甲骨文 (ORCL) 2006 Q1 法說會逐字稿

Good afternoon.

My name is Katina, and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Sun Microsystems fiscal year 2006 first quarter earnings conference call. [OPERATOR INSTRUCTIONS.] Thank you, ladies and gentlemen.

I would now like to turn the call over to Mr. Barry Plaga, Vice President of Investor Relations for Sun Microsystems.

All right.

Good afternoon, everyone.

Thank you for joining the Sun Microsystems quarterly conference call.

I am Barry Plaga, Sun's Vice President of Investor Relations.

With me today is Scott McNealy, Sun's Chairman and Chief Executive Officer;

Jonathan Schwartz, Sun's President and Chief Operating Officer; and Steve McGowan, Sun's Chief Financial Officer and Executive Vice President, Corporate Resources.

The purpose of today's call is to discuss the results of Sun's fiscal year 2006 first quarter, which ended on September 25th, 2005.

During the last hour we e-mailed a copy of the operations analysis data sheet with nine quarters of financial and operations information, including the quarter just completed.

If you have not received the earnings announcement or the detailed financial data sheet for any reason or you wish to hear a live broadcast of this conference call, you may log onto our website at sun.com/investors.

We have posted slides you can review on the Web which accompany our prepared remarks.

These slides may be viewed at the same URL, sun.com/investors.

Simply click on the link marked Earnings Releases.

Finally, we will also post the transcript of our prepared financial remarks on our website.

The prepared remarks of our call today will last about 30 minutes, with the remaining 30 minutes devoted to the Q&A session.

During the course of this conference call, we will make projections or other forward-looking statements.

Such statements are just predictions and involve risks and uncertainties such that actual results may differ materially.

I'd like to refer you to Sun's periodic reports that are filed from time to time with the Securities and Exchange Commission, including the Company's annual report on Form 10-K for the fiscal year ended June 30, 2005.

These documents contain and identify important factors that could cause the actual results to differ materially from those contained in our projections.

In addition, during the course of the conference call, we will describe certain non-GAAP financial measures which should be considered in addition to, and not in lieu of comparable GAAP financial measures.

Please refer to the earnings call financial slides and the operations analysis posted in the earnings release section of our website at sun.com/investors for the most directly-comparable GAAP financial measure and related reconciliation.

Please note that, unless otherwise indicated, all reported results includes the impact of the StorageTek and SeeBeyond acquisitions from their respective dates of closing until Sun's quarter end on September 25th.

Had they remained independent companies, both StorageTek and SeeBeyond's quarter end would have been on September 30th, 5 days later than Sun's actual quarter end date.

Since SeeBeyond closed on August 25th, 2005 and StorageTek closed on August 31st, 2005, Sun's Q1 financials contain one month of data from SeeBeyond and 25 days of data from StorageTek.

I'll also mention that you can anticipate that we will speak to a number of new or extraordinary items during the call this quarter.

These items include -- the impact of the StorageTek and SeeBeyond acquisitions on Sun's revenue, gross margin, R&D, and SG&A expense and operating income in Q1, as shown on Slide number 13;

StorageTek and SeeBeyond purchase price accounting impact to Sun's operating income in Q1; and the impact of FAS 123 stock-based compensation expense to Sun's net income in Q1.

With respect to the accounting for the acquisitions completed during the quarter, we have estimated the fair value of certain tangible and intangible assets acquired and liabilities assumed.

Some of these estimates are subject to change, and adjustments to these estimates will be included in the allocation of the purchase price, which under normal GAAP rules, are allowed for a period of up to 12 months following the close of the transaction.

Now let's get to the financials.

Sun's total revenues for the first quarter of fiscal year 2006, including acquisitions were $2,726,000,000, an increase of 3.7%, as compared with the $2,628,000,000 in revenues reported for the first quarter of fiscal year 2005.

We had a favorable currency impact on revenue of approximately 0.8% year-over-year, and an unfavorable impact of approximately 1% sequentially.

Total gross margin, including acquisitions was 44.1% of revenue, an increase of 2.7 points over the gross margin for the first quarter of fiscal year 2005.

Total R&D and SG&A expenses, including acquisitions, were $1,267,000,000, an increase of $181 million year-over-year.

We recorded a $43 million tax provision on income generated in certain state and foreign jurisdictions.

GAAP net loss for the first quarter of fiscal year 2006 was $123 million, or a net loss of $0.04 per share, as compared with a net loss of $133 million, or $0.04 per share for the first quarter of fiscal year 2005.

GAAP net loss for Q1 fiscal year 2006 included a $60 million acquisitions-related charge for purchased in-process research and development costs, a $12 million charge for work force and real estate restructuring, a $13 million gain on equity investments, and a $4 million tax benefit for related tax effects, and a $50 million stock charge for stock-based compensation related to the implementation of FAS 123 during the quarter.

Excluding these charges, gains and tax effects, our comparable non-GAAP net loss was $18 million, or $0.01 per share.

But including the charge for stock-based compensation of $50 million, non-GAAP net loss per share was $0.02.

As I mentioned previously, the first quarter results included stub period operating results related to the acquisitions of StorageTek and See Beyond, both of which closed at the end of August.

These acquisitions increased total revenues by $226 million.

They increased gross margin by $99 million.

And they increased operating loss by $65 million.

However, due to the sales mix and disproportionate revenue volume historically experienced by these companies in the last month of each fiscal quarter, these stub period operating results are not indicative of the impact these acquisitions would have on revenue, gross margin, or other operating results for a full quarter, as Steve will discuss further.

Q1 products revenues totaled $1,704,000,000, an increase of 2% year-over-year and a decrease of 12% sequentially.

Within products revenues, computer systems products revenues were $1,274,000,000, a decrease of 6% year-over-year.

Network storage products -- network storage products revenues were $430 million, an increase of 34% year-over-year, and products revenues from StorageTek were classified as network storage products revenue in Q1.

Overall, Q1 product shipments were relatively linear within the quarter, with no significant component issues.

Q1 services revenues totaled $1,022,000,000, and were up 7% year-over-year.

Within services revenues, support services revenues were $835 million, up 12% year-over-year.

Services revenues from StorageTek were classified as support services revenues in Q1.

Revenues from client solutions and educational services totaled $187 million, a decrease of 10% year-over-year.

By geography, U.S. revenues were $1,159,000,000, up 5% year-over-year.

Europe revenues totaled $912 million, a decline of 1% year-over-year.

Japan revenues were $166 million, a decline of 9% year-over-year.

And rest of world revenues were $489 million, an increase of 16% year-over-year.

With respect to the balance sheet, DSOs were 69 days, ending sales channel inventory was $415 million, or less than six weeks of supply, which is within desired levels.

We ended the quarter with a cash and marketable securities balance of $4,533,000,000, and cash flow from operations totaled $224 million.

Finally, referring to Slide 5, Demand Metrics, Sun's deferred revenue totaled $2,056,000,000 in Q1, up 10% year-over-year.

Excluding deferred revenue attributable to acquisitions of $122 million, deferred revenue was $1,934,000,000, up 3% year-over-year.

This deferred revenue was comprised of $442 million of products and $1,492,000,000 of services.

Our combined products and services backlog at quarter end, excluding acquisitions, totaled $1,408,000,000, an increase of $128 million year-over-year, and a decline of $45 million sequentially.

Our Q1 book-to-bill ratio, excluding StorageTek and SeeBeyond was 0.97, up from 0.93 in Q1 '05.

And with that, I'll turn the call over to Steve.

Great.

Thanks, Barry, and welcome everyone.

As Barry mentioned, Q1 was the first quarter to incorporate financial results from StorageTek and SeeBeyond acquisitions.

We are very pleased with the integration progress to date with both acquisitions.

In this quarter there's a lot of new items for us to describe, so as a way of providing clarity to review the financials, I'm going to first comment on performance for Sun in total -- this is how we'll describe the results going forward -- and, then, for this quarter only, we'll discuss the results for Sun excluding the stub period for StorageTek and SeeBeyond.

For those people following the earnings slide deck we posted, let's get started.

We'll start with revenue and product metrics on Slides 2 and 3.

So for product revenue, within the overall Sun revenue growth of 4%, Q1 product revenues were $1,704,000,000, or a 2% increase year-over-year.

Excluding product revenue attributed to the acquisitions of 134 million, product revenues were $1,570,000,000, a decrease of 6% year-over-year.

Within products revenue, computer systems products revenues were $1,274,000,000, 6% decrease year-over-year, however, computer systems products that grew year-over-year included our x64 industry standard Opteron processor-based servers and 4- to 8-way SPARC processor-based servers.

And we continue to see a shift away from the data center and enterprise systems to our 1- to 8-way entry level servers, with now, approximately, 75% of server revenue derived from these low-end server offerings.

During the quarter we shipped approximately 71,000 computer system server units, approximately 14,000 of these being x64 Opteron servers.

This is a 2% year-over-year increase in total server shipment units and 109% year-over-year increase in x64 Opteron server shipments.

These x64 shipment figures do not include our new Galaxy x64 Opteron processor-based servers that were announced in mid-September and now shipping.

Turning to software products, we're pleased to announce the number of Sun Java Enterprise System subscribers has climbed 55% sequentially in Q1, to 957,000 subscribers, an increase of over 337,000 subscribers.

Of this 957,000 subscribers, 429,000 are JES suite subscribers, and these suites -- announced this past spring -- are comprised of five solution sets, the target customers' most critical business needs.

Individual suites are priced at $50 per subscriber per year, while the full Sun Java Enterprise System is priced at $140 per subscriber per year.

And, finally, SeeBeyond integration software has now become our sixth Java ES suite.

Looking at our storage business, network storage products revenues were $430 million, an increase of 34% year-over-year.

Excluding network storage products revenues that were attributed to acquisitions of $127 million, network storage product revenue were $303 million, or a decline of 6% year-over-year.

Product groups and the network storage group, with year-over-year increases in revenue include our mid-range arrays and our data center arrays.

Looking at the total storage revenue figures, it's very clear that StorageTek, led by their high-end tape solutions had an immediate, positive impact on revenue for the Company.

Turning to service revenues, Q1 service revenues were $1,022,000,000, or an increase of 7% year-over-year.

And excluding service revenues attributed to the acquisitions of $92 million, service revenues were $930 million, a decrease of 2% year-over-year.

However, within that, support service revenues were $835 million, or an increase of 12% year-over-year.

Again, excluding the support service revenue attributed to the acquisitions of 92 million, support service revenues were $743 million, or approximately flat with one year ago.

Despite a decrease in our products business, we've increased both our support services contract penetration and our managed services businesses to maintain this service revenue performance.

Finally on services business, client solutions and educational services revenue were $187 million, or a decline of 10% year-over-year.

And you may recall, on this year-over-year comparison, that in Q1 FY '05, client solutions and education services revenue increased 21% year-over-year, largely due to the recognition of a sizeable, multi-year deal in the U.K. with their National Health Service.

Let's take a look at revenue by geography on Slide 10.

Start with the U.S.

The U.S. revenues were $1,159,000,000, or up 5% year-over-year.

Our -- excluding the revenues attributed to acquisitions of $96 million, U.S. revenues were $1,063,000,000, down 4% year-over-year.

The softness in our U.S. business is primarily attributed to the financial services, communications, and government verticals.

Within the financial services, although our x64 Galaxy product launch was very well received, there is some indication that Wall Street customers may have delayed purchasing decisions in Q1 in favor of these new products.

In the telco vertical, continued consolidation and merger activity has delayed spending on Sun in some of these key, large accounts.

Looking at Europe, revenues totaled $912 million, a decline of 1% year-over-year.

Again, excluding revenue attributed to the acquisitions of $87 million, European revenues are $825 million, and were down approximately 10% year-over-year.

Again, if we exclude the impact, as I previously mentioned U.K.

NHS deal, our European revenue would have been down approximately 4% year-over-year.

Geographically when we look across Europe, we saw revenue declines in France, Germany and the U.K., primarily.

And from an industry viewpoint, telco was the most challenging vertical in Q1 for us in Europe.

Looking at Japan, the revenues were $166 million, or a decline of 9% year-over-year.

And excluding the revenues attributed to the acquisition of approximately $15 million, Japan revenues were $151 million, down 17% year-over-year.

Again, we experienced softness, mainly in the telco sector.

And, in addition, as our low end 1- to 8-way servers are our strongest server segment in Japan, we believe these Q1 results were negatively affected by the September x64 Galaxy announcement.

And, then, finally, from a geographical standpoint, when we take a look at the rest of the world, the revenues are $489 million, or a 16% year-over-year increase.

If we exclude the rest of world revenues attributed to the acquisitions of 28 million, rest of world revenues were 461, up 9% year-over-year.

Considerable strength was experienced in both products and services in Korea, India, and the Middle East, with some of the success coming from the key markets of telco, government, and education.

Next, moving onto P&L, if we look to gross margins on Slide 5 and 6, total gross margin for Q1 was 44.1%, an increase of 2.7 points sequentially.

And within these overall margins, the product gross margin for the quarter was 43.3%, a sequential increase of 1.9 points.

You want to look at the underlying components of this product margin strength, we saw -- first, a favorable impact of approximately 3 points due to decreased component costs; favorable impact of over 2 points due to pricing and discounting; and an unfavorable impact of approximately 2 points primarily due to a lower mix of software; and approximately 0.5 point unfavorable due to volume.

And, in addition, the net impact of acquisitions was favorable 1 point, offset by purchase accounting of approximately negative 1.6 points, and a negative 0.1 point associated with stock-based compensation.

Total services gross margin for the quarter was 45.4%, a sequential increase of 3.9 points.

Sun Services again delivered on another strong margin performance quarter by improving productivity and driving cost efficiencies.

The underlying components of the services margin improvements were -- a favorable impact of approximately 5.9 points due largely to cost reductions associated with lower headcount, seasonal labor cost improvements, reduced requirement for spare parts and the continued shift towards a more variable service delivery cost model; there was an unfavorable impact of approximately 1.7 points due to volume and mix; and an unfavorable impact of 0.5 point due to pricing and discounting.

And, in addition, for this quarter, the net impact of acquisitions was favorable 1.7 points, offset by the impact of purchasing accounting of negative 0.8 and a negative 0.7 points for stock-based compensation.

So moving further down the P&L to R&D and SG&A expense, total R&D and SG&A for Q1, including acquisitions was $1,267,000,000, or an increase of $181 million year-over-year.

Excluding the R&D and SG&A expenses attributed to the acquisition of $104 million, the overall Q1 combined R&D and SG&A for the quarter was 1,163,000,000, or an increase of $77 million year-over-year.

Now, of the $77,000,000, 41 million was due to FAS 123R stock-based compensation charges, with the balance primarily due to planned salary increases and engineering-related spending associated with our upcoming, exciting new product introductions.

Now a few words on stock-based compensation expense on Slide 9.

Barry mentioned at the beginning of the call, beginning fiscal year 2006, we adopted FAS 123R stock-based compensation.

And, as such, our financial results this quarter include the costs associated with stock-based compensation expense.

For the quarter, the total cost for compensation expense were $50 million, or approximately $0.01 per share.

This expense is included in the following components of the P&L statement -- approximately $2 million is charged to cost of sales products, approximately $7 million is charged to cost of sales services, $17 million is included in R&D expense, and $24 million is included in SG&A expense.

And also this quarter, an item to describe as our purchase price accounting, which we've laid out for you on Slide 10.

So included in the results for first quarter are a number of preliminary purchase accounting items associated with the acquisition of StorageTek and SeeBeyond.

The principal items relate to a write off of purchased in-process R&D costs totaling approximately $60 million.

Secondly, a reduction of revenue of approximately $20 million, primarily the result of adjustments made to reduce the acquired deferred revenue balances of StorageTek and SeeBeyond to fair value.

Third, a reduction in gross margin totaling $43 million, principally resulting from the impact of the deferred revenue adjustments above, fair value adjustments to inventory, and the amortization of acquisition-related intangibles related to developed technology.

And, fourth, an increased in operating expense of approximately $20 million related to approximately one month's amortization of other intangible assets established upon acquisition.

Now a few comments on the core balance sheet items on Slide 11.

Including acquisitions, we generated $224 million in cash flow from operations, including approximately $130 million from a tax refund.

And we ended the quarter with approximately $4.5 billion in cash and marketable debt securities.

The overall cash conversion cycle was 38 days.

And excluding the cash conversion cycle attributable to acquisition, cash conversion cycle was 23 days, which is 13 days better than Q1 FY '05 and seven days better than Q4.

Capital spending for the Company in Q1 was $68 million.

We continue to aggressively manage both the cash conversion cycle and capital expenditures to prudently manage cash.

And, now, looking forward, as we start to size up Q2, on the operating expense side, we expect R&D and SG&A to total approximately $1.6 billion.

The sequential increase from Q1 is primarily the result of the following -- one, having a full quarter of operating expenses associated with the acquisitions, it will be approximately $200 million; an increase in the amortization of intangibles related to the acquisition, and that will be an increase of $20 million to -- and it will move to a total of $60 million in Q2; third, an increase in stock-based compensation of $10 million, bringing the total stock-based compensation across all expense categories expected to be $60 million in Q2; and four additional days in the quarter compared with Q1, at a cost of approximately $50 million.

We expect net interest income in Q2 to be approximately 20 to $25 million.

And we expect capital expenditures, including spares, to total approximately $100 million in Q2.

And looking at our tax provision, we expect the full year FY '06 tax provision for the combined entity to be in the range of 200 to $250 million.

And as we mentioned earlier, this is preliminary estimate until we finalize the purchase price accounting.

And, additionally, by fiscal year end, we're targeting a cash conversion cycle of approximately 36 days.

With that, let me turn it over to Scott.

Thanks, Steve.

And that might be a huge understatement.

Those of you may know that Steve announced that he's going to be retiring in June of '06, at the end of our fiscal year.

And I just wanted to take a couple of seconds out to thank him and embarrass him publicly for all the great work he's done over 14 years.

He's just led this organization with integrity, character, class.

He's put his heart and soul into this job, and I think all of you have come to know and love what he's done for this Company.

We'll certainly miss him.

I know we've got a long history of CFOs that the Street can trust and count on to be open and transparent and available, and I think Steve only polished that history in a wonderful and positive way.

But before we all send him too many congratulations, he's not done yet, he's got until June to collect his Swatch, or whatever we're going to give him.

So anyhow, thanks, Steve.

I'll go quickly, because there's obviously a lot of stuff to talk about, and I want to give Jonathan a chance to talk.

But, clearly, the numbers are looking nice.

We are certainly turning cash into inorganic growth.

I believe that's a huge positive.

The gross margins are firming up nicely.

As we made this transition to low-end servers, you're seeing our gross margin percentages continue to climb.

And a nice cash balance position, with, actually more opportunities, as Steve mentioned, in the cash conversion cycle and capital and profits as we go forward to grow that cash balance going forward.

We're very excited about the acquisitions.

The pipelines, the customer activity, the customer response has been very exciting.

And we are now a major player in the storage world, and with 36% of the world's data archived on Sun equipment.

We have a big, huge storage event going on in D.C. this week called Forum -- StorageTek Forum -- with about 5,000 customers.

And we are now a major player in the storage business.

SeeBeyond has given us a great position, now, in the service-oriented architecture environment of business integration, as people are building these composite applications from these complex and legacy stovepipe kinds of environments that they have in their application space.

The storage products are growing nicely.

You heard the 6920 is growing 15% year-over-year.

We have good growth in the SPARC processor-based servers and our data center storage arrays.

And the numbers are quite stunning, in terms of what we're doing in the x64 business, with 109% increase year-over-year in units.

We weren't even a player a couple of years ago.

We're now the number six player, up from 99 a couple of years ago according to IDC.

And we have our sights on the number four spot before the end of this year, if we can continue to execute.

Java Enterprise System subscribers are approaching the magical one million mark, and we are also winning in, not just the subscriber space, but just in the license space, also.

We did a very large deal for 450,000 employees at G.E. for the Java Enterprise System Identity Manager product that is going to be implemented across 11 business units at G.E. throughout the world.

So it's not just the subscribers that are doing well, it's other parts of the business, too.

Solaris 10 downloads are off the chart.

Nice, big announcement recently with IBM announcing they're doing Solaris on their blade servers.

So now we have one of the -- one of the big three x86-x64 players supporting Solaris in a very aggressive manner.

And we had 2.8 million download registrations at the end of the fiscal quarter, Q1, and we blew past 3 million last week, so that number continues to up.

StarOffice, an OpenOffice.org surpassed 23 -- or excuse me, 53 million downloads.

You might have noticed that one of our newest partners is going to be dedicating some resource to the OpenOffice.org Open Source project, the basis for StarOffice.

So we're getting lots of help, not only on the Java front with Google, but also in the StarOffice OpenOffice front.

If you haven't checked it out, you ought to go check out on our website, or go to Business Week or Fortune or other places and check out the reviews on StarOffice 8.

Outstanding reviews.

And this is starting to make some very good progress.

We launched the new on Opteron-based Sun Fire x64 systems, 1.5 times the performance as a comparably configured 4-way server from Dell, about a third of the energy, about fourth of the footprint, about half the price, pretty cool price-performance advantages, being very well-received.

And they are shipping FCS, first customer ship, revenue released out of the factory, both the low-end -- code named Aquarius, I don't even know the product name -- as well as the two Galaxy products are shipping.

So that's pretty exciting.

Thirty-six world records across a range of benchmarks and technical computing and business computing.

We have five new UltraSPARC IV-based machines that are driving huge price performance, up to five-fold increase in performance over previous UltraSPARC generations.

And, again, those are all shipping today, and we're very excited about that.

So we talked about the Google partnership.

We also had at our announcement, I think everybody's aware that our x64 product runs Windows, Solaris, and Linux.

And, in fact, we had lots of support for the launch with AMD, MySQL, Oracle, Red Hat, all on stage showing their support.

And one point I'd like to highlight is, of the major x64 players -- x86-x64 -- Sun is the one Company, actually, that also has an operating system that works on those platforms and a web services stack with JES that has a full-featured web services stack.

So it's a rare, in fact, unique position that we have in the marketplace.

IBM, HP, and Dell don't have an operating system that runs on their industry-standard x64 platforms.

Nice move with the StorageTek deal.

That's working out well, as I said, and the SeeBeyond.

We also closed Tarantella.

With our RDP license we have a very interesting opportunity, and we're seeing the backlog and the interest level growing nicely, as well as unit volumes growing nicely in our thin client computing architecture.

So now we can bring you a Windows window, as well as other platform windows along with the Sun thin client computing environment.

All of the -- and the integration of all three acquisitions are going as planned, and we're thrilled to have all these folks on board.

Now just a quick look forward to the rest of this quarter, we got a busy calendar.

We'll be launching our 8-core, 32-thread, very-low-power Niagara chip.

We're ahead of schedule.

We're actually bringing that product in and expect some significant unit volumes this quarter.

So stay tuned for that announcement.

You'll be hearing about Sun's eco-responsible computing strategy in a very short order.

We look at our thin client computing models as very cost-effective.

We look at tape storage as a very energy-efficient way of doing archiving, and we archive 36% of the world's data on our platforms out there today.

We look at the energy efficiency of UltraSPARC versus our competitors and Opteron versus our competitors, and the new Niagara chips just blow away, in terms of energy performance.

And so you put that with a thin client computing model of 15-watt desktop, we have some ways to eliminate the digital divide without torching the planet at the same time.

So stay tuned as we carry that story forward.

We also have a bunch of other announcements that -- just stay tuned.

We launched some interesting ones today if you go check the environment -- but I'd rather turn it over now to Jonathan to talk about some of the big strategic wins that we had in Q1.

So, Jonathan?

Great.

Thanks, Scott.

As Scott discussed, we're seeing positive response to our product innovation and our partnering strategy.

And those demand indicators really span all of our core customer segments and across the globe.

I want to give you a couple of select names to really think about as we drive our strategy across the world and across industries.

Now we consider, specifically, the financial services marketplace and a few select customers to be a good leading indicator for the interest in and deployment, ultimately, of high-performance technology across the planet.

And we have seen excellent uptake in the adoption of Solaris 10.

And as Scott pointed out, there's probably a specific highlight there, being IBM's adoption of Solaris 10 for their BladeCenter servers.

But we've also seen numerous deployments of the newest industry standard Sun Fire servers.

One name in particular, Data Action, a leading retail banking services company in Australia recently replaced its HP LC server and storage environment with a comprehensive Sun infrastructure.

I think customers are really looking at HP LCs as coming pretty close to the end of its road map.

And as Scott mentioned, we've seen a very favorable response to the StorageTek acquisition and Sun's overall data management strategy, being the number four storage player on earth, and, obviously, eyeing progress up the charts.

We've got a tremendous install base and customer history now to work from to continue to grow that business.

Governments are certainly the world's largest service providers, and they are continuing to look to both consolidate their systems as well as embrace Open Source software and standards-based technology to get more services out over the Web to their citizenry.

One big win in the quarter, the Guangdong Local Taxation Bureau in China implemented a province-level centralized local taxation management information system based on Sun.

More broadly, our approach to sustainable Open Source licensing has been a differentiator for Solaris and for Sun with governments around the world, and we see that accelerating.

Looking at telecom and Internet Service Providers, they continue to sign up more subscribers demanding more innovation and advanced devices and interesting content.

Sun's position is strong in all three of these areas, with our Java technology offerings.

And, again, our approach to open systems and Open Source and sustainable intellectual property licensing models reassure our customers we're there to partner with them, and, unlike some of our competition, not to compete with them.

We recently closed a deal with T-Mobile to improve the provisioning fees used to store customer records and service definitions, process purchases via the T-Mobile Customer Portal across Europe.

And, in addition, one of the major wins was with Alcatel, who are deploying Solaris 10 to further improve their competitiveness.

And this is really across the entirety of Sun's ATCA industry standards server lineup.

So this Solaris 10 win with Alcatel really sets us up to sweep the ATCA market opportunity globally and to establish Solaris as the default Open Source operating system in carrier-grade deployment.

More providers are looking to Sun to deliver the infrastructure they need to meet increased demand.

We're orienting to broaden our focus beyond simply the telecommunications and Internet Service Providers, to look to the media and entertainment sectors, who are, again, looking to the network to broaden their business and broaden their market opportunity.

Within the quarter, we're helping HBO gain technical advantage as they launch their Video On Demand initiative.

Paramount Pictures -- and, again, the entertainment segment more broadly -- is really looking to embrace a server infrastructure and software infrastructure to deliver new animated features.

Paramount, specifically, is storing and archiving its digital content on storage offerings -- on Sun storage offerings, as well as looking to our infrastructure for their rendering plant.

And, finally, as you're aware, Sun's roots are in the academic community, and some of the most demanding computing projects, certainly we've seen in the world, are in academia.

Another highlight from the quarter, the Korea National Education Information Systems will now be spending about 70% of its IT budget on Sun.

And Korea NEIS selected Sun to provide new infrastructure for its elementary, middle, and high schools.

Stanford University Linear Accelerator Center, known as SLAC, has chosen Sun for high-performance computing solutions to enhance the speed and overall quality of its research.

And we're already seeing more positive signs already this quarter, in Q2.

One notable win over the weekend, TITech -- the Tokyo Institute of Technology -- has awarded Sun -- arguably one of the most prestigious high-performance computing contracts in the world -- to build its supercomputing campus grid infrastructure, a major win against IBM and proof point that our high-performance computing approach is back on track.

And in sum, we're making progress in our core markets.

We continue to relentlessly roll-out value and innovation, and are orienting our R&D and our marketing programs to help our customers win.

And I think, as Scott pointed out, we're more confident than ever in the opportunity and the fitness of our solutions to go after it.

So, with that, Barry, back to you.

All right.

And by the way, welcome to Sun, Barry.

Thank you.

Thank you.

Thanks, Jonathan and Scott and Steve.

Now it's time to take some questions.

Katina, will you please start the Q&A process?

And we'll get going.

Okay. [OPERATOR INSTRUCTIONS.] Your first question comes from Richard Chu with SG Cowen.

Yes, hi.

Good afternoon.

I appreciate the detailed breakdown, but I'm still left confused on some of the comparability numbers.

Could you give us, in as straight-forward fashion as you can, what you calculate the operating expenses of the core Company prior to the acquisitions was for the quarter before compensation expense?

And I have a couple follow ons.

Yes, Richard.

This quarter had a ton of moving pieces.

That's why we walked through it as carefully as we did.

So the operating expense that we gave you, the components we have in there -- and we've a slide, actually in the deck this time to break it out, it's actually Slide 13 when you get a chance to refer to it.

We put in what we call Sun stand alone, which, again, this was a one-quarter only.

And then we put a second one called STK/SeeBeyond acquisition.

We had $1,175,000,000 operating expense for Sun stand alone.

And I use that as the basis for the comparison that we discussed earlier when I bridged on the OpEx, and we had 164 million operating expense for STK and SeeBeyond, including we had the IP R&D was in Q1 in the SeeBeyond and STK acquisition.

So you'll see that on that slide.

That's one item that you want to address.

The second item you want to address is in the operating expense, we had the -- I mentioned the $41 million of FAS 123R stock-based compensation.

That's in there this time.

So those are probably two of the more significant items that we've got in there that we've broken out for you in both the ops analysis on non-GAAP bridge sheet on the -- I think it's Page 4 in the ops analysis -- and on Slide 13 to reconcile back to what the components were.

There's also 9 million of stock option expensing that's above the line in gross margin dollars also.

Okay.

Now back in July, you made some commitments with respect to spending targets for the full fiscal year prior to the acquisitions that you subsequently closed.

Is there a way that you can rephrase your targets on that score, given the new state of Sun?

How would you describe your spending targets for the year?

In terms of the spending for the year, you noticed we were being careful in giving the Q2 spending right now.

If you recall back three months ago, we ended last year with an OpEx at 4.7 billion, which is where we told the Street we'd land, and we -- all through the year we guided to it and we hit it.

This year, we guided to do a stand-alone Sun a little bit north of that.

We said we'd be at least 100 million higher, so probably about a 4.8.

And that was, again, Sun stand-alone before 123R, before the impact of purchase accounting associated with the acquisition, before the increase costs associated with the additional 7,500 people we picked up with the acquisitions.

So the 1.6 billion number I gave for Q2 was inclusive of those items, and I broke them out, Richard, I think as carefully as I could in that guidance going forward, so I could show you each component and each point.

I deliberately didn't give FY '06 full year guidance yet on the operating expense.

We just gave Q2 and the 1.6 billion.

At the next earnings call, we will break out what the second half of the year looks like, because we will have additional purchase accounting, that Barry mentioned, that we will continue to work on in the coming quarters.

We have restructuring activities that are going on.

We have synergies we're looking for as we bring together the integration of these different organizations.

And I'll take you through that at the end of Q2.

If I can follow on with Scott, you imply that the launch of Galaxy may have had a negative impact on some of the low end unit volumes in the quarter.

You also talked about Niagara coming in this quarter.

Will that -- could that cannibalize or cause hesitation on demand or other parts of your product line during Q2?

I think if it would, it already has.

And, again, given that we're planning on shipping within the quarter, I think we're expecting to see a pretty healthy backlog build up around those products.

And I think for the most part, the impact we saw in last quarter was a result of the new Panther systems, the UltraSPARC IV+, and Niagara is really targeting a different segment of the market, the low end.

So I think, yes, there will be some impact within the quarter.

I think we've, hopefully, experienced the biggest bulk of that in the first quarter.

And we're expecting to be able to deliver against that demand in this quarter and going forward.

One thing to remember, the Niagara machines are all SPARC 64-bit, V9, binary compatible Solaris machines, that will run Solaris 10.

They are binary compatible with the current install base and the current product we're shipping with SPARC and Solaris today.

So we hope that the migration and transition to that environment is as painless as can be.

It will be more like a speed bump than a migration.

It's just a pretty speed bump, frankly.

Okay.

Thanks.

Thanks, Richard.

Next question, please.

Our next question comes from Brent Bracelin with Pacific Crest Securities.

Thank you.

I guess if you back out StorageTek, it does look like this is now the fourth consecutive quarter of an annual decline in the core business, despite seven months of the Solaris 10 software being out there, despite, kind of, I guess, the UltraSPARC IV+ processor.

At what point do you expect to see a rebound, kind of, in the core business?

At what point do you reassess, kind of, the cost structure, kind of, on stand-alone basis?

And when do you expect to see the revenue and bookings and deferred revenue start to have a positive impact because of the upgrade cycle out there?

Just to clarify, revenue was down 6%, but gross margins were only -- at a dollar figure, if you do the analysis -- was only down about 2% on the Sun stand-alone environment.

So that's close.

Spending is attributable to the stock option expensing and some of the work we did on launching a whole bunch of new products.

And we still have a very strong product calendar on the hardware front which tends to drive spending up.

If you look at the unit volumes and those kinds of communities that we're building we still see positive effort there.

We have other areas we think we can lower cost.

There's certainly going to be cost synergies available to us as we have multiple offices with StorageTek and Sun offices in cities around the world.

We think there's more we can do in the cash conversion cycle and drive efficiencies and effectiveness there.

And, as we said, the cost synergies are going to take a couple of quarters to get at.

And the revenue synergies, which we believe are actually even more exciting on the storage front, will probably be four quarters out.

So there's a lot of transition, a lot for our customers to digest right now in the new products.

We are through the major reorgs in the Company.

And so a lot of it feels a lot better to us now going forward.

And by going through our channel partners, revenue sometimes comes down, but we made this transition from what was an E10K, E25 -- F25K kind of Company to one that is predominantly in the 1- to 8-way space while improving gross margin dollars.

So as we add in more software services, utility services, that sort of thing, we believe that we have an opportunity to improve productivity and cut costs while growing our way to a better and more comfortable operating margin.

I don't think anybody feels good about bumping around where we are today.

It sounds like the spend -- current spend plan is based on the assumption you can grow the stand-alone business.

A follow-up question here real quickly on, just, --

That's certainly how we're all being compensated, let me tell you.

Okay.

And, then, just quickly on UltraSPARC IV+, was there any kind of revenue contribution in the quarter from UltraSPARC IV+?

And do you expect any material contribution from that in Q4?

It was nominal in our fiscal Q2.

Yes, we do expect a more significant contribution from UltraSPARC IV+.

Thank you.

Operator, next question, please.

Our next question comes from Laura Conigliaro with Goldman Sachs.

Yes, a couple of things, please.

Considering that you saw softness in some of your key markets, for example, in the U.S. financial services, government, and communications, did you, in fact, see significant hold backs in revenue?

And that being the case, if so, could you give us a sense of how much of your backlog is actually Galaxy?

Laura in terms of the -- this is Steve -- in terms of the Q1 backlog, we just announced Galaxy at the end of the quarter, end of, I think, the second week of September, so a very, very non-material, very modest amount was in that last two weeks of the quarter.

Okay.

A couple of other things.

Your margins against revenue that was somewhat lower actually were surprisingly higher.

To what extent can you really count on, if you're looking at product gross margins, can you really count on favorable pricing and discounting, and also decreased component costs on a go forward basis?

Yes, Laura, that's -- well, a couple of us will probably take a stab at that question.

But with the product margin -- product and service margins, we've really been doing a good job as a Company.

With the product margins, again, the shift with 77% of the revenue now being in 1- to 8-way, that was supposedly going to really kind of crunch the margins.

Again, they've gone up.

It's been a positive.

We got the 3 points of cost.

We got 2 points of pricing and discounting.

We kind of expect the cost each quarter at 3 points.

And you know I go through it pretty carefully with the group.

Sometimes our costs improvements are only 1 point.

Mix volume went against us.

Traditionally, when we go into the second quarter, our mix volume goes in our favor.

We tend to sell more -- A, just more business in the second quarter over the first quarter, which helps in the volume, and the mix sometimes tends to improve in the second quarter over the first quarter.

So there's a number of moving pieces in here, but we feel positive about the results that the Company's put up in terms of these margin improvements and products, and equally so, as much as in services, with a significant improvement in the productivity and the cost.

Now to offset that, what we've got to look at is -- I mentioned some of 123R, where we charged some of that expense, it actually goes up into cost.

And we're going to have that as an ongoing basis as we go into Q2, and I broke that out for you earlier in the call.

And the second thing is we've got the acquisition, the purchase accounting that we have got to take also.

Some of that goes to SG&A, which has to do with the customer intangibles, and some of it has to go on the process, and the developed technology goes against the cost of goods.

So that's going to effect the product margins.

So these are -- there's a number of to-ing and fro-ing here, but we are really pleased with the progress we've made on each of the components to keep the margins strong for the Company.

And I -- Laura, this is Jonathan -- I just continue to believe that there is a certain level of volume which yields a much higher value envelope going forward.

So despite the fact there's 0 margin on a free copy of Solaris and, frankly, close to 0 margin on a skinnied-down 1-way x86 server, if you've got a presence in both of those markets, you've got an opportunity to go get the business on bigger systems.

And 100% of those systems will feature a computer with an operating system, middleware stack, a service relationship, and storage.

And the gross margin on that total system is very attractive, frankly, north of where we are today.

And we continue to see balancing the pursuit of volume as giving us more opportunities to go harvest more value.

Just one last question.

And that is -- Considering that you don't have very much Galaxy in your backlog, although you had been talking about it to customers for quite some time, how can you feel fairly confident that with Niagara coming this quarter you'll be able to -- and shipping this quarter -- you'll be able to get that business and turn it pretty quickly in a quarter that typically has a book-to-bill of above 1?

Well the good news, Laura, again, a couple of us will take a shot at this one.

But that backlog, being modest at the end of Q1 was just because it was -- it had just been announced.

It is booking now and it is shipping now.

That's the good news.

And it's shipping its revenue release and it's shipping globally.

So we can execute very well against it.

Our manufacturing group has performed extremely well with our shipments.

That's why we're getting such good margins.

And we don't see any constraints in terms of the capacity or the volume on this product.

I also would like to mention that UltraSPARC IV+ showed significant performance improvement relative to, not only our previous products, but also relative to Power.

And the Power5+ announcement, I have to tell you, was very underwhelming.

And, in fact, now we feel --

A great relief.

It was nice to finally see them not exactly execute on a new speed bump.

And we're holding as many LAN speed records as they are now, and it's kind of six of one, half a dozen of the other.

We just have an OS strategy.

They don't.

On the Galaxy product line, we think the price performance over Dell is stunning.

And that feels wonderful.

And unlike other chip efforts out there in the marketplace, we actually, David Yen and his team actually brought Niagara in early.

And when was the last time a CEO got to stand up and say, oops, we brought in a major, major ground-breaking, next-generation processor technology in early?

So we're pretty excited about the way the team's executing across the server story right now.

Thank you.

Katina, next question.

Your next question comes from Harry Blount with Lehman Brothers.

Hi, guys.

Couple questions, if I might?

First of all, on the storage attach rate, you guys did not disclose that and, obviously, the acquisitions kind of muddle the waters a little bit, but could you give a sense of what that might have looked like ex-the acquisitions.

Yes, Harry, hi. with the storage attach rates, we decided this quarter that we're looking at storage in a whole different way.

It will be getting into our Q2 segment disclosure, as well.

And we thought the attach rate wasn't as meaningful or as relevant a figure to look at.

I mean, when you get to how do we address the storage?

We're going to have a data management group that's all combined, it's all in, it's all together.

And as we go into the next quarter, how do we figure the attach rate of a, potentially, a tape device to a system?

And it was going to get too blurred.

So, the decision was made consciously, let's not go forward with that.

But in Q2, when we come out with our segment reporting, let's talk about what are the key performance indicators for storage.

Okay.

And, then, either Scott or Jonathan, just coming back to an earlier question, but maybe attack it a little bit different way, in terms of -- If you take a look at the leading indicators of customer metrics, whether it be your pipeline, your sales close rate in terms of engagements, what is it -- and you, obviously, highlight a lot of areas that performed well -- but what are some of the areas that have not performed well here that you need to turn around in order to start getting these year-over-year comparisons positive again?

I guess at a top level, the single biggest challenge we have out in the marketplace is perception, and just awareness.

And we're, I think, coming out of a three-year cycle in which we have revised and refreshed the road map on literally every single product line across the board.

And when we are with customers, I think we certainly see our fair share of the revenue coming our way, and -- by the way, in segments where we have largely been absent in the past couple of years -- the TITech win in Tokyo is probably the perfect example of that.

We have been largely absent from the high-performance computing space, and now we see ourselves and IBM as being kind of neck and neck in every deal that we participate in.

so the biggest issue for us is really turning around the perception among CIOs.

Frankly, the perception that we have been focused on over the past couple, three years has been among the developer community, which is the leading edge of large-scale IT deployments.

And I think it'd be hard to argue that the perception on Solaris has gone from proprietary and expensive to fabulous, perform and innovative and free, and that's opened doors with customers in governments, in the financial services space, with OEM and embedded partners.

But, again, there's still work to be done.

So I think the perception is probably the single biggest issue.

It is certainly not, at this point, technology or product road map.

Okay.

And, then, the last question is coming back to Steve.

On the tax provision that you outlined for full year '06, the 200 to 250 million, how does that -- how is that generated from StorageTek versus Sun core?

So, if you notice, Harry, that provision didn't change from the guidance we gave at the beginning of this year.

So what we've done is we basically have included StorageTek into that.

We're not splitting between the two.

Keep in mind that we have some NOLs that we can currently utilize with profitability, primarily in the U.S.

And that's what we plan to use.

So you picked up the point.

We have not changed that tax provision at all.

We will utilize the NOLs we've got on the balance sheet.

We'll use that to offset the profits as we move forward.

Thank you.

Thanks, Harry.

Operator, next question.

Our next question comes from Rebecca Runkle with Morgan Stanley.

Hi, just a couple of quick follow-ups.

First, just given your comments on verticals in the U.S., my interpretation is that you would expect an acceleration in some, if not all, of those verticals given the product launches.

Or, as you look at it, are there more form factors that need to be brought in before you really start to see those verticals accelerate, i.e., do we need to see the blade introduction before you start to see the green light in those verticals?

I think IBM is doing a wonderful job with Solaris on BladeCenter.

I think we continue to look at that market space.

But, again, I'm not sure that the gravitational orientation of a server really contributes much to the overall value proposition if they're horizontally or vertically stacked.

I haven't seen that be that big a differentiator.

I think, across the board, the one segment that may be getting back to Harry's question that we are working to recover.

And I think UltraSPARC IV+ certainly helps.

And it's not to suggest that customers have totally biased their purchases to want to build data centers out of little tiny servers.

I think the high end is still an opportunity for us.

And given that we've nearly doubled on some benchmarks, the performance of UltraSPARC IV+, while Intel has kind of flipped sideways on Itanium and IBM, kind of, underwhelmed the market with Power5+, it certainly gives me a lot of confidence that there's growth to be had.

I think those core markets that we were talking about, with the possible exception of the telco industry, given the consolidation, our belief is that financial services, the government, media, healthcare, are certainly going to be investing more and building out more because they think there's more opportunity out there.

So I think we're leading a mode of retrenchment, both with respect to our product road map as well as the customer sentiment.

And I certainly think we have the right product to go get that growth.

Now, it's a matter of executing after it.

And, then, Jonathan, just superficially as you look at the numbers, given the timing of the product launch, et cetera, it seems somewhat inconsistent that 1- to 8-way jumped to 75% of your volume in the quarter.

I believe that that just speaks to how strong the demand is in those form factors and that we should continue to see an acceleration and even greater penetration going forward with the new products.

Is that a fair interpretation?

I don't think it's a fair interpretation because that percentage is a reflection of two things.

One I think it's undeniable that customers are now building out grids, and we're certainly selling a lot of systems into those grids, running Solaris as well as Linux that allows them to run shared services in large scale data centers built off of small systems.

But I also think that that percentage number is a reflection of the weakness that we had with the old UltraSPARC IV line of SPARC engines.

And now that we've got IV+ out there and now that we've refreshed the road map more broadly, I think there's certainly an opportunity for us to build out more on the high-end, which will, obviously, bring the percentages more into balance.

So I think it's a little bit of both.

I don't think there's -- there's no one hammer for all nails.

I was just with another telecommunications customer that's building out large scale 25K-class systems to run very large scale billing system.

And you can't run the world on a grid right now.

And there's, certainly, again, no one server that fits all needs, whether it's blades or large SMP or rack-mount systems.

I think there's a lot of diversity.

And as we enter products that give us more competitive advantage, we're certainly planning on taking a bigger share of the market.

And, then, lastly, just real quickly, Steve, you talked about option expense, or non-cash comp expense going up next quarter, I'm assuming that's acquisitions.

Can you just walk us through, though, the strategy and how you guys are thinking about the various components of compensation, be it options, deferred, or restricted stock and cash and how we should think about that strategically?

Yes.

So there's two parts to that question.

You're right, the increase in 123R, I mean, a part of it has to do with the restricted stock that we granted in Q1 for the full quarter.

Another part has to do with the STK and SeeBeyond folks that -- who are in for a month and now it will be in for a quarter.

So that's what's really the causal that is kicking that up.

Crawford Beveridge, who heads up the HR organization, people and places in the Company, regular reviews with LDCC of the Board, different compensation strategies that include stock options, that include restricted stock, that include bonuses and different ways of how we compensate the executives and the entire organization for performance.

So I won't go through now what we're doing with the different strategies, but it is a regular topic at LDCC, and as those plans unfold next year, we'll let you know what they are, Rebecca.

Great.

Thanks, so much.

Sure.

Katina, next question, please.

Our next question comes from Tony Sacconaghi with Sanford Bernstein.

Yes, thank you.

I have a couple of questions as well.

Can you comment on what the revenues for the stub period were for SeeBeyond and StorageTek on a year-over-year basis?

My calculation suggests that revenues were down 5 to 10% or more in like periods this year versus last year.

Can you help with that?

Yes, Tony.

So I'm going to give you what the revenues were, and you've got to slide in the deck.

So we broke it out for you to make it easy, knowing you'd want to get a look at that.

So the total revenue was $226 million for STK and SeeBeyond for the stub period.

That's the revenue that we recognized for that period.

Now the challenge in doing a stub period to stub period comparison is the following -- let's take StorageTek specifically.

They used to have an end of September quarter end.

Like all technology companies, they have a hockey stick, like everyone else does, at the end of a month, particularly at the end of a quarter.

We cut off at the 25th of September.

So it's difficult to leave those last four or five days out of their number and do an accurate comparison and say, what if they shut their quarter off, hypothetically, five days before the end of a quarter?

Especially when they have so much business that comes in those last five days.

So, as we look at it and assess it, I think they did a good job closing business.

They accelerated as much as they could to try to replicate what would happen in a normal September end quarter for them.

Did they execute flawlessly?

Probably not.

Did they execute very well?

We think they did.

And we're pleased with the kind of range we got of that 226.

I would not go and compare and say that they've got an X% reduction on a stub period to stub period basis.

We will get some of -- by the way -- the last five days of September rolled into our Q2.

Right.

But you haven't done an analysis that said we had StorageTek for 25 days, the last 25 days of the quarter.

If we took the last 25 days of the quarter for StorageTek last year did a comparison, what that would suggest in terms of revenues?

I mean, the basic math says you typically get 50 to 55% of revenues in the last month of a quarter, you were slightly shy of 40% of StorageTek's revenues in the first quarter last year.

So that is a pretty substantial delta.

Yes, yes.

And the other thing to add to that -- so, Tony, we did do some things along those lines, but, again, it was estimating and starting to work with the StorageTek sales management.

Which deals that closed September 28th were really our Q2, but would have been their Q1, and why did it roll forward?

It's starting to get -- it started to get very complicated.

The second thing is just keep in mind the purchase accounting.

When you take a look at the revenue figure I gave you, that's a net 226.

So we took the customary purchase accounting haircut on the product and service revenue to the tune of about $20 million.

So that is also netted in there for that period.

Right.

Fair point.

Let's just say that we actually have seen fairly solid demand.

And the numbers we went into, the acquisition seemed to be holding.

And there doesn't seem to be any new data one way or the other.

And, in fact, the customer reception to this whole thing has been way more positive than we thought it would be.

And the field organizations are actually put together very nicely now and seem to be working very well together.

So --

And some of the positive momentum is also reciprocal in the sense that perspective on and the reception around Sun's traditional storage business is better as a result of the STK acquisition.

So I think we're seeing the positive begin to show up and not just in the STK traditional revenue, but also in the Sun traditional revenue.

And a couple more quick ones, please, if I may?

The -- my observation is that when you announced the Galaxy products this quarter, it took about seven weeks from the announcement date until you really had a true GA in your channels and geography, I think it's just started shipping in the last few days, as best I can tell.

If we are looking at Niagara announcement, that is, let's say, two weeks from now, that, there isn't seven weeks to actually get it shipping.

So given your historic announce date to GA availability would suggest that you're going to be really pressed to ship material Niagara units in this current quarter.

Can you explain either why we saw something different this quarter in terms of the Opteron boxes and why that would be different from Niagara?

That's the first question.

Then the final question is -- If we look at, kind of, the metrics that you have set for yourselves, they're, obviously, revenue growth, profitability, and cash flow.

The revenue growth on the core business and, likely, including the acquisitions on a like-for-like basis was certainly down, the lowest revenue growth in nine quarters and you weren't profitable.

Yet there definitely seems to be some optimism in your voice.

Is there anything that you can deliberately point to in terms of leading indicators from the month of October or any other volume indicators that you can point to that is generating this optimism which may be a little bit disconnected from some of the results this quarter?

Or do we just, kind of, need to wait and see and believe that the road map will take you there?

Thank you for that question.

I think we're not going to want to speculate on this quarter and we'll see going forward.

Maybe, Jonathan, you can handle the first part?

Yes, the first question.

We believe that neither demand nor supply are going to be problems with either the Galaxy line or the Niagara line.

This quarter.

Did that suggest that there was an issue in Q1 with demand or supply?

Because it took seven weeks.

So what would be different about Niagara this quarter?

I'm not sure what your seven-week number is and where that comes from, and we've been shipping Galaxy machines to customers since the summer.

And we've been shipping to ISVs and we've been ramping that up all through, and we picked a time when we think we can deliver to customer demand.

And, in fact, on some of the product that was announced at the Galaxy launch, we have basic near availability -- immediate availability on a product.

Other pieces have backlog.

So it just depends.

I don't know where your seven -- your seven-week is a weird or a generalization on things.

So, I think maybe to the second question as well, Tony, the optimism is somewhat a derivative of the growth that we're seeing in the industry standard server marketplace globally, not simply from within Sun, but also, I think you're seeing IBM and HP both deliver increasing volumes in industry standard servers.

As that occurs, we're also seeing customers become alienated from their core operating system because neither AIX nor HTUX actually runs on those industry standard servers.

So we're now in a position as the only systems vendor to walk in with a migration strategy off of HTUX and off of AIX.

And, again, the leading indicators on the core operating system are really giving us a perspective that with the volume we've got on SPARC 1- to 8-way systems, with the relevance and volumes around Solaris, the lack of availability, frankly, of HTUX, or AIX for that matter, that we've got a long runway ahead of us.

So we're seeing design wins come our way and, again, a lot of these big customers that we serve today started off as little customers a few years ago once they selected Solaris and once they selected Sun.

And we're seeing more of those selections occur.

And, again, we think there's lots of upside in there.

Thank you.

Just two final comments, very quickly.

We certainly are expecting to ship Niagara products at the end of Q2.

It would not be, based on the size, a material number to the quarter, but we sure are -- actually going to ship them.

That's our plan.

They will be revenueable for the quarter.

And, then, secondly, your very first question, the best way, probably, to look at that STK comparison is going to be, let's look at our Q2 results.

And the reason I say that is there was a Street estimate on STK before.

Obviously, analysts were following with a number out there in that 650 million range, or whatever the Street had for STK.

This way, we get, kind of, a full quarter, even though our quarter ends are off, we pick up the last five days of September, and even though we shut off our December before they did, we should get a full, kind of, 90-day quarter.

And that will be, I think, a better way for you to do that sizing and comparison.

Fair point.

Thank you.

Thanks, Tony.

Thanks.

Katina, could we have another question, please?

Your next question comes from Richard Farmer with Merrill Lynch.

Thank you.

Are you able to elaborate at all on some of the revenue synergies that you mentioned you might realize with StorageTek?

I guess, preferably, quantifying them, but if not quantifying, maybe just talking qualitatively about the kinds of activities that you're planning on undertaking to get those revenue synergies that you're expecting?

You bet.

We're going through in a relatively disciplined and diligent manner a list of Sun customers that don't do business with STK and STK customers that haven't done business with Sun.

And, obviously, there's a lot of cross-selling that can occur there.

We spent particular time and attention focused on training the STK sales force in the entirety of Sun's StorEdge product line.

And, again, we were probably more on the leading edge of the some of the disc innovation than STK.

And, obviously, given the software road map, especially around compliance and network identity, we can really round out the story to the STK customers as well as offer the reciprocal benefits to traditional Sun customers.

So we're very focused on revenue synergies, and not simply there, on SeeBeyond as well.

They folded naturally into the sales force that we had oriented around enterprise web services.

The team that goes off and does those big JES wins is now one and the same team that's driving the See Beyond opportunities.

So we're seeing businesses across the world look to Sun as kind of the founder of the Java movement.

And given that we can now elevate the Java discussion to business integration, an area that's been traditionally very proprietary, we've got another leg up there, and, again, a sales force that we can cross train as we go look for cross-selling and up-selling opportunities.

So we're as focused as you are on seeing some of those revenue synergies.

We're not going to quantify them, but we certainly targeted the team to go deliver against them.

Any comment on the timing of when you think you'll start to see those flow into the model?

I think we've already begun to see it.

And I think we're going to continue to see that and we believe it will accelerate.

Okay.

Thanks.

One other quick one, if I may?

On the Solaris 10 downloads, which you mentioned, are you able to clarify at all, beyond the downloads the percentage of the x80 ship -- excuse me, x86 shipments that are actually deploying Solaris versus Linux?

It -- again, it certainly is not -- Sun hardware is not representative of the broader market, because, obviously, although we've downloaded 3 million licenses, we by no stretch of any imagination have we shipped 3 million x86 systems.

So we're seeing a fair number of Solaris deployments on other people's x64 and x86 systems, probably notably, HP's equipment.

And I think that's just a natural derivative of HP's success in the Compac marketplace.

I think IBM, obviously, wouldn't have licensed Solaris for BladeCenter unless they thought there was an ample opportunity there.

I think they're going to leave, probably Dell and HP a little bit in their wake, given that they've got a multi OS strategy, and the other two guys, I think, are hiding from that.

And, then, within our own product, it's probably been about a quarter of them, but the numbers are ramping.

But, again, I don't want to have 100% of our x64 systems go out only running Solaris, because that would miss the Linux and Windows market opportunity out there.

So we want to see, not the interception in the Venn Diagram between hardware and software grow, we want to see the Venn Diagram grow, and as a result, the intersection will as well.

And, certainly, though, the Windows market needs higher-performance servers out there.

And we believe the Galaxy product line provides the best platform to go run those power-intensive, those performance-intensive Windows applications.

So we see a big opportunity there.

Thank you.

Thanks, Richard.

Katina, could we have one more question, please?

Next question comes from Keith Bachman with Banc of America Securities.

Thanks for the question.

I just have one.

Sun's had very good gross margins over the past few quarters, some really strong gross margins, in the face of what seems to be poor revenue performance relative to the industry.

There's been, what I characterize as optimistic comments from management over the past few quarters on the future potential, yet the revenue metrics continue to suggest difficulty with revenue growth.

At what point does the thesis of investing for growth, at what point does -- until you reconsider that and really go back and look at the cost structure rather than trying rekindle revenue growth?

Or is it something that you just continue to plow forward on trying to -- ?

Could you provide a little help on trying to understand what the longer-term thesis rest of it, what some metrics are that you're looking for to help investors try to understand the road map a bit better?

You bet.

So, I think the Street has us around 13 billion for the year.

Understanding, within that 13 billion, we're going to see some businesses that were in decline as well as pretty strong growth in other businesses.

So we're definitely investing for growth.

I think we're seeing evidence of that growth.

And what we've got to do is outpace the decline in some of the businesses that may be trailing off.

So I think we're definitely seeing the net result of that growth.

I think we're seeing some reasonably healthy demand metrics -- growth in deferred revenue as an example, the growth in the x64 system, certainly, the adoption and growth of Solaris, the adoption and growth of JES, and in some of the storage business as well.

So we've certainly been focused on driving cash generation.

I think we're looking, not simply to transition to x64, but to really go after the x64 marketplace as augmenting the SPARC and traditional business.

And, ultimately, looking for synergies across the entirety of that $13 billion-plus business to go deliver incremental growth opportunities.

So we can't just look at one line item and say that's the one we want to see grow.

We want to see the overall Company grow.

But as importantly, we also want to see margins expand, given the breadth of R&D that we're doing so that we can deliver growing earnings, which is probably the most important thing for us to go after, not simply top-line growth.

Let me just take one crack at that from my perspective.

You're going to see organic and inorganic initiatives from Sun.

We have $4.5 billion of cash, 16 straight years cash flow positive from our operations, and lots of great opportunities to continue to grow cash flow, despite the random walk through GAAP transparency.

I'm trying to be diplomatic here.

The unit volumes, when we sit back, we're generating cash, we're in a huge, wonderful cash position.

We're generating growing unit volumes in all of the big communities that Jonathan is always talking about, whether it be Solaris, JES, and the x-industry standard environments, even our SPARC communities are growing very nicely.

And you're going to love the announcements you hear coming in --

I also look at product execution.

And I will tell you the team over the last three years has been banging out product on time with significantly better price performance than we had done in the past, and now relative to the competition.

Very, very impressive price performance, whether we're talking about competing against the Power products with IBM, or the Dell industry standard platforms, or anybody in the OS space.

Nobody would have guessed that we'd be pushing 1 million JES subscribers a year-and-a-half ago when we launched Project Orion.

So I just look at the execution and say, that's a good leading economic indicator.

And then the partners are coming back on board big time, across the board, whether they be competitive [co-opitition-like] partners, or natural ones like an EDS or an NEC or a Google getting on board and getting on the bandwagon.

I would say we're getting awfully [expletive] relevant again.

And so all of that just is why we believe we're on the right track.

No customer I've ever met said stop innovating, stop cranking out great, new products.

And we've been very carefully, but aggressively, protecting that product calendar going forward.

And it's starting to pay off because a lot of other folks blinked and gave up on their processor strategy or gave up on their OS strategy or gave up on doing their own systems, all the rest of it.

And the world's going to need more servers going forward.

That's our basic thesis.

They're not going to need fewer of them.

They'll buy them in different ways, which is causing us to redo our business model to some degree.

And you're seeing higher gross margins, you see us driving cost.

We have lots of cost synergies as we bring -- and revenue synergies as we bring new environments on.

So, anyhow, enough of that.

And, anyhow, thanks, everybody, for listening.

All right.

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Thanks.

Operator?

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