Sun Microsystems CEO Scott McNealy had to do a bit of clever score-keeping last week to declare the company on a two-in-a-row winning streak. When the company reported a loss of $174 million on revenue of $2.6 billion for its first fiscal quarter, after a profit the previous quarter, McNealy noted that, excluding certain charges, it should be seen as a slight profit with growing sales.

"This year, we're focusing on profitability, growth, and getting back on offense," Sun's indefatigable CEO says. "While we still have some work to do, it looks like we've been underestimated again." In short, Sun has been standing its business model on its head--transforming its most-important commercial software into open source, embracing standard chipsets, converting rivals into partners, and tailoring subscription-style services. McNealy and Co. have been stewing over all these ideas for a year or longer, and over the next two months, customers will be able to judge how well they've delivered.

Next month, Sun is bringing out Solaris 10, an upgrade to its flagship Unix operating system that's more finely tuned for x86 microprocessors. This week, it's unveiling more pay-by-the-drink pricing options for grid computing. By year's end, it plans to finalize a sweeping plan to make its software available as open source, including a version of Solaris. And around the first of the year, it promises interoperability with Microsoft's identity-management and directory-services products.

By many accounts, the makeover is necessary for Sun's survival. The once-dominant company has struggled mightily in the last four years as customers flocked to lower-cost alternatives to its servers and software, and Sun has had only two profitable quarters in the last nine.

However, the yearlong expansions and modifications to its hardware, software, and services may renew some customers' faith. The "creative burst," as Steven Rubinow calls it, has Archipelago Holdings Inc. sticking to Sun-based systems and services, even as the electronic stock-exchange company evaluates alternatives. "Everyone in the world knows there's a competitive challenge for Sun," says Rubinow, Archipelago's chief technology officer. "But I give them a lot of points for creativity, which also gives me renewed confidence in their abilities longer term." In particular, Rubinow is interested in Opteron and improved versions of Solaris.

Sun's overhaul reaches into virtually every part of its core business. "Sun is doing a lot of things differently," says Gordon Haff, an analyst with research firm Illuminata. "Not all of them will pan out, but they've made fundamental changes."

In perhaps its boldest and riskiest move, the company plans to transform its proprietary software stack into open source that's available at no cost. In some ways, the move to open-source Solaris brings Sun full circle. In 1982, McNealy and colleagues founded Sun to sell a commercial version of a free Unix operating system. By putting a version of Solaris back into the public domain, Sun hopes to reinvigorate demand for its servers and broaden its ecosystem of Java developers.

While others have morphed commercial software into open source--IBM's Cloudscape and Computer Associates' Ingres databases are recent examples--none has done so with the core software that's driven its systems for years.

Sun won't be going halfway. The company will offer "a major portion, if not all, of our software foundation" as open source, says John Loiacono, the executive VP in charge of Sun's software group, adding that it will do so using an industry-norm license, "not some one-off specialty license." Sun is betting it can make money from service and support agreements, not unlike Red Hat Inc.'s approach to Linux. "If you want it fully supported or want input into new features, then you might have to pay for that," Loiacono says.

It's part of a broader push into a software-as-services model. Sun provides hosted storage on an as-needed basis, and, in January, it established a $100-per-seat model for its Java Enterprise development platform, which has attracted more than 345,000 customers. Sun also introduced in September hosted grid computing for $1 per processor per hour and this week will disclose details of a plan for third-party hosting.

November's Solaris 10 launch comes after much work to optimize the operating system to run on x86 microprocessors from Intel and Advanced Micro Devices Inc. Sun finally hopes to smash the perception that Solaris' quality and performance come at a steep premium. Solaris is "cheaper than Windows and less expensive than any of the major Linux distributions," Loiacono contends. Sun says it has addressed complaints about why Solaris hasn't done well on the popular x86-based servers before: too expensive, few applications, not enough hardware options, and poor interoperability with other systems.

Sun moved quickly to capitalize on the emergence of AMD's Opteron--a 64-bit, x86 processor--as a legitimate challenger to Intel's Xeon and Itanium chips, adding a new product line to address a lower-cost segment of the market it had been unable to reach previously, analyst Haff says. Major advances in throughput computing from its Sparc-based products remain a year or two away, and Opteron has provided new market opportunities and an immediate way to address customer demands, Haff says. Perhaps as significant, an agreement with Fujitsu was disclosed in June. The two companies jointly will develop future Sparc processors and market each other's high-end servers.

In addition, Sun is almost ready to play its Microsoft card. Having reached earlier this year a $2 billion legal settlement that included cross-licensing of technology and a joint-development agreement, Sun and Microsoft have identified up to 20 areas of potential collaboration. Within the next 90 days, they'll deliver the first fruits of that work.

The companies will provide single-sign-on capability for Microsoft's Active Directory and the Java Enterprise LDAP Directory. Sun's CTO, Greg Papadopoulos, and Microsoft's chairman and chief software architect, Bill Gates, have been working closely the past few months on a road map to bridge the Sun and Microsoft environments. The companies say they'll unveil integration products a few times a year over the next 10 years, concentrating initially on interoperability among their messaging services, applications, and systems management. "I don't anticipate that Microsoft is going to do any kind of similar deal with any of our major competitors," Loiacono says. "We have the inroad into technology and interoperability with them. Red Hat's not going to have this capability."

Whether that partnership and the rest of Sun's massive makeover can turn things around remains to be seen. But one thing is clear: It all adds up to a lot of change for Sun--and its customers--in the months ahead.

-- with John Foley