Sun Microsystems F4Q06 Earnings Conference Call Transcript (SUNW)

| About: Sun Microsystems (JAVA)

Sun Microsystems, Inc. (NASDAQ:SUNW)

F4Q06 Earnings Conference Call

July 25, 2006 4:30 pm ET


Jonathan Schwartz - CEO, President

Michael Lehman - CFO, EVP, Corporate Resources

Bret Schaefer - Vice President, Investor Relations


Rebecca Runkle - Morgan Stanley

Richard Farmer - Merrill Lynch

Ben Reitzes - UBS

Laura Conigliaro - Goldman Sachs

Keith Bachman - Banc of America

Toni Sacconaghi - Sanford Bernstein

Brent Bracelin - Pacific Crest Securities

Jonathan Hoopes - ThinkEquity

Andrew Neff - Bear Stearns

Chris Whitmore - Deutsche Bank


Good afternoon. My name is Katina and I will be your conference facilitator. At this time, I would like to welcome everyone to the Sun Microsystems fiscal year 2006 fourth-quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer period.

(Operator Instructions)

I would now like to turn the call over to Mr. Bret Schaefer, Vice President of Investor Relations for Sun Microsystems. Please go ahead, sir.

Bret Schaefer

Good afternoon, thank you for joining the Sun Microsystems quarterly conference call. I am Bret Schaefer, Sun's Vice President of Investor Relations. With me today is: Jonathan Schwartz, Sun's CEO and President; and Michael Lehman, Sun's Chief Financial Officer and Executive Vice President, Corporate Resources.

The purpose of today's call is to discuss the results of Sun's fiscal year 2006 fourth quarter, which ended on June 30, 2006.

During the last hour, we published a copy of the operations analysis data sheet, with nine quarters of financial and operational information, including the quarter just completed. If you have not received the announcement or the detailed financial data sheet for any reason, or you wish to hear a live broadcast of this conference call, you may log onto our website at

We posted slides you can view on the web which accompany our prepared remarks. These slides may be viewed at the same url --

The prepared remarks of our call today will last about 30 minutes, with the remaining 30 minutes devoted to the Q&A session.

During the course of this conference call, we will be making projections and other forward-looking statements regarding expected future financial results and business opportunities. Our actual future results may be very different from our current expectations. We encourage you to read the 10-K’s and 10-Q’s that we file periodically with the SEC.

These documents contain a discussion of the risks facing our business, including factors that could cause these forward-looking statements not to come true. We do not currently intend to update these forward-looking statements. In addition, during the course of the conference call, we will describe certain non-GAAP financial measures which should be considered in addition to and not in lieu of comparable GAAP financial measures.

Please refer to the results call, financial slides and the operations analysis posted on our website at, for the most directly comparable GAAP financial measure and related reconciliation.

Please note that unless otherwise indicated, all reported results include the impact of the StorageTek and SeeBeyond acquisitions for the full quarter ended June 30, 2006.

Now, let's get to the financials.

Sun's total revenues for the fourth quarter of fiscal 2006 were $3.828 billion, an increase of 29% as compared with the $2.974 billion in the revenue reported for the fourth quarter of fiscal 2005.

Total gross margin was 42.8% of revenue, an increase of 1.4 points over the gross margin for the fourth quarter of fiscal year 2005.

Total R&D and SG&A expenses were $1.676 billion, an increase of $416 million year-over-year.

In the fourth quarter of fiscal 2006, we recorded a $35 million tax provision. GAAP net loss for the fourth quarter of fiscal year 2006 was $301 million, or a net loss of $0.09 per share as compared with net income of $50 million, or net income of $0.01 per share, for the fourth quarter of fiscal 2005.

As reflected on slide 12, GAAP net loss for the fourth quarter of fiscal year 2006 included approximately $86 million, or a little over $0.02 per share principally related to intangible asset amortization associated with the acquisitions of StorageTek and SeeBeyond.

As reflected on slide 11, GAAP net loss included approximately $63 million, or just under $0.02 per share in stock-based compensation charges related to the adoption of SFAS-123R.

GAAP net loss for the fourth quarter of fiscal 2006 also included restructuring charges of $228 million and a related tax benefit of $8 million, $70 million in impairment of other acquisition-related intangible assets, $54 million in settlement income, and a loss on equity investments of $4 million. In addition, we incurred a $58 million tax charge and $14 million reduction in other income due to a repatriation of foreign earnings.

The net impact of these seven items is just over $0.09 per share. The total impact of all nine items I just covered, including intangible asset amortization and stock-based compensation charges, was approximately $0.13 per share.

Now back to revenue metrics.

Q4 products revenues totaled $2.524 billion, an increase of 31% year over year. Within products revenues, computer systems products revenue was $1.811 billion, an increase of 15% year-over-year. Data management products revenue was $713 million, an increase of 103% year-over-year.

Q4 services revenues totaled $1.304 billion, up 25% year-over-year. Within services revenue, support services revenue was $986 million, up 27% year-over-year.

Revenue from client solutions and educational services totaled $318 million, an increase of 18% year-over-year.

By geography, U.S. revenues were $1.523 billion, up 30% year-over-year. EMEA revenues totaled $1.375 billion, an increase of 21% year-over-year. APAC revenues were $657 million, an increase of 33% year-over-year. International Americas revenues were $273 million, an increase of 60% year-over-year.

With respect to some of the balance sheet items on slide 12, DSO was 64 days.

Excluding acquisitions, ending sales channel inventory was approximately $390 million or about 5.5 weeks of supply, which is within desired levels.

We ended the quarter with a cash and marketable debt securities balance of $4.848 billion and generated positive cash flow from operations of $410 million.

With that, I will turn it over to Jonathan.

Jonathan Schwartz

Thank you very much, Bret, and hello.

I wanted to remind everyone that we are about 90 days into a new team at Sun, and this call marks my and my team's first full quarter leading the company, so I am going to be brief. I am going to try to put the quarter into context and then hand it off to Mike, and we will get to your questions as quickly as we can.

As I mentioned on our last call together, which was back on May 31st, these first weeks and months have been exceptionally busy. We have conducted top-to-bottom reviews of nearly every corner of our business. We frankly wasted no time in making some tough decisions, so that we are all focused on driving consistent growth and financial performance.

At the outset, I have to say I am pleased with our initial progress and the results we are announcing today. We showed improvement across a diversity of our internal metrics and of course delivered the growth -- we continue to prioritize. Revenue growth of 29% year over year and 21% sequentially, along with substantial backlog in deferred revenue growth.

With that said, I would like to very briefly make sure you understand how Mike and I are going to be structuring these calls going forward and what you should expect to hear from us, or what we will be talking about in the future.

First and foremost, our business, the delivery of network innovations, is driven by the adoption of the Internet broadly, and our core developer platforms specifically, that being Java and Solaris.

Independent of whether we are paid up-front for that adoption, the more consumers that bank through a browser, the more banks will spend on Sun's core products. The more Java phones there are in the market, the more carriers will invest in Sun's network infrastructure. The more e-taxes are filed, the more OnStar cars are on the road, the more Verizon and Vonage grow their subscriber bases, the more auctioneers go to eBay -- the bigger the data centers they will all require.

This may sound obvious, and I am hoping it is, but I would like you all to understand the key leading indicators of Sun's business, the adoption of our core developer platforms being Solaris and Java, while you also understand our financial performance.

Looking at leading indicators, with that said, developer adoption is trending up. With nearly a billion citizens online around world, the number of registered Sun developer network numbers hit 2 million in Q4, and this is a big milestone, as we doubled the number of users in one year, adding a million new developers from all around the world, with very significant growth in China, in India, Russia and across other rapidly-growing economies, such as Brazil -- all good leading indicators.

Solaris passed the 5 million license mark downloaded since we open-sourced it, and we are nearing in on 6 million now.

Java is on a consumer tier, with the availability of Blu-ray DVD players embedded with Java technology. Java phones continue to be the world leader. I was particularly pleased we closed several multi-year deals with three of the top six mobile phone manufacturers within Q4 as well.

Not all of these events drive immediate financial benefit. Some definitely do but they all lead to growing usage of Sun's core developer platforms, which again drives demand for the infrastructure we monetize. We monetize computer systems, storage, software, and services.

Let me quickly review those businesses.

Q4's highlight was definitely our computer systems business, which had very, very solid revenue growth. This is now the second quarter in a row we have achieved year-over-year revenue gains. Analysts last quarter commented on our share gains, they showed remarkable insight.

Our UltraSPARC T1000 and T2000 systems, known as Niagara platforms, exceeded $100 million for the first time in Q4 -- this is just two full quarters after launch. This is among the fastest product ramps we have ever seen.

Our x64 business, with a totally refreshed product lineup, is now at a $500 million annual run-rate, and our volume 1 to 8 processor systems, which comprise the largest subgroup within our computer systems business, grew a great 21% year-over-year.

Our storage business, which has been combined with StorageTek for nine months, is now realizing top-line benefits for us. The standalone StorageTek business grew revenues in the mid- to high-single digits year over year. Mike will provide some additional information on cost actions related to StorageTek in a few minutes but we definitely saw in Q4 some of the revenue synergies we anticipated when we announced the acquisition.

Services revenues were up 25% year over year and up approximately 1% on a Sun stand-alone basis, which is slightly better than our expectations, given the fact that service revenues were impacted by softer product sales from one to two years ago and the mix shift toward lower-end systems. This also represents good field execution.

Sun's overall software revenues declined 8% year-over-year, reflecting continued changes in our business model towards subscription-based pricing and in contrast, our OEM software revenues including Solaris and Java, increased 23% year-over-year, reflecting some great design wins in key market segments.

In summary, this quarter's performance was an encouraging step toward our longer-term goal of greater than 10% operating margin. Q4 performance was also a validation of our statements on May 31st that we have increasing confidence in the stability of our business, driven by the growing adoption of our core developer platforms.

Hopefully that gives you at least a top-level overview of how we are focusing our time and energies, growing both leading indicators and continuing to execute on the business to deliver value and financial results. They are all important and both drive the long-term value of our overall business.

With that said, and for more details and specifics, I would like to pass it over to my officemate, Mr. Lehman. Mike.

Michael Lehman

Thanks, Jonathan, and good afternoon, everyone.

Jonathan has given you a good sense of the Q4 revenues. I will supplement his remarks with a bit more geography and business flavor. I will also take you through the Q4 income statement, as there are a number of one-time items that we want to be sure you understand.

I will also give you an update on how we see the current quarter shaping up, and talk a bit about additional ways to measure us as we progress throughout the fiscal year.

As I previously mentioned, we are looking at how we can increase transparency of our reporting in FY07, and intend to report the Q1 results by looking at revenues in four categories, namely Systems, Storage, Software, and Services.

Having said that, it is clear that products growth in Q4 was the strongest it has been in years, no matter how you look at it. The sequential revenue growth of over 20% was truly exceptional, especially given that it was not largely driven by any one-time items.

In fact, the last time Sun reported sequential revenue growth from Q3 to Q4 of more than 20% was in fiscal 2000.

You will note that our Sun stand-alone product backlog at $1.099 billion was up sequentially by approximately $119 million.

Further, as mentioned above, the revenue growth was fairly broad-based from both the geography and industry bases. For example, in the former Sun stand-alone business, more than half of the 15 geographies we measure had double-digit product revenue growth year over year. As I looked at preliminary reports covering industries, I saw wins in energy, education, government, financial services, telco and transportation, to name a few.

We are encouraged by the acceptance of our UltraSPARC T1 processor-based Niagara servers and the continued growth of the Opteron processor-based Galaxy family of servers, as well as a few big noteworthy wins with the Sun Fire E25K product.

With overall storage revenues showing growth, we are beginning to see top-line benefits from the relationships established by the StorageTek and Sun sales teams.

Revenue clearly was the highlight story in an eventful Q4.

If you turn to gross margins, slide 8, you will note that the overall gross margin percentage decreased by approximately 0.2% sequentially.

You will note that service margins increased about 3.7 points sequentially, which is expected in the fourth quarter, as seasonally increased revenues outpaced any incremental costs, while product margins declined sequentially by just over 2.3 points. The latter is largely driven by changes in volume and mix.

We shipped a greater portion of low-end servers, the Niagara and Galaxy products, and although we shipped an increased number of high-end systems, we are not able to recognize revenue on a number of those due to requirements for installation and/or acceptance.

You will note on slide 4 that total deferred revenues have increased substantially sequentially. We also experienced some of our highest growth in parts of Asia and Latin America, where gross margins are slightly less due to channel participation.

Further, our software revenues were slightly less as a percentage of overall revenues, as we continued to migrate our software products towards either open-source or subscription-based pricing.

In other words, we expect continued decreases in up-front licensing revenues in the near-term, as we monetize our software products in the form of services and/or recurring subscriptions.

All-in-all, we are quite satisfied with the gross margin.

We have a number of longer-term initiatives being pursued which will help us maintain gross margins in this range as we go forward.

We do expect that gross margins will decline in Q1 due to the normal seasonal volume declines in both product and service revenues that we experience. However, for the entire fiscal year, we still expect gross margin to be in the range of 42% to 44%.

Turning to slide 9, total R&D and SG&A expenses increased by approximately $133 million sequentially, excluding the restructuring-related items. The principal components of the sequential increase are:

  • Commissions related to higher revenues;
  • Annual incentives related to revenue and cash generation performance;
  • Increased compensation and benefits, including having nearly one additional week during Q4; and
  • Certain expenses, such as prototype spending, incurred prior to the launch of the x64 products in early July.

The company did an outstanding job remaining focused on the fundamentals during Q4, including shipping product, controlling inventory and managing the overall cash conversion cycle.

I will discuss the outlook for total operating expenses in a moment.

I also encourage you to look at the other slides we provided, as the company continued to focus on cash generation and asset management very effectively. As noted, we generated approximately $410 million of cash from operations during the quarter.

You will also note that our total stock-based compensation and amounts recorded for recurring purchase accounting were right in line with what we had expected.

During our Q3 results conference call, we indicated we were considering repatriating cash from offshore, as an opportunity to do so was provided by recent U.S. legislation. During Q4, we did in fact return approximately $2 billion of cash to the U.S.

As a result of that, we incurred a one-time charge to the income tax provision of $58 million, which is included in the Q4 amount reported. We also incurred a charge of approximately $14 million for liquidating certain investments. This charge is netted against reported interest and other income in Q4.

This repatriation allowed us to take advantage of a limited window provided by legislation for a favorable tax treatment.

Turning to restructuring, as we outlined in May, we have a number of ongoing initiatives aimed at lowering the run-rate of our total spending.

During Q4, we initiated the following restructuring activities:

  • Sale of our Newark, California campus -- as previously reported, the sale closed in early July and we have received just over $210 million from that sale. We will lease back a small part of that facility during most of this fiscal year as it takes a while to move certain labs and IT infrastructure to other Bay Area campuses;
  • We announced the closure and ultimate sale of our Puerto Rico manufacturing facility;
  • The closure and ultimate disposition of our Toulouse engineering and manufacturing facility;
  • The Louisville, Colorado facility has been classified as held for sale -- as such, we have a plan to vacate that campus as well during the next 9 to 12 months;
  • Also, we announced a reduction in force that is estimated to amount to between 4,000 and 5,000 people during the next nine months; and
  • We announced the cancellation of a number of R&D projects, some of which affected existing or acquired technologies.

As a result of those actions, we have recorded restructuring charges of approximately $228 million in Q4 and a further charge of approximately $70 million that reflects the impairment of previously-acquired intangible assets.

In addition, restructuring accruals associated with headcount and facilities actions, contract termination costs, taxes and adjustments to other accrued liabilities related to StorageTek and SeeBeyond, totaling approximately $70 million have been adjusted against good will.

I would like to reiterate that we have given guidance to the effect that we are targeting GAAP operating income of at least 4% of revenues during Q4 of this fiscal year.

The restructuring activities noted above, as well as other initiatives underway, do not all result in immediate run-rate savings. That is why we believe the best way for you to measure us in FY07 is to understand our revenues and market share position, which we can discuss each quarter, and to watch our progress towards our Q4 operating income target.

We do not expect to get to the operating income target in a linear fashion, which makes it a bit difficult to measure our progress with models.

Jonathan and I and his entire team are committed to monitoring the progress of all initiatives, and to take whatever steps are necessary for us to achieve that goal.

The actions that we announced late in Q4 are a good start and we need to complete implementation of those during the next three to eight months.

There are other measures being pursued which, although less visible externally, will also help lower our run-rate. We will have ongoing restructuring charges in at least the first three quarters of this fiscal year, as GAAP determines the period in which such actions can be reported.

With regard to Q1, there are a few things you might keep in mind as you look at our business model.

Historically, when one looks at the former Sun stand-alone business and the seasonality associated with the former StorageTek business, you would note that revenues from Q4 to Q1 decreased at least 20%. We expect that pattern to continue this year.

I mentioned that we expect gross margin in Q1 to decrease due principally to the volume reduction, but believe the gross margin for the year will remain between 42% and 44%.

In Q1, we currently expect total R&D and SG&A expenses, excluding any additional restructuring charges, to be in the range of $1.45 billion to $1.55 billion.

Finally, I would point out that you should still look for the following to be included in our entire FY07 business model:

  • We expect amortization with StorageTek and SeeBeyond acquisition-related intangible assets of approximately $70 million per quarter;
  • We expect stock-based compensation of approximately $60 million per quarter;
  • We anticipate an annual tax provision in the range of $200 million to $250 million;
  • We expect net interest income of approximately $30 million per quarter;
  • We expect annual capital spending to be in the range of $300 million to $500 million;
  • We are targeting a cash conversion cycle of approximately 30 days by the end of FY07, which would allow us to generate positive cash flow from operations for the full fiscal year;
  • We expect total operating expenses for fiscal '07 to be in the range of $5.6 billion to $6.0 billion, excluding any amounts related to restructuring, but including amounts related to stock-based compensation and amortization of purchased intangibles;
  • There will be fluctuations in our cash balance throughout the year, and during the first half of FY07, we do not expect to generate positive cash flow from operations;
  • In addition to the cash receipt from the sale of our Newark campus, we will pay off a debt tranche of $500 million in August, and we will be making severance payments throughout the remainder of this fiscal year;
  • At the highest level, absent any new initiatives, we are targeting a total cash position of approximately $3.9 billion to $4.3 billion at the end of FY07.

With that, I will turn it back over to Bret.

Bret Schaefer

Thank you, Mike and Jonathan.

Before we begin the question-and-answer session, I would like to request that each of you ask just one question consisting of one part. This way, we hope to get to most of the questions in queue today.

Katina, will you please start the question-and-answer session?

Question-and-Answer Session


(Operator Instructions)

Your first question comes from Rebecca Runkle with Morgan Stanley.

Rebecca Runkle - Morgan Stanley

Good afternoon, thank you. Just curious, you did not comment at all in terms of linearity in the quarter, and just given where several competitors have talked about a soft close in June, I would love to hear your perspective.

Then, on the telco vertical, gentlemen, you mentioned some wins there. Just curious if you could provide some color in terms of what type of product and where you are seeing the strength specifically within telco’s, since that has been so important to you historically.

Michael Lehman

Rebecca, it is Mike Lehman. The phone cut out. We did not understand the first part of your question.

Rebecca Runkle - Morgan Stanley

Linearity in the quarter, especially within the context of what several competitors have said, as it relates to a very soft close in the month of June.

Jonathan Schwartz

We saw no soft close in June. If anything, we saw things strengthening towards the back end of the quarter. I think that leaves us pretty optimistic going into Q1 but it also is an interesting contrast to some of our competitors.

Out in the telecommunications sector, we are seeing, in general, broad-based investment to go off and capture mobile subscribers, so certainly on the mobile side, with Nokia and Motorola frankly announcing very positive quarters, largely on the basis of the adoption of their Java phones, we are seeing carriers want to go invest after the next generation media and data services that you can deliver onto the phone, as well as the operational infrastructure you are going to need to put in place to go run a large-scale consumer network.

I am not sure there is a whole lot of color. It is certainly varied by geography but I think we saw, in general, a lot of strength on the mobile and wireless side. Even still, frankly, some strength on the wireline side as well.

Bret Schaefer

Next question, please.


Your next question comes from Richard Farmer with Merrill Lynch.

Richard Farmer - Merrill Lynch

Thank you. A question for Mike -- you talk a little bit about the cost-savings outside of headcount qualitatively, although really not in significant quantitative terms. You have talked a lot about the headcount savings themselves in quantitative terms. If you look around at some of the other restructurings in the IT hardware space, particularly HP, a large portion of the savings are coming from outside of headcount.

I wonder if you would just help us, even in a range, quantify how big those opportunities may be outside of headcount for cost savings?

Michael Lehman

We announced back at the end of May that there was a number of initiatives, and we gave targeted cost-savings and things like that. We do not want to sit and try and update, every quarter, a number that has a cost-saving associated with it.

Our view is that we have an overall business model, that we have been pretty clear about what we are targeting, and all the levers that we are pulling, including the ones that I mentioned. If you will note, restructuring was the one I mentioned last. Clearly there is a sizable cost-savings associated with it. The list was intended to show you that we are looking at a lot of different things.

We remain committed to looking at the entire cost structure up and down the line and ensuring we are going after everything.

Bret Schaefer

Next question, please.


Your next question comes from Ben Reitzes with UBS.

Ben Reitzes - UBS

Good afternoon, thank you. Could you talk about -- the revenue up-side was pretty significant, but a lot of it did not flow to the bottom line. It looked like SG&A and obviously product gross margin. Could you talk about, perhaps as we go throughout '07, how that may play out? Can you just recap again the factors in the quarter that made it so it did not flow through, and perhaps what might be one-time in nature that you get through?

Then, the cost structure is lower, outside of restructuring or with it. Anything you can quantify or qualify for how we move forward so that this revenue up-side can start to flow through to hit your goal?

One other thing -- can you just say what your book-to-bill is? I do not know if there is a typo here on this slide.

Michael Lehman

Essentially the book-to-bill was just north of one-to-one. Bookings were just over 3.9 billion, when you add in all the bookings from service orders and the StorageTek revenue. It is just over one-to-one.

While we focus a lot on product backlog for you, that is what we report. We do not report all the other backlog and we do not report the StorageTek backlog, so the book-to-bill was just north of one-to-one.

Ben Reitzes - UBS

Thank you.

Michael Lehman

With regard to your other question, I am afraid I would have to repeat all of my comments. I tried to give you a signal, first of all, of the incremental expenses sequentially. Those were largely driven by compensation-related items.

The best way for you to hear what I said was I gave you a range of op-ex for Q1 which basically says we expect op-ex to come down at least $150 million sequentially from Q4 to Q1, so that gives you a sense of the one-time nature of the non-restructuring items.

Bret also read a whole paragraph that basically had seven items in there that totaled $0.09, and those were all one-time items, if you will. I do not want to go back and read through them all, but that is why we reiterated them. There is quite a few.

When you go back and look at that, there are seven items that totaled $0.09. You take $0.09 away, it was essentially a break-even quarter.

Jonathan Schwartz

Let’s just add a little strategic color on top of that -- the fact of the matter is, we have a product line that allows us to go after our competitors and win. We were probably a little more willing, given some of the strength we were seeing in the win rates, to go after some of those competitors and throw price into the mix.

I think we are about two ticks off on the gross margin line.

In general, on the spending side, we had other -- they are not necessarily one-time, but we had other big spending items in the quarter, big prototype spending for product release.

Our expectation is, as we have said before, we are going to hit 4% operating margin in Q4.

Again, to me, the most significant accomplishment of the quarter is we grew 29%. Growth is the best way to go deliver that operating margin -- just sitting here cutting costs is a pretty short runway.

Ben Reitzes - UBS

Thanks a lot for the color.

Bret Schaefer

Next question, please.


Your next question comes from Laura Conigliaro with Goldman Sachs.

Laura Conigliaro - Goldman Sachs

Your restructuring is not only underway but it sounds like you are having some success. Does this make you more confident in the timing of reaching that 10% plus operating margin, even though you have not given us more detail on that yet?

Is there any way you can actually get there without reducing headcount further?

Jonathan Schwartz

Obviously we feel better about the going-forward projections, given some of the top-line growth we have seen. It certainly adds confidence to the model that we have articulated.

We are not going to really talk about the timing for that. Obviously, we want to get there as soon as we possibly can. What we have done is put a stake in the ground around 4% operating margins, but I will reiterate -- frankly, the best way to go get that operating margin is to go drive revenue and wins out in the marketplace, keeping our spending relatively constant.

We think again, given that we saw such a surge in demand in Q4, we can win the business that we get in front of. We are focused right now on getting in front of that business because the products that we have, with Solaris 10, with the adoption of the UltraSPARC platform, with some of the storage wins we are getting, suggests that we have a pretty clear path to how we get to a better operating model.

Bret Schaefer

Next question.


Your next question comes from Keith Bachman with Banc of America.

Keith Bachman - Banc of America

I have two, if I could. I did not hear your comment on it, but were there any supply constraints in the quarter that you think limited your ability to either rack revenue or add to the bookings? I have a follow-up, please.

Michael Lehman

The answer to that is no, there really were not. There were a lot of challenges, as there always are within any quarter, but we were not supply-constrained toward the end of the quarter.

Jonathan Schwartz

It was a very complex quarter, just given the transitions that the entire industry is going through around return of hazardous substances and WII initiatives, so I have to give credit to the OPs team for getting us through that.

Keith Bachman - Banc of America

Okay. The follow-up, Mike…

Bret Schaefer

We will go on to the next question and hopefully we will come back to you. Thank you. Next question, please.


Your next question comes from Toni Sacconaghi with Sanford Bernstein.

Toni Sacconaghi - Sanford Bernstein

Mike, you talked about your revenues being down 20% or more between Q4 and Q1. It actually only happened once in the last 10 years, and that was at the trough of the bubble. In fact, on average over the last 10 years, it has been down about 14.5%. Why the pessimism around guidance, especially given you have a very large background and commented on how strong the quarter should start?

Michael Lehman

Yes, we do have a pretty healthy backlog. Our view is we want to be conservative. As I have said a number of times and as Jonathan has said, we want to make sure that we put a plan in place to make money, given the sort of revenue levels that we have.

To the extent that the business is stronger, that will only help us accelerate getting to our goals. But we have to be realistic and we want to make sure that we are successful.

Those are the types of goals that we are putting in place. We are not limiting ourselves to the opportunity that is out there, but our view is that there is also a pretty historical component to the STK business and their seasonality is somewhat less predictable, so we just want to be conservative.

Jonathan Schwartz

To reiterate that point, we are going to drive our spending levels to map to conservative revenue projections so we can hit the operating margin we have articulated. Again, to the extent that we over-execute on the top-line, our hope is that is going to get us to our target a little more rapidly.

But as Mike said, we want to put targets out there that you can have confidence in and that we can also drive toward.

Bret Schaefer

Next question, please.


Your next question comes from Brent Bracelin with Pacific Crest Securities.

Brent Bracelin - Pacific Crest Securities

One on the Q1 outlook here. Obviously you have good momentum on the server side, accelerating growth year over year there. You got a rebound in storage. You have a healthy deferred going into next quarter. Are you being conservative here, or are you running the business a little bit differently, where you are going to try to drive a little bit more of the business to improve visibility on a quarter-out basis? Anymore color on why the expectation for that 20% sequential decline this quarter?

Jonathan Schwartz

We are definitely going to try to drive the business, both toward more transparency for you all as well as, frankly, more predictability for us. Moving towards subscription-based pricing, moving toward a greater share of systems business being sold, along with software and services -- all are going to give us a lot more confidence in the going-forward numbers, and our hope again is to give you more confidence.

Mike, I do not know if you have anything you want to add to that.

Michael Lehman

That is fair.

Bret Schaefer

Next question, please.


(Operator Instructions)

Your next question comes from Jonathan Hoopes with ThinkEquity.

Jonathan Hoopes - ThinkEquity

Thank you. Jonathan, you mentioned you were throwing price into the mix when you saw strength in the product sales. Are we to understand now that Sun has opened a new era of more fierce price competition?

On this topic, can you point to a single vendor, a single competitor -- Dell comes to mind -- that took the brunt of this price action, or was Sun's price activities equally distributed among your competitors?

Jonathan Schwartz

I think we were less focused on competitors than we were on making sure that we gained customers. We did see some strength at a systems level, which means we are selling both the hardware, the service as well as the software. That again just gives us an ability to price with a portfolio that some of our competitors cannot match.

Again, I think growing at the rate that we did is a reflection of having innovations that customers want. We want to make sure we can meet not only our existing installed base but one of those statistics that you might find interesting, we have a program we have called Try and Buy, which allows us to distribute hardware across the world to any customer that can pass a credit test.

Of the systems we have distributed, 60% have been to customers that have never done business with Sun before, so I think it is fair to say that we have entered a new era in which we are gaining new customers.

We want to make it as attractive as possible and keep the barriers as low as possible, whether it is through free software or Try and Buy programs, so that once we grab that share, we can go after it with gusto across the rest of our product line.

I feel pretty good that we are going to gather some new customers, and we have again good evidence that we are doing that already.

Bret Schaefer

Next question, please.


Your next question comes from Andrew Neff with Bear Stearns.

Andrew Neff - Bear Stearns

I just want to go back to a question asked before, in terms of the environment. Again, most of your competitors are talking about a fairly soft environment. Can you just elaborate on the comments you made before, in terms of why you are seeing the factors that are driving it and any signs of concern? Does that relate to your guidance also, in terms of the overall economic environment?

Jonathan Schwartz

As we said before, our core customers are those that view IT as a competitive weapon, so we do not see people slowing down their investment in IT to gather new customers or drive new value.

For those in the business that are serving customers who view IT as a cost center, that is going to be an increasingly difficult position to be in.

But the large-scale media companies, large-scale telco’s, financial services companies, they are all investing to get new customers and drive new value. I am not sure we have seen any slowing in their appetite to invest. In fact, I think frankly the Google’s and eBay’s and Yahoo!’s of the world are, if anything, pouring on the steam as much as they can to go after new customers.

Our customers are more looking at the total cost of operations. For example, looking at the fact that we have incredible power savings with our Niagara platforms, that we have tremendously low service costs on our new Thumper storage -- things that are not just about the optics of purchase price.

The example I have used on my blog, which I would of course point all of you toward, is selling a Ferrari right now is going to be pretty tough because it gets 9 miles to the gallon, but selling an electric vehicle, go sell a Tesla, you are going to find a lot of demand. I do not know what Mike is driving nowadays, but $4 a gallon is pretty steep.

When customers are paying through the nose for power and space, if you can deliver more power-efficient systems that are smaller, you are going to gain a lot of business. That is where we see ourselves gaining share.

Bret Schaefer

Next question, please.


(Operator Instructions)

Your next question comes from Chris Whitmore with Deutsche Bank.

Chris Whitmore - Deutsche Bank

Thank you. I’m hoping you can quantify or give us some color around the extra week in the quarter. How much do you think it impacted to the top-line and/or bookings? Thank you.

Michael Lehman

Again, on a year-over-year basis, probably nothing because we typically have some extra days in the fourth quarter. It is just hard to say.

In any quarter, there is always a linearity associated with that quarter and the close of the quarter. I think Jonathan's point earlier was the more interesting one, that we saw a pretty strong finish to the quarter, which is not what all of our competitors saw, so we are happy with it.

Bret Schaefer

Next question, please.


(Operator Instructions)

There are no questions at this time.

Bret Schaefer

Thank you very match. Thank you for joining us today. Investor relations personnel will be back in our offices shortly to respond to any further questions. You may contact us through our investor relations main number at 408-404-8427.


This concludes today's conference call. We appreciate your participation.

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