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Sun loss levels; acquisitions bring growth

Sun Microsystems narrows its loss, but misses expectations. Shares drop in after-hours trading.

Sun Microsystems on Tuesday reported a slightly narrower net loss of $123 million for its first quarter of fiscal 2006 versus previous year. The figure included results from the acquisitions of Storage Technology and SeeBeyond, as well as the mandatory arrival of stock-option accounting.

The net loss amounted to 4 cents per share using generally accepted accounting principles, the same with the year-earlier period with a loss of $133 million. Excluding a number of charges, the company's net loss was $68 million, or 2 cents per share. That was deeper than the average 1 cent loss analysts expected, according to Thomson Financial.

Revenue increased 4 percent to $2.73 billion for the quarter, which ended Sept. 25, from $2.63 billion a year ago. Of the revenue, $226 million was from StorageTek and Seebeyond, Sun said. Analysts expected an average of $2.89 billion.

Chief Executive Scott McNealy expressed optimism about the results and the affect of the company's acquisitions on its earnings. "Clearly the numbers are looking nice. We are turning cash into inorganic growth," he said.

Investors disagreed, sending Sun's stock down 15 cents, or 4 percent, in after-hours trading, from the market close price of $3.85.

Sun long has resisted regulatory requirements to report stock options as an expense, but this quarter the company had no choice. The move resulted in a $50 million charge, the company said.

The Santa Clara, Calif.-based Sun is in the midst of a major transformation to try to restore its ailing financial fortunes. It's banking on several efforts: the new "Galaxy" line of x86 servers, a revamp of the Solaris operating system to make it an open-source project and suited for x86 servers; a push to sell the Java Enterprise System server software; and a rejuvenation of the core UltraSparc server family.

However, it has many challenges ahead. Chief Financial Officer Steve McGowan announced plans to retire last week, the same day that

The company had $224 million in cash flow from operations for the quarter, with cash and marketable debt securities of $4.53 billion.

Making the most of margins
Gross margin increased 2.7 percentage points to 44.1 percent in the quarter from 41.4 percent in the quarter ended June 30.

Sun boasts of its increasing gross margins, a measurement widely predicted to decline as the company enters the competitive market for x86 servers. Sun already has become a lower-end server company in many ways: Though it sells machines with as many as 72 processors, 75 percent of units shipped have between one and eight processors.

"We're in transition from being an E10K, E25K company to one that is predominantly in the one- to eight-way space, while improving gross margin dollars," McNealy said. "As we add software services, utility services, we believe we have an opportunity to improve productivity and cut costs while growing our way to a better and more comfortable operating margin."

One way that Sun is counting on improving that margin is by selling Solaris support as well as the Java Enterprise System server software. But Windows and Linux remain much more popular operating system options. "About a quarter" of Sun's x86 servers use Solaris, President Jonathan Schwartz said, "but the numbers are ramping."

More than 3 million copies of Solaris 10, available for free since January, have been downloaded, Sun has said. Most of those copies are run on x86 computers, and most of those computers come from Hewlett-Packard or other non-Sun companies, Sun said.

The company shipped about 71,000 servers in the quarter, of which 14,000 used Advanced Micro Devices' Opteron processor. None of those were the new Galaxy systems announced in September and shipping in October, but shipments of earlier AMD Opteron-based server models increased 109 percent compared with the year-earlier quarter, Sun said.

However, Galaxy system sales hurt shipments in the quarter, McGowan said. "Though Galaxy was well received, there is some indication that customers may have delayed purchases for these products," he said. In a later conference call with reporters, he added that customers in Japan and the financial services industry were particularly inclined to delay purchases.

Java Enterprise System subscriptions are another way to increase margins on a server sale. Sun sells subsets of the software to companies for $50 per employee per year--letting the customer use as much of the software as desired--or sells the entire suite for $140 per employee per year.

Sun has sold 957,000 JES subscriptions so far, 429,000 of them the suites, McGowan said.

McNealy also claimed progress against IBM's Power processor family, which Big Blue began upgrading in October with the Power5+ model. "The Power5+ announcement was very underwhelming. It was nice to finally see them not exactly execute on a new speed bump," McNealy said.