The Unix Guardian--Sun Makes an Honest Profit in Fiscal Q2 on Weak Growth

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Volume 5, Number 4 -- January 31, 2008

Sun Makes an Honest Profit in Fiscal Q2 on Weak Growth

Published: January 31, 2008

by Timothy Prickett Morgan

The official financial results for the second quarter of Sun Microsystems' fiscal 2008 came out last Thursday after the market closed, and this was clearly a better day to do such an announcement than earlier in the week, when Wall Street was getting hammered. Sun had previewed its financials a little bit two weeks ago when it announced its $1 billion acquisition of open source database maker MySQL, but last week, it put the guts in and the flesh and skin on the skeleton.

In the quarter, Sun's overall sales rose by 1.4 percent to $3.57 billion, and because of cost cutting and a mix to heavier server configurations, gross margins for the company rose by 3.5 points to 48.5 percent in the quarter. The company had an operating profit of $292 million, almost triple that of the year-ago quarter, and after paying taxes and booking interest earnings, it brought $260 million to the bottom line. To make Wall Street happy, Sun also shelled out a staggering $750 million in cash in the quarter to buy back 36.7 million of its own shares, which helped boost earnings per share to 32 cents in the quarter, compared to 15 cents a share in the second quarter of fiscal 2007. (Sun has spent nearly $2.2 billion in cash buying back shares in recent quarters, and has another $800 million that its board of directors has authorized for this purpose.) Sun exited the quarter with $4.68 billion in cash and equivalents, although it will spend $800 million in cash and $200 million on stock options to acquire MySQL.

Sun's overall product sales in the quarter ended December 31, 2007, and came to $2.25 billion, up a meager 0.5 percent. The company's computer products--servers and workstations, mostly--had sales of $1.59 billion, down 2.4 percent, while storage sales rose by 4.6 percent to $655 million. Jonathan Schwartz, Sun's president and chief executive officer, said in a call with Wall Street analysts that UltraSparc-based product sales were good, and that sales of Sparc Enterprise servers, which are basically rebadged Sparc boxes made by Fujitsu-Siemens are selling better than expected. (Of course, a cynic might say Sun had set its expectations low, with its own UltraSparc-RK "Rock" processors and "Supernova" systems right around the corner in 2008.) I could have sworn I heard Schwartz say that sales of "Niagara" Sparc T1 and T2 servers accounted for $285 million in the quarter, up more than 100 percent from a year ago. Schwartz singled out the 7 percent revenue growth for disk-based storage products in the quarter, and said that the "Thumper" X4500 storage servers accounted for $26 million of that (up 30 percent from a year ago).

Sun has changed the numbers it reported for server shipments from the second quarter of fiscal 2007, so it is somewhat more difficult to make comparisons with the current quarter. But I will take a stab at it. According to the presentation Sun put together today, overall server shipments were up 4 percent in the year-ago quarter (a little more north of the 80,000 units and 1 percent growth it said it had in the quarter a year ago, and X64-based server shipments did not grow as fast then either, apparently, rising by 22 percent (not the 24 percent from the year-ago announcement) to right around 24,500 units. Obviously, Sparc shipments fell a year ago--approximately 2,500 units by my rough reckoning, to around 57,500 units, based on the new data--and in fiscal 2008's second quarter, Sun might have pushed 55,600 units. While X64-based server shipments rose to 27,700 or so (if my estimates from Sun's chart bear any resemblance to reality), this Galaxy product line was hurt by delays in Advanced Micro Devices's "Barcelona" Opterons and the relative sluggishness with which Sun is getting Xeon-based Galaxy machines into the field. That said, Schwartz is expecting more of a ramp with X64 machines in the second half of fiscal 2008, when AMD will have fixed the cache bug in Barcelona and the Intel-based Galaxy machines will be fully ramped.

"We did not see the growth we wanted in the quarter," Schwartz said, referring to the Galaxy server business.

On the services front, Sun's services unit continues to pull the company's top line up where server hardware can't (at least not in aggregate), with sales up 4.6 percent to $1.37 billion. Support services accounted for just over $1 billion, up 4 percent, while professional services, training, and education services brought in $325 million, up 6.6 percent in fiscal Q2.

Sun's product sales were hurt a little in the quarter, explained Michael Lehman, Sun's chief financial officer, by Sun's shift to a sellout methodology for its channel, and in fact, this hurt sales in the United States to the tune of $120 million in the quarter and also caused a dip in the Asia/Pacific region. (The channel shift cost Sun about 3 percent revenue growth, in fact, but makes its channel less choppy and inventories smaller going forward.) In the fourth fiscal quarter of this year, Sun will move to the sellout method in its EMEA channel, and EMEA will take a similar haircut. But thanks to the weak U.S. dollar, Sun won't feel this quite as much as the shift hurt this quarter in the United States.

Including this channel change, Sun had sales of $1.3 billion in the United States, down 8 percent, while the International Americas region (everything but the U.S. in this hemisphere) posted growth of 24 percent, with $289 million in sales. EMEA had $1.4 billion in sales, up 7 percent and representing the first time I can remember when Sun brought in more money from Europe and the Middle East than it did in the United States. (The price of oil and exchange rates against the dollar are a big part of this.) Asia/Pacific sales came to $615 million, up 2 percent and impacted by channel changes, too.

The real question all of us have to ask as we analyze the financial results for any IT supplier is whether results from the final quarter of 2007 have any bearing on what the quarters of 2008 will look like. It could turn out that the sales that IBM, Hewlett-Packard, Sun, Dell, Microsoft, Intel, and others enjoyed between October and December of last year are the last hoorah, the big IT budget blowout, until the financial markets, credit crunch, and housing crisis settles down in the major economies. Let's hope not.