Sun struggles in Q1

Analysts hungry for blood

As warned, Sun Microsystems posted underwhelming results for its first quarter, but the company's gripping conference call with financial analysts more than made up for the sub-par numbers.

For the period ended Sept. 28, Sun reported revenue of $2.54 billion, which is an 8 percent drop from the $2.75 billion reported in the same quarter last year. The company posted a net loss of $286 million in this year's Q1 versus a net loss of $111 million last year.

On top of the revenue slide, Sun was unable to generate cash from operations. The company takes great pride in generating cash even in tough times, and this certainly came as a blow.

Sun's CFO Steve McGowan did his best to put a positive spin on the news.

"Despite our challenges this quarter, we reached the highest level of services revenue ever for a fiscal first quarter and we made strong gains in the 1-2 way server market," McGowan said. "We reduced SG&A expenses by $84 million year over year, and although cash flow from operations was a negative $49 million, we exited the quarter with a cash and marketable securities position of over $5.5 billion."

McGowan then walked through the results in detail, pointing to a 4 percent rise in services revenue year-on-year to $902 million and a 13 percent decline in product revenue to $1.63 billion, which includes a 4 percent drop in storage sales. Revenue in Europe was down 3 percent, Japan was down 26 percent and the rest-of-the-world was down 9 percent year-on-year.

Sun added that it saw an unfavorable mix of high-end and low-end servers that hurt margins. Sales of the lower end V210 and V240 servers outpaced those of higher-end Sun Fire 12K and 15K servers by a wider than normal margin.

After dolling out these rather grim facts, Sun's volume systems chief Neil Knox jumped on the horn for a brief advertisement. He rattled off a number of facts about Sun's new Intel-based servers, Solaris x86 and low-end Sparc systems and how Sun beats Dell on price just about everywhere possible.

"We are doing what we need to do to make sure Sun stands for price performance," he said. "Please stay tuned for some more exciting announcements that will be coming this quarter. And now, back to you, Scott."

Sun's CEO Scott McNealy found the infomercial as bizarre as we did.

"Thanks, Neil," he said. "Do they get a Ginsu with that?"

McNealy took over at that point and returned a bit of respectability to the call.

Sun has endured a recent onslaught of critical analyst reports, calling for mass layoffs at the company and a change in strategy. Sun has only reached profitability a couple of times in the last two years, and the analysts are pressuring the company more than ever to say when it will be able to stay in the black. A recent $1 billion charge did not help matters.

"We are doing our best to be a disruptive innovator," McNealy said. "We think it's working. It's not showing up in the numbers, and we're not happy with that, but we'll keep plugging away."

McNealy noted that Sun has picked up 60 customers for its N1 software/hardware management technology and has 90 bids for the new Java Enterprise System software stack. He urged that these are both spots of hope for the company.

This was not enough to silence one of Sun's most vocal critics - Toni Sacconaghi, analyst at Sanford Bernstein. Sacconaghi pushed McNealy to say whether or not the board had a hand in refusing another round of layoffs or if this was just a CEO whim. As always, the analyst did so with eloquence and fairness, as he is a shining star in an otherwise tarnished profession.

After some teeth-pulling, McNealy assured the analyst crowd that the board and his top level staff agreed that the time is not ripe to make more job cuts.

"I have had a lot of talks with customers and none of them are saying, 'Please stop doing R&D,'" McNealy said. "None of them have said, 'Please back off on all the services and support.'"

Sacconaghi pushed again in what became a rather tense moment of the call.

"Is there not an imperative to at least toss around the pros and cons (of job cuts)?" he asked. "I am trying to understand how formally that was done. If this performance is repeated, what kind of assurance do shareholders have that Sun will be more firm in expense reductions going forward."

"The board has been involved every step of the way," McNealy responded. "I think we need to give this thing a little longer to ride."

For those who don't have time to spend listening McNealy and Sacconaghi duke it out, we hope this gives a flavor of the affair. Both men are quite good at what they do, and their sparring matches are a treat. The same cannot be said when Merrill Lynch's lip gloss guru Steve Milunovich decides to show up for a call.

The Loon charged that the "old Sun" had a singular focus on Sparc chips and Solaris. He wanted to know where this focus has gone and how Sun could repair its public image. (This question coming from an analyst who just weeks ago recommended that Sun drop Sparc and did so in the most public way possible, penning an open letter to McNealy.)

"Well, you could help," McNealy said, wondering how Milunovich's call got past the operator.

"I'm trying, but you're not listening," Miloonovich replied. The conference call having denigrated into a tit-for-tat squabble.

McNealy then tried to make nice by complimenting Milunovich's new pair of polka-dotted thigh-highs and snazzy Hello Kitty backpack.

Well, okay, the conversation didn't turn that ugly, but it may as well have. The analysts across the board pushed Sun to answer some tough questions. They've started calling more and more for Sun to bring in a strong number 2 to back McNealy up and are asking to see near-term results from a company that has very much a long-term strategy.

If Sun's current software strategy does not start helping the bottom line quick, it's only going to get uglier for Sun in the coming quarters. The company has plenty of cash to wait for its hardware bets such as multicore chips to pay off, but one wonders if the fierce financial mob will get to it before then. ®

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