Understanding Sun’s Business – Q1 Results

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.

21 Comments

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21 responses to “Understanding Sun’s Business – Q1 Results

  1. zohar

    Jonathan, every CEO shares us with infinite optimism, that’s natural and might be true.
    But one question you didn’t answer and that is when will the company be proftable ? That is, we the shareholders need to see a decent P/E so the share will go up and return our heavy losses.
    Its nice the product is getting adopted but it seems profitability is not in your horizons. I will appreciate if you can dedicate a post to this important issue.

  2. gohidg

    Why Sun have good technology but the market is not so good for Sun? I am confused.

  3. John Wallace

    I encourage Sun to keep up the push with JavaFX. The web is undergoing a shift from AJAX to real RIA, and JavaFX looks to be stronger than the alternatives. And since JavaFX runs on servers, it’s a great way to drive your server business. Good luck!!

  4. disappointed again

    Jonathan,
    When you made the pre-announcement, Sun stock lost a whole bunch of value.
    After the real results announcement, Sun stock dipped even more.
    What good did the pre-announcement get you and your shareholders apart from warning the market ahead of time of impending doom and gloom? You brought about more harm to the stock’s already low value with this approach. This IMO was a blunderous move.
    Also, as every CEO does, you say you have great products now but revenue keeps dipping.
    What does that tell you about the problem you have on hand? Blame recession only? Or is there a problem with Sun’s sales and marketing as well? Is there an execution problem?

  5. Tampa Bay Buccaneer

    Jonathan
    I appreciate that Sun is more exposed to the ups and downs in the market due to product mix, but we as shareholders are looking with longing at the type of stability your competitors have. Obviously there is some really innovative products comming out of the Sun labs but is this what customers buy? It is obvious to me, looking from a user experience viewpoint, that you do not have an clear idea of what makes IT Shops open their wallets – you have to regain that and soon. Sexy does not always sell.
    I have sticked with you for so long I am getting to be sure I will never recoup my loses – I am getting to the point where I do not mention anymore that I own Sun shares. Lesson learnt – do not let emotion get involved when investing.

  6. JP

    I don’t see much discussion of profits. You say you "make money off Java". That implies revenue, but how about profit? Rememeber doing all this cool stuff costs money, which is why the operating expenses are totally out of control.
    How about profit from the rest of Software? Even the ‘focus’ of "creating the world’s largest, and fastest growing developer communities" seems software-centric, yet the only really decent news I see is hardware-centric.
    It would appear to this unsophisticated shareholder that the only possible profit centers at Sun are hardware and services. Maybe it is time for Sun to sell-off or spin-off business units so that they can REALLY focus on their own products and profitability instead of subsidizing the rest of the company.

  7. Ben Tick

    Oh my God, did you mean to disclose your software revenues?
    http://blogs.sun.com/jonathan/resource/LineItems.pdf

  8. It is crushing to see the economies loose balance. It seems there is lesson in this, credit and spending future earnings is dangerous. It seems it’s wise to spend what we have and also to save. I have been studying the comments for some time now. It seems a lot of Sun’s hopes are on the future.On open source creating the consumer base and fueling the requirements. I do not have much knowledge about the exact nature of the commercial aspect of Sun’s products but it seems a shift from the future-based strategies, for sustainable growth, there has to be a model which at least breaks even and prevents the losses of the share holders. I am not sure, but for a place which is build on such positive principals of sharing freely, there must be a way to be profitable. Hope this recession passes over quickly.

  9. Anantha

    Cool technologies are ‘hot’ if the company has profitability to finance them in the future. If not, both the company and technology will be in cold storage.

  10. Amazed

    Jonathan
    you say "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. "
    I’m amazed that Sun’s primary focus isn’t to MAKE MONEY.
    Customer communities are all very good, in that it’s nice to have people aware of Sun’s products, but ultimately this company will survive only if it SELLS things.
    Unless/until Sun changes it’s focus onto money, there’s little hope for the future

  11. fun

    I’ve been reading this blog (and more importantly, the comments it generates) for a while now. A very interesting social study. There are some evident threads in the postings:
    o Jonathan using this as a pulpit for disseminating his vision for the company, and other insights.. (the old order changeth, a brave new world ..?)
    o Readers lauding Sun for its courage in following through the set vision, or mocking it for having and sticking to its broader scruples…
    o Readers (mostly shareholders?) chanting "money, money", "show me the money", "make money" .. (justified, I think)
    Eventually, I think the success (or failure) of this company is not only going to affect its shareholders and customers, but also a whole slew of emerging and future businesses that will model themselves around Open technologies. It will be a textbook case, either way.
    Good reading, as always.

  12. Can you elaborate what this means?
    "… you need to look at billings alongside our multi billion dollar support streams …"
    Greetings
    Bernd

  13. Observer

    @Bernd – if I understand the drift, traditional software companies show license revenue and support revenue. As Sun is moving away from traditional software license models, and toward service/support, a significant portion of their Software revenues will show up in Services – as would almost all the support revenue from Solaris being sold running on Sun hardware. So some fraction of their Services business is really Software, but they don’t want to make the judgement as to exactly how much, because it would be subjective (they don’t price it separately when they sell a CMT system, eg).

  14. SUN fanboy

    NOTE:
    1. This is a small call to reflection to persistent SUN critics. Read this to the end, understand the words and thoughts I write, before pouncing on your keyboards to reply with gibberish. Is that OK?
    2. I’m not affiliated to SUN in any way other than using Java programs. OK, clearly, I admire SUN.
    3. Some references to impolite posters are based on observations made from reading this blog and comments for a long time, not just this post.
    Proceed…
    It beats me how some of these SUN employees/stockholders are trying to mutate into Resident Evil creatures, metaphorically. Are these commenters actually SUN stockholders, part owners of SUN, who present themselves at shareholder meetings, write to Jon/Scott or just come here and rant away?
    SUN is Standford *University* ***Network***. Read again. Think a bit. Relax. SUN has many more highly talented individuals, much more than me and you. At least ten of them have supervised design and implementation of systems that run huge financial institutions. At least five of them know how to hire a competent advertising veteran or talent. They have the cash, as you can see how they splurge, right?
    Yet, they don’t know how to monetize? That’s a remarkable degree of thinking you show.
    IMO, Jon is doing a decent job. He’s telling you the calculated risks he’s taking and as we can all see, it is the very "stockholder" community that has screwed it up for the tech world. That is how their primitive brains work. They create the problem by speculating. They run away with cash. They dont invest. And some of the same fools sit at Board meetings to decide that XYZ is not competent. Maybe he is not, but he put most of his cards out there on the first day. Shouldn’t you have pulled him up right then? Not now, in these times. More than 5 huge financial institutions have just evaporated -they’ll form soon under another name, don’t worry – big money never sits still. Read some basic history.
    FYI, SUN is a tech company, just in case you have not realized it so far. How many of you, holding voting rights in the Board, have such an open way which details your company’s core expertise? So that people can understand what is good about SUN? And not wonder what is going on behind the scenes and what risks aren’t being communicated? And so on…
    To the marketers, do you want SUN to put up "sexy gals" and "sleek cars" next to coffee cups in ads? (SUN: Note this. Actually helps dimwits choose server products!)
    The ***absence of mandatory stockholder reciprocity*** is the core of the current financial problem – Sell, sell, sell. The problem is not Jon or SUN. The problem is *you* – the stockholder – who does not feel the need to stick with any stock at all.
    In other fields of life and business, it would be called "mass hysteria" and people would be shoved up elevators of mental health centers.
    Jon has a – what was it – yes, "fiduciary" – responsibility towards stock owners.
    Stock owners, who *own* parts of tech companies, have no reciprocal responsibility to stick to a company for a minimum period of time? Just sell, sell, sell?
    The problem, gentlemen, is that stockholders with "ownership" are selling faster than the sales teams can even imagine to cope with.
    The system is faulty, by design, gentlemen. If you are an ex-SUN employee (the most pointed critics out here) don’t you think you should equally strongly voice your concern over the absence of a minimum period of stock ownership – that intra-day trading be banned? At least for tech companies?
    You have the right to complain and demand the resignation of CEO in the middle of a complex business makeover. You must also have the duty to stick to SUN stock when it rises or falls.
    Why does your totally failed free-market system allow company ownership to be changed within minutes but does not allow steering a technology ship without interference?
    How many of you wrote to the Federal Reserve complaining that people should not be allowed to sell like this?
    At least that they should keep Tech companies insulated from gambling by dimwits?
    Agreed I’m no good in Finance, please read what Andrew Lahde has to say.
    Why did the Fed not stop trading for a long period of time?
    Why dont investor portfolios get analyzed and minimum time limits on holding stock get fixed according to the size of their portfolios?
    Did you write asking for any of these things? It is cowards who write here because SUN and Jon cant sue you for defamation and not write to the Feds because they’re powerful. It’s cowardice by definition. (PS: how nice does a caustic personal attack sound?)
    If you’re a SUN employee, most likely you have the ability to think critically. Have you even analyzed this angle of the problem? It’s like saying I have a secret-service-agency database built on top of a Cloud Computing platform from Microsoft – that’s exactly what happened on the London exchange – it got pwned by MS SQL Server 2000 (LSE was their talking point for the Get-the-Facts campaign!)
    SUN systems don’t crash that way – one of you Holy Stockholders could have made a couple of millions that day had the systems been running on any other platform.
    Stock markets pwned the tech sector (hint: read a lot of news) and ironically, stock holders will decide what to do next? What a world we live in!
    Please let us techies do our work, we’re making you pretty rich in the process, kindly do not interfere – or you’ll lose the big money you want – remember LSE.
    Post constructive suggestions or be quiet. Clear enough?
    (Sorry, I have to write in attacking language – these nuts don’t understand any other.)

  15. Small business still prefer PHP-apps. Personaly I like (and prefer) Java platform, so I’d like to see a rapid application development framework which support AJAX and other Web2.0 features for Java.

  16. reading observer's comments

    Services at Sun is a separate business unit, not under software.

  17. Matt Bryant

    Some observations from someone who is a recent Sun convert and customer, but not a shareholder.
    I’ve posted on your blog before, describing how I was introduced to Sun primarily from hearing about the inclusion of ZFS in Mac OS X. In a very short space of time I became truly sold on Sun Solaris; incredible technology that I have got my hands on for no cost. My experiments with Linux in this regard were short lived – great desktop OS that I’ve replaced WIndows with, but no comparison with Solaris in terms of, well, just about everything. You can *smell* the maturity when using Solaris, it’s a thoroughbred no doubt. Linux by comparison just *feels* like a kernel with a whole bunch of stuffed tacked on, with really crappy documentation.
    If there are thoughts about moving from being a "systems" company to a "software" one – please don’t!! I’ve backed up my commitment to Sun’s software by purchasing a SunFire – to have hardware and software engineered by the same company is a thing of beauty. Running Solaris 10 on my SunFire feels the same as running Mac OS X on Apple kit – everything is tailored.
    In fact, purchasing a SunFire to run Solaris on was, as they say, a no brainer. I truly believe now that Sun has image problems in this area – I say this working the front line in a large tertiary education provider, the largest in fact in its state. All the local technicians and IT Managers are of the view that Sun makes large, expensive, "big iron" kit only; lots of oohing and aahing ensues when I show them what I paid for an entry level x64 machine, with ILOM included, beautifully engineered at a price that is less than competing Dell kit. And purchased privately even.
    Go hard with raising awareness of Sun’s server offerings, especially at the lower end. I hope the great work that Andy has clearly done is not lost in this regard. Also, do on-site tech demos of CMT boxes – I’ve never had any hands on time on one, and meeting someone with experience and benchmarks to share is not really a goer in my area.
    Also go hard with Sun Ray. We are completing a proof of concept of this and the feedback has been amazing. Also amazing (keeping in the same tertiary environment above) is the complete and total lack of awareness from my colleagues that this even exists!
    Please, get your marketing and sales teams to do what Apple do: hire out on-campus facilities, do regular showcases of Sun technologies to anyone interested, and keep on at it! Push the energy savings angle as far as you can, as equally far as pushing the fact the Sun Ray is stateless and with the right server infrastructure can "run" Windows as well. I keep on hearing over and over from my colleagues that "Sun Ray can’t run this or that" – simply because they have zero exposure to the product.
    Push Project Wonderland like there is no tomorrow. Make a Sun Ray 3, load it with AMD integrated graphics and sell it to Universities and corporations for what it is; the mother of all zero-configuration and distance learning/remote working solutions. Get your sales teams to do on-campus demos of this, bundle it with Sun hardware running the back end, Sun Ray out front and centre on the desktop (or at least a nice Sun workstation or monitor!). Make it well known the server hardware does not cost a fortune and is not coloured purple anymore.
    Apache Roller – Sun has had a lot of input into this, it’s an awesome application – why not bundle this with Sun server hardware like the T2000s running blogs.sun, and sell it as a blog package to Universities?
    Last, a more personal note for you Jonathan. I have no input into your performance as a CEO as I am not a shareholder, however, I believe in what you are doing and hope that you continue to do it. You are a compelling public speaker, and the fact you are a generation removed from the Ballmers, Jobs et al gives you major cool factor. Pick sales and marketing persons that are as compelling and convincing as you are, and get them out into the field to sell, sell, sell!!
    I was present at a tech showcase at Sun’s headquarters (region shall remain nameless), this was an edu special at which technologies such as Sun Ray and Project Wonderland were demoed to tech people from secondary and tertiary providers. The two Sun staff flown in from overseas acknowledged early in the meeting that Sun has a problem with marketing their technologies – and then later in the meeting, incredibly, didn’t even give a hands on, nor even live demo of Wonderland – a colossal missed opportunity in every possible sense. I sat throughout that 1 hour+ meeting thinking that if only a Jonathan Schwartz had been in the room…!! Needless to say the meeting ended with not a huge amount of interest from attendees that otherwise would have been easy to sway.
    I have no doubt that if Sun remains on course and remains committed to the things you have set in motion, huge things will be on the horizon. I think your more thoughtful readership can see that. It’s just going to take a little bit moretime, and I think Sun needs to push the angle way more agressively than at present. Maybe hire some marketing experts from Apple🙂

  18. Venki

    Sun fanboy
    No attacks, just a few questions…
    a. If your money (possibly life savings) was going down the tube whom do you hold responsible when quarter after quarter you are are assured recovery is around the corner? And what would you do – hold or sell? And how many months would you hold while your savings erode?
    Especially, when its primary competitors (Dell, HP & IBM) have not been as affected?
    b. You could argue Sun is more affected by the US economy & specifically the Financial industry but why didn’t Sun de-risk its business more? And whose responsibility is it to take the company in those directions?
    c. Jonathan, by the nature of being the CEO, is the flashpoint for critism because people cannot blame "the company"; if not Jonathan, whom do stock holders show their ire towards?
    Remember he gets the big bucks to keep Sun profitable (and vibrant).
    d. You seem to be for protecting the companies from stock speculators; unfortunately that is what you expose your company to when you take it public – if you don’t like it take/keep it private. But who protects investors? If you invested US$1,000 say in year 2000 – what is the value of your investment (probably about US$50.00)? – Who takes responsibility to protect the "Resident Evil" investor, who according to you should be locked from selling his shares? And to which industry does this protection next extend to?
    Venki

  19. a sun shareholder

    The key point here is, did Sun make any money from BarackObama.com adopting MySQL?

  20. Another shareholder

    I spoke to an Oracle reseller today, He said he would pay the Obama people his entire yearly promotional allowance (seven figures) to get them as a reference. I wonder what Sun had to pay them to get that kind of publicity. I sure hope it wasn’t too much.
    Oh, wait, they didn’t pay anything.
    As a shareholder, I’m thrilled.

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