Updated from 12:11 p.m. EST

Investors finally got a glimpse Friday of a rising Sun ( SUNW).

The struggling server giant enjoyed a big stock jump after stunning Wall Street with a double-barreled news barrage. First, the company delivered details of its latest setback, a steep second-quarter earnings shortfall that will accompany another round of layoffs. But then CEO Scott McNealy saved the day by claiming a victory, and a much-needed $2 billion payday, in Sun's nasty legal spat with Microsoft ( MSFT).

Sun shares, which have fallen sharply in the last month and largely have failed to take part in the tech stock rally of the last year, were recently up 72 cents, or 17.2%, to $4.92 after trading as high as $5.05 intraday in Nasdaq-leading volume of more than 165 million shares. For its part, Microsoft added 66 cents, or 2.6%, to $25.73.

As troubling as the latest operational shortfall is -- Sun expects to post a loss twice as big as Wall Street expected, on a 7% revenue shortfall -- investors clearly chose to focus on the legal deal, which settles antitrust and patent claims against the Redmond, Wash., software titan.

"This agreement launches a new relationship between Sun and Microsoft -- a significant step forward that allows for cooperation while preserving customer choice," Sun CEO Scott McNealy said.

At a quickly called press conference in San Francisco, McNealy and Microsoft CEO Steve Ballmer marked the new chapter in their companies' tumultuous relationship by exchanging red jerseys from their hometown hockey team, the Detroit Red Wings.

"Friendship and partnership starts on the ice," Ballmer quipped.

Sitting side by side in director's chairs, the pair recounted how McNealy initiated the settlement efforts by inviting Ballmer to a game of golf almost a year ago. The two companies were close to reaching an agreement in December, but then Microsoft got preoccupied with the European Union antitrust case.

In sharp contrast to past badmouthing of Microsoft, McNealy noted that he and Ballmer are good friends who went to Harvard and then Stanford business school together. Striking a collegial tone, both executives repeatedly touted the interoperability between their two platforms that will result from a 10-year technical collaboration agreement -- interoperability that they claim customers have been demanding and consequently led to the settlement.

"Maybe we've grown up; maybe they've grown up," McNealy said in response to a question about whether Microsoft's behavior has changed. Or maybe the customer has become more in charge, McNealy added.

Relationships are surely nice, but Wall Street seemed equally pleased with the cash that Sun stands to take in. Microsoft, which is also in the process of being ordered by European regulators to publish the source code for its server products, will pay Sun $700 million to resolve antitrust issues and an added $900 million to resolve patent suits. Microsoft will make an additional $350 million upfront payment under a new royalty agreement, with Sun pledging payments when certain technology is incorporated into its server products.

The cash infusion comes at a good time for Sun. Just last month, ratings agency Standard & Poor's cut its corporate credit rating on Sun's debt, citing the company's "weak and inconsistent profitability, and our expectation that Sun will be challenged to profitably expand its market presence." S&P noted that the company appears to have "ample liquidity," but also pointed out that at year-end it had about $1.3 billion in debt.

Still swimming against that tide, Sun said Friday it will cut 3,300 employees across the board, or about 9% of its workforce. The firings come on the heels of a 1,000-worker layoff the company rolled out in September. Sun also laid out plans to promote Jonathan Schwartz, currently software czar, to president and chief operating officer. McNealy, who has been the target of increasing criticism on Wall Street, will remain as chairman and chief executive.

As for its impact on Microsoft, Sanford C. Bernstein analyst Charlie Di Bona called the settlement payment immaterial, noting that it represents only 3% of Microsoft's enormous cash stash. Microsoft is likely to put the money aside in a reserve this quarter, but analysts will probably treat that as an extraordinary charge and exclude it from the company's quarterly results, he said. (Di Bona has a buy rating on Microsoft and his firm doesn't do investment banking, although its parent, Alliance Capital, holds Microsoft shares.)

More importantly, the Sun settlement removes one more hurdle that Microsoft has cited in preventing it from taking action on sharing its cash with investors, Di Bona said. The analyst added that he thinks Microsoft will announce both a dividend increase and share buyback program at its analyst meeting this summer.

There was some surprise that Sun opted to replace former President Ed Zander, now chief at struggling wireless giant Motorola ( MOT), with an insider. In fact, McNealy had pledged that he wouldn't do that. Asked about the change of heart, McNealy said, "That was then, this is now."

Romeo Dator, who co-manages the All-American Equity fund at U.S. Global Investors, didn't like that answer: "They seem to be so insular.I think an external hire wouldn't be so attached to the culture and probably would be more willing to shake things up."

Dator's fund recently bought shares in Sun as a turnaround play, but he says he'd be inclined to take profits on today's strength.

Another fund manager, who asked to remain anonymous, was even blunter. "I don't think he Schwartz is COO material." He also said Sun has yet to outline a convincing plan to grow sales. "Where's the growth going to come from?" he wondered. " Red Hat ( RHAT) sold more licenses last quarter than Sun sold Solaris licenses, for the first time ever."


Rising Again?
Up and down at Sun


Sun expects to lose $750 million to $810 million, or 23 cents to 25 cents a share, in the quarter ended March 28, including a $200 million restructuring charge and a $350 million charge to increase the valuation allowance for deferred tax assets. Excluding the charges, Sun expects to lose between $200 million and $260 million, or 6 cents to 8 cents a share, on revenue of about $2.65 billion.

Analysts surveyed by Thomson First Call were forecasting a loss of 3 cents a share before charges on revenue of $2.85 billion in the quarter.

In a call with analysts before the market opened, McNealy said the company wouldn't release many details of its restructuring until it announces final results for the quarter on April 15.

Goldman Sachs analyst Laura Conigliaro noted that for every 1,000 people let go, Sun's annual cost savings will amount to around $100 million, or around 2 to 2.5 cents a share.

Although Sun shares were gaining strength, there was still plenty of skepticism on Wall Street about the company's future.

Patrick Adams, manager of the Choice Long-Short fund, said that leading up to today, he'd been toying with the idea of buying Sun Micro on the premise that the company was likely to post a disappointing quarter and that the stock would then sell off. But with Friday's surge, it's hard to see buying the stock right now, he said.

"I don't know how they get out of the box they're in," he said.

Staff reporter Ronna Abramson contributed to this story.

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