McNealy Skips as Sun Stumbles on Sharp Growth Slowdown

Updated from 5:07 p.m. EST:

Can't say you weren't warned about this warning.

Sun Microsystems' (SUNW) Thursday analyst call managed to match up to its dark billing, as the maker of Unix servers slashed third-quarter earnings and revenue guidance by half.

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Down, Down, Down They Go -- Until Something Good Happens

Sun cut third-quarter earnings guidance to 7 to 9 cents a share from the expected 15 cents and said revenue would grow 10% to 13%, well short of the 30% analysts were looking for. The stock has plunged over the last week as investors worried Sun would make just such an announcement on the regularly scheduled quarterly call.

Clouding Over

Sun blamed the shortfall on the general tightening in corporations' budgets for capital spending. But operating chief Ed Zander stressed that Sun was not seeing any cancellations of backlogged orders. "My take is, they just put the brakes on it," he said. "They just woke up one morning and told their IT departments and purchasing departments, Stop."

Sun declined to provide earnings or revenue guidance for the fourth quarter, citing the now-standard lament that the company lacks visibility, or the ability to forecast customers' ordering trends. Sun did mention that third-quarter gross margins would fall 2 to 3 percentage points from second-quarter levels, suggesting competitive pressures may be increasing or that Sun is suffering from an inventory overhang as customers cut back on spending.

Responding to the latter possibility, CFO Michael Lehman told analysts that they should expect third-quarter inventory to stay "relatively flat" from their level in the second quarter -- a period in which inventory rose 17.3% sequentially despite essentially no revenue growth. Meanwhile, Sun asserted that it was seeing "no major change" in channel inventory, or inventory held by the company's resellers. An analyst report released Wednesday had claimed that Sun's channel inventory was at a three-year high.

Sun shares dropped to $19 in after-hours trading on Instinet after closing up 6% at $20.81 during the regular session. The stock has dropped more than 20% in the last week and is down 40% for the year. Noting the weakness in its shares, Sun said on the call that it would seek to buy back some $1.5 billion in shares.

"We believe our stock is undervalued," said Lehman. "It's one of the best investments we can make right now."

Do As I Say...

True to recent form, Zander implored investors and analysts to look past the near-term uncertainty and focus on the big picture -- the story that Sun continues to build market share against competitors such as Hewlett-Packard (HWP), IBM (IBM) and Compaq (CPQ). Zander stressed the company's decision to increase its spending on research and development by 20% in the third quarter despite the cloudy outlook. "We think that's best for our shareholders," Zander said.

Notably, CEO Scott McNealy failed to appear on the midquarter conference call, despite his scheduled appearance, advertised on the company's Web site. Zander, picking up for the notoriously confident McNealy, insisted in spite of the sharp reduction in earnings and revenue estimates that the company's workers are "pumped."

But it's hard to get jazzed about tech after a day like Thursday, which brought a warning not just from Sun but also storage-systems king EMC (EMC). These were once two of the stock market's most beloved growth stocks, New Economy titans whose position as the leading suppliers of the nuts and bolts of the Internet economy had once convinced investors that one simply could not afford to bet against them.

Now, buying tech stocks looks at least as discretionary as the budgets corporations once had earmarked for additional storage and servers. Anyone still pumped?

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