Sun earnings trail expectations

The server company reports net income of $12 million on revenue of $2.98 billion for its final quarter of fiscal 2003, falling short of financial analysts' expectations.

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Stephen Shankland
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Sun Microsystems reported net income of $12 million on revenue of $2.98 billion for its final quarter of fiscal 2003, falling short of financial analysts' expectations.

The server company's net income of 1 cent per share, excluding special items, was less than the 2 cents that analysts expected, according to a survey of analyst on First Call, which compiles analyst reports. Net income also represented a decline from the $61 million the company earned during the same quarter of last year. Revenue was slightly less than the $3.06 billion expected by analysts and far less than the $3.24 billion the company reported during the same quarter last year.

Special factors included losses on equity investments, the reversal of a restructuring charge and tax effects, Sun said Tuesday.

"We reached profitability in the second half of the year, but we weren't (profitable) for the whole year, and we didn't grow the business. That's something we're not happy with, and we've got all our attention focused on it," McNealy said during a conference call Tuesday. Executive bonuses this year are tied to growth in cash, revenue and net income, he said.

Sun did point to some positive results. It decreased expenses by $477 million compared with the earlier fiscal year, chiefly through the layoffs it began in late 2002. It also generated more than $1 billion in cash. The company didn't offer incentives for salespeople and customers, which last year dipped into future sales. And the company said that it was able to fund $1.8 billion of research and development.

Sun is working to regain its poise and profitability after years of punishment from a stagnant economy, curtailed corporate spending and competition from IBM, Hewlett-Packard and Dell. The Santa Clara, Calif.-based company is responding with new technology initiatives such as its N1 management software, UltraSparc processors, desktop computers that use Linux, its first servers that use Intel and AMD "x86" processors, along with the Orion server software collection.

"Sun continues to be squeezed by formidable enterprise competitors at the top (IBM, Hewlett-Packard) and pressures from below (Windows and, increasingly, Linux, on Intel platforms). While it appears to be holding its own at the high end, it has been late in fending off the attack on the low end," SG Cowen analyst Richard Chu wrote in a report issued Tuesday before Sun?s earnings announcement.

New technology could help, Chu added. "If it executes, the future is likely to be far less bleak than envisioned by conventional wisdom. But the deliverables are not yet there."

Fulfilling technology promises can be difficult. The arrival of Sun's forthcoming x86 blade servers slipped a few months, the same fate the UltraSparc V processor suffered. And the company wasn't able to ship its lower-end V210 and V240 UltraSparc servers because of a problem with a component supplier, the company said.

Sun had about $50 million in orders for the V210 and V240 servers, Chief Financial Officer Steve McGowan said. The revised systems are in testing and are expected to ship by the end of July or in August, he said.

Sun spokesman Andy Lark said the problem was caused by a Broadcom chipset that under some circumstances corrupted data between the system and its Ethernet network ports.

Sun's quarter suffered in part because of decreasing gross margins, a key measure of profitability. McGowan said margins were hurt by price cuts triggered by competition and because memory and other component costs didn't decrease as much as in the past.

Overall, though, gross margins for products and services were higher than in the same quarter a year before, McGowan said, and overall gross margin improved from 41.3 percent to 43.7 percent. "We certainly had our share of challenges throughout the year, but we finished in a strong financial position," he told reporters in a conference call.

Sun's stock closed at $4.77 Tuesday, but it dropped to $4.30 in after-hours trading.

The company's employee count increased in the quarter. This was due partly to the acquisition of new companies and the hiring of about 100 temporary manufacturing workers, McGowan said. Another reason was that layoffs Sun began in 2002 weren't completed during the quarter in some countries, he said.

Sun had a net loss of $2.378 billion for the year, a figure that includes a $2.13 billion non-cash charge related to the reduced value of companies it acquired. That charge was taken in the quarter ended Dec. 31.

Some expenses will increase in the current fiscal year because of a large number of new processors Sun expects to "tape out," or complete the design of, McNealy said. Each chip requires extensive testing.

"We're going to tape out about a dozen new Sparc chips this fiscal year," McNealy said. "There's a lot of stuff coming to fruition here."

Sun hopes technology will help it get ahead. In the server market, it's banking on several low-end products, including the Intel Xeon-based V60 and V65 servers. Sun's Intel server line thus far hasn't fared well, with only 1,292 of the first-generation LX50 models selling in the first quarter of 2003, for total revenue of $3 million, according to market researcher IDC.

"We've got clearly a long way to go before we regard ourselves as being successful," Lark acknowledged. But he added: "Now that everything is aligned, we're looking to ramp significantly over the coming quarters."

McNealy believes Sun's Solaris operating system will be an advantage in its Intel server effort, particularly with the actions that Unix intellectual property holder SCO Group is taking. SCO has said that Linux users should pay a license fee or face legal action.

"I think the investment we made 10 years ago in owning our Unix intellectual property was huge, and the payoff was big," McNealy said. "I also think people want Unix-based technology on their low-cost, 32-bit, x86 environments. You get it with Solaris, with software indemnification with Sun. We will take that risk because we know where the code came from and we know what we paid for it."

And the Intel version of Solaris runs Linux software, he added. "You can run Linux applications on Solaris-x86 with software indemnification. You get Sun's support, not Red Hat's," McNealy said. "And you get it at a price more attractive than what Red Hat is charging. Solaris is a slam-dunk no-brainer."

Solaris also includes the Orion server software collection, he added, the pricing for which Sun will announce this quarter.

The Orion pricing announcement, as well as the launch of the MadHatter Linux desktop product, is expected at the SunNetwork conference, which runs from Sept. 16 to 18.