Sun Makes Peace with Microsoft, Restructures

In a series of bombshell announcements, Sun Microsystems said it accepted a $1.95 billion settlement to end its legal war with Microsoft and will cut 3,300 jobs as part of a restructuring.

Under the truce terms, Sun ended patent and antitrust suits against the Redmond, Wash., software giant. The companies also signed a 10-year technology sharing agreement.

The pact will mean a cash windfall for Sun. Microsoft will pay Sun $700 million for antitrust issues, $900 million for patent issues and $350 million for up-front royalties in the technology deal. The payments will come in the fourth quarter and will pad Sun’s significant reserves.

As for other issues, Sun Chairman and CEO Scott McNealy said Sun will certify its servers to run on Solaris, Linux and now Microsoft’s Windows operating systems. He also said Sun would not abandon its desktop strategy.

“We think this improves our desktop efforts by making us more interoperable,” McNealy said in an early morning conference call with financial analysts.

Later, at a news conference in San Francisco, McNealy and Microsoft CEO Steve Ballmer said customers have asked that the rivals “tone down the rhetoric,” and work on interoperability.

“Maybe we’ve grown up, maybe our customers have grown up,” McNealy said. “The message is that we are well established in the enterprise — wherever we go Microsoft is there, wherever they go we are there.”

The two men said that the collaboration framework was one of the biggest stumbling blocks. It was also the aspect that took lawyers the longest time to sift through. Ballmer said that after many sit-down talks during 2003, the two companies were very close to a settlement in December, but backed away for the holidays.

The agreement was not finalized until early Friday. Now, Microsoft Chief Software Architect Bill Gates and Sun CTO Greg Papadopoulos will hammer out the finer technical issues.

“This creates a patent regime between the two companies so that we don’t run
afoul of each other,” Ballmer said. “The specific technical collaboration is
focused on talking to each other across the network. But as we looked at
this we said, ‘Let’s make sure we are clean on our patents.”

Stephen O’Grady, senior analyst at research firm Redmonk, said the deal will benefit both parties.

“Microsoft obviously gets one big legal challenge off its plate and may have changed the face of its ongoing litigation with the EU, and for its part, Sun’s able to put the litigation behind it and pocket well over a billion to its coffers,” O’Grady told

O’Grady said he’s eager to hear more about the technology agreement. “While both companies are talking up the potential for interoperability and collaboration, few details have emerged,” he said. “It’ll be significant, no question, but how significant is tough to say at this point given the paucity of available information.”

Santa Clara, Calif.-based Sun also released financial information and restructuring plans. Sun will eliminate 3,300 jobs to drive down costs. The cuts will be “broad-based, geographically and functionally,” McNealy said.

The company also promoted executive vice president Jonathan Schwartz to president and COO.

Sun now expects third-quarter revenue of $2.65 billion, with a net loss between $750 million and $810 million, or 23 cents to 25 cents per share. The loss includes a $350 million charge for an increase in the valuation allowance for deferred tax assets, and approximately $200 million for workforce and real estate restructuring.

Sun will record total charges of $475 million over the next several quarters, including other $200 million charge in the preliminary results, in accordance with the staff reduction and property restructuring.

Sun said positive cash flow from operations for the quarter is expected to exceed $300 million, with the balance of cash and debt securities to increase to about $5.5 billion.

McNealy touted the success of the company’s server unit and promised to increase cash flow through improving the Solaris 10 Operating System and the UltraSPARC IV systems with Sun Throughput Computing capabilities. Services are another area he highlighted as important because the produce recurring revenue.

Sun’s maneuvers come after months of browbeating from analysts who said the company couldn’t sustain profitability unless it changed the way it positions and sells its hardware and software. The company had been losing ground in the server arena to rivals such as IBM and HP.

In a note to investors this morning, analysts at SG Cowen applauded Sun managers for deciding to “bite the bullet on the costs structure and the favorable resolution of Microsoft-related distractions.”

Colin C. Haley and Michael Singer contributed to this report.

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