At Sun, Outrunning the Bear

Will new CFO Stephen McGowan find his place in the sun? First, he'll have to convince the computer maker's customers to spend some cash.
Marie LeoneNovember 15, 2002

No question about it, Stephen McGowan has a tall task ahead of him. The new finance chief at Sun Microsystems, McGowan takes over the finance department at Sun at a particularly difficult time.

The truth is, it’s not necessarily the best moment to be a finance director at any high-profile, large cap company. These days, such executives are sometimes seen in handcuffs.

What’s more, many of Sun’s corporate customers have put the kibosh on new tech spending, which in turn, has put a crimp in the hardware and software maker’s revenues. At the same time, institutional investors are dissecting every square inch of Sun’s earnings statements — just like they’re doing with the filings of other publicly traded companies.

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Compounding McGowan’s difficulties: he’s replacing Michael Lehman, a well-respected and well-liked finance chief. Sun liked Lehman so much, in fact, they made him the highest-paid CFO in 2001.

McGowan, 53, took over for Lehman in July. Besides his finance department duties, he is a member of Sun’s executive committee and reports directly to Scott McNealy, Sun’s co-founder, chairman, CEO — and a Silicon Valley celebrity.

A 25-year finance veteran of the computer industry, McGowan joined Sun in 1992 after leaving Digital Equipment Corp. Before taking the CFO post at Sun — a job he spent a year preparing for –McGowan served as vice president of finance, planning, and administration for Sun’s Global Sales Operations.

McGowan earned his undergraduate degree in finance at Boston’s Northeastern University, and an M.B.A. from Loyola University in Chicago. He’s also a certified management accountant. Senior Editor Marie Leone recently spoke to McGowan about his rise to the top finance spot at Sun. During the conversation, McGowan talked about SG&A in a down economy, the battle to boost revenues, and the recent spate of accounting scandals.

In July you became the CFO of Sun Microsystems, replacing 15-year Sun veteran Michael Lehman. What was it like stepping into the job amid a significant recession in the technology marketplace?

Succession planning was key, and because of that, the transition went smoothly. We’ve been planning this move for a year.

It also helps that I’ve been a part of Sun’s finance team for 10 years. Our CEO, Scott McNealy, set up a strong succession planning system. He’s been on the board of General Electric, and that’s one of the things that Jack Welch did well, so Scott brought it back to us.

On average, Sun’s management team has 10 years of experience with the company. We are two to three managers deep in succession planning — we have great bench strength.

Your bench may be great, but you’re one of the starters. That puts you in the spotlight, especially during earnings announcements. What’s the most difficult part of that process?

Delivering uniform and coherent information to all the different constituents — investors, analysts, press, employees, customers, suppliers — so they understand what happened in the quarter. That’s the most difficult aspect.

Our information is straightforward, factual, and forthright; we don’t tolerate spin of the financials. All the constituents now receive the same information at the same time, primarily through two quarterly conference calls that are Webcast. We have a quarterly earnings call and a mid-quarter update to announce any significant changes.

The excitement surrounding earnings announcements tends to be short-sighted. What’s you’re philosophy about balancing short-term performance and long-term goals?

Our focus is to deliver value for long-term shareholders, by delivering superior products and technologies to market. To do that successfully, Sun uses a very disciplined R&D investment process. In that way, we can ensure that we retain our technology leadership and competitive edge.

But how do you convince investors that the long-term approach is the right one?

Well, with IT spending down, we ask our investors to look at three other things: technology leadership, market share gains, and cash flow.

Research and development provides technology innovation for Sun. Market share, which is measured by independent third parties — specifically, IDC and Gartner — is viewed by sequential quarters and year-to-year share results. And cash flow is straightforward. Sun’s balance sheet has $5.9 billion of gross cash and cash equivalents.

And despite some recent operating losses, we’ve always achieved positive cash flow from operations. The good news is that even with declining sales, Sun has taken market share from its competitors. In this case, we don’t have to outrun the bear, just the other hikers.

One more question about cash. How does Sun spend it?

Mainly, it’s reinvested into the company to support our product development and acquisitions.

According to CFO PeerMetrix, Sun gets a high cost management score. In fact, compared to IBM, Hewlett-Packard, and Microsoft, Sun only lags Microsoft. However, Sun’s SG&A as a percentage of revenue is higher than the rest (31.3 percent). What do think accounts for the higher ratio, and how will you close the gap?

The higher ratio is primarily due to a decline in revenue. Sun was a much larger company in the bubble than it is today. Our current annual revenue run rate is approximate $13 billion; it used to be $18 billion.

We have not yet fully aligned the cost structure with this revenue level. Over time, we plan to bring the SG&A/revenue ratio down to 25 percent, and that means focusing on cost structure, revenue growth, and operational efficiencies.

Earlier you mentioned bringing products to market, which means you must be involved in operations to some extent. How do you define your role as CFO?

My job is to ensure the integrity, accuracy, and clarity of our financial reporting and to be a business partner to the CEO and his staff. At times I must be a financial engineer, a corporate strategist, a financial planner, a budget gatekeeper, etc. It’s my job to explain to management and the board the financial ramifications of a decision.

Lately CFOs are being forced to answer some tough questions. Corporate scandals have put a lot of pressure on finance chiefs. How has the pressure affected Sun, and you personally?

The pressures are enormous, and they always have been that way. If any of the CFOs played a part in the alleged corporate fraud, they should be put in jail and the key should be thrown away.

But the vast majority of corporate executives are good, committed, honest people doing the absolute best they can for their stakeholders. As for Sun, we’ve managed the company straight as an arrow, which is not any different than most other technology companies in the country. We stick to both the letter and intent of the regulations. The key for us: that long-term investors understand and trust what we say and do.

I know Sun is looking forward to an increase in corporate IT spending, but switch hats for a moment. As a CFO of a manufacturing company that’s operating in a sluggish economy, what kinds of IT investments really make sense today?

Companies should invest in areas where they have opportunities for quick payback. From a manufacturing perspective, Sun has invested in supply-chain automation. For example, new systems have cut our inventory in half in less than six months. That freed up $500 million of cash. We also reduced delivery time to customers by moving into direct fulfillment. And we are using dynamic bidding with our suppliers so they can price to their own capacities.

What suggestions about IT investments do you have for other CFOs?

When the economy slowed, so did capital spending on IT. As a result, I see our customers trying to squeeze as much as they can out of old technology. But that may be an expensive idea. Payback on new technology is often less than a year, and it often costs less to deploy new technology than to pay for the maintenance of older technology.

Another idea is to monetize internal IT systems. For example, turn in-house systems into portals for customers, suppliers, or investors.

But how do you measure the payback of such a strategy?

Let me give you an example. We created a portal for Java and Solaris developers. There are hundreds of thousands of these developers around the world that now have access to software news, useful tools, upgrades, etc. through this portal. This gives Sun another sales channel where we both educate and sell to this community.

So far, do you like your job?

Yes. I’m lucky to work with people that like working with each other. It’s a competitive, aggressive environment, but the team is supportive and talented. I have an incredibly strong and deep financial team worldwide who do their jobs with quality and excellence. And we have the benefit of working for a CEO who has the highest standards and integrity of anyone I have met in business. I am proud to be part of Sun.