Staff Writer, CNET News.com
April 15, 2004, 6:20 PM PT
Sun Microsystems reported on Thursday a loss of $760 million, or 23 cents per share, on revenue of $2.65 billion for the quarter ended March 28, a loss in line with a Sun warning two weeks ago. The revenue declined 5 percent from the $2.79 billion garnered in the year-ago quarter, hurt by the transition to products based on the new UltraSparc IV processor, slow sales in Japan and price discounts triggered by fierce competition with IBM, Dell and Hewlett-Packard.
Leaving the company are Neil Knox, executive vice president of lower-end servers, and Mark Tolliver, chief strategy and marketing officer, Sun said Thursday. Clark Masters, executive vice president of the high-end server group, will leave the post but is considering other jobs at Sun, spokeswoman May Petry said.
Two executives will take over the responsibilities of Masters and Knox. Microprocessor chief David Yen, 52, will add to his responsibilities management of the high-end and low-end servers using Sun's UltraSparc processor, while software Chief Technology Officer John Fowler, 43, will add to his job the management of the lower-end server business using "x86" processors from Intel and Advanced Micro Devices, Sun said.
The change—the second high-level executive shake-up in two years—comes as Sun is dealing with 3,300 layoffs, the promotion of software chief Jonathan Schwartz to chief operating officer, worse than expected financial results for the first quarter of 2004 and a major new partnership with longtime enemy Microsoft.
In an interview, Schwartz said he made the choice to change management. "I'm making the decisions about the leaders that report to me...We are making sure we end up with the right leaders," he said. "We're interested in getting Sun on the right foundation with respect to leadership, with respect to technology and with respect to business models."
Although the server market once again is growing, Sun has struggled to return to profitability and has lost share to Dell and IBM. But Sun argues its cash and marketable securities—$5.5 billion at the end of March, with another $1.95 billion just received from Microsoft—means it's around for the long term.
"The wire transfer, I'm happy to report, went off without a hitch," McNealy quipped about the infusion from Microsoft during a conference call. "The $7.5 billion in cash takes the viability thing and makes it a ridiculous question."
Cash will come in handy, since Sun is willing to sacrifice server price to preserve shipment quantities in order to build the foundation for the company's push toward recurring revenue, McNealy said. To increase recurring revenue Sun plans to package hardware and software that customers pay for as a subscription; one example is the dual-processor server Sun sells with development software that costs $1,499 per year for three years.
McNealy also dismissed skepticism that the Microsoft partnership would result in true cooperation, with products that work well enough together that customers can easily select one or the other largely interchangeably. "It allows each of us to be second sources to the other," McNealy said.
"If we do this right, Sun and Microsoft will end up on the short list facing off against each other and facing a larger percentage of the IT (information technology) budget than we did before, and our joint competitors will get a smaller percentage of the dollars," McNealy said. "We will still compete like crazy."
The first shake-up occurred in 2002, when Chief Operating Officer Ed Zander left, strategy chief Schwartz was promoted to executive vice president of software, Chief Financial Officer Mike Lehman retired, and server and processor chief John Shoemaker retired.
That last management shake-up was announced over a period of months, though Sun argued it was part of a unified action. This time around, Schwartz wouldn't say whether Thursday's changes would be followed by more. "Change is a constant," he said.
Among Fowler's tasks will be overseeing Sun's coming line of servers based on AMD's Opteron processor. Sun's future Opteron servers will be based on designs from Kealia, a start-up Sun acquired that's run by Sun co-founder Andy Bechtolsheim.
Sun closed its Kealia acquisition Thursday, Chief Financial Officer Steve McGowan said in a conference call Thursday. The price was 20 million Sun shares, or $88.4 million at Sun's closing stock price of $4.42.
Filling in for Tolliver, as interim chief marketing officer, is Anil Gadre, 47, Sun said. In addition Brian Sutphin, 49, was named vice president of corporate development.
Knox, Tolliver and Masters couldn't immediately be reached for comment.
Given Sun's challenges grappling with the arrival of the Linux operating system and x86 servers, major changes aren't unexpected, said Meta Group analyst Tom Murphy. "I wouldn't say you could look at (Masters and Knox) and say they've done a cruddy job, but have they driven great breakthroughs? The revenue is down, so it would appear things have got to change," he said.
The $760 million loss posted Thursday includes a $300 million noncash charge for an increase in the valuation allowance for deferred tax assets, a $203 million charge for work force and real estate restructuring and a $3 million gain on equity investments. Excluding these unusual amounts, the loss was 8 cents per share, Sun said, a penny deeper than the 7 cents per share average expected by analysts surveyed by First Call.
After Sun warned of the troubled quarter earlier in April, analysts had lowered their revenue expectations from $2.79 billion to $2.65 billion and their forecast for net loss per share from 3 cents to 7 cents, First Call said. Sun's results were within the lowered range.
Sun began selling its new UltraSparc servers late in the quarter but wasn't able to meet demand, McGowan said in a conference call. The company had market demand for $70 million worth of the new systems but actually booked revenue only for $20 million of that, he said.
Sun canceled its UltraSparc V processor but still is wedded to the chip family in spite of competition from IBM's Power, Intel's Xeon and Itanium, and AMD's Opteron. McNealy said the UltraSparc V cancellation will allow Sun to move more quickly to its successor code-named Rock and previously code-named Project 30x because it's designed to be 30 times faster than a 1.2GHz UltraSparc III.
In addition, Sun plans to introduce a faster UltraSparc IV, code-named Panther and called the IV+, within a year, McNealy said.
Sun is laying off 3,300 employees, about 9 percent of its work force and its third major cut in the last three years, as the Santa Clara, Calif.-based company attempts to regain some of the prominence and profitability it enjoyed in the late 1990s. Most of the cuts will take place this quarter, the last of its fiscal year, Sun said.
The layoffs are part of a plan to cut $500 million from the company's operating expenses in fiscal 2005. Other changes will include outsourcing administrative tasks to companies that specialize in the work, Sun has said.
Sun is making gains in its effort to increase its recurring revenue, money customers pay regularly rather than on a one-time basis, Sun said. For example, the company has grown the number of subscribers to its Java Enterprise System server software—for which the company charges each customer $100 per employee per year—from 46,300 in the quarter ended September 2003 to 93,000 in the quarter ended December 2003 to 174,400 for the quarter ended March 2004.
About a third of the company's revenue is recurring, coming from areas such as services and contracts to manage customers' computing infrastructure. The company's goal is to increase that to half, and ultimately it may reach as high as two thirds, McGowan said.
But Richard Chu, an analyst at S.G. Cowen, expressed concern that Sun's Java Enterprise System subscription growth doesn't make for a financial windfall. "To come up with meaningful profit stream, you've got to get up to not 500,000 employees, but 10 million or 100 million a year," he said on a conference call.
"Absolutely. We agree," concurred Schwartz. The 88 percent subscription growth for the first quarter of 2004 "gets us to 1 million or 2 or 5 or 10 million fairly reasonably, and that's the trajectory we're driving toward.
Chu also fretted about Sun's subscription plan: "If you're going to give hardware away, you're going to bleed," he said.
But McNealy countered, "We're not giving the hardware away to run Java Enterprise System. It requires folks to buy our servers," and tows along purchases of storage, consulting, customer-ready system assembly and other revenue possibilities, McNealy said.