We announced our first quarter results on Monday after the close of the stock market. You can read the press release here. And as usual, I thought I’d offer some thoughts around our performance.
We’ve heard a number of questions, as we do every quarter – this quarter, those questions came down to basically three areas. What went well within the quarter? What didn’t go so well? Why didn’t you grow – augmented with why did the share price decline?
So, without a lot of fanfare, here are some thoughts.
What went well?
I was very pleased with the leverage in our operating model – that’s just a polite way of saying we delivered our single biggest Q1 profit since 2001, and it’s good to be back in the habit of making money. Even in what’s traditionally our toughest quarter of the year, and even with a restructuring charge that took three cents off our GAAP earnings, we generated $89 million in net income.
We executed on our R&D, and delivered a seven year high in gross margin – up 5 percentage (yes, percentage) points year over year to 48.5%. Product gross margins were up 5.3% year over year, services gross margin was up 4.3%. Customers appear to value what we’re building, and our teams are executing well.
While our overall revenues were up only 1% over the prior year, deferred product revenues were up 18% (or roughly $100m). Deferred product revenue represents products (hardware and software) we shipped, that either hadn’t been installed or met customer acceptance criteria – we will recognize them in the near term, and it’s generally good to have a growing backlog of deferred revenue. In addition, we took roughly $20m out of channel inventories as we make progress toward managing our business on a “sell out of the channel” basis, vs. “sell in to the channel.” This shift makes us more transparent for investors (we recognize revenue on customer activity, not channel enthusiasm), and more effective in working with our partners.
Again, while overall revenues were 1% up Y/Y, our high end and mid range business was up 23% (year over year), our Niagara chip multi-threading systems were up a fantastic 70% -to a $750 million annual run rate – and our X64 business was up 10%, with blades generating around $40 million) and growing nicely, along with good momentum in our higher scale x64 platforms (as I’ve said before, virtualization depresses units in the short term, but increases configuration, ASP and margin). Our storage business stabilized, and grew faster than Sun overall, at 2.9%. Storage is getting a lot of focus, both at the software level (you probably saw we just introduced our CIFS implementation into the OpenSolaris community, which makes it an ideal NAS platform for Windows users), and at the hardware/system level, as well.
We delivered a big cash quarter, generating $574m, our biggest Q1 cash flow in… well, recent memory.
So net/net, we had lots to be pleased about – in addition to announcing new relationships in which IBM agreed to OEM Solaris, Microsoft agreed to support our virtualization efforts (and vice versa) and Google agreed to promote StarOffice, we also demonstrated our confidence in the business by buying back a massive $1.25 billion in JAVA shares. We put our money where are mouths are, for those wondering.
What didn’t go well?
The top line revenue growth was marginal – at around 1%. Deferred revenue isn’t counted, obviously, and we chose to take inventory out of the channel, knowing it would go against revenue within the quarter. That yielded a mixed bag on the top line, even with help from currency shifts.
Although our EMEA (Europe, Middle East and Africa) and APAC (Asia Pacific) businesses grew (some geographies, like India and China, in big double digits), our US business was down roughly 4% year over year (and at 40% of our revenues, if the US catches a cold, Sun catches a cold). Why was the US slow? We don’t have a crystal ball. Was it related to the US mortgage crisis? I can’t imagine it helped. Some financial customers grew, others shrank. Partners seem more excited than in a long while. So there’s no easy analysis.
Our volume systems business grew only 3%, so our total computer systems business grew only .5%. Our new products haven’t eclipsed our legacy businesses – even though the former are on good ramps. Our support services business was down just under 1%. And we had demand for several non-shipping or new products, notably our newest quad core x86 servers and eight core Niagara 2 systems (both now shipping), but some customers may have waited for Q2. Again, very hard to tell at a global level. On an anecdotal basis, customer sentiment is way up on Sun. But sentiment and purchase orders are authored with different pens.
But push comes to shove, the only thing I was disappointed in was our top line growth – nearly every other metric is now moving in the direction we want. Financial measures, like margins, cash, predictability, quality, competitiveness of the product line – all the right foundational elements. And longer term measures – adoption around OpenSolaris, support for Java on devices and among the developer community, analyst ratings.
So fine, why didn’t you grow? Why’d the share price decline?
As I said, we don’t have a perfect answer, other than to say – we don’t see competitive issues holding us back, the team is executing well, and the brand and reputation of the company are now amplifying opportunity, not depressing it. The single biggest issue was some customers slowing down some purchases in the US, but it wasn’t specific to financial services (although companies in the midst of CEO transitions tend to put a lot of things on pause), or even more general to all customers (several industry sectors grew, like our government business).
Why’d the share price decline? This is obviously a question lots of folks asked (especially after today’s market decline) – and the only answer I can give definitively, and without meaning to be cavalier, is that there were more sellers in the market than buyers. The opposite of what makes our share price rise.
And just in case we failed to make it clear, of course revenue growth remains our highest priority. We’re focused on taking a refreshed product and service lineup, into markets we expect to grow across the earth – and investing to deliver value to customers and shareholders. In my view, we took another step forward in Q1.