Sun warning shakes after-hours traders

The company now sees third-quarter revenue of $4.41 billion to $4.53 billion. Analysts expected a lot more.

3 min read
Shares of Sun Microsystems slid more than 10 percent in after-hours activity after the company said it could miss consensus estimates by more than 50 percent in the third quarter.

During a Thursday conference call with analysts, executives for the maker of servers and network software said they now expect the company to report earnings of 7 to 9 cents per share, or possibly less than half of what Wall Street expected. Analysts surveyed by First Call predicted a profit of 15 cents per share for Sun's fiscal third quarter, which ends in March.

The company now sees third-quarter revenue growth of 10 percent to 13 percent year over year, which would result in sales of $4.41 billion to $4.53 billion. First Call consensus was predicting revenue of $5.25 billion.

Sun's third-quarter revenue increased 35 percent a year ago.

Shares of Sun traded at $19 in after-hours activity on the Island ECN, following the analyst call. Sun closed Thursday's regular trading at $20.81 ahead of the news.

"Believe me, it's the U.S. economy," said Ed Zander, president and chief operating officer. "That's the major factor here."

Sun on Thursday also announced a $1.5 billion stock buyback. The company's shares have fallen 68 percent from their 52-week high.

Corporations are delaying Internet and networking initiatives, said Zander, who was surprised about the abrupt slowdown in technology spending. "I don't know that I can recall something so sudden and of such magnitude in my career," he said.

Sun's original revenue targets could have withstood dot-com companies' collapse and telecom companies' spending cutbacks, Zander said, but a broad-based decline in spending is another story.

"That real thing that caught us in December, and continued in January and February, was the major corporations in the United States," Zander said.

Sun's business outside the United States is still on track with the company's original goals, he added.

Despite the slowdown, Sun will continue to increase research and development spending, executives said. The company plans to add 1,500 to 2,000 workers in the current quarter, although hiring will be less than 500 in the fourth quarter, CFO Michael Lehman said.

"We are not going to overreact to the near-term uncertainties," he said.

Because investments in research and development will continue and the company's manufacturing ability will be maintained, Sun's gross margin will fall 2 to 3 percentage points to 45 percent, Lehman said.

"Absent volume (growth) over the absolute levels that we're talking about for Q3, we're not going to see a major improvement in gross margin," he said. "We don't want to take out capacity, that's not what we're here for. We want to grow the business."

Company executives maintained a generally upbeat front. The company continues to gain market share against rivals such as Hewlett-Packard and IBM, Zander said.

"I would be way more concerned if we were losing business to our competitors, if we had major product issues, and we had major problems with our strategy," he said. "And nothing is further from the truth."

The company's long-term optimism won't stop Wall Street from being concerned, said Shebly Seyrafi, analyst with A.G. Edwards & Sons.

"A lot of people expected Sun to use this opportunity to lower guidance...but what really surprised investors is the magnitude of the decline," Seyrafi said.

A small part of the revenue shortfall can be traced to a continuing shortage of UltraSparc III chips, Sun executives said. And the company might be able to make up for some of the revenue decline by improving storage sales, Seyrafi said.

"But that's nit-picking," the A.G. Edwards analyst said. "The big item is the macroeconomic environment."

Look for shares of Sun and technology companies in general to fall in Friday's trading, Seyrafi said. Sun's market share gains mean little, he added.

"That's not what investors want to hear," he said. "They want to hear that revenue is growing without profit margins declining. Gaining market share when Hewlett-Packard is distracted by a tanking PC business is not terribly impressive."

Sun doesn't have a clear view of demand in the fourth quarter, executives said. "We're not sitting here prepared to tell you when it's all going to get better in the U.S.," Lehman said.

That makes Wall Street even more nervous. "If you asked me a month ago, I would have said the rebound would be in the second half," Seyrafi said. "Now, with this capitulation you're seeing from several companies, you're looking at Q4 at the earliest."