Sun Sales Cast Shadows

The company turns a profit, but revenue falls short in the third and coming quarters.
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Updated from 5:01 p.m. EDT

For the first time in three years,

Sun Microsystems

(SUNW) - Get Report

delivered two consecutive quarters of profit.

But the feat won Sun no points from the Street, as investors seemed more concerned with the Santa Clara, Calif.-based company's weak sales report and sold off the company's stock in extended trading Tuesday.

Shares of Sun recently tumbled 5.9%, or 35 cents, to $5.59.

Revenue declined 8% sequentially to $3.28 billion in the three months ended April 1, below analysts' expectations as well as the company's own guidance, which called for sales to slip between 3% and 5% in the seasonally-slow fiscal third quarter.

Echoing recent comments from

IBM

(IBM) - Get Report

, Sun's management pointed to the U.S. market as the cause of slowing sales.

According to CFO Mike Lehman, Sun sales hit a speed bump at the end of March, marring what had until then looked like a normal sales pattern for the time of year.

"In this quarter the normal seasonality was exacerbated by the U.S. and U.K. slowdown," said Lehman.

Hardest hit were Sun's server business, which saw sales increase 1.8% year over year. Data management products experienced a 0.2% decline in sales.

The results could hint at trouble for Sun, which has been taking a variety of steps to reinvigorate its product line, including introducing machines based on industry-standard processors from

Advanced Micro Devices

(AMD) - Get Report

and

Intel

(INTC) - Get Report

, as well as developing new versions of its Sparc processor geared toward Internet businesses.

In a postearnings conference call, Sun executives sought to reassure investors that the sluggish sales were the result of customers waiting for Sun to introduce new versions of its products later this year.

"This is not a competitive issue. This is not a product issue. For us this seemed to be a lot of customers saying 'I made the choice, I'm just going to execute on the purchase order in the next quarter,'" said Sun CEO Jonathan Schwartz.

The selloff came even as Sun made good on its promise to investors that the $126 million profit it reported in January was not a one-time fluke.

Sun came through in the recently ended quarter, with net income of $67 million, or 2 cents a share, vs. a loss of $217 million, or 6 cents a share, at this time a year ago.

The last time Sun had back-to-back profitable quarters was in 2003.

Sun said its latest results included charges for stock compensation expenses, which reduced its EPS by 2 cents. In addition, 2 cents in accounting adjustments and amortization relating to Sun's 2006 acquisitions were included.

It was unclear whether the average analyst expectation that called for Sun to earn a penny a share included any of these items.

Sun's gross margin was 44.5%, vs. 45.2% in the fiscal second quarter. CFO Lehman said Sun managed to maintain gross margin in the face of slowing sales thanks to lower overhead costs, lower component costs and management of inventory levels.

Cost-cutting has also played a big role within the company's turnaround plan. In May, Sun said it would consolidate its real estate holdings, selling its Newark, Calif., campus, and lay off up to 5,000 workers

in order to hew costs.

Though the company reported an operating loss in the quarter, Sun insisted it was still on track to deliver a 4% operating margin in the current quarter.

Sun projected that sales will increase between 15% and 18% sequentially in the current quarter, suggesting a range of $3.77 billion to $3.88 billion. Analysts were looking for Sun to report $4 billion in sales with EPS of 6 cents in the current quarter.

Sun said its gross margin in the fiscal fourth quarter would range from 42% to 44%.