We announced our earnings today, and put specifics around our preannouncement from a week ago.
We also greatly increased the transparency of Sun’s business by providing line item detail surrounding our most important product categories (and we broke out core elements of our Software business for the first time). If you’d like to listen to our earnings call, just click here – in addition, here’s a quick synopsis of the quarter and our business overall.
At a corporate level in Q1, Sun’s revenue was down 7% year over year. Growth in our emerging products was more than offset by declines in our traditional, high end products. We were surprised by the magnitude of the decline, which reflected a dramatic slowing in the US and Europe, and the effects the credit crisis is having on our customers – across nearly all geographies and industries, but clearly concentrated among financial services companies.
Unlike our peers, Sun is more exposed to high end systems – so declines in this business have an immediate impact, even if our newer, emerging businesses demonstrate fantastic growth (which many did). For example, the Tape market won’t sustain 30% year over year growth for any participant – but our ZFS based OpenStorage products are growing at more than 100%. The latter are smaller, emerging businesses, driven by open source and new innovations – and will take time to eclipse more traditional businesses in our P&L.
To drive an even greater level of transparency for investors and analysts, we’ve added a new management report to our quarterly updates – for the first time, this will give line item detail of our performance, and a sense for how we’re making some of the most important decisions at the core of our long term strategy. You can find that break out, here.
Here are a few of the major questions I’m receiving:
What went well within the quarter?
The biggest highlights were the performance of our Solaris based, chip multi-threading (CMT) systems, which again grew a whopping 80%, year over year. These systems leverage awareness of Solaris/Opensolaris and our outstanding ISV portfolio, and are driven by extreme energy efficiency and virtualization – attributes we just multiplied with the launch of our newest CMT system: the T5440.
Simultaneously, our Open Storage systems also delivered a great quarter, up 150+% year over year. These systems, known by many as Thumpers, are amplified by the awareness of our open source ZFS file system, a technology at the heart of Sun’s storage business. You’ll be hearing more about Open Storage at a launch event we’re holding on November 10th. If you’re technical, and you want some hints about what we’re about to unveil, click here.
And finally, most of our software business grew – including MySQL, Java,
alongside Solaris, management and our virtualization products. As we’ve been saying, open source is a great distribution model – and it feeds a great revenue model.
What about lowlights?
Clearly the traditional businesses slowed significantly – with enterprise systems (our largest, mainframe class systems) declining year over year. This time last year, those same systems grew nearly 20% – so the downturn is having an impact. It’s crucial to understand these systems are far less sensitive to open source innovations or Solaris adoption – they’re sold to customers who are scaling up existing Solaris applications, who rely on quality, fault tolerance and our capacity to deliver mainframe scale. We and Fujitsu just expanded this product line – and no matter the downturn, we remain exceptionally focused and committed to traditional enterprise computing. The expansion of scale out computing doesn’t negate scale up computing – if anything, it leads to even greater demand, over time. IBM was right, mainframes will always be sexy (especially when they run Solaris :).
On the storage front, tape declined slightly, although our high end storage systems grew, yielding growth overall in storage – growth we’re driving to accelerate with the introduction of our upcoming Open Storage innovations.
Why were gross margins lower this quarter?
A few reasons that Mike Lehman, our CFO, elaborated on during the call – the lull in very high end systems, along with discounting and component pricing depressed gross margins. In addition, we went through a series of product transition related expenses this quarter we do not expect to recur, that depressed margins by around 2 percentage points.
Now, how is Software growing if you give everything away?
We make our software freely available to enable its distribution to the farthest reaches of the market – which we then monetize with commercial subscriptions and services, alongside optimized hardware systems (like Open Storage, above). We continue to reach customers that have already settled on our software – the process of selling to them is simplified by the fact they’re already using our core products. And unlike most university students (who typically have more time than money), our paying customers view downtime or administrative complexity as more expensive than a software subscription (that is, they have more money than time).
Thus, customers will pay, and continue to pay for access to enterprise grade features, along with mission critical support and maintenance – the Software business is both a license, subscription and services business.
To understand the total size and value of Software at Sun, you need to look at billings alongside our multi billion dollar support streams – remembering that a lot of our software is sold as a subscription service (remember, it’s open source). In addition, you have to recognize that how much a “Systems Service” support contract is attributable to software is entirely subjective (we don’t price them separately to customers). It’s like asking how much revenue a mobile phone manufacturer should attribute to their operating system – you’re not charged separately at the point of sale.
Wait, you make money off Java?
Yes, it’s among the most profitable technology products at Sun – and improving. Java’s one of the most popularly distributed pieces of Software on the internet, we distribute over a million Java runtimes a day to users across every OS and geography on PC’s. That helps us reach a very broad community of users and, more importantly, developers. We have some exciting news coming up around these distribution volumes – and their value to us, and others.
What is Sun focusing on?
Strategically, we continue to focus on two core areas – creating the world’s largest, and fastest growing developer communities – for whom we build the products, services and technologies on which they’ll build their products and services. With brands like MySQL, Java and OpenSolaris – we measure and drive their adoption very aggressively.
And secondly, we deliver compelling commercial offers to those deploying applications – across a diversity of industries – through commercial subscription, services and optimized system products. That is, we sell datacenter systems, software and services.
We’re focused on today’s customers with our current products and services, and tomorrow’s customers with our investments in freely distributed software.
Operationally, we’re focused on execution – in the field, in the labs, and on behalf of our shareholders. Innovation loves a crisis, even when the stock markets don’t – and Sun’s positioned very well to supply the platforms on which the next generation of clouds will be built.
What are you hearing from customers?
It really depends upon industry and geography. From Wall St. I’ve heard, “I can’t take your call until I crawl out from under my desk,” (only a slight exaggeration) – at the other extreme, an executive at a professional social networking company said, “we’re being crushed with new accounts.”
But there are three basic themes I’m hearing.
The first is a profound concern surrounding the global economy. If the headlines are bad, you hold off consumer spending – if you hold off on consumer spending, the headlines are likely to worsen. It’s tough to break that cycle.
The second is a reaffirmation of the importance of technology – for discovering drugs, running businesses, modeling supply chains and automating business processes, technology’s not getting less important, it’s getting more important. Even if budgets are tight in the near term.
The third is the need for change – one executive to whom I spoke recently said her entire discretionary budget was consumed by one proprietary vendor’s price increase. So she’s out looking for an alternative, and MySQL fits the bill. Which is to say, necessity’s the mother of invention – and there’s a lot of necessity going around right now.
All in all, it was a tough quarter for Sun and our customers – but we’re emboldened by the progress we made in our emerging markets and technology areas, investments we plan on amplifying and accelerating. Investments whose adoption will be hastened by customers facing new choices.
Stay tuned for our newest storage announcements on November 10th… just as the popping of the internet bubble let loose a flood of innovation for the server world, the global credit crisis is about to shake up the storage industry, too.
Safe Harbor Statement
Jonathan’s blog contains forward-looking statements regarding the future results and performance of Sun including statements with respect to our commitment to enterprise computing, the demand for scale up computing, the continued business of our paying customers, upcoming news regarding Java distribution volumes and value, expectations for the OpenOffice community, our strategy and related progress, our positioning with respect to the next generation of clouds and our expectations with respect to investments in emerging markets and technology areas. 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: competition; pricing pressures; the complexity of Sun’s products and the importance of rapidly and successfully developing and introducing new products; Sun’s dependence on significant customers, specific industries and geographies; delays in product development or customer acceptance and implementation of new products and technologies; Sun’s ability to implement a new enterprise resource planning system; a material acquisition, restructuring or other event that results in significant charges; failure to successfully integrate acquired companies; reliance on single-source suppliers; risks associated with Sun’s ability to purchase a sufficient amount of components to meet demand; inventory risks; risks associated with the quality of Sun’s products; risks associated with international customers and operations; Sun’s dependence on channel partners; failure to retain key employees; and risks associated with Sun’s ability to achieve expected cost reductions within expected time frames. 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, 2008. Sun assumes no obligation to, and does not currently intend to, update these forward-looking statements.