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Sun sings survival song amid downturn

The server giant edges a penny ahead of previously lowered expectations and vows to stay adaptable amid a turbulent technology market.

Sun Microsystems on Thursday edged a penny ahead of previously lowered expectations and vowed to stay adaptable amid a turbulent technology market.

The Palo Alto, Calif.-based server seller reported pro forma net income of $263 million, or 8 cents a share, on revenue of $4.1 billion. Sales in the United States, however, declined 15 percent--an interesting comparison with year-ago levels when Sun was riding the Internet wave and pitching itself as "the dot in dot-com."

"In the old days, we had an economic cycle that was a nice rolling, gradual...curve. Now it seems we don't have rolling waves; we have real edges," said Chief Executive Scott McNealy during a conference call.

"The real issue is, can you turn on a dime as the needle starts flipping back and forth. If (the economy) rebounds like crazy or grows slowly, we'll provide a flexible response to that."

Sun lowered expectations in February. Analysts had expected net income of 15 cents per share, but Sun said it would earn 7 cents to 9 cents per share.

McNealy touted Sun's continued revenue growth despite the company's strong performance a year ago and the economic slowdown that has hammered Hewlett-Packard and other competitors.

Chief Financial Officer Mike Lehman, though, said spending appears to be slowing down somewhat outside the United States.

"Our results reflected the sharp decline in capital spending in the information technology sector, principally in the United States, although we did see some moderation of demand in Europe and Asia-Pacific," he said in a statement.

The company saw a "small impact" in the United States from sales of used Sun equipment, Chief Operating Officer Ed Zander said. "We think that is somewhat, if not all, behind us," he said, adding that those sales still increase Sun's market share and give it an opportunity to sell services.

But the company stood by its long-term strategy to sell the equipment to build what it calls a networked planet. "Betting against the Internet is like betting against the Industrial Revolution," Zander said.

Actual income at the company--including items such as one-time charges or gains and losses on investments--was $136 million, or 4 cents a share, compared with $509 million, or 15 cents a share, a year ago.

A critical time
Sun is at a critical juncture in its history, introducing its most important new servers during a major slowdown in technology spending. The company profited mightily the last few years from selling servers to start-ups and established companies building Internet operations, leaping ahead of IBM and HP.

But now the company must adapt its aggressive sales force and high-growth mentality to tougher times.

Sanford C. Bernstein analyst Toni Sacconaghi expects a more "sheepish" attitude from Sun. U.S. revenue for the most recent quarter will shrink 10 percent, he predicted, while he expects Sun's worldwide revenue to shrink for the current quarter.

Hampering the transition to Sun's latest products based on the new UltraSparc III CPU have been glitches that weakened the performance of the new chip and difficulties moving from 750MHz speeds to 900MHz.

At the same time that IBM and HP have stepped up their competitive pressure on Sun, the company faces a new North American threat in Fujitsu Technology Solutions, which is selling high-end servers with an operating system and CPUs similar to Sun's. Though Fujitsu earlier planned to begin selling a gigantic 128-processor server in April, a spokesman said the launch date has been pushed back to May.

Sun will sell thousands of its new midrange "Serengeti" servers this quarter, Zander said, though he acknowledged that some companies that would like to sell the systems don't have any. There currently is a delay of two to three weeks between ordering an UltraSparc III system and receiving it, he said.

Price cuts, challenges
Gross margins--a key measure of profitability--dropped 6 percent from about 47.9 percent to 41.6 percent, Lehman said. More than half of that drop was because Sun didn't sell as many products as it expected, meaning fixed costs were a higher fraction than the cost to produce each product and that Sun wasn't able to take advantage of cheaper component costs.

In addition, competitors cut prices more deeply, and Sun responded with its own discounts, Lehman said. This change was responsible for about 1 percent of the gross margin decline, he said.

A big part of Sun's effort to cope with the economic climate was a $240 million cut on administrative expenses, Lehman said. The largest factor leading to that expense cut was Sun's move to keep money it earlier had expected to pay employees as bonuses tied to Sun's performance.

But that's not all. "We've modified our policies on travel, capital acquisition, facilities expansion. We've stopped nearly all forms of discretionary spending," Lehman said.

Revenue in the United States dropped 15 percent compared with the year-ago quarter, Lehman said during the conference call. European revenue increased 16 percent, and Japanese revenue increased 21 percent. However, when compared with the previous quarter, U.S. sales declined 33 percent, and European sales dropped 11 percent.