Sun: Laggard or gaining momentum?

Sun Microsystems is becoming a bit of a battleground company for analysts. On the plus side, Sun has implemented good cost controls and ongoing profits. The negative: There's no growth.

Given these two largely offsetting developments it's no surprise that analysts are torn. Sun reported fiscal first quarter net income of $89 million, or 3 cents a share, on revenue of $3.22 billion. Revenue was up just 1 percent from a year ago--and that was helped by a weak dollar. On the bright side, Sun's earnings were on target despite a $113 million restructuring charge. Meanwhile, gross margins in the quarter were 48.5 percent, up 5 percent from a year ago.

Sun's earnings were in line with Wall Street estimates, but revenue fell short of targets.

Demand in the U.S. was weak (down 4 percent), international was strong (up 6 percent in Asia Pacific) and the financial services sector showed some slippage, but nothing dramatic. As for Sun's outlook, the company projected fiscal 2008 revenue growth in the low to mid single digits.

A few takeaways:

• Buyers are waiting for quad-core systems, a move that's holding back current demand.
• Sun did mention some slowdown in financial services demand like IBM did. Enterprise spending is sluggish to stable but not unraveling.

So what do we make of Sun (all resources) these days? It's a company that changed a ticker (JAVA from SUNW), but still sees Unix on the wane as its various software initiatives like open source Solaris have yet to yield gains.

"While we think Sun's cost controls and profitability improvements are a positive, we remain skeptical on Sun's ability to demonstrate sustainable revenue growth in the future," says Wachovia analyst David Wong in a research note.

But Citigroup analyst Richard Gardner upgraded Sun from sell to buy based on the quarter. "With the introduction of its  second-generation  differentiated Niagara chip architecture, the additionofIntelto its x86 lineup, and the introduction of Rock in  CY08, Sun looks to have a competitive server line from top to bottom for the first time in seven years," writes Gardner.

Gardner reckons that Sun won't deliver revenue growth right away, but the company has improved its profit and loss statement enough to matter to investors.

Sun's biggest challenge is to get its expense cuts, demand and profit margins going in the same direction. Right now Sun is a mixed bag. On the product front, storage is struggling and analyst expect a better processor and server product cycle in the second half of 2008.

Until then it's really wait and see with Sun.

Other odds and ends from Sun's earnings conference call:

On server unit shipments declining for three straight quarters CEO Jonathan Schwartz said:

I think there's obviously the trend in the server marketplace now isn't to buy lots and lots of little servers. It's to buy smaller numbers of very large servers if not to buy them racks at a time, and then simply virtualize them and run them logically as if they are lots of little things but in reality manage them as a small number of big things.

So I'm not exactly convinced that we're going to see a big rush to tower servers and one-way product out in the marketplace. I think if anything, we're seeing the experience and expertise we have in building very high scale systems is now putting us in a position to go consolidate away a lot of the low end systems, but that's a good trend. I think that simply means that enterprises are going to get more efficiency out of the infrastructure they own and they are going to look to vendors that have the expertise in how to run very large scale systems as among the more appealing.

On why Sun doesn't cut prices to stoke demand, Schwartz said:

I'm not convinced we're leaving a lot of demand behind for price right now, and frankly, for some of the systems that we're selling pricing is not the number one issue. It's the efficiency of the overall management of the platform. So we're certainly going to be investing and growing our market and growing our share. That doesn't necessarily equate to dropping our price to win business because again frankly, for a lot of the customers we're talking to, price is really second.

Acquisition price is by far and a way less interesting than total cost of operation over a long period of time, and for again, many of the customers we're talking to, power actually is beginning to exceed the cost of the device itself. So in a couple of our geographies quite literally the power bill exceeds the price of the server. As that happens, that means our ability to deliver highly efficient systems and to put the money into go building those markets becomes an avenue to grow, not simply standing still in our existing customer base and simply dropping price.