Paint SGI Black

February 03, 2011

Silicon Graphics International (SGI) has had a rough time the last few years. It is basically a combination of the old Rackable Systems, which specialized in datacenter server systems, and the old, bankrupt SGI, which specialized in high-performance science computing. The release of results for the fiscal 2nd quarter of 2011, which ended December 24, 2010, showed that management has done what it takes to forge two losers into a winner. After years of losses SGI reported GAAP earnings of $0.12 per share and non-GAAP earnings of $0.44 per share. Right now the stock is up 24% over yesterday's close.

With governments now being the main purchasers of SGI computers, Q2 was an exceptional quarter, and the quarter ending in March will see a substantial sequential decline in revenue. However, the overall trends in 2011 should be up.

The transformation of SGI is about technology, sales, and profit margins. If you look at my earlier critiques of SGI & Rackable, neither company's gross margins were high enough to allow them to book profits after operating expenses. For a while Rackable had done well, selling superior, low-energy racked server systems, but then bigger companies started undercutting them based on price. The old SGI, on the other hand, was famous for spending too much on R&D and perks, so managed to lose money on cutting-edge tech.

Now we are seeing the difference between good management and bad. The new Altix UV supercomputer line has no real direct competitors. It has a memory and processor model that make it very attractive to high-end technical users. Because of that profit margins are good. The rackable systems for server farms and cloud computing continue to offer innovative designs, but margins have been improved there as well.

The company is now truly international, which is important when your key product is supercomputers. Service revenue is also a key factor in the new, profitable business model.

How high can SGI fly? It is really difficult to tell. In 2010 it was largely a Linux story, but now Altix UV it is certified for Microsoft's high end products, so revenues from that segment should ramp in 2011. SGI's management believes it can address a $3 billion annual market; revenues in the quarter were just $186 million, so there should be plenty of room to grow.

It is notable that SGI came through the transition with $111 million in cash and no debt.

For more details on quarter results, see my SGI Q2 fiscal 2011 analyst call summary.

William P. Meyers