SGI Buys Linux Networx Assets with Stock Issue

Published: February 19, 2008

by Timothy Prickett Morgan

Bo Ewald, a long-time executive in the supercomputer industry who cut his teeth at Cray and who was named chief executive officer at Silicon Graphics last April, was also the CEO who was handpicked to run another supercomputer maker, Linux Networx, in June 2005. And late last week, Ewald convinced the SGI board and Oak Investment Partners, one of the venture capitalists behind Linux Networx, to let SGI take over the upstart cluster maker.

"This is another significant step in the growth of SGI," said Ewald in a statement announcing the deal. "We've grown orders more than 30 percent in each of the last two quarters. We're in a position to acquire key technology and expertise to further power our growth. This represents the first of such key technology acquisitions and will help further the development of our software environment and support for our clustered systems. In addition, we are very pleased that Oak and Lehman Brothers have provided additional financing to the company to help speed our growth."

This is putting the best face on what has been a difficult market for SGI for the past decade; and if SGI is able to buy the carcass of and retain the key employees of Linux Networx, that can only mean that business was even more difficult at the upstart maker of X64 and Itanium clusters. In its second quarter of fiscal 2008 ended in December, SGI did indeed have $100 million in bookings, up 30 percent from the year-ago fiscal 2007 second quarter, but actual sales in the quarter were $90.1 million, down 16.3 percent, with product sales down 31.8 percent to $43.4 million and services sales up 6 percent to $46.7 million. While SGI has been able to cut its operating losses nearly in half to $30.8 million, SGI still had a net loss of $42.2 million in the quarter.

The good news is that the Internal Revenue Service is allowing SGI to retain $1.2 billion in pre-reorganization losses to use as a loss carry forward for the time when it does go into the black. SGI is going to be able to keep from paying taxes to the Feds for a long, long time unless it grows very quickly. The other good news is that SGI exited its fiscal second quarter with a $95.8 million backlog of orders, up 47.4 percent. That is money that will eventually get into the bank. Wall Street is not very optimistic about SGI, inasmuch as the company has a market capitalization of $192.4 million, or less than half of annual sales in a supercomputing market that is outgrowing the larger server market. The market has not forgotten that only five years ago, SGI was kissing $1 billion in annual sales and now it is half that size. And is still shrinking until it demonstrates otherwise for four quarters. Bookings are not money, particularly among the supercomputing centers and large corporations that can--and sometimes do--say "no thanks" if a cluster doesn't perform as expected running their applications.

Linux Networx was founded in 1988 and is located in Bluffdale, Utah. The company has been a respectable player the high performance computing space as a supplier of clusters since Linux and X86 (now X64) processors displaced Unix and RISC processors as the preferred platform for clusters in the 1990s. The company currently has nine clusters in the listing of the Top 500 supercomputer vendors, giving it 1.8 percent of the aggregate computing capacity on the list (in this case, Linux Networx has 114.9 teraflops of capacity on the list). The largest machine on the list--and presumably the biggest machine Linux Networx has ever sold--went to the U.S. Army Research Laboratory and is currently ranked the 27th fastest machine in the world, with 40.6 teraflops of performance. This machine has 4,416 of Intel's "Woodcrest" dual-core Xeon 5100 processors running at 3 GHz and 8.6 terabytes of main memory; it uses InfiniBand interconnections and runs Novell's SUSE Linux Enterprise Server 9 operating system.

While neither SGI nor Linux Networx gave much detail on the sale, in an 8K statement filed with the Securities and Exchange Commission, SGI said that it had acquired Linux Networx' system management software products, intellectual property, and intellectual property rights. In the announcement made by SGI, it said further that it had acquired software from Linux Networx as well as several parents governing cluster design, power and cooling, and cluster optimization. SGI paid for these assets by issuing 390,000 shares of common stock, which Linux Networx' investors took in exchange for some unspecified form of indebtedness. The 8K filing did not say who gets the stock, but Linux Networx received investment funds from Canopy Group (the venture funding arm created by the former top executive at Novell and often cited as its founder Ray Noorda), Oak Investment Partners, Tudor Ventures, and Wasatch Venture Fund. In November 2004, Oak Investment Partners Oak Investment Partners and Tudor Ventures pumped $40 million into Linux Networx, but with Linux Networx being a private company and the company's Web sites now pointing to the SGI site, it is not possible to see what the aggregate investment in the company was. SGI apparently also owns the Web sites for Linux Networx, and it is unclear what, if anything remains of the company.

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