Sun's McNealy Steps Down

As the company reports a wider quarterly loss, it names Jonathan Schwartz to the top spot.
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Updated from April 24

Sun Microsystems'

(SUNW) - Get Report

third-quarter earnings report had a brief spotlight Monday until the company announced that longtime CEO Scott McNealy would be replaced by President and Chief Operating Officer Jonathan Schwartz.

McNealy, 51, will continue serving as chairman and a full-time employee, "devoted to expanding market opportunities for Sun around the globe," the company said. Schwartz also will keep title of president.

In early Tuesday trading, shares of Sun rose 22 cents, or 4.4%, to $5.20.

"I think Jonathan is the right person to ride Sun forward on this next big wave," McNealy said in a conference call following the announcement.

Emphasizing the continuity in the company's strategic vision going forward, McNealy said he and Schwartz "can finish each other's sentences," and described the two as being in "lockstep."

McNealy stressed that the decision to relinquish the chief executive title, which is effective immediately, was his and not the board's. "The timing fit me to a T and it was my call," he said.

McNealy founded Sun Microsystems along with Andy Bechtolsheim, Bill Joy and Vinod Khosla in 1982, and has been the icon for the "open systems" movement. He was named Sun's chief executive officer and elected chairman in 1984.

Rumors of McNealy's impending departure from the CEO chair had surfaced recently amid growing calls by Wall Street for the company to impose huge layoffs to reverse its financial struggle. With McNealy reportedly opposed to such deep cuts, some analysts wondered how long the company could carry on with current management.

McNealy said he has been working on a succession plan for the last six or seven years but that the timing was not right until now.

"I wasn't going to hand it over when the thing was deteriorating post-bubble," he said.

With Sun posting its solid quarterly sales growth in its recently completed fiscal third quarter, and having completed various transitions in its product lineup, McNealy said the time was right to hand over the reins.

Sun posted wider losses in its most recently completed quarter, but grew its top line by 21%.

The Santa Clara, Calif., computer company lost $217 million, or 6 cents a share, in the three months ended March 26, Sun said in press release Monday.

Sales were up 21% year over year to $3.18 billion, although they fell short of Wall Street expectations. Analysts polled by Thomson First Call were looking for Sun to generate $3.21 billion, with a loss of 6 cents a share.

At this time last year, Sun recorded a loss of $28 million, or 1 cent a share.

"We're growing again. Products are winning awards," said CEO Scott McNealy in a statement accompanying the financial results. "The next step is consistent profitability."

The company credited the revenue growth to recent acquisitions of StorageTek and SeeBeyond, as well as growth in Sun's traditional products. According to the company, it was the first quarter in nearly two years that Sun's business excluding recent acquisitions had experienced sequential revenue growth for both storage and servers.

Sun increased revenue in all its geographies during the quarter, with U.S. sales increasing 12% year over year on strength in the telecommunications and energy sectors.

Computer systems revenue totaled $1.47 billion up 6% year over year. And the company generated $197 million in cash from operations.

Sun's fiscal third-quarter loss included $87 million related to intangible asset amortization associated with recent acquisitions, $57 million in stock-option expenses and $36 million in restructuring charges.

The company's gross margin increased to 43% during the quarter, compared with 41.4% in the year-ago period.

For the current quarter, Sun projected that the gross margin would be flat to slightly down. Management did not provide any revenue guidance, but noted that historically, sales in the fourth quarter increase 10% to 15% sequentially.

"It is fair to expect solid sequential revenue growth," said CFO Mike Lehman.

The average analyst expectation calls for Sun to lose 2 cents a share on revenue of $3.6 billion in the second quarter.

Schwartz said the company was undertaking a comprehensive review during the next 90 days that will examine various aspects of the company's operations, although he noted that this was in keeping with Sun's typical annual review process.

And while he didn't rule out a reduction to Sun's 38,000-employee workforce, he portrayed the review as an opportunity to find new avenues of growth.

"We're looking at: How do we grow for the next 10 years? This is not about trying to figure out how we go about taking a whack at head count," said Schwartz.

Still, he said that the company's cost structure will be addressed during the review process. He noted that he will be sharing an office with CFO Lehman.

"The point is really clear we're driving after efficiency and driving after teamwork," said Schwartz, who added that the company was determined to boost both the top line as well as the share price.

One of the first tangible changes of the new regime was the appointment of Chief Technology Officer Greg Papadopoulos to executive vice president of research and development, where he will oversee all R&D at Sun along with Schwartz.

McNealy said he will take on the role of evangelist in his new role, meeting with customers and government officials across the globe. "All the indicators are showing that we have a huge market opportunity ahead of us," he said.