Sun Builds on Growth in Fiscal Q1, But Profits Still Elude

Published: October 31, 2006

by Timothy Prickett Morgan

Server and operating system maker Sun Microsystems continues to make progress on getting its business in order, and last week reported that for the first quarter of fiscal 2007 ended October 1 it saw sales rise by 17 percent to just under $3.2 billion. And while Sun was able to reduce the size of its loss in fiscal Q1, to $56 million, the company still has a ways to go to reach its long-term goal of 10 percent gross operating profits.

Sun's top brass--which these days means president and chief executive officer Jonathan Schwartz and chief financial officer Michael Lehman--are clearly pleased with the progress Sun has made in the past three quarters in terms of cutting costs, getting new products to market, and growing revenues in new markets as well as established ones.

Sun said in a conference call with Wall Street analysts after the market closed on Thursday that sales in its core Computer Systems unit, which is what peddles its servers, workstations, thin clients, and related software products, accounted for just under $1.5 billion in sales, up 15 percent from the year ago first fiscal quarter. Data management products, which include disk and tape storage products as well as their related software, accounted for $491 million in sales, up 14 percent.

During the quarter, Sun's overall server shipments were up 7 percent across X64 and Sparc lines; once again, Sun did not provide a shipment number. But the company did say that machines based on the "Niagara" Sparc T1 chips once again hit $100 million in sales during the quarter, as they did in the final quarter of fiscal 2006. Sparc server revenues were up 10 percent, while X64 "Galaxy" Sun Fire servers saw shipments grow by 52 percent and revenues grew by 75 percent. Schwartz said that the Galaxy server line, which for now uses Advanced Micro Devices' Opteron chips exclusively, is selling at a run rate that equates to $600 million a year. So, together, the Niagara and Galaxy lines are accounting for $1 billion a year in server sales. While this is great news for Sun, the numbers seem to imply that Sparc server shipments are way down. This stands to reason, since the Niagara and Galaxy products are aimed at volume customers who, in the past, would have settled for a technically less impressive UltraSparc-IIIi product.

Sun said that its Try and Buy program, where it lets potential customers play around with Niagara and Galaxy servers before committing to purchase, accounted for 252 deals in the first fiscal quarter.

When pressed about whether or not Sun would extend its Galaxy machines with Intel processors, Schwartz did not answer the question directly, but said that Sun had a strong relationship with Intel, based on all those X86 and X64 installs of Solaris at its competitors. "We're going to optimize for flexibility for Sun and for choice for our customers," he said.

From that comment, it might sound like Sun might be thinking about adding Xeon Core machines to its Galaxy line, but this seems highly unlikely. That statement sounds a lot stronger in print than Schwartz's tone on the phone suggested. Sun will not move to Intel chips unless customers require it, and they will only require it if AMD cannot deliver on promises or falls behind in price, performance, or thermals.

On the storage front, Sun said that its 14 percent storage growth in the quarter was driven by sales of midrange StorEdge 5000 and 6000 arrays and high-end StorageTek tape arrays, which all had unit shipment growth of 75 percent in the quarter.

Sun is in the process of breaking out its software products, which include a mix of software licenses and support contracts, as a separate business, but has not completed this as yet. But it did say that software product sales (including Solaris 10, Java, and various middleware) did see growth of 17 percent compared to the prior year.

During the quarter, the Solaris 10 Unix operating system reached a milestone of over 6 million registered downloads, and consistent with past trends, the majority of those registered licenses ended up on servers made by Sun's competitors--namely IBM, Hewlett-Packard, and Dell. Schwartz would not provide any statistics to show how many of those registered licenses have been converted to paid-for support contracts for Solaris, which obviously means the numbers are lower than Sun would like to admit publicly or it would be, in Sun fashion, bragging about it. Schwartz deflected questions about the conversion rate, saying that Sun was focused mainly on getting a Solaris ecosystem in place and that monetizing this base directly was not as important as getting Solaris in the hands of customers who use its competitors' products.

Schwartz also said that by giving away Solaris 10 so freely, it was giving Sun a chance to recoup lost customers. "With all of the destabilization that is going on with Linux, we are seeing customers who moved off Solaris to Linux come back to Solaris," he said.

Sales of per-seat subscriptions for Sun's Enterprise Java System continue to flatten, with Sun only adding 16,000 seats in the quarter, boosting the cumulative number of seats sold to just under 1.2 million seats.

On the services front, revenues increased by 20 percent to $1.2 billion. Sun had a deferred revenue backlog of $2.25 billion as it exited the quarter, and increase of 10 percent compared to the same quarter as last year. Deferred product revenues increased by 19 percent, while deferred services revenues were up by 7 percent. Most of Sun's deferred revenues are for services, not products.

Sun said its sales were up across all geographies. In the non-US Americas region, sales were up 54 percent, and in the United States, sales were up 12 percent. In EMEA, Sun boosted sales by 17 percent, and in Asia/Pacific, sales were up 20 percent.

The net loss that Sun booked in the first quarter of fiscal 2007 was $56 million, which is better than the $123 million loss in the year ago quarter. Lehman said that Sun was on track to deliver a 4 percent gross operating margin in its fourth quarter of this fiscal year, but as in financial results meetings in 2006, Sun would not say when it expected to hit that 10 percent gross operating margin target Schwartz and his team have set for the company.