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Sun Microsystems Inc. (JAVA)

F1Q08 Earnings Call

November 5, 2007 4:30 pm ET

Executives

Bret Schaefer - IR

Jonathan Schwartz - President & CEO

Mike Lehman - CFO

Analysts

Benjamin Reitzes - UBS

Katy Huberty - Morgan Stanley

Toni Sacconaghi - Sanford Bernstein

David Bailey - Goldman Sachs

Richard Gardner - Citigroup

Brent Bracelin - Pacific Crest Securities

Bill Shope – JP Morgan

Keith Bachman - Bank of Montreal

Kevin Hunt - Thomas Weisel Partners

Harry Blount - Lehman Brothers

Louis Miscioscia - Cowen

Operator

I would like to welcome everyone to the Sun Microsystems' fiscal year 2008 first quarter results conference call. (Operator Instructions) I would now like to turn the meeting over to Mr. Bret Schaefer, Vice President of Investor Relations for Sun Microsystems.

Bret Schaefer

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

The purpose of today's call is to discuss the results of Sun's fiscal year 2008 first quarter, which ended on September 30, 2007. During the last hour, we published a copy of the operations analysis datasheet with nine quarters of financial and operations information, including the quarter completed on September 30, 2007.

If have you not received the announcement or the detailed financial datasheet for any reason or you wish to hear the replay of this conference call, you may log on to our website Sun.com/investors. We've 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. After the prepared remarks of our call today, we will devote the remaining time to Q&A.

During the course of this conference call, we'll be making forward projections and other forward-looking statements regarding expected financial future 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 posted on our website at Sun.com/investors for the most directly comparable GAAP financial measure and related reconciliation.

Now, let's go to the financials. Sun's total revenues for the first quarter of fiscal 2008 were $3.219 billion, an increase of approximately 1% as compared with the $3.189 billion in revenue reported for the fiscal fourth quarter of 2007.

Total gross margin was 48.5% of revenue, an increase of 5 points over the gross margin for the first quarter of fiscal 2007. Total R&D and SG&A expenses were $1.385 billion, a decrease of $46 million year over year.

In the first quarter of fiscal 2008 we reported a $54 million tax provision. GAAP net income for the first quarter of fiscal year 2008 was $89 million or diluted earnings per share of $0.03 as compared with a net loss of $56 million or a net loss of $0.02 per share for the first quarter of fiscal 2007.

Q1's products revenues totaled $1.98 billion, an increase of 1.1% year over year. Within products revenues, computer systems products revenue was $1.475 billion, an increase of 0.5% year over year. Storage products revenue was $505 million, an increase of 2.9 % year over year.

Q1 services revenue totaled $1.239 billion, up 0.7% year over year. Within services revenue, support services revenue was $979 million, down 0.8% year over year. Revenue from professional services and educational services totaled $260 million, an increase of 7% year over year. We ended the quarter with a cash and marketable debt securities balance of $5.193 billion and generated positive cash flow from operations of $574 million in Q1.

During Q1 '08 we repurchased 244.6 million shares, which equates to approximately $1.25 billion. Shares were repurchased at an average price of $5.11. There is currently $1.55 billion remaining of the $3 billion share repurchase program we announced in Q4 '07.

With that I'll turn it over to John.

Jonathan Schwartz

Thanks, Brett and hello, everyone. I'd like to start by thanking our team and our partner community for continued progress in all key aspects of our business, turning in our fourth straight quarter of profit. We continued to focus on both operational discipline and execution during the first quarter and most notably delivered another improvement in our gross margins to a seven-year high of 48.5%, so customers are clearly seeing value in what we're delivering.

Overall in Q1, we saw strength in high end enterprise systems and infrastructure software, and we stabilized our storage business. Geographically, we continue to see strong performance in EMEA and Asia Pacific, and most notably in India and China. The U.S. was down year over year, however the U.S. did show strength in both the financial services and government verticals.

All this being said, Q1 was seasonally challenging as expected, and top line growth is still an area of focus. We shared some exciting announcements during the quarter that are key to bolstering future revenue growth, including strategic partnership announcements with Microsoft around virtualization and the Solaris platform, Google around Star Office and with IBM announcing a Solaris OEM agreement. We're also seeing virtualization, energy efficiency, storage and archival capacity and security in the announcement of the new four socket quad-core Intel and AMD-based servers powered by Solaris, Linux and Windows as driving incremental demand.

Clearly we're bullish about our longer term prospects as evidenced by our aggressive share repurchase in Q1 totaling approximately, as Brett, said $1.25 billion or approximately 245 million shares. I'd like now to walk through some of the business highlights for the quarter and end with a few comments on focus areas for FY08.

In microelectronics, we entered the commercial silicon market with the introduction of our UltraSPARC T2, the world's fastest commodity microprocessor and the industry's first volume processor with eight cores and eight threads per core. We've been praised by industry analysts as being a year ahead in the commodity chip market and believe that the T2 will further the growth of the Niagara and Solaris ecosystems for Sun.

In software and services, Solaris reached nearly 11 million licenses in Q1, with over 2 million sockets under commercial license. In August, we announced that IBM would become an OEM of the open source Solaris 10 operating system and they announced they would resell it on their X86 or X-series servers.

Identity management continued its strong growth with large deployments within the U.S. federal government and in addition, our consumer platform business, comprised of embedded Java, continued its success as the Java platform is built into more devices globally, now at 5.5 billion before what Google announced today.

Within services, our professional and educational services division showed its strongest revenue growth of 7% and strong margin performance, punctuating the contribution of Solaris to higher value-add professional services in conjunction with our systems offerings.

As I've said before, we have an objective at Sun to achieve greater transparency in reporting the performance of all of our business segments. With a 25 year history of thinking and operating as a highly integrated systems company, this effort is challenging. Regarding software and breaking out software-specific performance numbers, we're committed to clearly defining and articulating the size and the characteristics of our software and software services business so that investors can have greater insight into these strategic assets. We take this effort very seriously and will continue to keep you apprised as we make progress towards this disclosure.

Moving on to our systems business, we announced the combination of the storage and systems groups under the leadership of John Fowler to best capitalize on our R&D resources and to drive increased product integration with Solaris at the core. We continue to see growth in both our chip multithreading, as well as Intel and AMD-based businesses in Q1, and have particular strength in our OPL line developed with Fujitsu.

To maximize market reach, Sun will continue to offer compelling and differentiated enterprise-class systems using multiple microprocessor platforms that set new standards in eco-efficiency.

During the quarter we also introduced our first quad-core Intel Xeon processor systems, offering world class performance, unmatched density and expandability in an advanced energy efficient design. We previewed the first and only four socket 2U quad-core system on the market for the Intel Xeon 7300 series platform and also expanded our storage virtualization portfolio with the introduction of the StorageTek 9985 enterprise storage. For the remainder of FY '08 we expect to be shipping new Intel, AMD and UltraSPARC systems along with expanding our storage and archival systems offering.

The product line line-up and innovation pipeline has never been stronger. With gross margin at 48.5%, we continue to deliver real value and innovation to the marketplace. Solaris is continually proving it's competitiveness in a rapidly consolidating operating system market and the strength in our enterprise high end server certainly shows the value of SPARC and Solaris across all platforms on the market today.

To close, I want to be clear that top line growth is absolutely our number one priority for FY08. We will continue to drive operational discipline across the business and to maintain our laser focus on delivering value and differentiation across the entire pipeline of our organization.

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

Mike Lehman

Thanks, Jonathan. Our results in Q1 indicate that we are making continued progress towards our longer-term financial objectives. On a year-over-year basis we have improved our gross margins, lowered our R&D and SG&A expenses and reported GAAP net income for the fourth successive quarter, even with $113 million restructuring charge. We generated $574 million in cash from operations during Q1, the highest level in a first quarter since 2001.

We have achieved all that in what is typically a seasonally challenging quarter and this quarter was no exception. While we have more work to do in terms of reinvigorating the top line growth rate, Q1 makes a strong statement that we are on the right track.

There are a few things relative to the quarter’s performance that I want to be sure you understand. From a geography perspective, Q1 looked much like the past couple of quarters. We experienced revenue growth of approximately 5% in EMEA, which reflects some currency benefit. We experienced revenue growth of approximately 6% in Asia Pacific, despite a continued decrease in revenues in Japan. We experienced revenue growth of approximately 4% in the International Americas and experienced a decrease in U.S. revenues of approximately 4%.

While imprecise, we estimate that net revenues were favorably impacted by approximately 1% to 2% in Q1, based on exchange rate movements. This was partially offset by a higher level of operating expenses. We estimate that the overall net impact of exchange rate movements on the bottom line in Q1 was approximately $0.01 per share.

It is worth noting that in the U.S. we worked with our major channel partners and decreased the levels of inventory in the channel by around $20 million in Q1. Overall, channel inventory levels had been reduced by more than $100 million in the past five quarters. While this has a negative impact on current year revenues, this helps us improve profitability over time.

As we have talked about for the last year, we have made plans to move to a sellout inventory model in fiscal '08. The move will occur in the current quarter, Q2, for the U.S. and for Asia Pacific. We anticipate the move will negatively impact revenue by approximately $100 million to $150 million in this quarter. The move to sell out will occur for EMEA in the second half of fiscal '08 and will represent an additional $40 million to $60 million in channel inventory reversal. We have considered the impact of these actions in the full-year financial guidance that we have provided.

Back to the demand picture in Q1 and most of you are aware that during Q1 and early Q2, we announced a number of new systems products including Niagara 2 as well as certain new Intel-based platforms. We believe there is now more certainty in the market relative to the fiscal '08 product road map. That is always a good thing.

In terms of deferred revenue in Q1, products deferred were up approximately 18% year over year and overall deferred were up approximately 14% year over year. Gross margin was once again the highlight of the first quarter's results; at 48.5% this was above our internal estimates. Product gross margins were 48%, up 0.6% sequentially and up 5.3 points on a year-over-year basis in Q1. I would estimate that about $25 million to $35 million of the product gross margin improvement was above our expectations.

We also experienced an improved mix of software licensing revenues, a stronger showing from our mid and high end UltraSPARC based servers, and we managed our pricing actions within the normally competitive environment.

Service gross margins increased 2.1 points sequentially and 4.3 points on a year over year basis in Q1. This reflects continued cost reductions in our service delivery model and improved product quality.

Looking at operating expenses, you will note that both R&D and SG&A expenses excluding restructuring were lower sequentially which is typical, and lower than the prior Q1 of fiscal '07. We expect this pattern of year-over-year declines in absolute dollars of ongoing operating expense to continue throughout this fiscal year.

As we have signaled in the past, we have ongoing initiatives aimed at lowering our operating expenses both in the short term and longer term. Q1 expenses were right in line with our expectations. The income tax provision of $54 million in the quarter was right in the range that we had expected as well.

As most of you will recall, during our Q4 fiscal '07 results conference call, we gave a range of expectations for the current fiscal year. Looking forward to the rest of fiscal '08, we expect the following to be reflected in our annual fiscal year business model.

We expect revenue growth to be in the low to mid single-digits. We expect revenue growth to be a bit higher in the second half of the year relative to the first half. We expect gross margins to be in the range of 44% to 47% for the year. We have raised this range by 1 percentage point, based on the Q1 results and our view of the rest of the year.

We expect total operating expenses, excluding any actual or potential restructuring expenses and based on current exchange rates, to be in the range of $5.6 billion to $5.8 billion. We expect amortization of intangibles to be in the range of $250 million to $300 million. We expect approximately $225 million to $250 million of stock-based compensation. We expect net interest income of approximately $170 million to $200 million, and we expect the full year tax provision to be in the range of $200 million to $250 million.

In summary, we have not changed our view of the current fiscal year, with the exception that we expect slightly higher annual gross margins, as well as slightly lower net interest income given the level of share repurchase activity in the quarter. We have increasing confidence in our ability to deliver against our stated financial objectives.

Longer term, we are clearly focused on improving the revenue growth rate and will continue to consider organic and inorganic ways to do so. We are on track to deliver at least 8% GAAP operating margin in our fiscal Q4.

With that, I will turn it back to Brett.

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 to most of the questions in queue today.

If there is time remaining, we'll be happy to take your follow-up question. Calvin, will you please start the question-and-answer session?

Question-and-Answer Session

Operator

Your first question comes from Benjamin Reitzes - UBS.

Benjamin Reitzes - UBS

Could you talk about the demand environment? Jonathan, you said financial services, you gave some color there; it sounded like it was at least in line with expectations and nothing too bad there. If you could just talk about the overall demand environment as we go throughout the year.

One last thing is Mike, if you can give us an effective tax rate. It looked like there were $0.02 to $0.03 of net charges in the quarter, so the earnings were really $0.05 to $0.06, any clarity there would be helpful. Thanks.

Jonathan Schwartz

Ben, I'll take the first part of it. Congratulations on sneaking in two questions. First of all, obviously we talked about demand geographically. I think within the U.S, there's obviously sector differences and industry differences. We certainly have seen some slowing in the financial services especially those that were more exposed to the sub-prime mortgage issue.

Broadly, I think retail banking, commercial banking, the capital markets are otherwise pretty strong and are continuing to look at technology both from Sun and others as vehicles to grow. I think telecommunications, we also see as being reasonably strong. These companies and customers are seeing more opportunity especially given some of the innovations we're seeing on handsets.

I think more broadly, more traditional industries are slow and frankly have been for a while and I think beyond that, we'll see as time goes forward.

Mike Lehman

I am not quite sure about the effective tax rate question. We haven't changed our view of the overall tax provision for the year. It's still in the same range that we expect it for the year and the $54 million in Q1 was right in line with what we had expected. So the effective tax rate is essentially that number applied against the annual revenue and then it's not a normalized tax rate for all of the issues we've chronicled for years.

What you may be referring to is that yes, we reported net income of $0.03 on a GAAP basis, but included in that number was restructuring of $113 million, which was also approximately $0.03 and that may have been what you were getting at in the question.

Operator

Your next question comes from Katy Huberty - Morgan Stanley.

Katy Huberty - Morgan Stanley

What product categories drove the acceleration in deferred product revenue and does that suggest that we could see some incremental product growth in the coming quarters?

Mike Lehman

The answer is typical, it's the high-end products that require installation. It's typically the same types of products every quarter. It's not unusual to see more, larger deals like this so nothing unusual. It's just yes, it does indicate that there were a number of products that are in the process of installation that typically will turn into revenue in the next quarter.

Operator

Your next question comes from Toni Sacconaghi - Sanford Bernstein.

Toni Sacconaghi - Sanford Bernstein

Your support revenues were down year over year for the first time, I think in history. Can you explain the dynamic that's going on? Unit growth has been down the last three quarters, but I think you've stated that you felt very comfortable that you were still getting good ASPs and good revenue growth. I think the inference would be that there wouldn't be an impact on support, but we have seen support revenues decelerate very rapidly over the last eight quarters and are now negative. Can you talk about the dynamic there?

Mike Lehman

Well, without agreeing with your characterization of the change in the revenues, it is true that generally speaking as the unit count does not increase and as there are more lower-end systems, that all things equal, the revenue captured per service could be a little bit less related to those systems. That's offset by the increased software revenues that we are getting, et cetera, so there's a more complex dynamic than just a trailing unit indication.

But there's no doubt, as we've talked about for a long time, that the services business is competitive. People have choice for hardware support out there. People principally come to us for the software support, and the product quality has been getting better and better over time so we see all of that reflected in the business.

Bret Schaefer

It's also somewhat reflective of having a good quarter on the high end, but also seeing a fair amount of that deferred so obviously that wasn't going to trigger the service revenues as well.

Jonathan Schwartz

Tony, I would add that we refreshed the product line principally in the very low end over the last 18 months or two years, so it's not surprising that we see a little bit of a slowdown in regard to the services. But as we refresh the rest of the product line, we would begin to see that pick back up.

Operator

Your next question comes from David Bailey - Goldman Sachs.

David Bailey - Goldman Sachs

I was wondering if you could comment a little bit about services margin and the sustainability of that? Other than the mix going more to professional services, how sustainable are the gross margins there?

Jonathan Schwartz

I think there's a fair degree of sustainability to it. Again what folks pay for when they buy a service from Sun is largely the intellectual property that we deliver to them in the form of updates and patches to the operating system and the software that goes around it. So that is a pretty resilient business. I think we're somewhat less exposed to some of the labor arbitrage that characterizes the more traditional break/fix business. So that business is improving and has been for a while and again we're expecting and planning for it to continue to do so.

Operator

Our next question comes from Harry Blount - Lehman Brothers.

Harry Blount - Lehman Brothers

I wanted to focus on growth again for a second. Mike, you reiterated you expected low to mid single-digit growth with acceleration in the back half and I think you said both organic and inorganic. Could you help us a little bit there? You guys have been talking about seeing an acceleration in growth now for several years. We really still haven't seen it. What gives you the confidence now, and this is either for Jonathan or Mike, that we truly will see an acceleration in the back half and hopefully you mean an organic acceleration , not just your acquisition.

Jonathan Schwartz

No, I think when we're planning our business we're not planning for inorganic growth. We're planning for organic growth. I think if you look year over year at some of the key businesses, our CMT business and Niagara-based business is up 70% year over year. The enterprise business is up 23% year over year, the X64 business was up 10% year over year, so I think we're just going to be more exposed to that growth and so obviously as time goes forward, those revenue lines are going to get bigger and we're expecting to see more of that upside.

Mike Lehman

The other thing too that I tried to point out to you, we've been talking about the change to sell out for quite awhile and in the long ramp down to this process, revenues have been negatively impacted. They will be negatively impacted in Q2 and in the second half of the year. When we get behind that, as we report revenues on sell out, we're going to finally be able to have good compares as we go forward, so that's going to begin to show up in the U.S. and in Asia in the second half of the year. Lots of good things from that perspective as well.

Operator

Your next question comes from Richard Gardner - Citigroup.

Richard Gardner - Citigroup

Jonathan, I just wanted to confirm that the 70% year over year growth that you cited for Niagara and the 10% for X64, those were revenue growth rates year over year for the current quarter, the quarter just reported?

Jonathan Schwartz

Billings.

Richard Gardner - Citigroup

Billings. I was wondering if you could give us maybe some qualitative color on Niagara 2 and how that's being received within the customer base and whether you think that this is the CMT platform that's going to start to see broad production deployments?

Jonathan Schwartz

Well, I think we're already in broad production deployments with Niagara 1 and there's a whole variety of household names that today when you go visit their website and hit their web services infrastructure they are actually on Niagara systems. So Niagara 2 has a couple of very big benefits over Niagara 1.

First of all, it had a chip multithreading predecessor in the marketplace, whereas when Niagara 1 shipped it really didn't.

Secondly, as you may know, we doubled the core count, so this is now a 64-way chip instead of a 32-way chip. We added floating points back in, so we're looking at a much broader marketplace as a result of that. I do expect that certainly with some of the early activity, we just continue to see the right brand names and the right infrastructures really embracing Niagara's focus on power efficiency.

The fact that it's got virtualization built in, we can run 64 separate operating systems on the same piece of silicon, and these are all things that enterprises we talk to find very valuable and so we think there's plenty of opportunity there.

Operator

Your next question comes from Katy Huberty - Morgan Stanley.

Katy Huberty - Morgan Stanley

When KKR invested back in January, you alluded to the potential for accelerated acquisition spend, but we really haven't seen any major deals yet. Has anything changed in terms of the landscape of available companies or your appetite for acquisitions since earlier this year?

Jonathan Schwartz

Nothing has changed at all. I think we're just as interested, just as focused and there's just as many opportunities that are out there. So I think we certainly see leveraging our balance sheet and our scale as being one of the assets we can bring into the marketplace and we're fully expecting to continue thinking that way and acting that way.

Operator

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

Brent Bracelin - Pacific Crest Securities

A follow-up question on growth, obviously three consecutive quarters here with server units declining. At what point do you expect to see a rebound in the server business from a unit perspective? With the strong gross margins you guys reported over the last three or four quarters, would you plan to get a little bit more aggressive on price to try to reaccelerate growth there?

Jonathan Schwartz

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.

I think we've also seen a tremendous upsurge in interest from our customers in our virtualization offerings. The fact that we're going to be delivering into the free and open source community a virtualization platform that gives folks the ability to consolidate both Solaris Windows and Linux makes our systems more appealing as well as makes our software platforms more appealing.

I think that's the way we see things going forward. Again, we expect a smaller number of more richly configured systems to be pushing on the right trends to yield more margin, unit volumes are really going to be I think more questionable.

Operator

Your next question comes from Bill Shope – JP Morgan.

Bill Shope - JP Morgan

Expanding on that previous question, so you've clearly said that top line growth is still the priority for this fiscal year. Why wouldn't we see you investing more of the gross margin upside into pricing, whether that's to drive volume or revenue growth and even if it's in high end systems?

Jonathan Schwartz

So 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.

Operator

Your next question comes from Louis Miscioscia - Cowen.

Louis Miscioscia - Cowen

Could you go into gross margins in a little more detail? Obviously you just delivered a fantastic gross margin in really what is a seasonally weak quarter. You've got two seasonally strong quarters coming up. You mentioned already that servers are moving to high end of the range and you've only raised the basis point range by 100 basis points.

As you look forward to the rest of the year, what do you think is going to keep it depressed and also if you could tell us if components aided gross margins in this quarter and if so by how much?

Mike Lehman

I potentially answered the second part of the question by quantifying the $25 million to $35 million impact on the quarter. That's essentially what we saw that was better than we had expected, and obviously that's largely component pricing.

From a planning perspective, we don't plan on that continuing. That could happen, but that's not how we plan the company by expecting above average component cost decreases to go on forever.

The other factors with regard to overall gross margin we've touched on a bit. We've gotten a lot of increase in the services gross margin over the last couple years. We expect that to be stable. On the other hand, we are not going to walk away from business. Jonathan talked about that we don't necessarily need to drop prices in certain places, but I can tell you that the salespeople are certainly looking for ways to go do that. They're looking for opportunities to grow the business. Margin is one of the levers they have and in the context of everything Jonathan said we'll be continuing to look at that.

So from our perspective, raising the gross margin range for the year by 100 basis points is a pretty good indicator that we feel good about where we're at.

Operator

Your next question comes from Keith Bachman - Bank of Montreal.

Keith Bachman - Bank of Montreal

I just wanted to focus on storage for a second. Obviously you moved to a positive year-over-year growth rate. Jonathan, if you could give us a little bit of color on where were the strengths and weaknesses? I didn't hear any commentary on Thumper in particular unless I missed it.

Related, given that this quarter was helped a little bit by an easy compare, would you expect storage to have a positive year-over-year growth rate number for the December quarter? Thanks.

Jonathan Schwartz

Without going into the specifics of the December quarter, I think we had a weaker tape quarter than we would have liked. Mid range was up and I think the high end was stable. Thumper was seasonally down Q4 to Q1, but certainly we've gotten a lot of attention and awareness in the marketplace as a result of some of the activity occurring around ZFS which is the file system that's at the core of our software offerings. We've just seen frankly a huge upsurge in interest in enterprise beginning to look at ZFS and its ability to help them compress prices and get more flexibility out of some of their proprietary vendors. That's something that we're obviously building our storage platform around.

If you look back in the quarter at how we're building our platforms, we're increasingly looking to the supply chains and the design expertise of the systems team that's building out our Niagara platforms and our X64 platforms and simply applying that same methodology and engineering discipline to how we build our storage business. So it's going to be increasingly characterized by systems that look an awful lot like the computing systems we build but based on the ZFS file system and some of the new storage technology coming in behind that, I think we feel very, very good about our position in the marketplace.

Operator

Your next question comes from Kevin Hunt - Thomas Weisel Partners.

Kevin Hunt - Thomas Weisel Partners

I just want to follow-up once more on the component and gross margin question. So you've clearly had some benefit for several quarters in a row now I think from the component side, which has a cumulative effect. The question here is you calculate the about 100 basis point benefit you got this quarter based on what you said there. How much of that, if you go back say two or thee quarters, is it 300 basis points better than what you thought or is are you resetting every quarter down, where you aren't going to get any incremental benefit from components? Does that make sense?

Mike Lehman

No, it doesn't make sense but I'll tell you what we do. We reset our standards every quarter based upon what we expect the component costs to be in the next quarter, and that's how we set our standard and that's how we base our plan. We have gotten some incremental benefit through the last few quarters from component costs. I've described that benefit every quarter. Again, because we reset standards at the beginning of the quarter, we don't expect for there to be an upside surprise to that in the current quarter. If that happens, that certainly isn't something that we've been able to predict.

Kevin Hunt - Thomas Weisel Partners

So it's fair to say you've been accruing some cumulative benefits but you don't expect any further benefit next quarter?

Mike Lehman

No, I haven't been able to explain myself. To the extent that component costs have gone down, we reset the standards with those lower component costs. What we don't expect is further upside to that or decreases in cost in the next quarter. If it happens, it happens.

Operator

At this time I'm showing no further questions.

Bret Schaefer

Thank you for joining us today. Investor Relations personnel will be back in our offices shortly to respond to any further questions and you may contact us through the Investor Relations main number 408.404.8427.

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Source: Sun Microsystems F1Q08 (Qtr End 9/30/2007) Earnings Call Transcript
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