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Sun Likes It Hot

In the new high-tech frontier, CFO Mike Lehman promises Sun Microsystems will continue to sizzle.

1Aug

Mike Lehman isn't known as a high-profile deal maker. Nor is the 49-year-old CFO of Sun Microsystems Inc. a certified black belt in balance-sheet legerdemain. After all, Sun has engaged in relatively little financial engineering or deal making during its 18-year rise from a four-person start-up to a high- tech giant. Nevertheless, analysts say Lehman's leadership and salesmanship are a big reason why Sun shines so brightly today.


A 13-year veteran of the Palo Alto, California-based company, Lehman is known as a consummate detail man. And at Sun, few roles are more important. Scott McNealy and Ed Zander--the company's CEO and COO, respectively--are press-the- flesh extroverts who spend more time out of the office than within. Someone has to mind the store, and that someone tends to be Lehman.


Vision, of course, has never been in short supply at Sun. Its motto, "The network is the computer," was coined in the late 1980s, before many dot-com zillionaires could legally take a BMW's wheel. But when Sun take a BMW's wheel. But when Sun first laid claim to the strategy, investors had serious doubts about its ability to execute. True, the company was big in high- margin workstations, but soon found itself the monkey in the middle between IBM and Hewlett-Packard in lower- priced workstations, on the one hand, and Compaq and Dell in high-powered PCs on the other. Sun responded by seizing new opportunities in servers, as more computer users began shifting applications from mainframes to the desktop.


Today, no serious investor doubts Sun's ability to compete with the likes of Microsoft or IBM. At virtually every stage of the industry's evolution to a network computing model, Sun has come up with the hardware, software, and services needed to stay one step ahead of the competition. Analysts now say that no other computer company is better positioned to exploit the growth of the Internet. Some of the credit goes to Java, Sun's Internet programming language, although Java reportedly still accounts for less than 10 percent of total sales. More important, say analysts, Sun has mustered a much higher level of technical dependability and customer support than it had before, which is crucial to corporate networks.


To strengthen its hold on those networks, Sun has beefed up its spending on R&D, investments, and acquisitions. Its new data storage product is aimed at grabbing a share of a lucrative market now dominated by EMC Corp. And though Lehman says Sun isn't worried about its market share in servers, the company recently began a systematic effort to market its products in a more integrated fashion, binding customers more tightly to the company. At the same time, Sun has become more aggressive in providing vendor financing.


Finally, Sun is dot-comming itself (project code name: eSun) as quickly as possible to cut costs and get closer to customers. All this reflects Lehman's handiwork, as he, McNealy, and Zander meet every two weeks to plan strategy and tactics. Indeed, these days Lehman, who in 1998 added the title of vice president of corporate resources to reflect his operating responsibilities, is out of the office almost as frequently as his two compatriots. But you won't find him speaking at computer conventions or testifying before Congress on the evils of Microsoft's monopoly. As senior editor Ronald Fink learned during a recent interview in the CFO's Palo Alto office, Lehman is far more likely to be holding a major customer's hand--as he tries to help sell it more of Sun's offerings.



Analysts say Sun's strategy has always been visionary. But early on, there was some question about whether the company could execute. How did you prove the doubters wrong?
We have very clear goals and objectives at the top, and the way we're organized allows Ed Zander and myself to focus on operations. All the finance people in the company work for me and for the business. And we have common goals and objectives. Our bonus plans are the same. We're incented to do the same things. We track those, and we meet every couple of weeks and talk about where we are.


At the same time, Ed is doing the same things with his business managers, focusing with the same regularity on the same things. We then get two views of the world. If there are any disconnects, we just work the issues from there.



Analysts point to you as the more cautious or realistic member of the management team. Some talk as if you were the skunk at the garden party.
I haven't heard that one! [Laughs] But we really have a great, fun team. Scott is the visionary, the leader of the place. He's got a great personality, and his personality and energy are a lot of what's been driving this company. And he's very irreverent and outspoken. He's a character, and that's part of what the market expects from him.


Ed mitigates that a bit by talking more about customers and markets and direct opportunities. Where Scott is sometimes at the visionary level, Ed's more along the lines of, "Here's the competitive front, here's how we're dealing with it."


I'm sort of the guardian of disclosure and of expectations. But the reality is, Scott and Ed and I agree ahead of time about the messages that we want to send. We just deliver them in three different ways. And I get to be the voice of reason--the one who's going to temper some of the hyperbole and excitement that the other two generate.



As a team, you've recently adopted a more integrated approach to products and services at Sun. But Microsoft is under threat of dismemberment because of such integration. Is now the time to be linking products and services?
This is night and day. When we talk about integrated hardware, it doesn't mean technical integration at such a deep, insidious level that nobody can interoperate with it. It just means we have more comprehensive product offerings, and we're going to continue down that path as far as possible.



There are two schools of thought on the larger impact of the court decision against Microsoft. On the one hand, it would seem to open new opportunities for companies like Sun. On the other, some analysts fear the case has taught the Justice Department so much about high technology that other companies may be vulnerable to antitrust activity if they move to exploit those opportunities. What do you think the implications of the court decision are for Sun?
The issues that Microsoft had with the government were clearly based on the fact that they were a monopoly. I don't see us or too many other companies being in danger of being found to be a monopoly. That's the core issue. On the other hand, we're not depending on the government to make our life any easier.



IBM seems to be getting deeper into server hardware and software. How much of your new integrated approach is a response to that?
It really has almost nothing to do with the competition. It has to do with, can we get better relationships with our customers by doing business in a different way?



How seriously do you regard Microsoft's efforts to move up the server food chain via Windows 2000?
They're no different than any other competitor. We obviously pay close attention to what they're doing and the capabilities of their products.



You often sit in on sales calls. What's your role there? What do you bring to the table?
I have five customers that I'm the executive sponsor for, which is a formal program inside the company. My job is to be the focal point to help develop these relationships-- to help the sales team with its account planning and think through how we can do more business with those customers. And then, in some cases, my job is to be the last resort: If something's not going well, then the customer can leap over the organization and call me.


In addition, I do about 50 to 75 sales calls per year at our visitors center, where the sales teams are bringing in customers from around the world. I do either the vision and strategy pitch of Sun, or [I explain] why Sun technology works, because we use it in our company. And I take them through how we use it, where we use it, how we're organized, and the cost savings that we get from it.



Like other technology companies, Sun is doing more customer financing these days. How far are you willing to go, and how do you manage the risk?
A couple of ways. First, we decided to partner with General Electric on the core leasing business. They do the majority of our traditional lease financing. And then, in some cases, we share the risk. When GE doesn't want to take the credit, we have established a recourse pool ourselves, where we're willing to go. We want part of our financing to support real, start-up dot-coms. Part of it we want to go to companies building their platform around Sun.


We're augmenting that [pool] with equity investments in some of these companies. We have made upwards of $200 million in such investments, partly to facilitate sales transactions, partly to facilitate investments in technology that we may want to acquire or partner with down the road. Things like that. We've authorized this equity investment group to go up to $400 million to $500 million. We look at those opportunities every two weeks.


We are investigating having other companies participate in the risk. These portfolios of recourse transactions are of interest to other companies and other types of investors. Without going into too many specifics, you can imagine almost a pool of these assets, perhaps bundled with participation in the equity upside, that can be laid off on investors who want to participate in that.



How do you decide how much risk you want to take on?
Partly it's a matter of how much do you want the business to grow. In this environment, unless you're willing to take on some risk, companies will go elsewhere.



On the equity side, what's your emphasis in terms of technology?
We do a pretty good job of doing a gap analysis inside our business. So the storage business knows what its product holes are, same for the computer systems [business], and so on. Then we attempt to identify companies that we may either want to acquire or that may work well with our product line.



Sun sometimes pursues products even when the revenue stream isn't eye-opening, such as with Java. Is Java a success even if it merely helps sell other products?
There's no question that Java and the Java platform, by itself, is not a major revenue stream. We've been very clear about that. It's a set of enabling technologies, and it certainly enables the development of cross-platform applications. It also allows us to then sell other products based around and on top of it.



Is that also your approach to StarOffice, Sun's office productivity software? You seem to be putting a lot of effort into it, and then you give it away via Web download.
We want to continue to demonstrate that more and more, software is really just a service over the Internet that people will subscribe to.



Does that suggest you don't consider software a major revenue source?
We don't really intend to have this large, stand-alone, software-only component of revenue. But offering software will certainly drive the rest of our business, including the service and support end. We don't really see a business model that has a significant component of stand- alone software license revenue. We think that's a thing of the past.



How much of a competitive threat is an open-source code operating system, like Linux, to your own?
Most of the Linux-type opportunity is in the small space where Microsoft competes. From our perspective, we see that as taking more business from Microsoft in the near term. We have a stake in Linux in the sense that we have invested in a couple of the service companies that are out there. In the longer run, we will evaluate how Linux is doing in the marketplace to see whether or not there's a place for it in our product line. But at this point, our customers aren't asking us to build that in.



Same question about application service providers. How do you view rentable applications, in which companies access software over the Internet rather than own it? If users begin cutting back on their infrastructure, where will that leave Sun?
That's a benefit to us. They want a platform that scales with the volume of users. That's really where we play well. If you take, say, an Exodus Communications [an Internet hosting and data center provider] business model, where the more users they have, the more capacity they add, that really plays to our strength in terms of our product line. What we're doing differently from some of our competitors is that we are not trying to be an ASP ourselves.



So fewer customers don't necessarily produce fewer sales?
Absolutely not. We will ship to fewer end-user sites. That makes things a whole lot easier. Having fewer orders, fewer invoices, fewer transactions to deal with would certainly result in a lower cost structure.



Are there any particular gaps in your product line that you're looking to fill right now?

There are always gaps we're looking to fill. We're an intellectual-property-driven company. More than anything, we want to own our IP. We can either make it or buy it.



Any sense of how much would be the latter these days?
We've accelerated the pace of acquisitions. We've done 20 in the past couple of years. Before that, it was 2 or 3 a year.



Do you care whether pooling accounting for acquisitions goes away?
We've done only one pooling in the last couple of years. Sun looks at acquisitions more from the standpoint of the true economics; the form of the transaction is irrelevant. Purchase [accounting] has been the prevalent one. Pooling is a good vehicle, as long as it's available. But we're not going to spend our life worrying about pooling going away.



What do you mean by "the true economics"?
We look at the net present value of expected future cash flows. And it really doesn't matter if you're paying cash or stock at some level. We don't need to get into the structure of transactions. Pooling just disguises the accounting impact on the company, and I think most analysts and most people are figuring that out. You see more and more companies these days reporting earnings that pretty much aren't GAAP earnings, they're the earnings that they want to report. So pooling is becoming more irrelevant.



You don't hear a lot of technology CFOs express that view.
I'm not sure why. I know some people are very vocal about it, and I know one or two of our board members are very vocal about wanting to keep pooling. I just know that the conversations that Scott and Ed and I have about acquisitions have nothing to do with purchase versus pooling.



Let's talk about eSun, your program to Webbify the company's operations. You seem a little more skeptical than others about just how far you can take internal use of the Internet.
I'm skeptical about companies that claim victories before they're real. And I'm very conscious that if we say [eSun will result in] a number of cost savings, the Street is going to bake that into its models and expect we're going to deliver. So I'm cautious from that standpoint. We have a huge opportunity to take cost out of the system. I'm just not willing to go out there and proclaim victory before it's done.



How big a role do you expect eSun to play in terms of sales?
We definitely expect to be taking the vast majority of our orders from our customers over the Web during this next fiscal year [which ends next June 30]. This past year [we invested] in the infrastructure to make that happen, and now we're going to be rolling out this capability aggressively to our customers.

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