Silicon Graphics Q2 2009 Earnings Call Transcript

Silicon Graphics (SGIC)

Q2 2009 Earnings Call

August 6, 2009 4:00 pm ET

Executives

Mark Barrenechea - President and CEO

Jim Wheat - CFO

Erik Bylin - IR

Presentation

Operator

Thank you for standing by everyone and joining us for today's conference call to discuss SGI's second quarter fiscal 2009 preliminary results conference. I would like to remind you that this call is being recorded and simultaneously webcast at investors.sgi.com.

At this time, I would like to turn the call over to Mr. Erik Bylin for opening remarks and introductions. Please go ahead, sir.

Erik Bylin

Good afternoon. Thank you for joining us to discuss our second quarter fiscal year 2009 preliminary financial earnings press release of this afternoon, which is available on our website at www.sgi.com. I'm Erik Bylin, Investor Relations for SGI and I'll be managing the call. Joining me today on the call are Mark Barrenechea, our President and Chief Executive Officer and Jim Wheat, our Chief Financial Officer.

Before I turn the call over to Mark, I'd like to bring the following to your attention. The date of this call is August 6, 2009. This call is the property of SGI and any recording, reproduction or transmission of this conference call without the express, prior written consent of SGI is strictly prohibited. This call is being webcast live and a web replay will be available on our website for approximately 90 days.

Our presentation today contains forward-looking statements reflecting management's expectations about our markets, business, products, operating plans and financial performance, as well as events and circumstances that have not yet occurred. Statements containing words such as will, expect, believe, project and intend and other statements in the future tense are forward-looking statements.

Any statements contained in the press release that are not statements of historical facts may be deemed forward-looking statements. Actual outcomes and results may differ materially from the expectations expressed or implied in these statements due to a number of risks and uncertainties, including SGI operates in a very competitive market, and increased competition has in the past, and may continue, to cause pricing pressure on SGI's products, which would negatively affect SGI's gross and operating margins, as well as other financial measures.

If SGI is unable to integrate the acquired legacy SGI businesses or manage its more extensive international operations, its business will be harmed, and a significant portion of the company's revenues come from a small number of customers, and so the delay in placing an order, or the failure of a significant customer to place additional orders, could have significant negative effect on SGI's financial performance.

Accordingly we caution you not to place undue reliance on these statements. These and other risks and uncertainties affecting SGI are set forth in our annual report on Form 10-K under the caption "Risk Factors," which was filed with the Securities and Exchange Commission on March 19, 2009, as updated by SGI's subsequent filings with the SEC, all of which are available at the www.sec.gov.

We expressly disclaim any obligation to update or alter our forward-looking statements whether as a result of new information, future events or otherwise. We will be disclosing non-GAAP financial measures in this presentation. For a reconciliation these non-GAAP financial measures to the corresponding GAAP measures, please see our press release of today, which is posted on our website at www.sgi.com.

I'll turn the call over to SGI CEO, Mark Barrenechea.

Mark Barrenechea

Very good, thank you Erik, and thank you for joining us today. It has only been 90 days since we completed the acquisition of Silicon Graphics. And over the short period, I've become more and more excited about our opportunity to create a strong business. I felt the transaction was compelling at the time of close and our first 90 days only reaffirms this belief. I'm very pleased to report that our integration activities are on track and proceeding well.

For today's call, I'm going to spend the bulk of my time on the business, our outlook and our future. Jim will focus on the acquisition details, purchase accounting effects, our new opening balance sheet numbers, Q2 preliminary results, and additional details around fiscal year '10. After Jim, I'll provide some final remarks on synergies.

Let me start by restating the strategic rational for combining Rackable Systems and Silicon Graphics. A differentiated product line offering, or scale out, scale up and data center technologies, a worldwide service organization, the ability to sell, deliver, and provide service to customers in the major global markets in relative large verticals, a large US federal business, the opportunity to expand our gross margin, the opportunity to accelerate time to profitability, the creation of a large and active install base of customers with the ability to cross sell products and finally cost synergy.

This strategic rationale has been well received by our customers, employees, and business partners. The SGI mission is to help our customers solve their most demanding research, technology, and business challenges; by providing innovative solutions to deliver at the extremes of scale, speed, power, density, and reliability; two, innovative solutions that unify compute, storage, networking, datacenter, and software technologies; and third, expert services.

Our vision is to provide solutions that enable our customers to accelerate their business results. This is the overarching theme whether an SGI customer is optimizing a search engine index algorithm, querying massive in memory databases, programmatically deciding real time, financial market transactions or many other activities that define success for our customers. When time matters, accelerating results is an operational imperative. This vision is supported by many customer success stories such as Microsoft, MIT and Imperial College of London, LRZ and HLRN.

I'd like to transition to discuss in Q2 at a high level than on to our FY '10 plans more specifically. As Jim will describe, Q2 FY '09 financial dynamics were highly complex given partial quarter silicon graphics results, new purchase accounting rules, a change in our fiscal year end and a fair valuing of the assets we purchase. As a result, we believe our Q2 expected results are not comparable to the immediate or long-term potential.

As expected, in completing the legacy SGI asset purchase process, we have some remaining work to complete our rebuilding of customer confidence, and we believe we will. Further, we remain in a severe global economic recession that has affected both businesses and most businesses worldwide. Having said that, there are signs that the pace of deterioration has slowed and may be close to bottom, this is by no means is healthy but finding the bottom at least creates a baseline from which we can better plan and build.

Factoring in the economy our product road map and our pipeline, we are working towards an FY '10 internal plan of $500 million in revenues, with gross margins in the 20's, both metrics on a non-GAAP basis. In support of FY '10 internal plan, I'd like to spend some time in discussing our sales and service organizations, as well as our product strategies. To best capture the market opportunity, we have organized our sales organization by geography, vertical markets, channel and function. By geography we created the traditional segments of North America, Latin America, EMEA, APAC and Japan.

Within the geographic organizations, we've organized by commercial, federal and select industries, including the internet, oil and gas, financial services, manufacturing and others. We have also consolidated the traditional functions of sales operations, internal sales channel and system engineers. Our channel organization is focused on better servicing our existing partners, as well as expanding the network.

Our Tier 1 partners include large system implanters such as Raytheon, Lockheed, Boeing, Northrop Grumman, CFC and Harris. We're leveraging these successes and investing to build our Tier 2 and Tier 3 partners. We believe this is an ideal structure to support our installed base of 6,000 customers and to grow our business.

Equally important is our service business. We took this acquisition opportunity to create a standalone service organization focused on professional services, onsite services, assessment services and customer and technical support. Services, is a strategic asset for SGI. More and more, our customers are asking us to deliver a complete solution over the life time of their deployment. Our multi-year goal is to have our service business to be of equal revenue size to our product business. This is an ambitious goal but given the strategic rationale behind the acquisition that I've outlined, the customer opportunity is there for SGI.

As our products, we're repositioning ourselves and aligning by five key platforms. These platforms include scale out compute, scale up compute, storage, data center technologies, and software. Our lead scale out solutions, include the Rackable, CloudRack and Altix ICE. Design point includes extreme configurability, density, power efficiency, low latency and high connectivity speeds. Our scale up solution is focused on SMP, Symmetric Multi-Processing with our Altix 4700. These are large single system image, shared memory systems solving some of the world's toughest computing problems.

With the new combined company, storage as front and center given the product portfolio strength, the size of the installed base and the market opportunity. Within storage, we've already consolidated on the Infinite Storage brand. Our focus is on large scale network attached storage, RAID, external JBODs and RBOD, Solid-State and SAN Infrastructure. We continue to invest in our file systems and see a growing market for our (inaudible) storage management solutions as larger and larger data sets needed to be managed.

Data center technologies encompasses our enclosure products including the ICE Cube, AC and DC power distribution, Power XE, cooling products such as our thermal neutral doors, new fan-array technology as well as the modern in cabinet [PEECO] UPS system.

Collectively, our data center technologies enable customers to build out large scale data centers both economically and ecologically and some we intend to invest approximately 50 million in R&D this fiscal-year, while expanding our large patent portfolio. Our integration is well underway. Our alignment between sales, service and products is in place to support our FY '10 internal plan.

With that, I'll turn it over to Jim.

Jim Wheat

Thank you, Mark. Before I begin, please let me add to what Erik said earlier about our use of non-GAAP financial measures. Our non-GAAP financial measures appear in our press release issued today, which is available on our website along with the required reconciliation tables. In this call I'll be discussing revenue and gross margin on a non-GAAP basis, which are reconciled in those tables. If an item is not specified as non-GAAP, then I am referring to a GAAP number in my remarks.

Let me also note that our results today are preliminary and subject to change. The company is still in the process of completing the fiscal year end close and audit, and final fair value analysis. We do expect to record a one time non-taxable gain associated with the difference between the Silicon Graphics, Inc. purchase price of $42.5 million and the fair value of the net assets purchased. This gain will be an offset to operating expenses. Given, this work is not yet final. We are unable to speak to net income and EPS until we file our final results. We expect to file Q2 fiscal year 2009 and fiscal year 2009 annual results on or about August 10, 2009.

On May 8, we completed the purchase of the assets of Silicon Graphics for $42.5 million in cash. With the acquisition, we received approximately $33 million in cash, $22.5 million in accounts receivable and $56 million in inventory, as well as real-estate, fixed assets, patents and stock of foreign entities. We also assumed select liabilities necessary to operate the business which included accounts payable of $15.4 million, supplier contracts and tax and employee obligation.

In addition after purchase accounting adjustments, we expect our opening balance sheet to contain between $63 million to $68 million and differed revenue with approximately 80% expected to flow through our P&L this fiscal year. We have incurred acquisition costs of $6.2 million to date, which are shown in operating expenses and we expect to incur additional charges in our Q1 of fiscal year 2010. Our opening balance sheet will reflect the assets and liabilities acquired in the transaction.

At June 26th, our cash and cash equivalents, long-term and short-term investments totaled $139.5 million. Our accounts receivable and accounts payable are now $64.8 and $52.6 million respectively and our net inventory is approximately $114 million. Of this, $45 million relates to product shipped, but not invoiced and the majority will flow to the income statements as revenue this fiscal year. Our property plant and equipment is now $32.7 million. Other assets are approximately $33 million, which include $14.3 million in spare parts and our investments in SGI Japan valued at $5 million.

Beginning today we will be reporting non-GAAP revenue to offer more transparency to our results. Our non-GAAP revenue will add back the revenue that is deferred to the balance sheet under GAAP. In addition, we have changed our fiscal year end to the last Friday in June from the last Saturday in December and our most recent fiscal-year ended on June 26, 2009. The quarter ending September 25th, will be the first quarter of fiscal year 2010. This change facilitated an acceleration of the integration and consolidated reporting of the new business.

Moving to an overview of our quarterly results, we expect our revenue for the second quarter to be in the range of $55 million to $60 million, compared to $44.4 million in the first quarter and $75.8 million in the year ago quarter. Our second quarter revenue had solid sequential growth and this was our second consecutive quarter of revenue growth in difficult economic times.

We expect pro forma non-GAAP revenue to add up to another $2 million in revenue for the second quarter, because of the change in calendar, the Rackable business lost eight business days at the end of the quarter, typically some of our heaviest shipping days of the quarter. And our second quarter revenue results included 32 business days of the former Silicon Graphics business.

We added 53 new customers in the second quarter. The internet vertical was about one-third of our revenue. We increased our government and defense businesses to about a quarter of our revenue, and university, research and manufacturing sectors combined accounted for approximately 20% of our revenue. Our second quarter international revenue was 31% of revenue and we had one 10% customer in the second quarter which was Amazon.

We expect gross margin for the second quarter to be in the range of 6% to 10% as compared to 6.1% in the first quarter and 9% in the year ago quarter. We expect non-GAAP gross margin for the second quarter to be in the range of 14% to 18% as compared to 6.3% in the first quarter and 9.5% in the year ago quarter. This would represent our best gross margin performance in three quarters.

Included in second quarter, GAAP gross margin is approximately $2.3 million of cost of goods sold related to the step-up in value of inventory acquired. Further, we estimate another $5 million in additional step-up value will flow through COGS in the next few quarters. Other impacts cost of the goods sold included approximately 900,000 of amortization of intangibles and 300,000 of stock compensation charges.

We are viewing this integration as an opportunity to consolidate our buying power with a whole life cycle of materials to reduce manufacturing costs, which will contribute to the company achieving gross margin into the 20's. We are finalizing the accounting fair value of the assets we've purchased and thus we are not able to discuss operating expenses or EPS today.

Having said that, we expect the fair value of the net assets acquired to be greater than the $42.5 million that we paid. The excess of net assets acquired over the purchase price will result in negative goodwill. This negative goodwill will flow to the income statement in the second quarter as a one time non-taxable gain under operating expenses. The final numbers will be in our 10-Q filing.

At the end of the second quarter, total employee headcount was 1,361. Further, we ended the quarter with cash, cash equivalents and long-term and short-term investments of $139.5 million down from a $180.7 million at the end of Q4 fiscal year 2008. We remain debt free, and believe we have sufficient capital to meet our business needs at this time.

Now, I'll turn the call back over to Mark to provide closing remarks.

Mark Barrenechea

Thank you, Jim. I'd like to spend the remaining time speaking about the synergies. Specifically expenses, products, and the customer opportunity. Pre combination, each company was reducing their OpEx spend rate. Post combination, we'll continue this focus but mainly through synergies. The largest areas of synergy expense reduction include the right balancing of our workforce, greater supply chain buying leverage, consolidation of manufacturing into Chippewa Falls, elimination of unnecessary facilities, reduced public company costs and overhead, specific foreign operation actions in other areas.

Synergies will kick in throughout the year, which will be reflected in our OpEx run rate and gross margins overtime. As for products, the cross pollination of ideas, enhancements and refinements has exceeded my expectations. Continuing today's announcement of the SGI CloudRack X2. The X2 is targeted at scalable workgroup clusters. It fills a market gap between an 8 core desk side server and a 800 core data center cabinet.

The unit of scale for the X2 is roughly 200 cores and we launched products today with concurrent support for four market segments. The micro server market with Intel Adam, and AMD Phenom, and AMD Athlon support, into that web 2.0 and cloud computing apps. The third market segment of HPC applications with Intel Nehalem and AMD Shanghai and Istanbul support and for fully graphic based applications with NVIDIA, GPGPU support.

X2 is ecological. It supports an unprecedented 99% power efficiency with an enablement for higher inlet temperatures by means of our Power XE technology. More information is available on our website in my blog. Each company individually could not achieve such an offering. Together we can.

To describe the customer synergy opportunity, there is no better way than providing a few examples. We closed a large oil and gas seismic platform last month as a joint team effort between SGI Europe and Rackable Texas. A Rackable US financial services customer had never previously considered us for their Asia-Pacific deployment. This customer has now placed new orders this quarter, given our ability to deliver and provide service in that region.

Our containerized solution discussions are on an up tick, as our HPC customers are asking about modular data center configurations. Many HPC customers are looking to reduce their very large power bills, gain greater density and many are simply out of space. This is just a sampling in many exiting developments in the short 90 days.

In summary, our rational for the combination of the two companies is being realized. We are off to a strong start in integrating the business and we're optimistic about the future.

With that, we'll turn the call over to the operator for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And there appear to be no questions at this point, gentlemen.

Erik Bylin

Okay, I think we can close the call then.

Operator

Thank you very much. That does complete the Q&A portion of our call. One final comment; SGI will be presenting at the Morgan Keegan Technology Conference in New York on Tuesday, August 11 at 3:10 pm, Eastern Time. Thank you for your attention this afternoon and your participation.

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