Sun Lays Off 3,300 As Fiscal Q3 Falls Short

by Timothy Prickett Morgan

Sun Microsystems may be expecting a $1.95 billion cash infusion from formal rival and now best buddy Microsoft in the wake of its lawsuit settlements and cross-licensing and collaboration agreements that were announced today, but it is not counting that money before the check clears. And maybe not even after. The company's third quarter is coming in below Wall Street expectations, and just as Sun was announcing the Microsoft deal before the market opened on last Friday morning, it was also announcing that it would cut 3,300 employees from the payroll and report a substantial loss in the third fiscal 2004 quarter ended March 28.

"It's never a dull moment around here," said Sun chairman and CEO Scott McNealy as he opened a call with Wall Street analysts. No one in the computer business was better able to put Microsoft in its place--at least verbally, if not competitively--and the simple fact is that McNealy is not going to be able to say the inciteful and insightful things about Microsoft that used to spice up such meetings. McNealy has serious things to do, and one of them is to try to get Sun profitable. The other is to keep it profitable.

Less than two months ago at Sun's annual analyst conference, McNealy said that he would not layoff employees or cut back on research and development to artificially move Sun to profitability, particularly as it was trying to get a new Solaris 10 operating system, UltraSparc-IV and Opteron servers, and various Java-based software stacks out the door. Conditions change, and while McNealy has a reputation for being stubborn, he is also a trained economist who can do math and as Wall Street has been saying for months, Sun would have to cut workers if revenue didn't pick up. It didn't. According to preliminary estimates by Steve McGowan, Sun's chief financial officer, the company will post revenues of approximately $2.65 billion in the fiscal third quarter, with a net loss of between $750 million and $810 million, which works out to between 23 and 25 cents a share. The street consensus, as gauged by the analysts polled by Thomson First Call, was for Sun to rake in $2.85 billion in sales for the quarter and report a net loss of 3 cents a share.

To be fair, the losses Sun will book in its fiscal third quarter include $350 million for an increase in the valuation allowance for deferred tax assets, which is a one time charge that Sun is most likely taken now so it doesn't have to do it later. There is another $200 million charge for workforce reductions and the shuttering of some three million square feet of office space, to a total of 10 million worldwide. If you do the math, Sun would have been running at close to breakeven if it had hit that $2.85 billion mark. But clearly Sun does not think that this is sustainable, so it had to cut 9 percent of its workforce. After the layoffs, Sun will have approximately 32,700 employees. The total costs of the layoffs and the closing of properties will come to around $475 million, and it will be spread over several quarters, according to McGowan.

Interestingly, McNealy said that Sun would step up its efforts to allow employees to work from home and to work without dedicated office space, so-called mobile office workers who use shared offices. Right now, he said, 44 percent of Sun's employees do not have dedicated offices, and 2 percent work from home. Not setting up offices can cut down significantly on costs, and this is something many small companies have learned through necessity, not by choice. It will be interesting to see how virtual Sun's corporation goes as it tries to trim costs and increase profits.

When asked as to whether he or the Sun board of directors was calling the shots concerning the layoffs and the appointment of Jonathan Schwartz as president and chief operating officer, McNealy was blunt. "It is my decision, it is my call, and I am making these calls." He added, however, that there is "huge transparency" in the decisions he makes with the board of directors.

Schwartz came to Sun through a relatively minor acquisition seven years ago, and he takes over the job vacated by Ed Zander, Sun's boisterous and feisty president and COO who helped steer the development, manufacturing, and sales of Sun's entire product line through the boom times in the 1990s. Zander left two years ago left Sun and is now chairman and CEO at communications giant Motorola. McNealy explained that post-bubble, he did not name a successor to Zander because Sun was going through a tough time, he had a whole new set of executives, and they were trying to manage a difficult set of product transitions. He wanted to keep firm control. Now, as the executives have seasoned a bit, McNealy says that there is a "just a lot to go do" and now he feels he can delegate authority to Schwartz. It is no accident that Sun has chosen a software executive to run the day-to-day operations of the company, since this, more than hardware and maybe more than services, is where Sun's future profits are likely to come from. McNealy said that Schwartz was the only person considered for the job, but said that he interviews everyone he meets for a potential job at Sun.

McNealy will still have the financial, technology, and human resources executives reporting to him, and will focus on larger matters, as a chairman and CEO is supposed to do. One of those big picture jobs is to paint an optimistic picture for the salespeople and current and potential customers. McNealy, of course, ended with this. "I love where we are. I love our cash. I love our installed base. And I love our product line."

Despite the bad news for the fiscal third quarter, Sun managed to add another $300 million of cash, boosting its hoard to $5.5 billion. And when Microsoft kicks in another $1.95 billion in the fiscal fourth quarter, you can bet that McNealy is just going to sit on it and save it for a rainy day.