McNealy on message

For Scott McNealy, fixing Sun Microsystems' problems is personal.

The chief executive has been working for years to put the server and software company back on an even keel after a period of explosive growth during the dot-com spending frenzy in the late 1990s. Although the server market once again is expanding, Sun's share of its sales continues to shrink, and the company's own revenue growth remains elusive.

But the 50-year-old McNealy said his Midwestern values require him not to leave the recovery to someone else. "I feel a huge sense of duty and loyalty," McNealy said. And though he's testy at times, he insists he enjoys the work: "It ain't a bad job."

In McNealy's opinion, much of Sun's problem is merely perception--compounded by flawed Generally Accepted Accounting Principles (GAAP) that draw attention away from the company's track record of cash generation.

To try to restore its position, Sun has many irons in the fire--among them, a newly open-source operating system, servers using Advanced Micro Devices' Opteron processors and a marketing campaign boasting of Sun's "sharing" values. McNealy discussed his views in a meeting at CNET News.com's offices on Wednesday.

Q: What would you say is Sun's biggest problem today and its biggest strength?
McNealy: I just came back from an executive advisory committee meeting with all our top ISVs (independent software vendors) and partners. If you listen to them, their biggest beef coming in was they didn't know what our strategy was. The biggest beef coming out was, 'Why don't you tell somebody?' When you're making money, you get to position yourself. When you're losing money, your competitors position you. So nobody knows our story. We've got to do it directly and on our own.

It doesn't help that GAAP is a random walk through irrelevancy right now and that the media's primary guideline for quoting financials is GAAP, when we're 16 straight years of cash-flow positive from operations. We cannot have lost billions of dollars in GAAP and somehow magically ended up with $7.5 billion in cash and no SEC investigations. We didn't cheat. We didn't steal that money. People actually felt very good about paying for the invoices we gave them. There's something wrong with the deferred tax asset impairments and all the rest of it, but because it's a GAAP profitability issue, we haven't been able to position ourselves.

What are our assets? We're one of three processor architectures--Intel-AMD being one, Sun and Fujitsu's Sparc being another and Power being another--that are going to survive. We have one of the two, maybe three operating systems that are going to survive: Windows, Solaris and maybe Red Hat. I'll be happy to compare Solaris vs. Red Hat.

We'd love to hear what your strategy is.
McNealy: I'll start with the vision. We believe we're moving out of the Ice Age, the Iron Age, the Industrial Age, the Information Age, to the participation age. You get on the Net and you do stuff. You IM (instant message), you blog, you take pictures, you publish, you podcast, you transact, you distance learn, you telemedicine. You are participating on the Internet, not just viewing stuff. We build the infrastructure that goes in the data center that facilitates the participation age. We build that big friggin' Webtone switch. It has security, directory, identity, privacy, storage, compute, the whole Web services stack. We build that infrastructure piece.

We have a mission, and that's make money and grow. That allows us to realize our cause, and that is to eliminate the digital divide. We believe our strategy, way more than a PC on everybody's desk or a mainframe everywhere, is the way to make that happen.

We have a strategy that's very different from everybody else's, and it's community development. The way we say that is with the S curve in all our new literature. It's not for Scott, it's not for Sun, it's for "share." We're grabbing that word and saying, of anybody, we own the word "share." We own that space.

During the last earnings call, you said you need more revenue growth. What do you do to make that happen?
McNealy: We have massively focused on customer satisfaction in terms of field satisfaction and hardware reliability. We've never had higher customer satisfaction with respect to how our product works, how it stays up out in the field. That was not true back in the (dot-com) bubble. We were just getting the stuff out the door as fast as we could, and that wasn't a good thing.

Second, three years ago I had a 900MHz UltraSparc III processor that didn't work very reliably. Now we have UltraSparc IV and IV+ coming later this year, UltraSparc IIIi and IIIi+ coming later this year, both of which double the per-socket performance. We've got Opteron dual-core shipping now, and Andy's new machines are due out in the next six months. (Editor's note: That's Sun co-founder Andy Bechtolsheim, chief designer of the company's Opteron servers.) We've got the APL (Advanced Product Line) Sparc mainframe chip jointly developed with

Fujitsu coming out early next year. We've got Niagara in early access right now, our 32-thread, eight-core chip multithreading environment. Niagara II will tape out this year, and Rock will tape out next year, which is our high-end machine. So you look just on the microprocessor side, what we've done in the last three years from one 900MHz underpowered product to what we're doing. We're leveraging every single microprocessor out there except two: Itanium--ha ha--and Power, which with OpenSolaris out there, we might be able to leverage with a Power port.

What are we doing in the OS world? I think Solaris 10, now open-sourced, is the best new product we've introduced in 10 years--with DTrace, with ZFS, with containers, with trusted Solaris features, with the new, fast IP stack, with the self-healing features, with the coming ability to run Red Hat applications native, and simultaneous support of Intel, AMD and Sparc. Then we open-sourced it and priced it for free.

We are now at 2.5 billion Java devices on the planet--(including) 700 million cell phones, 700 million PCs. We had 17 million and 20 million downloads in the last couple months of the J2SE environment. That is a stunning number. The new Blu-Ray spec is going to put a Java virtual machine in every new next-generation DVD player, and all your DVDs are going to have Java bytecode on (them) that gets executed.

What else have we fixed? The Java Enterprise System. I think we have a good chance of breaking through a half a million subscribers with our Web services stack at some very unique pricing models. I think we're going to be the player in Web services. People are tired of doing best of breed--tired of getting their directory server from Novell, their file system from Veritas and their app server from BEA and putting that all together. The Microsoft relationship is a very unique selling proposition.

How do you think the OpenSolaris launch went? Have you learned anything since you put it out there?
McNealy: I always make the Al Gore-ish statement that we invented community development. We started doing community development before we got founded. Three or four years before we founded Sun, one of our founders (Bill Joy) was pioneering the idea of open-source community-developed kernels in the operating system space, doing BSD licensing models with the Berkeley Software Distribution. We were the Red Hat of Berkeley before Linus (Torvalds, the Linux founder) was out of diapers.

Is there anything we've learned new around community development? During the late 1980s and early 1990s we let Solaris get encumbered as we were trying to build features and compete with mainframe OSes. Plus the fact that we did the AT&T Unix System V Release 4 base, which required us to buy our way out of the SCO license. It just occurred to us, probably six or seven years ago, that we can't do what we want to do with the source code here. We spent a long, long time getting the encumbrances out. They kind of spaghettied themselves deeply into the operating environment. The one thing we learned was just don't let the stuff get encumbered again. That was the mistake we made, by going too fast too quick. By going a little slower and letting the community help, we wouldn't have gotten encumbered. We would have been in better shape if we'd kept it open source along the way.

How does StorageTek fit in?
McNealy: We have done very well in the server space. We have lagged in market penetration on the data management side...We have a 25 percent, plus or minus a few points, storage attach rate. It should be 70 or 80 percent. We're aren't even getting the bun with our burger, much less the fries, the milk shake and the hot apple pie.

(In the storage market,) there's NetApp, there's EMC, there's IBM, there's Sun, and there's the old Compaq storage business. We have better product now than EMC. The (StorEdge) 6920 with Pirus virtualization and provisioning blows the doors off the EMC product line. What we've done with Hitachi in the high end, Dot Hill in the low end, Seagate and LSI Logic--we have integrated all this into a wonderful environment. It's a wonderful story. We have no way to bring this to market.

All of a sudden we grow by over an order of magnitude the number of data storage sales specialists we have in the field, plus a couple thousand service folks. Why do people choose EMC over us? They trust EMC. StorageTek has a very outstanding reputation of safeguarding their data asset. StorageTek has 17,000 customers. They archive 36 percent of the planet's archived data on their tape libraries. All these tape libraries are tied to IBM mainframes. You'll trade out your mainframe before you trade out your tape library.

Everybody says tape's going away. I don't think so. It hasn't been going away for 20 years like everybody's said. And only more stuff is getting archived. Think about all these camera clicks that are going to get archived. With HIPAA and Sarbanes-Oxley (regulations), the world is only going to need to archive more.

Financially it made a lot of sense. We were making $100 million on the $3 billion, pretax. StorageTek is making several hundred million dollars, pretax. It's immediately accretive, non-GAAP. From a cash flow perspective, they're generating cash, we're generating cash. We don't need to have any revenue synergies to have this be a positive for our shareholders. Any cost synergies are all upside. The problem with the Compaq-HP merger is it was all about cost synergies, and cost synergies are very disruptive.

Since they're profitable and going up, do you think that'll get you out of your GAAP jail so you'll be able to tell your story?
McNealy: We're very close. Last quarter, we lost $3 million dollars. We are nine months into this fiscal year. Year-over-year, on an operating margin basis, we have improved for the first nine months, year-over-year, $550 million. If you believe what the analysts say, it's going to be between a $700 million and $800 million improvement year-over-year in operating margins, pretax, pre-GAAP, pre-one-time any of that stuff. That, on an $11 billion or so revenue run rate, is stunning. If I do that again next year, move over Jack Welch in the hall of fame.