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Sun Microsystems Inc. (SUNW)

F3Q07 Earnings Call

April 24, 2007 4:30 pm ET

Executives

Bret Schaefer - VP of IR

Jonathan Schwartz - CEO

Michael Lehman - CFO and EVP of Corporate Resources

Analysts

Andrew Neff - Bear Stearns

Laura Conigliaro - Goldman Sachs

Ben Reitzes - UBS

Richard Farmer - Merrill Lynch

Katy Huberty - Morgan Stanley

Harry Blount - Lehman Brothers

Louis Miscioscia - Cowen

Bill Shope - JP Morgan

Toni Sacconaghi - Sanford Bernstein

Chris Whitmore - Deutsche Bank

David Wong - A. G. Edwards

Richard Gardner - Citigroup

Brent Bracelin - Pacific Crest Securities

Presentation

Operator

Good afternoon. My name is Michael and I will be your conference facilitator. At this time, I would like to welcome everyone to the Sun Microsystems' Fiscal Year 2007 Third 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).

Thank you, ladies and gentlemen. I would now like to turn the call over to Mr. Bret Schaefer, Vice President of Investor Relations for Sun Microsystems. Sir?

Bret Schaefer

Good afternoon. Thank you for joining the Sun Microsystems' quarterly conference call. I'm Bret Schaefer, Sun's Vice President of Investor Relations. With me today is Jonathan Schwartz, Sun's CEO, 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 2007 third quarter, which ended on April 1, 2007.

During the last hour, we published a copy of the operations analysis data sheet with nine quarters of financial and operations information, including the quarter just completed. If you've not received the announcement or the detailed financial data sheet for any reason or you wish to hear the broadcast of this conference call, you may log on to our website at sun.com/investors. We have posted slides you can view on the web, which accompany our prepared remarks. These slides may be viewed at the same URL, sun.com/investors. The prepared remarks for 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-Ks and 10-Qs 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 may 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 operations analysis on our website at sun.com/investors for the most directly comparable GAAP financial measure and related reconciliations. Now let's get to the financials.

Sun's total revenues for the third quarter of fiscal 2007 were $3.283 billion, an increase of 3.3% as compared with the $3.177 billion in revenue reported in the third quarter of fiscal year 2006.

Total gross margin 44.5% of revenue, an increase of 1.5 points over the gross margin for the third quarter of fiscal year 2006.

Total R&D and SG&A expenses were $1.471 billion, a decrease of $72 million year-over-year.

In the third quarter of fiscal 2007, we reported a $3 million tax provision benefit.

GAAP net income for the third quarter of fiscal year 2007 was $67 million or diluted earnings per share of $0.02, as compared with the net loss of $217 million, or a net loss of $0.06 per share for the third quarter of fiscal year 2006.

Q3 products revenues totaled $2.060 billion, an increase of 1.2% year-over-year. Within products revenues, computer systems products revenue was $1.500 billion, an increase of 1.8% year-over-year.

Data management or storage products revenue was $560 million, a decrease of 0.2% year-over-year.

Q3 services revenue totaled $1.223 billion, up 7.1% year-over-year. Within service revenue, support services revenue was $950 million up 5.1% year-over-year.

Revenue from Professional Services and Educational Services totaled $273 million, an increase of 14.7% year-over-year.

We ended the quarter with a cash and marketable debt securities balance of $5.486 billion, and generated positive cash flow from operations of $175 million in Q3.

With that, I'll turn it over to Jonathan.

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Jonathan Schwartz

Great, thanks Bret, and good afternoon everybody. I’m pleased to announce another quarter of growth and profitability and continued progress operationally, strategically, and financially. And I’m going to divide my comments into an overall perspective on the quarter. A quick review of updates within the quarter, and then on comments related to our fourth quarter.

First, we once again achieved profitability, but as we hit it out in the second quarter call, we expected Q3 to be seasonally challenging and in fact it was.

At a top level, I’m pleased with our performance generally, and with the growing adoption and momentum around our core development platforms. But we did face a difficult environment in the U.S. and U.K. markets and specifically in March.

We saw a double-digit growth in a variety of geographies around the world, across Asia-Pacific and Europe broadly. But with such a significant portion of our business exposed to the U.S. and U.K. customer set, a slow March certainly limited our overall growth rate.

Now, despite this weakness, we maintained very strong gross margins in the quarter. We grew services and increased our deferred revenue, signaling the value of our offerings and the durability of those customer relationships.

Now, this was the quarter in which we continued to build the partnerships that extend our presence and opportunity in the marketplace. And so, in addition to our strong relationship with AMD, we kicked-off the quarter with a broad strategic alliance with Intel centered on their endorsement of Solaris Operating System. And our commitment to deliver a new line of systems based on Intel Xeon processors.

We also recently highlighted the release of our Fujitsu APL are now our mainframe-class or M-class systems which we won just last week.

Now, let me go through each of product groups starting with our newest, the Microelectronics groups.

This is a group set up to pursue intellectual property arrangements that grow the markets for Sun's silicon innovations. We’ve announced our first relationship with Marvell Technology Group, a leader in storage and network communication to build the industries first network interface designed to optimize throughput between multi-threaded processors, virtualized operating systems, and a historically single-threaded network. As a result of this relationship, we'll partner in the release of this in derivative products, and further develop innovations around network computing with Marvell acting as an OEM and collaboration partner around our core IP.

We will certainly continue to focus on building out such partnerships with the full breadth of Sun silicon activity. As you are probably aware, we taped out our hexadecacore Rock microprocessor that’s 16 cores, as well, and are continuing to build our own systems while engaging others in the industry around building platforms to leverage our innovation.

Secondly, our software and services group’s headline the quarter and grew approximately 12% and 7% respectively year-over-year in Q3. This reflects execution against the goal of making Solaris the most broadly adopted software platform for enterprise and embedded software.

The bulk of Solaris Support contract continues to be sold on our own systems, which is only natural given our starting point. But we ended the quarter with approximately 7.6 million Solaris 10 license is distributed, including over 5 million now on, non-Sun x64 system. We continue to see Solaris as a key differentiator not only in systems but now storage deals as well.

In addition, we saw several multimillion dollar embedded Java deals, as Java continues to wend its way going forward on handsets and desktops creating relationships with some of the world's best known consumer electronics company.

The Java Enterprise suites subscription was increased by 209,000 in Q3 as very large healthcare and federal enterprises, such as the UK National Health Service, Blue Cross that’ll be in Canada, as well as the large federal government organization here in the US standardized on Sun’s middleware platforms to deliver service oriented architecture around identity and integration.

The strength of our software offerings is a direct driver of our services business. Support services revenue increased 5% year-over-year with our professional and educational services groups growing 15% year-over-year. The expansion and success of our infrastructure software platforms coupled with new infrastructure deployment have driven longer and richer service engagements with customers.

Now our storage business showed pockets of strength but wasn’t overall as strong as I would have liked. With our archive or tape business growing and would have been a traditionally weaker quarter, but our disk business seeing continued challenges as we transition to the Solaris based platform.

We saw several very significant design-wins within the quarter for our Thumper platform. And we continue to see the evolution of this platform essential to our strategy of leveraging general purpose innovation to deliver more value, more efficiently, with more productivity to customers.

We also had our first purchase order in Q3 for our project Blackbox, the world's first virtualized data storage center, data center that is. The first unit is for the Stanford Linear Accelerator Center, which plans to use project Blackbox to rapidly expand its high performance computing and data center capabilities for physics and astrophysics research.

Finally, our systems business, which grew 2% year-over-year, saw the same seasonal challenges focused in the US and UK. And although, we did see strengths in the high-end systems, which we expect to continue with our new SPARC Enterprise M-class 8000 and 9000 systems. These products built-in collaboration with Fujitsu will deliver approximately 30% power savings over previous systems and increased performance, reliability, as well as, higher grade virtualization.

In Q3, there is also strength in our Netra Telco business and again we see Solaris continued to be the standard there for our carrier grade networks deployments. Niagara systems or the enterprise T1000 and T2000 systems delivered another $125 million plus quarter in Q3. You'll see many interesting opportunities emerge from our systems focused on power, space and operational efficiency. No matter which direction we turn, the conversation is around energy, around energy efficiency, climate change and eco responsibility. And I am proud that Sun sits at the forefront of addressing these problems for our customers, as well as within our own business.

With Nigara 2 coming in the first quarter of fiscal year '08 and our Rock systems on target for calendar year '08, the product innovation pipeline for system remains robust.

Looking forward to Q4, we remained focused on delivering at least 4% operating profit. We continue to see more opportunities emerge in front of us, continue to see the rise of Java and Solaris’ with avenues to licensing wins and market opportunity and overall see a broadening market for Sun's core innovations.

In Q4, we'll have several significant product announcements and events. We'll launch our first video delivery platform this week inclusive of servers, networking components, and storage for cable and broadband operators leveraging Solaris 10.

In June, we will introduce our newest Blade known as Constellation with support for intermingled Opteron, Niagara and Xeon blades. The Xeon product will be our first for an Intel based on the partnership we announced in Q3. Also, JavaOne is coming up May 8th through 11th focusing on the continued evolution of our open-source developer community, so it will be another busy quarter.

With that said and for more details and specifics. I'd like to pass it over to my officemate, Mike Lehman, Chief Financial Officer.

Michael Lehman

Thanks, Jonathan. Jonathan has covered most of the bigger picture matters. From my perspective we are continuing to make progress towards our near-term and longer-term financial goal. While we did experience the softening of orders in the last few weeks in March, we still recorded revenues that were within a couple of percentage points of our internal plan.

As I mentioned in our last conference call, the March quarter is always seasonally challenging. In this quarter, the normal seasonality was exacerbated by the US and UK slowdown.

While difficult to quantify, it appears that part of the slowdown was, in fact, anticipation of higher performing products which were announced by Sun and Fujitsu last week.

From the analysis we have done, it appears we are not losing business to competitors, but we are seeing orders for projects being put on hold or delayed. There is little that a company can do to predict the slowdown that happens in a relatively short period of time.

During the March quarter our linearity and predictability metrics were tracking well through week 10. Right after that, we began to experience the departure from our expected patterns. And as many of you know, our normal linearity is such that at least 50% of the orders in shipments in any quarter occur in the last few weeks. That is not unique to Sun, but it is something that is the challenge to manage.

I’m going to keep my comments at a pretty high level this quarter and not go through every line item on our published operations analysis. I will point out a few things with regard to Q3 results.

We continue to work with our major channel partners around the world, and once again reduce the overall levels of systems and storage inventory in our channel. During the quarter, we lowered our net channel inventory by around $30 million or approximately one more week of inventory.

As previously mentioned, over the next few quarters we intend to lower this to an absolutely minimal level. The improved economics to both Sun and its partners will manifest themselves overtime as well.

While revenues were lower than we had expected, the gross margin rate was actually slightly above our expectations. This reflects the combination of factors. Our component cost reductions exceeded our expectations. Our overhead costs were lower, reflecting improved benefits from previously announced outsourcing and restructuring activity. And certain of our ongoing expenses were lower due to better management of inventory levels.

In addition, we maintained the focus on margin management through our sales and services organizations.

From an operating expense standpoint, while it does not appear we are making much progress. This is the one financial statement line item in which we see the negative impact from currency changes. The Dollar has continued to weaken against the Pound, the Euro, the Yen and other currencies. We have a large portion of our operating expenses denominated in local currencies and the conversion of these to the US dollar results in incremental US dollar expenses.

Having said that, as in the December quarter, we estimated that we had a year-over-year overall net positive impact from currency, on our bottom-line of approximately $0.01 per share.

As part of our settlement with Microsoft a few years ago, we received this year’s payment of $54 million that was due in March. The payment was received on March 30 and accordingly it was recorded in the March quarter which ended on April 1.

In the prior year, this payment was received in our fiscal June quarter.

You will also note that the March quarter’s income tax provision was in fact at $3 million benefit.

During the quarter, we settled a couple of opened federal tax years with the IRS. We had a state refund and we had a net favorable adjustment to the annual FY ‘07 provision due to changes in certain items. As most of you know it is simply not possible to predict with any accuracy when settlements of prior year federal or state tax returns will be reached. As such, adjustments of that nature are recorded in the period in which they occur.

Looking forward to the June quarter, we expect the following to be reflected in our business model.

Taking into account the last few weeks of March, we now expect a seasonal sequential increase in revenues in the range of 15% to 18%. This will be the single most important element of our overall quarter’s business model. We expect gross margins to be in the range of 42% to 44% for the quarter. We expect total operating expenses to be in the range of $1.475 billion to $1.5 billion. We expect amortization of intangibles of approximately $75 million. We expect approximately $50 million to $55 million of stock-based compensation. We expect interest income of approximately $50 million and absent any discrete period adjustments. We expect the tax provision to be in the range of 55 million to 65 million for the quarter.

I want to emphasize what Jonathan stated earlier, we remained on track to achieve a Q4 operating margin of at least 4%. We remained committed to a longer-term fiscal year '09 goal of 10% operating income.

During the June quarter, we will finalize our plans for next fiscal year, that mean what changes if any, we need to make to our products portfolio, growth plan, business model and the capital structure.

During our Q4 conference call, we will talk more specifically about ways to measure us next fiscal year.

As I have said previously, we are planning for low-to-mid single digit revenue growth, stable gross margins, and we plan to reduce total operating expenses in absolute dollars. We intend to have a broader discussion about next fiscal year in July.

With that, I will turn it back to Bret.

Bret Schaefer

Thank you, Mike and Jonathan. Before we begin the question-and-answer session I'd like to request that each of you ask just one question consisting of one part. This way, we hope to get most of the questions in queue today. If there is time remaining we will be happy to take your follow-up questions.

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

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Andrew Neff with Bear Stearns.

Andrew Neff - Bear Stearns

Sure. I wanted you to talk a little bit more in detail about the operating expenses, because I understand there were some currency issues. But basically, if you look at the sequential decline, revenues which you anticipate, the operating expenses were kind of flattish. Can you give us a sense about what steps you are taking to improve on that? And what’s going to allow you to get operating expenses down year-over-year?

Michael Lehman

Yeah, Andy, it’s Mike Lehman. So, keep in mind when we talk about total OpEx. You may or may not be including the restructuring charges that we had somewhere north of 30 million of restructuring in the quarter as well, and we tend to talk about GAAP total OpEx. So, that could be in there.

We continue to look at as you know all of our processes, all of our activities we are looking very closely at headcount by activity and functions. So, there are a lot of things that we are looking at both in the near-term and longer-term that will help us to lower our OpEx. But we are confident that some of the restructuring actions that we took earlier in the year going to start to pay-off as well in the fourth quarter. Some of those are facilities-related and in the manufacturing arena, as we’ve talked about. So, we are working on a lot of things. Nothing in the quarter has changed our view where we think, we can go with OpEx directionally.

Jonathan Schwartz

And there is no group at Sun, it's not focused on productivity in one form or another, so it is also that added in everything.

Andrew Neff - Bear Stearns

Just to clarify, like you said sequential. You said the operating expenses in the next quarter going to be say 1.45 to 1.57, is that right?

Michael Lehman

1.475 to 1.5 in total.

Bret Schaefer

Next question, please.

Andrew Neff - Bear Stearns

Thank you.

Operator

Your next question comes from Laura Conigliaro with Goldman Sachs.

Laura Conigliaro - Goldman Sachs

Yes, question clarifications. So, the second quarter in a row your server unit growth was well below systems revenue growth and what are you actually doing to get to a point where you can actually start to see some improvement there? Or is the change really going to be that we would start to see revenue growth? Start to settle back towards the levels that your server unit growth is? And also can you clarify what the impact of currency was on revenue?

Jonathan Schwartz

So, I'll differ the second portion of the question, Laura to Mike. On the first, we're going to continue to build that compelling as possible a low-end product line to make sure we can get after volume opportunities. We're continuing to ship a very high volume of course and certainly if you ship multicore platforms, you can consolidate work loads under the smaller number of units.

But it's just focus, and there is also just some element of where do we see growth in the marketplace. You want to go after the growth where the products make the most sense. And as we get into the next product cycle and as you get into blade platform, unit volumes are in a way going to get tougher to measure because you're going to be measuring larger and larger scale systems and not components within them.

So, the top-line is, we are very focused on getting up to the volume marketplace because that's where a lot of next wave of innovations occurs. This is also where our customers buy first. But we're as much focused on top-line revenue growth, as we are on the volume unit.

Michael Lehman

So, I am not going to quantify the impact of currency on any one particular line item, as many of you know, it is an imprecise measure at best when one tends to do this, where we see the benefit of currency and the revenue line is typically in our services' contracts that are longer term that are denominated in local currencies.

When those [translated] in the dollar as you can, at least, best to quantify year-over-year amount, but in the systems business, there are so many things that are different year-over-year, such as different products, different pricing, different channel models, et cetera, that it's really almost meaningless to attempt to quantify a currency impact on systems and storage. So, I will leave it at that

Bret Schaefer

Next question please?

Operator

Your next question comes from Ben Reitzes with UBS.

Ben Reitzes - UBS

Yes, good afternoon. Could you talk a little bit more about your 15% to 18% revenue guidance in terms of sequential growth for June? What, Jonathan, needs to happen in order for you to do that? Does the market need to pick up? Do we need to see a nice pick up in demand as we go throughout the quarter? Or do you have enough backlog and visibility right now that you are comfortable with to hit that number based on the products you have?

Jonathan Schwartz

To hit the range, and by definition, if we have an exact number, we'd give you the exact number. But, I think for the most part, we've got to execute out in the field, we've got to continue delivering on the innovation that we have announced and again, we wouldn't prescribe the range unless we had some level of comfort in our ability to hit it.

So, I don't think there is any one thing specifically we need to focus on. I think we continue to believe that network computing is a place that our customers want to invest. We want them to look to us. We have got a more compelling product line. Just seasonality tends to pick up for us in the fourth quarter. It's the last quarter of the year. So, lot of things, go our way in that regard. But, again, if we had a specific number we would give it.

Ben Reitzes - UBS

Is April looking good enough to give you confidence, I guess?

Jonathan Schwartz

We don't comment on the quarter.

Bret Schaefer

Next question please.

Operator

Your next question comes from Richard Farmer with Merrill Lynch.

Richard Farmer - Merrill Lynch

Thank you. Just want to follow up a little bit and try to understand the deceleration in the product revenue, particularly in servers. I heard your comments on strength in the high-end and I guess Netra and Niagara sounded okay. But, is there any other color you can provide there, how is Galaxy doing? What's the pricing environment like? And where do you expect the rebounding in your revenues to be most accentuated in the next quarter?

Jonathan Schwartz

I don't think we are, number one, we are not going to break this down into which product line do we expect to do better going in the fourth quarter. I will tell you that, as Mike alluded, we are just now launching our first Intel products. We are just now launching our new M-class products. We've got roadmap updates almost across the Board on the system side.

So, a lot of that is fueling on the one hand some level of hesitation from customers in Q3 that wanted to see where that all nets out. And on the other hand, interest in Q4 now that we've got close to those products and they want to come back and talk to us.

So, I think for the most part just by definition, the majority of our current business is SPARC based platforms. We're continuing to see more and new opportunities emerging around the world, but also, frankly, we're really stepping into the blade market now, in the first really serious way with high volume blade offerings, getting into the VOD marketplace with what we are going to be announcing this week.

The roadmaps on our side, economy is always going to be a question mark for everybody, but not withstanding the economy, I think we are pretty well positioned.

Bret Schaefer

Next question please.

Operator

Your next question comes from Katy Huberty with Morgan Stanley.

Katy Huberty - Morgan Stanley

Hi, thanks. Just quickly on the $5.5 billion of cash. When are we going to see that put to work in the form of other acquisitions or share buyback?

Jonathan Schwartz

We are going to use that to grow the business as soon as we find the right opportunities and you will be the first to hear about them.

Katy Huberty - Morgan Stanley

And on share buybacks, any update?

Michael Lehman

What we said before, and what I alluded to in my comments was, we've got a couple of board meetings this quarter. We will look at our capital structure in this quarter and have those discussions and if there is anything new to announce, we would be announcing that later.

Katy Huberty - Morgan Stanley

All right. Thanks.

Bret Schaefer

Next question please.

Operator

Your next question comes from Harry Blount with Lehman Brothers.

Harry Blount - Lehman Brothers

Thanks guys. Mike, you had indicated that metrics were tracking relatively close through week 10. I just want to make sure I understand what you are saying there. Were they tracking, so you guys were on track for an upside at that point or are you basically towards the midpoint of guidance? So, I'm just trying to understand exactly what you are saying there?

Michael Lehman

So, when I say tracking it means tracking towards our own internal plans, and the achievement against that based on where we would typically be in week 1, week 2, week 3, week 4, et cetera. So, when I say tracking, I mean against our internal plans.

As I indicated, we ended up about a couple of percentage points short of our internal plans at the end of the day. And we saw that follow us, if you will, in the last few weeks.

Bret Schaefer

Next question please.

Harry Blount - Lehman Brothers

I didn't understand exactly where they came from that fall-off is. Will you be a little bit more specific? Thanks.

Michael Lehman

I don’t know how much more specific I can be. I don’t know if you mean by geography or where we said it was principally in the U.S and U.K and it was principally in our systems business to a lesser extent in the storage practice but that’s a better detail as we can get.

Jonathan Schwartz

And maybe just to give you some color on that. We actually saw some strength in our federal business. Our Telco business was reasonably strong, financial services seem to be executing pretty well, as well, the weakness we saw it was kind of outside the major industry verticals and to a somewhat lesser extent to our indirect channels rather than our direct ones. So, again as Mike said, we are not looking at this. This is not a competitive issue; it is not a product issue, for us, it really was. It seemed to be a lot of customers saying you know I made the choice but I’m going to execute on the first (inaudible) on the next quarter. So, I don’t think we are worried about this at a strategic level. We just want to get back to executing in Q4.

Harry Blount - Lehman Brothers

Thanks.

Bret Schaefer

Next question please.

Operator

Your next question comes from Louis Miscioscia with Cowen

Louis Miscioscia - Cowen

Okay, thank you. May be you can just add some more color on the storage area. Second quarter in a row I guess where growth is actually down a little bit on a year-over-year basis? And obviously you are coming up against a very tough comparison into the fourth quarter?

Jonathan Schwartz

We saw a strength it was a little bit above our plans on the archive side of the business, on the tape side. We had a good growth quarter there.

On the disk side, I think we are a little disappointed, but on the other hand we are just introducing the first of our Solaris based offerings and getting out in front of the NAS market. So, we want to continue to focus on innovation in ways that differentiate us from the competition, we think having an operating system in a general purpose systems infrastructure gives a fair advantage, and now we want to go execute against it.

Bret Schaefer

Next question please.

Operator

Your next question comes from Bill Shope with JP Morgan.

Bill Shope - JP Morgan

Okay, thanks guys. Can you give us a read on how mix affected our margins on a year-on-year basis particularly in the server segment given the high-end strength you mentioned?

Michael Lehman

Just off the top there certainly was a little bit higher mix of the higher end servers. We certainly did well in the very high-end of the server line. So, that was positive. As Jonathan mentioned, the archive and tape business was good year-over-year, so that helped some of the margin. There was a bit more software in the quarter on the year-over-year basis that helped some of the margins. Those are probably the big mix issues or rest of it as I said really came from cost.

Bill Shope - JP Morgan

Okay. Thanks a lot Mike.

Jonathan Schwartz

And it's good to be back on the high-ends. It's good to have among the most competitive platforms of marketplace, that’s a pretty rich market, it tends to be a pretty high margin and with what we just announced around the M8000 and M9000 we're fully back in that market now.

Bret Schaefer

Next question please.

Operator

Your next question comes from Toni Sacconaghi with Sanford Bernstein.

Toni Sacconaghi - Sanford Bernstein

Yes, thank you. I just wanted to see if you saw any changes in the competitive environment, as best I can tell from your charts SPARC units were down 17%. My guess is SPARC revenue was probably down. IBM’s Unix revenue was up 14%. That’s a pretty strong reversal relative to trends we have seen in the last few quarters. Did something change competitively other than the potential freeze around products that you expressed? And then on the Intel server side, again you have pretty dramatic deceleration over last couple of quarters on x64 side decelerating from 50%, 80%, 90% to 12%. Is the Blade offering from Intel in June going to be enough to really reverse that against what is a very tough compare in Q4?

Jonathan Schwartz

I think depending on how you look at it, Tony. First of all, I think IBM announced the negatives 13% on their iSeries. And what they are doing is shifting at least from what we see shifting iSeries units over to T-Series and so as it put together you are going to end up with maybe a different conclusion. I think, from our perspective, we are definitely seeing a slowing in the growth rate. But if you look at our growth rate year-over-year in the x64 space, it is a multiple of the industry’s growth rate. So, by every measure we are gaining share.

So, I think both across the SPARC and the x64 product set, and the delivery of those and other platforms like storage platforms, we feel very good competitively. I think the Blade offering that we will introduce, it allows you to put a SPARC Blade and Intel Blades and AMD Blade will be unique in the marketplace, and will give us entry to a segment in the marketplace that appears we’re not going to be able to address. The fact that we have an operating system that runs across all three of those blades also gives us I think the differentiation that if anything makes them pretty good about the growth prospect. All that said, to your point we’ve got to execute in the marketplace and make sure we can deliver it.

Bret Schaefer

Next question please.

Operator

(Operator Instructions). Your next question comes from Chris Whitmore with Deutsche Bank.

Chris Whitmore - Deutsche Bank

Thanks. My question regards the Congo and cost structure and the 10% operating margin go into fiscal '09, given the weakness you are seeing, in the U.S. and U.K. et cetera, do you think more restructuring will be required to hit those op margin targets.

Jonathan Schwartz

No, I think I’ll speak first then Mike can join in. As I said earlier, we are always focused on how we can do something more efficiently and whether that is to build the next generation of systems or operate our business infrastructure. We continue to see lots of opportunity. We just got to go get after it. So, we don't have any formal plans but we're always looking at ways to get leaner and to become more productive and more efficient.

Bret Schaefer

Next question please.

Operator

Your next question comes from David Wong with A. G. Edwards.

David Wong - A. G. Edwards

Thank you. Your newly formed microelectronics units; can you give us some idea about the product stream that we can look forward seeing come back over the next couple of years or so?

Jonathan Schwartz

You bet. So, we have seen a couple of pretty interesting trends in the marketplace. One of them is around the decline and demand for special-purpose silicon. There is a lot of focus out there that our building proprietary silicon platforms that have a very hard time building up eco-systems building up software partners.

The fact that with Niagara for example, we can deliver a technology and a silicon platform too and appliance manufacture that then immediately has a large eco-system and software partners because again it's a general-purpose microprocessor. Seems that there are a lot of special purpose appliances that are going to begin using a general-purpose silicon and a general-purpose operating system.

That's exactly the market that we're attacking with our microelectronics team. It's to take the general purpose innovations we have, whether they're in networking ASICs or in the general-purpose computing platforms, such as the innovations within Niagara and Rock. And to find alternative deployments vehicle, so, not just a server but instead whether it's medical equipment or network equipment or other special purpose devices that can take advantage of the volume and economics that we can leverage as a result of being a high volume systems manufacturer.

So, that's really the focus. And in terms of roadmap, everything we build inside our system is going to be made available in the merchant silicon marketplace. We want to take the same path with our silicon as we have with our software, which is we don't want to limit the market opportunity simply to running inside our own systems. We want to take Solaris and run it on HP and IBM, just as much as we want to take SPARC and our networking ASIC and run them in other people's computers and appliances.

Bret Schaefer

Next question please.

Operator

Your next question comes from Richard Gardner with Citigroup.

Richard Gardner - Citigroup

Thank you. Good afternoon. In the past you have been willing to give us annual run rates for x86 servers in Niagara, in the quarter, would you be willing to give us that data this quarter?

Michael Lehman

I think Jonathan hinted that the run rate for Niagara, it was essentially flat sequentially and I do not have the other one right in front of me. Sorry.

Jonathan Schwartz

We can follow up. In general, we are not shy about providing the data that we've got, and to the extent that we've got insight around the unit volumes or the revenue we are expecting for the next quarter, we will provide it.

Richard Gardner - Citigroup

Okay, and then, also just some qualitative comments on Niagara. Where do you think customers are in (inaudible) process for that particular product? Do you think that there is a significant amount in customers that have made the decision to migrate that are waiting for Niagara 2 to come to the market here within the quarter or two? What are your thoughts on where customers' heads are on the Niagara platform?

Jonathan Schwartz

I continue to be surprised by the volume of the design-wins, and not migrations by the way, but upgrades moving off of competitor platforms, as well as moving off of legacy platforms. And I don't know how to characterize what percentage of our existing business is the derivative of new customers and new design-wins. I know that most of the promotions we do externally tend to be dominated by new customers. But the only real, I think, amplifying effect or potentially attenuating effect is that we've announced Niagara 2, announce that we are going from a 32 thread machine with 64 thread machines in the same form factor.

And again, the ability to run Solaris unmodified and run applications unmodified just twice as fast, certainly presents those opportunities, as well as for those customers that are looking at very large scale deployments and potentially may want to wait to do so, a good reason to think about the future as well as where we are currently.

So, I think in general, there is nothing that we've seen to suggest that customers are on hold. As we continue to see more and new opportunities emerged, whether it's from energy efficiency or the fact that we can run highly virtualized environment on a 32 thread microprocessor going to 64.

But again, as soon as we get the data, we'll provide. For FY '07 I think we had it, looking at the numbers here $500 million to $600 million for Niagara. And again, we want to see that growing as we go forward and we got a lot of innovation and product line expansions coming around that.

Michael Lehman

And again, just a clarification, so the x64 run rate is again in the $600 million plus kind of range, basically the same it was last quarter.

Richard Gardner - Citigroup

Okay. Thank you.

Operator

(Operator Instructions). Your next question comes from Brent Bracelin with Pacific Crest Securities.

Brent Bracelin - Pacific Crest Securities

Thank you. I had a specific question on channel inventory in your guidance. I believe you are at six to seven weeks of channel inventory at the beginning of the period. If I remember correctly, you indicated you worked that down by one week. Is the expectation of guidance growing 15% to 18% sequentially, also include working down inventory by another week in the next three months? Or how should we look at your guidance for Q4 and channel inventory levels?

Michael Lehman

So, the answer is, we talk about revenue in the June quarter anticipating that we will probably take down channel inventory by approximately another week. That is correct.

Brent Bracelin - Pacific Crest Securities

Okay. Thank you.

Bret Schaefer

Next question please.

Operator

Your next question comes from Harry Blount with Lehman Brothers.

Harry Blount - Lehman Brothers

I’m sorry the question has been answered. Thanks

Bret Schaefer

Next question please.

Operator

There are no further questions at this time. Gentlemen.

Bret Schaefer

Thank you very much.

Jonathan Schwartz

Thank you for joining us today. Investor Relation’s 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.

Operator

This concludes today's conference call. We appreciate your participation. We are again providing an encore replay service this quarter. If you joined us late or wish to hear any part of the conference call again, you may call the replay service anytime after 3:30 p.m. Pacific Time today to hear a recording of this conference call. The phone number for the replay is 800-642-1687 or 706-645-9291 and you must enter the conference reservation ID number 2944410 on your touch-tone telephone. Thanks again for taking the time to join the Sun Microsystems call this afternoon. You may now disconnect.

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Source: Sun Microsystems F3Q07 (Qtr End 4/1/2007) Earnings Call Transcript
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