Guidance Throws Some Shade on Sun

Updated from 4:34 p.m. EDT

Jonathan Schwartz rang in his first quarter as CEO of Sun Microsystems ( SUNW) by soundly exceeding Wall Street's top-line projections Tuesday.

But the company's cautious guidance for the current quarter mitigated the initial lift that the company's shares received from the financial report.

The Santa Clara, Calif., computer company lost $301 million, or 9 cents a share, for the three months ending June 30. But those results included various charges such as $228 million in restructuring charges and $83 million for intangible asset amortization from recent acquisitions.

Excluding those charges, Sun said it had a loss of 2 cents a share compared with the average analyst expectation of a loss of 3 cents a share. At this time last year, Sun had a profit of $50 million, or 1 cent.

Sun's shares rose about 4% in extended trading initally after the report, but then moderated to a gain of 1.2%, or 5 cents, at $4.14.

Strong sales of computer server and storage hardware boosted Sun's revenue 29% from the year-ago period to $3.8 billion. Analysts polled by Thomson Financial were expecting $3.6 billion in sales.

Sales of the volume servers featuring between one and eight microprocessors, which comprise the bulk of Sun's server business, grew 21% year over year, while the company notched more than $100 million in sales of its recently introduced servers featuring the Niagara chip.

"We're making progress returning Sun to growth and profitability," said Schwartz in a statement. "Revenue, bookings and backlog are all up substantially -- indicating we're gaining traction, market confidence and share."

Schwartz replaced Sun co-founder Scott McNealy as CEO in April. Since then, Sun has announced sweeping organizational changes, including layoffs of between 4,000 to 5,000 employees and the sale of its Newark, Calif., office campus.

"These first weeks and months have been especially busy," Schwartz told analysts during a conference call Tuesday. "We wasted no time in making some tough decisions."

According to CFO Michael Lehman, Sun expects its first-quarter revenue to decline "at least" 20% sequentially, which he said was in keeping with historical patterns.

The average analyst expectation called for Sun to generate $3.1 billion in first-quarter sales, representing a 14% decline from the average revenue estimate for the fourth quarter.

Given the better-than-expected fourth-quarter performance, Sun's sales guidance appeared surprisingly gloomy and somewhat out of whack with its recent sales trends at this time of year.

Last year, Sun's first-quarter sales dipped only 8% sequentially. In fact, the last time the company's sequential revenue decline surpassed 20% was in 2001.

Sun executives acknowledged that the company was setting its spending levels based on a conservative outlook to ensure that it hits its margin targets, and cited the seasonality of the recently acquired StorageTek business.

Sun expects first-quarter gross margins to dip from the 42.8% level achieved in the fourth quarter. But Lehman said the company remained confident that it would hit its fiscal 2007 target of gross margins between 42% and 44%.

Additionally, the company continues to aim for 4% operating margins by next year's fourth quarter, it said.

With competition in the market for corporate servers especially fierce, CEO Schwartz hinted that some of Suns' sales growth in the just-ended quarter had come as a result of price cuts, saying that the company was more willing to "throw price in the mix."

"I think it's fair to say that we have entered a new era in which we are adding new customers," said Schwartz, noting that the company was determined to make the barriers to adopting Sun's products as low as possible.

After seeing its customer base wither in the wake of the dot-com implosion, Sun has taken steps to reinvent the company and diversify its product line. The company began selling low-cost servers based on the Advanced Micro Devices ( AMD) Opteron processor as well a new line of servers featuring its Niagara chip.

Earlier this month, Sun introduced the so-called Thumper machine, an innovative piece of equipment that combines the traditionally separate server and storage hardware.

The company has also begun giving away its Solaris operating system for free and made it open source -- a plan designed to win over developers who Sun hopes will in turn build Internet services based upon its products.

According to Sun, the company saw strong sales growth into the telecommunications, energy and government sectors, among others, during the fourth quarter. And more than half of the 15 geographic regions in which Sun operates experienced double-digit revenue growth for Sun from the year before.

Going forward, Schwartz indicated that fattening the top line would remain a priority.

"Growth is the best way to deliver that operating margin," said Schwartz, referring to the 4% operating margin target. "Just sitting here and cutting costs is a short runway."

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