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Can Sun also rise?
Scott McNealy is making nice with Microsoft. Great. Now the real work for Sun begins.
April 14, 2004: 3:43 PM EDT
By Eric Hellweg, CNN/Money contributing columnist

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SAN FRANCISCO (CNN/Money) - After the end of trading tomorrow, Sun Microsystems will give investors its third-quarter results.

Though the state of the company's balance sheet isn't much of a mystery (Sun warned on April 2 that its loss will be twice what analysts had expected, with a 7 percent revenue drop), look for heightened interest in the question-and-answer session following the call.

That's because this is no ordinary time for Sun. April has been a rock-and-roll month so far for the company.

Take a look at this list of events: Sun agreed to bury the hatchet with its longtime nemesis, Microsoft, which, among other things, will result in nearly $2 billion in payouts from Redmond; it announced a layoff of 3,300 employees; and it named Jonathan Schwartz as president and chief operating officer.

Sun needed some pretty jarring developments.

"Last fall, I gave the company 18 months," says Daryl Plummer, a group vice president and fellow at Gartner. "They were about to become the next DEC."

What's in the works?

What should investors expect from McNealy & Co. in the earnings call and during the next quarter?

First, investors will want evidence of a renewed focus among Sun executives, specifically Scott McNealy. In the past, McNealy never missed an opportunity to slam Microsoft, and many observers felt his obsession with Microsoft came to hurt his company.

"[McNealy has] wasted so much energy on bashing Microsoft," says Charles Wolf, an analyst with Needham & Co. "It's been a distraction."

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Second, even though all observers I spoke with saw the Microsoft/Sun dtente as positive for Sun, the fact remains that the company is struggling. It's lost its vision in a shifting marketplace and is in the unenviable position of seeing market share erosion on both the high end (IBM and others) and the low end (Linux and Intel) of the product spectrum.

As such, Sun needs to quickly seize on the momentum of the Microsoft deal and announce interoperability initiatives within the next 90 days. By making its products interoperable with Microsoft software, it will likely find a few more doors open for it in the enterprise realm.

Schwartz's role

One final aspect of Sun's shift intrigues me: Schwartz's ascendancy to president and COO. Tomorrow's earnings call is likely too early to obtain any significant guidance from McNealy about what the promotion will mean for the company, but Schwartz is a software guy. Before April 2, he was the executive vice president for software. In the past few years, Sun has largely morphed into a hardware and services company. Will Schwartz's presidency mean a return to a software focus?

Whatever Schwartz's role, Sun is at a crossroads.

Yes, the Microsoft agreement tucks some cash in the coffers and keeps Sun's foot in the door at many companies. But the problem remains that it's a high-cost, largely proprietary producer in a market that has steadily become a low-cost, standards-based play.

And, according to Wolf, Sun's operating-expense structure is such that the company needs 40 percent gross margins to be profitable. That's proving harder and harder to meet, and it is part of the reason for the recent layoffs.

Sun's stewardship through the rest of the year requires force and finesse. The company must force down its operating expenses and also force itself into discussions with potential customers that previously haven't included Sun on their shortlists of candidates.

Sun Microsystems Incorporated
Microsoft Corporation

And it will need to employ finesse to manage the transition to offering low-end, Windows-compatible products without sacrificing many of its high-end product sales.

"Introducing cheaper versions of servers running Linux or Windows is OK as long as Sun increases [overall] revenue generation," Wolf says. "But if all it does is motivate customers to substitute [the low-end products] for [higher-margin] Solaris, they're screwed."

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