross margin. Overall gross profit decreased by $14.1 million to $142.3 million in the nine months ended March 29, 2013 from $156.3 million in the nine months ended March 30, 2012. Overall gross margin decreased to 23.8% in the nine months ended March 29, 2013 from 27.3% in the nine months ended March 30, 2012. Our gross margin decreased primarily as a result of the low margin deals described above as well as certain low margin deals that occurred in the first quarter of fiscal 2013 in Japan and EMEA. We also recorded higher excess and obsolete inventory charges during the nine months ended March 29, 2013 compared to the nine months ended March 30, 2012 which also contributed to the lower gross margin. Product gross profit increased by $5.6 million to $34.6 million in the three months ended March 29, 2013 from $29.0 million in the three months ended March 30, 2012. Product gross margin decreased to 18.5% in the three months ended March 29, 2013 from 19.3% in the three months ended March 30, 2012. Product gross margin decreased by 0.8 percentage point on higher product revenue of $36.9 million primarily of the low margin deals that occurred in the third quarter of fiscal 2013 in EMEA and Americas. Service gross profit decreased $4.7 million or 20.7% to $17.9 million in the three months ended March 29, 2013 from $22.5 million in the three months ended March 30, 2012. Service gross margin decreased to 39.3% in the three months ended March 29, 2013 from 45.8% in the three months ended March 30, 2012 as a result of the low margin deals that were previously discussed.
Product gross profit increased $0.1 million or 0.2% to $89.0 million in the nine months ended March 29, 2013 from $88.9 million in the nine months ended March 30, 2012. Product gross margin decreased to 19.3% in the nine months ended March 29, 2013 from 21.1% in the nine months ended March 30, 2012 as a result of a few low margin product deals that occurred in both the first quarter of fiscal 2013 primarily in APJ and EMEA and the third quarter of fiscal 2013 in EMEA and the Americas compared to the nine month period ended March 30, 2012. Service gross profit decreased $14.2 million or 21.1% to $53.2 million in the nine months ended March 29, 2013 from $67.4 million in the nine months ended March 30, 2012. Service gross margin decreased to 39.4% in the nine months ended March 29, 2013 from 44.6% in the nine months ended March 30, 2012 primarily as a result of low margin deals that were previously discussed. Operating Expenses
Operating expenses for the three and nine months ended March 29, 2013 and March 30, 2012 were as follows (in thousands except percentages):

                              Three Months Ended                    Change                Nine Months Ended                Change
                                                                                      March 29,      March 30,
                      March 29, 2013      March 30, 2012         $           %           2013           2012            $           %

Research and
development         $         15,518     $        14,982     $    536       3.6%     $   45,017     $   47,427     $  (2,410 )    (5.1)%
Sales and
marketing                     19,824              21,824       (2,000 )    (9.2)%        59,059         66,722        (7,663 )   (11.5)%
General and
. . .
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