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

Sun Microsystems CEO Jonathan Schwartz Justin Sullivan/Getty Images

by Aaron Ricadela and Peter Burrows

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 (BusinessWeek.com, 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.'"