Sun: Shame on us if we can't grow

"Shame on us, with 42 or 43 percent gross margins...our intellectual property, our installed base, if we can't leverage that into some growth, into making money," McNealy said at Sun's annual meeting with financial and industry analysts, held this year in San Francisco. At Sun in the future, he said, "there will be much greater emphasis on "make money and grow.'"

Video: Sun shines for analysts
Sun's President Jonathan Schwartz

And retiring Chief Financial Officer Steve McGowan steered analysts toward a Barron's article that argued Sun's stock price should increase, once the company's business starts to stabilize. "It is our view and belief that it has stabilized," McGowan said.

But Sun, whose stock price has been largely flat for years, faced skeptics in the audience. "This is the fourth straight year where your priority is to make money. It's the third where your priority is to grow," said Sanford C. Bernstein analyst Toni Sacconaghi. "You haven't fulfilled those priorities."

Sun is banking on a major overhaul to its core server products--including the UltraSparc T1 "Niagara"-based servers and "Galaxy" line of x86 servers, both introduced late in 2005. It's also betting on systems based on the UltraSparc IV+ processor, which were in higher demand last quarter than Sun expected. At the same time, it's giving all its software away for free and making most of it open-source to attract developers and customers.

Sun has stopped a revenue slide but has yet to achieve consistent profitability. Its revenue growth of 17 percent to $3.3 billion in its most recent quarter stemmed from the acquisitions of software maker SeeBeyond and storage specialist Storage Technologies.

McNealy and Sun President Jonathan Schwartz encouraged analysts to scrutinize several "leading indicators," such as licenses for Sun's now-free Solaris operating system, which the company believes portend later revenue.

"We shipped more licenses of Solaris in the past 12 months than we have in the combined history of the company," Schwartz said, estimating that the total was probably 100 or 1,000 times more than rival Unix products from IBM or Hewlett-Packard. That, in turn, attracts developers, software companies and ultimately customers, Sun argued.

Another proposed indicator is sales of the Java Enterprise System subscriptions. Sun sells support for the free software on the basis of how many employees a company has; the entire suite costs $140 per employee per year, and subsets cost $50 per employee per year. In the fourth quarter of 2006, JES subscriptions rose to 1.1 million.

"Two years ago...there was an enormous amount of skepticism in this room" about the JES project, then code-named Orion, McNealy said. "If we'd told you we'd sign up General Motors, General Electric, American Express, the U.K. National Health Service, Blue Cross Blue Shield Massachusetts (and) FedEx, and (show) this kind of a growth rate, you'd have laughed us off the stage."

Bullish McGowan
In Sun's most recent quarter, expenses jumped 36 percent to $1.6 billion, in large measure because of the StorageTek and SeeBeyond acquisitions. But people shouldn't worry that the increased expense signals an end to Sun's cost-cutting days, McGowan said.

Sun can save $100 million by reducing the cost of goods sold, by taking measures such as moving StorageTek product manufacturing to external partners and having those products shipped directly to customers, he said. Another $100 million will come from operating-expense "synergies" with the purchased companies, he added.

Sun also has closed numerous offices in recent years, cutting real estate from 16 million square feet in fiscal 2002 to 10 million in fiscal 2005. That trend, too, will continue: Sun plans to cut 160 offices that were made redundant by the StorageTek acquisition. And Sun just announced it's closing most of its Sunnyvale, Calif., campus.

Sun spent a large fraction of its cash on the StorageTek and SeeBeyond buys, but the company doesn't expect to dip further into its remaining assets of $4.3 billion. "Our plan now is to start growing the cash now from that base," McGowan said.

"I sat down with Larry and said, 'Larry, you're killing us,'" McNealy said. "Part of the problem is we didn't have the fastest microprocessors, so you had to throw a lot of microprocessors at it. When you charge $30,000 per core, we ended up looking very expensive."

"He said, 'You know, you're right.' I almost fell off my chair," McNealy said. "It's turned around 180 degrees for us. This is a big, big win. Larry Ellison basically lowered the cost of goods sold in one fell swoop."

Sun's Oracle problem got worse with UltraSparc T1, which has eight processing cores. "We we had a $3,000 server, but it would have cost $240,000 for the Oracle licenses," McNealy said. Now Oracle only charges one-quarter the license fee for T1 cores. "It only costs $60,000 for a $3,000 server. That's progress!"

McNealy said Sun's embrace of two open-source databases, PostgreSQL and Derby, aided his cause. "I think there was some incentive and motivation to do the right thing," he said.