COMMENTARY -- Am I the only one who was encouraged after listening to the conference call yesterday from SGI (NYSE: SGI)?
That's a dangerous thing, mind you -- this is the same writer who saw positive things in 3dfx (Nasdaq: TDFX) and Novell (Nasdaq: NOVL) more than a year ago, before those respective stocks went into slides from which they have yet to recover.
With that caution in mind, know that I liked what I heard from SGI executives. Yes, the company will miss first quarter estimates, but for the first time in awhile, executives talked about a restructuring that involves more than simply firing people and creating new divisions or product lines.
CFO Hal Covert outlined concrete targets for the long-term, including 42.5 percent gross margin, 10 percent of revenue for R&D, 18 percent of revenue for sales and marketing, and 7 percent for administration. He noted plans to install new systems for ERP and CRM. He pointed to simple efficiency, rather than drastic slashing, as a way to save $100 million in annual expenses.
You can't turn yourself into a growth engine simply by cutting costs, of course. The reality of SGI is that it has chosen to focus on a relatively mature market expected to expand only 8 percent a year, according to International Data Corp. The demand for high-end workstations and high-performance computers simply isn't increasing on a par with, say, wireless data transfer.
SGI's reputation has tumbled not only on the stock market, but evidently among suppliers as well. The company blamed its first quarter shortfall a lack of materials, particularly wafers and ceramic packaging for custom chips. During yesterday afternoon's call, J.P. Morgan analyst Daniel Kunstler basically asked if SGI was being shafted by suppliers who place other customers higher on the priority list:
Kunstler: On the components thing, I don't want to beat a dead horse, but is part of the issue allocation with any one supplier, or is it more like a production issue?
Warren Pratt, executive VP of engineering: I think it's pretty well known throughout the industry that a number of types of components are in very high demand and supplies of various technologies are lagging at this point in time. So in this situation, obviously there is allocation involved as well as the need to increase overall capacity.
So in your discussions with your vendors, is what you're discussing an improvement in your allocations as you show them the improved operating model? Is that the topic? I'm just trying to get to what extent you're being treated sort of like a poor relative when it comes to allocations.
Hal Covert: Bob's going to expand on a meeting that he had with some of the people involved.
CEO Bob Bishop: Daniel, we have been meeting at the very top of our supply here, and there will be, in fact, a public statement from them very shortly, possibly during this week, where they are committed to increment capacity, both in wafer starts and ceramic packaging. These are precisely the two areas that we are feeling some pain, and we expect to hear some rather positive news during the week.
Covert: And we've also pushed them very hard, Daniel, to make sure that we have the right allocation and we're getting as much as we can.
It's hardly a ringing affirmation of SGI's ability to get what the company needs immediately. I got the feeling that if there are only enough ceramic bases to supply two companies and it comes down to SGI, Sun Microsystems (Nasdaq: SUNW) and Hewlett-Packard (NYSE: HWP), SGI would be the odd one out.
Nonetheless, SGI says it expects supply problems will be ironed out by the second half of fiscal 2001, which ends June 30. The company sees year-over-year revenue growth of more than 20 percent in the third and fourth quarters, along with a operating profit of $55 million to $60 million for that period.
Covert predicted an operating margin of 7 to 8 percent going into fiscal 2002. Again, that's not great, but it's far better than what it has been recently.
In any case, SGI's stock price doesn't call for strong growth. People talk about Apple (Nasdaq: AAPL) being oversold, but SGI's fall is nothing short of stunning.
SGI now commands a market cap of roughly $720 million, about one-third of its expected revenue for the current fiscal year and just 30 percent of the company's trailing 12-month revenue. Were the same standard applied to Apple, AAPL shares would be valued at little more than $6 today.
When you think about it, SGI right now is about at the same point Apple was at three years ago. SGI's technology is well-received in the markets targeted by the company, and there's a large installed base. SGI might be a financial mess, but at the very least the company can make some money with the product lines it has.
And just like Apple, SGI isn't going to go away. A $2 billion business doesn't just disappear, even if Wall Street thinks it's worth less than $4 per share.
Assuming parts shortages do ease as expected, SGI could be in for some steady, solid improvement. The company's bottom line won't be pretty in the second quarter, and SGI probably will never be the high-flier it once was, because turnarounds can only go so far. Just look at Apple these days.
But in the long run, SGI could have a strong niche of its own. It's not about to reach the level of a Sun or an HP, but it's enough to make SGI deserving of more than its current status as a penny stock. 22GO>