We announced the results of our third fiscal quarter (Q3) on Thursday last week, and the results weren’t what I, or any of us, wanted.
As you can read in the press release, we delivered $3.267 billion in revenue for Q3, roughly flat with a year ago. On that revenue, we delivered a GAAP loss of 4 cents (equal to the charge associated with the acquisition of MySQL, which closed within the quarter) – on that revenue, we generated around $320m in cash.
The low light of the quarter was revenue in the US – which declined year over year by nearly 10%, a big step down for a geography that typically contributes 40% of our total revenue. The highlight of the quarter was our India performance, up 30% year over year – and our chip multi-threading Niagara systems, which grew (billings) 110%.
We had growth in 12 of 16 geographies in which we sell, but a shortfall in the world’s largest economy (and the largest in Sun’s portfolio), is tough to make up elsewhere. So we showed no growth at the corporate level.
Despite a weak US economy, we still see growth and opportunity across the world. We are going to be making some changes as a result of the quarter, certainly, but not in our core vision or strategic direction – network infrastructure is being built out across the world, developers will continue to define its architecture and shape demand, and we will continue to position ourselves to drive and capture that market.
With that, I’ll go through a few questions:
What happened in the US?
Late in the quarter, we saw a fairly aggressive slowdown – among smaller customers, and for larger systems (like enterprise servers and large tape libraries). As you recall, we left Q2 with a healthy backlog, lots of momentum, and feedback from customers that we were totally on the right track, so we were as surprised as anyone that deals started stalling in early March.
Why did big systems slow?
It’s counterintuitive, but larger systems and purchase orders’s are easier to slow down than smaller purchases. When you sell the systems and storage behind a big buildout, it’s typically a long selling cycle, and a fairly long implementation process (systems aren’t powered up the day they arrive). So holding off for a few weeks, either because you’re spooked about the US mortgage crisis or because your CFO decided to put a pause on capital spending, is fairly straightforward.
And remember, our business is a portfolio – from high growth, low end blades and training services, to slower growth, high end enterprise systems an infrastructure software. There is no one system or product for all workloads, it’s a portfolio.
So how are you going to adjust going forward?
We’ll continue to diversify our business – geographically, and with the introduction of our Open Storage initiatives this past week and acquisitions like MySQL and Vaau, we’ll continue moving into adjacent markets.
We also announced a restructuring plan, through which we’ll be making targeted reductions in operating expenses. The net result will be the elimination of up to 2,500 jobs.
To be clear – we are taking assertive, and prudent steps to focus on growth opportunities, and to pull our cost structure in line with our business model. As we’ve done in years past, we’re doing both – making choices to invest and disinvest.
Evolving companies are never done making choices.
Where did you grow in the quarter?
In 12 of the 16 geographies we serve – including India (up 30%), Brazil (up 20%), up in China, Russia, the Middle East, Canada, to name a few places. In general, the world continues to look to technology as a source of growth, automation and efficiency. Even our Wall Street business was up this past quarter.
On the product front, our focus on energy efficiency continues to pay off, with Niagara systems grew (billings) 110% year over year, and our newest (AMD, Intel and SPARC) blade systems growing at an even higher clip. The MySQL team delivered a great growth quarter, and Service revenues were up 3% (a major portion of which are software related, of course). Disk storage billings were up 6%.
Deferred product revenues were again up nicely, more than 25% – these deferred revenues tend to be for higher end systems and more complex configurations, with gross margins above the corporate average. Deferred Services were down, attributable to the ERP transition I mentioned earlier (we expect to recover that in Q4).
What didn’t go well?
Enterprise systems, which were great growers in Q1 and Q2 (20% and 8% growth, respectively), were down in the quarter – and not specifically attributable to competition. We saw exceptional performance on our APL systems built with Fujitsu, and a strengthening partnership. Tape libraries were also down, although media sales were strong.
Given the size of both these line items, our higher volume lower end businesses were not yet at a sufficient scale to eclipse the slowdown on the lower volume, high end systems.
Why don’t you just stop giving your software away?
Because we prioritize developer adoption. Let me give an example.
Last week, we saw a very high profile media company raise a considerable sum of money. They had not otherwise been on our radar. I sent a note to the head of our global sales team, given the fundraising had cited a growing infrastructure buildout, and asked if we’d made contact.
He said no, but we were immediately reaching out – and it turns out they’re completely built around MySQL.
So before we arrived, before we were engaged, and before they began building out a large infrastructure, the MySQL team had scored a design win – ahead of the proprietary competition. What should we have charged them beforehand? No matter what it was, they wouldn’t have used the product – startups and developers don’t pay for software. But here’s a diffrent question: what would we have paid them to select MySQL over the proprietary alternatives before embarking on a massive expansion?
Right question. We didn’t pay them, the MySQL team earned their adoption.
Will they buy a license now? Maybe not, but we’ll be well positioned if and when they, like Facebook or Nokia or the New York Times, do. And in the interim, it costs us nothing for the reference. I was with a bunch of startups at our StartupCamp this morning, and asked how many folks in the audience *didn’t* use free software… no hands were raised. Why are we focused on startups? Because we’re focused on all developers, in big companies and small.
How do you feel about the competition?
Just fine, we looked at the deals slowing in the US, competition wasn’t our big issue – it’s not that someone else was getting the purchase order, it’s that no PO was being issued in the quarter. We’re more exposed to the US markets, and potentially more exposed to discretionary purchases (although I don’t really believe that servers are more discretionary than storage – they’re converging). Avnet, one of our big distributors, had a similar experience in the US.
Why didn’t you pre-announce the quarter?
We wanted to be sure, when we made our announcements, to have finalized our numbers and our plan to adjust our cost structure going forward. Given we’re in the midst of an ERP transition, we were still finalizing work late into April. Secondarily, we needed to review our FY 2009 restructuring plan with the board before going public. We announced as soon as we’d met, reviewed and approved the plan.
How did you lose money compared to a year ago profit?
Well, although we generated a lot of cash in the quarter (more than $320m from operating activities), we also incurred a number of charges which reduced our net income. These included non-cash items related to stock-based compensation and amortization of acquisition-related intangible assets as well as other acquisition-related charges – all of which added up to 20 cents worth of charges.
Are you repurchasing your own shares?
We don’t comment on buyback plans, but we’ll report any potential purchases at the end of the quarter.
When will the US recover? Will the malaise spread overseas?
We build network innovation at Sun, we don’t predict the global economy.
And with that, you’ve hopefully got a clearer sense of what we saw, and what we see. So I’ll end on a particuarly vexing question,
“Why does Sun’s CEO waste time writing that blog?”
Because I believe in providing clarity surrounding our strategy and operations – not just once a year in the Annual Report. I believe clarity behind our direction is useful for our shareholders, customers, partners and employees.
In good times, and in challenging ones.
Safe Harbor Statement
Jonathan’s blog contains forward-looking statements regarding the future results and performance of Sun including statements with respect to the effects of our restructuring plan, and expectations for deferred revenue. These forward-looking statements involve risks and uncertainties and actual results could differ materially from those predicted in any such forward-looking statements. Factors that could cause actual results to differ materially from those contained in such forward-looking statements include: risks associated with developing, designing, manufacturing and distributing new products; lack of success in technological advancements; pricing pressures; lack of customer acceptance of new products; the possibility of errors or defects in new products; competition; adverse business conditions; failure to retain key employees; the cancellation or delay of projects; our reliance on single-source suppliers; risks associated with our ability to purchase a sufficient amount of components to meet demand; inventory risks; and delays in product development or customer acceptance and implementation of new products and technologies. Please also refer to Sun’s periodic reports that are filed from time to time with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the fiscal year ended June 30, 2007 and its Quarterly Reports on Form 10-Q for the fiscal quarters ended September 30, 2007 and December 30, 2007. Sun assumes no obligation to, and does not currently intend to, update these forward-looking statements.