Sun lifted by revenue growth, Microsoft settlement

Struggling company posts profit of $795 million, gaining from server shipments and its $1.95 billion settlement.

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Stephen Shankland
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After three years of declines, Sun Microsystems returned to revenue growth in its fourth quarter of fiscal 2004.

Sun, a server maker struggling with competition against IBM, Dell and Hewlett-Packard, posted on Tuesday net income of $795 million, or 24 cents per share, for the quarter ended June 30. Revenue rose 4.3 percent to $3.11 billion from $2.98 billion last year. However, excluding the $1.95 billion it received from an antitrust suit settlement with Microsoft and other unusual items, it had a loss of $169 million, or 5 cents per share.

Compared with the average expectations of analysts surveyed by Thomson First Call, it was a mixed quarter. Those analysts expected lower revenue of $3 billion but a narrower loss of 4 cents per share.

Chief Executive Scott McNealy said in a statement that shipments of Sun servers increased 46 percent from the year-earlier quarter. "Delivering growth and preliminary profits in the fourth quarter is a great way to end the year," he said.

Sun is in the midst of major change to deal with its financial and market share losses, most prominently the appointment of Jonathan Schwartz as president and chief operating officer. Since Schwartz became the new No. 2, Sun has discussed releasing major software packages as open-source software, and Tuesday, Schwartz floated the idea of versions of Sun's Solaris operating system for its competitors' servers.

In the quarter, Sun was boosted by the arrival of servers using the new UltraSparc IV processor--systems that accounted for 30 percent of shipments--and by resurgent purchasing on the part of Sun's two most important customer types, financial institutions and telecommunications companies, Chief Financial Officer Steve McGowan said during a conference call.

Shipments of Sun servers increased 46 percent from the year-earlier quarter, which Chief Executive Scott McNealy said portends good news.

"Volume matters," McNealy said during the conference call. "It is the leading economic indicator. It is what drives the long-term growth of this company," enriching software and hardware partners and increasing the number of customers that can later buy services, software or upgrades from Sun.

But some analysts are still leery. "You had a very strong server unit quarter. Services revenue was strong, the storage attach rate went up, and yet you still weren't able to show any kind of stability...on the product gross margin side," said Goldman Sachs securities analyst Laura Conigliaro on the conference call. Gross margin--which declined because of the UltraSparc IV transition and other factors--is a key measure of profitability.

But Schwartz took an aggressive tone. "We are now unquestionably on the offensive, with powerful resources at our disposal and an excellent product calendar," he said in a statement.

And in an interview, McNealy said Sun plans on profitability, revenue growth and positive cash flow from operations for fiscal 2005.

Sun called its $795 million profit "preliminary" until it receives confirmation from the Securities and Exchange Commission about accounting details of the Microsoft settlement funds.

After years favoring only its own UltraSparc processors, Sun has introduced servers with Advanced Micro Devices' Opteron processor, a model that adds 64-bit extensions to the x86 line such as Intel's Pentium and Xeon. Sun's embrace of Opteron hasn't yet been materially significant to Sun's finances, the company said.

One change will come with the arrival of Opteron models designed after Sun's acquisition of Opteron specialist Kealia. Sun is working on server designs that use the same chassis for either Opteron or UltraSparc chips, McNealy said, and Schwartz said that move will increase manufacturing efficiency.

UltraSparc and Opteron both run Solaris, Sun's version of Unix, but those aren't the only chips the Santa Clara, Calif.-based company is eyeing. Others include those of Sun's deepest rivals, IBM with its Power family and HP with the Itanium chips it helped Intel develop.

Solaris on Power, Itanium
"We've begun looking at Solaris on Power as well as Solaris on Itanium as a way of delivering incremental volume," Schwartz said--though McNealy immediately cautioned afterward, "That was not a product announcement!"

Such an expansion would mark a much broader ambition for Solaris, which today runs almost exclusively on Sun's UltraSparc processors and Fujitsu's compatible Sparc64 processors. Sun canceled a version of Solaris for Itanium in 2000 before it was ever released as a product, nearly killed the version of Solaris for x86 chips, and never had a version for Power.

Sun now has attracted 700 software companies to support the x86 version of Solaris, Schwartz said.

Meanwhile, Schwartz also disparaged the top Linux seller, Red Hat. "We're seeing disaffection from the Red Hat community in response to their new pricing," he said, with customers concerned that they can't switch to another version of Linux. "Linux has become--because the cost of switching is so high--about one company, that being Red Hat."

Regarding higher-level software, Sun signed up 128,000 new subscribers so far for its Java Enterprise System collection of server software, which the company sells for $100 per year for each person employed by a buyer. Sun now has 303,000 subscribers total, and Schwartz said he believes model produced pricing pressure is partly responsible for the financial troubles reported by many software companies.

Sun is in the midst of cutting its staff by 3,300 from 35,400. A total of 2,400 were notified in the quarter that their jobs will be cut; the full reductions will be complete by the end of 2004, McGowan said in a conference call.

The cuts are part of cost-cutting that will reduce expenses by $200 million in the quarter ended Sept. 30 and $500 million in the year ended June 30, 2005, McGowan said.