When new CEO Jonathan Schwartz took over in June 2006, Sun Microsystems (SUNW-NASDAQ) announced an 11-13% workforce reduction, and many investors thought that Sun was serious about getting costs under control and returning to obvious, not maybe, profitability. When the company first made the announcement they estimated that this, along with other cost-cutting measures, would save the company between $480 and $590 million by the fourth quarter of 2007 after charges.
Based on the company’s latest quarterly report, total headcount (as of 12/31/06) stood at 34,600, down from 38,300 in March of last year, a 9.5% reduction. Only about half of the drop was related to the planned reductions, with the remainder due to regular attrition that was simply not replaced.
But here’s the rub with Sun: while they eliminated $84 million from SG&A due to the smaller workforce, total SG&A expenses actually rose $54 million in the last two quarters of 2006. Why? Because compensation expenses for existing employees rose by $119 million. It’s like we’re seeing some twisted form of stock dilution, only it’s being done with employees. How much of the gain was from one-time charges is a question, but how much could it really be?
It’s been a year now since the StorageTek acquisition, they secured a $700 million investment in January from KKR, and Sun should have a clearer picture of what the product offering mix will be by now. In line with this, the functions and knowledge base of every one of their thousands of consultants and sales reps should be evaluated much more. These employees are some of the highest-paid in their industry, and because Sun is still trying to be a jack of all trades, there’s still way too many of these über-consultants on the payroll. Now they are even looking at an internal revitalized SPARC initiative, and Wall Street isn’t impressed.
Revenue per employee for 2006 was just under $400,000 on a static basis. It’s hard to compare this figure directly to one company, but one could argue that the product/service mix at Sun compares more to Hewlett-Packard ($600,000 per) than to an IBM ($250,000 per). Until Sun shows a more meaningful portion of revenue coming from recurring revenue streams (a la IBM), their high gross margin products should give SUNW a goal of reaching the $600,000 mark. But there’s still sweat aplenty for both management and shareholders as Sun tries to figure out what kind of company they want to be, and how to make money off the many ventures that are based on open-source initiatives.
Sun does have the saving grace of finally getting in the black last quarter, earning $110 million. But operating margins are still light years away from the company’s stated long-term goal of 10%, and achieving $500 million in savings from the latest round of cuts seems like a hallucination.
Sun may need to announce a much more aggressive cut – to the tune of 15-20% – to really get the attention of those who have been very disheartened at the 10% goal of last year. We ran a break-up value analysis of Sun back in February, and we noted then that the story of SUNW going forward is going to be all about costs.
Wall Street wants you to decide who you want to be, then set a firm & focused path to get there. Bernstein downgraded the stock this morning, sending shares down about 2.8% to $5.84′ it still trades toward the upper end of their 52-week range of $3.74 – $6.78. Sales growth is estimated to be about 8% for the current year and the street is only looking for 4.5% revenue growth next year. Estimates are wide for Fiscal 6/2007 and even wider for 2008, but for it to reach these goals the company sure looks like they are going to need to trim down employees in many units. It should also look at potentially just eliminating less fruitful activities, but that’s another issue entirely.
Written by Ryan Barnes, edited by Jon Ogg
April 2, 2007
Ryan Barnes can be reached at [email protected]; he does not own securities in the companies he covers.
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