Sun settles with Microsoft, announces layoffs

update The deal dictates that Microsoft must make $1.95 billion in payments to Sun, which separately says it will cut 3,300 jobs, as its losses mount.

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Sun Microsystems announced on Friday that it has moved to a new phase of legal and technical cooperation with longtime foe Microsoft that will involve a payment of $1.95 billion to Sun.

Sun also said Friday that it plans to cut 3,300 jobs, after it issued an earnings warning. The company now sees deeper-than-expected losses for the quarter that just ended.

Making amends
Longtime foes Sun Microsystems and Microsoft reached several agreements that will result in payments to Sun of nearly $2 billion. Here are some of the main points:

• Legal settlements: Microsoft will pay $700 million, and Sun will withdraw its antitrust lawsuit in the United States.

• Patents: Microsoft will pay $900 million to Sun as part of a broad agreement not to sue each other over past patent infringement claims. They also are seeking a patent cross-license agreement.

• Technical collaboration: The companies will have access to each other's server technology, enabling their products to work together. Initially, the technology sharing will include Windows but will expand to include e-mail and database software. Microsoft will initially pay Sun $350 million, while Sun could later make payments, as it incorporates Microsoft technology.

• Communications protocols: Sun will license communications protocols for the Windows desktop OS under terms established through the consent decree with the Department of Justice.

• Java support: The companies will work together to improve technical collaboration between Sun's Java and Microsoft's .Net technologies.

• Certification: A Windows certification for Sun's Xeon servers will be created.

In addition, the Santa Clara, Calif.-based company named Jonathan Schwartz, 38, previously executive vice president of software, as president and chief operating officer. Previously, Chief Executive Scott McNealy had said the company didn't need to fill the position, after the departure of Ed Zander in 2002.

Under the 10-year pact with Microsoft, the software company will pay Sun $700 million to resolve antitrust issues and $900 million to resolve patent issues, the companies said. The companies will pay royalties to use each other's technology; Microsoft is paying $350 million now, with Sun to make payments when it incorporates technology later.

"Our companies will continue to compete hard, but this agreement creates a new basis for cooperation that will benefit the customers of both companies," Microsoft CEO Steve Ballmer said.

The executives said they had been working on the deal for a year, since McNealy had made a call to his Microsoft counterpart. In a press conference in San Francisco on Friday, Ballmer addressed why it took so long to finish the deal, which was wrapped up only a few hours earlier.

"I think we were close in December," he said. "We needed a little bit more creativity."

For Microsoft, the deal with Sun is the latest settlement it has struck with a key rival. Last May, the company inked a $750 million deal with America Online to drop pending litigation, share technology and jointly distribute software. And in 1997, the software maker and Apple Computer agreed to settle their differences.

A $1 billion antitrust suit filed by RealNetworks in December, however, is still pending.

Ballmer said the deal with Sun was not driven by events in Europe, where regulators last week levied a record fine on Microsoft in an antitrust decision that also seeks changes in the way the company offers its software.

"I think you need to completely separate the two things," Ballmer said at the press conference.

Complaints from Sun had been a key factor behind the European action, but with Friday's deal, the company backed down from its earlier claims. Sun said the points of the agreement "satisfy the objectives" it was pursuing in the European Commission's case against Microsoft.

Lawyers said the Sun settlement will bolster Microsoft's efforts to get a stay, or temporary hold, in the antitrust decision. That's because the deal allows the software giant to argue that there is no need to rush forward with regulators' remedies for server interoperability, before the case can be heard in a European appeals court.

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Scott McNealy and Steve Ballmer
"This will strengthen Microsoft's hand in arguing for a stay. I don't think there is any way this can't help them," said Chris Compton, an antitrust attorney at Wilson Sonsini Goodrich & Rosati. "It will also put pressure on RealNetworks to settle their case against Microsoft. And if they do, the Court of First Instance may get out of the line of fire and say they will not require any remedies until the case is formally heard."

The judge in the European Union's Court of First Instance is expected to hold a hearing in the coming weeks on whether to grant Microsoft a stay. A trial, however, is not likely for years.

"This settlement could be the first domino to fall in resolving Microsoft's problems with the European Commission," Compton said.

Broad pact with Microsoft
The goal of the technical collaboration between Sun and Microsoft is to improve interoperability between the companies' respective products, according to Sun.

"This is a big day for customers. Everywhere we go, customers say, 'We have Sun and Microsoft technology, and we need interoperability.' We need peace," McNealy said.

As to how the peace treaty came to pass after years of Sun complaining about Microsoft's behavior, McNealy gave several possible reasons.

"Maybe we've grown up. Maybe they've grown up. Who knows?" he said. "Maybe the customers have gotten more in charge."

The Sun executive also challenged the crowd at the press conference to find customers who don't like the deal. He acknowledged, though, that there might be some fretting.

"There may have been a few customers who were a little shaky," McNealy said.

The 10-year technical collaboration will encompass several facets, designed to improve information sharing between the companies' server and desktop products.

The companies will share technical information to allow their respective security products, namely their directories and identity servers, to work together. The agreement could also be expanded to e-mail and database software, the companies said.

Sun will also license access to the Windows desktop communications protocols under a program initiated as a result of Microsoft's settlement with the U.S. Department of Justice in 2002.

Microsoft will be allowed to continue to provide technical support for customers that use its Java Virtual Machine, the software needed to run Java programs. The companies also vowed to work to improve technical collaboration between Sun's Java software and Microsoft's .Net programming technology.

Sun also said its servers based on Intel's Xeon and Advanced Micro Devices' Opteron processors have been certified to run Windows.

As part of the deal, the companies have agreed to not to sue over past patent infringement claims they may have against each other. That agreement can also be expanded to cover future situations. In addition, the companies have agreed to discuss a patent cross-licensing agreement.

Ups and downs for Sun
Sun, which chiefly sells powerful networked computers, called servers, has been struggling to return to the profitability that rivals such as IBM, Hewlett-Packard and Microsoft enjoy. The company already has suffered 12 straight quarters of shrinking revenue, after previously enthusiastic customers from the late 1990s curtailed spending and embraced technology that Sun didn't support.

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Sun now has made several dramatic changes, including the embrace of x86 processors from Intel and AMD, alongside Sun's own UltraSparc chips; and the lukewarm adoption of the Linux operating system, alongside Sun's Solaris.

McNealy put the moves in a positive light: "Now is the appropriate time to take cost out and drive productivity improvements in anticipation of returning Sun to sustained profitability," he said.

"Over the past three years, we have made substantial progress in reducing cost and capacity," McNealy said. "We completely revamped our product line, leveraging open source and industry economics while improving product quality and availability. And, we have re-energized our channels and developer communities."

McNealy and Sun Chief Financial Officer Steve McGowan refused to say whether product issues, broader economic problems or other factors affected the quarter's financial results. They promised details when the company reports full results April 15.

McGowan said in a conference call Friday morning that Sun expects to reduce both administration and research and development expenses by $500 million from about $5.2 billion in fiscal 2004, which ends June 30, to $4.7 billion in fiscal 2005.

The Microsoft payments will be recorded in the fourth fiscal quarter, McGowan said.

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Offsetting the payments will be a charge of about $475 million, to be spread over upcoming quarters--including the charge of about $200 million for the third quarter--to pay for the restructuring and reductions in the company's product portfolio, Sun said.

A deeper loss
For its fiscal third quarter, which ended Sunday, Sun expects revenue of $2.65 billion and a net loss of $710 million to $810 million, or 23 cents to 25 cents per share. The loss includes charges of about $350 million for an increase in the valuation allowance for deferred tax assets and about $200 million to restructure its work force and real estate, Sun said.

Excluding the charges, the loss would have been $200 million to $260 million, or 6 to 8 cents per share. The average estimate of analysts surveyed by Thompson First Call was less pessimistic: a loss of 3 cents per share on revenue of $2.85 billion.

The company says it has more than 35,000 employees worldwide, so the layoffs account for about 9 percent of its work force. The job cuts will affect all divisions and geographic areas, McGowan said. The majority of cuts will take place by the end of September, he added. Sun already had cut 8,500 employees in two major layoffs in 2001 and 2002.

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Schwartz's role, meanwhile, won't be ceremonial, McNealy said on a conference call. "He will be driving the product, sales, marketing and manufacturing efforts at Sun with a huge, hands-on chief operating officer role at Sun. This is a good thing," McNealy said.

Asked what he plans to do with Sun's billions in cash, McNealy said, "It's going to sit there, and we're going to continue to say we've got the best cost structure of any noninvestment-grade company you've seen." Standard & Poor's in March lowered Sun's credit rating to "junk" status.

CNET News.com's Martin LaMonica and Ina Fried contributed to this report.