Sun Makes Quarterly Revenue Increase Twice in a Row

by Timothy Prickett Morgan

The top brass at Sun Microsystems are a little more chipper than in the past few years since the company posted its second year-on-year quarterly revenue increase as it closed its first quarter of fiscal 2005. Chairman and CEO Scott McNealy wisecracked last quarter that the company had posted "one in a row," and his management team obviously believes that the new hardware, services, and pricing models that the company is rolling out give it a chance to shake up the IT industry.

Sun can't predict exactly what the company's revenue and profit picture will look like as it transitions from selling hardware on a quarterly basis to selling solutions on an annual subscription basis. There are far too many variables in play as Sun makes that transition, and despite repeated requests for clarification and forecasts from Wall Street analysts on a conference call with McNealy, president and chief operating officer Jonathan Schwartz, and chief financial officer Steve McGowan, they simply said that "our calculators work" and in essence told Wall Street that they would have to take a leap of faith along with Sun that this new approach will work. To Sun's credit, its old way of packaging and selling its wares surely wasn't working, and trying something new, as Sun is attempting to do, means that the future is inherently hard to predict. If guessing server sales in the past four years was nearly impossible, guessing IT sales under this subscription model is absolutely unreasonable. And that would be fine, if Sun were a private company. But, alas, Sun is a public company, and one that can't afford to take itself private. So until Sun shows solid revenue growth and decent profits with no qualifications about write-offs, legal settlements, and accounting principles, this cat-and-mouse game between Sun management and the Wall Street analysts that represent investors will continue.

Sun's fiscal first quarter is typically its weakest, but the last few years have been anything but typical for Sun. So the fact that sales were up 3.6 percent, to $2.63 billion, in the quarter ending September 26, while encouraging, is not necessarily a sign that Sun is out of the woods quite yet. It is, nonetheless, a good sign. Product sales were up a tiny amount in the quarter, to $1.67 billion, with services sales up 6 percent, to $952 million. Computer product sales were up 6 percent in the quarter, to $1.35 billion. McGowan said that sales in the United States were down 5 percent, primarily because of a cyclical spending decline in the telecommunications market, on which Sun heavily depends, and because of a cutback in government spending on defense and security initiatives that consume computing. Sales in Europe were up 18 percent, however, driven by growth in the United Kingdom, Italy, and Spain. He said that 52 percent of server sales were for machines based on the new dual-core UltraSparc-IV processors, and that sales of machines with between four and 24 processors really drove sales in the quarter. Sun's X86 server sales were up 36 percent in the quarter, but Sun has a miniscule share of the X86 market, and that growth was well below the growth rate that Sun had in its fiscal fourth quarter of 2004. Sun seemed unconcerned by this, since it is just getting started in the X86 market. At some point--perhaps within a few quarters--Sun will have to show consistent sales and steady market share if customers and investors are to believe that it can be a player in the X86 server market.

Sun booked a $108 million restructuring charge in the quarter, as it said it would do when it announced layoffs a few months ago, and it also booked an $82 million charge for a litigation settlement with Kodak, a $4 million loss on investments, and a $7 million benefit related to tax settlements with the IRS. Sun booked an operating loss of $162 million and a net loss of $174 million in the quarter, or 5 cents a share. In last year's first quarter, Sun booked a $286 million loss, or 9 cents a share. The company generated $124 million in cash from operations and had $7.4 billion in cash and securities as the quarter ended. So, while it is still not profitable, money is time and that means Sun has time to undergo the transformation that McNealy and Schwartz are spearheading.

McNealy said that Solaris 10, which is increasingly the focal point of the revitalized Sun, would launch in November. "Starting now, we're going on the offensive, big time," he said. He even went so far as to chide rival IBM for not being more aggressive in supporting Solaris 9 and the future Solaris 10 on its xSeries servers. "Look whose stubborn now, since IBM refuses to get on the Solaris bandwagon."