(FORTUNE Magazine) – MONDAY, MARCH 22: It's not even 8 A.M. in Redmond, Wash., and it's already been a hellacious day for the PR staff at Microsoft. This morning the Wall Street Journal ran a story claiming that the software giant plans to initiate settlement talks with the Department of Justice aimed at ending the Microsoft antitrust trial, currently on hiatus. The story, which clearly comes from the Microsoft camp, offers no details of a Microsoft settlement proposal. The closest it comes is this hint from an anonymous executive: "There are ways we can adapt our business practices to resolve [the government's] concerns."

Now, a quote like that is bound to make one wonder whether Microsoft is really interested in settling the case or whether this is just a public relations ploy. After four months of trial--during which numerous Microsoft witnesses have been skewered by prosecutor David Boies--the government strongly believes it has the upper hand. It is hard to envision the feds suddenly allowing the company to get off merely by "adapting" a few business practices.

Nevertheless, the story has created a small riot among the reporters on the Microsoft antitrust beat. "Ted Britis from AP called at 5:30 A.M.," says Jim Cullinan, a young Microsoft flack. "That's way too early for me," he laughs. Eventually Cullinan fielded half a dozen calls before breakfast, as reporters from the East Coast tried to flesh out the details. Not that Cullinan was divulging any. Yes, he said, Microsoft was willing to talk about settlement, in large part because Judge Thomas Penfield Jackson expected the two sides to try. But Microsoft's long-held position that it has an absolute right to add features to its Windows operating system remained nonnegotiable. Which, of course, is why it's so hard to take talk of a settlement seriously. The fact that Microsoft folded its browser, Internet Explorer, into Windows is what caused the feds to bring this case in the first place.

Cullinan and I are sitting in a Microsoft bus as he describes his hectic morning. By coincidence, I am spending the day on the company's campus, and Cullinan is my escort. A 31-year-old former Clinton Administration staffer, he's been part of the Microsoft trial team since the case was first filed last May. He is the feistiest member of the team, but he's also very likable; if I have to have an escort, I'm glad it's Cullinan.

I've pushed for this visit for several reasons. First, with the trial in recess, it seems like a good time to take stock. Second, I want to learn how the case, which seems so momentous to those of us attending it, is viewed within Microsoft. And third, I want to visit some of the people I've met in Washington, D.C.--to get a snapshot of their "real life" at Microsoft.

It doesn't take long to realize that the question of how the trial is viewed at Microsoft will be the hardest to gauge. Here and there, I get hints that it looms large--I see a bumper sticker on an office door: BOYCOTT THE GOVERNMENT. BUY MICROSOFT. But every person I interview insists that it's barely a blip on the radar screen. "The trial?" says Dave Fester, the group manager for Windows marketing. "I'm completely focused on products and customers. I don't think about it." I'm given a demonstration of a wonderful new product, still in development, called ClearType, which makes computer type as easy to read as print. ClearType will help make electronic books a reality, says Dick Brass, who is overseeing the project. But a few minutes later, one of his top programmers casually mentions that ClearType will also wind up in the operating system. These are hardly the words of someone worried about the outcome of an antitrust trial.

Later--and out of Cullinan's earshot--several people give more nuanced views. The company's greatest fear was that the bad publicity would hurt recruiting; there was enormous relief when that turned out not to be the case. I also hear that while it is true enough that the trial is not something people talk about much, it has had an effect on morale. Microsoft employees absolutely believe that they work with the smartest people on the planet, so the thought that they're being outsmarted by the government--the government!--is almost too painful to contemplate. "It doesn't bother anybody when we're called monopolists," says one Microsoft hand. "But it drives us crazy when we look incompetent."

In the view of Tod Nielsen, Microsoft's 33-year-old developer relations head, one reason Microsoft employees don't spend a lot of time obsessing over the trial is that Bill Gates has, in effect, compartmentalized it within the company. "Bill set up a team to handle this so that the rest of us can spend our time shipping great products," says Nielsen. Besides, he adds, "the Apple lawsuit was potentially far more devastating than this case, and Bill Neukom [Microsoft's general counsel] won that one." (In 1988, Apple accused Microsoft of copyright violation in creating Windows. Four years later the case was dismissed without going to trial.)

Nielsen is another of the Microsoft hands I've gotten to know in Washington, D.C. A preternaturally upbeat man, "the Todster" doesn't seem any different on his home turf. When he walks down a corridor, people slap him on the back or wave hello; if Microsoft had a mayor, he would be it. Nielsen started coming to the trial about a month into the thing, once it was clear that it had become a public relations debacle. Ostensibly his job is to boost morale and also to help the lawyers understand technology issues as they arise. But he also has another, quieter role: He is Gates' eyes and ears at the trial.

"I thought when I got back that people would come up to me and ask me what it was really like," he says. "Instead it was just the opposite. People kept telling me all the things that had been going on here and that I had to catch up on." In fact, when Nielsen first arrived in his office, it had been decorated with fake cobwebs by his staff. Now, says Nielsen, he is spending all his time preparing for the major company reorganization that is set to be announced one week from today--and in which he will be promoted to vice president (see "Microsoft Gets Ready to Play a New Game"). Still, sometimes he wishes people at Microsoft talked about the trial more. "I have a cathartic need to talk about it," he says. "So sometimes I call Mark Murray [Microsoft's chief trial flack] just because he understands."

One thing that comes through in almost every interview is the feeling that the company is getting a raw deal in the press. And nobody I talk to feels that more powerfully than James Allchin. Allchin is a top Microsoft executive, but among the trial aficionados he has another, sadder identity. His name will forever be attached to the "video disaster," as it's come to be called. Allchin was on the stand when the infamous "doctored" video demonstration was introduced as evidence. And he was the one who had to answer for it as Boies took it apart, not once but twice, in the most dramatic sequence of the whole trial.

Nearly two months later Allchin still hasn't gotten over it. The video flap, he says slowly, "was the most humiliating moment of my professional life." He's lost sleep over it. He's tried to imagine how he could have handled things differently. He wishes he'd taken more control over the making of the video. "Having my integrity questioned was super, super hard for me," he says. Which is not to say he's making excuses for what happened. "It was our own fault," he tells me sorrowfully.

Yet Allchin will also go to his grave believing that it was all an irrelevant sideshow, and that in the end his essential testimony went unrefuted. The press, he feels, was so enthralled by the drama of Boies' cross-examination that it refused to point that out. After Boies' second go-round with the video, Allchin won permission to redo the demonstration, which he did late into the night, in the presence of representatives of the Justice Department. And it was during that taping, he says, that he proved the series of points the original, flawed video was intended to show all along. But nobody reported that.

"I wouldn't say the trial has hurt morale," he says. "But it has made people question: Why is this happening? People just can't believe it. We know the good our products have done for consumers. We've seen how the entire industry has benefited from Microsoft." He sighs and stares off into space. "The one thing I do believe is that eventually the truth will come out," he says. In his mind there is only one truth: Microsoft has done nothing wrong.

The subtext all day long has been the Journal's settlement story; so naturally, when I finally get in to see William Neukom late in the afternoon, I press the issue. Truth to tell, even after listening to Cullinan spin the press all day on his cell phone, I still find the notion of a settlement inconceivable. The gulf between the two sides is just too wide.

Partly that gulf has to do with the perception of who's ahead. The government may firmly believe it is winning the case, but so does Microsoft. Neukom goes down the list with me: The government has failed to prove that Internet Explorer and Windows are separate products, he claims. The government has failed to show consumer harm. The government has failed to prove any of its charges, despite the headlines they've generated. "What matters is the law," stresses Neukom--not whether David Boies can ask questions that make reporters salivate. And the law, he insists, is solidly with the company. (What he doesn't say, but what I've heard from others, is that Microsoft also believes that Judge Jackson has made enough procedural errors to give the company plenty of issues to appeal should it lose at the trial level.)

Yet Neukom also says that he thinks the case is, as he puts it, "settleable"--even though Microsoft says that its control over the Windows operating system is nonnegotiable. "At this stage," he says, "it's a little like a poker game. Do they really think their hand is that good? Do they think we've lost faith in our strategy?" Apparently we're about to find out.

WEDNESDAY, MARCH 24: Mitchell Kertzman, the CEO of a Silicon Valley company called NCI--Network Computer Inc.--began his week in Scottsdale, Ariz., at PC Forum, Esther Dyson's annual confab. So did antitrust chief Joel Klein, the driving force behind the Microsoft case. By the time Klein rose to deliver his Monday morning speech, Kertzman--and the other 700 attendees--had already read the Journal story. Klein, of course, knew it was coming--but only because the reporter had called Justice for comment.

In truth, Justice was annoyed. The government had gotten no hint that Microsoft wanted to start talks, yet here was the software giant laying out its position to the press. And because Klein was at this conference, he had to respond. He did so by giving a short, blandly worded statement that nonetheless managed to signal his annoyance. "[I]f there are to be any settlement discussions," he said, "it is best that they occur directly between the parties...."

"Joel was very discreet about the Microsoft case," Kertzman is telling me now in his office. At the conference Klein did his share of schmoozing, but he shut down any effort to engage him on Microsoft. "It's not like we were trying to give him high-fives," laughs Kertzman. He adds, "I did have a moment alone with him, and I told him that the case has already made a difference."

NCI is an Oracle spinoff that competes with Microsoft in areas like TV Internet software. Oracle's CEO, Larry Ellison, is one of the great Microsoft bashers, but Kertzman is no shrinking violet either. He's been known to compare Microsoft to the Mob, and he is openly scornful of the notion that Microsoft is fighting the lawsuit to protect its "ability to innovate." "Microsoft is one of the least innovative companies ever," he scoffs. "When they can't win on the merits, they just buy the business."

You don't have to spend much time in Silicon Valley to hear comments like that. Listen, for instance, to Jean Louis Gassee, the CEO of Be Inc., a small company that makes an operating system that has been cited in the trial by Microsoft as a potential threat to Windows. "Microsoft," he says in his thick French accent, "is like the French Foreign Legion. They shoot the dead."

Six months ago, when people in Silicon Valley made comments like these, they glowered. Now they grin. Six months ago few people in the Valley thought the Justice Department had a prayer against Microsoft; now that the government seems to be winning, there is a sense of satisfaction that can border on outright giddiness.

Indeed the Valley now feels so sure of a government victory that many people have turned their attention to the issue of remedies. According to one school of thought, just losing will be enough. After all, if Microsoft loses, it will be officially labeled a monopoly, which will have all sorts of ramifications, none of them good for Microsoft. Among other things, it will mean ongoing government scrutiny. "Scrutiny is good," says Sun's CEO, Scott McNealy. "Government scrutiny will change their behavior. I think it already has," he adds. According to McNealy, Microsoft customers are far more willing now to do business with Sun because they no longer fear retribution from Microsoft. "Dell is reselling Solaris [Sun's operating system]. Do you think that would have happened if Microsoft still felt unconstrained?"

Mostly, though, one hears a different chant: that the inevitable result of this trial will be the breakup of Microsoft. Or at least that it should be. "If all that comes out of this is a narrow remedy...that will be a disappointment," says Kertzman. In fact, he thinks that Gates should preempt the government and offer a breakup as part of a settlement. "Breakups aren't horrible things," he says. "Look at AT&T."

What is alarming about this talk is not just that it's premature but that it's fantasy. Though a breakup has often been speculated about in the press, antitrust experts are practically unanimous in their belief that nothing in this trial will lead the court to seek so extreme a remedy. Even the government's antitrust lawyers don't talk about breaking up Microsoft, not even off the record. The government's goal is to find a way to neuter the Windows monopoly. It clearly believes that the solution will be something more surgical--and less drastic--than a breakup.

THURSDAY, MARCH 25: A few details have begun to emerge about each side's opening offer. Microsoft is saying that it would be willing to give computer manufacturers more leeway in what they can offer to consumers in the "boot-up" sequence, which runs when a PC is first turned on. It also would be willing to ease "exclusivity" contracts it has struck with Internet service providers and others. (In fact, these are moves Microsoft has already made.) USA Today reports another detail: that Microsoft would be willing to allow computer manufacturers to hide the Internet Explorer icon--something it does not now allow.

As for the government, it is seeking, as a starting point, an agreement from Microsoft to make public the price it charges computer manufacturers for Windows. That, the government believes, would prevent the company from giving price breaks to manufacturers who agree to do its bidding in other, non-Windows areas. Note, please, that the two parties are still faced with the fundamental problem that one of them won't talk about the operating system and the other won't talk about anything else. And note also that nobody is talking about breaking up Microsoft.

MONDAY, MARCH 29: Remember Joe Btsfplk, the character in the "L'il Abner" comic strip who always had a rain cloud over his head? That's how Bill Gates must feel these days. No matter where he goes or what he does, people want to ask him about the trial. Last week it kept getting raised during Gates' publicity tour for his new book, Business @ the Speed of Thought. And today it happens again. Gates and Microsoft President Steve Ballmer are hosting a conference call to officially announce the big reorganization. The two spend 20 minutes laying out for reporters and Wall Street analysts the details of how the company will be split into five divisions and how this will benefit Microsoft and its customers. Then they take questions.

First question: "Is this any type of prelude to the kind of breakup that has been envisioned by the Department of Justice?" "No!" barks Ballmer. "There is no breakup of this company into smaller companies that I would find acceptable." An obviously irritated Gates chimes in: "This is about competition and consumers, not about some lawsuit."

TUESDAY, MARCH 30: There are days when the Microsoft trial watch feels the way the Monica watch must have felt. This, alas, is one of those days. Since 2 P.M., several dozen reporters and cameramen have been huddled outside the Justice Department, knowing that the settlement talks are supposed to begin today. And what do they get for their trouble? They get a shot of Boies, fresh from a quick vacation in Palm Beach, strolling into the building. They get to watch Neukom's car drive into the entranceway a little before 5 P.M. About two hours later they get to watch Neukom's car drive out again. (Boies slips out another entrance.) And that's it. No participant says a word about the two-hour meeting. As frustrating as that is for the press, it suggests that maybe--just maybe--these talks are more serious than we've thought. After all, in just about any kind of negotiation there is an inverse relationship between how much the negotiators are blabbing to the press and what they're actually accomplishing in the talks.

WEDNESDAY, MARCH 31: You have to hand it to Judge Jackson. There is no doubt that he would like to put this case behind him, and this morning, during a routine "status hearing," he unveils a clever stratagem designed, it would seem, to ratchet up the pressure on Microsoft to settle. First he explains that the drug-trafficking and murder trial he is currently conducting is lasting longer than expected. So the Microsoft trial, originally set to resume on April 12, won't start up again until sometime in May. Then he drops his little bombshell.

He tells the lawyers that he is planning to divide the final arguments into two phases--one devoted to "findings of fact" and another devoted to "conclusions of law." What's more, he plans to rule on the facts before they even begin arguing over the law.

It's quite diabolical. Microsoft has long assumed that even though most if its witnesses have had their credibility shredded by Boies, it would win on the law. Now the judge seems to be signaling to the company that the credibility of its witnesses is going to matter a great deal. The "findings of fact" are going to come down to which version of events the judge finds more believable--and anyone who's spent any time in this courtroom knows how that's going to come out. By separating the facts from the law, the judge has done two things: He has signaled to Microsoft that its theory of how it will win is unlikely to hold up. And he has created a new opportunity for settlement--after the two sides see how he rules on the facts but before he gets to the law. Of course, if they wait that long to get serious about a settlement, one side will have a huge advantage, since it will know that the judge is leaning in its direction. Pretty shrewd.

Afterward Neukom and Boies stand side by side while Boies makes a statement. From this point forward, Boies says, neither side will be commenting on the settlement process. "If there are going to be productive settlement talks," he adds, "they must not take place publicly." Normally Boies would hang around after making a statement and gab with the press. But not now.

The Microsoft trial has entered the quiet period.

INSIDE: Cool Company bonanza! Check out RCN, WorldSpy, and Muze... Shaffer explains why digital devices will proliferate... The Dreyfuss Report on the hassles of installing Linux... Alsop: Copyright protection is for dinosaurs