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Setting Sun

In light of a surprising third-quarter loss, analysts sound cautionary notes and CEO Schwartz announces plans to lay off up to 2,500 employees

A day after posting its worst financial results in more than a year, Sun Microsystems (JAVA) announced May 2 that rock musician Neil Young would join its executives on stage in San Francisco to promote a new music project that uses Sun's Java programming language. Young's appearance at Sun's annual JavaOne conference May 6 may grab headlines, but it surely won't help the worsening business fortunes hammering Sun's already battered shares.

Just when it looked like the embattled computer maker was emerging from a multiyear spiral, an unexpected third-quarter loss reported on May 1 sent Sun's shares even lower. The stock, temporarily buoyed by a one-for-four reverse stock split in November, 2007, fell sharply—tumbling $3.69, or nearly 23%, to close at 12.64 on May 2. The results suggested a turnaround begun under CEO Jonathan Schwartz may be losing steam and fueled concern the economic slump is taking a bigger toll on Sun than on peers.

In the quarter that ended Mar. 30, Sun suffered a loss of $34 million, or 4¢ a share. Wall Street was looking for a profit of 18¢. The fiscal third-quarter results ended a five-quarter profit streak for Sun. During a conference call with investors, Schwartz said Sun's U.S. business customers postponed buying decisions in March amid uncertainty over U.S. economic growth. Schwartz, who succeeded co-founder Scott McNealy as CEO in 2006, also said he'd cut as many as 2,500 jobs.

The results include costs of 4¢ per share for Sun's $1 billion acquisition of database-software maker MySQL (, 1/17/08) in January and a $52 million tax charge. Excluding those costs, results still disappointed. Sales were $3.27 billion, missing analysts' estimates by more than $100 million. To top it off, the company said fourth-quarter sales would be flat compared with a year ago, while Wall Street expected sales to grow 3%.

Hopes for Recovery

Sun's shares "are now a 'show-me' story and only appropriate for patient investors," Citigroup (C) analyst Richard Gardner wrote in a May 2 note to clients. Gardner, who rates the stock a high-risk buy, also questioned whether a 28% drop in sales of server computers based on Sun's Sparc chip were solely a reflection of economic weakness in the U.S., or whether corporate buyers are forsaking Sun's technology in greater numbers. "Many investors will wait for assurance that Sparc weakness is solely macroeconomic related," he wrote.

Schwartz has preached a gospel of increasing Sun's market share, giving away more software, including the company's once prized Solaris operating system, to sway customers to stick with its hardware and slow defections of customers to cheaper technologies. Many analysts considered Schwartz's approach Sun's best hope for recovery, but to date the moves haven't generated massive support from developers and corporate buyers. Sun may need another breakthrough product—like networked computing in the 1980s or its Java programming language in the 1990s—to regain relevance.

Until that happens, Sun's focus on cutting-edge innovation during an economic slowdown—when many tech buyers focus on the most pressing IT needs—may in fact backfire. "Sun is always pushing the most interesting new technology," says Dan Kusnetzky, president of tech consultancy the Kusnetzky Group. "But companies often say, 'That's an interesting idea, but we'll focus on what works today.'"

Casting More Doubt

Sun was one of the hardest hit computer companies after the crash of Internet and telecom companies earlier this decade, racking up billions of dollars in losses. The company was also slow to react to an industry transition to low-cost computers that run on chips from Intel (INTC) and Advanced Micro Devices (AMD), rather than more expensive servers that run on Sun's own Sparc processors. Total revenue from computers running the Unix operating system, including those using Sparc and Sun's newer Niagara chips, fell 11% in the quarter.

The latest results contrast with positive first-quarter results reported by other tech companies, including IBM (IBM) and Google (GOOG) (, 4/17/08), and cast doubt on whether Sun can regain a central role in the computer industry. "When we look at turnarounds, we hold companies to a specific standard: we expect them to meet milestones set for investors and get concerned when they miss against what we assume are conservative goals," Bear Stearns (BSC) analyst Andrew Neff wrote in a May 2 research note. Neff, who lowered his rating on Sun to peer perform, said Sun has not successfully negotiated the slowdown, unlike IBM, EMC (EMC), and Hewlett-Packard (HPQ).

Cutting Back

In light of the weakness, Schwartz announced a layoff to cut expenses, the third of his regime. Sun eliminated more than 4,000 jobs in May, 2006, shortly after Schwartz became CEO. Another 1,600 jobs were cut in September, 2007. The new layoffs would eliminate 1,500 to 2,500 jobs, resulting in a charge of $130 million to $220 million. The job cuts should lower Sun's annual operating expenses by $100 million to $150 million, with the majority of the savings reflected in the quarter that ends in December, a spokeswoman said. She declined to say what areas of the company the cuts would come from.

Sun's JavaOne announcement enticed recipients to "come hear and see what Java technology means to Neil Young." The company needs all the star power it can get right now; for their part, investors are probably identifying too closely with the words of Young's seminal song, Helpless.

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